The paper will investigate the influence of RTAs on MNEs’ supply chain configurations. To do so, the behaviour of German MNE's after the 2004 EU enlargement will be considered, and German MNE's’ supply chain activities in the new EU member states before and after the countries’ accessions will be compared.
In contrast to previous research focusing on FDI and trade flows, this research, based on secondary data of the German Central Bank and the World Bank Group, relies on further indicators to capture the effects of supply chain configuration. Supply chain activities of German MNEs' in the Czech Republic, Latvia, Poland and Slovenia grew faster after 2004, while in Estonia a slower growth in supply chain activities post 2004 was noticeable.
For the case of Cyprus, Hungary, Lithuania, Malta and Slovakia an overall positive development after 2004 was observable even though for single indicators a slower growth was detected. The results demonstrated that the EU accession increased German MNEs’ supply chain activities in the new EU member countries, but country differences, based on locational characteristics the individual countries possess, exist.
Table of Contents
1. Introduction
2. Literature Review
3. Methodology
3.1 Data
3.2 Concepts and Operationalisation
3.3 Analysis and Strategy
4. Analysis of Findings
4.1 German MNEs' supply chain activities in the EU-
4.2 Locational differences in German MNEs' supply chain activities
4.2.1 The beautiful swans: Czech Republic, Latvia, Poland, and Slovenia
4.2.2 The ugly duckling: Estonia
5. Conclusion
6. Reference List
7. Appendix
Abstract
The effects of regional trade agreements on FDI and trade flows have been examined by various authors, but effects on MNEs' supply chain configurations have been missed so far. The dissertation will investigate the influence of RTAs on MNEs' supply chain configurations. To do so the behaviour of German MNEs after the 2004 EU enlargement will be considered, and German MNEs' supply chain activities in the new EU member states before and after the countries' accessions will be compared. In contrast to previous research focusing on FDI and trade flows, this research, based on secondary data of the German Central Bank and the World Bank Group, relies on further indicators to capture the effects of supply chain configuration. Supply chain activities of German MNEs in the Czech Republic, Latvia, Poland and Slovenia grew faster after 2004, while in Estonia a slower growth in supply chain activities post 2004 was noticeable. For the case of Cyprus, Hungary, Lithuania, Malta and Slovakia an overall positive development after 2004 was observable even though for single indicators a slower growth was detected. The results demonstrated that the EU accession increased German MNEs' supply chain activities in the new EU member countries, but country differences, based on locational characteristics the individual countries possess, exist.
1. Introduction
The dissertation addresses the influence of regional trade agreements (RTAs) on supply chain configurations of German multinational enterprises (MNEs) in the European Union. This with regard to Eastern European countries after the accession of Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia (EU-10) in 2004, which were popular host countries for German MNEs (Frankfurter Allgemeine Zeitung, 2004). Supply chain configuration is understood as the adaptation of supply chain structures to changes in the MNE's environment, like policies and locational conditions among others. The Frankfurter Allgemeine Zeitung (2004) points out that 32% of the German firms offshored production steps between 1999-2004 and 60% intended to do so between 2004 and 2009, thus the topic is highly important to determine where the production activities were relocated to and whether the EU expansion influenced the relocation. The managerial decision of choosing the most advantageous location for production facilities is central in this dissertation and restrictively the geographic distribution of supply chain activities is focused on.
