2. Why Multinational Corporations (MNCs) and Foreign Direct Investment (FDI)?
3. Strategy and Strategic Options of MNCs
4. MNCs, Government Policy and (Inter)national Competitiveness - Overall Conclusion and the Future of MNCs
International Business Economics Session 1 Introduction: ‘Globalisation’ (Nature, Evolution, Perspectives)
Exhibit 1.1: A Framework
FIRMS (Business, Competitive)
GOVERNMENTS (Competition, Industrial)
The Nature and Scope of International Business
International Business(IB) deals with the nature, strategy and management of international business enterprises and their effects on business and national performance (e.g.,efficiency, growth, profitability, employment).
IB is interdisciplinary. It draws, among others, on economics, politics, sociology, marketing, management (human resources, strategic).
Some definitions (i)
FDI is the control of production which takes place in one country (‘host country’) by a firmbased in another country (‘home country’). FDI is the defining feature of the multinational corporation (MNC).
Globalisation refers to the increasing integration of markets (exchange) and production, to include the mobility of resources (capital, labour, ‘organization and knowledge’).
Some definitions (ii)
A firm is an organisation which produces commodities for sale in the market for a profit, and allocates resources (such as capital and labour) without direct reliance on the price mechanism (the market) on the basis of internal entrepreneurial decisions (hierarchy).
An MNC is a firm which controls production in countries other than (and including) its home base.
Some definitions (iii)
The market (price mechanism) is an institution of resource allocation, based on voluntary exchanges (transactions) by individuals, motivated by preferences and market prices.
The state is an institution which allocates resources and influences the organization of economic activity through a legal monopoly on force.
Origins of IB (i)
IB is the result of the internationalisation of production and the emergence of the multinational corporations (MNCs), the subject matter of IB.
Internationalisation of production (‘globalisation’) involves international capital flows, international trade of commodities (exports-imports) and Foreign Direct Investment (FDI) by MNCs.
Origins of IB (ii)
Until the 1980s, there has been a tendency towards concentration of industry, and oligopolistic market structures. Firms have observed a ‘law of increasing size’ consisting of four stages:
First, the owner managed and controlled small firm (nineteenth century).
Second, the public limited ‘national’ company (limited liability, separation of ownership from management).
Third, the multidivisional (M-form) organisation (division- based), separation of strategic (long term) and operational (day-to-day) decisions.
Fourth, multinational corporations (MNCs) with production activities outside (and including) their home-base.
Exhibit 1.2: The unitary (U-form) firm
Exhibit 1.3: A multidivisional (M-form) structure
Central Services (e.g., Finance)
Exhibit 1.4: A holding company structure
Some facts and trends in IB (i)
International trade inside the world’s largest 350 MNCs accounts for almost 40 per cent of world merchandise trade.
The world’s largest MNCs (e.g.,General Motors, Exxon, Microsoft etc) have annual sales higher than the annual gross national product (GNP) of all but around 15 nation states.
In the early 2000s in the USA, nearly half of manufacturing exports and around two thirds of imports were flowing within MNCs (intra-firm trade).
Some facts and trends of IB (ii)
FDI increased by over 20 per cent between 1985 and 2000, twice the growth rate of exports or output.
In the period 1991-2000, 63 per cent of global FDI flows was received by the developed countries (DCs) (down from almost 80% in 1989), around 33 per cent by developing countries and just over 3 per cent by Eastern European countries.
Among the developing countries, China receives the lion’s share of FDI.
Some facts and trends of IB (iii)
Within the DCs, the US, the UK, Canada, France and Germany are leading players.
Since 1960 the relative importance of the US and the UK as sources of outward FDI has been declining.
In the ‘Triad’ (Europe, USA, Japan), total FDI between US and the EU was almost one third of global FDI in 2000.
European FDI is largely due to M&As.
FDI declined sharply in 2001 (over 50%, the largest drop in 30 years), 2002 and 2003.
