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Multinational Corporations and Foreign Direct Investment

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Multinational Corporations and Foreign Direct Investment Avoiding Simplicity, Embracing Complexity

Stephen D. Cohen

1 2007

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Library of Congress Cataloging-in-Publication Data

Cohen, Stephen D.

Multinational corporations and foreign direct investment: avoiding simplicity,

embracing complexity / Stephen D. Cohen.

p. cm.

Includes index.

ISBN-13 978-0-19-517935-4; 978-0-19-517936-1 (pbk.)

ISBN 0-19-517935-8; 0-19-517936-6 (pbk.)

1. International business enterprises—Finance. 2. Investments, Foreign. I. Title.

HG4027.5.C64 2006

332.67'314—dc22 2006010605

9 8 7 6 5 4 3 2 1

Printed in the United States of America

on acid-free paper

Acknowledgments

Given what for me was a formidable challenge to say the least, it is no pro forma

courtesy to thank a number of people whose assistance was invaluable in re-

searching and editing this book. First off, I extend a deeply felt appreciation for

the contributions of Daniel de Torres and Craig Matasick, who performed

magnificently during their two-year stints as my graduate assistants. The exact

same feelings are extended to Erin Teeling and Christopher B. Doolin Jr.; their

tenures as my graduate assistants were shorter, but their contributions were of

the same high quality. It is fact, not just courtesy, to say that without their

collective research and editing talents, my work schedule would have been much

longer, more painful, and less productive, not to mention the end product being

less accurate and more verbose.

The text of several chapters has benefited from the expertise of professional

colleagues and personal acquaintances. I thank them very much for the time and

effort they spent in offering me many valuable suggestions on the chapter or

chapters they read. In alphabetical order, they are Michelle Egan, Roger Golden,

Louis W. Goodman, Tammi Gutner, and Stephen Kobrin.

Given the content and approach of this study, the standard disclaimer needs

to be emphasized: None of the acknowledged persons is responsible for factual

errors, subjective interpretations, or conclusions. These should be attributed

solely to the author.

Finally, I thank my wife, Linda, and children, Sondra and Marc, for their

patience while I spent a lot of time working on this project.

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Contents

Abbreviations ix

Introduction 3

Part I Fundamentals

1 A Better Approach to Understanding Foreign

Direct Investment and Multinational Corporations 11

2 Defining the Subject: Subtleties and Ambiguities 27

3 From Obscurity to International Economic Powerhouse:

The Evolution of Multinational Corporations 41

4 Heterogeneity: The Many Kinds of Foreign Direct

Investment and Multinational Corporations and

Their Disparate Effects 62

5 Perceptions and Economic Ideologies 93

Part II The Strategy of Multinationals

6 Why Companies Invest Overseas 117

7 Where Multinational Corporations Invest and

Don’t Invest and Why 148

Part III Impact on the International Order

8 Effects of Foreign Direct Investment on Less Developed

Countries: Vagaries, Variables, Negatives, and Positives 179

9 Why and How Multinational Corporations Have

Altered International Trade 205

10 Multinational Corporations versus the Nation-State:

Has Sovereignty Been Outsourced? 233

11 The International Regulation of Multinational Corporations:

Why There Is No Multilateral Foreign Direct

Investment Regime 252

Part IV Three Bottom Lines

12 The Case for Foreign Direct Investment and

Multinational Corporations 283

13 The Case against Foreign Direct Investment and

Multinational Corporations 308

14 An Agnostic Conclusion: ‘‘It Depends’’ 332

Part V Recommendations

15 An Agenda for Future Action 355

Index 365

contentsviii

Abbreviations

AFL-CIO American Federation of Labor and Congress of Industrial Organizations

BIT Bilateral Investment Treaty

EPZ Export-Processing Zone

EU European Union

FDI Foreign Direct Investment

FIRA Foreign Investment Review Agency (Canada)

GATT General Agreement on Tariffs and Trade

GDP Gross Domestic Product

IMF International Monetary Fund

IT Information Technology

LDC Less Developed Country

M&As Mergers and Acquisitions

MAI Multilateral Agreement on Investment

MNC Multinational Corporation

NAFTA North American Free Trade Agreement

NGO Nongovernmental Organization

OECD Organization for Economic Cooperation and Development

OPEC Organization of Petroleum Exporting Countries

R&D Research and Development

TNI Transnationality Index

TRIMS Trade-Related Investment Measures

UN United Nations

UNCTAD The United Nations Conference on Trade and Development

WTO World Trade Organization

ix

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Multinational Corporations and Foreign Direct Investment

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introduction

Why another book on multinational corporations? The answerbegins shortly after the new millennium, when an involuntary end came to what had been my nimble effort spanning three decades to avoid

teaching the course on multinational corporations (MNCs) offered by American

University’s School of International Service. The simple truth is that although I

have long been an avid student of international economic relations, I was not

enamored with the scholarly and policy literature on foreign direct investment.

Most of what I read sooner or later became either a strident all-out defense or

condemnation of MNCs. To my personal way of thinking, this was an oversim-

plified and ultimately not very compelling intellectual exercise—one in which

the two opposing sides were unable to find any common ground even after much

discourse. Seeing no resolution of their disagreement in sight, they began yelling

at each other.

My preparations for teaching our MNC course forced me to confront the

issues in a much more detailed and systematic manner than ever before. As I read

extensively and looked for good class readings, two thoughts began to dominate

my approach to the subject. First, the advocates and critics of MNCs continued

to talk past one another mainly because they shared a faulty frame of reference

and an inadequate appreciation of how much an observer’s ideology and per-

ceptions had come to define the reality of MNCs and foreign direct investment

(FDI). Second, the literature suffered from an important gap that needed filling.

Scattered throughout were many insightful comments on the subject as a whole

and many good studies and essays on narrowly focused aspects of the FDI and

MNC phenomena (e.g., their impact on less developed countries). What was

missing was a nonjudgmental study of FDI and MNCs in full economic and

political context, one that treated them as heterogeneous and still evolving sub-

jects that did not lend themselves to the usual black-or-white evaluation. Too

3

many authors were writing with an attitude, one that either advocated or opposed

these phenomena. I found no analytical pieces proclaiming that the authors were

neutral concerning the net virtues and vices of FDI and MNCs because of their

diversity and the gaps in our knowledge about them. Nor did I find many authors

urging a case-by-case approach in lieu of generalization. In short, an opportunity

existed to contribute to closing what I perceived as a major void in our under-

standing of an important subject.

Unlike most people, I agree partially with much of what I have read and heard

on both sides of the argument. Also unlike most people, I do not identify with

either the pro or con schools of thought on these subjects. My feeling is that both

sides have made valid points on parts of the subject while maintaining a blind

spot as to the big picture. No one seemed to be expounding the seemingly obvious

thesis that a dispassionate inquiry would see that the phenomena of FDI and

MNCs were far too complex and heterogeneous to warrant all-inclusive labels

being applied to their nature, behavior, and effects. It seemed that I was the only

one answering ‘‘it depends’’ to most questions about these phenomena and

endlessly railing against generalization. My credo became ‘‘never say never’’ and

‘‘never say always’’ about them. Eventually, I came to believe that being outside

of not one but two mainstreams of thought was something to build on, not try to

overcome. Given my many years of scholarly inquiry into the economics and

politics as well as the domestic and international aspects of international eco-

nomic policy, I felt I possessed good credentials for having something new to say

about a subject for which I claimed no long, deep expertise. Once convinced this

self-evaluation was not mostly hubris, I began outlining and researching this

book. In designing an innovative approach that can make a meaningful contri-

bution to advancing knowledge of FDI and MNCs, I have played the roles of be-

liever, skeptic, and synthesizer. The big fascination for me was not pretending to

have mastered the subject and come up with a multitude of breakthrough answers

but in understanding how and why these phenomena could be viewed—

incorrectly—in one of two diametrically different lights for so long with virtually

no movement toward consensus.

A study whose premise rests heavily on the importance of perceptions should

be sensitive to the possibility that some people will anticipate a work that rep-

licates their view of how to assess the subject or is devoted mainly to the specific

subtopics in which they are most interested. It is wholly appropriate, therefore,

to present a succinct statement of what this book is not about and what it does

not try to do. It is not about telling readers what to think about multinational

companies, but it does suggest how to think about them. This is not a political

science book about the governance of corporations, appropriate regulation of them

by government, or the ‘‘proper’’ distribution of income and economic power.

Nor is it a business administration text about the management, product mix, and

multinational corporations4

marketing techniques of MNCs. And it is not an economics treatise examining

the theory of the firm or the implications of oligopoly in the marketplace. No

attempt has been made to do what I think is the impossible: producing a single

integrating economic theory that accurately and consistently explains why FDI

exists in such large volume or a single comprehensive conclusion explaining the

behavior and measuring the effects of MNCs as a collective entity. In many cases,

efforts to understand the issues being examined are better served with an inquiry

as to why inconclusiveness prevails rather than a presentation that purports to

have transformed limited soft data into hard facts. Although not a sentiment

shared by many academics, I feel no personal need or desire to reach a firm

conclusion on the much debated question as to whether these international

business phenomena are, on balance, good or bad. As this study argues, that is not

the right question, anyhow.

The process of producing an accurate interpretation of the FDI/MNC phe-

nomena is different from assembling a jigsaw puzzle. The latter has a finite

number of smooth-edged pieces designed to produce a perfectly assembled end

product with a fixed image. The step-by-step process to connecting them is a

physical reality that can be precisely reproduced an infinite number of times.

Unlike jigsaw puzzle pieces, the ever-changing numbers and shapes of pieces that

form the collective personae of FDI and MNCs do not necessarily fit neatly

together to produce a demonstrable, enduring reality. Even if they could all

be neatly connected at a given time, some of the pieces periodically need to be

moved about, reconfigured, or discarded, and some new ones need to be added

to accurately depict an ever-changing, multifaceted abstraction. Final assembly

of the foreign investment puzzle is further complicated by the need to keep a

few pieces blank in recognition of the significant gaps in our knowledge of the

subject.

My main objective is to raise the level of understanding that we should have

about the nature and diversity of these international business phenomena and

about the range of effects they have had on domestic economies and the inter-

national economic order. Hopefully, the arguments developed will contribute

something to narrowing the long-standing, unresolved public policy debate

conducted between those ardently in favor ofMNCs and those bitterly opposed to

them. A recent book on this subject said that ‘‘most theoretical frameworks are

still based on the simplifying assumption of homogeneous agents, and theories

encompassing heterogeneity are still in their infancy.’’1 A major goal of this

volume is to nurture the heterogeneity concept at least as far as young adulthood.

The fifteen chapters that follow will not and cannot provide a definitive expla-

nation of these issues. No matter how responsive a chord this book hits, it is still

just one step in a very long journey to a fuller, more accurate understanding. The

need for continuing research and additional data in this field remains unequivocal.

introduction 5

Structure of the Book

Different levels of analysis are used throughout this study because it examines its

subject in both a vertical and horizontal manner. Depending on the specific topic

at hand, the focal point may be the international economic order, MNCs as a

whole, categories of FDI and MNCs (e.g., extractive, manufacturing, or service

sector), categories of countries (home and host; rich and poor), or case studies

involving specific countries or companies.

The first of the book’s five parts lays out a series of fundamental concepts to

set the stage for the analytical and thesis-advancing chapters that follow. Chapter

1 explains how the approach and perspective of this study are different and why

they can enhance the current level of understanding of FDI and MNCs. The

second chapter deals with the deceptively tricky subject of definitions and ter-

minology. The third chapter is on one level a straightforward chronological sum-

mary of the history of multinational companies; on another level, it speaks to the

usually understated external forces that have played a large role in shaping these

enterprises. A separate section examines their contemporary economic impor-

tance. Chapter 4 moves to a second stage of fundamentals by developing a

critically important theme: The largely ignored diversity of FDI and MNCs

undermines the validity of most of the generalizations that have long been the

main elements of their public image. The fifth chapter looks at the broad eco-

nomic ideologies that shape differences of opinion on these phenomena and

perpetuate two mutually exclusive, partially valid arguments over the relative

merits of multinationals.

The two chapters of part II look at two core strategies of MNCs. The first

analyzes the very important issue of why companies establish subsidiaries in

countries outside their home market, when in fact this activity is seldom man-

datory or easy. This chapter reviews the main academic theories purporting to

explain management’s rationale for doing this and then outlines the expanding

list of real world practical reasons encouraging the proliferation of direct in-

vestment overseas. Chapter 7 examines the main variables determining where

companies choose to invest and not invest abroad. In doing so, it identifies the

economic and political conditions in countries that tend to attract or repel foreign

companies looking to invest overseas.

Part III looks at four key links between the international political and eco-

nomic order and the FDI/MNC phenomena. Chapter 8 looks at the multiple

ways that their effects on economic growth in less developed countries can be

gauged. Chapters 9 through 11 analyze the impact of FDI on the international

trading system, examine three interpretations of the allegation that MNCs have

nullified the sovereignty of nation-states, and explain why the nature of these

multinational corporations6

phenomena has precluded establishment of a multilateral framework to impose

norms and rules on them.

The thesis that FDI and MNCs can be judged in at least three ways is laid out

in part IV. Chapters 12 and 13 are similar in style and diametrically opposite in

content. The first makes the case in favor of the argument that the FDI/MNC

phenomena are on balance beneficial, while chapter 13 argues that on balance

they are harmful. Both views are presented debate-style, without qualification or

endorsement by the author; the purpose is not to advocate one side or the other

but to faithfully re-create the main arguments advanced by both sides in the

debate. A synthesis of the two arguments, emphasizing the appropriateness of

making positive or negative evaluations only on a case-by-case basis taking in-

dividual circumstances into account, is the subject of chapter 14.

Finally, chapter 15 offers recommendations that are intended to be useful and

feasible measures to reduce the downside and increase the upside of FDI and the

companies that engage in it.

Note

1. Giorgio Barba-Navaretti and Anthony J. Venables, Multinational Firms in the World

Economy (Princeton, NJ: Princeton University Press, 2004), p. 281.

introduction 7

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PART I

Fundamentals

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1

a better approach to understanding foreign direct investment and multinational corporations

In an old tale, six blind men have come into contact with an elephant

for the first time. They are curious to know what it is like. The first

blind man touches its side and says an elephant is like a hard wall.

The second puts his hand on the trunk and disagrees, saying an elephant

resembles a giant snake. The third blind man touches its tail and

compares the animal to a fuzzy piece of rope. The fourth feels the legs

and says the elephant is like four tree trunks. The fifth touches the

ear and describes it as a soft carpet. The last blind man touches

the tusk and proclaims an elephant to be sharp like a spear. Confused

that they all had come to radically different conclusions, they seek a wise

man to ask which one of them has it right. He tells them that they all

are right. The reason, he explains, is that ‘‘Each of you has ‘seen’

only one part of the elephant. To ascertain the truth, you must see

the whole animal.’’

Speaking metaphorically, this book is about a better way to analyzethe nature and impact of things that are having an increasingly important effect on our lives—things that receive much attention but are not easy

to comprehend. More to the point, it is about using largely ignored analytical

techniques to assess the nature and impact of the process of foreign direct

investment (FDI) and the business entities known as multinational corporations

(MNCs). It is intended to add to our far from comprehensive knowledge of what

they are and how they really affect the domestic and international economic and

11

political orders. This is a deceptively difficult task for several reasons. Far more

layers and variants of these international business phenomena exist than are com-

monly recognized. They are constantly assuming new shapes and permutations.

Perceptions frequently substitute for facts in defining reality.

Subsequent chapters will show that consensus has been unable to extend

much beyond agreement that FDI is growing in importance and that MNCs are

growing in number, and like untethered elephants, they cannot be ignored. The

clash of ideas centers on the questions of nature and effect. DoMNCs excessively

exploit the majority to benefit the relatively few owners of capital and harm the

environment? Or are they mainly a vehicle for enhancing the standard of living of

workers and consumers while doing relatively little social and environmental

harm? Returning to metaphor, should the multinationals be allowed to roam

relatively freely in search of profit or be constrained by the chains of vigorously

enforced governmental regulations aimed at ensuring they operate in what is

defined as the public good? ‘‘Touching’’ one part of them produces not only the

image of excessive concentrations of power in the hands of management and

wealth in the pocketbooks of shareholders but a precipitous decline in the power

of labor as well—all of which perpetuate social inequities. Touching another part

of the FDI/MNC phenomenon produces the image of unprecedented efficiency,

good jobs, and competitive prices for a constant array of new goods and ser-

vices—all of which make people’s lives better. Touching other parts reveals the

possibility of neutral effects and the presence of unknown factors suggesting

conclusions should be tentative.

‘‘Foreign direct investment’’ and ‘‘multinational corporation’’ are composite

phrases describing two separate but related phenomena. Both exist in many dif-

ferent forms, as will be spelled out in chapter 4. The number of valid general-

izations that can be made about the approximately 70,000 companies that meet

the definition of multinational dramatically declines when they are viewed in

anything but the broadest terms.1 Plentiful exceptions exist to almost any specific

rule about them. Patterns discerned in studies of all FDI in a single country or

FDI by a single industrial sector in many countries may or may not be legiti-

mately extrapolated to broader conclusions; it depends on specific circumstances.

Unambiguous black-or-white positions and generalizations tend to be the

outgrowth of inquiries based on too few data and too much preconceived bias.

Given its emphasis on objectivity and its tilt toward ambiguity, this study does

not (consciously) take sides. It is neither an endorsement of the criticisms by

detractors of FDI and MNCs nor an endorsement of the praise offered by their

supporters. To play advocate for a single point of view would contradict and

undermine the core thesis that depending on circumstances, these phenomena

can be very beneficial, very harmful, neutral, or uncertain in their impact.

fundamentals12

Needed: A More Accurate and Productive Method

of Evaluating FDI and MNCs

The most frequently asked question about FDI and MNCs (as defined in the

next chapter) is whether on balance they are a positive or negative thing for the

international community—and by extension whether governments should or

should not tightly regulate them. A two-tiered cottage industry exists to provide

evaluations of both. One floor cranks out proof that their collective contributions

to economic growth and efficiency comfortably outweigh the effects of their self-

aggrandizing oligopoly power and harm to society. The second floor generates

proof that the situation is in fact the other way around. The popularity of the

good-versus-bad question notwithstanding, this is not the most intellectually

productive avenue of inquiry into this subject. To be blunt, this is the wrong way

to frame the question. It typically leads to a very unrewarding least common

denominator approach. The whole is composed of so many dissimilar and con-

stantly evolving parts that generalizations about good and bad are superficial

at best and inaccurate at worst. Placing a list of pros and cons on either side of a

scale and then rendering a sweeping endorsement or condemnation of all FDI

and MNCs is an oversimplified and all-around unsatisfactory exercise.

A far more fruitful line of inquiry and the integrating thesis of this study is the

inevitability of heterogeneity in FDI and MNCs and accordingly, the imperative

of disaggregation. Nuance is too pervasive to permit many valid generalizations.

This leads to the hardly earth-shattering but surprisingly infrequently offered

conclusion that FDI in the form of foreign-owned or controlled subsidiaries is

sometimes a positive thing on balance, sometimes a bad thing on balance,

sometimes neutral or irrelevant on balance, and sometimes has an indeterminate

effect. This conclusion results in the phrase ‘‘it depends’’ being the mantra of the

approach taken in this study. Massive numbers of foreign subsidiaries operating

in hundreds of different national and regional environments generate a sliding

scale of economic effects that ranges from highly deleterious to highly beneficial.

Facts and circumstances are seldom if ever identical and need to be considered on

a case by case basis according to circumstances.

A disconcertingly large percentage of policy advocates and researchers of all

ideological persuasions has failed to explicitly recognize the seemingly obvious:

Different kinds of businesses produce different kinds of corporate activity and

diverse results. Stated another way, the result of different input is different output.

The nature, objectives, and effects of specific kinds of foreign subsidiaries are

not applicable to others. This guideline applies within countries, within business

sectors, and on a global basis. Even the notion that all multinationals are big

a better approach to understanding fdi and mncs 13

companies is a false generalization. No two MNCs are organized exactly alike,

share the same production profile, have the same business culture, and produce

identical effects on host and home countries. Some are genuinely socially en-

lightened, perhaps because they are based in countries that literally legislate the

requirement that corporations serve the interests of the larger community of

stakeholders (see chapter 2). Some are socially amoral with no discernible concerns

beyond serving the interests of their executives and shareholders. Few MNCs find

themselves in such a static business environment that their current management

strategy is the same as it was twenty to thirty years ago. Furthermore, very few (if

any) foreign subsidiaries, even of the same company, are identical in their output

and impact on the local economy.

The concepts of heterogeneity and disaggregation are essential elements in

providing a relatively objective and balanced explanation of the infinite number

of combinations within and among three main variables: the nature and the

effects of tens of thousands of individual foreign subsidiaries plus the conditions

in countries where they are located. MNCs and FDI have genetic codes that,

virus-like, are able to mutate in response to new external threats and opportu-

nities. Hundreds of variables create a complex, seldom (if ever) duplicated con-

fluence of factors that shape the characteristics and actions of each of the world’s

estimated 700,000 individual foreign subsidiaries, the end product of FDI and

the operating arm of MNCs.2 These foreign-owned factories, service facilities,

and natural resource extractive projects operate in dozens of different business

sectors in more than 200 countries and territories, each of which has its own

distinctive political, regulatory, and commercial milieu. Foreign subsidiaries are

created for different reasons (see chapters 4 and 6) and pursue their goals dif-

ferently. Among the diverse tasks they can be assigned are production of services,

components, or finished goods; wholesale distribution; retail sales; and research

and development. Different tasks and different locations mean that few, if any,

subsidiaries have identical needs for labor skills and identical schedules of pay

and benefits for workers.

Every overseas subsidiary faces a one-of-a-kind mix of pressures from cus-

tomers, headquarters, host governments, workers, and civil society. Each sub-

sidiary responds to its total environment in a unique way. Some provide lasting

benefits for the country in which they are operating, others exploit it and then

leave. Some countries hosting incoming FDI are powerful, highly developed, and

longtime practitioners of capitalism. Other host countries are just a few years

removed from bloody civil wars or communist economies where the concepts of

markets and private enterprise were alien. Companies founded in what are

popularly dubbed less-developed countries (LDCs) are now regularly becoming

multinationals with subsidiaries in industrial countries, thus reversing the his-

torical North to South direction of FDI (see chapters 4 and 8).

fundamentals14

Disaggregation also is an essential diagnostic tool to identify and measure the

different levels of quality by which an individual foreign subsidiary can be assessed.

As discussed in chapters 4, 12, and 13, certain kinds of FDI have a high statistical

probability of providing a favorable impact on the country inwhich they are located,

whereas other kinds have exhibited a high propensity for unfavorable, costly re-

sults. As argued throughout this book, the compatibility of MNCs with the welfare

of the countries in which they operate and those in which they are headquartered is

mainly determined by specific circumstances. A universally applied label of be-

nevolence or malevolence is at best misleading, at worst inaccurate. So, too, is an

operating assumption that all necessary data needed for evaluating FDI andMNCs

are available and accurate. If one accepts the hypotheses of the dominance of

heterogeneity and the need for disaggregation, no compelling economic or political

logic exists to demand that an all-inclusive guilty or innocent verdict be issued

regarding the cumulative net desirability of all foreign-owned or -controlled

subsidiaries in all countries. Most of the important questions, such as ‘‘Do MNCs

promote economic growth and employment?’’ ‘‘Do MNCs seek unconstrained

market power?’’ ‘‘Does FDI promote exports and upgrade local labor skills?’’ and

‘‘Do MNCs threaten local companies and culture?’’ have only one thing in com-

mon. The appropriate answer to all of them begins the same way: ‘‘sometimes.’’

Whether these questions should be answered in the affirmative or negative depends

on the nature of an individual subsidiary, the specific pattern of economic and

social effects by a foreign subsidiary on its local surroundings, and the economic-

political conditions prevailing in the host country. The answer to the question of

whether governmental policy should emphasize market forces or government

regulation is: It depends on one’s values.

The diversity of MNCs creates the opportunity for subjective research to find

at least one or two examples of just about any kind of corporate behavior, from

the most abhorrent to the most beneficial. The appropriate research question is

and always has been whether the presence of one or two case studies is adequate

to confirm existence of a larger truth as opposed to merely demonstrating isolated

anomalies. The answer is that it depends on the circumstances. Even multiple

case studies can strain credibility if the corporate behavior patterns cited no

longer are in effect. It is all too easy to start from a preconceived notion and find

at least some scattered examples for affirmation of a specific point of view.

Accuracy is more likely to be forthcoming from a research strategy that starts

with a blank ideological slate and no agenda, conducts a broad and deep exam-

ination of the many forms and behaviors of MNCs, and then reaches conclusions

integrating both the charms, warts, and intangibles of heterogeneous phenomena.

Another guideline for a more accurate and productive line of inquiry is to

appreciate that MNCs respond in large part to the larger business environment in

which they operate; they are not exclusively proactive movers and ‘‘shapers.’’ Yes,

a better approach to understanding fdi and mncs 15

they are the proximate cause of major changes in the way that business is conducted

throughout the world. But they are better described as the middlemen of change

because they themselves are largely the effect of even larger phenomena. The two

most important are technological changes that restructured the international

economic order and the post–World War II relaxation of official barriers to in-

ternational trade and capital movements. Multinational companies are mainly the

offspring of the bigger, more powerful forces that rendered obsolete the concept of

national markets, meaning that producers of sophisticated manufacturing and

services products no longer can remain competitive if they produce and sell only in

their country of origin (see chapter 6). A more specific cause-and-effect conun-

drum is whether incoming FDI is a cause of accelerated economic development or

whether a country’s success in achieving high rates of economic growth and de-

velopment attract foreign companies/cause inward FDI (see chapters 8 and 14).

International business issues should be viewed in context, not as stand-alones.

MNCs long ago became a natural extension of corporate activity. The conflicting

attitudes toward the costs and benefits of private enterprise are similar whether

considering them on a global scale or in terms of a single country. Issues in-

volving multinationals are derivatives of larger divisive issues, just geographically

wider in scope and introducing the political/psychological variable of foreigners

being involved. The optimal division of wealth between owners of capital and

workers; the growing concentration of market power in fewer, increasingly large

companies; business’s influence on government policy makers; and environ-

mental damage are as much national as they are worldwide concerns. The pros

and cons of a handful of large nationwide retail chains driving out locally owned

stores by charging low prices and skimping on employee benefits (the Wal-Mart

syndrome) have many similarities with the mixed message of a large, aggressive

MNC amassing increasing market share on a country-by-country basis through

low prices and excellent customer service.

One of the very few generalizations that accurately characterize FDI andMNCs

is that their benefits have been exaggerated by advocates and their harm has been

exaggerated by critics. The massive proliferation of foreign-controlled subsidiaries

cannot accurately be characterized in the aggregate as a zero-sum game as its

harsher critics argue, nor can it accurately be labeled a positive-sum game as its most

enthusiastic advocates do (see chapters 12 and 13). Both sides of the public debate

have tended to oversimplify and share the same methodological deficiencies.

Shortcomings of Traditional Diagnosis

The approach to the study of FDI and MNCs advocated here is tantamount to

arguing the need to take the tale of the blind men to the next level. To see the

fundamentals16

whole elephant in front of you is a necessary but not sufficient means to achieve

an adequate understanding of the full range of characteristics and behavior of an

entity that exists in multiple forms. When the men in the story heard the one-

sentence explanation as to why each had a different experience when touching

the animal, their curiosity was satisfied—but prematurely so. They still were far

removed from becoming fully informed about the subject of their inquiry. This is

the overlooked fallacy of the story. The men did not achieve full enlightenment

about elephants simply because a sighted person told them that all descriptions of

their individual tactile experiences had been correct, albeit limited in scope. They

learned only that there is utility in aggregating data to resolve apparent contra-

dictions. Errors of omission are still possible if some important parts of the

elephant were not touched by the six sets of hands and therefore could not be

entered into the equation. Seeing only a few aspects of FDI and MNCs similarly

provides only partial, potentially misleading understanding.

The limited inquiry conducted by the blind men in the tale provides a second

valuable lesson for students of the FDI/MNC phenomena: The specific object

being observed may or may not be representative of the entire range of the ob-

ject’s forms and variants. Examining only one form of the object under scrutiny

can result in inadequate data sampling that leads to inaccurate extrapolations

rather than a genuine mastery of the subject. If sightless people seeking to learn

about elephants touch only a three-month-old animal, their assessment of the

physical dimensions of the species will be faulty. However, it would be the same

situation if twenty people with perfect eyesight attempted to learn about ele-

phants by looking only at a relative newborn.

In addition to the need to account for age as a variable, a full understanding

here requires knowledge that the elephant family is composed of different spe-

cies. Asian and African elephants are not physically identical. Hence, both need

to be touched, if not visually examined, to assemble critical data on the different

forms of these animals. In some cases, information gathering done solely by touch

would be wholly inadequate. A rare strain of white elephant actually does exist,

but its most distinctive feature would elude the touch of 100 highly educated

blind people.3 Similarly, the heterogeneous nature and impact of FDI andMNCs

cannot be fully understood by touching only one, two, or three of the many forms

that they take.

The larger lesson of this classic tale goes beyond the virtue of information

seekers combining several perspectives to provide broader insights. It is a lesson

about the need to recognize the limits of partial knowledge and the need to

pursue further lines of inquiry to attain larger truths. The story never suggested

that after the blind men learned why each of their tactile experiences was dif-

ferent from the others, they realized the possibility that they were still missing

key pieces of data, that is, they were still ignorant of certain physical attributes of

a better approach to understanding fdi and mncs 17

the elephant. Another lesson that is transferable to study of FDI and MNCs is

that all six assessments by the blind men were equally valid because each cor-

rectly portrayed partial reality. None negated the accuracy or usefulness of com-

peting descriptions.4 No one assessment could claim to have described the most

important trait of the animal, that is, none could claim to be the definitive

explanation of what they had touched. Additional fact finding and data analysis

would be necessary to produce such an explanation. At times, it is appropriate

that pursuits of a definitive study of elephants and a definitive understanding of

the world of FDI and MNCs incorporate a Hegelian dialectic to seek synthesis

between the valid points of numerous theses and antitheses.

A major shortcoming of most prior studies and discussions of FDI andMNCs

is their failure to emphasize that neither is cut from a single mold. They defy all-

inclusive labels and need to be understood as generic terms encompassing a

variety of formats. They are heterogeneous. A few studies have made this critical

point, but regrettably only briefly, without emphasis, and no follow-up. In an

incisive observation made too quickly and with no fanfare, David Fieldhouse

wrote, ‘‘Each corporation and each country is a special case. Individual examples

can neither prove nor disprove general propositions.’’5 Buried in the middle of a

paragraph on page 450 of a well-known 1978 book on the subject, the authors

quickly noted in passing that one of their ‘‘principal findings is that foreign direct

investment is an extremely heterogeneous phenomenon.’’6 The need to em-

phasize diversity goes beyond academic methodology; it has an important im-

plication for public policy as well. To the extent that systemic heterogeneity is

recognized, national laws and international agreements can be designed to deal

with specific contingencies and address specific infractions rather than regulate

on a broadly indiscriminate basis. As the authors of the just cited book said,

generalizations, including theirs, about the effects of FDI ‘‘must be treated with

extreme care, as must calls for sweeping policy approaches.’’7

Although the issues surrounding FDI andMNCs are numerous, difficult, and

not conducive to easy answers, they ultimately are about the two most complex

policy issues in political economy. The latter can be stated succinctly and clearly:

(1) what is the optimal trade-off for society between fairness and efficiency in the

economic order, and (2) where in economic policy is the optimal dividing point

between government regulation and free markets on both a national and global

basis? The wording of these two mega-questions never changes, but countless

responses over the years have failed to provide answers simultaneously satis-

factory to the opposite ends of the political spectrum. All of the chapters that

follow directly or indirectly touch on these questions. They are not intended to

provide definitive answers one way or the other but to analyze the two sides of the

argument in a way that helps point the way for a mutually acceptable common

ground between two clashing perspectives.

fundamentals18

Thousands of articles, books, and reports, together with uncountable speeches

and debates, collectively provide a vast body of information on the many facets of

our subject. Large quantities, at least in this case, are not synonymous with

complete, accurate, and up-to-date data. Though this is a personal opinion, the

combined written and oral efforts of practitioners, advocates, and researchers

do share at least one demonstrable failing: They have been unable to change a

measurable number of preexisting attitudes—pro, con, and noncommittal—

regarding FDI and MNCs. Scant progress has been made toward reaching

consensus on what kind of public policies should be applied to them. Closure has

been blocked in part because so many opinion makers, scholars, and casual

observers on both ends of the political spectrum either embrace international

business as a whole with open arms or attack it with a clenched fist. The standard

rhetoric of the opposing sides exudes the erroneous belief that the generic terms

FDI and MNCs are compatible with a one-size-fits-all set of government reg-

ulations, lenient or restrictive as the case may be. In fact, these terms are holding

companies for infinite variations of economic and business situations.

That relatively few people have switched from being favorably disposed to

opposed and vice versa seems to be a function of the continued paucity of uncon-

testable universal truths, real and perceived. New arguments have not come along

that were convincing enough as to be capable of changing people’s perceptions.

This is part of the explanation for a forty-year-old public debate about the virtues

and implications of FDI and MNCs that is better known for its intractable,

occasionally strident inconclusiveness than for its intellectual acuity. Given their

present and future importance to a growing percentage of the world’s population,

this is an unsatisfactory state of affairs. FDI is an important variable in deter-

mining economic growth, employment, incomes, and international trade flows.

By dominating global production of many key capital and consumer goods,

MNCs have become the most important nonstate actors in the international

political order, so much so that legitimate but not necessarily accurate concerns

have been raised about their ability to diminish the sovereignty of nation-states

(see chapter 10).

Another basic shortcoming of many of the words written and spoken on this

subject is failure to explicitly recognize how important perceptions, value judg-

ments, ideology, and sometimes self-interest are in shaping discussions by both

advocates and critics. When ‘‘attitude’’ fills a vacuum caused by a shortage of in-

controvertible data, a contest between diametrically different positions is likely to

provoke and perpetuate disagreement and crowd out objectivity. People tend to

view the FDI/MNC phenomena through differently configured lenses that have

been individually molded by the unique mix of values and experiences that

shapes our thinking. Greek philosopher Epictetus said some 2,000 years ago,

‘‘Men are disturbed not by things, but by the view which they take of them.’’

a better approach to understanding fdi and mncs 19

Assessing what one sees when considering FDI and MNCs is somewhat akin to

taking a Rorschach test made up of concepts instead of ink drawings. Evaluations

of FDI and MNCs are prime examples of perceptions defining ‘‘truth.’’ (Full

disclosure: The text of this book is largely a manifestation, sometimes subcon-

sciously, of the author’s values and preferred methods of processing informa-

tion.)

When the need to make choices takes place in the absence of proven fact and in

the presence of perceptions, a political process is at work. Blanket condemnation

and praise of MNCs and FDI stem from divergent personal philosophies and

ideological beliefs (see chapter 5) that are subjective in nature. They cannot

definitively be proved or disproved by controlled laboratory experiments that,

as might be possible in the natural sciences, produce exactly the same result

after hundreds or even thousands of replications. Only a few things about these

phenomena can be deemed factual or be precisely quantifiable, such as corporate

sales, profits, and assets and the most popular country destinations of overseas

subsidiaries. The exact amount of annual worldwide FDI flows and the total

value of cumulative FDI outstanding are unknown due to data collection short-

comings and different definitions in national statistics (see chapter 14).

Subjectivity, the stuff of politics, is also deeply rooted in our subject matter

because of the totally hypothetical nature of the ‘‘what if ’’ scenario. Definitive

assessments of the gains or losses that would have accrued to a host country from

nonexistent FDI that might have been established, or of the net effects of not

introducing foreign subsidiaries that were in fact established are not possible.

Counterfactuals by definition are hypothetical statements and pure guesswork.

Irrefutable impact assessments could be achieved only by the science fiction

device of freezing time, turning back the clock, then either creating new foreign

subsidiaries that were not established or eliminating those that were, and finally

restarting time. The results of the new chain of events could then be definitively

compared to the original version of history.

Reduced to its essence, different perspectives in this case equate to a refer-

endum on big capitalism. Persons with very liberal or very conservative political

views are likely to process information in such a way that they perceive domestic

and international business operations mainly with skepticism or enthusiasm,

respectively. It is yet another case of honorable people looking at the same abstract

phenomena and seeing two mutually exclusive albeit completely legitimate ver-

sions. Both sides remain dogmatic and dug in for the long haul even though

neither can offer irrefutable proof that its position is the most accurate and

equates to first-best public policy strategy.

In the introductory lecture of my course on MNCs, the potential ambiguity of

perceptions is illustrated by showing students optical illusions in which two

images are entwined in an especially clever manner. When one looks at the classic

fundamentals20

illusion in figure 1.1, the initial perception most likely will be the profile of an old

woman; a second look eventually will reveal the profile of a young woman. It’s all

a matter of perspective, not unlike viewing MNCs and FDI.

Scholarly Inquiry Needs to Keep Up with a Rapidly

Changing Business World

Finally, studies of FDI and MNCs should avoid a common error of commission

in the debate: failure to explicitly assert that these are not static phenomena.

Their dynamic properties have been clearly demonstrated historically in two

opposite ways. The first is the multinationals’ nonstop ability to adapt to and then

exploit changing economic and market conditions. The second face of dynamism

is big companies’ tendencies to restructure, fail outright, or be bought out by

bigger, more successful companies. To revert to cliché, the only constant has

been change. The new economics of high-technology production and the advent

of the information and telecommunications revolution have helped fuel an ac-

celerated flow of new products and new forms of international business opera-

tions since the 1980s. The continuing pace of change also reflects the overlapping

rise in the need for a successful multicountry business strategy and the decrease

in the difficulty of establishing foreign subsidiaries. The bottom line is that

relentless change in international business operations has reduced much of what

figure 1.1.

a better approach to understanding fdi and mncs 21

has been written about them to an interesting but somewhat outdated snapshot of

a particular point in time (a fate awaiting at least parts of this book) rather than an

accurate reflection of present-day conditions.

The start of a new millennium is a propitious time to suggest that more per-

sons and organizations on both sides of the pro/con argument need to recognize

the wide gap between conventional wisdom and changing real-world conditions.

MNCs have changed at a far faster rate than is commonly recognized. Several of

the contending arguments’ most cherished, longest used images and allegations

date back to the early 1970s and before. Continuing to repeat them without mod-

ification has become more a reflex action than an intellectually sound analytical

exercise. Several long-running allusions now qualify for antique status and are

badly in need of updating—if the objective is to construct timely and accurate

characterizations. The forecast of an operatic drama featuring apocalyptic

struggles between gargantuan, avaricious, unaccountable, monopoly-seeking,

amoral-exploit-the-workers commercial baronies and altruistic protectors of the

people but overmatched government officials has not quite materialized. Neither

have the promises that MNCs could work wonders in reducing poverty and

economic backwardness and that a new age of enlightened corporate executive

embraced the practice of responsible corporate behavior.

The accumulated literature seldom highlights the extent to which the con-

tinuing evolution of FDI and MNCs impedes formulation of a permanently

accurate analysis or critique of how they behave, what their objectives are, or

what effects they have. A good example of this syndrome is Global Reach—The

Power of the Multinational Corporations, a book Richard J. Barnet and Ronald E.

