4.5.2 Investment in specialised assets
'Specialised assets' in this context means assets such as a bauxite refinery like the one at Gladstone in Australia which was set up to a particular engineering specification for the treatment of bauxite from Weipa in northern Australia . The value of the Gladstone refinery would be significantly reduced if it was required to process bauxite from another source such as Indonesia . Increases in the production cost of aluminium by 20% to 100% are cited by Hill (2005, p. 230), depending on the source of bauxite. Let's imagine that Comalco (one of the partners in the Gladstone refinery) bought its bauxite from Indonesia . Comalco now has two possible scenarios to consider:
- Scenario 1
The Gladstone refinery processes the Indonesian bauxite at considerably reduced efficiency and higher cost because the plant is specifically engineered to treat bauxite from Weipa and operates less efficiently with any other type of bauxite.
- Scenario 2
Comalco constructs a new refinery at, for example, Bell Bay in Tasmania , to process the Indonesian ore. Comalco is now 'locked in' to the Indonesian supplier and risks subsequent increases in the price of bauxite. The solution in this scenario is for Comalco to buy the Indonesian mine - a case of vertical FDI.
That completes our discussion of vertical FDI except to say that Knickerbocker's theory of horizontal FDI does not apply to vertical FDI because there is not the same stimulus for MNEs to compete head-to-head. There is scope to enter at any point in the vertical integration chain. Now turn to your textbook, whose exposition uses different examples from those used in this section.
In your text
Hill 2005, Chapter 6, pp. 229-233.
Activity 4.4
Compare and contrast these two explanations of vertical FDI: the market power approach and the market imperfections approach. Which approach do you think offers the better explanation of the historical pattern of vertical FDI? Why?
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