Some issues in IB (i)
The main issues which arise from the facts and trends of FDI concern the following:
Why international production, FDI and MNCs?
How do (should) MNCs conduct their business strategies? (competitive and corporate strategies)
Some issues in IB (ii)
What is the relationship between MNCs, nation states (in developed and developing countries) and international organisations and what is the impact of MNCs on growth and development?
What is the link between MNCs and international competitiveness?
Efficiency: Firms pursue profit through reduction of production and transaction costs.
Hybrid: Firms pursue profits through efficiency and (market) power.
Neoclassical: Firm is ‘a production function’, a ‘black box’; it is concerned with the industry price-output ‘equilibrium’, which maximizes profits. Price-output equilibria depend on market structure, e.g., perfect competition, monopoly.
Managerial: Firms maximize utility of managers, e.g., sales revenue, growth. Based on alleged ‘separation of ownership from control’.
Transaction Costs: Firms are multi-person hierarchies which result from, and give rise to reduced market transaction costs, resulting in efficient industry structures.
Resource-Based: Firms are bundles of human and non-human resources under administrative co-ordination. There are internal and external stimuli to growth which lead to industry concentration.
Behavioural: Given ‘bounded rationality’ and different objectives of groups within them, firms do not maximize, they ‘satisfice’.
‘Austrian’ - Chicago School - Schumpeterian: Alert, profit seeking entrepreneurs, enhance market co-ordination and give rise to ephemeral monopoly profits, eroded through competitive process of ‘creative destruction’ (innovations).
‘Marxist’: Firms produce commodities for sale in the market for a profit, under hierarchical control of capital over labour. Dialectic link between competition and monopoly, for maintenance of monopoly (power).
Some critical elements for economic analysis (DISCO) (i)
Demand (D): The demand conditions firms face, in the form of a Demand Curve, derived from ‘Theory of Demand’.
Industry Structure (IS): The extent of industry concentration, barriers to entry, etc, leading to competitive, imperfectly competitive, oligopolistic, or monopolistic industry structures.
Some critical elements for economic analysis (DISCO) (ii)
Costs (C): The cost conditions faced by the firm, in the shape of a Cost Curve, derived from ‘Theory of Production and Costs’.
Objectives (O): The firms’ aim. It allows the derivation of price-output ‘equilibria’. Usual assumption is profit maximization (Marginal Cost equals Marginal Revenue). Others are maximization of sales revenue or growth. Alternatives are ‘satisficing’, ‘entrepreneuring’…
Exhibit 1.5: Monopoly versus Competition
, minimum efficient scale
PM monopoly price
PC perfect competition price
LAC = LMC
[End of Background 1]
Firm growth because of
Use of excess internal resources at near zero marginal cost
Sale of products to new markets at high profit rates (due to high fixed costs).
Reductions in transportation costs.
Improvements in information and communication technologies.
International Business Economics Session 2 Why MNCs and FDI?
The Multinational Corporation (MNC)
MNC = firm which controls production across national boundaries through intra-firm (non-market) operations.
Why MNCs as opposed to exports, franchising, licensing, etc. ?
Background 2 (pp 32-65, starts here): Perspectives on the theory of firm
The Neoclassical analysis (i)
Simple Market Structure Analysis (Perfect Competition vs Monopoly)
Perfect Competition defined: Market structure characterised by a large number of profit maximising buyers and sellers selling homogeneous products, and no entry barriers.
Result: Price taking behaviour, price at minimum long run average cost (LAC) curve ‘normal’ profits.
The Neoclassical analysis (ii)
Monopoly defined: market structure characterised by a single profit maximising producer and very high entry barriers (no entry).
Conclusion: departures from perfect competition result in increases in prices and reductions in output. Also to ‘welfare losses’ due to ‘monopoly power’.
The Neoclassical analysis (iii) - Oligopoly
Defined: market structure characterised by interdependence of (usually a small number of) producers-firms. Duopoly is the case of two firms.