Müller, published in 1974. It became a major source of grist for the mills of an

entire generation of skeptics and critics who saw a dangerous if not disruptive and

harmful trend in the making. When examining this much-quoted book three

decades later, one finds a largely accurate description of the unprecedented scale

and scope of MNCs, the implications of which had not previously been articu-

lated in such a detailed manner.

Some of its arguments, however, invite an update or a disagreement. In

response to the statement that ‘‘Driven by the ideology of infinite growth, a

religion rooted in the existential terrors of oligopolistic competition, global

corporations act as if they must grow or die,’’8 one should begin by noting that

big corporations are anything but immortal. Any company faced with aggressive,

smart, and persistent competitors will eventually confront financial death if it is

too incompetent or self-assured to innovate, cut costs, and serve customers in a

way that allows it to protect and increase its profits. It is common for those who

criticize large corporations and markets to downplay the degree to which chang-

ing conditions in the latter can render summary judgment on the former. Per-

manence is not a fringe benefit that comes with a company growing in size and

fundamentals22

profitability; ‘‘here today and gone tomorrow’’ is the more prevalent syndrome.

One-third of the corporate giants listed in the Fortune 500 in 1980 were not there

in 1990 because of decline, acquisition, or bankruptcy; another 40 percent of the

1980 class was gone by 1995.9 The constant change in the composition of the

Dow Jones Industrial Average is additional testament to the ebbs and flows of

business success. Sometimes the cause is management mistakes, for example,

they ignore what Andrew Grove called inflection points—full-scale transfor-

mational changes in a business sector that can provide a responsive company with

an opportunity to ‘‘rise to new heights’’ or signal the demise of a nonresponsive

one.10 At other times, hot-selling products fall by the wayside, victims of new

technology or fickle consumers.

When the authors of Global Reach offered a list of firms in support of their

argument that a global company is by definition an oligopoly,11 they uninten-

tionally demonstrated the fallacy of overlooking the fact that only a select few

companies remain dominant in their product line for extended periods of time.

The list began with IBM, who in the 1970s was the prototypical mighty MNC.

No one could have guessed then that a few years later it would have to rush to

reinvent itself after it suffered a nearly fatal disregard during the 1980s for the

shift away from its one-time core product, mainframe computers. More recently,

as part of its transition to becoming a business services company, IBM sold its

personal computer division to, improbably, a Chinese company.

Ford and General Motors, two other companies cited in the Global Reach list

of market-dominating oligopolists, remain huge global corporations, but they

have become symbols of American manufacturing giants in distress. A steady

erosion in their domestic market share, high fixed costs (especially for workers’

health benefits and retiree pensions) relative to their foreign competition, slim-

to-nonexistent profit margins, and lack of confidence in management’s ability to

turn the situation around resulted in credit ratings agencies downgrading their

debt (i.e., bonds) to ‘‘junk’’ status in 2005. No outside financial analyst could rule

out the possibility of either or both of these one-time corporate icons needing to

seek protection under U.S. bankruptcy law. Other companies listed as examples

of big oligopolists included the seemingly omnipotent international oil companies

known as the seven sisters. They would later have to adjust to nationalizations of

their oil concessions and respond to the rising costs of oil exploration by engaging

in a spate of mergers, which reduced their number to four. Of the four remaining

firms on the list, National Biscuit was acquired by a cigarette company, and Du

Pont, Dow Chemical, and Bayer no longer command the status of market-

dominating, rapidly expanding kings of the universe.

Barnet and Müller’s claim that ‘‘The global corporation is the first institution

in human history dedicated to centralized planning on a world scale’’ is an

oversimplification. It can be countered with the observation that many MNCs

a better approach to understanding fdi and mncs 23

prefer decentralized, that is, subsidiary-by-subsidiary decision making by exec-

utives of various nationalities who are closer to and more knowledgeable about

local market conditions and changing tastes of customers throughout the world.

Successfully standardized ‘‘world products’’ have proven to be the exception

rather than the rule. Elsewhere, the authors raised a two-part question as to

whether the rise of ‘‘world managers’’ would lead to ‘‘a new golden age or a new

form of imperial domination,’’ and whether MNCs represent ‘‘mankind’s best

hope for producing and distributing the riches of the earth’’ or ‘‘an international

class war of huge proportions, and, ultimately ecological suicide?’’12 Offering

only these diametrically opposite, black-and-white choices incorrectly ignored

what unsurprisingly, subsequently occurred: a large gray area of mixed, some-

times ambiguous results that falls between the extremes.

There was and is no good reason for the world not to be vigilant against allow-

ing excessive power to accrue to MNCs. Still, a better assessment of the major

changes then under way in the international order and the role of multinational

firms in these changes can be found in a 1968 book by renowned management

guru Peter Drucker:

Genuinely new technologies are upon us. They are almost certain to create

new major industries and brand-new major businesses and to render ob-

solete at the same time existing major industries and big businesses. . . .We

face an Age of Discontinuity in world economy and technology. . . .The

one thing that is certain so far is that it will be a period of change—in

technology and in economic policy, in industry structures and in economic

theory, in the knowledge needed to govern and to manage, . . .While we

have been busy finishing the great nineteenth-century economic edifice, the

foundations have shifted under our feet, . . . Imperceptibly there has emer-

ged a world economy in which common information generates the same

economic appetites, aspirations, and demands—cutting across national

boundaries and languages and largely disregarding political ideologies as

well. The world has become, in other words, one market, one global shop-

ping center. (emphasis in original)13

The Paradigm to Be Examined

An opening exists for an even-handed, ‘‘no attitude’’ analysis that connects more

dots than its predecessors and illustrates more clearly how irregularly shaped

pieces relate to the larger picture. In seeking new clarity and more accuracy, this

study is distinctive from the mainstream by virtue of emphasizing diversity and

presenting a menu of answers, not definitive conclusions. Instead of searching for

fundamentals24

a uniform, predictable set of behavior patterns, it stresses the nature and im-

plications of heterogeneity in the subjects being analyzed. Hence, the emphasis

placed on the use of disaggregation and the avoidance of generalization. No

attempt is made to pursue the arguably unattainable quest to formulate uni-

fied theories about the nature and net welfare effects on countries of FDI and

MNCs. The ‘‘anti’’ theory presented in this study is that there is no provable, all-

encompassing hypothesis capable of synthesizing the aggregate character, relative

merits, and overall impact of FDI andMNCs. The already large and still growing

numbers of foreign-controlled subsidiaries share too few specific, nonobvious

characteristics to justify stereotypes.

This new methodology is actually a throwback to one of the first academic

books written specifically on FDI and MNCs. In the introduction to his 1969

work, Charles Kindleberger advised his readers, ‘‘We shall encounter a variety of

attempts to prescribe general precepts, and I will find it possible as a rule to suggest

circumstances in which they are not appropriate.’’14 This is also my intention.

Some readers of this book will dismiss such an approach as a cop-out lacking in

intellectual vigor and appreciation of theory. Their numbers will be reduced to the

extent that subsequent chapters are convincing in their arguments as to why it is

the best and most accurate assessment, or at worst, the least imperfect.

In sum, the integrating theme of the chapters that follow is that our cumu-

lative knowledge about FDI and MNCs is still inadequate and the heterogeneity

of corporations and countries is too great to permit generalized conclusions that

can be defended as accurate and enduring. The subjects being observed are too

dissimilar, fluid, and ambiguous to permit more than a handful of ‘‘correct’’

analytic answers and ‘‘optimal’’ government policies to regulate FDI and MNCs

at any given time. In the past, most of the judgments made about international

corporate behavior have had to be revised and expanded as MNCs continuously

adapted to relentless forces of change. Extrapolations have amassed more of a

record of medium-term obsolescence than sustained accuracy. The forces of

change will continue to manifest themselves, and the results cannot be predicted

with any more certainty than upcoming patterns in a turning kaleidoscope.

Notes

1. Data source: United Nations Conference on Trade and Development (UNCTAD),

World Investment Report 2005, p. 13, available online at http://www.unctad.org; ac-

cessed November 2005.

2. Ibid.

3. In theory, the potential for pachyderm heterogeneity goes further. Drunks reportedly

have seen pink elephants, though no scientific evidence exists to confirm their exis-

a better approach to understanding fdi and mncs 25

tence. Furthermore, ever since 1941, the movie classic Dumbo has implanted the

image in the imaginations of successive generations that given sufficiently large ears,

an elephant could fly. After the blind men, the second most famous fictional collective

to contemplate the characteristics of an elephant was a group of talking crows in

Dumbo. They, too, fell short in their elephant IQ when they initially dismissed

Dumbo’s chances of taking flight.

4. George J. Marshall, ‘‘Hegel and the Elephant,’’ available online at http://www.bu

.edu/wcp/Papers/Inte/InteMars.htm; accessed October 2004.

5. David Fieldhouse, ‘‘ ‘A New Imperial System’? The Role of the Multinational Cor-

porations Reconsidered,’’ in Jeffry A. Frieden and David A. Lake, eds., International

Political Economy, 4th ed. (Boston: Bedford/St. Martin’s, 2000), p. 176.

6. C. Fred Bergsten, Thomas Horst, and Theodore H. Moran, American Multinationals

and American National Interests (Washington, DC: Brookings Institution, 1978), p.

450.

7. Ibid.

8. Richard J. Barnet and Ronald Müller, Global Reach—The Power of the Multinational

Corporations (New York: Simon and Schuster, 1974), p. 364.

9. ‘‘The World’s View of Multinationals,’’ The Economist, January 29, 2000, p. 21.

10. Andrew S. Grove, Only the Paranoid Survive (New York: Currency Doubleday,

1996), pp. 3–4.

11. Barnet and Müller, Global Reach, p. 34.

12. Ibid., pp. 14, 25.

13. Peter F. Drucker, The Age of Discontinuity (New York: Harper and Row, 1968), pp. ix,

10, x; emphasis in original.

14. Charles P. Kindleberger, American Business Abroad (New Haven, CT: Yale University

Press, 1969), p. 36.

fundamentals26

2

defining the subject Subtleties and Ambiguities

In what might be called a retro innovation, the substantive assessmentof the nature and impact of foreign direct investment (FDI) and multinational corporations (MNCs) begins in a relatively unusual manner. It

pauses to explain in detail precisely what these terms mean because their defi-

nitions are neither self-evident nor common knowledge. The absence of consensus

about their overall nature and effects begins at a very rudimentary level: What are

the defining characteristics of these complex, diverse, and abstract entities?

Before defining FDI and MNCs, this chapter takes two steps back to advance

the simple, but somewhat unconventional argument that there are two important

issues that are even more basic than definitions of our subject matter. The first

section examines the conflicting perceptions and definitions of that which pre-

ceded and later gave birth to FDI and MNCs: the domestic corporation. The

next section assesses the very basic question of whether multinational corporation

is the most appropriate term for that which is to be defined. Finally, the chapter’s

third section presents a broad range of definitions covering this study’s subject

matter. This would seem like the logical starting point, but definitions of FDI

and MNCs are best presented after a generic description of the corporation and a

look at the conceptual difficulties associated with determining the most accurate

term for what is to be defined.

What Is a Corporation? What Is Its Mission?

Insights into the nature, functions, responsibilities, and impact of MNCs begin

with insights into the same four aspects of that which spawned them: the domestic

corporation. A corporation is the most important private sector institution for

creating wealth and allocating resources on a country-by-country basis. MNCs

27

serve this role in the global economy. As a consequence, domestic corporate

issues extrapolated to the international business arena shed light on the under-

lying themes of most major MNC/FDI-related issues. In some cases, domestic

and international corporate questions are the two sides of the same coin.

The domestic-international parallels begin with the difficulties inherent in

constructing a consensus definition of either type of corporation and in setting

criteria for measuring their net impact, either good or bad. Given the eclectic

approach of this book, the appropriate starting point is to quote the observation

by two business analysts that definitions of the corporation ‘‘reflect the per-

spective (and the biases) of the people writing the definitions.’’1 The near im-

possibility of devising a single concise, universally accepted definition of the

modern corporation reflects the important roles of perceptions and value judg-

ments, as well as the nature of the beast. Another obstacle is the multiple dimen-

sions inherent in the corporate phenomenon: legal status, purpose, internal

governance, external responsibilities to society (if any), and so on. Is there an

order of priority among these subthemes? Do all have to be considered or just

some? If the objective is to make a one-sided case for the corporation’s net virtues

or net drawbacks, a succinct, deliberately worded, unnuanced definition would

suffice. Given this book’s broader perspective and commitment to an objective

study emphasizing heterogeneity, legitimate differences in perceptions are in-

evitable, and the need for disaggregation, multiple definitions and descriptions of

the corporation are necessary.

In the most literal, basic terms, a corporation is a business entity that has met

certain legal requirements and has had its incorporation papers approved by des-

ignated national and/or local government authorities in the country where the new

corporation resides. From a narrow legal perspective, at least under U.S. law, a

corporation is no more than a web of contracts and other legal documents that tie

together various parties to a specific company. In broader legal terms, a corporation

(as distinct from a sole proprietorship or a partnership) is a freestanding entity

separate from its owners and is a de facto citizen. It possesses separate legal rights,

liabilities, and responsibilities; these include the ability to buy and sell assets, enter

into contracts, issue debt, and sue or be sued in the judicial system. Three other

important characteristics of corporations are that they

1. Have an unlimited life that allows them to continue even though owners

and managers come and go.

2. Allow easy transferability of ownership interests by shares of stock that

can be transferred from one owner to another quickly and easily.

3. Have limited liability. Owners’ losses are limited to the funds they

invested in the corporation, that is, owners cannot be assessed to cover

corporate deficits or obligations.2

fundamentals28

Beyond these legalistic characteristics, definitions often demonstrate value

judgments, if not outright biases. Critics of free markets and those with doubts

about capitalism would sympathize with the caustic definition of a corporation as

‘‘an ingenious device for obtaining individual profit without individual respon-

sibility.’’3 Disdain for corporations can be taken to the next level by branding

them as ruthless seekers of self-aggrandizement with a genetically embedded,

irrepressible desire to seek enough market power to fix prices for its goods at

levels that guarantee maximum profits for the long term. This goal is derided as

an effort to provide limitless riches to a relatively small capitalist class, with little

or no concern about possible negative costs to society as a whole or the relative

lack of benefits accruing to workers whose toil produces the goods and services

being sold. The implication of this characterization is that governments must

systematically monitor, tax, and regulate companies to limit their alleged natural

inclinations to exploit the majority and abuse their power in a perpetual, single-

minded drive to maximize profits.

Most critics of corporations would go one step further and express concern

about the diminishing likelihood of proper government regulation when the

financial power and reach of corporations continue to grow beyond what these

critics perceive as already being at disturbingly large sizes. They would define

corporations in terms of their supposed ability to convert economic power into

the ability to co-opt government officials’ interpretation of the public good. They

presumably could do this through massive increases in donations to politicians

and political parties and by means of threats to move the company and its jobs to

a different jurisdiction.

Most people embracing a right-of-center political ideology would offer a very

different core definition: A corporation is a business entity designed to make

profits by pleasing customers. By doing so, it justifies the confidence placed in it

by its owners. Profits enhance the wealth of shareholders through rising stock

prices and higher dividends. The idealized version of perfectly functioning mar-

kets affirms that the quest to create wealth for shareholders is a positive-sum game

because to achieve it, companies must serve the public interest. The unrelenting

need to maximize efficiency—for which corporations are superbly designed—in

producing goods or providing services presumably translates into rising living

standards for the public at large. Companies do this by optimizing output

(usually through high volume), increasing the ability of people to consume by

keeping prices low (in economic terms, the result is increased real incomes), and

by widening consumers’ choices. The pro-corporation line of reasoning explains

that superior management is acquired and retained by competitive salaries and

bonuses linked to increased corporate profitability and rising stock prices, neither

of which can be generated for long by overpriced or underperforming goods and

services.

defining the subject 29

To depict private corporations as efficiency-driven, positive-sum game in-

stitutions is to argue that a successful company does what no government agency

can do. Relentless competition and unforgiving market forces afford the private

sector no alternative to utilization of resources in the most efficient manner,

constant innovation, quick adjustment to changing tastes and needs of consumers,

and taking risks to keep one step ahead of competitors. New technology creates

new business opportunities and pushes obsolete businesses into oblivion. Cor-

porate growth translates into additional jobs. Unlike the typical government

agency, a commercial company must be able to meet its customers’ present and

future needs to perpetuate itself. Only government agencies can enjoy perma-

nence and increased budgets through statutory authority.

Another useful insight into the nature of the corporation is to examine the

evolution of its structure as logical responses to constantly changing external

stimuli. Until the second half of the nineteenth century, most manufacturers

were relatively small, unincorporated sole proprietorships or partnerships serv-

ing geographically limited markets. An unprecedented progression of innova-

tions in transportation, communications, and power generation that began in the

second half of the 1800s encouraged the move to ever larger factories to utilize

economies of scale (see chapter 6) through larger volumes of production and

sales—a trend that continues today. Individual owners needed increasing amounts

of capital to keep growing, and many found incorporation and selling shares in

the company (above and beyond borrowing) to be a cost-effective means of doing

so. As production techniques became more complex, corporations continued

growing in terms of size and the number of owners. Gradually, many companies

became so large that they began replacing their founders with professional

managers hired from outside or promoted from within. The continued growth in

the number of shareholders meant an increasing disconnect between ownership

and control of corporations.

By the mid-twentieth century, the larger, more successful manufacturing

corporations extended their capabilities beyond the production line to include

marketing, distribution, research and development, and international divisions.4

A significant organizational innovation became commonplace after WorldWar II,

first in the United States and soon elsewhere, establishing subsidiaries in nu-

merous foreign countries; in other words, growing numbers of firms were trans-

forming themselves into MNCs.

A definitive definition of the corporation must go beyond what thus far has

largely been a U.S.-centric point of view. Deeply held beliefs throughout much

of Europe and Asia go beyond the legal, economic, and organizational definitions

to include assigning it an organic role as a societal institution. This concept puts

less emphasis on corporate profits and stock prices and more emphasis on the

need to fulfill what are deemed essential obligations to the broad public interest.

fundamentals30

Country-by-country differences in assigning priorities to serving the interests of

society relative to shareholders largely derive from differences in deeply rooted

cultural values. Acceptance of the proposition that corporate operating guidelines

can differ from country to country adds credence to the school of thought that the

world is populated by transnational companies with distinctive national qualities

and priorities that do not universally fall into the category of like-minded stateless

MNCs. As globalization proceeds and business interaction among countries in-

tensifies, it is logical to wonder whether their differing systems for regulating

corporations, based as they are on strong cultural preferences, present oppor-

tunities for convergence, cooperation, or conflict5—or all three. (The questions

of how and to what extent MNCs should be regulated are addressed in chapter

11.)

The issue of corporate obligations and goals is frequently framed as a question

of primacy between two contending interest groups. For whom should a cor-

poration primarily be run? On one side are the shareholders who bought stock in a

company for the purpose of receiving a return on investment and who ultimately

own it. On the other side are the stakeholders, a broader, more inclusive group that

is composed of all persons or entities that are affected by the activities, successes,

and failures of a corporation. This ‘‘public commons’’ is composed of the

community at large (including the environment), employees, customers, other

companies doing business with the corporation, national and local governments,

lenders (banks, bondholders, etc.), along with shareholders. Which set of in-

terests should be served first and foremost is a decision that tends to flow from

one’s place on the political left-to-right spectrum (see chapter 5).

The Anglo-Saxon model (so named because it has mainly been used in the

United States and the United Kingdom) favors a market-oriented economic

ideology. It therefore tilts in favor of giving priority—not exclusivity—to the

interests of shareholders. The Economist opined that a corporation placing social

responsibility ahead of profits is ‘‘philanthropy at other people’s expense.’’ Man-

agers are entrusted with the care of assets belonging to the company’s share-

holding owners; if executives want to support good causes out of their own

pockets, that would be admirable. Besides, asked the article, ‘‘is it really for man-

agers and NGOs to decide social-policy priorities . . . ? In a democracy, that is a

job for voters and elected politicians.’’6 By encouraging maximum corporate

freedom and efficiency short of violations of laws and regulations, the private

sector has been instrumental for many decades in generating steady increases

in standards of living. Hence this viewpoint argues that government should

encourage and support the dynamism of business, not stifle efficiency and in-

novation with red tape.

The majority of Western European and developing countries plus Japan have

a different set of values. They believe that the primary purpose of economic

defining the subject 31

activity is to serve and protect the population as a whole, not an economic elite.

They embrace a government-dominated model to pursue a ‘‘just’’ society that

serves the vast majority. Pursuit of full employment, worker benefits, and a com-

prehensive social safety net at some cost to corporate profits and after-tax income

of the owners of capital is deemed fully justified.

The efficiency maximization and societal enhancement models of the corpo-

ration are not mutually exclusive. Although it would be naive to suggest that they

will eventually meet in the middle and merge into a single theory of economic

structure, both versions of corporate missions and responsibilities have seen the

need to adopt some principles of the other. Many persons who still define the

ultimate justification of the corporation in terms of its unmatched ability to gen-

erate physical output, efficiency, and wealth would probably accept Peter

Drucker’s definition that the ‘‘modern corporation is a political institution; its

purpose is the creation of legitimate power in the industrial sphere.’’7 They likely

would have more reservations about more ‘‘progressive’’ assertions, like ‘‘The

corporation cannot—and should not survive if it does not take responsibility for

the welfare of all of its constituents and for the well-being of the larger society

within which it operates.’’8

Committed advocates of stakeholder rights think that the legitimacy of the

contemporary corporation—its social charter—‘‘depends on its ability to meet

the expectations of an increasingly numerous and diverse array of constituents.’’9

Much to the dismay of these activists, some companies and policymakers in

Western Europe and Japan at the start of the millennium were reluctantly

conceding that swelling global competitive pressures necessitated at least a small

step in adopting the unsentimental brand of U.S. capitalism that allows forced

layoffs and a frozen benefit scale for workers, accepts most corporate bank-

ruptcies, and seems content to accept a secular decline in the power and size of

unions. In its most polarized form, the shareholder-stakeholder debate extrap-

olated to the global stage has long been a major contributing factor to the backlash

against globalization (see chapter 5).

The larger reality is that the corporation is still a work in progress. Its or-

ganizational structure and mission continue to evolve and diversify, for better or

worse. No matter how someone defines it at any given time, the terms used

inevitably will need to be modified and expanded—on more than one occasion—

if obsolescence is to be avoided.

Until the late 1990s, governance had been an arcane aspect of the corporate

process largely ignored by the public. It became a hot policy topic that swelled in

importance as news headlines trumpeted the latest in what seemed to be an endless

series of corporate financial scandals engineered by senior executives, mostly in the

United States but also in Europe, Japan, and elsewhere. Corporate governance as

discussed here is a term roughly synonymous with oversight of management.

fundamentals32

(Lacking a precise meaning, it can also be used to refer to the structure of internal,

day-to-day corporate decision making and procedures for resource allocation). The

better the oversight by a select group of informed, independent outsiders that

outranks senior operational executives, the less likely that the latter will commit

such crimes as ‘‘cooking the books’’ to inflate earnings, siphoning funds from the

company, engaging in insider stock trades, making patently false statements about

the company’s financial health, and so on. Good corporate governance also hastens

the exit of executives guilty of such noncriminal acts as recklessness, repeated poor

business decisions, unethical acts, and so on.

Externally, corporate oversight is administered by government agencies such

as the U.S. Securities and Exchange Commission, the Internal Revenue Service,

and by private entities such as the two major national stock exchanges. Internally,

corporate governance is centered in the board of directors, a body mandated by

government statute in many countries. In the United States, it is charged with

establishing and adjusting the levels of salary and benefits earned by senior man-

agers and, when necessary, with firing them. Boards also approve broad changes

in corporate strategy, examine and certify company financial statements, and

(at least in the United States) ensure that the interests of shareholders are rea-

sonably protected. In Germany, a different philosophy about corporate priorities

and responsibilities led to a governance practice known as codetermination.

Medium and large corporations are required by law to have a supervisory board

(roughly analogous to the board of directors of U.S. corporations) that is equally

divided between members chosen by employees and members representing

shareholders.

Depending on one’s perspectives, a good board could be defined as a toothless

group that stays out of the way of senior managers. The latter in theory are full-

time executives with distinguished credentials who are the best informed on

current market conditions and the intricacies of the company’s operations. A ‘‘see

no evil, hear no evil, and speak no evil’’ board of directors that eschews second-

guessing management begins with having the chief executive officer (CEO)

double as chairperson of the board, as opposed to having an independent member

of the board of directors hold the position. The all-important second step is

recruiting a majority of directors who will not rock management’s boat. These

kinds of directors include personal friends and relatives of the chairman/presi-

dent, employees of the company, executives of outside businesses that want to

retain their contracts to sell goods or services to the company, and persons too

busy or untrained to pore over corporate documents.

A genuine ‘‘checks and balances’’ board operates very differently and corre-

sponds to the opposite definition of desirable oversight. It is one composed mainly

or totally of independent, knowledgeable directors and a chairperson with no

conflicts of interest. They conscientiously keep close tabs on what management is

defining the subject 33

doing and saying. The board is prepared to bare its sharp teeth and has the

inclination and competence to vigorously hold management responsible for

running the corporation efficiently and honestly in the home country and, in

cases of MNCs, in host countries abroad. This is the kind of board of directors

that the U.S. government has mandated for U.S.-based companies. The most

tangible response of the U.S. Congress to the early twenty-first century parade of

corporate scandals was the Sarbanes-Oxley Act of 2002. Designed to reduce

conflicts of interest at the highest corporate echelons, the legislation mandated

several requirements to ensure a minimum level of independence for boards of

directors, prohibited accounting firms from performing a number of (usually

lucrative) consulting functions for the companies they audit, and so on. It is an

open question as to whether these and additional safeguards can ever entirely

prevent unscrupulous executives from bending the rules or attempting the

perfect white-collar crime.

What’s in a Name? Are MNCs Really ‘‘Multinational’’?

A second step needed before defining the subject matter of this book is trying to

resolve the seemingly pro forma task of determining what to call the interna-

tionally oriented business entities that will be defined and later analyzed. No

universal consensus on the most basic terminology exists. The term multinational

corporation is employed throughout this book because it is the most commonly

used, and it satisfactorily (though perhaps imperfectly) conveys the nature of this

kind of business enterprise. A number of scholars and analysts use the equally

suitable term enterprise in lieu of corporation. Arguably, the choice here is mostly

a matter of semantics. In theory, a business with foreign subsidiaries might not

be incorporated in the headquarters country; even fewer could be government-

owned enterprises, often referred to as parastatals. However, these rare excep-

tions are so greatly overshadowed in size and importance by traditional corpo-

rations that there seems to be no compelling intellectual reason to opt for enterprise

on the basis that it has a more all-encompassing connotation.

A far more significant question is whether to use multinational or transnational

as the adjective before corporation. The choice of words in this case involves more

than semantics. These two modifiers symbolize a conceptual disagreement about

how, at their core, MNCs are organized and managed and how they establish

priorities. On one side is the belief that MNCs are a new kind of stateless entity

with no allegiance to any particular country or business style. Such companies

allegedly represent an economic and political revolution in the form of a radically

new business paradigm, one unusually disdainful of government authority and

dismissive of what they see as obsolete old-order constraints, such as national

fundamentals34

loyalties and borders. MNCs are sometimes depicted as new age global players

that have methodically shed a single national identity in favor of the multiple

identities needed to conquer multiple national markets. Their goal is a new

level of cosmopolitanism in the quest to successfully compete in dozens of far-

flung countries having diverse cultures. Japanese business consultant Kenichi

Ohmae once exhorted executives to accept that neither an MNC’s country of

origin nor the location of its headquarters matters. ‘‘The products for which you

are responsible and the company you serve have become denationalized,’’ he

wrote.10

To those who subscribe to this viewpoint, multinational connotes a blending of

various national traits. The end product is a novel form of enterprise that op-

erates in as many different ways as countries in which it maintains subsidiaries

and major sales operations. Decisions on where to produce what goods pre-

sumably are based on worldwide searches by globally oriented technocrats guided

solely by the credo of seeking maximum efficiency with minimum costs.

The opposing theory holds that MNCs are in fact transnationals, because

ultimately they are nothing more than big national companies with operating

subsidiaries in at least one other country, not a mixture of multiple nationalities.

The statistically average MNC employs about two-thirds of its workforce and

produces more than two-thirds of its output in the home country, typically a

large industrialized economy.11 Some scholars reject the notion that a new breed

of denationalized corporation has emerged, one having an entirely new modus

operandi shaped by a truly globalized mindset. This school of thought holds that

even the most geographically dispersed companies do not and cannot totally

divorce themselves from the national heritage that shaped their growth, corporate

culture, and operating rules. A globally active corporation can ‘‘go native’’ on the

surface, but not systemically. For example, a Japanese company operating in any

country is likely to bring with it its native predilection for long-term growth and

market share over immediate profits. As already noted, governance requirements

under German corporate law preclude companies from dismissing the interests

of their employees in the race to maximize shareholder value.

In The Myth of the Global Corporation, one of the most widely cited books

espousing what, with only a slight exaggeration, might be dubbed as the uni-

national overseas corporation thesis, the authors argue that ‘‘the most strategically

significant operations of MNCs continue to vary systematically along national

lines.’’ ‘‘Distinctive national histories have left legacies that continue to affect the

behavior’’ of even the largest MNCs. History and national culture allegedly

‘‘continue to shape both the internal structures of MNCs and the core strategies

articulated through them.’’ The authors further assert that MNCs should not

be depicted as engines of globalization because they ‘‘are not converging to-

ward global behavioral norms’’ devoid of their respective national origins. ‘‘The

defining the subject 35

global corporation, adrift from its national political moorings and roaming an

increasingly borderless world market, is a myth.’’12 Another scholar argues that

the typical MNC does not ‘‘leave’’ country A for country B; she feels that it is not

an either/or situation. The management, governance, and organizational struc-

ture of a corporation overlap the political boundaries of home and host coun-

tries.13 The global nature of multinationals also has been questioned on grounds

that many have a very high percentage of their sales in their home country and a

limited number of foreign markets.

In some cases, the relatively recently coined term multidomestic company may

be the appropriate appellation. This would be applicable to MNCs that em-

phasize global decentralization and maintain small headquarters operations.

Some or all of their overseas subsidiaries are given above-average autonomy and a

relatively free hand to act as much as possible as a locally owned company in host

countries. The managerial ranks at these stand-alone subsidiaries usually are

staffed mainly or even totally with local nationals. Another relatively new term,

global corporation, may catch on if only because it has a nice ring to it. Finally, two

seldom used terms suggest a more value-free, all-inclusive label: multination

business and transnational production.

Definitions of FDI and MNC

Foreign direct investment and multinational corporation are two inextricably in-

tertwined concepts but not perfect synonyms. They are subtly different facets of

the phenomenon of international business operations, but are often jointly re-

ferred to in the chapters that follow.

FDI is a financial process associated with companies operating and controlling

income-generating facilities in at least one country outside their country of or-

igin. Governments adopt and administer FDI policy. AnMNC is a tangible entity

that in some way will impact a home country, which is where its main head-

quarters is located, and one or more host countries, the recipient(s) of incoming

FDI. Although a company might designate a tax-haven country as its official

place of incorporation, in practical terms the headquarters or home country is

where the offices of the top echelon of management are located. In most cases,

this is also the country where the corporation began and where the largest per-

centage of its shareholders resides.

The terms FDI and MNC share the problem of inexact definitions. In con-

sidering the definitions that follow, one should be mindful that they are not

immutable. They have been altered over the years and are likely to undergo

further modifications in the future. Moreover, a few countries use definitions that

differ from the one most commonly used.

fundamentals36

FDI is a term used in at least four ways. First, it is the corporate activity that

confers the status of multinational on certain firms. It is what MNCs do to

become MNCs. Second, FDI is a financial activity. It normally consists of an

international capital flow from the home country to the host country for the

purpose of acquiring partial or full ownership of a tangible business entity, such

as a factory, extractive facility, or wholesale distribution system. As a branch of

international finance, FDI has implications for the balance of payments of both

home and host countries. Third, FDI is the generic term used to designate the

economic policies toward MNCs and international investment flows maintained

by governments and international organizations. Finally, FDI is the generic term

used by official statistical agencies to measure in monetary terms the annual

incoming and outgoing flow and the cumulative value, that is, the stock of inward

direct investments, on a country-by-country basis.

Two important technical qualifications are necessary. First, an FDI transac-

tion does not literally need to involve an international capital flow to conform to

these definitions. MNCs occasionally opt to finance the building, acquisition, or

expansion of an overseas subsidiary by raising the needed funds in the host coun-

try’s capital markets through bank borrowing or issuance of stocks and bonds.

When expanding an existing operation, a corporation might tap the subsidiary’s

retained earnings (profits) as opposed to transferring capital from the home

country. Second, FDI can take place without an MNC being involved; for ex-

ample, a group of independent investors in one country could acquire a 10 percent

or more (see following discussion) equity stake in a company incorporated in a

foreign country. An always accurate but unwieldy definition of FDI would be:

‘‘significant’’ ownership in an income-producing entity in at least one country

other than the one in which the controlling company or group is domiciled.

Certain specific criteria differentiate FDI from other international capital

flows, even other kinds of international investment.14 Portfolio investment is

frequently and erroneously confused with FDI. The former occurs when an

individual or financial institution (a mutual fund in most cases) buys a relatively

small number of shares in a company located in another country because of the

expectation that those shares will appreciate in value and can be sold at a profit

sometime in the future. The investor in this case has no influence over man-

agement decisions and no long-term commitment to the company, just the vis-

ceral hope that he or she eventually will profit from rising share prices and

dividends.

FDI is further defined on a qualitative and quantitative basis. Qualitatively, it

is about ownership and control. FDI is done by companies with the intent of

having sufficient ownership to ensure a partial or total say on a lasting basis in the

management of a corporate entity located in a foreign country. In other words, a

company based in the home country has at the least a meaningful long-term voice

defining the subject 37

in shaping output, production, and marketing strategies; constructing corporate

budgets; selecting senior managers; dealing with labor relations; and approving

new product development in a company incorporated and doing business in the

host country. FDI is about long-term, perhaps permanent relationships that

could have a significant financial impact—good or bad—on the foreign company

making the investment. It involves relatively large transfers of capital that cannot

easily be reversed (whereas stocks and bonds can usually be sold in seconds).

When establishing a foreign manufacturing subsidiary, a corporation commits

more than a relatively large amount of capital—it also commits its prestige.

For manufacturing subsidiaries in particular, the foreign company will inject

into the host country’s economy a package of resources that typically include

advanced, possibly state-of-the-art management skills and production tech-

niques, technology, and marketing savvy. Increased jobs and exports are often

associated with FDI. None of these qualities apply to the purchase, say, of 100

shares of Toyota Motor Corporation stock by an American citizen. This would be

foreign portfolio investment.

Quantitatively, the nearly universally accepted definition of FDI is ownership

of at least 10 percent of the common (voting) stock of a business enterprise

operating in a country other than the one in which the investing company is

headquartered. Having an active voice in an enterprise’s management does not

require 100 or even 51 percent ownership of the foreign entity’s voting shares. In

most countries, 10 percent ownership is considered sufficient for a foreign com-

pany to have entrée to at least some control over management decisions; in ad-

dition, it usually ensures selection of at least one member of the board of directors

or its equivalent. According to the stylebook of the International Monetary Fund

(IMF) and the Organization for Economic Cooperation and Development

(OECD), a foreign subsidiary is an incorporated enterprise with a foreign investor

having more than 50 percent equity ownership; the parent of a foreign subsidiary

would normally have the right to appoint a majority of the members of its board of

directors. The IMF/OECD stylebook uses the term foreign associate for an en-

terprise with a foreign investor having 10 to 50 percent ownership. Because the

vast majority of FDI undertaken by large MNCs involves majority to full owner-

ship by a single parent company, the term subsidiary will be used throughout this

book for simplicity’s sake. (For consistency’s sake, the synonymous term of for-

eign affiliate, preferred by some government agencies, will not be used.)

A foreign subsidiary can be an entirely new entity or be formed through a

merger with or acquisition of an existing company. FDI may also take the form of

a joint venture with another company; in this case, a new, jointly owned cor-

porate identity is created. A foreign branch involves ownership of an unincor-

porated business entity by a company headquartered abroad.

fundamentals38

A few countries utilize other formulas to designate FDI, thereby preventing a

uniform global statistics gathering standard. Some of these countries establish a

higher minimum level of stock ownership, usually 25 percent, to define FDI. A

very few make exceptions to the 10 percent rule in certifying FDI. If the in-

vesting company meets or exceeds that threshold but apparently will not have an

effective managerial voice in the foreign firm, the transaction will not be classified

as FDI. On the other hand, if the foreign investor appears to have secured a

meaningful management role in the firm with less than 10 percent ownership,

these countries will include the transaction in their FDI statistics.15 Limitations

on the cumulative data are further imposed by the difficulties facing even the best

government statistical agencies in recording all FDI flows in a given year and in

assigning accurate monetary values to those flows that are recorded. Some less

developed countries do not have an established capability to accurately and fully

compile such statistics.

MNCs, in contrast to FDI, are a kind of living organism because they are

actively engaged overseas in producing goods and services and may be dissem-

inating technology, managerial skills, and capital. The nearly universally ac-

cepted definition of a multinational corporation is one that owns outright,

controls, or has direct managerial influence in income-generating, value-added

facilities in at least two countries. Prior to the 1990s, the definition referred to a

simpler, more concrete term: production facilities. However, relatively rapid rates

of growth in FDI by service sector companies such as banks, engineering firms,

accountants, and advertising agencies necessitated terminology that went beyond

portrayals of factories, oil wells, and mines.

The relative precision of the definition of an MNC does not prevent con-

ceptual problems. A company doing business on a global scale is not necessarily

an MNC. Neither exports nor the presence of salespeople or wholesale distri-

bution centers to distribute imports in a foreign country meet the definition of

managerial control of an incorporated subsidiary in at least one foreign country.

A very wide range of companies are designated as MNCs. The broad spec-

trum ranges from small enterprises whose overseas subsidiary might consist of

one small factory with statistically insignificant output and a handful of em-

ployees in just one other country, to huge corporations owning factories in thirty-

plus countries that garner large market shares in host countries. A small number

of purists want to deal with this incongruity by imposing additional statistical

requirements before labeling a company an MNC. One suggested criterion is to

require foreign subsidiaries to collectively contribute some minimum percentage

of a company’s annual total sales and/or profits. Another proposal is to require

that a company have value-added facilities in more than two countries, perhaps

four or more, before being classified as a multinational.

defining the subject 39

Notes

1. Robert A. G. Monks and Nell Minow, Corporate Governance (Malden, MA: Black-

well, 2004), p. 8.

2. For details on the legal nature of the corporation, see Eugene Brigham and Michael

C. Ehrhardt, Financial Management: Theory and Practice, 11th ed. (Mason, OH:

Thomson/South-Western, 2005), chap. 1.

3. Ambrose Bierce, The Enlarged Devil’s Dictionary (Garden City, NY: Doubleday,

1967), p. 48.

4. Roger W. Ferguson Jr., ‘‘Lessons from Past Productivity Booms,’’ press release of the

Board of Governors of the Federal Reserve System, January 4, 2004, pp. 12–14.