Several trade agreements have been established over the last centuries, for example NAFTA in North America, being a free trade area, and ASEAN in South-East Asia. The case of the European Union will be investigated as members states are integrated more deeply and it has reached the stage of an economic union, meaning that is has a shared common market, including the abolishment of internal tariffs, and common trade policies towards outside countries. Additionally, by welcoming the EU-10 countries, a significant economic potential and 70 million new citizens joined the EU (Murphy, 2006). These emerged economic potentials posed new opportunities to German MNEs and supply chain configurations, as small adjustments can cause significant performance improvements (Branch, 2009). Besides the increase in market and population size, regional economic integration focuses on trade liberalisation and the creation of a common market for goods, services, people and capital (European Commission, 2018). Changes, caused by the EU extension, created new environmental conditions MNEs had to adopt to, making supply chain configuration necessary and an essential part of supply chain management (Chandra and Grabis, 2007). According to Chandra and Grabis (2007) a configurable supply chain can adapt its raw material producers, manufacturers, distributors, retailers and design as well as R&D activities to changing environmental conditions, including the selection of new suppliers and reallocation of resources. According to Chopra and Meindl (2013) offshoring is suitable for production steps with high labour content, predictable demand and low transportation cost. In general offshoring is beneficial when growth in surplus is greater than the increase in risk, thus this could apply to all steps of the supply chain (Chopra and Meindl, 2013). Ensuring efficiency in supply chains is crucial for firms as they influence internal efficiency, rate of return on investments and operating and sales expenses (Hugos, 2006).
The aim of the research was to explore effects of RTAs on supply chain configuration of German MNEs. This research considered various indicators, including German turnover abroad as well as intermediate imports and exports, and did not only rely on FDI to describe economic relationships among countries. The topic of supply chain configuration is highly important regarding upcoming Brexit. In case that RTAs shape MNEs' supply chain configurations it must be expected that firms refrain from allocating supply chain activities to the United Kingdom after March 2019. Furthermore, the research investigated the influence of RTAs on supply chain configurations and not on FDI and international trade, like in papers on Spain, Greece, Portugal, Ireland and the U.K. (O'Farell, 1983; Mayes, 1983; Winters, 1996). By doing so a new perspective on RTAs' influence on MNEs is created. Supply chain configurations of German firms towards the EU-10 were expected, as Ismail, Smith and Kugler (2009) detected a shift of economic activities to new member countries in the case of ASEAN.
In the following an overview over previous research is given, then the method used is explained, research findings discussed and other locational factors influencing supply chain configurations are pointed out. Finally, the conclusion answers the research question based on research findings and presents possible topics for future research.
2. Literature Review
MNEs have been widely discussed among scholars and various positions have been pointed out. The literature review focuses on the decision of firms to internationalise and points out aspects to consider from an internationalisation, regional economic integration and supply chain perspective.
Internationalisation of firms
This first part of the literature review focuses on general reasons for firm and supply chain internationalisation, to gain an overview over German firms' motivations to allocate activities abroad. One reason for the internationalisation of production facilities are locational differences among countries, as pointed out by various authors like Weber (1909), Vernon (1992) and Jones (2005). Having a strong focus on factor costs Weber (1909) emphasises that transportation and labour costs as well as cost of buildings, machines, material, and power supply should be considered. The aspect of cost efficiency is also taken into account by Jones (2005) who points out that outsourcing to most cost-efficient, low cost locations is common among MNEs and that leading manufacturers outsource core activities. Heckscher and Ohlin (1991) highlight the importance of production factor availability and locational production facility costs. Furthermore, shifts in production and international trade take place to mitigate country differences in factor endowment when production factors are limited in quantity and mobility (Heckscher and Ohlin, 1991).
Vernon (1974) argues that various conditions have to be taken into account when production locations are chosen. Besides factor costs, e.g. labour and land costs, tariffs and border barriers have to be considered. As the EU reduces border barriers this could have a positive effects on German MNEs' supply chain activities in the EU-10. Weber (1909) does not rate land costs to be decisive but both authors agree on the significance of labour and transportation costs in locational decisions. Location specific advantages of countries, like environmental and political conditions, are also seen as crucial in FDI decisions (Dunning, 1993). Dunning (1993) mentions the importance of internalisation and ownership advantages firms poses and that have to be considered when foreign activities are analysed, thus taking more firm-internal aspects into account than Weber (1909) and Jones (2005).
