FDI and MNCs Oatley, Chapters 8 & 9.

FDI and MNCs Oatley, Chapters 8 & 9

Ch.8: Multinational Corporations in the Global Economy
A corporation in which one country owns a facility in a foreign country, thus extending managerial control across national borders. This managerial control enables the firm to make decisions about how and where to employ resources. Decisions made are based on global strategies for corporate success rather than on basis of conditions within any of the countries in which the firm conducts its business. Multinationational corporations higlight the tensions inherent in an economy that is increasingly organized along global lines and political systems that continue to reflect exclusive national territories.

2 perspectives: MNCs as productive instruments of a liberal economic order: MNCs ship capital to where it is scarce, transfer technology and management expertise from one country to another, and promote the efficient allocation of resources in the global economy MNCs as instruments of capitalist domination: MNCs control critical sectors of their hosts’ economies, make decisions about the use of resources with little regard for host country needs, and weaken labor and environmental standards Regardless of this divergences, there is consensus that MNCs are the primary drivers and beneficiaries of the dynamics of globalization

MNCs in the Global Economy
MNC is more than a firm that engages in international activities MNC: a firm that controls and manages production establishments – plants – in at least two countries MNCs mean that extension of corporate ownership and corporate decision-making power across national borders

MNCs are involved in economic production, international trade, and cross-border investment
Example of General Electric (GE), which is regularly ranked among the world’s largest MNCs. GE controls some 250 plants located in 26 countries in North and South America, Europe and Asia. The ability to engage in international trade is equally critical to GE’s success. MNCs have existed since late 19th century This first wave of multinational businesses was dominated by Great Britain. British firms invested in natural resources and manufacturing within the British Empire, the U.S, Latin america and Asia. American firms dominate after WW2 European and Japanese governments discouraged the outward foreign direct investment (fearing risk to balance-of-payments consequences of capital flows) European Economic Community led to more US investment in Europe

US MNCs’ dominance diminished since 1960s when first European and Japanese MNCs began to invest overseas. Later MNCs based in Asia and Latin America Unprecedented growth in MNCs in recent decades (see Figure 8.1) 61,582 MNCs by 2000

Foreign Direct Investment (FDI)
FDI: when a firm based in one country builds a new plant or a factory, or purchases and existing one, in a second country FDI in 2000 reached more than $1 trillion UN estimates that MNCs currently produce 10% of the world’s GDP and employ 54.2 million people worldwide 100 largest firms account for more than 12% of the total foreign assets controlled by all MNCs, for 14% of sales, and 13% of MNC employment

MNCs account for 1/3 of world trade
Most of this is intrafirm trade: trade between an MNC parent and its foreign affiliates Intrafirm trade accounts for 30-40% of world trade MNCs activities are overwhelmingly concentrated in advanced industrial countries 75% of MNC parent corporations are based in advanced industrial countries Advanced industrial countries are also the most important recipients of FDI But in last 20 years we see increasing MNC activities in the developing world

MNC investment in a small number of Asian and Latin American countries
Asia’s share of FDI doubled, rising from one-tenth of the total, between and 1997, with China alone attracting more than half of all FDI inflows into East Asia between 1993 and 1997. Brazil, Argentina, Chile and Mexico captured 53 percent of FDI inflows in Latin America. Thus, MNC investment in the developing world has increased during the last twenty years, but the majority of this investment has been concentrated in a very small number of developing countries. MNC parents based in Hong Kong, China, South Korea, Singapore, Taiwan, Venezuela, Mexico, and Brazil Yet these developing world MNCs considerably smaller than MNCs in advanced industrialized countries (exceptions: Cemex, Samsung, Hutchinson Whampoa ranked amongst the world’s 100 largest MNCs in 2002).