5. Jeswald W. Salacuse, ‘‘European Corporations and American Style? Governance,

Culture and Convergence,’’ draft of paper presented April 2002; available online at

http://www.ksg.harvard.edu/cbg/Conferences/us-eu_relations/salacuse_corporate_

culture.pdf; accessed October 2004.

6. ‘‘Two-Faced Capitalism,’’ The Economist, January 22, 2004, p. 53.

7. As quoted in Laurence J. Peter, Peter’s Quotations—Ideas for Our Time (New York:

William Morrow, 1977) p. 85.

8. James Post, Lee Preston, and Sybille Sachs, Redefining the Corporation—Stakeholder

Management and Organizational Wealth (Stanford, CA: Stanford University Press,

2002), pp. 16–17.

9. Ibid., p. 9.

10. Kenichi Ohmae, The Borderless World: Power and Strategy in the Interlinked Economy

(New York: Free Press, 1990), p. 94.

11. ‘‘The World’s View of Multinationals,’’ The Economist, January 29, 2000, p. 21.

12. Paul Doremus, William Keller, Louis Pauly, and Simon Reich, TheMyth of the Global

Corporation (Princeton, NJ: Princeton University Press, 1998), pp. 9, 1.

13. Mira Wilkins, ‘‘Comparative Hosts,’’ Business History, January 1994, p. 24.

14. As noted by the UNCTAD Secretariat, ‘‘ ‘Investment’ does not have a generally

accepted meaning.’’ UNCTAD, World Investment Report 2003, p. 100, available on-

line at http://www.unctad.org. A generalized definition of investment is the purchase

of financial or tangible assets with a view to obtaining a relatively high financial return.

15. International Monetary Fund, Foreign Direct Investment Statistics—How Countries

Measure FDI 2001, October 2003, p. 23.

fundamentals40

3

from obscurity to international economic powerhouse The Evolution of Multinational Corporations

Multinational corporations (MNCs) did not suddenly appear onthe scene or emerge as part of a calculated design by a group of avaricious captains of industry lusting after more sales and less competition. In

fact, the nature, size, power, and number of the current generation of MNCs

are at least as much the outgrowths of larger events that were not of business

executives’ own making. The timetable and twists and turns of foreign direct

investment’s (FDI) long evolutionary process were determined to a significant

extent by external forces. Entrepreneurs and corporate managers did not set out

to create the soaring costs of producing new generations of high technology goods

that made an international presence necessary for companies in this sector. They

did not create investor pressures for steady increases in sales and profits. Nor

did they create the governmental policies that produced the business-friendly

international order that allowed modern-day MNCs to flourish. The manu-

facturing and to a lesser extent services sectors acted at least as much defensively

to external forces as they acted opportunistically to make a lot of money selling

goods and services that a lot of people wanted to buy. Some have been pleased

with the overall results of the pursuit of profit on a global basis by private en-

terprise; others have been bitterly critical.

This chapter examines the historical record in an effort to explain how the

various kinds of MNCs evolved into their current corporate structures. Ste-

reotypes and neatly wrapped conclusions are not consistent with the long,

winding, and at times bumpy road that preceded the emergence of modern

MNCs. The first section provides an overview of the infancy and intermediate

stages of international business operations that spanned 350 years. This is fol-

lowed by a closer look at the mix of factors causing the relatively recent onset of

41

the modern era of mature and seemingly ubiquitous MNCs. The third and final

section examines the reasoning and statistical data behind the assertions that (1)

FDI and MNCs have reached the top echelon of issues in international economic

relations, and (2) their economic impact is now sufficiently powerful to make

them politically significant on a global scale.

The Initial and Intermediate Stages

of MNC Development

The path that would eventually lead to the modern MNC followed a circuitous

route, displaying no consistent pattern in either content or timing. Periods of

rapid growth in multinational operations were interrupted by years of stagnation

or even decline. In different periods, corporations made different choices be-

tween alternative modes of operating abroad and among alternative forms of

internal organization.1 The long gestation process for the full blossoming of the

MNC was due to the need to wait for the arrival of a long succession of tech-

nological discoveries and nurturing economic conditions and public policy

changes. History suggests that the larger political, technological, and economic

environments mainly influenced the nature and timetable of the evolution of

international business, not vice versa. According to one of the preeminent

scholars in the field, John H. Dunning, the history of the development of the

multinational corporation is

The story of a series of political and social events that have affected the

ownership, organization and location of international production. . . .The

growth of international production in modern history essentially reflects

the way in which changes in the structure and organization of the world’s

resources and capabilities impinge on the cross-border production and

transaction strategies of companies. While historically the role of the

[MNC] has been both a pro-active and re-active one . . . the discovery of

new territories, increases in population, advances in the stock of knowledge

of production and organizational techniques, and the response of gov-

ernments to these changes have been the prime movers.

Enterprises have responded to these developments by realigning the

extent, form and geography of their value-added activities. . . . In many

ways the growth of international production is a microcosm of changing

commercial relationships, as they evolved from the personal trading of

individuals . . . through . . . the industrial . . . revolution . . . to the computer . . .

revolution.2

fundamentals42

Most economic historians trace the origins of the MNC back to the seven-

teenth century. The age of exploration was followed by colonization and large-

scale expansions of trade and humanmigration outside of the EuropeanContinent,

trends that gave birth to the first multicountry business enterprises. The British

East India Company and the Dutch East India Company, established as trading

companies in the beginning of the seventeenth century, are generally considered

to be the first version of the MNC as we know it today.3 The Western Hemi-

sphere version of this genre was the Hudson’s Bay Company, recipient of

a monopoly charter bestowed by the British Crown to operate a fur trade

monopoly and establish settlements in the Hudson Bay region of North America.

None of these three enterprises bear much resemblance to the contempo-

rary model because they were formally established by ruling monarchs for the

purpose of enhancing the wealth and power of the home country. The first

generation of MNCs also differed by undertaking overseas operations as soon as

they were chartered, not after compiling a successful business record in the home

country.

With long-distance communication primitive, the two East India companies

received little direct supervision from their home countries. Having been granted

monopoly power and broad authority to develop trade with the Far East as they

saw fit, they often transacted business by brute force more than by commercial

wiles. They were given authority to acquire territory if they deemed it necessary,

maintain their own army and warships, and issue their own currency. At the peak

of their power, these companies acted more like colonial governments than

commercial enterprises. The British East India Company eventually became the

de facto ruler of most of the Indian subcontinent, and its presence extended to

Hong Kong, Burma, and Singapore. The Dutch counterpart controlled regions

in Indonesia and built fortified posts in other locations to protect its Asian trade

routes. For a time, these companies enjoyed enormous profits from exporting

goods such as spices, cotton, silks, tea, and coffee to Western Europe and by en-

gaging in intra-Asian trade. Their propensity for overreach and new competition

eventually contributed to their demise.

Transition to the contemporary version of the MNC hit full stride in the

second half of the nineteenth century, the catalyst being an extended series of

interrelated events hitting critical mass. The Industrial Revolution had reached

its peak, and in its wake widespread changes appeared in the economic landscape.

Large-scale factories began to replace individually owned small businesses. The

sprouting of manufacturing companies forced the liberalization of British cor-

porate law, an approach adopted by other countries. Corporations no longer

needed to secure a royal charter to begin operation. Subsequent changes allowed

them to legally function as an ‘‘artificial person’’ that could issue tradable shares

to investors who would have limited financial liability, that is, they could lose

from obscurity to international economic powerhouse 43

only the money they had invested. As manufacturing spread from Great Britain

to other countries, so, too, did demand for new sources of energy and raw

materials and for varieties of food that the industrializing countries lacked phys-

ically or could not produce efficiently. The increased opportunity for profits

stimulated foreign investments in the primary sector.

An important indirect effect of the Industrial Revolution on the growth of

international business was its significant enhancement of technological capacity

and human skills in the production process. Once created, these two assets

often became the proprietary rights of the owners. . . .They were also

potentially mobile across space, opening up the possibility that firms might

utilize the human and physical assets they generated . . . in one country to

produce goods and services in another.

Taken together, these events heralded a watershed in the history of

international business. The age of merchant capitalism which had domi-

nated international commerce for the previous two centuries was now

replaced by an era of industrial capitalism. . . .Although the [MNC], as we

know it today, did not emerge until later in the 19th century, firms from

Europe and North America began to invest in foreign plantations, mines,

factories, banking, sales and distribution facilities in large numbers.4

As a consequence of the ratcheting up of technological progress and increased

worker skills in the late 1800s, wrote Dunning, ‘‘both the global structure of

value-added activities and the modalities in which goods and services are ex-

changed across national borders have helped push back the industrial and ter-

ritorial boundaries of firms, and have refashioned the competitive advantages of

countries.’’5

The intermediate stage of FDI, which runs roughly from the 1850s through

the 1950s, was created and sustained far more by exogenous events and trends

than calculated corporate planning. The most important changes in the global

commons were major technological advances in transportation and communi-

cations that allowed people, goods, and information to move long distances more

quickly, cheaply, and reliably than ever before. The nineteenth-century inven-

tions of the steam engine and the telegraph, the laying of undersea cables, the

spread of railroads, and the opening of the Suez Canal geometrically enhanced

the ability of corporations to operate and supervise distant operations. A second

stimulant was the gradual escalation of tariffs in the second half of the nineteenth

century in the United States and most European countries other than Britain. A

classic reason for establishing an overseas subsidiary is the need to jump import

barriers imposed by the government of a lucrative foreign market (see chapter 6).

fundamentals44

FDI was simultaneously facilitated by accommodating governmental policies

that placed no significant restrictions on international capital movements. Host

countries were universally amenable to what was still a limited stream of incoming

MNCs, although in some cases openness was a function of a country’s being a

colony with no indigenous government to voice objections.

The exact amount of FDI on the eve of World War I is not known. Gov-

ernments measured only total foreign investment. No need was felt at that time to

make a distinction between the direct and portfolio investments made by their

citizens in other countries because both were viewed as being parts of the larger

process of seeking a greater return on capital. A crude estimate of FDI at that time

is somewhere in the $14.5 to $18.2 billion range. Ownership of overseas

subsidiaries in 1914was heavily concentrated in just five countries. An admittedly

rough estimate puts Great Britain’s share at 45 percent, the United States and

Germany 14 percent each, France 11 percent, the Netherlands 5 percent, and

the rest of the world accounting for the remaining 11 percent. ‘‘Given that a

considerable amount of the service sector investments was concerned with fi-

nancing, insuring, transporting and otherwise making possible international trade

in raw materials and foodstuffs, it can be estimated that at least three-quarters of

world FDI [in 1914] was concerned with the exploitation of natural resources.’’6

In addition to such high-profile companies that would become notorious for the

power they wielded in host countries (Standard Oil and the United Fruit Com-

pany, for example), a growing number of manufacturing companies sought a

secure supply of critical raw materials by buying, among other things, rubber,

tobacco, and palm oil plantations; mines; and cattle ranches in developing coun-

tries. Dunning estimated that more than 60 percent of FDI (by value) in 1914 was

located in developing countries; an important component of this amount was U.S.

investment in mining operations in Latin America.7

The second half of the nineteenth century was notable for the initial ap-

pearance of multinational manufacturing companies. Unlike their counterparts in

the primary sector, these companies shared the pattern of contemporary MNCs:

starting out selling goods in their home country, becoming successful exporters,

and then becoming ‘‘first movers’’ in establishing overseas subsidiaries to en-

hance sales in key foreign markets. In 1855, Siemens built a factory in Russia

to manufacture equipment for a nationwide telegraph network after receiving a

contract from the Russian government. Twelve years later, the Singer sewing

machine company opened a factory in Scotland that is considered to be the first

sustained overseas American manufacturing subsidiary.8 In some ways it can be

considered as the original prototype of the contemporary manufacturing MNC;

Singer’s Scottish factory was built in an effort to maximize direct sales to foreign

customers by taking a step beyond exports and not relying on European licensees.

from obscurity to international economic powerhouse 45

By the turn of the century, Singer probably became the first truly global man-

ufacturer by virtue of also having established factories in Canada, Austria,

Germany, and Russia.

Ford Motor Company opened an automobile assembly plant in Britain in

1908; five years later it had become that country’s largest carmaker.9 In buying

the Opel automobile company in 1929, General Motors can be given credit for

what may be the first recorded cross-border acquisition of consequence. Kodak

opened a factory near London in 1891 to produce film and cameras after its

export efforts in Europe had become so successful that combined international

and domestic demand exceeded the capacity of its headquarters in Rochester,

New York.10 Early in the twentieth century, Lever Brothers expanded beyond

its British base by establishing soap-making factories in three European coun-

tries, the United States, Canada, and Australia.11 A vanguard of manufacturing

companies from France, Switzerland, Germany (mainly chemical companies),

Sweden, and Japan also began establishing production facilities outside their

borders.

As the twentieth century began, the estimated values of foreign trade and

foreign investment (portfolio and direct) as a percentage of world output were at

historic highs. The unprecedented scale of international economic integration,

however, was temporary. Turbulent events in world history intervened to deflate

what potentially was FDI’s coming of age; by most calculations, it was not until

the early 1990s that MNCs returned to the same relative importance to global

gross domestic product (GDP). Two world wars and years of recovery from their

devastation knocked the upward trajectory of commercial economic activity well

off course for many years. A similar effect was experienced between the wars as

the Great Depression shrank economic growth by double-digit percentages in

many countries, and triggered a worldwide adoption of ‘‘beggar thy neighbor’’

policies. Import barriers and capital controls were implemented in a futile effort

to protect jobs at home and export unemployment. The deteriorating interna-

tional economic and political atmosphere encouraged manufacturing and raw

materials companies in sectors with a relatively small number of producers to

shift strategies from expanding production facilities in foreign countries to col-

lusion with competitors to control markets. International cartels spread in the

1930s; their principal attraction was giving participating companies the benefit of

being able to influence prices and output on a global basis without incurring the

growing risks of investing overseas.12 The Soviets’ nationalization of foreign-

owned enterprises following the Russian Revolution and later the formal collapse

of the gold standard in the early 1930s were two additional factors dampening

enthusiasm for new FDI ventures between 1917 and 1939.

In the years after World War I, MNCs in the secondary sector began to more

closely resemble the traits later exhibited by their contemporary counterparts.

fundamentals46

The biggest difference was that prior to the 1970s, overseas subsidiaries of big

manufacturers were too few in number to be seen as a threat to the economies

of either home or host countries. Nor were they portrayed as forerunners of an

economic revolution. In retrospect, we know that in some ways that is exactly

what they were. Although their numbers and profits were not noticeably rising, a

handful of multinational manufacturing companies operating in a limited num-

ber of countries were, by the 1930s, regularly introducing new products at at-

tractive prices, changing consumer tastes, and winning a growing market share in

host countries.

In contrast to minimal growth in FDI activity by the manufacturing sector

during the interwar period, resource-seeking investment increased in Latin

America and Canada (mainly by American companies) and in Asia, the Middle

East, and Africa (mainly by companies based in one of the European colonial

powers). Companies engaged in extractive activities still accounted for a clear

majority of the value of total world FDI on the eve of World War II. This sit-

uation was transitory, like so many others involving international business. The

steep increases after the war in MNCs operating in the secondary and tertiary

sectors would relegate the primary sector to a minority share of the world’s stock

of FDI in the third stage of MNC development.

MNCs at Full Maturity and Full Force

The start of the 1960s saw the full effects of a ‘‘perfect storm’’ of synergistic

forces that triggered a period of unprecedented increases in the amount of FDI

and in the numbers and new forms of MNCs. A new chapter in the history of

FDI materialized by virtue of the relatively sharp increases in the value of foreign

subsidiaries output, the sharp increases in the number of subsidiaries, and the

surge in the value of their output as a percentage of domestic economic output,

that is, world GDP. As seen in figure 3.1, the value (stock) of cumulative inward

FDI hit take-off in the 1960s, and relatively high growth rates continued in the

early years of the new century. The estimated 7,000 MNCs in 1970 more than

quadrupled to about 30,000 in 1990, and then more than doubled to approxi-

mately 77,000 in 2005.13 These trend lines move steadily and sharply upward

only when viewed over a long time horizon. Annual increases in new FDI flows

have demonstrated short-term volatility because of large, sudden shifts in cor-

porate foreign investment commitments or reactions to global economic crises,

such as the two great oil price shocks of the 1970s and early 1980s.

Unfortunately, data are not available to provide detailed, year-by-year insights

on the first two decades of the newest era in the history of FDI and MNCs; there

was little recognition of the utility in documenting their coming of age. The most

from obscurity to international economic powerhouse 47

comprehensive compiler of global FDI data, the United Nations Conference on

Trade and Development (UNCTAD), publishes a database going back only to

1982. Nevertheless, using this as a starting point still produces a dramatic quan-

titative portrait. The dollar value of global FDI outflows recorded by this UN

agency increased about ninefold, from $27 billion in 1982 to $239 billion in 1990;

outflows of $730 billion in 2004 were triple the 1990 level. UNCTAD data show

sales of foreign subsidiaries surging from an estimated $2.8 trillion in 1982 to

$18.7 trillion in 2004. Total recorded assets of these subsidiaries grew seven-

teenfold between these years from $2.1 to $36 trillion.14

The blossoming of the modern MNC post-1960 was brought about by mul-

tiple forces.15 In addition to synthesizing the more important aspects of con-

ventional wisdom, the analysis that follows contains some important causal

factors that have received little or no attention.

The international economic climate in the post–World War II era was infi-

nitely better and more nurturing than the two decades of economic turmoil

following World War I. The tragic historical record of the 1930s provided a very

clear guideline of what not to do, and the costly economic mistakes were not

repeated. A core element of the ensuing Pax Americana was a remarkably suc-

cessful set of policies designed to help rebuild and restore the shattered

10,000

9,000

8,000

7,000

6,000

5,000

4,000

3,000

2,000

1,000

0 1914 1938 1960

Years 1980 1990

6286626.414.5

1,769

2004

8,900

D ol

la rs

( B

ill io

n)

figure 3.1. Estimated global inward stock of FDI. Sources: UNCTAD for 1980 and beyond, various academic estimates for pre-1980 data.

fundamentals48

economies of allies and former enemies alike. The U.S. government provided

generous foreign aid to Western Europe and Japan, kept the American market

open to their exports, and maintained a high tolerance for the discriminatory

import barriers erected by these countries. For their part, the Europeans and Jap-

anese implemented growth-friendly domestic economic policies that com-

plemented the American efforts. Despite the beginning of the Cold War, the

industrialized countries of the U.S.-led bloc enjoyed an unprecedented long-

term run of noninflationary growth during the 1950s and 1960s, a period later

dubbed the golden age of the international economy. With increased prosperity

came increases in corporate sales, profits, exports, and concerns about how to

protect growing foreign markets.

The largest single source of newFDIflows in the 1960s and1970swasAmerican

manufacturing companies opening factories in Western Europe.16 They began

arriving en masse in response to the creation in 1958 of the European Union

(originally called the European Economic Community). The movement to re-

gional economic integration in Western Europe presented foreign companies

with a classic good news/bad news situation. On the one hand, the move to

internal free trade held great promise for above-average economic growth rates in

member countries. On the other hand, the largest regional U.S. export market

was at risk: It was about to be surrounded by a common external tariff that would

put exports from nonmembers at a potentially serious price disadvantage. One

phase of a two-pronged U.S. response to this potential financial hit was to ne-

gotiate deep reciprocal tariff reductions beginning with the Kennedy Round of

trade negotiations. The second was a private sector initiative: history’s largest

surge of FDI designed to leapfrog newly introduced trade barriers. A foreign-

owned factory had the same status as a European firm: It could produce in any

EU country and freely ship its output to all other member countries.

Many U.S. MNCs in important sectors like computers, electronics, motor

vehicles, pharmaceuticals, and machinery established commercially successful—

in terms of rising market shares and profits—subsidiaries in the countries of the

so-called Common Market. The proliferation of American companies on the

Continent was so great that it inspired a best-selling book still discussed today.

The American Challenge, originally published in French by Jean-Jacques Servan-

Schreiber in 1967, galvanized European and world thinking with the warning

that if existing trends were not reversed, the third greatest world economic power

after the United States and the Soviet Union would soon be, not Europe, but

American-owned industry in Europe. Depending on the value judgments of the

individual commentator, the book’s message is variously depicted as a positive

call for closer European cooperation and increased emulation of American

business methods to prevent a serious loss of economic sovereignty, or an agitated

warning of an American scheme to dominate the world economy.

from obscurity to international economic powerhouse 49

Not all regions experienced major inflows of FDI. The three and one half

decades after 1945 were wilderness years for direct investment in the less de-

veloped countries (LDCs). To say that most of them viewed MNCs with great

suspicion is an understatement. Many looked back at bad experiences with ar-

rogant foreign-owned extractive companies. As newly independent countries,

they looked forward to exercising full sovereignty and making a clean break

with their colonial past. Furthermore, widespread preference for extensive and

intensive government involvement in the economy led most LDCs to turn

their backs on free market economic principles and a foreign-owned corporate

presence.

The growing belief that a market-based international economy would only

preserve and widen the North–South income gap culminated in a collective LDC

demand through much of the 1970s that a new international economic order be

created. The system they wanted would have used multilateral intervention by

governments to ensure a sustained increase in the flow of financial resources from

rich to poor countries that was well above what the market mechanism was pro-

viding. Among the specific demands to this end was recognition of the right of

LDCs to expropriate foreign companies (which is accepted in international law)

and the unilateral right to decide if they should pay compensation to the company

whose property had been seized and if so, to unilaterally define what was ap-

propriate compensation (which is not accepted in international law). The effects

of an overtly hostile atmosphere can be seen in the amount of recorded FDI flows

into LDCs in 1970 being virtually zero.17 The other major reason for the geo-

graphical shift of FDI flows from South to North was the surge in direct in-

vestment in the manufacturing sector. For the first time, the cumulative book

value of that sector exceeded that of the relatively stagnant FDI in the primary

sector. The gap has grown ever since.

The slow but steady increase in global FDI flows during the 1970s and 1980s

partly reflected the resumption of overseas direct investments by Western Eu-

ropean nations and Japan, a by-product of their full recovery from the physical

devastation of World War II. The time when U.S. companies accounted for 80

percent or more of new FDI came to an end by 1970 as the result, like most

MNC-related trends, of a changing international economic landscape.The amount

of FDI flowing from the United States did not decline in absolute terms; instead,

the number of companies headquartered in other countries opening overseas

subsidiaries swelled. The first wave came mainly from Great Britain, France, the

Netherlands, and West Germany, countries whose companies historically had

been active foreign investors.

The next wave consisted of construction of overseas subsidiaries by dozens of

Japanese manufacturers that within the span of the 1980s propelled their country

from statistical insignificance to the number two position on the list of MNC

fundamentals50

home countries. Corporate Japan was forced to abandon its postwar reluctance to

rely on foreign assembly line workers, deemed to be less dedicated and disci-

plined than their Japanese counterparts, because of a confluence of events im-

posed on Japan’s corporate chieftains not of their own making. The most

important events were a rising protectionist sentiment in many of Japan’s trading

partners (especially in the United States) kindled by resentment toward its

chronic trade surpluses, rising domestic salaries that had reached the upper

echelon of world wages, and a seemingly endless appreciation of the yen.

The 1990s witnessed record growth in the flows and stock (historical value) of

FDI across a wide geographic front. The collapse of communism and increased

reluctance of banks to lend to LDCs following the Latin American debt crisis of

the 1980s further encouraged countries in Latin America and the Caribbean,

Asia, and to a lesser extent, Africa to embrace market-oriented domestic eco-

nomic policies and to shift from indifference to proactive policies to attract

MNCs. Similar measures were adopted by Central European countries in tran-

sition from planned to market-based economies. These decisions were made

easier by growing empirical proof that a significant statistical correlation existed

between relatively extensive government ownership of the means of production

and involvement in the economy and below-average increases in a country’s

economic growth and productivity. Developing and transition countries con-

tributed to an upward blip in global FDI in two ways: first, by becoming more

open and appealing to foreign companies, and second, by privatizing scores

of state-owned industrial companies and public utilities, many of which were

bought by foreign companies operating in similar sectors.

Later in the 1990s, the volume of FDI hit all time highs in large part due to

a temporary upsurge in mergers and acquisitions (M&As) between companies

headquartered in different countries. Most of this spate of international busi-

ness marriages was attributable in dollar terms to a spike in European acquisi-

tions of U.S. companies. FDI in the form ofM&As soared from an annual average

of about $10 billion in the 1987–94 period to an average of about $65 billion in

the years 1998 through 2003.18 As the century drew to a close, yet another new

source of outgoing FDI emerged, this time from the growing number of elite

companies based in the relatively advanced developing countries (a.k.a. emerging

markets) that increasingly felt the need to move to the next level and establish a

multinational presence. The final years of the century also were the time that FDI

in China grew from negligible in the early 1980s to moderate in the early 1990s to

some $50 billion annually; in 2003, it temporarily surpassed the United States as

the world’s number one recipient of FDI inflows in dollar terms.

A new series of space- and time-shrinking technological advances in trans-

portation and communication has further simplified and reduced the costs of

managing manufacturing and services subsidiaries scattered around the world.

from obscurity to international economic powerhouse 51

Larger ships, cargo containers, cheap and fast travel by passenger and freight

aircraft, fax and telex machines, satellite communications, powerful computers

that rapidly talk to one another, and last but far from least, the Internet collec-

tively brought about what is often called the death of distance. Easy collaboration

among white-collar workers and between production lines thousands of miles

apart became common. In sum, national borders and physical distance have been

marginalized as considerations when corporations calculate the most cost-effi-

cient places to produce their products or offer their services.

Inadequate emphasis has been placed on the economics of high-tech pro-

duction in pressing companies to pursue global production as part of a strategy

to maximize sales. Computer, semiconductor, pharmaceutical, automobile, and

machinery companies typify the extraordinarily high fixed costs (research and

development, factory machinery, and training highly skilled workers) that accrue

to high-tech companies before the first sale of a new product is made. Failure to

achieve economies of scale for these companies brings with it near certainty that

competitors who do so—usually through FDI—will have lower unit costs and

higher profits (see chapter 6).

The intricacy of high technology production largely explains the development

of yet another new form of FDI. Vertical integration occurs where subsidiaries in

various countries produce the many specialized components that are assembled

into sophisticated goods like electronics and automobiles. In these cases, no one

factory can efficiently make all the complex parts needed, the result being that

rising transactions among specialized subsidiaries of the same company is a major

cause of the dramatic increase in intrafirm trade since the early 1980s.

The information and communications technology revolution has further

spurred FDI by unleashing a revolution of rising expectations that arguably has

raised competition to a new level. Never before has the public expected pro-

ducers of computers and consumer electronic devices (e.g., cell phones, personal

digital assistants, digital cameras, and high-definition TVs) to constantly enhance

the performance of these products while simultaneously lowering their prices or

at least keeping them steady. To the extent that bigness equates with cost

competitiveness, multicountry production and sales by fewer and larger MNCs

will be the order of the day in emerging technologies. UNCTAD’s 2002 in-

vestment report explained the new business pressures in these terms: ‘‘Height-

ened competition compels firms to explore new ways of increasing their

efficiency, including by extending their international reach to newmarkets . . . and

by shifting certain production activities to reduce costs. It also results in inter-

national production taking new forms.’’19 In sum, defensive reactions to eco-

nomic realities are part of the reason why virtually every major manufacturer of

capital-intensive commercial goods is or will be an MNC.

fundamentals52

A big boost to the growth of FDI in recent years has come from the services

sector. More services companies are investing overseas because in recent years

there have been steady increases in the number of these companies and in the

kinds of services they provide, especially in informatics and telecommunications.

In addition, a growing number of accounting, law, and advertising firms followed

their clients overseas. Although high-tech is the fastest growing segment of FDI

by services companies, traditional sectors—finance, wholesale trade and distri-

bution facilities, transport, hotels, utilities, and construction—still account for

most of the value of overseas investment in the tertiary sector.

The move to a more liberal international economic order is yet another cause

of the proliferation of MNCs. A steady dismantling of controls on international

capital movements reduced the obstacles to corporate expansion overseas. This

factor is related to the argument that political factors also played a role in creating

and sustaining the proliferation of FDI. Noted political economist Robert Gilpin

has been the chief advocate of the view that MNCs were able to become powerful

actors in international relations only because hegemonic powers, first Great

Britain and then the United States, felt it was in their political and economic

interest that their corporations flourished on foreign soil. ‘‘While economic fac-

tors are obviously important for the emergence and success of MNCs, they could

not exist without a favorable international political environment created by a

dominant power whose economic and security interests favor an open and liberal

international economy.’’20 In addition, leadership exerted by the United States

beginning in the 1950s has been the single greatest force promoting successive

rounds of multilateral trade negotiations that progressively lowered trade bar-

riers. Freer trade was another postwar trend facilitating the conduct of multi-

national business operations.

The Importance of FDI/MNCs

When economic issues are considered to be very important, they cross an invisible

line and attract the attention and concern of senior government leaders. In a

word, they become politicized. The process of FDI and its agents of im-

plementation, MNCs, began moving into the advanced stages of politicization in

the 1970s. This was the time when it was becoming widely understood how

extensively the multinationals were dominating critical systems of the interna-

tional economy: production, technology, finance, trade, and energy and raw

materials. The power and financial stakes involved in the spread of big inter-

national enterprises are so high that the executive and legislative branches of

many countries find themselves directly involved in FDI-related issues. In

from obscurity to international economic powerhouse 53

addition to frequently seeking to attract incoming MNCs, politicians are caught

in the middle of conflicting demands about policies and regulations from two

powerful and committed political forces—one condemning and the other

defending MNCs. Opinions sharply diverge on their costs relative to benefits,

but unanimous consensus exists concerning their importance.

If perceptions define reality, then the FDI/MNCs phenomena have intro-

duced extraordinary, perhaps revolutionary changes to the international order.

The prevailing belief that these phenomena have had an extraordinary impact

in the way goods and services are produced and income distributed is illustrated

by the following arguments:

� MNCs are ‘‘huge organizations with considerable control over economic

resources; they are not just business firms, but the most complex and

most highly developed organizations in world capitalism, operating in the

most important branches and the most highly concentrated sectors of

the economy. . . . [We] should regard MNCs not only as a new feature of

the world economy, but as the emerging new organizational form of that

system in recent decades. (emphasis in the original)’’21

� The increasing importance of MNCs has profoundly altered the struc-

ture and functioning of the global economy. These giant firms and their

global strategies have become major determinants of trade flows and of

the location of industries and other economic activities . . .These

firms . . . have become major players not only in international economic

but in international political affairs as well. . . . [They have created] ‘a

qualitatively different set of linkages’ among advanced economies.’’22

� The preeminence of MNCs ‘‘in world output, trade, investment and

technology transfer is unprecedented.’’23

In statistical terms, the importance of MNCs to the international economy

begins with the fact that for more than twenty years, FDI has regularly grown

faster than world GDP (output) and other macroeconomic measures of activity.

The result is that international production is becoming an arithmetically more

significant component of world economic activity.24 Between 1982 and 2004, the

value added (also referred to as gross product) of foreign subsidiaries worldwide

increased sixfold, whereas world GDP only tripled (as explained in box 3.1, it is

incorrect to compare GDP and sales by MNCs). The value added total in 1982 as

a percentage of world GDP was a little bit above 5 percent; by 2004, it had

doubled to slightly above 10 percent.25

The result of inward FDI becoming an increasingly larger percentage of

virtually all middle-income and advanced national economies is to make it a more

important variable of how well or poorly a country’s workers and businesses fare.

fundamentals54

box 3.1 How Not to Demonstrate the Importance of MNCs

One of the oldest statistical series used to dramatize the size and, by implication,

power of MNCs is to compare their sales with the GDPs of countries. ‘‘Of the 100

largest economies in the world, 51 are corporations; only 49 are countries.’’*

The attention-grabbing technique of claiming corporations are as big as large

countries is not used in this study because it is a seriously flawed puree of statistical

apples and oranges. GDP is calculated on the basis of value added by the private

sector. Otherwise, double counting would seriously exaggerate the value of a

country’s total output of goods and services. Double counting is inherent in cor-

porate sales numbers. By way of example, suppose that Worldwide Widget Corp.

assembles its product from two sets of components supplied by two contractors; each

set costs Worldwide $50 million a year. After adding assembly costs, overhead,

profit, and so on, the company’s final sales come to $125million. That means the net

addition to the country’s overall economic output is only the $25million added to the

value produced by the two contractors; only value added is counted as the widget

company’s contribution to national GDP, not $125million. The $100million in sales

made by the contractors also includes double counting if they used subcontractors.

The proper way to measure the size of MNCs against country GDP is to try to

calculate and then compare value added by corporations, not their final sales. Two

researchers, De Grauwe and Camerman, estimated (based on a sample of high-

ranking companies in the Fortune 500) that the average worldwide value added by

manufacturing and services MNCs in 2000 was 25 and 35 percent, respectively.**

By these criteria, only two of the fifty ‘‘biggest economies’’ in the world were

MNCs; Wal-Mart ranked forty-fourth and ExxonMobil forty-eighth. However,

thirty-five of the second fifty biggest economies were judged to be MNCs. This

methodology puts the MNC-GDP comparison into the proper perspective. On the

one hand, the data in this study show that very few MNCs rank with the biggest

national economies; the U.S. economy in 2000 was 200 times bigger than the

largest MNC ranked by value added, and Belgium was 5 times bigger. When

measured in comparable terms, even the largest MNCs do not rival the larger

economies in size. On the other hand, the data clearly indicate that the largest

MNCs, again by value added, are as big as or bigger than the GDPs of most

medium to small countries. Using slightly different data, an UNCTAD analysis

(World Investment Report, 2002) produced similar results.

* Sarah Anderson and John Cavanagh, ‘‘Top 200—The Rise of Corporate Global Power,’’

December 2000, online document available at http://www.ips-dc.org/reports/top200text.htm;

accessed October 2004.

** Paul De Grauwe and Filip Camerman, ‘‘How Big Are the Big Multinational Companies?,’’

January 2002, online document available at http://www.econ.kleuven.be/ew/academic/intecon/

degrauwe/PDG-papers/Recently_publishedarticles/How%20big%20are%20big%20multination-

al%20companies.pdf; accessed October 2004.

55

Annual recorded inflows and the stock value of FDI both increased more than

tenfold from 1982 to year end 2004, a rate far in excess of the three and a half-fold

growth of world output and the fivefold increase in world exports. If educated

guesses about the value added of MNCs in their home countries are combined

with the estimated value added of their overseas subsidiaries, companies having a

multinational presence probably accounted for between 50 and 80 percent of

the world’s industrial output in the early 2000s.26 As seen in figure 3.2, two key

indicators of FDI increased their share of world GDP by a significant amount in

the relatively brief span between 1990 and 2004. The amounts, value added,

sales, and exports of the overseas operations of the world’s MNCs in years to

come will, more likely than not, continue to grow at a faster rate than world GDP

and trade, a trend that would further enhance the perceived importance of FDI

in the world economy. In view of this growth, critics of FDI/MNCs believe that

they have become excessively important (see chapter 13).

‘‘Why do we focus on FDI?’’ asked a report prepared for the World Trade

Organization. ‘‘The answer is very simple—FDI has become an increasingly

more important factor of economic growth.’’27 The stimulus given to domestic

economic growth by the relatively rapid increases in FDI comes from three

50

45

40

35

30

25

20

15

10

5

0 FDI inward stock

P er

ce nt

Sales of foreign subsidiaries

1990 2004

figure 3.2. Growing importance of Foreign Direct Investment to world economic production, 2004 versus 1990: Key FDI indicators as a percent of global GDP (in U.S.

dollars). Source: UNCTAD.

fundamentals56

directions. An indirect link between inward FDI and economic growth is the

long-term increase in the share of country GDP attributable to inward FDI as

measured by historic, or book, value (see figures 3.3 and 3.4). Figure 3.5 depicts

the growth of inward FDI flows as a percentage of a second important economic

benchmark, domestic investment (gross fixed capital formation).

The growing share of foreign-owned or -controlled subsidiaries in the in-

dustrial production of many countries is a third means of their providing stim-

ulus to domestic economic activity. Byway of example, inmostWestern European

countries, the percentage of industrial production accounted for by FDI in 1998

was in the range of 25 to 30 percent; the figure rose to 70 percent in Ireland and

Hungary.28 Elected politicians also are aware of the contribution incoming FDI

can make to the universal political priority of seeking full employment. MNCs

probably provide work, usually at or above prevailing average salaries, for as

many as 200 million people worldwide in host countries.29 This figure pre-

sumably would generate an annual worldwide payroll in excess of $1.5 trillion.

The importance of FDI and MNCs also can be demonstrated in the corporate

world. Production and sales in more than one country to increase sales and profits

and reduce production costs on a per unit basis has become an essential part of

the business strategy of most large and medium-sized companies. A statement by

a well-known business consultancy speaks pointedly about international pro-

duction being something between a priority business strategy and literally a

30

25

20

15

10

5

0 Developing Countries

1980

P er

ce nt

World

Region Developed Countries

2004

figure 3.3. Inward FDI stocks as a percent of gross domestic product, by country category, 1980 and 2004. Source: UNCTAD.

from obscurity to international economic powerhouse 57

means of corporate survival: ‘‘Globalization is no longer merely an option but an

imperative.’’30 A scholarly study reached a similar conclusion: ‘‘For the major

MNCs . . . overseas activity is no longer (if it ever was) marginal to corporate

operations . . . but rather is increasingly central.’’31

The importance of FDI/MNCs to economic development (see chapter 8)

is demonstrated by the statistic that FDI has been the largest single source of

external finance, that is, access to hard currency, for the more advanced devel-

oping countries since the early 1990s.32 (Foreign aid and workers’ remittances

are more important for poorer, relatively less developed countries.) Estimated

net capital flows to LDCs in 2002 were $175 billion; of this amount, $147 billion,

or 84 percent, was FDI, an amount far in excess of net official development

assistance (foreign aid) flows of $21 billion.33 Looking at aggregates in this case

is misleading because of asymmetries. The poorest, least developed countries

receive disproportionately little FDI inflow, whereas China, at about $50 billion

annually, receives a disproportionately large share (it can be as much as one-

third) of annual FDI flows going to all countries classified as developing.

The importance of FDI/MNCs to international trade can be quantified in

several ways. MNCs and their subsidiaries account for about two-thirds of

the world’s trade in merchandise.34 Large firms use FDI more than they use

150

135

120

105

90

75

60

45

30

*** 15

0

Si ng

ap or

e

Ire lan

d

Ne the

rla nd

s

Hu ng

ary

Sw itz

erl an

d

M ala

ys ia

Un ite

d K ing

do m

Br az

il

Ch ina

Ge rm

an y

Un ite

d S tat

es Ja

pa n

1980

* At or near zero

P er

ce nt

Country2004

figure 3.4. Inward FDI stocks as a percent of country GDP, 1980 and 2004. Source: UNCTAD.

fundamentals58

exports—by a factor of 1.5 (half again as much)—to sell to foreign markets.35 At

an estimated $17.6 trillion in 2003, sales of foreign subsidiaries worldwide were

almost twice as large as world exports of goods and services and almost one-half

the size of world GDP.36 In many countries, the volume and product compo-

sition of exports has been radically altered thanks to overseas shipments by

foreign-owned companies (see chapter 9).