Buckley and Casson (2010) highlight that in case of export-orientation of foreign production facilities production costs gain importance. This shift in production facilities to low-income countries is also observed by Jenkins (1984), particular when lower-cost firms start to compete in the market. Shifting production facilities allows firms to maximise profitability advantages (Jenkins, 1984). Contrary to the assumption of Buckley and Casson (2010) and Jenkins (1984), Vernon (1974) argues that the described shift to low-cost countries cannot be observed, as locational decisions are not only based on local factor costs, but technology and production factor availability have to be considered. Furthermore, export barriers and overvaluation of exchange rates are possible explanations for the absence of the shift towards low-cost countries (Vernon, 1974).
Besides cost reduction firms configurate their supply chains to adapt to competitors' behaviours (Vernon,1974; Jenkins, 1984). Vernon (1974) highlights that firm behaviour aims at avoiding that competitors gain first mover advantages based on host country locational advantages. This argument is also picked up by Goldsby, Griffis and Roath (2006) in their work on supply chain strategies and Knickerbocker (1973) who points out that firms aim at avoiding that competitors can offer products at lower prices as a consequence of newly exploited locational advantages.
Regional economic integration
Regional economic integration theory is reviewed as RTAs create specific institutional frameworks that can steer relocation decisions to certain countries, through the abolishment of internal trade barriers.
Many authors demonstrate the influence of regional economic integration on internationalization of MNEs, FDI and trade flows, while the effects on supply chain configurations are not yet sufficiently addressed. Observed shifts in FDI and trade are also applicable in the case of supply chain configurations, as supply chain activities generate FDI if German firms invest in the host country to set up subsidiaries while trade increases when finished and intermediate goods are traded between Germany and the host country as a consequence of offshored production. Dunning (1997b), Pain and Lansbury (1997), Baltagi, Egger and Pfaffermayr (2008), Kreinin and Plummer (2008) and Medvedev (2012) argue that intra-regional FDI and trade increase as a consequence of economic integration, while Dee and Gali (2005) highlight opposing observations.
Levy-Yeyati, Stein and Daude (2003) as well as Im (2016) recognize an impact of RTAs on investment and trade flows but argue that the impact is dependent on the type of FDI, as horizontal FDI decreases, while vertical FDI increases. In line with the argument that different types of FDI respond differently to regional economic integration Motta and Norman (1996) point out that especially intra-regional FDI increases in RTAs.
Differing benefits for countries were observed by Winters (1996) in his work on Spain, Greece and Portugal. While Spain and Portugal enjoyed increased FDI inflows after entering the European Community, Greece did not enjoy similar benefits from its membership. Related trends were pointed out in case of Ireland and the U.K by Mayes (1983) and O'Farell (1983). While Ireland profited from joining the European Community in form of increased internal and external FDI the situation of the U.K. was less positive. Differences in supply chain configuration benefits are expected to be observed for the EU-10.
Regarding the argument why FDI and international trade are conducted in RTAs there is a general understanding in the regional integration literature of the fact that MNEs act in other countries to respond to locational differences and exploit these, which is in line with arguments of the internationalisation theory (MacDermott, 2007; Dicken, 2015). Dicken (2015) indicates that MNEs exploit wage, regulatory and geographic differences while Hanson, Mataloni and Slaughter (2001) demonstrate that factor costs, market sizes, policies and technology have to be taken into account to understand MNE activities.
Yannopoulos (1990) points out that economies of scale can be exploited in case of centralised international production, consequentially leading to cost reduction. Additionally, internationalisation of investment and production allows to adjust to competition and locational as well as organisational changes created through the establishment of RTAs. In line with Yannopoulos (1990) and Dicken (2015), Nayak and Choudhury (2014) argue that a general agreement in academia is that firms conduct FDI to exploit advantages based on locational, firm specific and internalisation advantages.
Factors influencing supply chain configurations
In these paragraphs firm-level aspects are evaluated as supply chain configuration decisions are taken on this level. The decision which steps of the supply chain should be offshored is complicated and has to be evaluated on a case-to-case basis taking into account growth in surplus and risks.