Exhibit 5: Industrial Organisation (IO) and the S(tructure) - C(onduct) - P(erformance) model
IO Defined: Branch of economic theory analysing structure-conduct and performance (SCP) of oligopolistic industries (set of firms producing similar products).
SCP Model: Suggests there exists a (initially unidirectional) link between structure (S), conduct (C) and performance (P) of industries. Feedback relationships from conduct and/or performance to structure later allowed for.
Main Focus: The concentration (S) - Profitability (P) relationship assuming profit maximisation (C).
‘New IO’ analyses impact of conduct on structure and performance in oligopolistic games.
Theoretical specification of industry structures
1. Limit pricing
2. Unconstrained profit maximizing oligopoly
3. Contestable markets
1. Limit Pricing
Assumes constrained profit maximisation (maximum profits subject to no entry), barriers to entry (minimum efficiency scale) and that incumbents leave post-entry output at pre-entry levels and entrants know this.
Result: Limit price derives from limit output found by subtracting the minimum efficient scale level of output from the perfect competition level.
Exhibit 2.1: Derivation of the limit price
PL is determined by QL, i.e. the level to which, if the MES was added, the competitive output would result, thus PC, thus no ENTRY.
2. Unconstrained profit maximising oligopoly
Assumes blockaded entry and joint profit maximising price-output levels (Monopoly). Entry is blockaded through strategic entry barriers, e.g., investment in excess capacity.
3. Contestable markets
Assume free entry and costless exit. This ensures perfectly competitive price-output levels, even in the presence of economies of scale and oligopolistic market structures, as any departures from perfectly competitive prices lead to hit-and-run entry and exit.
IO models compared
Main issue is the nature and importance of entry barriers, both ‘innocent’/structural (scale economies) and strategic (conscious actions by incumbents designed to deter entry), e.g., excess capacity, product proliferation.
Well analysed strategic entry deterrence strategy, the investment in ‘excess capacity’. In the limit even monopoly pricing is sustainable if incumbents have excess capacity sufficient to produce full perfect competition output. To be credible, excess capacity investment should be optimal post-entry.
Exhibit 2.2: An expository diagrammatic framework to Industrial Organisation
, minimum efficient scale
QS, strategic capacity output
PM monopoly price
PL limit price
PC perfect competition price
LAC = LMC
Firm-industry structures and business strategy
Oligopoly, crucial for (competitive) strategy, which is absent in cases of both perfect competition and monopoly. Emergence and effects of oligopoly analysed by theory of Industrial Organization (IO), which is based on and extends the Cournot/Bertrand models of oligopoly.
M-Form organisation is important condition for development of corporate strategy (existence of multitude of business units).
Theory of Firms & Industries: Alternative Perspectives
Transaction Costs, Markets and Hierarchies
Resource-Based and related perspectives
Transaction Costs, Markets & Hierarchies (i)
Origin: Coase (1937)
i) Market is ‘original’ means of resource allocation =>
ii) Existence of hierarchies (e.g., firms) due to market failure
Nature of market failure
Cognitive (natural) not structural; i.e., due to transaction costs and not monopoly power.
Transaction Costs, Markets & Hierarchies (ii)
(Market) Transaction Costs are costs of information, bargaining, contracting, policing and enforcing agreements.
internalization of markets by hierarchies, i.e., replacement of voluntary exchanges with hierarchy => savings in transaction costs => hierarchy (firm) more efficient way to allocate resources.
Horizontal and vertical integration, the M-form, and conglomeration result from pursuit of transaction cost reductions.
Transaction Costs, Markets & Hierarchies (iii)
In neoclassical approach departures from perfect competition => market failure (structural) => => need for government intervention.
In transaction costs approach hierarchies (including M-form conglomerates and MNCs) =
efficiency improving solutions to (natural) market failure => => less need to interfere with the markets.
