Strategic Microeconomic Considerations of Macroeconomic Analysis: Fiscal, Trade and Security Impacts of Aerospace and Defence

ABSTRACT

The usage of foreign direct investment (FDI) is a crucial element in the economic growth literature focusing on sustainable development. In the case of the aerospace sector, security considerations restrict FDI flows and the market-based creation of multi-national enterprises (MNEs), even more than they restrict trade. The role of the government is instrumental as such industries as they exercise significant control over structure and performance through procurement and regulatory aspects. Moreover, there are countries like the US whose aerospace is a leading exporting sector, while significant government expenditure flows impact through fiscal policy the economy at large. The analysis in this paper applies a sectoral analysis of economic development based on the ownership-location-internalization (OLI) theoretic framework for MNE activity for the case of the aerospace industry combined with the strategic trade and macroeconomic implications. The behavior of the government is examined within the macroeconomic, strategic economic and security framework towardidentifying a comprehensive framework of analysis.

KEYWORDS:

• Strategic trade
• fiscal policy
• defence industry
• DI

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1. Note that in this context microfoundations refer to the industrial policy implications for macroeconomic performance and policies. This is a somewhat different setting to the economic agent behavioral aspects traditionally referred to as ‘microfoundations of macroeconomics’(see Weintraub 1977), with a methodology not necessarily deviating from the orthodox uniform homogenous agent foundations, but allowing for specialization and cost characteristics determining heterogeneity at the industry level and a political-economic approach. Evolutionary models are closer to this approach, though with methodologies closer to the biological framework of analysis (see Van Den Bergh and Gowdy 2003). The approach in this paper focuses on the more traditional role of the government in the presence of market failure for industries that exhibit externalities and scope cutting through product and service markets that are both commercial and government-led in nature.

2. O-advantages derive from technical knowledge, intangible assets (marketing, organizational skills like lean management), and firm-specific economies of scale due to high-fixed (R&D) costs (see Harris and Robinson 2003). Characteristics such as endowments, presence of tariffs, and size of markets support the development of O-advantages (See Hanson 2001). During the late 1990s, there was a significant wave of M&As across the developed economies owing to ‘search for new markets, increased market power and market dominance’ (UNCTAD 2001: 143), followed by the presence of economies of size, diversification, financial motivations and personal motivations (ibid: 143–144). This mode of FDI is used by oligopolistic competitors as a strategic tool to boost their competitive position in a speedy manner and is best employed in developed economies where such assets are in existence. The process of FDI has an impact on the dynamics of comparative O-advantages between the host and home nation. The presence of technology transfer through FDI may result in the host nation strengthening its technological base, improving its productivity and becoming a net source of outward FDI owing to its developing of O-advantages (Dunning 1993: 267), as one can argue with regards to China that is becoming increasingly a source of outward FDI. This is a dynamic process whereas FDI-determinants and the impact of FDI on the difference in O-advantages between host and home nations are interlinked through time. The result of this time-dynamic format can be to nullify, or augment relative advantages in production. The type of FDI (for example, if it is R&D-based FDI), the absorbing technological capacity of the host economy, as well as, relevant government policies play a key role in determining economic development and the dynamics of the differences in production advantages between host and home nations (‘The stages approach’ developed in Dunning 1993: 273). Therefore, the global distribution of comparative advantages and economic development of nations is affected through time by the means of FDI and technology transfer (see UNCTAD 2005).

3. This structure implies rival pairs of ownership and management, and the incentives mechanism must be relevant to an oligopolistic market (see Zervos 2005 for an analysis in a multi-product market; Chaim and Judd 1987). The incentive schemes for the industry managers in government-dependent industries may well be heavily influenced by the government sector, as a major customer in an imperfect market. The incentive scheme for the managers is a function of profits and/or output from the operations of the firm in the two markets: Oi = si * (Bi) + (1-si) * Qi (3) where Oi = the payoff the managers are maximizing (‘i’=1, 2), Bi = firm i’s consolidated profits Qi = total sales from the respective markets, si = the variable determining the relative mix of output and profits to the payoff function for i = 1, 2 and 0 < s < 1.

4. In an extended form we have Y = $\left(\frac{1}{1-mpc\left(1-t\right)+m}\right)$ (A-mpcT +I + (qdi a + $\left(\frac{b}{r}\right)$ qdi qdj – bqdi²) (1 + x) +Xf-Mf).

5. Or arguably Russia (see also Appendix).