These are topics to be examined in detail in the subsequent chapter
Debate about globalization (criticisms) that MNCS shift jobs from advanced capitalist countries to developing countries. Sweatshops: MNC affiliates based in developing countries are sweatshops engaged in systematic exploitation. Erosion of government regulations designed to protect workers, consumers, and the environment These are topics to be examined in detail in the subsequent chapter

Economic Explanations for MNCs
Opting for a large investment in a far-off country is not an obvious choice for corporate participation in the global economy Why not simply handle economic transactions through the market (instead of between MNC parent firms and their foreign affiliates)? Why not sign contracts with locally owned firms that produce and then sell them to the retailer? This is common in the apparel/textile industry

But, in some cases transactions are taken out of the market
E.g. Volkwagen in Mexico Volkswagen took economic transactions that would otherwise have taken place between suppliers of components, assemblers, and corporate headquarters out of the market and placed them under the sole control of Volkswagen corporate headquaters Why did Volkswagen (and other MNCs) do this?

MNCs buy inputs from factories that it owns, and it sells a portion of its output to factories that it owns We need to analyze the specific characteristics of the economic environment in which MNCs operate Locational advantages and Market imperfections

Locational Advantages
Locational advantages derive from specific country characteristics that provide opportunities for MNCs to internationalize their activities 3 specific country charateristics: Large reserve of natural resources Large local market Opportunities to enhance the efficiency of the firm’s operations

Market Imperfections Locational advantages help us understand why some firms opt to internationalize activities, but they do not help us to understand why firms sometimes choose to take the resulting transactions out of the market and place them within a single corporate structure. Market imperfections: arises when the price mechanism fails to promote a welfare-improving transaction. Firms will be unable to profit from an existing locational advantage unless they internalize the international transaction. 2 different types of market imperfections have been used to understand 2 different types of internalization: horizontal integration and vertical integration.

Horizontal integration: occurs when a firm creates multiple production facilities, each of which produces the same good or goods (e.g. auto producers) Cost advantage is gained by placing a number of plants under common administrative control, important when intangible assets are the most important source of a firm’s revenue Intangible asset: value derived from knowledge or skills possessed by firm’s team of human inputs (e.g. Coke’s formula, software, etc.) Intangible assets are often difficult to sell or license to other firms at a price that accurately reflects their true value: in other words, markets will fail to promote exchanges between a willing seller of an intangible asset and a willing buyer (“fundamental paradox of information”) Create additional production sites: integrate horizontally: firm realizes full value of its intangible asset without having to try to sell it in the open market

Vertical integration: refers to instances of internalization of transactions for intermediate goods; outputs of one production process that serves as an input into another production process E.g. crude oil and refineries and retail outlets Specific assets: investment that is dedicated to a particular long term economic relationship (e..g shipowner and railroad; agreement on building of a rail spur (A spur is a railroad track on which cars are left for loading and unloading) to the dock; a specific asset) But it is difficult to write and enforce long-term contracts Problem of renegotiation of initial contract conditions Opportunistic behavior once investment has been made Awareness of this possibility may prevent investment in the first place In the book’s example, the railroad owner will recognize that the shipowner has an incentive to behave opportunistically after the spur is built and will refuse to build the spur Vertical integration eliminates the problems arising from specific assets

Locational Advantages, Market Imperfections, and MNCs
Although locational advantages and market imperfections often occur independently of each other, we expect to see MNCs-firms that internalize economic transactions across national borders- when both factors are present. Locational advantages tell us that cross-border activity will be profitable, whereas market imperfections tell us that the firm can take advantage of these opportunities only by internalizing the transactions within a single corporate structure.

Table 8.6 When locational advantages and intangible assets are both present, we expect to find horizontally integrated MNCs that have undertaken foreign investment to gain market access. Horizontally integrated MNCs are therefore often present in manufacturing sectors. FDIs by auto producers in the markets of other advanced industrial countries are perhaps the prototypical example of this type of MNC.

When locational advantages combine with specific assets, we expect to find vertically integrated MNCs that have invested in a foreign country either to gain secure access to natural resources or to reduce their costs of production.