Resource-based & related perspectives (i)
Early work by Penrose (1959)
Firm = “a collection of resources bound together in an administrative framework, the boundaries of which are determined by the ‘area of administrative co-ordination and authorative communication’” (Penrose, 1995, p xi).
Focus on ‘the internal resources of the firm’, then the external environment. Latter is different for each firm depending ‘on its specific collection of human and other resources’. Environment can be manipulated by firms to serve their objectives.
Resource-based & related perspectives (ii)
Dynamic interaction between internal and perceived external environment (‘image’, and ‘productive opportunity’).
Endogenous Growth, results from
i) resource indivisibility,
ii) knowledge creation within firms, which releases resources.
A firm’s prospects are in terms of existing and new products; diversification as new markets become relatively more attractive than existing ones.
Resource-based & related perspectives (iii)
Knowledge is tacit.
‘History matters’, growth is an evolutionary process, based on cumulative growth of collective knowledge in the context of a purposeful firm.
Rate of firm’s growth limited by growth of knowledge within it, and a firm’s size by the extend to which administrative effectiveness continues to reach expanding boundaries.
Resource-based & related perspectives (iv)
Firm strategies result of differential capability, e.g.,
Vertical Integration, due to ability of firms to serve their own needs better.
Diversification, due to growth and multiple applicability of resources.
Mergers and Acquisitions; to acquire managerial resources for expansion.
MNCs, due to differential ability e.g., in transferring tacit knowledge (Kogut-Zander).
Resource-based & related perspectives (v) (Nelson & Winter, 1982)
In Nelson and Winter’s evolutionary theory of the firm, routines, search (changes in routines) and competition are economic analogues to genes, heredity and struggle for existence in biology.
Resource-based & related perspectives (vi) (Capabilities-based)
Use and develop hard to imitate and costly to apply internal capabilities.
Rents in equilibrium.
Resource-based & related perspectives (viii) (knowledge-based theories, Penrose, etc.)
Firms better than markets in using, preserving, transferring and developing knowledge.
Value creation – growth through knowledge and value appropriation.
Resource-based & related perspectives (ix) (Richardson and co-operation)
“Dense network of co-operation and affiliation by which firms are inter-related.”
Markets, hierarchy and networks are a function of degree of complementarity and similarity of activities
weakly complementary activities => MARKET
complementary and similar activities => HIERARCHY
complementary and dissimilar activities => CO-OPERATION
[End of Background 2}
Theories of the MNC
Two main types:
- Other factors – “theories”
Supply-side theories. Mainly
- Monopolistic – ‘ownership’ advantage
- Transaction costs and internalisation
- Eclectic theory (or Ownership, Location, Internalisation - OLI paradigm)
Resource-based => efficiency and inefficiency may co-exist
Synthesis => coexistence of efficiency and power => ‘trade-off’.
The MNC and ‘Uneven Development’(Hymer)
For Hymer (1972), the operations of MNCs tend to globalize the tendency towards concentration; generate an uneven development between the centre (developed countries) and the periphery (less developed countries); erode the power of labour unions and the nation state, and tend to shape the world to their image by creating ‘superior’ and ‘inferior’ countries. They are responsible for the dependent industrialization of the Newly Industrialized Countries.
International Business Economics Session 3 Strategy and Strategic Options of MNCs
Background 3 (pp 83-99, starts here) Business Strategy
Business Strategy (i)
Firms’ evolution – strategies
Horizontal integration (mergers and acquisitions)
Vertical integration (backward and forward)
Multidivisional (M-) form (business units under central control)
Conglomeration (unrelated business activities)
Foreign Direct Investment - multinational corporations (foreign direct investment)
Networks, alliances clusters, joint ventures, etc.
All such strategies involve future cash flows, thus require ‘capital budgeting’.
Business Strategy (ii)
Types of strategy
Competitive: Strategy of Business Units
Corporate: Strategy of firm as a whole
Competitive Strategy Porter: based on IO
‘Five forces’ model (rivalry of existing competitors, potential entrants, power of suppliers-buyers, substitute products).