Finally, FDI/MNCs are at the core of the very big and very controversial process

of globalization (see chapters 5 and 13). Their importance in this case can be sum-

marizedwith the observation that the process of FDI and the proliferation ofMNCs

are second to none as a leading cause of the globalization of economic activity and

all the good and bad things—real and perceived—that flow from this trend.

Notes

1. Geoffrey Jones, The Evolution of International Business (New York: Routledge, 1996),

p. 23.

2. John H. Dunning, Multinational Enterprises and the Global Economy (Wokingham,

UK: Addison-Wesley, 1993), pp. 133, 132.

3. It can be argued that the Medici Bank, which established branches in several Euro-

pean countries in the fifteenth century, was the first MNC.

4. Dunning, Multinational Enterprises p. 99.

10

8

6

4

2

0 World

1970

P er

ce nt

Developed Countries

Region Developing Countries

2004

figure 3.5. Inward FDI flows as percent of gross fixed capital formation, 1970 & 2004. Source: UNCTAD.

from obscurity to international economic powerhouse 59

5. Ibid., p. 603.

6. Jones, Evolution of International Business pp. 29–32.

7. Dunning, Multinational Enterprises p. 118.

8. The Colt firearms company established a subsidiary in Britain in 1852 to make guns,

technically making it the first American-owned overseas manufacturing subsidiary.

However, it did not become profitable and within a few years was sold to local

interests.

9. John Micklethwait and Adrian Wooldridge, The Company (New York: Modern Li-

brary, 2003), p. 169.

10. Source: http://www.kodak.com; accessed February 2005.

11. Source: http://www.unilever.com; accessed February 2005.

12. Jones, Evolution of International Business pp. 41, 44, and 124.

13. Data sources: Medard Gabel and Henry Bruner, Global Inc.—An Atlas of the Mul-

tinational Corporation (New York: New Press, 2003), pp. 2, 3; and UNCTAD, World

Investment Report 2006, p. 10, available online at http://www.unctad.org; accessed

October 2006.

14. Data source: UNCTAD, World Investment Report 2005, p. 14.

15. See, for example, Robert Gilpin, U.S. Power and the Multinational Corporations (New

York: Basic Books, 1975), pp. 3–19; Theodore H. Cohn,Global Political Economy, 2nd

ed. (New York: Longman, 2003), p. 326; Dunning, Multinational Enterprises chap. 5;

and Jones, Evolution of International Business pp. 23–24.

16. Previously, U.S. investment in Canada was probably the largest single flow of FDI.

17. Data sources: Stephen Thomsen, ‘‘Investment Patterns in a Longer-Term Perspec-

tive,’’ April 2000, available online at http://www.oecd.org; accessed February 2005;

and Yu Ching Wong and Charles Adams, ‘‘Trends in Global and Regional Foreign

Direct Investment,’’ August 2002, available online at http://www.imf.org; accessed

February 2005. FDI going into LDCs increased to an annual average of $20 billion

during the 1980s.

18. UNCTAD, World Investment Report 2004, p. 336.

19. UNCTAD, World Investment Report 2002, p. 4.

20. Robert Gilpin, Global Political Economy (Princeton, NJ: Princeton University Press,

2001), p. 288.

21. Volker Bornschier, ‘‘Multinational Corporations in World System Perspective,’’ in

Imperialism and After—Continuities and Discontinuities (London: Allen and Unwin,

1986), pp. 243, 242 emphasis in original.

22. Robert Gilpin, Global Political Economy—Understanding the International Economic

Order (Princeton, NJ: Princeton University Press, 2001), p. 290.

23. David Held, Anthony McGrew, David Goldblatt, and Jonathan Perraton, Global

Transformations (Stanford, CA: Stanford University Press, 1999), p. 282.

24. UNCTAD, World Investment Report 1997, p. xvi.

25. Data calculated from table 1.3, UNCTAD, World Investment Report 2005, p. 14.

26. See, for example, Raymond Vernon, Louis Wells Jr., and Subramanian Rangan, The

Manager in the World Economy, 7th ed. (Upper Saddle River, NJ: Prentice Hall, 1996),

p. 28; and ‘‘TheWorld’sViewofMultinationals,’’TheEconomist, January 29, 2000, p. 21.

fundamentals60

27. Zdenek Drabek and Warren Payne, ‘‘The Impact of Transparency on Foreign Direct

Investment,’’ World Trade Organization Staff Working Paper ERAD-99-02, No-

vember 2001, available online at http://www.wto.org; accessed November 2004.

28. OECD, Measuring Globalisation, vol. 1, 2001, p. 13.

29. This guesstimate was derived by multiplying the 700,000 foreign subsidiaries esti-

mated to exist in 2004 by a rough guess of an average of 300 workers per subsidiary.

30. BostonConsultingGroup, ‘‘CapturingGlobalAdvantage,’’ April 2004, available online

at http://www.bcg.com; accessed December 2004.

31. Held et al., Global Transformations p. 271.

32. Linda Goldberg, ‘‘Financial-Sector Foreign Direct Investment and Host Countries:

New andOld Lessons,’’ Federal Reserve Bank ofNewYork Staff Report no. 183, April

2004, available online at http://www.newyorkfed.org/research/global_economy; ac-

cessed October 2004.

33. World Bank, Global Development Finance 2004 p. 8, available online at http://

www.worldbank.org; accessed January 2005.

34. UNCTAD, World Investment Report 2002, p. 153.

35. UNCTAD, World Investment Report 1998, p. 5.

36. UNCTAD, World Investment Report 2004, p. 9.

from obscurity to international economic powerhouse 61

4

heterogeneity The Many Kinds of Foreign Direct Investment and Multinational Corporations and Their Disparate Effects

The heterogeneity and diversity of foreign direct investment (FDI)and multinational corporations (MNCs) are not compatible with the generalizations that dominate the conventional wisdom about them. This

chapter begins with a defense of this transcendent theme by arguing that FDI

and MNCs can be divided into so many distinct formats that they cannot

conform either to a single model of behavior or to a uniform checklist of effects.

Emphasis is placed on the importance of their multifaceted and variable nature.

The second and third sections of the chapter consist of a straightforward exercise

in disaggregation. The common tendency of those speaking about FDI and

MNCs to give them a universal persona, good or bad, has blurred the real nature

of these phenomena behind a fog of generalization.

Viewed as a whole, the chapter also seeks to defend a second transcendent

theme: the balance between costs and benefits of FDI andMNCs should primarily

be calculated on a disaggregated basis to adjust for the different forms that they

take. The relatively lengthy discussion that follows of the many different kinds of

international business phenomena lays out their distinctive behavior patterns and

mixed record of effects on countries’ economies, people, companies, and the en-

vironment. A methodology based on making an all-inclusive pronouncement on

what are portrayed as homogenous entities is inadequate and misleading.

The Implications of Diversity

The terms FDI and MNC for the most part appear in the public domain at

relatively high levels of generalization. It is common for people to form a pro or con

62

view of them on the basis of a generalized judgment, declaring that ‘‘they are what

they are.’’ This is oversimplified reasoning sustained in large part by the con-

tinuing failure of government officials, business executives, nongovernmental or-

ganizations, scholars, and journalists to explicitly recognize the seemingly obvious

points that these phenomena are not all alike and that important implications flow

from this reality. Deep insights into the nature and impact of FDI and MNCs will

not be forthcoming if they are treated as generic terms for a kind of investment

strategy and a kind of business entity, respectively. Neither FDI nor MNCs as

entities are monolithic. As a group, foreign subsidiaries share only two major traits.

Physically, they all transact business in at least one country outside the one in which

they are headquartered. Strategically, they all have been established to strengthen

the parent company in some way and to avoid being a financial failure.

Making the assumption that all forms of FDI and all kinds of MNCs are

homogenous is to take a wrong turn in the journey to an accurate understanding

of their diverse nature and effects. Their intrinsic heterogeneity means that, if

evaluated separately, the 77,000 multinational companies that operate 770,000

individual foreign subsidiaries and affiliates mentioned in the previous chapter

would be scattered along two vast continuums. One would be for home countries

and the second for host countries. Each would measure a range of effects from

very positive to very negative, with a large gray area in between. If we can get

more and better data than currently exist, an elaborate matrix could be con-

structed in which the vertical axis would portray the distinctive kinds of FDI and

MNCs described in the next two sections. The horizontal axis would portray the

quality of various behavioral patterns of inward direct investment; the main

criteria for judging quality are the ripple effects on the host country’s economy,

financing arrangements, level of job skills, propensity to export and import,

likelihood of technology transfer, and environmental impact. Because every in-

vestment has some distinguishing features, when the many possible kinds of

investments and multiple levels of quality are factored in, an individual overseas

subsidiary could have any of dozens of profiles.

Unfortunately, the magnitude of the depth and breadth of heterogeneity is

usually underemphasized or ignored outright by opinion makers of all political

persuasions. Sometimes failure to give appropriate weight to this factor reflects

a speaker or author’s narrow frame of reference, for example, implications of

multinationals for unions and the impact on less developed countries (LDCs). In

other cases, people with their minds firmly made up about MNCs being good or

bad things may not wish to be bothered with nuance and details. Overgeneral-

ization may also reflect unfamiliarity with the ever expanding kinds of services

being offered on a transnational basis. Accountants, brewers of beer, restaurant

chains, discount retailers, and employment agencies were not part of the early

wave of MNCs that set the terms of the debate that still exists. The large number

heterogeneity 63

of industrial sectors engaged in transnational operations is suggested by the

twenty-two specific types of manufacturing industries and twenty-six specific

kinds of services industries listed in the United Nations Conference on Trade

and Development (UNCTAD) industry guide to its FDI data.1

The often oversimplified processing of information has been a contributing

factor to a debate waged since the 1970s that is at once spirited, fascinating, and

frustrating. Admittedly, the dividing line is blurred between excessive general-

izations and the proper level of specificity when analyzing FDI and MNCs. The

problem remains, however, that on balance, past efforts to bridge the perceptions

gap have generated far more heat than light. A single, one-size-fits-all pro-

nouncement on the net positives or net negatives of all MNCs in every country

opens itself to suspicion that it is more the outcome of selective data collection in

support of a preexisting value judgment than a painstaking, open-minded ex-

ercise in inductive reasoning. In any situation, different inputs can be expected to

produce different outputs. The bottom line is that the quality, that is, the net

economic benefits to the host country, of a foreign-owned subsidiary will vary on

a case-by-case basis (this argument is developed in detail in chapter 14). The

behavior and effects of any given foreign investment project may warrant effusive

praise, strong condemnation, or the label of a wash between good and bad. This is

the result of the inevitability of heterogeneity and the fallacy of generalization.

The proper answer to the question of whether an individual foreign subsidiary is

of high quality or low quality is: ‘‘it depends.’’ Too many pronouncements on the

advantages and disadvantages of FDI and MNCs have been made after looking at

them as undifferentiated wholes.

The logic of a gray-area conclusion about net desirability is consistent with

the underlying fact that corporations per se are idiosyncratic. Corporate cul-

ture really does vary from company to company; it is not a theory only found in

readings assigned by business school professors. Large companies do not adhere

to a single standard operating procedure beyond the most basic legal and regu-

latory guidelines and the financial imperative of avoiding perpetual losses. Every

company has created a unique mosaic of priorities, procedures, traditions, and

standards that mirrors its weaknesses, strengths, successes, failures, operating

philosophies of past and present senior managers, product mix, and so on. Cor-

porate culture will reflect the extent to which it has grown from within or been

built by mergers and acquisitions (M&As). A study, conducted by the MIT

Industrial Performance Center, of how MNCs compete added a number of

additional variables that individualize corporations’ strategic and tactical ap-

proaches to business: the institutions and values in a company’s country of origin;

the aggregate learning experience derived from customers, suppliers, and rivals;

and the know-how and skills gained from solving problems of survival, renewal,

and growth. The report added that the history of a company shapes the way the

fundamentals64

owners and managers structure their organization, and it influences corporate

strategies and the way they are implemented. In some cases, a corporation’s

operational DNA reflects ‘‘accidents of history.’’2

The existence of so many variables allows for a very large number of varia-

tions as to how a company goes about establishing and then reviewing its de-

gree of decentralization, guidelines on personnel evaluation and promotion, lines

of communication between different layers of hierarchy, importance attached to

current profits versus long-term growth and community service, marketing

strategies, optimal extent of product diversification, and so on. Tolerance for risk

and the premium placed on continuous product development vary from company

to company. Dissimilar corporate cultures also account for variations in two

key international areas of decision making: (1) where and how much to invest

overseas, and (2) the degree of control exerted over overseas subsidiaries by

headquarters-based executives.

Additional data and improved methodology would permit a more complete

and accurate understanding and evaluation of FDI and MNCs, a desirable goal

given their status as increasingly powerful global forces. A big step in this di-

rection is to distinguish between the many kinds of overseas business production

and examine their (usually) distinctive mix of beneficial, disruptive, and neutral

qualities. The method of disaggregation employed in the next two sections

cannot demonstrate absolutes because the subject matter cannot be reduced to

absolute, irrefutable facts and figures. The taxonomy that follows represents

an imperfect effort to differentiate between the two components of international

business production, FDI and MNCs. Airtight compartments cannot always be

constructed within and between these two symbiotic, often overlapping phe-

nomena. Some readers may perceive occasional arbitrary or incorrect classifica-

tions in the sections that follow. Occasional disagreements and author error need

not damage the creditability of the larger, more important ideas about hetero-

geneity to be developed here.

Identifying and Classifying Different Forms of FDI

FDI is defined as a financial phenomenon that takes place whenever a company

acquires 10 percent or more of the voting stock in a commercial entity incor-

porated in a foreign country. A key assumption is that this magnitude of in-

volvement will allow the investor to actively participate in management decisions

on a long-term basis. Beyond this solitary universal requirement, FDI is anything

but a uniform process having uniform results. Diversity can literally be cross-

referenced. The various criteria by which different kinds of FDI can be identified

and classified are presented roughly in the order of most general to most specific.

heterogeneity 65

The former need to be further disaggregated to identify important second-stage

variables, which influence and occasionally determine the idiosyncratic behavior

and effects of individual foreign subsidiaries.

By Objectives of/Motivations for Establishing

a Foreign Subsidiary

All of the different kinds of FDI share a common genesis: the decision by cor-

porate executives that prospective financial rewards outweigh the projected costs

of launching an overseas subsidiary. The means to achieve this common end

differ according to the nature of each individual company. Each of the four

subcategories of business objectives that follow tends to demonstrate distinctive

characteristics and effects. Each has a distinctive set of likely assets and liabilities.

Will a new subsidiary engage in strip-mining or operate a sophisticated research

and development (R&D) facility with highly paid, skilled workers? A perceptive

host government should be able to anticipate with reasonable accuracy many of

the trade-offs associated with an incoming FDI project simply by looking at what

path it will take to produce financial rewards for the parent company.

Resource-Seeking FDI The first sustained, wide-scale FDI materialized in the second half of the nineteenth century. The dominant players were natural

resource-seeking enterprises that extracted minerals and metals, such as oil, gold,

and copper, or harvested tropical commodities, such as bananas and rubber.

Resource-seeking FDI accounted for a majority of worldwide FDI until after

World War II. Decisions on country locations of these kinds of investments were

and still are determined in the first instance by geology and climate: the physical

questions of where minerals and metals are located and where are the most

favorable climactic conditions for crop growth. Secondary factors in MNC de-

cisions on where to extract natural resources include the quality of the trans-

portation infrastructure, accessibility of the rawmaterials, and the extent to which

political officials accommodate foreign companies by providing good governance,

favorable tax and regulatory policies, and the rule of law.

Relative to manufacturing and services, the reputation of MNCs in the pri-

mary sector is poor, to say the least. Their alleged callous disregard for the peoples

of host countries has attracted a disproportionately large share of the total crit-

icism and negativism leveled against FDI as a whole. Part of the explanation for

this is the geographic fact that the vast majority of extractive FDI has taken place

in LDCs, virtually all of which were colonies at some point in their history (many

until the 1950s and 1960s). The resulting North-to-South investment axis partly

explains why companies in the primary sector often have been labeled as

neoimperialists. In addition, they have a long record of being accused (often for

fundamentals66

good cause) of such misdeeds as preferring collusion to genuine competition,

trying to bypass or undermine host countries’ governments when they got in the

way, conspiring to minimize royalty payments to governments for raw materials

extracted and sold abroad, and polluting the environment (see chapter 13).

Another distinguishing characteristic of resource-seeking FDI is the lack of

intention to sell its output in the host country’s market. The underlying business

objective is to export the extracted raw materials to feed the North or to fuel its

industrial machine. A third commonality within this sector has been the absence

of any measurable damage to the economies of the countries in which resource-

seeking MNCs are headquartered. The nature of the latter’s output precludes the

losses of either jobs (hence, the absence of significant barriers to the import of raw

materials in the major consuming countries) or exports in these home countries.

The debates about the net trade-off between costs and benefits for primary sector

investment are directed solely to its impact on host countries in the South, not on

rich home countries in the North. Among the few certain answers about that

trade-off is that it is has differed over time and on a product-by-product and

country-by-country basis. More assertive governments, intensified threats of ex-

propriation, and more media attention given to criticisms of corporate behavior

explain the trend toward LDCs gradually but steadily increasing their overall

share of the financial benefits from resource-seeking investments.

The gross benefits to host countries can be assessed with relative precision;

they equate to the foreign exchange income obtained from oil companies, mining

companies, and the like. In many cases, these earnings have been considerable

both in absolute terms and relative to GDP size. Efforts to calculate net benefits

are clouded by variables on the other side of the equation that cannot properly be

answered with generalizations. To what extent have these revenues been spent

to directly benefit the public well-being? Has a ‘‘fair’’ price been received for a

nonrenewable resource? Has there been a fair mark-up between the price of a raw

material, such as coffee beans, and the final retail price in Northern markets? Has

environmental damage resulted from mining, drilling, or farming operations, and

if so will the MNCs responsible fully pay for cleanups?

Market-Seeking FDI Establishing an overseas subsidiary to protect or expand a foreign market is an example of market-seeking FDI. The typical sequence of

events is that this kind of investment is the second phase of marketing strategy that

follows an initial effort based on exports. The rapid post–World War II growth of

direct investment inside the industrialized countries can largely be linked to a

geometric increase in corporate perceptions that export-based marketing strategies

had peaked or were at risk because of changing conditions in the foreign market. In

sum, the dependence by major corporations on exporting as the primary means of

selling to foreign customers has diminished, presumably on a permanent basis.

heterogeneity 67

The core assumption behind market-seeking FDI is that for both defensive

and proactive reasons, the best way to sell to existing and potential customers in a

foreign country or region is by having production facilities physically close to

them rather than by exporting from thousands of miles away. Defensive con-

siderations include rising competition from locally owned producers, the arrival

of subsidiaries from third-country MNCs, erection of new import barriers, and

projections of a steady appreciation in the exchange rate of the home country’s

currency. Proactive reasons begin with the potential for reductions in trans-

portation time and costs, an especially attractive option for large, bulky, or heavy

products. In addition, ‘‘being there’’ improves the likelihood that the investing

company will be better attuned to sensing how and when to modify a product

to accommodate changing tastes of local consumers and to anticipating future

changes. Being there also aids a company’s efforts to portray itself as a home-

grown operation that is providing jobs and economic stimulus to the local

economy.

The geographic focus of market-oriented FDI is large, affluent, and growing

markets. The inherent logic of adding production facilities in lucrative markets

explains why FDI since the 1960s has mainly flowed into the relatively few rich

industrialized countries (see chapter 7). Market-seeking FDI is exhibit number

one in contradicting the antiglobalization camp’s contention that venal multi-

nationals naturally gravitate to countries with the cheapest, most exploitable

labor and the least enforced environmental protection regulations. The average

consumer goods-producing MNC wants customers. The average capital goods-

producing MNC needs skilled labor. The best place to find both is in the in-

dustrialized countries. Nevertheless, it is still necessary to heed an often repeated

theme of this book that evolutionary change in FDI is a constant, and it cannot be

ignored. Industrialized countries are in the process of losing their virtual mo-

nopoly on incoming market-seeking FDI. China is the prime example of an

emerging market with sufficient current and future consumer buying power to

convince hundreds ofMNCs to expand beyond an export strategy for that country

and move up to the next phase.

Market-seeking FDI has the potential to provide more benefits to host

countries than any other form of incoming direct investment. Market-seeking

MNCs typically bring with them much more than the capital needed to build and

equip a factory. They also will bring, in various degrees depending on circum-

stances, advanced production technology, marketing know-how, and most likely,

the environmental protection technologies used in their plants elsewhere. Fur-

thermore, a market-seeking subsidiary tends to do well in creating relatively high-

skilled jobs and generating additional tax revenue. It tends to be above average in

forging links with the local economy to fulfill needs for components and business

services. Market-seeking MNCs might force competing local companies to

fundamentals68

produce more efficiently, improve product quality, and lower prices. Alterna-

tively, incoming foreign manufacturers might bankrupt local competitors, in-

crease unemployment, and allow foreign-owned companies to acquire a near or

full monopoly on certain goods and services. Which will it be? It depends on

individual circumstances.

The effects of market-seeking FDI on the home country further exemplify the

appropriateness of the ‘‘it depends’’ response. Negative effects would be in-

consequential if one accepts as true the long and often repeated corporate

assertions that this strategy is overwhelmingly defensive in nature. Outsiders

seldom, if ever, have presented a convincing case that they knew better than

experienced corporate officials that for any of various reasons (see chapter 6),

their ability to serve a market by exporting had peaked and faced a clear and

present danger of steady decline. If exporting is destined to lose its viability as the

primary overseas marketing strategy for a particular company, the home country

in such a case presumably would at least benefit from remittances of profits from

newly established overseas subsidiaries. Conversely, if the danger of declining

overseas market share was exaggerated, the home country might well have

unnecessarily lost jobs and export revenues in that instance. Establishment of a

new foreign subsidiary may result in increased net exports from the home country

in the form of components, assembly line machinery, and models of the product

that won’t be produced in the new subsidiary. However, this rosy scenario will

materialize only in some cases.

Efficiency-Seeking FDI A third common motivation to invest overseas re- volves around the quest to reduce costs of production. Efficiency-seeking FDI is

quite distinct from the two previously discussed business motivations and

therefore produces distinctive behavioral patterns and economic effects. The first

of two principal rationales for this kind of FDI involves establishing a subsidiary

in a low-wage country. Relatively low-paid workers tend to be low-skilled work-

ers. However, if they possess a work ethic, they can be and are cost-effective when

producing low-tech, labor-intensive goods (apparel and footwear, for example) or

assembling goods having a mature, that is, standardized and unchanging tech-

nology (radios and analog television sets, for example). The second major ratio-

nale for efficiency-seeking FDI is to achieve economies of scale. As will be

discussed in chapter 6, pressure to minimize per unit costs of capital-intensive

goods having very high upfront development and manufacturing costs explains

the urgency that high-tech MNCs attach to successfully selling these goods in

every national market of any significant size.3

Efficiency-seeking direct investments are a close proxy for a debate on the

virtues of free markets. They have the potential to provide significant benefits by

increasing the efficiency of global resource allocation. Yet this kind of FDI and

heterogeneity 69

free markets also can inflict hardship on specific groups in what some regard as

the overly aggressive drive to provide financial rewards for corporate executives

and the relatively few owners of capital. The number one grievance against FDI/

MNCs by unions in industrialized countries has been the allegedly growing

tendency of employers to reduce labor costs by shutting down production in

the home country and moving it to LDCs—or threatening to do so. Job shifts

to foreign subsidiaries in lower wage countries have been most lambasted in the

United States, but they also have occurred in Japan (mostly to other Asian

countries) and Germany (mostly to Central Europe). No data exist to definitively

test the standard corporate riposte that their ability to remain in business would

have been put at risk if they continued relying on relatively high-priced labor in a

globalized world of efficiency-seeking competitors. Nor are there conclusive data

to validate labor’s claims that significant increases in aggregate unemployment can

be linked directly to outward FDI.

MNCs seeking to cut production costs are attracted by differences in factor

endowments, most notably an ample labor supply. In such cases, incoming FDI

will tend not to raise the overall skill or income levels of the labor force. The

benefits will come in providing additional jobs, at or above prevailing wage levels,

to countries likely to have relatively high rates of unemployment and underem-

ployment. Cheaper labor, however, is not always the main objective. If a sub-

sidiary is turning out state-of-the-art high-tech goods, relatively high-wage jobs

will be created in host countries.

Whether the objective is highly skilled labor, very cheap labor, or strategic

geographic location, this form of FDI has an above-average likelihood of gen-

erating increased foreign exchange earnings for host countries. An efficiency-

seeking subsidiary is not ordinarily established to serve a single national market.

Many are specifically designed to be export platforms. The statistic that U.S.-

owned subsidiaries in Ireland export more than 95 percent of their output in that

country epitomizes the export-platform/efficiency-seeking model of overseas

investment.4 One study of the overall impact of FDI on LDCs found that in

addition to increased foreign exchange, efficiency-seeking FDI ‘‘is more likely to

bring in technology and know-how which is compatible to the host countries’

level of development, and enables local suppliers and competitors to benefit from

spillovers through adaptation and imitation. . . .As a result, one would expect a

relatively strong growth impact of . . . efficiency-seeking FDI.’’5

Strategic Asset-Seeking FDI A relatively specialized and infrequent moti- vation for engaging in FDI is to acquire some or all of the assets of a foreign com-

pany to enhance the purchasing corporation’s competitiveness, either through

increased synergy or less competition. The business objective in this case is not to

reduce costs or protect specific markets. Instead, it is to acquire assets that are

fundamentals70

perceived to be capable of strengthening the overall competitive position of the

acquiring company or weakening that of competitors.6 Acquisition of strategic

assets may allow a company to swallow a competitor, broaden its product line,

upgrade the technology embedded in its products, or prevent a third company

from acquiring the purchased assets. This form of direct investment has no

inherent advantages or disadvantages (except possibly to reduce competition)

of significance for either the host or home countries as a whole. If this kind of

transaction successfully achieves its commercial goals, the main beneficiaries

most likely will be the shareholders of the acquiring company.

By the Role in the Parent Company’s Global

Production Strategy

A second kind of FDI can be defined in terms of which of two broad production

strategies a foreign subsidiary is designed to contribute. In the manufacturing sec-

tor, the most common form of FDI is characterized as horizontal. This term refers

to a horizontal transfer of a portion of home country production to overseas

subsidiaries for the purpose of strengthening the firm’s global competitive position.

The potential benefits to the host country’s economy would be similar in most

cases to those previously attributed to market-seeking FDI.

An initial reduction in exports of the finished products whose manufacture has

been shifted out of the home country is the norm. But in the medium to long

term, the home country’s total exports would not automatically decline by the

amount of production that had moved overseas. Given the sharp increases in

intracorporate trade experienced by the two biggest MNC home countries, the

United States and Japan, the chances are good that the initial export loss will be

partly or totally offset by increases in exports of other products from the home

country. As already noted, overseas subsidiaries can trigger increased shipments

of components of the product now being made overseas, capital equipment and

replacement parts to be used on the new subsidiary’s assembly line, and com-

plementary models manufactured only in the headquarters country that will be

marketed by the overseas subsidiary. In a similar vein, some domestic jobs will be

eliminated when production lines are shifted overseas, yet the aggregate number

of unemployed workers need not necessarily rise. The affected workers might

simply be assigned to making other goods produced by the same company.

Alternatively, they might find comparable or even better jobs elsewhere, a rel-

atively common occurrence in a growing economy. The closing of a given pro-

duction line (for any reason) may or may not result in a net loss of jobs on a

nationwide basis; total employment depends mainly on the business cycle.

Vertical FDI has been the faster growing subcategory of production strategy

since the 1980s. This is due to the increasing technical complexity of a wide range

heterogeneity 71

of manufactured goods, most notably automobiles and information technology

hardware. Advances in communications, data transmission, and transportation

have allowed the business strategy known as global production networks and ver-

tical integration to thrive and operate at high rates of efficiency. Technological

progress is responsible for the growth of vertical FDI beyond its original phase in

which oil and other resource companies extracted raw materials and exported

them to company-owned facilities for processing.

The most common version of vertical FDI is dividing the manufacturing

process into segments in which various parts of a finished product are made by

two or more subsidiaries in two or more countries anywhere in the world. For

example, as components become more numerous and more complicated to design

and manufacture, automakers increasingly designate individual subsidiaries to

specialize in making engines, transmissions, and so on. Geographic specialization

exploits cost advantages in different countries for different products. In eco-

nomic jargon, companies are minimizing production costs by taking advantage of

international factor-price differentials, a core concept of the law of compara-

tive advantage. Capital-intensive goods and high-skilled services mainly will be

produced in capital and skilled labor-rich developed countries. Labor-intensive,

low-tech products and simple assembly work will be assigned to subsidiaries in

poorer countries with relatively low labor costs. The spread of global production

networks is praised in some quarters as elevating the efficient use of the world’s

resources to a new level.

Vertical FDI is inherently trade-creating. Intracorporate trade blossoms

as intermediate goods are exported from various countries either to the home

country or to a third country for final assembly. As parts, components, and raw

materials move back and forth in a highly complex global production network,

the ‘‘traditional connection between production and market is broken.’’7

Export processing zones (EPZs; also referred to as free trade zones) are a

common player in vertical integration. EPZs have been established almost exclu-

sively by LDCs. MNCs operating subsidiaries in EPZs usually do so for the

purpose of exporting labor-intensive goods to other subsidiaries of the parent

company. Incentives to build a subsidiary in an export zone, which is usually phys-

ically separated from the rest of the country, include exemptions from import

barriers, most business regulations, and some or all corporate income taxes.

Method of Establishing a Foreign Subsidiary

Another kind of FDI can be identified on the basis of how a foreign subsidiary or

affiliate has been established. Once again, disaggregation is appropriate to des-

ignate the options available to MNCs. And once again, each of three distin-

guishable options has its own characteristics and brings its own cost-benefit ratio

fundamentals72

to the table. The vast majority of new FDI has originated either as greenfield

investments or through M&As. The former involves incorporating and building

a brand new local company, hypothetically involving construction of new facility

on an open, grassy field. The latter involves acquisition by a foreign-based

company of management control over an existing company in the host country; it

does this through the purchase of voting stock in the local corporation. Alter-

natively, the transaction could involve a mutual transfer of stock to consummate a

formal merger of equals located in two countries. M&As emerged only in the

1990s as a consistently significant percentage of new FDI, presumably because a

growing number of companies were nearing the limits of further growth from

within. The larger M&A deals thus far have mostly been between big European

and American companies. (There is no way to know whether the relatively recent

upsurge in M&As relative to greenfield investment is a temporary or long-term

change in corporate strategy.)

The third means of establishing a foreign subsidiary is via privatization. The

purchase of a government-owned industry, utility, transportation system, and

so on is a by-product of the shift in the 1990s toward free market policies by

developing countries in Asia, Latin America, and Africa, as well as in formerly

communist countries in transition from command to private enterprise-based

economic systems. In economic terms, privatization differs from M&As in that

the seller is the government of what becomes the host country and the buyer

acquires an entity for whom profits were not a priority goal (or necessity). Unless

renationalized, an entity can only be privatized once. Any further transfers of

ownership would be between two private companies and fall into the commercial

M&A category.

The most important difference in economic impact between incoming FDI

taking the form of greenfield plants and incoming FDI via M&As or privatization

can be summed up in one word: incrementalism. A takeover of an existing business

entity does not initially create the incremental economic activity, jobs, and tax

revenue in host countries associated with greenfield investments. Mergers, take-

overs, and privatization at the outset involve only a change in ownership. Though

the foreign company may later decide to expand output in its newly acquired

foreign subsidiary, it might first go on a cost-cutting offensive that reduces the

local payroll by a considerable margin. This is the likely scenario when a foreign

company acquires a poorly managed, money-losing company. The new property

in such a case tends to be viewed as a candidate for a corporate ‘‘makeover’’

incorporating better management and more efficient production processes.

Although free-market economists praise any and all improvements in effi-

ciency, political leaders prefer the benefits of incrementalism provided by

greenfield investments—especially those that do not compete with local com-

panies. Very few voters express happiness if a foreign firm is able to maintain the

heterogeneity 73

output of what previously had been a locally owned company while using only a

fraction of the old workforce. Nationalists in all countries will be alarmed at the

perceived loss of control associated with any extensive takeovers of local busi-

nesses by foreign interests. This was exactly the feeling voiced by some Amer-

icans in the 1980s as Japanese companies went on what was widely viewed as a

buying spree in the United States (see chapter 7).

By Method of Financing a New Subsidiary

Absent an exchange of common stock, new FDI cannot occur without a capital

outlay by a foreign-based company in a host country. The foreign MNC most

likely will transfer hard currency, usually dollars, from its home country. For

greenfield investments, these funds will be converted into the local currency to

pay for the initial purchase of land, construction of buildings, equipment, and the

hiring and training of workers. For most M&As, the capital outlay consists of

purchasing equity from the existing owners of the targeted local company. In-

flows of dollars or euros converted into local currencies have a favorable balance

of payments impact of special importance to LDCs: They provide additional

resources to pay for imports of goods and services needed to spur economic

development and raise living standards. For many countries, FDI-related capital

inflows have become a relatively stable and important source of financing trade

deficits and therefore a valuable force for economic growth.

FDI can take place without international capital flows. New subsidiaries can

be built and acquisitions of existing companies can be made by borrowing in the

local capital markets. A foreign MNC may calculate that it can save money by

using its superior credit rating to raise needed capital by borrowing from banks or

selling bonds in the host country. Locally financed FDI has two drawbacks for

the host country’s economy. First, by definition, the host suffers the opportunity

cost of forgone incoming foreign exchange from the foreignMNC’s headquarters

country. Second, there may be a crowding-out effect as domestic banks prefer to

engage in relatively risk-free lending to blue-chip foreign companies rather than

making loans to local businesses with lower quality credit ratings. The potential

for crowding out is greatest in countries where the volume of borrowing by

foreign investors is highest relative to the domestic availability of lendable funds.

By Extent of Foreign Ownership

When a foreign company owns at least 10 percent equity in a foreign-based

company, it is considered to be FDI. However, it is not axiomatic that a relatively

small percentage of ownership translates into an active voice in management

decisions. The foreign company in such cases may be more interested in the

fundamentals74

financial rewards associated with investment in a growth company than having an

active voice in the day-to-day operation of the company. A ‘‘hands-off’’ FDI

would normally have no direct impact on the economies of either the host or

home country. At the other extreme is the highly visible, attention-grabbing kind

of FDI that takes place when large corporations establish major overseas sub-

sidiaries that in almost all cases are 100 percent owned. Big, globe-spanning

companies like ExxonMobil, Royal Dutch Shell, IBM, General Motors, Ford,

Toyota, General Electric, Nestlé, and Siemens can have a significant impact on

the economies of countries that host their investments. Their above-average size

and ability to attract attention means that they are important but not necessarily

the benchmark for assessing the behavior and impact of MNCs in general.

A discussion of how the variable of foreign ownership creates differences in

FDI characteristics and effects would not be complete without an examination of

international partnerships. They seek to facilitate the achievement of business

objectives that would be financially burdensome, excessively time-consuming, or

possibly unattainable if the two (and occasionally more) partnering companies

acted independently. Partnership is attractive when a company has rejected ac-

quiring or merging with another firm, perhaps due to the latter’s being involved

in business lines that are alien or unattractive to the potential suitor.8

International joint ventures and strategic alliances are the two most common

and important forms of partnership between companies headquartered in dif-

ferent countries.9 Imbued with at least two separate corporate cultures, jointly

owned business entities tend to require more compromise and consultations than

a subsidiary of a company with a single set of priorities, executives, and share-

holders. Joint ventures and strategic alliances have not demonstrated extraordi-

nary or distinctive effects on national economies. They tend to be microeconomic

phenomena best analyzed mainly at the company level.

The most important qualitative difference between these two arrangements is

that a joint venture requires creation of a newly incorporated, jointly owned

business entity in an agreed-on country (or countries). A strategic alliance con-

sists only of formally specified areas of collaboration between cooperating com-

panies who remain legally independent of one another. Otherwise, both have

similar objectives and potential consequences. International partnerships between

two already powerful, well-managed companies can represent a healthy step

forward in achieving greater efficiency and better products. Alternatively, a mu-

tual strengthening of two ostensible rivals and an increase in their market shares

can reduce competition, deliberately or unintentionally, by squeezing existing

competitors and discouraging new entrants.

Collaboration between companies in different countries is nothing novel. ‘‘What

is new is their current scale, their proliferation and the fact that they have become

central to the global strategies of many firms rather than peripheral to them. Most

heterogeneity 75

strikingly, the great majority of strategic alliances have been between competitors.’’10

According to an OECD study, companies that ‘‘have long shunned joint ventures

or close collaboration with other firms in their core business areas are increasingly

entering into such co-operative arrangements.’’11 By one measure, international

strategic alliances, including joint ventures, increased more than fivefold to 4,440

between 1989 and 1999. The study also found evidence that recent international

partnerships had become ‘‘far larger in scale and value terms than earlier part-

nerships.’’ It concluded that the two-to-one ratio between international and do-

mestic strategic alliances illustrates that globalization ‘‘is a primary motivation for

alliances.’’12

Arguably, the search for synergy is the most common rationale for strategic

alliances and joint ventures. Synergy in this case can be defined as ‘‘additional

economic benefits (financial, operational, or technological) arising from cooper-

ation between two parties that provide each other with complementary resources

or capabilities.’’13 In particular, an international partnership can promote econ-

omies of scale for the partners in the various stages of manufacturing: raw ma-

terials acquisition, production, marketing, and distribution. Another common

inspiration for formal international cooperation among even the largest corpo-

rations is the need to pool capital to spread financial risks. The multibillion-dollar

pursuit of a breakthrough technology (new generations of semiconductor chips

are an excellent example) may be too expensive to be borne by just one company.

Business alliances can reduce the absolute size of each participant’s R&D outlays,

and they can reduce potential losses in expensive and risky efforts at innovation

that are long shots to produce a commercially viable product.

Strategic partnerships and joint ventures are used sometimes to enlarge the pool

of scientific and engineering talent needed to successfully develop an especially

challenging new technology. This is yet another reason to mutually learn from and

draw on some aspect of the superior intellectual capital or marketing know-how of

the other company. New United Motor Manufacturing, Inc. (NUMMI) is a joint

venture established in California in 1984 whose origin is generally attributed to dif-

ferent needs of two automobile giants. General Motors reportedly wanted to ob-

serve firsthand the lean production techniques of Toyota. The Japanese company

reportedly wanted to observe firsthand GM’s expertise in dealing with the regula-

tory and marketing nuances of manufacturing andmass retailing automobiles in the

United States. The NUMMI partnership supports the contention that any given

FDIproject can bemutually advantageous and that an injured party is not inevitable.

