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FDI and MNCs. Oatley, Chapters 8 & 9. Ch.8: Multinational Corporations in the Global Economy. A corporation in one country owns a facility in a foreign country, thus extending managerial control across national borders Decisions on how and where to employ resources
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FDI and MNCs Oatley, Chapters 8 & 9
Ch.8: Multinational Corporations in the Global Economy • A corporation in one country owns a facility in a foreign country, thus extending managerial control across national borders • Decisions on how and where to employ resources • Global strategies for corporate success rather than on basis of conditions within any of the countries in which the firm conducts its business • 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 GE • MNCs have existed since late 19th century • Great Britain (natural resources and manufacturing) • 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 • European and Japanese MNCs • 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 increased too 1/5th by 1997 • China received half of that • Brazil, Argentina, Chile and Mexico dominate FDI inflows in Latin America (53%) • MNC parents based in Hong Kong, China, South Korea, Singapore, Taiwan, Venezuela, Mexico, and Brazil • Cemex, Samsung, Hutchinson Whampoa
Debate about globalization (criticisms) • Effects on jobs • Sweatshops • 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 too 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
Natural-resource investments • Market-oriented investments • Efficiency-oriented investments
Some firms can profit from internationalizing their activities and some cannot
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 inermediate goods; outputs of one production process that servers 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 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 • Table 8.6 • Horizontally integrated MNCs where there are locational advantages and intangible assets in order to gain market access • Vertically integrated MNCs where there are locational advantages and specific assets. • If there are no locational advantages but intangilble assets we see horizontally integrated domestic firms • And, if there are no locational advantages but specific assets, we see vertically integrated domestic forms
MNCs and Host Countries • Positive externalities • Transfer of savings, technology, and managerial expertise to host countries and 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
Regulating MNCs in the Developing World • Nationalization • Performance requirements • Export-processing zones (EPZs)
Regulating MNCs in the Advanced Industrialized Countries • Exon-Florio Amendment
Bargaining with MNCs • Obsolescing bargain • Locational incentives
The International Regulation of MNCs • Calvo doctrine • United Nations Resolution on Permanent Sovereignty over Natural Resources • Trade-related investment measures (TRIMs) • Multilateral Agreement on Investment (MAI)