International Business Economics Session 4 MNCs, Government Policy and (Inter)national Competitiveness
Differential productivity, value-added – wealth creation, relative to other economic units (firms, regions, nations…)
Can be achieved through
Government (competition, industrial and competitiveness) policies
Competition and Industrial Policy
Early competition-industrial policies in West derive from IO theory, in particular the issue of the welfare effects of monopoly (power). This includes analysis of
i) Static effects (monopoly and reduced consumer welfare, due to high prices);
ii) Dynamic effects (e.g., monopoly and innovation).
Monopoly & international competitiveness (i)
Main claim that large firms can exploit economies of scale and scope, therefore can compete with large firms from other countries.
Idea particularly prevalent is 1960s and 1970s in Europe, in part as response to the ‘American Challenge’, e.g., Servan-Schreiber’s claim that US multinational corporations dominate technologically European markets.
If large size increases competitiveness (thus export surpluses) these could offset any static losses.
The international competitiveness idea is in part responsible for the permissive (and even encouraging) attitude of European countries to mergers and large size.
Monopoly & international competitiveness (ii)
Counter arguments are:
i) higher X-inefficiency
ii) may suppress major inventions if they result in major re-equipment
Schumpeter’s ‘Differential Innovations Hypothesis’, that large firms are large because they have been more successful innovators to start with.
ii) Managed trade, with initial focus on internal competition.
iii) Management of competition (the ‘Golden Mean’) and co-operation.
iv) Dynamic competition through innovativeness, as in Schumpeter - Hayek.
Practice – The Four Tigers (Singapore, Taiwan, South Korea, Hong Kong) (i)
Basis: Similar to Japan, adaptive industrial strategy involving
i) Import substitution.
ii) Export promotion based on labour intensive manufacturing.
iii) Promotion of high technology/high value added sectors.
iv) Attraction of FDI (Singapore, Taiwan), technology transfer.
Practice – The Four Tigers (Singapore, Taiwan, South Korea, Hong Kong) (ii)
Relative success of ‘Far East’
Result of multitude of complex factors which include culture, high saving, effective public administration, close relation between industry and finance, consensus, new (strategic) management techniques, etc.
Question: Can we exclude role of industrial strategy? Is it unrelated to the other factors?
‘New Trade Theory’
New location economics
New (‘Endogenous’) Growth Theory
MNCs, deindustrialisdation and ‘Competitive Bidding’
1. New trade theory (i)
Traditional focus of Western industrial policy, the welfare effects of monopoly and the theory of (static) comparative advantage. According to this countries should specialize and trade in products in which they enjoy a comparative advantage. Benefits from trade arise when each country pursues such a strategy.
Presence of monopolistic competition, economies of scale, positive externalities and first mover advantages led to conclusion that focus on high return industries can affect the distribution of benefits (and even lead to losses, Krugman) – Strategic Trade.
1. New trade theory (ii)
This led to concept of dynamic comparative advantage; i.e., attempts by countries to create (not accept the existing) comparative advantages.
Best known case of dynamic comparative advantage policy is Japan.
2. The New Competition (i)
Based on observation of successful industrial districts, in North Italy, Germany, USA, Cambridge UK, etc.
Such districts consist of small and medium sized, highly innovative, customer oriented firms, with a hands-on approach to management, which cooperate on issues of infrastructure, technology etc and compete in the market for customers. Often rely on support by state/local authorities, are based more on trust than hierarchical relations, try to ‘exploit’ the dispersed knowledge of their labour, suppliers etc and use new production methods such as Just-in-Time, etc.
2. The New Competition (ii)
Success of industrial districts questions benefits of large size and provides a different (“Post-Fordist”) model of industrial development. However, such methods are also adopted by major, particularly Japanese, MNCs, through e.g., subcontracting.
3. New Location Economics (Krugman, Porter)
Importance of location in generating external economies, reducing transaction costs through trust, and further innovation.