Joint ventures are typically the partnership vehicle of choice if a foreign

company is uncertain about the vagaries of an especially ‘‘exotic’’ foreign market

it wishes to enter and sees virtues in piggybacking on the domestic expertise and

the commercial and political connections of a savvy local company. A foreign

company may opt for a joint venture with a local company to project an image of a

fundamentals76

domestic business and reduce perceptions that it is an outsider. Government

restrictions may make joint ventures compulsory. Until the Japanese government

was pressured into genuine liberalization beginning in the 1970s, nearly all in-

coming FDI took place through joint ventures with foreign ownership capped at

50 percent. (Even if it was a 50/50 partnership, in most cases there was no doubt

that the Japanese partner had the upper hand and would manage the company in

conformity with that country’s unique business culture and equally unique

government-business relationship.)

Identifying and Classifying Different Kinds of MNCs

To the casual observer, the term MNC invariably conjures up the image of the

usual suspects: big oil companies, big manufacturers of consumer goods, big banks,

and so on. The 100 largest MNCs, as measured by UNCTAD, do indeed account

for a statistically significant percentage (roughly 15 percent) of the annual sales and

employment of the approximately 700,000 foreign-owned or -controlled sub-

sidiaries doing business around the world.14 None of these indicators, however,

suggest that it is valid to define the behavior and effects of allMNCs in terms of the

largest, most visible, and often most notorious companies. Because size itself is an

important variable in determining behavior and effects, an objective analysis cannot

logically declare the behavior of a numerically small sample of corporate behemoths

to be representative of the much larger statistical universe.

As with FDI, MNCs can be divided into a number of distinctive kinds, most

of which have their own unique subsets of identifiable qualities. Also like FDI,

differences in business objectives, relationships to the host country’s economy,

financial structure, propensity to export, and so on will produce two continuums,

one for host and one for home countries, on which MNC activities can be charted

from very favorable to very unfavorable. Even within the same industrial sector

and among companies of comparable size from the same home country, the

heterogeneity factor prevails. Given the large number of variables, an individual

foreign subsidiary should not be stereotyped through a one-size-fits-all ledger of

positive and negative trade-offs. With the chance of identical results so slim, it is

not a big exaggeration to advocate disaggregation down to a subsidiary by sub-

sidiary review as the ideal means of avoiding the fallacy of generalization when

evaluating the overall FDI and MNC phenomena.

By Economic Sector

Economists divide national economies into three broad sectors based on their

distinctly different outputs and characteristics. The primary sector extracts raw

heterogeneity 77

materials and harvests commodities. The secondary sector equates to manu-

facturing. The tertiary sector encompasses services. MNCs within each of these

sectors share a number of common traits and effects that tend not to be found in

companies operating in the other sectors.

Primary Sector As noted, natural resource-extracting companies led the first wave of modern FDI. Being first has done nothing to enhance their image. As

also noted, for a number of reasons, fear and loathing have long been directed at

them to a degree that is disproportionately high to their numbers relative to

MNCs in the manufacturing and services sectors.

The questions of ownership and control over natural resources production

schedules assume maximum significance in the frequent instances where the

producing country is relatively poor. Most overseas subsidiaries of mining and oil

companies were and are located in former colonies, most of whom have lingering

fears about neocolonialism in general and concerns about the power of foreign-

owned companies in particular. The dependency of countries in the South on

MNCs to deliver hard currency payments in exchange for overseas sales of their

natural resources is especially sensitive when dealing with nonreplenishable re-

sources. By definition, such a mineral or metal eventually will be exhausted, as

will the income flow derived from selling it. For this reason, noncorrupt gov-

ernments of resource-rich countries cannot be pleased when foreign companies

dominate decisions on production levels and price.15

Oil is the most important example of powerful control over LDC-based natural

resources by carpetbagger MNCs. For decades, the large international oil com-

panies collectively set terms for royalties received by host countries, determined

volumes of drilling, and effectively controlled worldwide prices of that com-

modity. However many billions of dollars in potential royalties have been forgone

by LDC governments, a dramatic about-face begun in the early 1970s revolu-

tionized the relationship between countries belonging to the Organization of

Petroleum Exporting Countries (OPEC) and the oil companies. The eruption of

accumulated anger in the oil-producing countries of the Middle East, North

Africa, and in Venezuela triggered a classic case study in the ultimate power of

sovereign governments, even in small countries, over the largest, most econom-

ically powerful MNCs. In the 1970s, one OPEC country after another national-

ized local operations of foreign oil companies and began dictating to them financial

terms and levels of output. In his seminal study of the history of oil in world

affairs, Daniel Yergin eloquently explained the legitimate but conflicting claims

that formed the two sides to the story of host country-oil company relations:

The host country [has] sovereignty over the oil beneath its soil. Yet the

oil was without value until the foreign company risked its capital and

fundamentals78

employed its expertise to discover, produce, and market it. The host

country was, in essence, the landlord, the company a mere tenant,

who . . . [paid] an agreed-upon rent. But, if through the tenant’s risk-taking

and efforts, a discovery was made and the value of the landlord’s property

vastly increased, should the tenant continue to pay the same rent as under

the original terms . . . ?

[Producing countries saw the companies as] ‘‘exploiting’’ the country,

stifling development, denying social prosperity, . . . and certainly acting as

‘‘masters’’—in a haughty, arrogant, and ‘‘superior’’ manner. . . . [Oil

companies felt] they had taken the risks . . . and they signed laboriously

negotiated contracts, which gave them certain rights. They had created

value where there was none. They needed to be compensated for the risks

they had taken—and the dry holes they had drilled.16

A second lightning rod for criticism of primary sector MNCs is the relatively

limited degree to which the typical extractive project is commercially integrated

with the local economy, especially in developing countries. Most mines, oil wells,

plantations, and so on are largely self-contained enclaves (sometimes fenced-in

communities) located away from main population centers. The result is minimal

linkage with host country economies in comparison with manufacturing direct

investment, which often procures goods and services from indigenous compa-

nies. The local workers hired by natural resource companies tend to be relatively

few in number and concentrated in the lower skilled or most dangerous jobs.

Another aspect of the separation between resource-seeking FDI and the host

country’s economy is that it has seldom provided transfers of technology that

could be incorporated into the local industrial sector. Furthermore, it historically

has established little value-added activity within LDCs. Processing raw materials

such as petroleum or cut diamonds into finished products requires capital and

skilled labor, both of which are in short supply in LDCs. The payoff from adding

value is that industrialization and rising levels of productivity work hand in hand

as the chief catalysts of increased wealth and higher living standards. Hence, a

handful of wealthy countries prefers to retain dominance in the value-added

process. Their success in doing so is suggested by the fact that facilities for

processing raw materials into manufactured goods are located predominantly in

the North.

The invaluable benefit provided by FDI in the primary sector has been

provision of much-needed foreign exchange to governments that lack the in-

digenous technical and marketing expertise to act entirely on their own to cash in

on the commercial value of their natural resources. For most LDCs, the money

earned from the in-country activity of primary sector MNCs is a major source of

revenue for the national government. These hard currency revenues typically are

heterogeneity 79

the major means of paying for imports of consumer and capital goods needed for

economic development and poverty reduction. Saudi Arabia earned approxi-

mately $100 billion from oil sales in 2004. During the 1950 and 1960s, the copper

produced in Chile by the Anaconda and Kennecott corporations ranged from 7

percent to 20 percent annually of Chilean GDP, 10 to 40 percent of government

tax revenues, and 30 to 80 percent of all hard currency earnings from exports.17

The most vexing problem for LDCs has been that even if a fair market price is

the basis of their royalty earnings, capital flows alone have never been sufficient to

guarantee economic prosperity and social stability.

Secondary Sector A major milestone in the evolution of the international economy was reached in the 1960s with the onset of a numerical and geographic

proliferation of FDI in the secondary, or manufacturing sector. The subse-

quently rapid growth in the output of the overseas subsidiaries of manufacturing

companies relative to domestic output and exporting was a critical ingredient in

the internationalization of economic activity. By the mid-1970s, manufacturing

MNCs had eclipsed those in the primary sector to become the face of FDI and

the focal point in the public debate about it. Critics usually cite the manufac-

turing sector when expressing their opposition to MNCs, be it exploitation of

workers, increased pollution, reduced competition, crowding out of domestic

businesses, or erosion in national sovereignty. Debates about the contribution of

incoming FDI to economic development, poverty reduction, shifts in interna-

tional trade flows, and the need for technology transfers also tend to be couched

in terms of what manufacturing MNCs do or do not do.

FDI in the secondary sector is dissimilar to that of the primary sector in

several important respects. First, it involves possible economic dislocations in the

home country. The labor force might shrink in the short run (or longer during

periods of economic stagnation) if domestic production lines are closed because

overseas production has been selected as the means of serving customers in the

host and/or home countries. Even if total unemployment does not increase, job

losses due to foreign competition are always a politically sensitive issue for elected

representatives of the people. Second, host countries find incoming manu-

facturing FDI to be particularly appealing because as a group, these companies

have demonstrated a greater willingness to reinvest profits, expand operations,

and increase jobs in host countries than the other sectors. Incoming subsidiaries

of manufacturers that are market-seeking (see previous discussion) tend to be the

most economically beneficial to host countries because of the near certainty that

they will employ skilled workers (and train them if necessary) and pay them

above-average salaries. A final difference is that unlike resource-seeking invest-

ments, the pioneers of manufacturing MNCs built foreign subsidiaries in other

industrialized countries.

fundamentals80

Companies in nearly every subsector of manufacturing have now become

multinational, some to protect overseas markets, some to cut production costs,

and some to do both. High-tech companies (information technology, semicon-

ductors, pharmaceuticals, heavy machinery, and so on) are avid overseas inves-

tors because their need to amortize high fixed costs and hold down per unit costs

requires achieving economies of scale through maximum sales volume. Manu-

facturing industries with more than $75 billion of inward FDI stock at year end

2003 were chemicals and chemical products; motor vehicles and other transport

equipment; electrical and electronic equipment; processed food, beverages, and

tobacco; metal and metal products; machinery and equipment; wood and wood

products; and petroleum and fuels.18 Not all MNCs in the secondary sector are

traditional manufacturers. Like most large publishing houses, Oxford Univer-

sity Press, the publisher of this book, is a multinational, operating sales offices

in more than 50 countries and printing facilities in 13 countries.19 Three man-

ufacturing sectors are noticeably absent from overseas investment: steel, textiles,

and apparel. Not by coincidence, they are three of the most vociferous, long-

standing seekers of import protection among all industries in the United States

and elsewhere.

Tertiary Sector The fastest growing segment of FDI since the beginning of the 1990s has been services, also known as the tertiary sector. Its relatively vig-

orous and sustained growth spurt was sufficient to propel this sector to the largest

category of worldwide FDI. Reaching an estimated level of $5.2 trillion at the end

of 2003, the worldwide value of inward FDI stock by services sector companies

accounted for approximately 60 percent of the worldwide total, up from 25

percent in the early 1970s. (FDI in the secondary sector declined to a share of

about 34 percent in 2003, and the primary sector accounted for about 7 percent of

global inward FDI.)20

The relatively recent growth spurt in the tertiary sector was caused by a

different mix of factors than those that acted as catalysts for increased direct

investment by manufacturing and raw materials companies. Services have be-

come the fastest growing sector by far within the GDPs of the wealthiest in-

dustrialized countries. One reason for this is the constant stream of new kinds

of services that find a ready market among increasingly affluent customers with

more leisure time.

FDI activity by tertiary sector companies has been given a major boost by

technological advances, particularly in information processing and telecommu-

nications, which have allowed a growing array of service industries to operate

efficiently on a global basis. Relatively new entrants include data transmission,

overnight freight deliveries, and back office support centers. A whole new subset

of MNC that is increasingly making its presence felt on a global basis consists of

heterogeneity 81

Internet-based companies like Yahoo!, Google, Amazon.com, and eBay, who

have set up overseas subsidiaries to handle content, sales, customer support, and

market research efforts. More recent entrants into multinational business are the

U.S.-based gambling companies Las Vegas Sands Corporation and Wynn Re-

sorts, who are building casinos in Macau and Singapore.

No limit is in sight for the kinds of innovative services that can be provided on a

multinational basis. Foreign-based companies that manage regional water supplies

and operate toll roads and bridges, once a curiosity, are becoming common. Press

reports in 2005 noted that a U.S.-based operator of senior citizen housing com-

plexes had opened facilities abroad and that Laureate Education had expanded the

number of college campuses it owned overseas. This new wave of service com-

panies joined long-established, still expanding MNCs in tourism, passenger and

freight transportation, banking and finance, wholesaling and distributing, insur-

ance, construction, and energy exploration and transmission services.

A third source of growth in services MNCs has been the need for and op-

portunities provided to banking, accounting, legal, advertising, and other busi-

ness services to set up branches close to the proliferating overseas presence of

their manufacturing sector clients. Another factor is the steady increase in con-

sumers’ discretionary income throughout much of the world that induced many

retailers, restaurant and specialty food chains, health care providers, and cable

networks to become MNCs. Finally, the expanding trend of privatization of

government-owned enterprises post-1980s caused a surge in overseas investment

by what had traditionally been the most home-bound of corporations: trans-

portation and utilities providing electricity, water, natural gas, and telecommu-

nications.

FDI in the services sector shares relatively few of the characteristics attrib-

utable to MNCs in the primary and secondary sectors. The tertiary sector has

much less scope than manufacturers for traditional exporting. In some cases,

such as in construction, resorts, and oil drilling, the services rendered personify

the economic concept of nontradability, that is, services providers must physi-

cally be present in the place where their product is consumed. The prevalence of

the nontradability syndrome has precluded controversy about services-oriented

FDI displacing exports from home countries. Conversely, no claims can be made,

as they are in the secondary sector, that overseas services subsidiaries generate a

high volume of alternative exports from the home country in the forms of

components, machinery, and models of goods not being produced abroad.

MNC critics traditionally did not accuse FDI in the services sector of caus-

ing substantial job losses in the headquarters country. Part of the reason was

nontradability; another part was the propensity of service companies to send

accountants, lawyers, advertising copy writers, and senior supervisory personnel

from headquarters to serve a temporary overseas assignment. White-collar

fundamentals82

workers did not feel the same sense of vulnerability that workers on the factory

floor did. No data exist to suggest that the former received the same threats from

employers as did blue-collar workers that entire production lines would be

transferred to low-wage countries if demands for increases in wages and benefits

were not restrained.

The exemption long given to service sector FDI from criticism alleging

losses in home country jobs came to an abrupt end in the early years of the new

millennium. A heated backlash, mainly in the United States, erupted almost

overnight against international outsourcing (a term that usually denotes an arm’s-

length transaction between two companies in different countries). More specif-

ically, the target of heated finger-pointing has been offshoring (see chapter 13).

Also lacking a single, precise definition, this term refers to a decision by a local

company to shift service functions being performed in the headquarters country

to a subsidiary located in a lower wage country or to a different company in a

different country.21 Advances in information and communications technologies

have caused great distances to become irrelevant to a growing number of services

sectors. An x-ray can be evaluated quickly and cheaply by a radiologist 10,000

miles from the patient, and software code can be written almost anywhere and

transmitted quickly and cheaply to any other point on the planet. This trend has

helped launch a new attack on the theory of free trade (see chapter 11). Some

have agonized that if very high-skilled, high-income service jobs are going to be

shifted overseas to further fatten corporate bottom lines, the irreversible un-

raveling of America’s high standard of living has begun.

In the past, services companies established overseas subsidiaries solely as part

of market-seeking strategies. The efficiency-seeking strategy (offshoring) is still

in its infancy, and resource- and strategic asset-seeking are statistically irrelevant

as foreign investment motives. Overseas subsidiaries of service companies have

not been accused of being part of the alleged race to the bottom. They do not

engage in activities that pollute the environment (think of accountants or exec-

utive job recruiters working in a modern office building). They seldom have been

accused of exploiting local workers or imposing sweatshop conditions. Except for

a few big retailers like Wal-Mart, service MNCs have not been loudly criticized

for crowding out local business establishments. Foreign subsidiaries in the ser-

vice sector are not associated with lost jobs and exports in the home country; in

many cases, such as hotel chains, lawyers, journalists, and retailers, new positions

for expatriates from the headquarters country would be created. An additional

factor muting public criticism is that many service multinationals, for example,

wholesalers, distributors, and trading companies, have a low profile and are

largely shielded from public view.

McDonald’s, Starbucks, MTV, and Disney exemplify the main criticism of

the new wave of tertiary sector FDI: alleged threats to the integrity of local

heterogeneity 83

culture and lifestyles. This is a complaint seldom directed against MNCs in the

primary and secondary sectors. Other service-related problems on the horizon

are governments squabbling over how to collect sales taxes from international e-

commerce transactions and further growth and expansion of multinational media

conglomerates.

FDI by service companies is not so unique as to be exempt from the

heterogeneity/don’t generalize thesis. Some overseas subsidiaries are part of

megacorporations (Citigroup, for example). Others are small cogs in relatively

small companies that are partnerships or non-stock trading corporations (ad-

vertising, public relations, and architects, for example). They operate in a limited

number of countries, have relatively few employees overseas, and have little need

to subvert local laws and regulations. Some overseas subsidiaries of services

companies generate relatively few new local jobs, for example, law and accounting

firms. The tourism industry is a different story. The arrival of multinational

hotels and resorts can create a flourishing tourist sector that needs thousands of

jobs to give direct service to tourists and provide a variety of logistical support

functions, such as food deliveries and all manner of hotel supplies.

Miscellaneous

MNCs have become so diverse that not all correspond to one of these three

traditional categories. First of all, there are what can be called virtual MNCs,

companies that design and market state-of-the-art information technology,

electronics, and telecommunications products but do not actually manufacture

them. Overseas subsidiaries of such companies would mainly be R&D and design

operations that mostly employ engineers and scientists, not traditional factories

employing blue-collar production workers. For example, Microsoft is more a

multinational research and product development campus than a manufacturing

company. It is almost totally reliant on outsourcing for the manufacture of CD-

ROMs, video game machines, and other physical products bearing its name.

A growing number of major companies in the high-tech sector contract out—

outsource—to specialized assemblers and manufacturers. This has given rise to a

new industrial category, electronics manufacturing services. It consists of con-

tracted manufacturers and distributors of information technology products de-

veloped elsewhere by familiar brand names (Cisco Systems, Dell, Hewlett-

Packard, and Nokia, among others). All the large electronics manufacturing

specialists are themselves MNCs because they need to respond quickly to orders

and provide rapid deliveries in the dozens of markets in which their major clients

are marketing their goods. Flextronics, a Singapore-based electronics manu-

facturing services provider, operates production centers in over thirty countries

on five continents.22

fundamentals84

Nike is a low-tech version of the virtual MNC. It does not own any of the

dozens of licensed plants overseas that physically assemble the footwear that it

designs, promotes, and sells on a global basis. Absent overseas marketing and

distribution subsidiaries, it would not, strictly speaking, be an MNC.

Coca-Cola may be the most ubiquitous brand name on Earth, but the com-

pany does not fit the typical profile of a consumer goods multinational. It is more

an intermediary supplier than a retailer. Coke has foreign subsidiaries in sur-

prisingly few countries given the fact that its products are sold in more than 200

countries and territories. Its overseas manufacturing presence is concentrated in

some twenty factories that prepare its proprietary syrup. These plants then sell

the syrup to bottling companies and wholesalers throughout the world. Although

some foreign bottlers are wholly or majority-owned Coca-Cola subsidiaries, most

of the bottling companies operating in 478 licensed marketing districts worldwide

are locally owned.23 They are the ones that literally do the heavy lifting of selling

countless millions of bottles and cans of beverages bearing the Coca-Cola logo.

They also pocket the profits from doing so.

Singapore actively promotes itself as an ideal location for the Asian regional

executive headquarters of MNCs. This kind of subsidiary ensures a strong local

job market for office professionals, generates income taxes, and stimulates de-

mand for upscale housing. Regional headquarters offices do not operate sweat-

shops, do not pollute, and pose no threat to domestic companies. But neither do

they produce large numbers of jobs for local residents.

By Corporate Size

The popular view of MNCs is that they rank among the biggest, most powerful

companies on Earth. Though literally true, this is only a small part of the picture.

The largest companies are the ones most frequently discussed by critics and

supporters of FDI/MNCs. The fact that a relatively small number of very large

corporations accounts for a disproportionately large percentage of the worldwide

economic activity of multinationals does not mean that they should define the

nature and effects of all FDI and MNCs—even if they represented a homoge-

neous cohort. In numerical terms, the majority of MNCs are medium and small

companies that lack the financial and market power of the elite minority of mega-

MNCs. Lacking the clout of the giants, small firms provide another set of ex-

ceptions to challenge the generalization that FDI/MNCs inevitably have a major

impact on host countries and inherently are monopoly-seeking phenomena that

stifle competition and exacerbate the asymmetrical global distribution of income.

Small and medium-sized MNCs seldom have a perceptible economic, polit-

ical, or social impact on either host or home country. ‘‘Most of the estimated

45,000 firms that operate internationally employ fewer than 250 people. It is

heterogeneity 85

commonplace to find service companies that maintain fewer than 100 employees

operating across more than 15 countries.’’24 A Conference Board study found

that most small and medium-sized goods-producing companies had only one to

three overseas plants, whereas big companies had an average of thirty-six plants

in fourteen foreign countries.25 Paris-based BVRP Software, with only $74

million in annual sales in 2003, became a multinational after acquiring two small

California software firms, one of which had annual sales of only $8 million.26

By Degree of Multinationality

MNCs differ quite literally in their worldliness. An American company might

have as its sole FDI presence one relatively small factory in Canada that sells only

in that market. This modest operation does not fit the image of a gigantic globe-

spanning company seeking to manage the world as an integrated unit and dom-

inate all major markets for its products. Deutsche Post, Ford, Nestlé, and Royal

Dutch Shell do fit that profile as each has facilities in more than ninety host

countries.27 The most widely cited quantitative estimate of the degree to which

corporations ‘‘gear their activities outside of their home countries’’ is the ‘‘trans-

nationality index’’ (TNI) published periodically in UNCTAD’s annual World

Investment Report. The index is a composite of three ratios compiled for each of

the top 100 nonfinancial MNCs: foreign assets to total company assets, foreign

sales to total sales, and foreign employment to total employment. The average

TNI for all 100 corporations increased by only 2 percentage points, from 51 to 53

percent, between 1990 and 1999. This suggests that the corporations with the

largest foreign assets were not on average becoming more global in the 1990s.28

Economic necessity correlates well with degrees of transnationality. Consistent

with economic reason, countries with small domestic markets, most notably

box 4.1 A Study in Contrasts: MNC Output and Economic Impact,

Big and Small

Intel opened a $300 million, state-of-the-art microprocessor assembly and testing

subsidiary in Costa Rica in 1998. One year later, the plant’s output contributed 60

percent of the country’s GDP growth for that year and accounted for nearly 40

percent of its exports.

Beard Papa’s, a subsidiary of a Japanese restaurant and bakery chain, opened its

first carry-out shop in the United States in spring 2004. A small storefront op-

eration, the Manhattan-based outlet sells a few hundred cream puffs daily.

Both are examples of FDI.

No meaningful parallels can be drawn about their economic effects on the host

country’s economy or on the international trading system.

fundamentals86

Switzerland and the Netherlands, continue to account for an above-average

number of the most globalized companies as measured by the index. U.S.

and Japanese firms on average register well below the 50 percent mark on

the TNI.

The degree of a corporation’s multinationality is a factor in the way it orga-

nizes itself. A certain degree of decentralization is necessary to the extent that a

large share of a company’s assets, sales, and employment are located outside of its

home country. A low degree of multinationality would facilitate a decision to

exert tight control from corporate headquarters and could reduce the linkage

between its overseas subsidiaries and host countries’ business sectors.

By LDC-Owned MNCs

One of the harshest and longest running criticisms of FDI/MNCs is their alleged

use of economic might and political leverage to exploit the poor countries of the

South. The image of massive extraction of profits and minimal infusion of long-

term benefits first emerged from the often controversial behavior of extractive

companies already summarized. More recently, criticism was expanded by op-

ponents of globalization to include allegations of a rush to the South by big

manufacturing companies to exploit cheap labor and lax enforcement of envi-

ronmental protection laws (see chapter 7). Viewing MNCs in this harsh light

grew out of a valid generalization: Outward FDI historically had flowed in one

direction—from the rich countries of the North mostly to other rich countries.

This is another international business trend terminated by the constant of change.

FDI and MNCs have not been and are not likely to become static phenomena.

A new trend that has yet to attract much public notice is the increasing

number of prosperous, growing corporations in LDCs establishing overseas

subsidiaries, that is, becoming MNCs. The old one-way, North-to-South axis of

FDI is being reconfigured by the spread of market forces. Most of the companies

headquartered in emerging market countries that have made the decision to be-

come MNCs have done so largely for the same reasons that companies in in-

dustrialized countries went overseas according to UNCTAD, a UN agency

whose mandate is to protect and enhance the economic interests of the South.

LDC-owned companies recognize that ‘‘in a globalizing world economy, they

need a portfolio of locational assets in order to be competitive internationally.’’

This formula for long-term survival applies to both manufacturing and services

companies and involves ‘‘complex as well as simple’’ industries.29 Although

motivations to invest overseas are similar, FDI by LDC-based manufacturing

companies has mostly been in industrial countries and therefore does not raise

the traditional concerns that giant foreign investors will dictate to relatively weak

host countries.

heterogeneity 87

The statistical significance of the emerging ‘‘new geography’’ of outward FDI

can be demonstrated in several ways. UNCTAD statistics show that annual FDI

outflows from developing countries grew at a faster rate in the 1989–2003 period

than those from developed countries. Negligible until the early 1990s, outward

FDI from emerging market countries accounted for about one-tenth of the world

stock of outward FDI and about 6 percent of total world flows in 2003.30 In some

years, South-South FDI flows now grow at a faster rate than North-South direct

investment.

When measured as a percentage of gross fixed capital formation, some de-

veloping countries invested more abroad between 2001 and 2003 than developed

ones; by way of example, Singapore (36 percent), Chile (7 percent), and Malaysia

(5 percent) topped the United States (7 percent), Germany (4 percent), and Japan

(3 percent).31 Other emerging market countries that UNCTAD considers to be

current or soon-to-be factors in new outward FDI flows are Korea, Mexico,

South Africa, Brazil, and India. Chinese enterprises were singled out as being ‘‘at

the threshold of becoming major foreign direct investors in Asia and beyond’’

because of the country’s rapid economic development and the government’s

avowed interest in encouraging outward FDI.32

Mexican-based Cemex has grown into one of the world’s largest cement

producers. As a result of newly established subsidiaries and acquisitions on five

continents, about three-fourths of its revenues are generated outside of Mexico,

including the highly competitive U.S. market. In 1987, a book by Louis W.

Goodman titled Small Nations, Giant Firms looked at attitudes of MNC exec-

utives and economic policy officials in several Latin American countries to assess

the impact of inward FDI from powerful foreign-based companies. Ironically,

the title would be perfectly appropriate for a new book looking at the increased

outward flow of FDI from large companies in emerging market countries.

It is not only the larger, more economically advanced developing countries

whose companies have become multinationals. A number of companies head-

quartered in the relatively small and remote island country of Mauritius opened

foreign subsidiaries. Apparel companies established subsidiaries in lower wage

African countries to produce low-end garments, and some of Mauritius’s more

experienced hotel management companies expanded their operations to other

countries in the region.33

Assuming the trend of increased outward FDI from emerging markets con-

tinues, the school of thought equating MNCs with exploitation of LDCs will face

a quandary. The tendency to portray MNCs as oversized, capitalist villains will

become increasingly incompatible with the growing numbers of LDC-based

companies replicating the global business model conceived in the North. If

the anti-MNC/pro-LDC faction retains a platform whose unequivocal message

is the need for increased government-imposed restrictions on the growth of

fundamentals88

box 4.2 Following in the Footsteps: Chinese and Indian

Companies Venture Overseas

One of the more optimistic pronouncements made by development economists in

the 1970s was that the main difference between industrialized, rich countries and

LDCs was a matter of timing, not economics, politics, or sociology. LDCs were

said to be at an earlier stage of the development timetable and would gradually and

inexorably follow the same path to prosperity taken by the developed countries.

This claim was off the mark and is seldom heard today. However, it bears close

resemblance to the recent propensity of MNCs based in emerging market countries

(not the poorer LDCs) to invest abroad for reasons identical to those that many

decades ago induced companies in the North to venture overseas, most notably to

seek new markets for manufactured goods and new sources of natural resources.

The Haier Group, a Chinese conglomerate, opened a subsidiary in South

Carolina in 2000 to produce refrigerators. Corporate officials stated that one of two

primary reasons behind this move is to provide better and quicker service to its

expanding sales base in the United States; in doing so, it hoped to increase its

market share at the expense of domestic competitors. The second primary reason is

to save on shipping costs: ‘‘When you ship refrigerators, you ship a lot of air, and

shipping air is expensive,’’ an American executive at the subsidiary told a reporter.

Some observers have surmised that there was an additional factor. Government-

owned Haier may have been willing to take a financial risk in return for reaping the

prestige of being a pioneer in demonstrating that a Chinese company could prosper

and build market share in the tough, highly competitive U.S. market. Haier

America is paying its assembly line workers at least ten times as much per hour as

their Chinese counterparts.* This raises the unique possibility that workers in the

home country feel exploited, not those working for a foreign subsidiary.

In purchasing IBM’s personal computer unit for nearly $2 billion in late 2004,

the Lenovo Group, a computer producer partly owned by the Chinese government,

risked a lot of money in an effort to become a global player. Economies of scale are of

particular importance to a product like personal computers. They have become a

commodity sold mainly on the basis of price, not brand loyalty or promises of su-

perior performance.

An even more striking example of FDI by LDC-based companies was the pur-

chases during 2004 of several U.S. and Canadian call centers and forms-processing

centers by Indian-owned business services companies. These are probably the first

examples of what could be dubbed reverse offshoring. Among the public reasons

given by the Indian companies for this strategy was the belief that a global presence

will be necessary to further expand their customer base, expertise, and geographic

reach. An unstated reason may be that the striking success of Indian companies in

attracting labor-intensive back office work from companies operating in higher

wage countries enabled them to buy some of their battered U.S. and Canadian rivals

at deep discounts. A second unstated reason for Indian companies to establish a

U.S. presence and employ a limited number of Americans is to defuse the political

furor in the United States associated with offshore outsourcing by American

companies, most of which has gone to India.**

* ‘‘When Jobs Move Overseas (to South Carolina),’’ New York Times, October 26, 2003, p. C1.

** ‘‘India’s Outsourcers Turn West,’’ BusinessWeek Online, available at http://www.businessweek

.com; accessed July 2004.

89

multinational firms, they leave themselves open to being ostracized for a callous

attitude toward the long-term competitiveness of companies owned and managed

by citizens of the South. The paradigm critical of big business will have to give

greater effort to disaggregating FDI flows to categorize those going from South to

North as being unlikely to seriously threaten the political, economic, and social

fabric of the industrialized countries. Outward FDI from the South is likely to

create another conundrum: How should the pro-South faction deal with the

almost inevitable rise of claims that some MNCs headquartered in the emerging

market countries are exploiting workers in subsidiaries they operate in poorer,

lower wage LDCs?

Postscript

This is a long chapter because of the large body of (underutilized) data relevant to

the thesis that generalizations cannot be applied to something that comes in as

many forms as do FDI andMNCs. The heterogeneity factor is incompatible with

any simple declaration that they are good or bad, desirable or undesirable. It is

also incompatible with a single theory as to why they exist and what their effects

have been. Finally, the heterogeneity factor precludes any easy formulation of

multilateral policies to regulate the flow of FDI and operations of MNCs.

Notes

1. The URL for the industrial and geographical breakdown is http://www.unctad.org/

Templates/Page.asp?intItemID¼3149&lang¼1. 2. Suzanne Berger and the MIT Industrial Performance Center, How We Compete—

What Companies around the World Are Doing to Make it in Today’s Global Economy

(New York: Currency-Doubleday, 2006), pp. 44–45.

3. An example of the relatively infrequently used efficiency-seeking model of FDI is the

effort to employ an additional level of highly skilled, relatively high-paid foreign

workers in strategic foreign markets to design and manufacture sophisticated high-

tech goods.

4. Frank Berry, ‘‘Export-Platform FDI: The Irish Experience,’’ European Investment

Bank, EIB Papers no. 2, 2004, p. 9.

5. Peter Nunnenkamp and Julius Spatz, ‘‘Foreign Direct Investment and Economic

Growth in Developing Countries,’’ Kiel Working Paper no. 1176, July 2003, pp. 6–7,

available online at http://www.uni-kiel.de/ifw/pub/kap/2003/kap1176.pdf; ac-

cessed September 2004.

6. John H. Dunning, Multinational Enterprises and the Global Economy (Workingham,

UK: Addison-Wesley, 1993), p. 60.

fundamentals90

7. Peter Dicken, Global Shift (New York: Guilford Press, 2003), p. 248.

8. Andrew Inkpen, ‘‘Strategic Alliances,’’ in Alan Rugman and Thomas Brewer, eds.,

Oxford Handbook of International Business (Oxford: Oxford University Press, 2001),

p. 407.

9. Some textbooks categorize joint ventures as a specialized form of strategic alliance, not

as separate phenomena.

10. Dicken, Global Shift, p. 258; emphasis in original.

11. Nam-Hoon Kang and Kentaro Sakai, ‘‘International Strategic Alliances: Their Role

in Industrial Globalisation,’’ OECD Directorate for Science, Technology, and In-

dustry Working Paper 2000/5, July 2000, p. 6, available online at http://www.oli-

s.oecd.org/olis/2000doc.nsf/linkto/dsti-doc(2000)5; accessed September 2004.

12. Ibid., p. 7.

13. Oded Shenkar and Yadong Luo, International Business (Hoboken, NJ: Wiley, 2004),

p. 315.

14. Data source: UNCTAD, World Investment Report 2005, p. 15, available online at

http://www.unctad.org; accessed October 2005.

15. Pricing strategy for nonrenewable resources is a highly complex, ongoing search for

prices that will maximize total long-term revenues to the country owning the re-

sources. Too low a price is akin to selling one’s birthright too cheaply. However, too

high a price can encourage a permanent switch by consumers to other raw materials or

synthetic substitutes. In the case of oil, for example, oil producers would not find it in

their long-term interests to have oil prices reach and remain at levels so high that the

development and use of alternative fuels becomes commercially feasible.

16. Daniel Yergin, The Prize: The Epic Quest for Oil, Money, and Power (New York: Simon

and Schuster, 1991), pp. 432–33.

17. Theodore H. Moran, Copper in Chile (Princeton, NJ: Princeton University Press,

1974), p. 6.

18. Data source: UNCTAD, World Investment Report 2005, p. 260. Inward FDI stock of

all manufacturing totaled $2.9 trillion at year end 2003.

19. Source: www.oup.com/about/worldwide.

20. UNCTAD, World Investment Report 2005, p. 260.

21. Both of these terms informally crept into the economics lexicon. Neither has been

standardized to refer to only one kind of international transaction. Hence, they can

either refer to an intrafirm transaction between two subsidiaries in different countries

or to an arm’s-length outsourcing to a different company in a second country.

22. Data source: http://www.flextronics.com; accessed June 2005.

23. Corporate information came from the company’s 2004 10-K report and a telephone

interview with a corporate spokesman, October 2004.

24. JohnStopford, ‘‘Multinational Corporations,’’Foreign Policy,winter 1998/1999, p. 14.

25. As quoted in Shenkar and Luo, International Business, p. 119.

26. ‘‘The Rise of ‘Small Multinationals,’ ’’ Business Week Online, February 1, 2005, avail-

able online at http://www.businessweek.com; accessed February 2005.

27. Data source: UNCTAD Investment Brief, no. 4, 2005, available online at http://

www.unctad.org; accessed October 2005.

heterogeneity 91

28. UNCTAD, World Investment Report 2001. The consistency of this data series is

limited by constant changes because companies are dropped and new ones added.

29. UNCTAD, ‘‘FDI from Developing Countries Takes Off; Is a New Geography of

Investment Emerging?’’ Press release dated August 10, 2004, available online at

http://www.unctad.org; accessed September 2004.

30. Ibid.

31. UNCTAD, World Investment Report 2004, pp. 5, 7.

32. UNCTAD, ‘‘China: An Emerging FDI Outward Investor,’’ e-brief, December 4,

2003, available online at http://www.unctad.org; accessed September 2004.

33. UNCTAD, ‘‘Investment Policy Review of Mauritius,’’ available online at http://

www.unctad.org; accessed December 2004.

fundamentals92

5

perceptions and economic ideologies

Attitudes toward multinational corporations (MNCs) and foreigndirect investment (FDI) tend to be outgrowths of beliefs associated with larger issues. A predictable progression of value judgments flows from broad

to specific. This chapter takes a brief detour into the realm of political philosophy

to suggest how people are predisposed to endorse or condemn FDI and MNCs

in their entirety based on their larger attitudes about income distribution and the

relative merits of free markets versus government regulations.

If you, the reader, believe that economic progress and a country’s standard of

living tend to be inversely related to the extent of government management of

economic activity, there is a near 100 percent certainty that you will agree with

the idea that entrepreneurs and corporations should largely be left alone to make

invaluable contributions to society at large by creating jobs and regularly intro-

ducing new goods and services produced with maximum efficiency. It logically

follows that on balance, you view MNCs in positive terms and are not anxious to

have a sweeping array of new regulations and international agreements enacted to

curb what is viewed as their largely beneficial behavior.

Conversely, you may believe that the soul of a country should be defined by

more than materialism and a just, stable society is incompatible with unregulated

markets that give priority to the quest by businesses to maximize profits. If so,

there is a near 100 percent certainty you will agree with the idea that government

should redress the balance of power that has tilted too far in favor of protecting

the interests of capital instead of serving the needs of ordinary people. It logically

follows that on balance, you view MNCs in unfavorable terms and support

implementation of new regulations and international agreements to curb their

excessive domination of markets and political influence.

This chapter examines how and why there is a close correlation between one’s

attitudes toward the core dilemma of economic policy, fairness versus efficiency,

93

and positive or negative perceptions of MNCs. The purpose is decidedly not to

take sides on economic ideology or multinationals. Instead, two broad assump-

tions are made: First, there is no clear-cut right or wrong associated with personal

beliefs about an intangible; second, no single economic ideology has cornered the

market in wisdom. The chapter is designed to lay the foundation for under-

standing an essential theme: There is compelling logic, not inconsistency, in

accepting the principle that each of the two irreconcilable viewpoints on FDI and

MNCs exhibit both truths and fallacies. Neither demonstrates irrefutable logic or

clear intellectual superiority.

The first section of the chapter consists of an overview of the role of per-

ceptions in the study of our subject and a summary of the perceived differences

between governments and markets. Specific arguments used to advocate an

economic order based on the market mechanism are presented in the second

section, and the third part advances the arguments made in favor of a system

based on extensive and intensive governmental control. The antimarket critique

is followed up with a separate, more specific analysis of the role played by

MNCs in fomenting the worldwide backlash against globalization. The fifth and

final section offers an explanation as to why a broad consensus exists for a middle

ground approach between the two extreme versions of organizing the economy

and why it is the most reasonable option, both academically and policy-wise.

Perceptions, Subjectivity, and the Separate Worlds

of Governments and Markets

The ultimate reason MNCs as entities and FDI as process are viewed in two

starkly dissimilar ways is that human nature has long meant that people can look

at the same thing and come away with different, irreconcilable perceptions of

the object under scrutiny. The aphorism that perceptions define reality assuredly

applies in this case. Contrasting perceptions are easily understood if one accepts

the theme of chapter 4 that pervasive heterogeneity has produced examples of all

manner of MNC behavior—good, bad, and indifferent. Everyone has the option

of embracing whichever category is most in accordance with his or her biases.