The best example of firms investing to secure access to natural resources is found in the oil industry. An oil refinery must have repeated transactions with the firms that are drilling for oil. The refinery is highly vulnerable to threats to shut off the flow of oil, because inconsistent supply would be highly disruptive to the refinery and its distribution networks. Thus, a high degree of vertical integration in the oil industry is expected.

When locational advantages exist, but there are neither intangible nor specific assets, we do not expect to find a significant amount of MNC activity. Instead, firms will prefer to purchase their inputs from independent suppliers and to sell their products through international trade, or they will prefer to enter into subcontracting arrangements withs firms located in the foreign country and owned by foreign residents. e.g apparel production. Major retailers such as GAP rely heavily upon producers located in developing countries, but they rarely own the firms that produce the apparel they sell.

In those industries in which market imperfections exist, but locational advantages are absent, it is less likely to find significant amounts of MNC activity. In such instances, firms do have an incentive to integrate horizontally and vertically, but integrated firms cannot easily expand sales into foreign markets, are not heavily dependent on foreign sources of raw materials and cannot easily reduce their costs by exploiting cost differentials between their home country and foreign countries. As a result, firms in these industries have little incentive to extend their activities across national borders.

MNCs and Host Countries
Positive externalities: arise when economic actors in the host country that are not directly involved in the transfer of technology from an MNC to a local affiliate also benefit from this transaction. Transfer of savings, technology, and managerial expertise to host countries can allow local producers to link into global marketing networks Yet, opening a country to MNC activity does not guarantee that the benefits will be realized Dilemma for host countries: attract MNCs to capture the benefits that FDI can offer, but they need to ensure that activities by MNCs actually deliver those benefits. Next chapter: most of the politics of MNCs revolve around government efforts to manage this dilemma

Chapter 9: The Politics of MNCs
“The regime of nation states is built on the principle that the people in any national jurisdiction have a right to maximize their well-being, as they define it, within that jurisdiction. The MNC, on the other hand, is bent on maximizing the well-being of its stakeholders from global operations, without accepting any responsibility for the consequences of its actions in individual national jurisdictions”. The tension inherent in these overlapping decision-making frameworks shapes the domestic and international politics of MNCs. In the domestic arena, most governments have been unwilling to forgo the potential benefits of foreign investment, yet few have been willing to allow foreign firms to operate without restriction. Most governments have used national regulations and have bargained with individual MNCs to ensure that the operations of foreign firms are consistent with national objectives.

Chapter 9: The Politics of MNCs
Governments’ efforts to regulate the activities by the MNCs carry over into international politics. Host countries, especially in the developing world, pursue international rules that codify their right to control the activities of foreign firms operating within their borders. Countries that serve as home bases for MNCs- essentially the advanced industrialized countries- pursue international rules that protect their overseas investments by limiting the ability of host countries to regulate the activity by MNCs.

Regulating Multinational Corporations
Governments prohibited foreign firms from engaging in certain activities, and they have required them to engage in others. All of these regulations have been oriented towards the same goal: extracting as many of the benefits from the FDI as possible. Even though both developed and developing countries regulated MNC activities, developing countries have relied far more heavily on such practices.

Regulating MNCs in the Developing World
In the early postwar period, most developing country governments viewed MNCs with considerable unease. Governments in newly independent developing countries wanted to establish their political and economic autonomy from former colonial powers, and often this entailed taking control of existing foreign investments and managing the terms under which new investments were made.

Most developing countries entered the postwar period as primary-commodity producers and exporters. Yet MNCs often controlled these sectors and the export revenues they generated.

In agricultural products, the fifteen largest agricultural MNCs controlled approximately 80 percent of developing countries’ exports. And although foreign direct investment shifted toward manufacturing activity during the 1960s, MNC affiliates also played an important role in these sectors.

Allowing foreign corporations to control critical sectors raised political and economic concerns. The central political concern was that foreign ownership of critical natural resource industries compromised the hard-won national autonomy achieved by the developing countries’ struggle for independence. Economic concerns arise as governments adopted import substitution industrialization (ISI) strategies. If MNCs were allowed to control export earnings, goverments would be unable to use these resources to promote their development objectives.