Nayak and Choudhury (2014) argue that government policies and high education levels attract MNEs, while Alfaro and Charlton (2009) highlight that higher GDP levels, shorter geographic distance to the MNE's home country and low skill level differences increase MNE activities in the host country. Hanson, Mataloni and Slaughter (2001), Nayak and Choudhury (2014) and Dicken (2015) point out that national trade policies influence degree and type of MNE activities, agreeing with Alfaro and Charlton (2009) on the positive impact of shorter geographic distance between home and host country on MNE activities. Moreover, Alfaro and Charlton (2009) add the aspects of industry and country characteristics to explain an uneven distribution of benefits among countries.
The degree to which countries attract FDI is extensively analysed by MacDermott (2007), pointing out economy size, geographic proximity, trade openness and difference among home and host country production factors as being influential in MNEs investment decisions. Additionally, MacDermott (2007) indicates that being a member of a free trade area has a positive impact on bilateral FDI, whereas FDI-unfriendly countries suffer from net-FDI losses in RTAs, explaining possible differences among the EU-10.
Levy-Yeyati, Stein and Daude (2003) explain uneven distribution of FDI benefits with differences in policies and trade openness, as also mentioned by MacDermott (2007) and Nayak and Choudhury (2014) and add infrastructure, tax systems and institutional differences, to give a more profound explanation for differing MNE activities. To determine good production locations Baltagi, Egger and Pfaffermayr (2008) consider the effects of country size, instead of the previously mentioned economy size, labour endowment as well as trade and investment costs. Contrary to Alfaro and Charlton (2009) the host country's skill level is not taken into account, but labour endowment in general is considered.
Franko (1976) focuses on linguistic and cultural similarities, arguing that more similar countries enjoy higher FDI levels, while especially neighbouring countries are attractive. Furthermore, Franko (1976) asserts that a country's market size is of minor importance in explaining differences in FDI benefits among countries, while FDI-friendly government policies increase FDI. Siegel, Licht and Schwartz (2012) point out a correlation between cultural distance and FDI decisions, but highlight that certain kinds of cultural distance positively influence FDI flows being opposing positions of Franko (1976). Slangen and Beugelsdijk (2010) point out the importance of cultural similarity but highlight that government performance is more important in MNEs' decision making. Opposing the assumption of Franko (1976) that geographically neighbouring countries enjoy a higher level of FDI, Ismail, Smith and Kugler (2009), for the case of ASEAN, demonstrate that shared borders have no effect on FDI decisions in RTAs. However, low transportation costs and linguistic similarities lead to an increase in FDI among countries and FDI flows are strongly directed to new ASEAN member countries after joining the RTA (Ismail, Smith and Kugler, 2009).
The effects of regional economic integration on MNEs are described by Dunning (1997b) who concludes that regional economic integration impacts firms' competitive advantages. Dunning (1997b) emphasises that regional economic integration shifts MNE activities to foreign countries and leads to a concentration of economic activities, also pointed out by Motta and Norman (1996) and Robson (2002). With regard to supplier relations Dunning (1997b) highlights that liberalization and deregulation results in an internationalisation of MNEs' supply bases which might be observable in German supply chain activities in the EU-10 after 2004. Blanchard (2010) points out that centralization and relocation close to producers of intermediate parts influence the location of supply chain activities. Hanson, Mataloni and Slaughter (2001) support observations made by Dunning (1997b) and argue for an increased level of outsourced production, especially for large-scale and low-transport costs goods.
The topic of production facility location is discussed in supply chain management literature and it is pointed to various locational factors being of importance for supply chain configurations. Partovi (2006) argues that good supply chain locations can develop into a competitive advantage for the firm. Chopra and Meindl (2013) highlight, that the overall firm strategy and tasks individual actors perform have to be examined to determine which location is right for production and supplier facilities. Besides the company's internal characteristics, political, infrastructure and competitive factors, have to be considered, while political factors, like tax incentives, regulations and union activities, are of highest importance (Partovi, 2006).