Hard data can be assembled that empirically measure the behavior and effects of

a control group composed of a limited number of corporations sharing similar

characteristics. However, the behavior and effects of MNCs as a whole constitute

an enormous abstract mass that cannot be scientifically weighed or measured.

Even though companies exist in a physical sense, the determination that col-

lectively they are a positive or negative force is a value judgment that is usually

derived from and shaped by larger beliefs.

fundamentals94

The larger philosophical debate over how strongly or loosely to manage the

market mechanism effectively establishes the intellectual borders within which

the debate over the relative merits of FDI and MNCs takes place. Because they

are far more real than abstract economic theories, MNCs are an ideal proxy for

casting either support for or opposition to capitalism. Selection of one of these

two mutually exclusive views is the inevitable result of a thought process that

channels images of MNCs through two dissimilar ideological prisms. People who

embrace free market values are predisposed to see the merits of companies op-

erating under the discipline of having to be profitable and seeking the most cost-

efficient means of production. If companies are good enough to dominate the

market for a given product in 100 or more countries, so be it; people must like

their products because no one is forcing them to buy. Critics of free markets are

predisposed to see the merits of government-imposed limits to reduce the an-

tisocial behavior of corporations.

The free market versus government regulation debate is also sustained by

pointed disagreements on assigning a priority between creating wealth and dis-

tributing it. A nation’s income can take the form of a growing pie that is unevenly

sliced among income groups or a smaller, slower growing pie that is sliced into

roughly equal-size pieces. Those who prioritize the economic logic and benefits

of creating wealth before worrying about how to distribute it tend to be to the

right of the political center. They favor leaving markets relatively unburdened by

official dictum to maximize efficiency and minimize waste. Those who prioritize

the social benefits of distributing wealth more evenly and maintaining a generous,

all-inclusive social safety net favor aggressive government presence and perhaps

government ownership of some or all major producers of goods and services to

relegate profit seeking to a secondary goal. Determination of what constitutes a

fair distribution of income is a subjective political and ethical decision, not an

economic one.

The value-laden issues of how evenly income should be distributed and how

best to maximize the public’s standard of living provide fertile soil for cultivating

two rational but incompatible beliefs that likely will never be fully reconciled.

A market system based on greed that may or may not debase the quality of life

is pitted against an economic order guided by a relatively small number of

government officials whose judgments may or may not slow growth and impede

innovation. The unsurpassed ability of free markets and MNCs to generate

output in an efficient manner must be weighed against their propensity to dis-

proportionately distribute the financial bounty of an incentives-based system to a

relatively few shareholders and entrepreneurs. True, the latter supply the capital

and ideas and take the financial risks necessary to provide goods, services, jobs,

and rising standards of living to the majority. However, many question whether

perceptions and economic ideologies 95

they deserve or need unlimited incomes and vast tax loopholes when a large

percentage of most countries’ populations is living below the poverty line. De-

termination of how and how much a government should use the tax system to

redistribute wealth is another highly subjective political question. The line be-

yond which entrepreneurs are discouraged from innovating and taking risk is

invisible for all practical purposes.

A similar dichotomy exists on the issue of how good or bad a job MNCs do in

providing goods and services at the cheapest possible prices. One side believes

they do a good job because they respond quickly to market signals and are able

to overcome governmentally imposed market imperfections, such as regulatory

red tape and import controls. This view praises multinationals ‘‘as an integrating

force in the world economy, surmounting national barriers, circumventing high

transaction costs and improving the allocating of resources.’’1 The contrary view

asserts that MNCs, rather than being a means of overcoming market imperfec-

tions, are in fact a major distorting force in the global allocation of resources. This

is partly because they operate mostly in oligopolistic markets and partly because

of their ability to bypass market mechanisms and/or government regulations. Far

from promoting competition, MNCs are said to engage in restrictive practices,

raise barriers to entry, and thereby freeze existing production patterns.2

The ability of governments to enact laws transferring a politically determined

percentage of wealth from the rich minority to the less affluent majority must be

weighed against bureaucrats’ propensity to wreak economic havoc by distorting

prices and imposing barriers to the efficient use of resources, maximum returns

to capital, and risk taking in the name of promoting group equality. Government

regulation, even if deemed socially necessary, can result in disincentives to

entrepreneurs who might otherwise start new companies and create new jobs.

Regulation can also diminish incentives for existing companies to commit capital

to develop new products, new technologies, and new cost-cutting production

techniques. Although there is universal agreement that the goals of economic

policy are increased incomes, rising living standards, and an improved quality of

life for all people, there is no consensus as to the best and quickest means of

achieving these objectives. No economic ‘‘ism’’ is foolproof. Winston Churchill

put it this way: ‘‘The inherent vice of capitalism is the unequal sharing of bless-

ings; the inherent virtue of socialism is the equal sharing of miseries.’’3

Conflicting perceptions also shape the debate on corporate social responsi-

bility. Should the interests of shareholders or stakeholders (see chapter 2) have

the greater say in guiding corporate behavior? Are managers of domestic and

multinational corporations simply employees whose job it is to serve the financial

interests of the owners, or do they have a larger obligation to serve society at

large? Has emphasis on the profit motive worked against the overall public

interest, or has it allowed corporations to fully justify their existence through

fundamentals96

their contribution to the material well-being of billions of the world’s people? Is

the pursuit of profits so inherently destructive and exploitive that government

must tightly rein in companies and proactively protect the populace from their

wickedness? Have corporations so badly fallen short in serving the larger public

good that they must redeem themselves by financially supporting charities and

social causes?4 The response to all these imponderables should start with ‘‘It

depends.’’ It depends on one’s larger political philosophy, mainly whether one

prefers the official or the private sector to have the upper hand. It further depends

on whether one realizes that there is no single pattern of behavior by MNCs as a

whole, owing to substantial differences in corporate cultures, management and

organization, size, product line, relationship with the host country’s economy,

and so on.

Governments and corporations live in different worlds. Their formulas for the

proper ordering of human relationships diverge so much that some level of

tension between them is inescapable. In Robert Gilpin’s view, the state is based

on ‘‘territoriality, loyalty, and exclusivity,’’ whereas the market is based on the

concepts of ‘‘functional integration, contractual relationship, and expanding

interdependence of buyers and sellers.’’ National governments need territorial

boundaries as the basis of national autonomy and political unity. Markets want to

minimize political obstacles to the operation of the price mechanism. To quote

Gilpin again,

Whereas powerful market forces in the form of trade, money, and foreign

investment tend to jump national boundaries . . . [and seek to] escape po-

litical control, the tendency of government is to restrict, to channel, and to

make economic activities serve the perceived interests of the state and of

powerful groups within it. The logic of the market is to locate economic

activities where they are most productive and profitable; the logic of the

state is to capture and control the process of economic growth and capital

accumulation.5

Bottom line: The transcendent issue is deciding which is the more desirable,

or at least the lesser of the evils: free markets or government regulation. The first

of two answers that I would offer is ‘‘it depends’’ on what specific issue is being

examined. Broad generalizations are not the right framework to determine how to

rank the net desirability of states and markets. Second, despite a lot of strong

feelings in favor of one over the other, it is by no means obvious that it should be

necessary to select the black or white option to the exclusion of the other. The

viewpoint underlying this study is that neither a pure private sector nor a pure

public sector model is indisputably more effective in all circumstances in all

countries at all times. If one accepts the logic of a mix of free markets and

perceptions and economic ideologies 97

regulations falling in some indeterminate spot between the two extremes, the

logical progression is acceptance that MNCs are not always so magnificently

beneficial economically as to merit nearly total freedom of action and blanket

praise, nor so blatantly corrosive socially as to justify comprehensive government

regulation and blanket condemnation.

The substance of discussions about governments versus markets and about the

net desirability of FDI and MNCs should be less a manifestation of the ideological

leanings of writers and speakers and more a dispassionate investigation of the

multiple truths inherent in a subject as multifaceted and heterogeneous as this one.

The larger but seldom recognized truth is that ‘‘there is no possibility of a ‘value-

free’ assessment of foreign direct investment.’’ Readers of articles and books on the

subject ‘‘are left with the problem of identifying the values underlying any analysis

of [MNCs], given that these are rarely defined and stated explicitly.’’6 Chances for

a significantly clearer understanding of the multiple layers of truth about FDI and

MNCs would improve if there was less advocacy and more effort to methodically

synthesize the many legitimate views embedded in all but the most exaggerated,

simplistic, and demagogic assessments of these phenomena. Identifying which

assessments meet these criteria is, of course, a value judgment.

The discussion that follows analyzes the ideas that sustain the two principal

economic ideologies—free markets and governmental regulation. The overused,

black-and-white alternatives of the ‘‘good society’’ and the ‘‘efficient economy’’

are offered as a simplified template for analysis. One-sided arguments on behalf

of both ideological perspectives are presented for illustrative purposes as they

might be in a debate, not necessarily on the basis of verifiable accuracy; neither is

endorsed by the author as the preferable policy prescription. The intent is to

defend the conclusion that these opposite belief structures have only enough

validity to provide fragments of the whole truth, and only enough precision to

provide a partial road map to the optimal design for managing national econo-

mies, shaping the international economic order, and regulating FDI and MNCs.

There needs to be balance between government’s implicit capacity to look out for

the interests of the majority and business’s explicit drive for efficiency and in-

novation to increase sales and keep customer loyalty.

Thesis: Follow the Invisible Hand, Curb

Government Obstructionism

The first ideology to be summarized is known as the market, noninterventionist,

and liberal (not the counterpart of political liberalism) economicmodel. It espouses

what it perceives as the demonstrable benefits of allowing the private sector to

operate on a relatively unregulated basis, both domestically and internationally.

fundamentals98

This approach is rooted in the belief that markets by far are best able to make the

infinite number of decisions necessary every day to allocate resources domesti-

cally and internationally in the most efficient, quickest manner. The discipline of

risking one’s own capital plus enlightened self-interest (a euphemism for the

pursuit of profits) is deemed the natural means of ensuring maximum economic

output, minimum costs, and maximum economic welfare. To best keep supply

and demand in equilibrium, prices must respond in real time to changing market

forces, not be set according to government fiat. This kind of economic order is

most compatible with the philosophy that consumption is the number one

purpose of economic activity.

The intellectual origin of this perspective is Adam Smith’s epic work, The

Wealth of Nations, published in 1776. By directing industry to perform in such a

manner that its products are of greatest value, he wrote, the business community

seeks its own gain. Yet in being forced to provide customers with goods and

services that they want and can afford, each business owner is, often uncon-

sciously, ‘‘led by an invisible hand’’ to promote the interests of society. ‘‘I have

never known much good done by those who affected to trade for the public

good. . . . it is not from the benevolence of the butcher, the brewer, or the baker,

that we can expect our dinner, but from their regard to their own interest.’’7 If

private companies do not give consumers good products at competitive prices, or

if they invest their capital in unprofitable endeavors, they face extinction—unless

rescued by government bail-out. This sense of mortality seldom applies to gov-

ernment agencies; they just keep on spending the unending inflow of taxpayers’

money.

Effusive praise for the modern corporation comes from two British business

journalists who called it ‘‘the basis of the prosperity of the West.’’ Among other

benefits cited: ‘‘Companies increase the pool of capital available for produc-

tive investment. . . .And they provide a way of imposing effective management

structures on large organizations.’’8 The promarket ideology points to the steady

stream of product and technological innovations spurred by the self-interest of

increasingly large corporations. These advances are cited as being the major

contributing factor to unprecedented rates of increase in material well-being and

quality of life experienced over the past 100 years by much of the Earth’s pop-

ulation. Guided by hard-nosed number crunching that takes them to the lowest

cost locations anywhere on the planet and strengthened by economies of scale,

globalized companies have taken efficiency to the ultimate level.

Skepticism and at times outright disdain for government is the other part of a

belief structure that favors maximum freedom of maneuver for and minimum

regulation of private corporations. One need only have a rudimentary knowledge

of history to be aware of the countless physical and spiritual gulags imposed

by hundreds of dictatorships on a populace deemed undeserving of personal

perceptions and economic ideologies 99

freedoms and the right to choose their leaders. When viewing the past, Martin

Wolf sees ‘‘corrupt, incompetent, brutal, and, depressingly often, murderous gov-

ernments everywhere. A big part of the history of the twentieth century is a story

of the crimes inflicted by those in power upon an innocent people.’’9

The extent to which corruption by government officials has impeded eco-

nomic development is beyond calculation. Many billions of dollars have been

diverted from the masses into the offshore bank accounts of political rulers and

the pockets of lower level civil servants. The World Bank identifies corruption as

being ‘‘among the greatest obstacles to economic and social development.’’

Dishonesty by government officials, it says, undermines economic development

by ‘‘distorting the rule of law and weakening the institutional foundation on

which economic growth depends. The harmful effects of corruption are espe-

cially severe on the poor, who are . . .most reliant on the provision of public

services, and are least capable of paying the extra costs associated with bribery

[and] fraud.’’10 Correlation between lack of development and official corruption

can be seen in the annual report by Transparency International, a nongovern-

mental organization (NGO) that coordinates efforts worldwide to identify and

reduce the corruption in the public procurement process, which it estimates

siphons off at least $400 billion annually from the development effort. Its 2004

Corruption Perceptions Index identified sixty countries suffering from ‘‘rampant

corruption.’’ All of them are either among the world’s poorest countries or

middle-income, oil-rich states (Nigeria, Venezuela, Russia, and Iran) failing to

realize their potential for raising incomes and living standards.11

The U.S. Congress faced one of the largest waves of congressional scandals in

a generation during 2005 and 2006. Republican Majority Leader in the House,

Tom DeLay, was forced to step down from his post after being indicted on

charges of criminally conspiring to inject illegal corporate contributions into

Texas state elections. Then a California representative was sent to jail for ac-

cepting the equivalent of more than $2.4million in bribes. The guilty plea by big-

time lobbyist Jack Abramoff to charges of tax evasion, conspiracy to bribe public

officials, and fraud requires him to cooperate in a comprehensive investigation of

his illegal dealings with members of Congress, members of their staffs, and

Executive Branch officials. The potential for a major domino effect of indict-

ments was signaled when the chair of the House Administration Committee

‘‘temporarily’’ relinquished his post after his involvement with Abramoff leaked.

The bribery investigation of an obscure Louisiana Congressman probably would

not have made headlines amidst these events had it not been for the FBI finding

$90,000 of alleged payoffs in the freezer at his home and then raiding his con-

gressional office in search of further incriminating evidence. Nonbelievers in

congressional integrity received no surprises at ensuing events that repeated an

old pattern: Resolute congressional promises to quickly remedy the ethics crisis

fundamentals100

resulted in watered-down reform language by subcommittees in both houses, and

that was followed by studied inaction (as of mid-2006) by the joint conference

committee charged with reconciling differences in the two bills. Few expect a

serious dent in the influence and largesse of lobbyists. Voters were not expressing

outrage and a determination to punish unethical incumbents. Maybe voters

‘‘expect lawmakers to be dishonest,’’ mused one journalist.12 A look at the record

will show that in an average year, more elected politicians in the United States are

charged with criminal wrongdoing than are senior corporate executives. Ac-

cording to one estimate, more than 1,000 U.S. government employees were

convicted of corrupt activities in the 2005–2006 period, with the FBI investi-

gating hundreds more.13

The combination of enlightened government and a free, prosperous, and

egalitarian country has been all too infrequent throughout history. Communism

claimed to serve the masses, but it disdained political freedom and created an

equal distribution of income by making everyone poor, except for the top echelon

of the party. James Madison wrote in the Federalist Papers that it is necessary to

place controls on government because ‘‘if men were angels, no government would

be necessary. If angels were to govern men, neither external nor internal controls

on government would be necessary.’’14

Critics of the market mechanism feel threatened by it, wrote Johan Norberg,

not because they think it results in a genuine loss of democracy but by the absence

of the policies they want democracies to pursue. Many of those policies involve

greater governmental power over society’s economic decision making. ‘‘But

saying that the market threatens government control of our economic actions is

less exciting than calling it a threat to democracy. Why should it be ‘more dem-

ocratic’ for a democratic government to have more powers of decision-making

over us? . . .Democracy is a way to rule the state, not a way to rule society.’’15

The theory of public choice (sometimes referred to as rational choice) casts

doubts on the benefits to be gotten by giving more power to any government,

even a democratic one. This is a theory of recurring governmental failure that is

fully comparable to the economic theory of private market failure, according to

James M. Buchanan, the principal architect of the public choice approach.16

Governments do not make decisions, elected officials and bureaucrats do, and

therein lies the problem. This theory holds that it is a pipe dream to consider

political decision makers as altruistic seekers of the public good. Instead, like

everyone else, they put their own self-interests first, for example, reelection, a

well-paying job after leaving government, or simple bribes. A corollary is that

democratic governments more often than not support policies and programs that

favor loud, well-organized, and well-financed special interest groups. This is

most likely to happen when an official decision can prevent major harm to such an

interest group without inflicting substantial harm that is clearly felt by the public

perceptions and economic ideologies 101

at large. The Bush administration’s imposition of higher tariffs on steel in 2002

arguably is an example of this scenario.

Public choice theory does not say that self-enhancement always results in

corrupt, undesirable, or harmful official actions (special interests sometimes have

a good argument). But it does argue that there is no incentive for government

officials to give priority to the interests of a general public that is usually ignorant

of, or not concerned with, noncosmic government actions and has a relatively

short memory span—especially when confronted with demands from a com-

mitted minority with reasonable requests and a lot of cash.

The theory makes no pretense of being the definitive guide to government

behavior or denying that many elected officials and civil servants are committed

to doing the right thing. However, this paradigm does help explain such foibles as

the enthusiasm of all members of U.S. Congress—past, present, and of all po-

litical persuasions—for championing the funding of even the most dubious pork

(public works projects) because constituents want and are made happy by new

projects in their localities, no matter how unnecessary. The frequency with which

members of Congress insert funding for pet projects into unrelated legislation has

spiked dramatically higher since the mid-1990s—despite a nearly equal increase

in negative publicity and outright derision from those not on the receiving end.17

Public choice theory also explains the equally long-standing history of U.S. reg-

ulatory agencies giving the benefit of the doubt to the industries they regulate

rather than to the interests of society as a whole.

Acceptance of the hypothesis that politicians seldom act like selfless statesmen

who put the long-term interests of their country before their political careers or

ideological beliefs makes it easier to understand the endless bumbling and cor-

ruption in Washington, DC. There is not nearly enough space to provide an

extensive review of the foibles of the U.S. government just in the 2004–2005

period; a few examples will have to suffice. President Bush’s phrase ‘‘Brownie,

you’re doing a heck of a job’’ has entered the language as ironic comment on

government incompetence. The shocking if not outright inhumane ineptitude

exhibited by the Federal EmergencyManagement Agency in responding to flood-

ravaged New Orleans in fall 2005 is suggested by the first sentence of a front page

article in theNew York Times on June 27, 2006: ‘‘Hurricane Katrina . . . produced

one of the most extraordinary displays of scams, schemes and stupefying bu-

reaucratic bungles in modern history, costing taxpayers up to $2 billion.’’

Members of the so-called 9/11 Commission were so alarmed at the failure of

the federal government to act on its recommendations to lessen the chances of

another major terrorist attack that they took the unprecedented step of con-

tinuing as a private group to lobby for more effective security efforts. Much

attention but little action resulted when the members gave low to failing grades in

fundamentals102

late 2005 to the federal government’s actions on its forty-one recommendations.

One of their sharpest criticisms was aimed at congressional insistence on dis-

tributing state antiterrorist grant money on a ‘‘pork barrel’’ basis, whereby a

significant percentage of appropriated funds are disbursed in even amounts

among the states, not prorated on the basis of risk, vulnerability, or consequences

of a terrorist attack.18

The premise that politicians and government officials have a high propensity

to put their own interests on par with (if not ahead of) the public’s interest is

applicable to the actions of other governments. It explains, for example, the

heavy burdens imposed on the Japanese people long after World War II by their

government’s economic policies. High food prices were the cost of rewarding the

ruling party’s strong farm base by restricting agricultural imports. Individual

incomes, living standards, environmental protection, and interest on personal

bank deposits were systematically curtailed to promote the bureaucrats’ and

politicians’ fixation with creating world-class manufacturing companies at the

fastest possible pace. Big business’s interests uniformly were given higher pri-

ority than the public good. Elsewhere in Asia, the endemic corruption in China’s

state-owned banking system is another reason to challenge the notion of public

servants as protectors of the public commons. Buchanan counseled those who

wanted to reform the political process to do so by changing its rules and in-

stitutions, not waiting for a new crop of politicians and civil servants to be the

first to see the light and become uncompromising defenders of the majority’s

interests.

Antithesis: Protect the Majority,

Curb Corporate Avarice

As seen from a different perspective, the relentless pursuit of profits and an

unregulated business sector produce a society marred by excesses of inequality,

exclusion, and environmental degradation. This assessment is part of the political-

economic ideology that sees capitalism producing unacceptably skewed results

that fall well beyond the boundaries of fairness or logic. A small minority of the

population reaps a large majority of the economic benefits in a winner-take-all

pursuit of wealth that leaves a bare minimum to trickle down to working-class

families. Capitalism can produce an abundance of goods, services, and material

wealth; the problem is that it is intrinsically unable to distribute them on an even

or ‘‘fair’’ basis. Production based on profit maximization produces too many

antisocial distortions. Free markets perpetuate poverty in a large have-not class of

people within a country and a large have-not class of countries internationally.

perceptions and economic ideologies 103

Have-not people and have-not countries face an uphill battle to break out of a

vicious circle of poverty and inadequate education while the relatively few rich

continuously get richer.

The capitalist international economic order allegedly is structured to protect

and enhance the relative wealth of industrialized nations by preserving their

domination of high value-added goods. Developing countries are shunted to

the periphery, perpetually dependent on the North for advanced technology and

capital. The systemic inequities of the old international economic order are

sustained in part by holding the economic futures of developing countries hos-

tage to decisions made in the headquarters countries of large MNCs, where the

priority is most decidedly not promoting growth and higher living standards in

host countries.

Heads of large U.S. corporations typically are paid millions of dollars in salary,

bonuses, and stock options (on average, Chief Executive Officers (CEOs) in the

United States were paid 300 times as much as rank-and-file workers in the early

2000s).19 Furthermore, they seldom have their pay packages reduced even if cor-

porate profits decline. Corporate CEOs also earn tens of millions of dollars more in

severance packages and retirement benefits; at least eight current ones reportedly

will be eligible for retirement benefits exceeding $3 million annually.20 Michael

Ovitz received a severance package valued at about $140million after being ousted

in 1996 as president of the Walt Disney Company after fourteen months in office. In

the meantime, tens of millions of Americans lack health insurance.

Rather than giving business free rein to do whatever it takes to fatten the

bottom line and raise dividends, fairness-driven, left-of-center ideology calls for

economic institutions and laws to ensure that economic activity primarily serves

the interests of society at large, not the relatively few owners of capital. This kind

of economic order is most compatible with the philosophy that elevation of the

human spirit is the number one purpose of economic activity. Those to the left of

the political center are alarmed at what they see as a growing tilt in the balance of

power in favor of companies and against the incomes and job security of labor,

especially the relatively less skilled. Workers are viewed as disposable parts, easily

shed whenever necessary to boost corporate profit margins. The rewards of cap-

italism, in short, are distributed on an unjustifiably unequal basis.

A much published American philosopher decried a ‘‘global overclass which

makes all the major economic decisions’’ and makes them independently of the

legislature and the will of the voters in any given country. ‘‘The absence of a

global polity means that the super-rich can operate without any thought of any

interests save their own.’’21 ‘‘Never before in modern times has the gap between

the haves and the have-nots been so wide, never have so many been excluded or

so championless,’’ claims a British academician. Those at the lower end of the pay

scale continue to lose ground in both political and economic terms. ‘‘Jobs and

fundamentals104

incomes in rich and poor countries have become more precarious as the pressures

of global competition have led countries and employers to adopt more flexible

labour policies, and work arrangements that absolve employers from long-term

commitment to employees.’’22 Voltaire may have been the first to decry the plight

of the many against the enrichment of the few when he reputedly said that the

comfort of the rich depends on an abundant supply of the poor.

‘‘Enron syndrome’’ is a recent addition to a long list of reasons to distrust

corporations, the engines of capitalism. Employees, in the eyes of corporations,

are interchangeable parts, not human assets deserving of special respect. Cus-

tomers, in the eyes of corporations, are materialistic purchasing units meant to

be manipulated into wanting your product. To people of the political left, any-

thing with such traits cannot be left to its own devices. The parade in recent

years of corporate chieftains on trial in the United States for various criminal

offenses has added credibility to the view that private corporations are illegal and

immoral actions waiting to happen. To some, it cannot be otherwise because

companies are intrinsically amoral institutions, devices to serve and enrich their

owners without regard to the well-being of everyone else. By one hard-edged

reckoning,

The corporation’s legally defined mandate is to pursue, relentlessly and

without exception, its own self-interest, regardless of the often harmful

consequences it might cause to others. As a result, . . . the corporation is a

pathological institution, a dangerous possessor of the great power it wields

over people and societies. Today, corporations govern our lives. . . .And

like the church and the monarchy in other times, they posture as infallible

and omnipotent. . . . Increasingly, corporations dictate the decisions of their

supposed overseers in government and control domains of society once

firmly embedded within the public sphere. . . .As a psychopathic creature,

the corporation can neither recognize nor act upon moral reasons to refrain

from harming others. Nothing in its legal makeup limits what it can do to

others in pursuit of its selfish ends, and it is compelled to cause harm when

the benefits of doing so outweigh the costs. Only pragmatic concern for its

own interests and the laws of the land constrain the corporation’s predatory

instincts, and often that is not enough to stop it from destroying lives,

damaging communities, and endangering the planet as a whole.23

In short, the critical school of thought thinks corporations need parental

supervision. The author of this critique, a Canadian law professor, recommends

that society and its elected leaders challenge corporate rule ‘‘in order to revive the

values and practices it contradicts: democracy, social justice, equality, and com-

passion.’’24

perceptions and economic ideologies 105

Profit-making corporations are attacked for their economic shortcomings as

well as their alleged moral and aesthetic deficiencies. Some have suggested that a

reason that the invisible hand is invisible is that it does not really exist. ‘‘Even

in the very developed countries, markets work significantly differently from the

way envisioned by the ‘perfect markets’ theories.’’ Markets have limitations that

sometimes are too significant to ignore.25 The existence of what economists call

market failures is an integral part of ideology favoring strong, activist government

regulation to limit corporate-induced distortions. Examples of market failures

include the inability or refusal of companies to produce goods the public wants;

external costs, such as pollution, that are not included in prices; and absence

of price competition because a market is dominated by one (monopoly) or a few

(oligopoly) large companies. The latter situation is of direct relevance to the study

of FDI and MNCs in the international economy. Vladimir Lenin wrote in the

early twentieth century that ‘‘Imperialism is capitalism in that stage of devel-

opment in which the domination of monopolies and finance capital has established

itself; [and] in which the export of capital has acquired pronounced importance.’’

A major long-term decline in competition was in progress, he wrote. It ‘‘was

creating large-scale industry and eliminating small industry, replacing large-scale

industry by still larger-scale industry, finally leading to such a concentration of

production and capital that monopoly has been and is the result.’’26

Lenin believed that imperialist expansion abroad allowed capitalism to post-

pone the inevitable crisis of having nowhere to expand sales and profits. The

vehicle for this expansion was MNCs, though the term had not been invented

in Lenin’s day. Perhaps he was just ahead of his time. The drive to maximize

economies of scale in the high-tech era have produced just the kind of business

concentration in the hands of a relatively few, relatively large global corporations,

just as Marx and Lenin had prophesied. Discussions of oligopolies and mo-

nopolistic competition are not confined to radical treatises; they are standard fare

in the international trade theory chapters of contemporary textbooks on inter-

national economics. Indeed, it is now assumed that market forces encourage the

emergence of a relatively few dominant companies in industries characterized by

economies of scale; the result is a growing number of markets characterized by

oligopoly, that is, three or four giant MNCs that influence if not control prices.27

The best guess answer to the question of whether this situation on balance helps

or hurts the world’s peoples depends on which ideology one embraces.

MNCs and the Antiglobalization Movement

The nature and impact of the process known as globalization is arguably the most

contentious new issue in international political economy. In the final analysis, the

fundamentals106

dispute is about the relative costs and benefits of the internationalization of

capitalism. More specifically, it is about the costs and benefits of an international

economic order that some believe has moved much too far in favor of protecting

corporate assets and promoting profits and too far away from protecting the

rights of workers. A central irony here is that the absence of consensus on a

general definition or on a framework of analysis has not interfered with the heated

arguments about it. Globalization remains an all-inclusive buzzword capable of

generating great emotion but containing little intellectual precision. One of the

more incisive assessments is that it is ‘‘a myth, a rhetorical device, a phenomenon,

an ideology, a reality, [and] an orthodoxy.’’28

The most commonly used definition, increased economic interdependence, is

short and to the point but does not do justice to the broad scope of what is

involved. Globalization is much more than a greater interconnectivity of national

economies in the wake of faster growth rates in foreign trade, international capital

movements, and FDI relative to the growth of world domestic output (GDP).

Those in favor of globalization argue that it was, is, and always will be the

indispensable factor in stimulating economic growth and rising living standards.

Conversely, countries that have not integrated themselves into the international

economy have lagged behind. Criticism is leveled at globalization on a multi-

disciplinary basis: economics (income gains and losses are distributed in a very

uneven, unfair manner); national politics (the alleged diminution of national

sovereignty, discussed in chapter 10); local politics (concerns that people are

increasingly losing control of their destinies to all-powerful global forces); and

culture (principally, the perceived effects of excessive Americanization).

As the most visible symbol of what people like and dislike about globalization,

FDI and MNCs are inextricably intertwined in the dispute between its advocates

and critics. The core economic criticism of globalization is the same as that of

capitalism—an increasingly unequal distribution of benefits—just on a broader

geographical scale. Because corporations are the principal bête noire of critics of

capitalism, it follows that MNCs are the principal bête noire of critics of glob-

alized capitalism. It has been argued that ‘‘a major feature of globalization is the

growing concentration and monopolization of economic resources and power by

transnational corporations.’’ Investment resources and modern technology are

concentrated in the few rich countries, and a majority of developing countries are

excluded from the positive aspects of globalization. The resulting international

income imbalance ‘‘leads to a polarization between the few countries and groups

that gain, and the many countries and groups in society that lose out or are

marginalized.’’29 Another concern is that the budgetary costs of providing

incentives—subsidies and reduced rates of corporate taxation being at the top of

the list—to attract and retain incoming FDI have inflicted financial harm on

the populace of a growing number of countries in two ways. First, many

perceptions and economic ideologies 107

governments have becomemore willing to reduce business tax rates in response to

demands by country-hopping corporations, presumably with the result that the

tax base needed to support the social safety net has shrunk. The second alleged

source of harm is that some governments are partially offsetting lower business

taxes by disproportionately increasing the tax burden on workers’ incomes.30

Democracy deficit is the term used to describe the belief that size and wealth

allows MNCs to bully governments into giving them concessions that are not

desired by, or in the interest of, the majority of the local population. Those who

adhere to this argument see governments as having abandoned priority com-

mitment to social justice and assistance to the most disadvantaged citizens in

favor of pursuit of an economic and political environment pleasing to business

interests. To Noreena Hertz, ‘‘Governments once battled for physical territory;

today they fight for market share. . . .The role of nation states has become to a

large extent simply that of providing the public goods and infrastructure that

business needs at the lowest costs.’’31

The anti–free market school of thought believes that MNCs enjoy an intoler-

able advantage in mobility, namely, the ability to move production to subsidiaries

in foreign countries far easier than workers can move from country to country.

This power allows management to issue ultimatums to host governments and

their own workforce to accede to its demands or watch a factory move to a more

economically attractive country. One does not read reports of companies who had

forced give-backs from their workers subsequently raising wages when profit-

ability returns.32 Skeptics are concerned that globalization is solidifying class

divisions between the haves and the have-nots, that is, those who have the work

skills and mobility to flourish in global markets and those who do not. The danger

is that international economic integration will contribute to domestic social

disintegration.33

The perception that MNCs are engaged in a race to the bottom is another

plank in the antiglobalists’ platform. Though not documented, belief persists that

profit-maximizing companies scour the planet to construct factories in countries

where the wage scales are the lowest and the enforcement of antipollution laws is

the least. Countries therefore would face the dilemma of choosing between losing

out on industrial production or reducing their labor and environmental protec-

tion standards.

A critic of international capitalism concluded that the world economy is

‘‘running downhill—a system that searches the world for the lowest common

denominator in terms of national standards for wages, taxes and corporate ob-

ligations to health, the environment and stable communities.’’ The international

economic order allegedly is evolving into a ‘‘kind of global feudalism—a system

in which the private economic enterprises function like rival dukes and barons,

warring for territories across the world and oblivious to local interests’’ inasmuch

fundamentals108

as local governments are no longer strong enough to govern giant global cor-

porations.34 Although no data have been produced to demonstrate any significant

correlation between inward FDI and low wages or low environmental protection

efforts in host countries, anecdotal evidence can be used to depict a more limited

ratcheting down of manufacturing to progressively lower wage countries. For

example, by one unofficial estimate, 200,000 assembly jobs were lost in Mexico’s

maquiladora sector in 2002 as the result of more than 300 companies, mainly

foreign-owned, shifting production to lower wage China.35

Synthesis: Somewhere between the Market and the

State Is the Least Bad System

Unconditional reliance on either the social benevolence of government or the

efficiency-maximizing invisible hand of the marketplace is not something that

generates widespread support in most countries. A hybrid economic philosophy

appeals to Joseph E. Stiglitz, a Nobel Prize winner in economics, because he

believes that ‘‘Both the left and the right have lost their bearings.’’ Both sides

need to update their economic agenda to make them relevant for current reali-

ties, and they need to accept that there is no ‘‘single set of policies which will

make all of us better off.’’ Unconditional faith that markets by themselves in-

evitably lead to efficient and fair economic outcomes ‘‘has been stripped away.’’

At the same time, the collapse of communism has effectively ended support for

socialism even in those countries that previously embraced it. The big challenge

today is to find the right balance between the state and the market at the local,

national, and global levels.36 Stiglitz wrote that

as economic circumstances change, the balance has to be redrawn . . .we

cannot escape the issues of democracy and social justice in the global

arena. . . .Economies can suffer from an over intrusive government, but so

too can they from a government that does not do what needs to be done—

that does not regulate the financial sector adequately, that does not pro-

mote competition, that does not protect the environment, that does not

provide a basic [social] safety net.37

Fundamentalists who put complete faith in either totally free markets or

comprehensive government planning and regulation seem oblivious to the long

empirical record of market failures and government failures. Acknowledging the

shortcomings of markets does not logically lead to the conclusion that reliance on

government is essential and vice versa. It does seem logical that both have an

important role to play, in part to offset the shortcomings and vices of the other.

perceptions and economic ideologies 109

As one study put it, ‘‘an unbridled economic role for the government in the name

of distributive justice is often a recipe for disaster in the long run, but, on the

other hand, market solutions are often ruthless to the poor.’’38 Selecting the ideal

course for economic policy requires some very difficult choices.

Speaking cynically (‘‘realistically’’ may be more accurate), the Marxist-radical

and the free market perspectives have it half right at best when accusing the

other’s model of woolly thinking and disgraced policies. Each side has it totally

wrong to think that the public sector, the business sector, or nonprofit groups

perform in the noblest manner in the service of the public interest and don’t need

to be subjected to constant oversight. Neither government, nor private business,

nor nonprofit organizations have anything close to a spotless record for effec-

tiveness, honesty, and competence.

Institutions are run by people, and history clearly demonstrates that indi-

viduals act in reprehensible ways with frightening frequency no matter for whom

they are working, what their salary is, or how noble the cause for which they are

working. Questions about the need for adoption of more vigorous and effective

accounting standards by nonprofit groups were raised by the 2004 imprisonment

of the chief executive of the United Way’s Washington, DC, branch after he pled

guilty to embezzling nearly $500,000 from donations and the charity’s pension

fund. (The image and fundraising efforts of this particular charity received an-

other setback over the next two years, when accusations were leaked that the new

CEO was receiving overly generous salary increases. The new CFO subse-

quently resigned because, among other things, she was angered that exaggerated

fundraising totals had been publicly reported.)39 The Nature Conservancy, one

of the largest conservation groups in the United States, was the target of a series

of stinging criticisms in the Washington Post in May 2003. The articles ques-

tioned the propriety of property sales made by the organization to its major

supporters on favorable terms, its relationship with corporations, and other

issues. The Nature Conservancy subsequently admitted it had made errors in

judgment and needed more comprehensive executive oversight.40

The Senate Finance Committee of the U.S. Congress, having been told by the

Internal Revenue Service that abuse by charities and nonprofits of their tax-

exempt status was not uncommon and increasing, announced in April 2005 that it

would investigate the extent to which these groups were ‘‘excessively’’ com-

pensating their executives and spending on public relations.41 Later in the year,

Senator Charles Grassley, chair of the Finance Committee, began an inquiry into

the governance and effectiveness of the saintly Red Cross. He also demanded

hundreds of documents from American University, where this author teaches, to

shed light on how the oversight function in a tax-exempt, nonprofit institution

failed to contain the unusually generous salary and benefits provided the then

recently deposed university president.42

fundamentals110

People with unshakable faith in either the public or private sector as champion

of their values and material well-being should consider the fate of whistle-

blowers who expose unethical or criminal behavior by their employers. Their

commitment to honesty and protecting the public’s welfare has not resulted in

awards or promotions from admiring companies whose bottom line has been

hurt. The usual result is harassment or being fired and finding little demand in

the job market for ex-whistle-blowers. That federal agencies exhibit the same

high propensity as private enterprise to intimidate and fire those who would air

institutional dirty linen is suggested by the U.S. government’s having enacted no

fewer than thirty-five separate statutes to protect civil servant whistle-blowers.43

The Clinton Administration felt compelled to issue a presidential directive in

1997 ordering the Justice Department to implement regulations protecting

whistle-blowers in the Federal Bureau of Investigation, an organization that one

would think is unequivocally committed to truth and honorable behavior. It

cannot be assumed that nonprofit NGOs or even charities would take a more

enlightened and benevolent stance if one of their own went public with charges of

dishonesty or malfeasance after being unable to affect change from within. Rare is

the government agency or private sector business or nonprofit organization that

places the desire to reveal and halt internal wrongdoings above protecting its

public reputation and the jobs of its leaders.

Even with improved supervisory and enforcement measures, human nature is

such that there will always be a few people who reach the upper echelons of any

organization, even humanitarian and law enforcement groups, who will violate

the trust put in them because of urges for self-enrichment and power, a lack of

ethics and personal discipline, an out-of-control ego, or terrible personal judg-

ment. As will be suggested in chapter 15, government, the corporate sector, labor

unions, and NGOs should all have a voice in setting policies regulating FDI and

MNCs; in part this is because they deserve it and in part because that is the most

effective way that each can keep a close eye on the others.