In response to these concerns, developing countries regulated, not blocked FDI. Governments sought to control access to their economies to ensure that the benefits were in fact delivered. Governments did block foreign investment in some sectors of the economy. For example, MNCs were excluded from ownership of public utilities, iron and steel, retailing, insurance and banking and extractive industries. When foreign firms already owned enterprises in these sectors, governments nationalized the industries. Through nationalization, the host-country government took control of an affiliate created by an MNC.

Most governments created regulatory regimes to influence the activities of the MNCs that did invest. Many developing countries required local affiliates to be majority owned by local shareholders, instead of allowing MNCs to own 100 percent of the affiliate. Local ownership, governments believed, would translate into local control of the affiliate’s decisions. Governments also limited the amount of profits that MNC affiliates could repatriate, as well as how much affiliates were allowed to pay parent firms for technology transfers.

Governments also imposed performance requirements on local affiliates in order to promote a specific economic objective. If a government was trying to promote backward linkages, it required the affiliate to purchase a certain percentage of its inputs from domestic suppliers. If the government was promoting export industries, it required the affiliate to export a specific percentage of its output.

Not all developing countries adopted identical regimes. Governments that pursued ISI strategies imposed the most restrictive regimes. India after achieving independence was determined to limit the role of MNCs in the Indian economy. It expelled existing enterprises that owned more than 40 percent of the local subsidiary by forcing them to choose between selling equity to Indian firms or leaving India together.

Governments that adopted export-oriented development strategies, such as the East Asian newly industrialized countries were relatively more open to FDI. Singapore and Hong Kong imposed almost no restrictions on inward foreign investment, to the contrary, Singapore based its entire development strategy on attracting foreign investment. South Korea and Taiwan were less open to investment than Singapore and Hong Kong. In both countries, the government developed a list of industries that were open to foreign companies, but proposals to invest in these industries were not automatically approved.

Still Taiwan and South Korea did more to attract foreign investment than did most governments in Latin America or Africa. Beginning in the mid-1960s and early 1970s, both the Taiwanese and the South Korean gvt created export-processing zones (EPZs) to attract investment.

Export processing zones are industrial areas in which the government provides land, utilities, a transportation infrastructure, and buildings to the investing firms, usually at subsidized rates. Foreign firms based in EPZs are allowed to import components free of duty, as long as all of their output is exported. Taiwan created the first EPZ in East Asia in 1965 and South Korea created its first in These assembly and export platforms attracted a lot of investment from American, European and Japanese MNCs and helped to fuel the takeoff of East Asian exports during the 1970s.

Most developing countries have greatly liberalized FDI since the 1980s. Sectors previously closed to foreign investment, such as telecommunications and natural resources, have been opened. Why did these developing countries ease their restrictions on MNC activities? -The restrictive-investment regimes yielded disappointing results. FDI fell during 1970s as the wave of nationalizations and tight restrictions led MNCs to seek opportunities in less risky markets.

MNCs that did operate in the developing countries were reluctant to bring in new technologies, and the sectors that governments had nationalized performed well below expectations. In short, efforts to foster industrialization by managing MNC activity yielded disappointing results. Second the decision to liberalize FDI came as part of the broader shift in development strategies. Governments intervened less in all segments of the economy as they adopted market- based strategies.

Regulating Multinational Corporations in the Advanced Industrialized Countries
The typical advanced industrialized country has been more open to FDI and less inclined to regulate the activities of MNCs than the typical developing country has been. Only Japan and France enacted regulations that required explicit government approval for a manufacturing investment by a foreign firm. Most governments of industrialized countries have excluded foreign firms from owning industries seemed “critical” but they have not drawn the lists of sectors from which foreign firms are excluded so broadly to discourage MNC investment.