The most important reason to shift production facilities abroad, according to Chopra and Meindl (2013), Handfield et al. (2011) Mangan, Lalwani and Lalwani (2016), is the reduction of costs which is in line with arguments in internationalisation and regional economic integration theory. However, Simchi-Levi, Simchi-Levi and Kaminsky (2000) and Mangan, Lalwani and Lalwani (2016) emphasise that not only labour costs have to be looked at, being important for Weber (1909), but the total costs, including management, risk and coordination costs, have to be considered. These aspects influencing supply chain configurations were not yet taken into account in relation to RTAs and especially the European Single Market.
Fawcett, Ellram and Ogden (2007) highlight the importance of infrastructure, environmental regulations, taxes, competition and costs, but furthermore underline the education level of the labour force, like Alfaro and Charlton (2009). The importance of infrastructure, geographic distance and education levels is also pointed out by Rudberg and West (2008) and Wisner, Tan and Leong, (2014).
Chopra and Meindl (2013) and Christopher (2003) argue that lead times have to be taken into account when locational decisions are taken, which is in line with arguments of regional economic integration theories as highlighted earlier. Through the abolishment of border controls RTAs influence MNEs' supply chain configuration, as transportation times, thus lead times, are reduced (Simchi-Levi, Simchi-Levi and Kaminsky, 2000; Wisner, Tan and Leong, 2014).
On the other hand, factors, ranging from adaptation to risks, possibly preventing German firms to shift their supply chain activities to the EU-10 are pointed out in the literature. Regarding continuous supply chain adaptation the relations to suppliers are of importance, as managers are often not willing to end existing supplier relations even if necessary (Blanchard, 2010). This behaviour could prevent a shift of German supply chain activities to the EU-10, as firms are not willing to end relations with old suppliers. Additionally, Fawcett, Ellram and Ogden (2007) point out that trust is created through successful long-term relationships. Danese (2013) highlights that supplier integration, in form of coordination of business activities, allows for the same advantages as vertical integration and increases trust and consequentially favours tactic knowledge and firm performance, while transaction costs decrease. Monczka et al. (1998) point out that business alliances do not purely rely on the exchange of goods, but that trust, commitment and interdependence has to be created to ensure sustainable relations.
Long-term buyer-supplier relationships, thus a possible absence of supply chain configurations towards the EU-10, can be caused by a high degree of asset-specificity of products leading to high switching costs (Buvik and Gr0nhaug, 2000; Handfield et al., 2011; Tan, Lyman and Wisner, 2002). The argument that long-term relations result from an adaptation process is also presented in internationalization theory (Hennart, 1982; Jones, 2005; Forsgren, 2017, Williamson, 1981). Forsgren (2017) argues that good relationships are the basis of an effective business cooperation and long-term interaction allows for adaptation and learning in the field of product manufacturing.
Another aspect possibly restraining German MNEs' supply chain configuration to the EU-10 is that risks and complexity increase. Chopra and Meindl (2013) conclude that international supply chains are more risky than national ones. Especially performance of partners, supply disruptions and delays as well as price fluctuations are seen as problematic factors. Farahani et al. (2014) argue that unpredicted disturbances, larger geographic distance, longer lead times, tariffs and exchange rates can cause problems. Simchi-Levi, Simchi-Levi and Kaminsky (2000) see the host country's government attitude towards foreign firms as a potential risk, besides exchange rate risks and supplier reliability. Handfield et al. (2011) go a step further and highlight negative consequences disruptions can have, especially focusing on profit and stock price losses and Peck (2006) mentions potential reputation damages as a consequence of supply chain failure.
Conclusion - Literature Review
Scholars of all three theoretical backgrounds point out several reasons for MNEs to internationalise and highlight reasons for supply chain configuration decisions.
Locational factors, like wages, labour availability, infrastructure, and geographic distance, pointed out as important by many authors of all theoretical streams, seem to be decisive, as they affect lead times, transportation, and total costs, being important in managerial decision. Additionally, aspects crucial in managerial decisions are influenced by customs duties and border controls, as well as industry and product standards, which are discussed in regional integration theory.
Internationalisation, supply chain management and regional economic integration theory are used to address the aspect of German MNEs' supply chain configuration as they combine country characteristics, regional institutional conditions and firm level decisions, all influencing managerial supply chain configuration.
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