Notes

1. John H. Dunning,Multinational Production and the Multinational Enterprise (London:

George, Allen and Unwin, 1981), pp. 36–37.

2. Ibid., p. 37.

3. Speech to the House of Commons, 1952, as quoted in Bartlett’s Familiar Quotations

(Boston: Little, Brown, 1980), p. 746.

4. Many of these questions are based on issues raised in ‘‘The Good Company—A

Survey of Corporate Social Responsibility,’’ The Economist, January 22, 2005, special

section, pp. 6–16.

perceptions and economic ideologies 111

5. Robert Gilpin, The Political Economy of International Relations (Princeton, NJ: Prince-

ton University Press, 1987), pp. 10–11. The author cited Robert Heilbroner, The

Nature and Logic of Capitalism (New York: Norton, 1985) in connection with the final

portion of the block quotation.

6. Neil Hood and Stephen Young, The Economics of Multinational Enterprise (London:

Longman, 1979), p. 353.

7. As quoted in The Concise Encyclopedia of Economics, available online at http://

www.econlib.org; accessed March 2005.

8. John Micklethwait and Adrian Wooldridge, The Company (New York: Modern Li-

brary, 2003), pp. xv, xxi. The authors’ praise of the corporation included the following

quote attributed to Nicholas Butler: ‘‘The limited liability corporation is the greatest

single discovery of modern times.’’

9. Martin Wolf, Why Globalization Works (New Haven, CT: Yale University Press,

2004), p. 70.

10. ‘‘Anticorruption,’’ available online at http://www.worldbank.org/publicsector/

anticorrupt/index.cfm; accessed March 2005.

11. Data source: Web site of Transparency International, http://www.transparency.org;

accessed January 2005.

12. Jeffrey Birnbaum, Washington Post, May 29, 2006, p. D1.

13. Source: Michael Josephson, ‘‘Character Counts,’’ May 12, 2006, available online at

http://www.charactercounts.org.

14. James Madison, ‘‘The Structure of the Government Must Furnish the Proper Checks

and Balances Between the Different Departments,’’ Federalist Paper no. 51, available

online at www.constitution.org/fed/federa51.htm; accessed March 2005.

15. Johan Norberg, In Defense of Global Capitalism (Washington, DC: Cato Institute,

2003), p. 273.

16. James M. Buchanan, ‘‘Politics without Romance: A Sketch of Positive Public Choice

Theory and Its Normative Implications,’’ in James Buchanan and Robert Tollison, eds.,

The Theory of Public Choice II (Ann Arbor: University of Michigan Press, 1984),

p. 11.

17. The Congressional Research Service counted 13,000 ‘‘earmarks’’ costing a total of $67

billion in the first half of 2006. Source: New York Times, May 28, 2006, p. IV 4.

18. See, for example, ‘‘Security Loses; Pork Wins,’’ New York Times, July 14, 2005,

p. A26.

19. Data source: Web site of United for a Fair Economy, http://www.faireconomy.org;

accessed March, 2005.

20. New York Times, April 3, 2005, p. III 6.

21. Richard Rorty, Philosophy and Social Hope (New York: Penguin Books, 1999), p. 233.

22. Noreena Hertz, The Silent Takeover—Global Capitalism and the Death of Democracy

(London: William Heinemann, 2003), pp. 8, 46.

23. Joel Bakan, The Corporation—The Pathological Pursuit of Profit and Power (New York:

Free Press, 2004), pp. 1–2, 5, 60.

24. Ibid., p. 166.

25. Joseph E. Stiglitz, The Roaring Nineties (New York: Norton, 2003), p. 13.

fundamentals112

26. V. I. Lenin, Imperialism: The Highest Stage of Capitalism (1916), as quoted in David

N. Balaam and Michael Veseth, Introduction to International Political Economy (Upper

Saddle River, NJ: Prentice Hall, 2001), pp. 68, 77.

27. See, for example, Thomas A. Pugel, International Economics (Boston: McGraw-Hill/

Irwin, 2004), pp. 96–98, and Paul R. Krugman and Maurice Obstfeld, International

Economics—Theory and Policy (Reading, MA: Addison-Wesley, 2000), pp. 125–26.

28. Arie M. Kacowicz, ‘‘Regionalization, Globalization, and Nationalism: Convergent,

Divergent, or Overlapping?’’ 1998, available online at http://www.ciaonet.org/wps/

kaa01.index.html; accessed October 2004.

29. Martin Khor, ‘‘Globalization and the South: Some Critical Issues,’’ UNCTAD

Discussion Paper 147, April 2000, pp. 4, 7, available online at http://www.unctad

.org/en/docs/dp_147.en.pdf; accessed September 2004.

30. See, for example, Dani Rodrik, Has Globalization Gone Too Far? (Washington, DC:

Institute for International Economics, 1997), p. 6.

31. Hertz, The Silent Takeover, p. 8.

32. See for example, a story about the poststrike revitalization of Caterpillar Corporation

that resulted in a monetary rewards for executives but not for rank-and-file pro-

duction workers. Washington Post, April 19, 2006, p. D1.

33. Rodrik, Has Globalization Gone Too Far?, p. 2.

34. William Greider, ‘‘The Global Marketplace: A Closet Dictator,’’ in The Case against

Free Trade (San Francisco: Earth Island Press, 1993), pp. 195, 213.

35. ‘‘China’s FDI Boom Brings Benefits to Neighbours,’’ FDi [sic], February/March,

2005, available online at http//www.fdimagazine.com; accessed January 2006.

36. Stiglitz, The Roaring Nineties, p. xii.

37. Ibid., pp. xii–xiii, 318.

38. Khor, ‘‘Globalization and the South,’’ p. 51, citing A. Bhaduri and D. Nayyar, The

Intelligent Person’s Guide to Liberalization (New York: Penguin Books, 1996).

39. Washington Post, May 22, 2006, p. B1.

40. Washington Post, May 4, 5, and 6, 2003; and the Nature Conservancy’s Web site,

http://www.nature.org/pressroom.

41. Washington Post, April 6, 2005, p. E1.

42. He was forced to resign on grounds of excessive and legally questionable expenditures

of university funds.

43. Data source: National Whistleblower Center’s Web site, http://www.whistleblowers

.org/html/nwc_publications.html; accessed March 2005.

perceptions and economic ideologies 113

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PART II

The Strategy of Multinationals

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6

why companies invest overseas

Atfirst glance, the answer to the question implied by the title of thischapter is simple and straightforward: a company establishes value- adding production facilities overseas to increase profits. Because no chief execu-

tive has publicly proclaimed that a desire to lose money and court bankruptcy was

the reason for his or her firm’s engaging in foreign direct investment (FDI), this

answer is incontestable. The problem is that it explains only a small part of a big

story. It is the truth, but not the whole truth. Profit maximization is too general a

concept to provide deep analytical insight into the variety of differentiated mo-

tives behind a process as complex as this one.

Given the many variables associated with different kinds of multinational

corporations (MNCs) operating in different industrial sectors, following differ-

ent business strategies, and investing in different host countries, it is naive to

expect a single reason to provide ameaningful, comprehensive answer to the ques-

tion of why all FDIs have taken place year in and year out. Significant differences

exist in the motivations behind natural resource, market, efficiency, and asset-

seeking direct investments. The situation is further complicated by the fact that

in business and economic terms, it is by no means axiomatic that producing

overseas is the only, or even the shortest path to profit maximization. Feasible

alternatives exist. A better but nondefinitive answer to explain why FDI takes

place and why MNCs have proliferated is, predictably, ‘‘it depends’’ on relevant

circumstances.

This chapter seeks to provide an appropriate level of disaggregation and detail

on the heterogeneous forces behind corporate decisions to establish or purchase

overseas subsidiaries. The diversity of the motivations behind this commitment

has frustrated academicians’ efforts to develop a single all-purpose model to

explain and predict the establishment of overseas subsidiaries. Implicit in the

analysis that follows is the belief that this is an inevitable and acceptable state of

117

affairs. After an initial examination of how FDI and MNCs relate to general eco-

nomic theory, the three major academic theories concerning these phenomena are

examined. The chapter’s third section consists of what is intended as an exten-

sive checklist of real-world reasons for FDI. In some cases, they track theory, but

more often they do not. Many of the motivations cited in this section are ignored

by mainstream economic theory for a variety of reasons. The fourth and final sec-

tion uses the automobile industry as a case study in support of the argument that

multiple factors served as catalysts for the hundreds of thousands of individual

foreign subsidiaries operating today.

Fundamentals of Economic Theory and the

FDI Process

In the beginning, economic theorists made no efforts to explain why companies

establish overseas subsidiaries. FDI was treated as a nondifferentiated interna-

tional capital flow, that is, it was generically the same as any other kind of cross-

border money movement. MNCs were viewed as being just another variant of

capital arbitrage. It was assumed that companies shifted funds from one country

to another for the same reason as any bank or individual investor would: to get a

higher rate of return than could be obtained in the home country.

FDI has no place in the pure world of neoclassical economic theory. ‘‘Perfect’’

competition is assumed in an environment where ‘‘atomistic firms all enjoy equal

access to technology and markets, with none large enough to influence inputs or

outputs.’’1 With perfect international markets (roughly synonymous with the

colloquialism ‘‘perfectly level playing field’’) for technology, management, labor

skills, components, and other material inputs, national markets would be con-

trolled by local firms. Stated slightly differently, ‘‘in a world of perfect compe-

tition for goods and factors [land, labor, and capital], direct investment cannot

exist.’’2 MNCs in the manufacturing and service sectors would be few and far

between in view of insurmountable competitive advantages bestowed on indig-

enous companies relative to carpetbagging foreign competitors. Local businesses

would be more familiar with the economic, social, legal, and cultural aspects of

the home market, have better political connections, possess closer relationships

with wholesalers and retailers, and so on. Foreign companies would have to pay

dearly for the insights native business managers either already learned or could

find out on a relatively quick and cheap basis.3 If firms everywhere manufacture

essentially similar products and sell them at comparable prices, no company has

dominant market power. In a pure textbook world, companies would not grow

beyond the size of a single efficient plant and would have negligible problems of

the strategy of multinationals118

logistics and coordination. Any sales to foreign customers would be in the form of

exports. The traditional theory of free trade unrealistically assumes that tech-

nology and production techniques are open-sourced and available to all.

Trade theorists paid little attention to the forces underlying FDI and MNCs.

Their attention was directed to the Heckscher-Ohlin theorem (see chapter 9)

whose assumption of perfect competition, constant returns to scale, and so on

meant that the issues of ownership, proprietary technology, and corporate size

mattered little or not at all. Relative factor endowments of a country were all-

important for global economic efficiency. The transfer of manufacturing tech-

nology and other corporate assets to production facilities in foreign countries was

not considered a ‘‘matter requiring analysis.’’4

Academicians could also ignore FDI on the grounds that it was and still is

merely one of several options for selling in foreign markets available to nonex-

tractive companies, not a priority business strategy. FDI is absolutely essential

only for extractive companies who must conduct business where raw materials

are physically located and where climatic conditions are favorable for growing

agricultural commodities. In principle, any internationally competitive manu-

facturing company and companies providing certain services (e.g., education and

data transmission, but not hotels) can successfully sell to foreign customers

without opening subsidiaries in other countries. Exporting may have long ceased

to be the only method of selling abroad, but it is still used to ship trillions of

dollars worth of goods and services across national borders every year. Exporting

has not lost its ability to allow some companies to increase production in their

main manufacturing facility to levels that reduce average per unit production

costs to a minimum (see discussion of economies of scale, to follow).

Partnerships of various kinds with local companies are another alternative to

FDI as a means of generating profits from foreign markets. Licensing is the most

common variant of this strategy. In lieu of the major financial commitment and

risks associated with creating foreign subsidiaries, a manufacturer, retail chain, or

service company can simply transfer, under predetermined contractual terms,

basic know-how to an overseas firm that will then produce and market the good

or service. The two main benefits to the foreign company of this option are first,

the local licensee’s greater knowledge of the domestic business scene and cultural

patterns, and second, the licensee uses its own capital to start and operate the new

sales effort. If it is successful, royalty fees provide a steady cash flow to the foreign

company with no expenses or exposure. If the project should fail, the licensor

suffers no out-of-pocket loss. High on the list of disadvantages to licensing is the

need to share business secrets, such as proprietary technology, assembly tech-

niques, and marketing strategy, with a potential rival. The RCA Corporation’s

licensing of its color TV technology to Japanese TV producers in the 1960s is the

why companies invest overseas 119

classic case study of how licensees can reverse teacher–student roles and take

major market share away from the original innovator. Other drawbacks for the

licensor include ceilings on profits; absence of control over pricing, sales volume

targets, and quality control; and uncertainty as to the licensee’s level of com-

mitment to the project. These same advantages and disadvantages apply to two

other common forms of partnership: joint ventures (consisting of co-ownership

of a newly formed corporation) and international strategic alliances in which two

corporations agree to specific forms of cooperation but do not create a new busi-

ness entity (see chapter 4).

It was only in the 1960s that economic theory finally resolved its curious

disinterest in the details of a phenomenon clearly growing in size and importance

to the international economic order. Sooner or later, economists were going to

have to come to grips with the discrepancies between the proliferation of MNCs

and what was then a wholly inadequate conceptual framework about what exactly

motivates companies to produce in multiple countries. Treating FDI simply as

just another form of international capital flow seeking higher returns was a gross

oversimplification; the fact that the literature defined higher returns mainly as

higher interest rates further undermined the relevance of this concept in ex-

plaining direct investments. According to economic theory, capital should flow

mainly from capital-intensive countries to capital-poor countries having low cap-

ital-output ratios; capital would be more valuable in this environment and garner

higher yields. One obvious inconsistency was that the vast majority of U.S.

corporate direct investment after World War II was going to relatively capital-

abundant, high-labor cost West European countries. In addition, construction of

a number of foreign subsidiaries was being financed within the host country; in

these cases, no capital flows exited the capital-rich United States. More impor-

tant, as increasingly sophisticated overseas factories hired and trained well-paid

workers to manufacture increasingly high-tech goods and occasionally became

one of the host country’s largest exporters, the notion that FDI involved nothing

more than a simple cross-border transmission of money became progressively

untenable.

Even today, mainstream theory suffers from an inadequate degree of disag-

gregation when analyzing the myriad motivations of corporations to expand over-

seas. For example, when larger companies build overseas subsidiaries, it may be

at the initiative of only one corporate division among many. Hence, a given

decision to invest overseas might reflect calculations by specialists wanting to

increase their relative contribution to the collective bottom line, and that might

differ from the calculus of a company-wide decision.

FDI flows represent an extraordinary package of corporate physical resources

and intellectual property—the source of both praise and condemnation. The

opening of foreign subsidiaries poses potential short- and medium-term risks and

the strategy of multinationals120

prospective long-term benefits to host and home countries as well as to the

companies involved. Transfers of manufacturing from one country to another

raise the specter, among other things, of lost jobs in home countries and di-

minished sovereignty in host countries. FDI also holds out the promise of access

to well-paid jobs, technologies, and management systems that otherwise would

be beyond the reach of some host countries. The widening gap between the

growing importance of MNCs and the static understanding of their effects

created a pressing need by the 1960s to examine the more ‘‘qualitative attributes’’

and impact of MNC activity in host countries, namely, their sectoral distribution

and technological content, along with the nature of the linkages to the local

economy.5

A Survey of the Major Academic Theories

The academic literature dealing with the twin questions of why FDI takes place

and how companies can successfully produce goods and services in distant and

unfamiliar foreign environments is dominated by three theories.6 How well they

succeed in explaining these things is a value judgment.

It was not until the 1960s that the innovative ideas of Stephen Hymer pro-

vided the first meaningful insights into the theoretical underpinnings of FDI and

MNCs. He was the first to expound on how these companies were different from

purely domestic enterprises and why nonextractive companies could successfully

compete in foreign countries, a task fraught with dangers and problems. The

revolution in thinking in fact emerged as a slow evolution; Hymer’s ground-

breaking doctoral dissertation completed in 1960 made no immediate impact and

was not published until 1976.7 He dismissed as irrelevant the generic theory of

differential returns on capital to explain FDI. In its place, he used industrial or-

ganization theory to explicitly outline for the first time why success in operating

overseas subsidiaries was contingent on parent companies possessing advantages

that overrode the daunting and costly process of producing goods and services in

distant, perhaps inscrutable business environments.

Hymer’s core thesis begins with the assumption that companies are motivated

to move overseas as a second stage of efforts to maximize profits, ‘‘rent’’ in

economic terms, derived from their monopolistic control over what they pro-

duce. However, management could project a comfortable profit margin from

overseas production only if the company enjoyed an adequate mix of product

innovation, low production costs, managerial excellence, or marketing advantages

unique to the company and not easily duplicated by competitors. The now-

familiar concept of ownership advantage (also called firm-specific advantage) had

been born. Before opening a foreign subsidiary, Hymer said, management needed

why companies invest overseas 121

to make two specific determinations. The first is that ownership advantages were

sufficient to outweigh the disadvantages and risks incurred when competing head

to head with foreign companies on their home turf (as opposed to exporting or

licensing deals).8 Later theorists provided a list of specific ownership advantages:

cutting-edge technology; superiority in management, production, marketing, and

distribution know-how; advanced organizational techniques and information

management capabilities; sufficient size to ensure economies of scale in produc-

tion and maximum advertising; and the ability to parlay a blue chip credit rating

into lower cost financing. The second requisite determination is that direct in-

vestment will produce better long-term results for the company than exporting,

licensing, or joint ventures.

A second core assumption of Hymer’s theory, initially disseminated by well-

known economist Charles Kindleberger, is that ownership advantage works on a

global basis only in the absence of perfect competition and perfect markets.

(These concepts allude to the increasingly rare situation in which companies

compete on a totally equal footing.) For FDI to thrive, there must be some im-

perfection in markets for goods or factors such as technology differentials or some

interference in market competition by government or by firms.9 Business prac-

tices causing market imperfections include technological exclusivity protected by

patents, superior managerial and marketing know-how, product specialization

(differentiation), collusion on pricing, and preferential access to borrowed cap-

ital. Governmental policies such as tariffs, quotas, and subsidies to favored in-

dustries constitute a second category of market failure.

Economies of scale is, in economic theory terms, a market imperfection that has

become a critical applied factor leaving essentially all large producers of capital-

intensive, high value-added goods no other option than to produce and market on

a multinational basis. The theorists of Ricardo’s day lived at a time when en-

trepreneurs could start and maintain a cloth or wine business for a minute frac-

tion of the cost of starting and growing a high-tech company in the twenty-first

century. The Heckscher-Ohlin theorem’s assumption of constant returns to scale

in measuring a country’s relative competitiveness is completely at odds with the

absolute requirement for today’s advanced technology companies to achieve in-

creasing returns to scale. Size matters in amortizing (spreading) fixed costs which

consist mainly of R&D, factory preparation, and worker training. In all cases,

these are expenses that a company incurs before it makes the first sale of a new

product—assuming that massive R&D expenditures did in fact produce a com-

mercially viable product. More than $3 billion is now required to develop a new

generation of semiconductor chip and build and equip one factory for produc-

ing it.

Fixed costs, which must be recovered if a company is to maintain long-term

financial health, remain the same (i.e., they are fixed) no matter how low or

the strategy of multinationals122

high the ensuing volume of sales. Selling limited numbers of new chips after a

multibillion-dollar investment would impose either a prohibitively high price tag

on each unit offered for sale or a crushing financial burden on the producer.10

Conversely, maintaining the largest possible sales base, which is planet Earth,

could help keep per unit costs to a minimum. Maximum volume equates to mul-

tinational marketing strategies. No single national market is large enough to allow

for scale economies in the contemporary high-tech sector. The drive for maxi-

mum sales volume relative to current and potential competitors explains why it is

de rigueur for the strategies of aggressive high-tech companies to maintain pro-

duction and marketing operations in the consumer-rich Triad (Western Europe,

Japan/East Asia, and the United States).

Much FDI now gravitates to high-tech business sectors where major com-

petitors are so few in number that the market can be characterized as oligopolistic

or even monopolistic. The pharmaceutical industry epitomizes this kind of mar-

ket. Seeking to recoup an estimated $800 million in development and clinical test

costs now needed to bring the average new medicine to market,11 drug companies

jealously protect their intellectual property and maximize their sales base. New

market entrants are obviously limited by the extraordinary costs involved. The

end result is that successful innovators possess a temporary global monopoly on

products that in some cases generate billions of dollars in annual sales. Unsur-

prisingly, pharmaceuticals is an industry dominated by a relatively few, very large

MNCs, many of which have grown in size through cross-border mergers. These

companies are worldwide price makers, not passive price takers. Conversely,

perfect competition exists in the novelty T-shirt industry. Unlimited new en-

trants are possible in a low-overhead business with simple technology, limited

production runs sold by street vendors or small retailers, intellectual property

consisting of a small design or a few cleverly chosen words, absence of govern-

ment interference, and so on. These characteristics explain why there is no public

record of a major MNC in the specialized T-shirt sector.

The related concepts of oligopoly and corporate size led Hymer to a theme

that attributes sinister traits to MNCs. His later writings emphasized the Marxist

principle that private corporations are inexorably driven by the law of increasing

size. Executives were presumed to believe that steady increases in profits can

come only through constant expansion, first domestically and then, after market

saturation occurs, globally. A second Marxist tenet in Hymer’s theory is the law

of uneven development. It predicted that the size, mobility, and monopolistic

power of MNCs maturing in the industrialized countries of the North would

bestow these companies with sufficient economic power to control and exploit the

whole world to their own financial advantage.12 The implication of this thesis is

that globalization of production is more a malevolent effort to expand corporate

power over prices and preempt the entry of new competitors than a benevolent

why companies invest overseas 123

response to competition and a laudable quest for efficiency. The result, said

Hymer, would be a hierarchal world economy literally separated into two hemi-

spheres where above-average national affluence and influence would be deter-

mined by whether a country was a headquarters country to powerful MNCs.

Host countries would have relatively little wealth or power. The North would

grow richer, and the South would struggle under the burden of structural pov-

erty, ostensibly all in the name of a more efficient utilization of the world’s

resources.

The second widely heralded academic explanation of why manufacturing

companies chose to become MNCs is the product life-cycle theory of Raymond

Vernon. First advanced in the mid-1960s, it emanated from the premise that

the United States possessed a comparative advantage in product innovation;

the theory therefore focused on the experiences of American companies in that

time period. Vernon’s core thesis was that products and production processes

move through a three-stage cycle culminating in the need to invest overseas. (A

tangible frame of reference for the conceptual description to follow is the com-

petition dynamics that followed Xerox’s introduction in the 1960s of the modern

photocopying machine.) During the first phase, the one immediately following

innovation and initial sales, the product is produced in limited amounts—the

ultimate market potential and optimal assembly techniques are still unknowns—

by skilled labor at relatively high costs. Retail price is of limited importance at

this point due to the innovator’s initial monopoly, the product’s novelty and

limited supply, and the relatively price-inelastic demand of initial users. Manu-

facturing at this stage is confined to the company’s home base. Foreign sales

initially are handled through exporting.

The second phase of Vernon’s cycle is product maturation. The key change

here is the start of sustained downward pressures on price. Imitators begin pro-

ducing their own versions of the innovation, some of which will have more fea-

tures and/or lower prices. Competition forces the innovator to improve its

original product and trim costs. Consumers begin to comparison shop and be-

come cost-conscious. Price reductions are facilitated by declining costs brought

about by the product’s being mass produced by better designed machinery and

by the learning curve’s effect: a more efficient assembly line operation. In this

intermediate stage, an export surge has caused some countries to pressure the

major foreign exporter(s) to produce locally. Somewhere in the transition be-

tween the second and third cycles, the innovating company and some of its major

competitors determine that market-seeking and market-protecting FDI is nec-

essary to replace sole reliance on exports. The latter no longer appear capable of

protecting existing overseas market shares or allowing for expansion. At the time

Vernon first articulated this theory, American wages were the world’s highest, so

investments in any other country presumably meant lower labor costs.

the strategy of multinationals124

Product standardization represents the final stage. The technology to produce

the product has reached its zenith, no major design or production changes are

anticipated. Engineers and scientists are no longer tweaking the product or the

assembly process. Less skilled workers far from headquarters can now be trained

on a one-time basis and put to work on the assembly line. The product has be-

come a commodity (like an analog television set), where price is a more important

selling point than the name of the company making it. Market-seeking FDI is

gradually replaced by efficiency-seeking FDI in relatively low-cost, low-wage

countries where subsidiaries are designated as export platforms. Some of their

exports may be destined for the home market where production of the now stan-

dardized product is being phased out in favor of manufacturing newly developed

goods.

Most scholars have concluded that the product cycle theory itself has passed

through a life cycle and descended into obsolescence. It was a good guide to and

predictor of MNC strategy from the 1950s until the early 1970s when a lot of

FDI took the form of American manufacturing companies setting up overseas

subsidiaries to produce goods becoming susceptible to price competition. How-

ever, the theory does not explain most of the more recent developments that have

introduced major alterations and additions to the FDI process. These include

increased numbers of mergers and acquisitions, vertical FDI where companies

produce components in a number of countries for final assembly elsewhere, and

the growing numbers of companies, including those based in LDCs, engaging in

market-seeking FDI in countries with higher labor costs than those in their home

countries.

The eclectic paradigm introduced by John H. Dunning is an amalgam of three

separate explanations of why overseas subsidiaries are established. His approach

incorporates the theory of industrial organization (how a company can achieve

competitive advantage over other firms); the theory of the firm (why does a

company choose one organizational mode over another to create, use, and enhance

its competitive advantages, the so-called transactions cost perspective); and the

theory of location (to explain how firms choose where to locate overseas value-

adding activities). The end result is a broad framework asserting that at any given

moment, the ‘‘extent, ownership, and pattern’’ of MNC activity depends on the

configuration of three variables/conditions being satisfied.13 The requisite

preconditions for management determining that overseas production is the best

business strategy are commonly abbreviated as the O, I, and L advantages.

Ownership advantages are intellectual property and other intangible assets ex-

clusive to a firm that can be transferred in full from the home country to overseas

facilities. They include products and manufacturing processes protected by pat-

ents, trademarks, copyrights, and trade secrets; superior marketing and organi-

zational skills; and the advantages of ‘‘common governance.’’ The latter,

why companies invest overseas 125

according to Dunning, consists of size and established reputation of a company

that affords it favored access to labor, natural resources, finance, and other in-

puts; economies of joint purchases by worldwide subsidiaries; and so on. Own-

ership advantages, whatever their exact mix, must provide a company withmarket

power and/or cost advantages sufficient to outweigh the costs of setting up one or

more subsidiaries in foreign countries and the burdens of succeeding there.

An internalization advantage exists when management determines its owner-

ship advantages are sufficiently formidable or sufficiently sensitive that it does

not need to rely on sources external to the company or should not risk sharing

proprietary assets. In such cases, licensing assets to another company or sharing

them in a joint venture arrangement are ruled out. Ownership advantages are best

exploited internally within the company. Sales and profits presumably are max-

imized by retaining sole control of foreign production.

Assuming the first two conditions are satisfied, a company will opt to build

and operate its own subsidiaries abroad if it also determines the existence of

location-specific advantages. When existing in sufficient magnitude, these ad-

vantages designate a foreign country as the production site most likely to max-

imize profits from overseas sales. Location advantages can exist in the form of

such simple market imperfections as import barriers that rule out exporting,

prohibitive transportation costs, or overly long shipping times. In addition, they

can take the form of pull factors like cheap real estate and labor, financial in-

centives for incoming FDI, and abundant endowments of key natural resources.

The three main theories are not the final word on corporate motivations to

become multinational. Dunning suggested that a changing world economy had

somewhat left behind the ideas of Hymer and Vernon (e.g., foreign trade barriers

were reduced considerably since the early 1970s). They were ‘‘scholars of their

time, and their explanations were strongly contextual. Both tended to deal with

first-phase—rather than sequential—U.S. direct investment.’’ Similar limita-

tions, he added applied to the other FDI theories put forward in the 1960s and

1970s.14 Above and beyond the limitations of the academic theories advanced is

the fact that they overlook several relatively simple and specific business strat-

egies. A second line of analysis as to why firms invest abroad is therefore nec-

essary. The applied, real-world reasons are the subject of the next section.

Real-World Motivations for Direct Investments

If something works in practice, it is unclear how important it is that it also works

in theory. The emphasis in this study on the heterogeneous nature and effects of

FDI and MNCs is inconsistent with the premise that three thirty- to forty-year-

old theories can provide a complete understanding of why these phenomena take

the strategy of multinationals126

place and why their growth has accelerated since the 1980s. For a number of

reasons, the theories are insufficiently disaggregated and too limited in scope to

do justice to the diversity of FDI and MNCs. They implicitly assume that firms

in traditional manufacturing sectors (like chemicals and office equipment) rep-

resent a more or less standardized form of MNC. Even if this had been a rea-

sonable assumption in the 1970s, it clearly is no longer valid today. And even if

new forms of MNCs were not constantly evolving, a single theory of why FDI

occurs is unlikely to be applicable to all foreign-owned subsidiaries, regardless of

their product, business objective, size, mindsets of senior management, and so

on. It cannot be taken for granted that corporate decisions to invest overseas are

so consistent and coherent that as a group that they can be blended into a com-

prehensive economic model.

Another error of commission is the naive assumption of conventional theories

that a decision to invest abroad is always a rational end result of meticulous

research and coldly objective calculations of risk/reward trade-offs. Decisions to

build foreign subsidiaries ultimately are based on the perceptions of a small group

of senior managers, not a scientific formula. Sometimes these perceptions are

formed under unique circumstances that follow no previous script. On occa-

sion, the commitment to expand overseas might be the result of an impulse

by a strong-willed executive, for example, a new subsidiary opened by an arch-

competitor cannot go unanswered. Dunning, one of the giants of FDI theory,

believes that ‘‘it is not possible to formulate a single operationally testable theory

that can explain all forms of foreign-owned production any more than it is

possible to construct a generalized theory to explain all forms of trade or the

behavior of all kinds of firms.’’15 In a literal sense, that overstates the case. All

FDI technically can be explained by the single postulation that a judgment has

been made, for any one of a variety of reasons, that a new foreign subsidiary

eventually will positively contribute the parent company’s bottom-line perfor-

mance. This explanation, however, is so broadly constructed that the insight it

provides is somewhere between irrelevant and useless.

The ability of the major academic theories on FDI to illuminate is further di-

minished by serious omissions. A few very basic business strategies and objectives

are missing entirely, possibly a reflection of the paucity of social science acade-

micians who have worked as managers in an MNC. In addition, minimal atten-

tion has been given to several major changes in business economics that have

added new motivations for corporations to expand overseas. Textbook theory

arguably has not kept full pace with changes in the international marketplace.

Relatively simple real-world explanations are therefore necessary to supple-

ment the purported substantive shortcomings of basic academic theories. A

second round of answers to the why question is also necessitated by the author’s

belief that much of traditional theory is written in an overly arcane manner; many

why companies invest overseas 127

of the specific inspirations behind the opening of foreign subsidiaries are rela-

tively simple and concise. In the interest of brevity, the various real-world ex-

planations of FDI are presented in the form of an annotated list divided into five

classifications with, unavoidably, occasional overlaps.

Marketing 101 Strategies

There are very basic reasons why companies find FDI to be attractive. Econo-

mists tend to ignore the simple fact that corporate executives of countless com-

panies see overseas expansion as an essential part of meeting the relentless

demand from shareholders for growth. Increased sales and profits can come dis-

proportionately from foreign subsidiaries because the domestic market where the

company started may be saturated and because the rest of the world always con-

tains more potential consumers than the home country.

Economic policy throughout history has focused on the core dilemma of try-

ing to satisfy infinite demand with limited resources. It was not until late in the

twentieth century that overcapacity and market saturation became a reality for

some of the goods (e.g., steel, cars, and fiber-optic cable) and some of the services

produced in the industrialized countries. Expansion overseas became the only

feasible expansion route for companies so affected. Speaking more broadly, FDI

for many successfully established companies represents the greatest opportunity

for growth of sales and profits. Diminishing opportunity to expand in its home

market was the deciding factor for McDonald’s bold commitment many years ago

to a global presence. One of the early architects of the restaurant chain’s growth

strategy explained that having ruled out diversification into other business ac-

tivities, the only growth path for the company ‘‘was to do what no American

retailer had ever done—successfully expand its service worldwide. . . . The ra-

tionale for going international was as simple as determining that the market was

there.’’16 Validation of this strategy is visible in the 66 percent of the company’s

total revenues of $20.5 billion in 2005 that came from its nearly 32,000 owned and

franchised restaurants in more than 110 countries outside the United States.17

Decades later, Starbucks is following the same growth strategy and finding the

same favorable foreign reception to a ‘‘fun’’ product representative of the Amer-

ican lifestyle.

Citigroup, one of the world’s largest diversified financial institutions, be-

lieves it has ‘‘largely accomplished the strategic build-out in the U.S., and [is]

now ready to project our products and services globally.’’ With the maturity of

the consumer-finance market and credit card saturation in the United States,

Citigroup’s goal over the next decade is to increase the contribution of non–

North American earnings to total earnings from an already respectable one-third

to one-half.18

the strategy of multinationals128

The second most common fundamental reason for manufacturing companies

to invest overseas is the frequent assessment that it is essential to protecting and

expanding an existing export market or to developing a new overseas market.

Overseas manufacturing sites can reduce production costs and delivery times;

they can also tailor products to local tastes and needs and respond more quickly to

changes in consumers’ preferences. The cell phone is a product that epitomizes a

constant progression of new models with additional features geared to pleasing

localized tastes, characteristics not conducive to exclusive reliance on exporting.

‘‘Make it where you sell it’’ has become a mantra among business executives,

chanted so often that it is now accepted as a rule of business strategy. Being an

insider is increasingly perceived as being critical to sales success in major markets

around the world.19 An executive from Intel, a true high-tech global titan, told a

congressional committee that ‘‘to optimize global competitiveness, it is important

to locate manufacturing and other facilities around the world.’’20 The claim has

to be taken on faith because he provided no explanation why this is so.

The constant of change in international business has added new wrinkles to the

traditional goal of going overseas to lower production costs. ‘‘The China price’’ as

an incentive to engage in FDI is an increasingly important variable. It occurs when

an American or European supplier of manufactured goods is warned by important

customers that they will go elsewhere if the company fails to match the significantly

lower prices offered by China-based companies. Unable to do so from their fac-

tories in high-wage countries, the most feasible alternative to a potentially serious

loss of business is to establish their own subsidiaries in the low-cost manufacturer,

China.21 India, China’s neighbor to the south, has taken the lead in convincing

American and European companies that for competitive reasons, they should set up

foreign subsidiaries to engage in a variety of service sector activities. Offshoring (see

chapters 4 and 13) was created and is sustained by the combination of lower salaries

abroad for skilled service workers and the growing speed, sophistication, and ef-

ficiency of international telecommunications links.

As stated in the location theory discussed earlier, tariff jumping is a classic

reason for companies to produce in foreign markets; tariffs literally are taxes de-

signed to reduce or eliminate the price advantages of imported goods. In some

cases, quotas or other prohibitive nontariff barriers leave foreign companies no

alternative to FDI as a means of gaining market access for high volume sales. One of

the most important impetuses for the surge in FDI in EU countries by U.S.

companies that began in the 1960s was the widespread perception that their top

foreign market would best be protected by avoiding the newly instituted Common

External Tariff applied to goods from nonmember countries. The ‘‘voluntary’’

export restraints on textiles and clothing that many developing countries were

pressured by industrialized countries to administer from the 1970s through 2004

encouraged direct investments in less developed countries (LDCs) that had not

why companies invest overseas 129

signed such an agreement. The loophole gambit explains why Chinese textile and

apparel companies opened subsidiaries in Cambodia and Nigeria, two low-wage

countries that did not agree to annual export quotas to the United States and the

EU.22

Efficiency-seeking direct investments are pursued for cost-cutting purposes

and are not designed to sell their output in the host country. Being export-

oriented, they search for and invest in relatively low-cost labor in countries

having efficient economic systems and accommodating political environments.

Finally, to repeat, companies in the primary sector are forced to

seek out multiple overseas sources of minerals and oil resources since few exist in

adequate supply in just one country.

Finesse Marketing Strategies

Generalized offensive and defensive efforts to preserve and grow foreign markets

comprise only the outer, highly visible layer of MNCs’ marketing strategies.

Companies seriously committed to sales growth in foreign markets tend to have

more subtle and sophisticated objectives and tactics that go beyond reducing

costs or circumventing import barriers. Ambitious overseas sales targets often

inspire efforts to display deep roots in the local market. Finesse marketing strat-

egies were described in a letter to shareholders by the chairman of General Elec-

tric. It said economic reality ‘‘requires us to view the world as our market.’’

However, the company’s overseas growth strategy ‘‘requires more than simply

shipping products. You must be equally committed to developing capabilities

and relationships in the markets where you want to succeed.’’23

Practitioners of finesse marketing strategies cultivate the image of a company

that is an integral part of the local landscape, a business with deep ties to the host

country, a benefactor to its economy, and a philanthropist for local causes. One

author suggested that IBM’s decisions to construct overseas subsidiaries during

the three decades beginning in the late 1960s were not primarily determined by

the quest for cost efficiencies. Instead, the company allegedly selected locations

mainly ‘‘to limit imbalances in its trade between its main markets and to ensure

that in most markets it was a big employer as well as a big seller. Why? Because

IBM felt it had to keep relationships with governments friendly. It needed to

avoid regulatory attacks on its market dominance.’’24

Risk diversification is accomplished by geographical dispersion of production

facilities to hedge against unforeseen events, such as labor strikes, natural di-

sasters, unfavorable changes in legislation and regulatory procedures, and plant

fires or sabotage. Desire to hedge against risk would seem to be an important

motive for Intel’s commitment to overseas operations. Although preferring FDI

to having to worry about new trade barriers in key markets like the EU and

the strategy of multinationals130

anxious to discourage its competitors from establishing lucrative overseas

subsidiaries, it still retains a picture-perfect profile of a company presumably able

to prosper by manufacturing, assembling, and testing its main product, micro-

processors, exclusively within the United States. It does not seem urgently in

need of foreign plants. With an estimated 80 percent share of worldwide unit

sales of mass market microprocessors and a 90 percent share by revenue,25 Intel is

a global oligopolist and is considered by some to have monopolistic power. It

manufactures a capital-intensive, physically lightweight product that can be

cheaply air-freighted overnight anywhere in the world. Production workers are a

relatively small factor in its total cost of doing business.

box 6.1 Toyota’s Americanization Strategy

Toyota has literally become too successful selling cars in the United States to rely

solely on exports to service the market. After Japan was unceremoniously advised

by the Reagan administration and Congress in 1981 that rapidly rising exports of

Japanese cars to the U.S. market had become disruptive and excessive, Toyota

accepted the fact that its ambitious plans to expand sales and market share required

a major manufacturing presence within the United States. Good product is not

enough. To nurture its steadily growingU.S. sales (about 2.2million cars and trucks

in 2005) and market share (exceeding 13 percent in 2005 and poised to overtake

Daimler-Chrysler for third place in the U.S. market), Toyota Motor Sales, U.S.A.,

is actively cultivating the image of a domestic automobile producer and a de facto

American company. Many statistics are quoted in this effort. Cumulative direct

investment in the United States in 2005 was approaching $14 billion, and pur-

chases of parts and goods and services from U.S.-based companies (linkage per-

sonified) were $25 billion annually. Full-page advertisements appearing in many

American magazines emphasized that the company’s ten vehicle manufacturing

and assembly plants; marketing, research, and design facilities; suppliers; and

dealers accounted for more than 386,000 jobs in the United States.* Toyota’s

‘‘American-ness’’ strategy centers on producing domestically more than 60 percent

of the vehicles (including Lexus) that it sells in the United States.** Data on the

company’s Web site confirm that roughly 60 percent of total U.S. vehicle sales in

2004 were domestically produced.