Regulating MNCs in the Advanced Industrialized Countries
Until 1970, Japan tightly regulated inward FDI. Japanese government ministries reviewed each proposed foreign investment and approved very few. Proposals that were approved usually limited foreign ownership to less than 50 percent of the local subsidiary. Such restrictions were motivated by the Japanese gvt’s economic development objectives.

Government officials feared that Japanese firms would be unable to compete with MNCs if FDI was fully liberalized. In particular, the Japanese government feared that unrestricted FDI would prevent the development of domestic industries capable of producing the technologies deemed critical to the country’s economic success. Regulations on inward investment, formed an important component of Japan’s industrial policy.

Since the late 1960s, Japanese investment restrictions have been greatly liberalized. In 1967, Japan increased the number of industries open to foreign investment and began to allow 100 percent ownership in some sectors. Additional measures taken in the 1970s and early 1970s further liberalized inward FDI, so that Japan now has no formal barriers to such investments.

Many scholars argue that structural impediments continue to pose obstacles to foreign investment in Japan. For example, the crossholding ownership (A situation in which a publicly-traded corporation owns stock in another publicly-traded company) that characterizes Keiretsu groups makes it difficult for foreign firms to purchase existing Japanese enterprises. Thus, even though gvt restrictions on FDI have been eliminated, Japan continues to attract only a small share of the world’s foreign investment.

Despite the general tendency toward greater openness, governments in the advanced industrialized countries have been sensitive to foreign control of critical sectors. During the 1960s, the French government became concerned about losing economic autonomy as a result of of the large FDIs made by American MNCs following the formation of the EU. French government believed that industries like electronics and computers, defense, aerospace and the nuclear industry were too important to be controlled by foreign companies.

The French government instituted a more restrictive policy governing all inward direct investment. Proposed foreign investments were carefully screened, and many were rejected. In cases where a foreign MNC was attempting to purchase an existing French firm, the government would actively seek a French buyer. These more restrictive measures were greatly eased beginning in the mid-1980s and today France actively seeks MNC investments.

A similar reaction in the US in the late 1980s. During the 1980s, Japan became a major direct investor in the US, as did European multinationals. The rapid rise of FDI, especially by Japanese MNCs sparked concerns about foreign ownership of critical sectors of the American economy, particularly in companies and semiconductors which are the foundation of modern electronics.

In 1988, the Congress passed legislation the Exon-Florio Amendment to the Defense Production Act of 1950 that allowed the executive to block foreign acquisitions of American firms for reasons of national security. Although such concerns diminished during the 1990s as Japanese investment dwindled, they reemerged in the 2000s.

The Dubai Ports World controversy began in February and rose to prominence as a national security debate in the United States. At issue was the sale of port management businesses in six major U.S. seaports to a company based in the United Arab Emirates (DP world) and whether such a sale would compromise port security. The United States House of Representatives held a vote on 16 March 2006 on legislation that would have blocked the DP World deal, with 348 members voting for blocking the deal, and 71 voting against. The company could not operate in the United States after this.

Bargaining with Multinational Corporations
Host countries and MNCs often bargain over the terms under which MNCs invest. The more the host country has exclusive control over things of value to the MNC (such as natural resources, a large domestic market, access to factors of production that yield efficiency gains), the more bargaining power it has.

Equally critical is the extent to which the MNC exerts monopolistic control over things of value to the host country. Does the MNC control technology that cannot be acquired elsewhere? More broadly, are there other MNCs capable of making and willing to make, the contemplated investment? The more the MNC has exclusive control over things the host country values, the more bargaining power it has.

Host countries have the greatest bargaining power when they enjoy a monopoly and the MNC does not. In such cases, the host country should capture most of the gains from investment. In contrast, an MNC has its greater advantage when it enjoys a monopoly and the host country does not. In these cases, the MNC should capture the largest share of the gains from investment. Bargaining power is approximately equal when both sides have a monopoly. The gains should also be evenly distributed when neither side has monopoly over things the other values.