4. New Endogenous Growth Theory (Lucas, Romer)
Importance of human resources and technological change in effecting (‘endogenous’) macroeconomic growth.
5. MNCs, Deindustrialization and Competitive Bidding
Link between multinational corporations and deindustrialization questions link between large size and international competitiveness
Main idea is that countries like the UK which suffer from deindustrialization tendencies are home bases of privately successful MNCs. This questions the benefits of large size for the case of MNCs home base.
In era of multinational corporations ‘name of the game’ that of ‘competitive bidding’, i.e., attempt by governments to attract investments by home and foreign firms (MNCs).
Theory and Practice
Question: New approaches support/explain ‘Far Eastern’ miracle?
‘New Industrial Strategy for Democracy’ (Cowling & Sugden)
MNCs give rise to multinationalism, centipetalism and short termism. Needed is a shift of power to communities and regions, e.g., through appropriate ‘flexible specialization’ policies.
Possibility for Machiavellian scenario i.e., adaptive industrial strategy (in partnership with corporate sector) including
i) dynamic comparative advantage
ii) managed competition and co-operation
iii) managed trade
iv) playing the ‘competitive bidding game’ and/or
v) tackling the challenge of MNCs
vi) considering alternative forms of competitiveness, like ‘flexible specialization’
Some common features: small internal size of market, lack of large ‘national’ MNC’s (over-) reliance on small family run businesses, and foreign MNCs, relatively underdeveloped industry.
Main issue: selection, suitability, transferability and feasibility of policies.
The Importance of Institutions (i)
Main problem of implementation, ‘government failure’. Although a general problem, often more acute in developing countries. Indeed underdevelopment may be the effect of inefficient property rights, and incentive mechanisms? (North)
Culture, consensus, other institutional constraints.
Need for promoting an institutional framework conducive to development. This includes addressing the problem of ‘capture’ of the state by MNCs.
The Importance of Institutions (ii)
Government can be enabling (reduce private sector transaction and production costs) to increase output. It can also be developmental, i.e., try to improve the revenue side.
Analysis of the state suggests that problem of ‘capture’ reduced through pluralism of institutional forms (large and small firms) and competition in the political market.
‘Capture’ effects support a competitiveness strategy favouring smaller firms (potential competition to established giants).
Possible and necessary to devise a competitiveness strategy which learns from economic theory and international practice and addresses the issue of implementation (e.g., institutions and ‘capture’ of the ‘state’) and for the EU its declared needs to promote Competition and Convergence
Developing countries should consider their policies in the above framework, striving for an emphasis on dynamic competition, value creation and supply-side convergence. Internally they should address the issue of the institutional constraints.
Identification and development of distinct capabilities and competencies of a nation and governments important condition for effective, implementable strategy.
‘Anti-trust’ today: some problems
Potential problems with current policies
i) Downplay lessons from the ‘Far East’ and the ‘new approaches’.
ii) Do not address the problem of MNCs (as a potential threat to competition).
iii) Ignore distribution issues, intra-EU and between EU and ‘The South’, which undermines sustainability.
Industry structure - conduct and regional - locational milieu
macroeconomic environment - policy mix
institutional environment - governance mix
“The Productivity - Competitiveness - Wheel” for Firms, Regions and Nations
Main routes to competitiveness
Firm size & FDI by MNCs
Clusters of Small and Medium-Sized Enterprises (SMEs)
What are Clusters?
(Geographical) agglomerations of firms (and other organizations-institutions) linked horizontally (and/or vertically) intra- (and/or inter-) sectorally, in a facilitatory socio-institutional and cultural milieu, which compete & co-operate (co-opete) in (inter)national markets.
Clusters and the Wheel
reduced unit cost economies (economies of scale, scope, transaction costs, learning, external, diversity, etc.)
better human resources
strong regional infrastructure
more facilitatory institutional context (through co-opetition, etc.)