The obsolescing bargain: The MNC cannot easily remove its fixed investment from the country, so the investment becomes a hostage. In addition, the MNC’s monopoly over technology diminishes as the technology is gradually transferred to the host country and indigeneous workers are trained. This leads to MNCs losing their earlier bargaining power (esp. in natural resource industries). The host country can exploit this power shift to renegotiate the initial agreement and extract a larger share of the gains from the project, i.e nationalizations in the 1960s and 1970s.

MNCs enjoy more bargaining power than host countries in low-skilled labor intensive manufacturing investments. No host country enjoys a monopoly on low-skilled labor, MNCs can pick and choose between many potential host countries. Often investment in low-skilled manufacturing entail a relatively small amount of fixed capital that can be readily moved out of a particular country.

Evidence that MNCs enjoy greater bargaining power than do host countries when it comes to manufacturing investment can be seen in the growing competition between host countries to attract such investment. Locational advantages: packages host countries offer to MNCs that either increase the return of a particular investment or reduce the cost or risk of that investment.

Tax incentives (reduced corporate income tax rate), tax holidays MNCs also exempted from import duties, many advanced industrialized countries also offer MNCs direct financial incentives (provided as a grant from the government to the MNC or subsidized loan).

The typical advanced industrialized country has less been inclined to try to restrict the activities of foreign firms than has the typical developing country.

Three factors explain this: Developing countries have been more vulnerable to foreign domination than advanced industrialized countries. The advanced industrialized countries have more diversified economies than the developing countries, consequently, a foreign affiliate is more likely to face competition from domestic firms in an advanced industrialized country than in a developing country.

There is a strong correlation between a country’s role as a home for MNCs and its policies toward inward FDI. The two largest foreign investors during the last 140 years- the US and the UK-also have been the most open to inward foreign investment. Finally, there have been fundamental differences in how gvts approach state intervention in the national economy. Although many developing countries pursued ISI strategies that required state intervention, most advanced industrialized countries have been more willing to allow the market to drive economic activity.

The International Regulation of Multinational Corporations
Even though there are partial rules, set out within the WTO and OECD, there are no comprehensive international rules governing the activities of the MNCs.

The reason is that conflict between the capital- exporting developing countries has prevented agreement on such rules. Developing countries have advocated international rules that codify their right to control foreign firms operating within their borders. Advanced industrialized countries have pursued rules that protect foreign investment by limiting the ability of host countries to regulate the MNCs operating in their economies. Hence the lack of a consensus.

International rules governing FDI have been based on four legal principles. Foreign investment are private property to be treated at least as favorably as domestic private property. Second, governments have a right to expropriate foreign investments, but only for a public purpose. Third, when a government does expropriate a foreign investment, it must compensate the owner for the full value of the expropriated property. Finally, foreign investors have the right to appeal to their home country in the event of a dispute with the host country.

Such principles were accepted by capital-exporting and capital-importing countries throughout the 19th cc.

The capital-importing countries began to challenge these legal principles following WWI. The first challenge came in the Soviet Union, after rejection of private property. The comprehensive nationalization of industry that followed “constituted the most significant attack ever waged on foreign capital”.

Led by the United States, the advanced industrialized countries, in their role as capital exporters, have placed greatest emphasis on creating international rules that regulate host-country behaviour in order to protect the interests of the MNCs. Developing countries by contrast, in their role as capital importers have placed greatest emphasis on creating international rules that regulate the behavior of MNCs so that those countries maintain control over their national economies. This basic conflict has prevailed for more than fifty years of discussions about international investment rules and prevented agreement on comprehensive rules.

Throughout the 1960s and 1970s, developing countries undertaken a number of efforts to create international investment rules that reflected their interests as capital importers, and sought international recognition of their right to exert full control over all economic activity within their territories. pp Such efforts met opposition from the advanced industrialized countries.

FDI and MNCs Oatley, Chapters 8 & 9.

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FDI and MNCs Oatley, Chapters 8 & 9.

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