As the result of extensive and still growing manufacturing presence in the

United States, the president of Toyota Motor Corporation proclaimed in a speech

that it could keep growing in the U.S. market without arousing ‘‘trade or political

friction.’’***

*Data source for Toyota’s U.S. FDI: http://www.toyota.com and http://www.toyota.com/about/

usa/usdata/by_numbers.html; accessed December 2005.

**Wall Street Journal, November 12, 2005, p. A3.

***Fujio Cho, as quoted in the Dollar Morning News, January 12, 2005, Web site of the American

International Automobile Dealers Association: http://www.aiadalists.org/default.asp; accessed

November 2005.

why companies invest overseas 131

A separate set of motives fits under the rubric of outmaneuvering or matching

the international moves of your competition and having to choose between being

the leader and following the leader. The advantage of being first to market either

in geographic or product terms is one of the oldest business stratagems. Being the

first to establish brand identity, distribution networks, and retail outlets often

allows the first mover to permanently stay one step ahead of competitors. The

latter then find themselves engaged in a second-best situation of playing catch-up

and having lower market shares. A large and efficient market-seeking subsidiary

in a medium-sized economy might well limit competition by creating disincen-

tives for any further foreign entrants. Companies deprived of the FDI option in

such a market may be forced to suffer the third-best practice of ceding a lucrative

foreign market to a competitor, something archrivals like Coca-Cola and Pepsi

are especially loathe to do.

Yet another foreign investment motivation related to head-to-head competition

is building a subsidiary to launch a full-scale marketing effort in a major com-

petitor’s home market. The objective of this strategy is to force the competitor to

lower prices and profit margins to protect its home turf and ideally distract the

competitor’s attention away from sales efforts in the first company’s home mar-

ket.26 Lincoln Electric Company, a successful American-based manufacturer of

arc welders, watched with increasing discomfort in the 1980s as ESAB, a Swedish

company it considered to be its only real competitive threat, began acquiring Eu-

ropean arc welder manufacturers. Concerned that ESAB was planning to establish

a fortress on its home ground and then attack the U.S. market, Lincoln took pre-

emptive action. In a relatively short time, it expanded from five plants in four

countries to twenty-one plants in fifteen countries, mostly in Europe.27

Post-Theory Innovations in MNCs

Beginning with banks, a growing number of companies in the services sector

becameMNCs, not so much for O, I, or L reasons as the perceived need to follow

and serve their important home market clients who were building major manu-

facturing facilities overseas. Companies providing accounting, legal, advertising,

and public relations services began establishing a worldwide presence in the late

1970s, mainly in response to the overseas initiatives of their major clients. An

often overlooked service industry that has become prominent in FDI is wholesale

distribution subsidiaries established to expedite sales of exports from the parent

company, goods made by local subsidiaries, or both.

Internet companies and cable TV networks present a new business model, one

that can operate multinationally with little more than secure servers and a satellite

link. They can sell their services to literally billions of potential new customers

for a nominal capital outlay, the result being a very favorable leveraging of capital.

the strategy of multinationals132

box 6.2 Why Did eBay Feel the Need to Become a Multinational?

eBay provides a Web site that users can access from any Internet-connected

computer in the world. The servers that support the platform enabling electronic

buying and selling of merchandise around the world are located at its headquarters

in California. From a technical point of view, overseas subsidiaries are unnecessary

for this company to conduct its business on a global basis. Location has a different

connotation in cyberspace. But the potential rewards of doing business on a global

basis are the same for all companies. Non-U.S. revenue has been growing much

faster than eBay’s home country revenue, and in 2004 overseas transactions rev-

enues accounted for more than 40 percent of total corporate income. Given the

company’s relatively young, still-expanding international operations (including

China), the overseas share of income could eventually rise above 70 percent.

The corporate strategy to establish wholly owned overseas subsidiaries to

provide country-specific Web sites is based overwhelmingly on marketing con-

siderations. (The demand by some governments that it have a locally domiciled

business operation is a secondary reason.) The assumption is that revenue growth

and the introduction of new services outside the United States cannot be maxi-

mized by having Americans living in California running an evolving ‘‘people’’

business still in its infancy. Foreign subsidiaries are managed by nationals of the

host countries who understand the pulse of the local Internet market. Local na-

tionals are presumed to be in the best position to gauge current needs and evolving

desires of the individuals and companies who are buying and selling merchandise on

eBay’s overseas Web sites. They also are presumed best qualified to know how to

structure and advertise each site to attract a maximum number of customers. If the

company’s larger task is bringing buyers and sellers together, a geographically

decentralized organization makes sense for reasons that include understanding

cultural nuances; creating local language Web sites and responding in the local

language to customers’ questions and complaints about unfilled orders or

nonpayments; and acting on customers’ requests for new services (e.g., fixed price

sites and the ability to reconfigure the Web site’s welcome page). In sum, the

company believes steady increases in revenue and market share are best assured by

giving people in different countries exactly what they want and need on their local

eBay site—things not best recognized from headquarters.

The company’s overseas subsidiaries are not factories or even repositories of

high-tech equipment. Instead, they consist of twenty to sixty office workers, almost

all of whom are local hires. They include a country manager, a marketing team, and

financial and legal specialists. The company’s strategy for wholly or majority-

owned foreign subsidiaries (twenty-three in 2005) is to hire talented people, give

them the resources they need, and hold them accountable for servicing the needs of

customers and increasing revenues in their country of responsibility.

Sources: Telephone interview with Matt Bannick, president of eBay International, September

2005, and eBay’s 2005 Form 10-K, available online at http://www.ebay.com.

133

Companies like Yahoo!, Google, and eBay have established relatively spartan

value-added facilities overseas; they have no need to erect $2 billion factories like

their counterparts who produce semiconductors. Nor do their overseas facilities

require a large workforce. Another compelling reason for these companies to be-

come multinationals is the utility of communicating with customers in the local

language and in a format compatible with local tastes.

For defense contractors, a local manufacturing presence may be a legal re-

quirement to actively sell in foreign markets. With European defense budgets

relatively stagnant, some of Europe’s largest defense contractors have become

enamored with gaining a toehold in the fast-growing, mega-billion-dollar U.S.

market for military procurement. But before being eligible to secure a major U.S.

government defense contract bid, a foreign-based company needs to manufacture

or at least assemble weapons and equipment in a U.S.-based subsidiary. For na-

tional security reasons, the Pentagon does not import major purchases of military

matériel. A prime example of this kind of FDI motivation is BAE Systems of

Great Britain. Its aggressive contract bidding and facilities and offices in thirty

states allowed it to move into the ranks of the top ten Pentagon contractors in

dollar terms.28

Post-Theory Changes in the International Economic Order

The international monetary system in general and sustained exchange rate swings

in particular were not major issues to the first generation of MNC theorists. What

few exchange rate changes took place under the Bretton Woods system of fixed

exchange rates were almost all currency depreciations needed to offset a country’s

declining competitiveness. The advent of a floating exchange rate regime in 1973

meant that chronic surplus countries might—and some did—experience chronic

appreciation of their currencies, a move that, all things held constant, makes their

exports more expensive to foreigners. Anticipation of a continuing erosion in price

competitiveness from large-scale yen appreciation (and rising labor costs) lead to

unprecedented flows in the early 1980s of outward FDI by Japanese manufacturing

companies. Cost-containment efforts centered on off-shore production of com-

ponents and labor-intensive finished goods in relatively low-cost Southeast Asian

countries with currencies unlikely to appreciate. After the follow-the-leader syn-

drome kicked in, the magnitude of the FDI exodus was so large that fears of an

impending hollowing out of the Japanese industrial sector were heard with in-

creased frequency. Should the Chinese yuan ever face prolonged appreciation,

Chinese manufacturing companies might someday need to duplicate the Japanese

strategy of containing costs by establishing a massive sourcing operation in low

wage Asian and African economies with weak currencies.

the strategy of multinationals134

Another source of structural change in the international economic and business

environment affecting FDI was the information technology revolution that began

in the United States in the early 1990s. One immediate effect was an upsurge in

strategic asset–seeking direct investment in the United States. Foreign companies,

mainly European, were responsible for record amounts of acquisitions andmergers

with U.S. companies, often those possessing advanced technology or proven

marketing prowess. Much of the buying of American companies was attributed to

the desire by foreign firms to offset their own shortcomings, and some was mo-

tivated by the growing conventional wisdom that a major presence in the vast U.S.

market was the sine qua non of corporate success and staying power. This merger

and acquisition (M&A) boom cannot be explained by the theories of monopolistic

designs and the product cycle or by the eclectic paradigm. When asked why his

relatively small software company had made two U.S. acquisitions, a French

executive said that being part of the ‘‘Silicon Valley world’’ was the major reason.

An innovative European software firm ‘‘cannot become a global player without

being strong in theU.S. market. It puts you in a situation to understand themarket

and have relationships with suppliers,’’ he said.29 An executive of a small Austrian

software company used similar phraseology to explain his company’s opening of a

southern California subsidiary: the necessity to tap into informal networks and to

be close both to distributors and customers and, equally important, to develop a

feeling for the market. The ‘‘positive image’’ the company would project by

operating in California also was a factor in the final decision to invest there.30

The size and growth of the U.S. and Chinese markets have made these

countries the main destinations for foreign companies using FDI as a stimulus to

sales and profits. Consider the financial reports on two companies issued by the

brokerage arm of Morgan Stanley. Analyzing the growth and profit outlook for

Yum! Brands, a multibrand restaurant chain (Pizza Hut, KFC, and Taco Bell,

among others), a 2004 report described the ‘‘international market as the core

growth engine’’ for the company. While this market contributed 35 percent of the

company’s profits at that time, Morgan Stanley’s analyst estimated that overseas

restaurants would deliver 60 percent of the growth in earnings over the next three

years.31 All but ignoring the U.S. market, another Morgan Stanley report on

Yum! Brands concluded that the company’s first mover advantage in China, its

significant potential for expansion in that populous country, and strong accep-

tance by Chinese consumers are ‘‘primary reasons to own the stock in our view.’’

Between 2005 and 2008, the estimate was that ‘‘China alone will contribute

35 percent of Yum’s earnings growth.’’32 A similar growth scenario was given for

the payments services of Western Union. China was projected as the key growth

driver of the company on the basis that in the second half of 2004, its business in

China was ‘‘growing at a rate in excess of 100%.’’33

why companies invest overseas 135

China is the source of another new variant of perceived need to establish overseas

subsidiaries. The Phoenix Electric Manufacturing Company, a medium-sized

producer of electric motors for power tools, kitchen appliances, and other products,

opened a second subsidiary in China in 2005. The strategy was ‘‘a matter of sur-

vival’’ because the company’s customer base has been moving there, explained its

chairperson. Many of its biggest clients had shifted most of their consumer elec-

tronics production to China to cut costs.34 Proximity of Phoenix’s subsidiaries to its

customers’ Chinese subsidiaries preserved a critical portion of its business.

Regional free trade agreements are a major catalyst of FDI not given sufficient

attention by the main academic theories on MNCs. The early success of what is

now called the European Union encouraged two international economic trends.

The first was the subsequent decision by every major trading country to pursue

economic benefits through free trade with neighboring countries. The contem-

porary surge in regional free trade areas is measured by the existence in 2003 of

more than 265 agreements, more than half of which had been created after 1995.35

Second, the proliferation of these agreements has encouraged direct investments

by foreign companies establishing a subsidiary in one member country to take

advantage of unrestricted market access to all other members. This strategy is the

number one reason for the attractiveness of Ireland to most foreign companies; it

is also the number one reason for the above-trend growth of FDI in Mexico as

soon as a free trade agreement with the United States appeared to be in the offing.

Two recent events in the international economic order had the effect of

making acquisitions of existing corporations in the South uncommonly appealing

to financially strong companies in the North. Privatization of government-owned

enterprises in LDCs and former communist countries provided a one-time op-

portunity for well-managed foreign companies to buy potentially valuable assets

at relatively low prices. Later, the financial crisis that hit much of East Asia in the

late 1990s pushed many companies in Korea, Indonesia, and Thailand into de

facto bankruptcy, making them available to foreign rescuers at what some called

fire sale prices.

A new pragmatic reason to invest overseas is the growing concern about the

international security of supply for oil and other critical commodities. The anxiety

over the issue of control is keenly felt in China. Hence the official policy en-

couraging a growing number of Chinese corporate acquisitions of and bids for

foreign-based natural resources companies whose output would help feed the

country’s voracious appetite for industrial raw materials (see box 8.1 in chapter 8).

‘‘Thinking outside the Box’’ Motivations

Academic theory does not openly pay attention to the possibility that execu-

tives may approve opening a foreign subsidiary based on faulty assumptions

the strategy of multinationals136

or pressure to conform to a current management fad. The ‘‘make it where you sell

it’’ strategy has taken on a life of its own. Although appealing in principle, it has

not categorically been proven to be necessary, in part due to the impossibility of

knowing the consequences of a subsidiary’s not being established. A knee-jerk

presumption that to ignore this guideline is to suffer diminished market share

may sometimes be a substitute for hard data making an overwhelming case

for FDI over exporting or licensing. Gut feelings can substitute for hard-nosed

demonstrations of ownership, internalization, and location advantages. Exag-

gerated fears about the need to grow and to match the overseas moves of com-

petitors appear to have been the motivating force to invest overseas in more than

a few cases, one of which was automobiles in the 1990s (see following discussion).

‘‘An unsettling possibility is that foreign direct investment may to some extent

reflect irrational follow-the-leader behavior.’’ It might prove to be a temporary

business fad like the overdone acquisitions and leveraged buyout craze that had a

limited life span in the United States during the 1980s.36 The ambivalence

associated with conventional wisdom is evident in the following passage from an

analysis by McKinsey and Company, a business consultancy:

Most investors and executives want a piece of the booming Asian market

for the right reasons. . . . And for many sectors, such as high technology

and manufacturing, the advantages of going to Asia, particularly China,

have so changed the competitive dynamics that there’s little choice but to

join the rush.

But the decision to go to Asia can be unsound as well. Many execu-

tives who invest in China or India believe that these markets will suddenly

kick-start stalled growth at home, reviving their companies’ sagging pros-

pects. On that score, we think caution is in order . . . the returns from

investment in Asia just aren’t going to be that large—at least over the next

decade.37

On a personal note, I still remember what a friend who worked for a lobbying

group representing a number of large MNCs said to me back in the 1970s. He

was convinced that some major overseas subsidiaries owed their existence to

the personal prestige factor. A few executives, he surmised, did not want to be

branded ‘‘provincial’’ for keeping their companies domestic, and some others did

not like staying home while their counterparts were regularly flying off to consult

with their affiliates in glamorous European settings.

Another reason for overseas investment not found in textbooks is the principal

motivation for the establishment of one of Intel’s first overseas subsidiaries. A

design and development center in Haifa, Israel, was opened in the mid-1970s partly

due to a traditional reason: the ready availability of skilled engineers and scientists.

why companies invest overseas 137

But the main impetus was management’s decision to accommodate one of the

senior researchers at headquarters, a native Israeli who was planning to resign

because of the desire to return to his homeland. Rather than lose his valued talents,

Intel established a research center in Israel under his supervision.38 The success of

this initial enterprise later led to extensive investment in manufacturing facilities.

A chain of Austrian pastry and ice cream shops became multinational when it

opened a restaurant–ice cream parlor and a company-owned franchise operation

in Santa Monica, California. The owner of this relatively small business said his

decision to open the restaurant was very spontaneous and made without consul-

tations. He asserted that none of the traditional factors influenced his decision, as

his intention to invest in the United States originated solely from his personal

experiences during a vacation the previous year in California. While there, two

thoughts had a major impact on his thinking. He did not find any place selling ice

cream freshly made on the premises, as was the case with his shops in Austria. In

addition, he realized he was very fond of the Los Angeles area and wanted to visit

regularly. He told an interviewer that the investment decision was purely a matter

of personal preference and the desire ‘‘to make a dream come true.’’39

Because the Dublin-based law firm of Matheson, Ormsby, Prentice deals only

with Irish law, its decision to open subsidiaries in Silicon Valley and New York

City made for an unlikely MNC. It expanded across the Atlantic for the coun-

terintuitive reason of supplying the previously overlooked market for providing

counseling on Irish law and regulations to U.S.-based executives of MNCs who

have invested in Ireland or are preparing to do so. The firm attributes part of its

success in attracting as clients blue-chip U.S. MNCs like Microsoft, Hewlett-

Packard, and Xerox to its distinctive ability to provide lawyers for person-to-

person consultations with senior executives at their U.S. headquarters.40

Case Study: What Drives the Multinationalization

of the Automobile Industry

The automobile industry provides an excellent case study in the incentives and

pressures that sometimes encourage and sometimes force industry consolidation

into a relatively few globe-spanning companies. It is also an excellent case study

of what can go wrong when companies become too enamored with bigness and

too eager to seek global reach. The trend to fewer and bigger competitors in the

automobile sector by no means has been accompanied by uniform success and

profitability, nor has it generated universal shareholder happiness. If anything,

the world’s major carmakers suffer from the same negative syndrome that has

befallen the dwindling number of U.S. airlines: A consistently profitable, fi-

nancially sound company is the exception, not the rule.

the strategy of multinationals138

In the early years of the twenty-first century, every large-volume, mass-market

automobile maker is an MNC. The perception that only the very large global play-

ers will survive in this industry has become so strongly ingrained among automobile

executives that it was elevated to a presumed truth many years ago. Increased global

market share has become the ultimate test of an automaker’s success and survival.

The advantages of being a multinational carmaker are not imaginary; they are

rooted in the economics of the business. Major companies spend billions of dollars

on nonstop R&D efforts, redesign of existing models and development of entirely

new ones, and factory retooling expenses. Very high fixed costs are inescapable.

The end product is now a capital-intensive collection of hundreds of technologi-

cally sophisticated components, yet car models below the luxury names must

vigorously compete for the approval of price-conscious consumers.

No single national market is currently large enough for a major car company

to amortize fixed costs and offer competitive pricing. Consequently, all top-tier

companies have assembly plants in at least two countries; hence, they are MNCs.

Substantial sales to foreigners are no longer an option in the industry. To maximize

sales, be close to customers, and avoid the threat of import barriers, the high-

volume automakers no longer rely on exports as the sole or major vehicle for foreign

sales to anywhere other than relatively small markets with no indigenous car in-

dustry. The one exception to this rule is continued reliance on exporting by very

limited-edition luxury brands, such as Porsche and Ferrari. Toyota, the world’s

most profitable automaker and perennially at or near the top of the list of increased

annual sales, operated fifty-one overseas manufacturing plants in twenty-six

countries in 2005 to meet its sales, growth, and cost-containment goals.41

World car and truck production of more than 60 million units in 2003 was

dominated by twelve large MNCs. General Motors, Ford, Toyota, Volkswagen,

DaimlerChrysler, PSA Peugeot, Nissan (controlled by Renault), Honda,

Hyundai-Kia, Renault, Fiat, and Suzuki (partly owned by General Motors) pro-

duced more than 48 million units, or 80 percent of world output; the remaining

20 percent was split among more than forty other companies.42 The current

degree of consolidation in this industry is starkly different from the early part of

the twentieth century, when nearly 200 companies were producing cars in the

United Kingdom and almost 100 were operating in the United States.43 Fol-

lowing the demise of MG Rover in 2005, the United Kingdom was left with no

locally owned mass-market automakers. All are foreign-owned.44

The global automobile oligopoly has been strengthened since the 1990s by a

spate of cross-border M&As plus an expanding web of minority ownerships, joint

ventures, and strategic alliances. With more than a tinge of the follow-the-leader

syndrome,Daimler-Benzmerged/took overChrysler; Ford acquiredVolvo, Jaguar,

and Land Rover; GM’s acquisition of Saab and a minority stake inDaewoo (Korea)

added to its longer-standing ownerships of Opel and Vauxhall and minority stakes

why companies invest overseas 139

in Japanese companies Suzuki, Isuzu, and Subaru. Even BMW, a mid-sized pro-

ducer of luxury cars, added to its offerings by acquiring ultra-luxury Rolls Royce.

The most surprising cross-border acquisitions were the minority stakes taken in

three ailing Japanese companies (Nissan by Renault, Mazda by Ford, and Mitsu-

bishi Motors by DaimlerChrysler). In the 1980s it would have been considered

ludicrous to predict that a country with a seemingly unstoppable automobile in-

dustry would be left with just two fully independent producers at the turn of the

century. The two, Toyota and Honda, have been unique among the major pro-

ducers in refusing to pursue growth through acquisitions or joint ventures.

In addition to the match-the-overseas-expansion-of-your-major-competitors

model, automakers have been inspired to act over the past three decades by all the

other leading reasons why nonextractive companies invest in other countries.

High fixed costs have compelled the world’s major automakers to pursue econ-

omies of scale via sales in all major markets as a core business strategy. The rise in

prominence of strategic asset–seeking direct investments and alliances is clearly

demonstrated by the surge in major cross-border acquisitions designed to gain

entrée to new markets, acquire new product offerings, or gain access to new

technologies or assembly techniques. Efficiency-seeking FDI in the automobile

sector thus far has mainly taken the form of vertical supply networks, with sub-

sidiaries making parts in relatively low-wage countries like Thailand, Indonesia,

China, and Mexico.

The need to cater to varied local preferences has become an important factor

encouraging production in foreign markets in lieu of exporting. An idea gained

traction a few years ago that companies could mass produce a single ‘‘world car.’’

It made great financial sense; designing and assembling essentially the same

vehicle for worldwide sale was potentially one of the greatest ever applications of

economies of scale. The concept has been dramatically downsized, however. It

was the victim of consumers around the world stubbornly demonstrating an

incompatible mix of preferences for a product associated with differences in life-

style, road conditions, disposable incomes, and so on. Americans are in a category

by themselves in their insistence on multiple cup-holders in their vehicles. The

larger automobile producers demonstrate sensitivity to accommodating local

tastes not only by producing in multiple countries but also by maintaining fa-

cilities engaged in product design, R&D, and technical evaluation on a regional

basis. Hyundai’s decision to open a billion-dollar assembly plant in the United

States despite incurring significantly higher wage costs reflects the priority of

being able to provide car buyers with what they want when they want it. A senior

corporate official explained the move in these terms:

Our decision to build this facility in . . .Alabama underscores our com-

mitment to the U.S. market. . . .Hyundai is in the process of doing more

the strategy of multinationals140

design and engineering in the United States so that our products will be

even better adapted to the American consumers’ needs and tastes. Our new

plant will allow us to build more vehicles for this growing market and get

them to our customers more quickly.45

It is highly probable that the decision also reflected the growing article of faith

that sales success in the United States is a prerequisite for being a world player

among automakers, as well as the desire to avoid a protectionist backlash down

the road.

Avoidance of trade barriers has attracted major commitment to foreign-owned

auto assembly facilities in the United States, Western Europe, and more recently,

China. The automobile assembly sector has an extraordinary impact on all na-

tional economies in which it operates. Not only is it among the largest industries

by sales and jobs, it also affects a vast supplier network in parts, steel, rubber,

glass, electronics, plastics, and textiles. Governments covet auto assembly plants

and ferociously oppose the loss of any locally owned producers to import com-

petition.

At the onset of the 1980s, Japanese automakers were still categorically dis-

missing repeated exhortations by the U.S. government and the United Auto-

mobile Workers to begin serving the American market through local assembly

facilities. The universal attitude among Japanese manufacturers at the time was

that exports of made-in-Japan vehicles were essential for cost and quality consid-

erations. They unanimously perceived American workers as overpaid and lacking

the skills, discipline, and dedication to emulate the fastidious, hardworking,

relatively low-paid, and strike-averse Japanese workers who were major cogs in

the production of high-quality, price-competitive cars. Large, sustained increases

in U.S. imports of Japanese cars, together with the falling market share and rising

financial problems of Detroit’s Big Three producers, lead to a showdown in the

first year of the Reagan administration that changed the policy equation. The

opposition of Japan’s automakers to establishing facilities in the United States

eroded in the face of escalating pressures in Washington. Congress intensified

threats to pass highly protectionist legislation as it became increasingly apparent

that U.S. automakers needed breathing room from further import increases while

they borrowed and invested tens of billions of dollars to retool to make better

quality, more energy-efficient cars (the second oil shock had peaked in 1980).

Japanese government officials prevailed on executives of the auto companies to go

the FDI route when the new administration sternly warned that uncapped in-

creases in U.S. car imports would trigger protectionist legislation in Congress

that it could not derail by veto.

The subsequent ‘‘voluntary’’ export restraint adopted by an agreement be-

tween Japan’s government and auto industry marked a radical shift in the latter’s

why companies invest overseas 141

overseas business strategy. Henceforth, increased market share in countries with

an indigenous automobile industry would be pursued mainly through local pro-

duction. Once the Japanese companies found that carefully selected foreign work-

ers could adapt quite well to the advanced assembly line operations that had been

so successful at home, the internationalization of the larger producers was off and

running.

Three decades later, Toyota, Honda, and others proudly celebrate in the U.S.

media how Americanized their companies have become. Responding to contin-

ued strong increases in U.S. sales and increased concern for a backlash against its

growing prosperity in the midst of GM’s and Ford’s sales and financial stability

problems, Toyota assiduously advertises its local roots and intentions to build

additional manufacturing and assembly plants in North America (see box 6.1).

Honda’s booming overseas sales base led to a corporate philosophy of ‘‘glocali-

zation,’’ defined by the company as a commitment to manufacture products ‘‘in

areas close to the consumer.’’46

For the three major companies, Toyota, Nissan, and Honda, steadily increas-

ing foreign sales have offset sluggish domestic sales caused by the stagnation in the

Japanese economy that persisted from the early 1990s to 2005. Toyota was selling

more than twice as many cars overseas than domestically in 2003; for Honda, the

foreign-to-domestic ratio was more than three to one in 2004.47 About two-thirds

of both companies’ profits in 2003 were derived from the highly lucrative, no-

need-for-discounts American market.48

China is the hottest new FDI destination for the automobile industry. Eleven

of the twelve major foreign producers already mentioned (financially troubled

Fiat is the exception) had opened subsidiaries in China by 2002.49 Massive FDI

inflows resulted from foreign companies wanting to produce within what is pro-

jected to remain the fastest growing national market, but one still protected by

high tariffs on imported cars. It is also a market that lacks the buying power to

easily tolerate transportation costs being added to retail prices. Foreign sub-

sidiaries in China are also appealing as a means of keeping close tabs on the kinds

of cars and accessories that will appeal to China’s emerging middle class. Skilled

but low-wage Chinese labor makes the country a natural to produce cheap small

cars for export.

The compelling logic and widespread practice of major automobile makers to

increase their global presence through new subsidiaries and acquisitions obscure

the deep potholes on the MNC highway. GM had to pay the Fiat car division

$2 billion in 2005 to extricate itself from an unusual contractual obligation to buy

the 90 percent of the company that GM did not already own. It seemed like a good

deal in 2000 when the commitment was made, but the Italian company sub-

sequently began suffering large losses and incurring surging debt. Given GM’s

own financial problems, the last thing it needed was to be saddled with the purchase

the strategy of multinationals142

and management of perhaps the only automaker with worse troubles than its

own.50

A second jolt in 2005 to the auto companies’ globalization model came in the

form of the decision by the CEO of DaimlerChrysler to bow to long-standing

criticism by stockholders and securities analysts and take early retirement. Jürgen

Schrempp’s plan to transform Daimler-Benz, a middle-sized maker of luxury

cars with a sterling reputation for advanced technological prowess, into a world-

spanning company selling a full line of models was compelling on paper, but a

resounding failure in application.51 Shortly after it acquired Chrysler, the latter

began suffering declining sales and heavy losses. Serious differences in corporate

cultures added to the problems of trying to shore up the Chrysler division.

DaimlerChrysler’s purchase of a minority stake inMitsubishi Motors, the would-

be Asian pillar of its global presence, proved a worse investment. The Japanese

manufacturer soon after went into a sales and earnings tailspin, accelerated by

scandals over hiding defects in its cars to avoid a massive recall. Schrempp’s plan

in 2004 to shore up the ailingMitsubishi Motors with a multibillion-dollar capital

infusion was overturned by an incredulous management board. The ongoing fail-

ure of top management to get the gears of DaimlerChrysler’s worldwide empire

to mesh came full circle by 2005. Chrysler began turning a small profit at the

same time that sales of the flagship Mercedes nameplate suffered a major decline

amidst well-publicized quality control problems.

Earlier examples of global overreach included BMW’s ill-fated takeover of

Britain’s Rover. After capital infusions in excess of $3 billion could not stanch the

steady stream of red ink at what cynics dubbed ‘‘the English Patient,’’ the

German company jettisoned its Rover division in 2000. Volkswagen planned to

capitalize on earlier success in exporting its famous Beetle model by producing

the new Golf model in the United States. It failed. ‘‘Nearly disastrous quality

control problems and lack of cost competitiveness in the face of Japanese com-

petition’’ caused it to be shut down in 1989 after only a decade of operation. As

such, it is one of the rare failures of a foreign-owned consumer goods–making

subsidiary in the large, affluent U.S. market.52

Part of the explanation for the numerous failures in automobile companies’

globalization strategies is that on occasion, invalid or irrelevant reasons seem to

have been the driving factor in overseas investments and acquisitions. The pos-

sibility exists ‘‘that managers are driven to seek bigness as a goal itself. They may

do so for private material benefits, such as higher salaries, or for the less tangible

glory of empire building.’’ Because it is difficult to find categorical evidence

that increased size has bestowed auto companies with greater long-term effi-

ciency and profitability, ‘‘size maximization remains as a residual category of

explanation . . . after all the more conventional explanations’’ of mergers have

been considered and dismissed.53 The mixed record of the automobile makers’

why companies invest overseas 143

globalization strategy notwithstanding, GM’s largest individual shareholder

advanced a dramatic proposal in mid-2006. To get the auto giant’s restructuring

efforts on the fast track, he suggested that GM enter into some firm of three-way

partnership-alliance with the already existing Renault-Nissan partnership.

Notes

1. Rachel McCulloch, ‘‘New Perspectives on Foreign Direct Investment,’’ in Kenneth

Froot, ed., Foreign Direct Investment (Chicago: University of Chicago Press, 1993), pp.

39–40.

2. Charles P. Kindleberger, American Business Abroad (New Haven, CT: Yale University

Press, 1969), p. 13.

3. Richard E. Caves, ‘‘International Corporations: The Industrial Economics of Foreign

Investment,’’ Economica, February 1971, p. 5.

4. Geoffrey Jones, The Evolution of International Business (New York: Routledge, 1996),

p. 7.

5. Ibid., p. 6.

6. For a detailed survey of the various theorists and the ideas that made more lim-

ited contributions to the evolution of MNC theory, see chap. 1 of John H. Dunning,

Explaining International Production (London: Unwin, Hyman, 1989).

7. There are two inconclusive theories why this is so: (1) Hymer’s ideas were so

groundbreaking that they were incapable of immediate acceptance, and (2) his Marxist

ideology caused him to be ignored by mainstream economists.

8. John H. Dunning, Multinational Enterprises and the Global Economy (Wokingham,

UK: Addison-Wesley, 1993), p. 69.

9. Kindleberger, American Business Abroad, p. 13.

10. Although Boeing does not meet the criterion for being an MNC because it produces

planes only in theUnited States, it presents one of the clearest examples of the high fixed

cost/need for economies of scale syndrome. The unit price of a new generation of Boeing

aircraft—which cost $8 billion and up to develop and build—would be astronomical if

the company sold planes only in the U.S. market. The high price tag associated with a

relatively small sales base for amortizing the company’s enormous fixed costs would

place it at a severe disadvantage against its archrival, Airbus. The latter would price its

planes at a much lower level by being able to allocate fixed costs over a much greater sales

volume thanks to the potential for selling aircraft to every major airline in the world.

11. Data source: ‘‘Pfizer Shows the Way,’’ Economist.com Global Agenda, July 15, 2002,

available online at http://www.economist.com; accessed July 2002.

12. Robert Gilpin, Global Political Economy—Understanding the International Economic

Order (Princeton, NJ: Princeton University Press, 2001), p. 287.

13. John H. Dunning, ‘‘Globalization and the Theory of MNE Activity,’’ in Neil Hood

and Stephen Young, eds., The Globalization of Multinational Enterprise Activity and

Economic Development (New York: St. Martin’s, 2000), p. 26.

the strategy of multinationals144

14. Ibid., p. 21.

15. Dunning, Multinational Enterprises and the Global Economy, p. 68.

16. Fred Turner, quoted in John F. Love, McDonald’s—Behind the Arches (New York:

Bantam Books, 1986), p. 417.

17. Data source: McDonald’s Corporation, 2005 Financial Report, available online at

http://www.mcdonalds.com; accessed June, 2006.

18. ‘‘Citigroup Looks Abroad for Its Future Growth,’’ Wall Street Journal, March 15,

2004, p. C1.

19. Joseph Quinlan and Marc Chandler, ‘‘The U.S. Trade Deficit: A Dangerous Ob-

session,’’ Foreign Affairs, May/June 2001, pp. 88–89.

20. Statement of SeanMaloney before the Senate Finance Committee, June 23, 2005, p. 2,

available online at http://finance.senate.gov/sitepages/hearings.htm; accessed De-

cember 2005.

21. See, for example, ‘‘Big Three Outsourcing Plan: Make Parts Suppliers Do It,’’ Wall

Street Journal, June 10, 2004, p. A1, and ‘‘Increasingly, American-Made Doesn’t

Mean in the U.S.A.,’’ New York Times,March 19, 2004, p. C1. The latter article fea-

tured the man tapped by President Bush to be his coordinator of efforts to strengthen

the U.S. manufacturing sector but quickly dropped when his company’s outsourcing

to China was revealed.

22. UNCTAD, ‘‘China: An Emerging FDI Outward Investor,’’ December 4, 2003, p. 8,

available online at http://www.unctad.org; accessed January 2005.

23. General Electric Corporation, 2003 Annual Report, available online at http://www

.GE.com; accessed December 2004.

24. ‘‘Survey on Multinationals,’’ The Economist, March 27, 1993, p. 9 of the survey.

25. Data source: ‘‘AMD Files Antitrust Suit against Intel,’’ Associated Press, June 28,

2005, available online at http://www.macnewsworld.com; accessed July 2005.

26. Unable to pursue this invest-in-your-competitors’-backyard strategy, a number of

American companies were especially bitter about being blocked from establishing

subsidiaries in Japan in the 1970s and 1980s. They perceived the need to bring price

competition there because of widespread belief that a Japanese market largely

impenetrable to imports of goods made there allowed domestic companies to inflate

domestic prices and profit margins, something acceptable to the stoic Japanese pop-

ulace. This in turn allegedly enabled them to offset the rock-bottom export prices

used to maximize sales and market shares in foreign markets.

27. New York Times, September 7, 1995, as quoted in Raymond Vernon, Louis Wells Jr.

and Subramanian Rangan, The Manager in the International Economy, 7th ed. (Upper

Saddle River, NJ: Prentice Hall, 1996), p. 27.

28. More recently, to be eligible to win Defense Department contracts for aerial refueling

tankers and other military aircraft, the European Aeronautic Defense and Space

Corporation (the maker of Airbus) opened an aircraft engineering center in Mobile,

Alabama, in 2005. The company announced it would add an assembly plant if and

when it is awarded a major defense contract.

29. ‘‘The Rise of ‘Small Multinationals,’ ’’ BusinessWeek Online, February 1, 2005,

available online at http://www.businessweek.com; accessed February 2005.

why companies invest overseas 145

30. Gerhard Apfelthaler, ‘‘Why Small Enterprises Invest Abroad: The Case of Four

Austrian Firms with U.S. Operations,’’ Journal of Small Business Management, July

2000, p. 94.

31. ‘‘Yum! Brands,’’ Morgan Stanley,U.S. Investment Perspectives,May 5, 2004, pp. 25–26.

32. ‘‘Yum! Brands,’’ Morgan Stanley, U.S. Investment Perspectives, May 11, 2005, p. 60.

33. ‘‘First Data,’’ Morgan Stanley, U.S. Investment Perspectives, December 1, 2004,

p. 67.

34. ‘‘It’s Getting Hotter in the East,’’ BusinessWeek, August 22, 2005, p. 81.

35. Data source: ‘‘Regionalism: Friends or Rivals?,’’ available online at http://www

.wto.org; accessed June 2005. The WTO believes that the growing enthusiasm for

regional free trade agreements may push the total well beyond 300 within a few years.

36. EdwardM. Graham and Paul R. Krugman, ‘‘The Surge in Foreign Direct Investment

in the 1980s,’’ in Froot, Foreign Direct Investment, p. 30.

37. ‘‘The Scrutable East,’’ McKinsey Quarterly, November 2004, available online at

http://www.mckinsey.com/ideas/mck_quarterly; accessed January 2005.

38. Not for attribution interview with a former Intel employee, summer 2004.

39. Apfelthaler, ‘‘Why Small Enterprises Invest Abroad,’’ p. 95.

40. ‘‘Ireland: Pluck of the Irish,’’ Lawyer (London), October 20, 2003; accessed on the

ABI/Inform database, August 2004.

41. Data source: Toyota’s corporate Web site, http://www.toyota.com.

42. Data source: Ward’s Communications, Ward’s Motor Vehicle Facts & Figures, 2004,

p. 15.

43. John A. C. Conybeare, Merging Traffic—The Consolidation of the International Au-

tomobile Industry (Lanham, MD: Rowman and Littlefield, 2004), p. 1.

44. Data source: U.K. Department of Trade and Industry, in email message to the author,

May 2005.

45. ‘‘Hyundai Motor Company Announces It Will Build Its First U.S. Manufacturing

Plant in Alabama,’’ press release dated April 2, 2002, available online at http://

worldwide.hyundai-motor.com; accessed May 2005.

46. See, for example, Honda’s 2004 Annual Report to Stockholders, available at http://

www.Honda.com.

47. Data sources: Toyota’s Form 20-F submission to the U.S. Securities and Exchange

Commission, June 2005, p. 42, available online at http://www.toyota.com; accessed

July 2005; and ‘‘Overview of Honda’s Financial Information,’’ available online at

http://www.world.honda.com; accessed July 2005.

48. Data sources: ‘‘Toyota Triumphs,’’ Newsweek International, May 9, 2005, available

online at http://www.msnbc.msn.com; accessed July 2005; and Honda’s Form 20-F

submission, May 2005, p. 41, available online at http://www.honda.com; accessed

July 2005.

49. Data source: Ministry of Commerce of the People’s Republic of China, ‘‘2003 Report

of Foreign Investment in China,’’ available online at http://english.mofcom.gov.cn/

column/report.shtml; accessed May 2005.

50. Michael Hastings, ‘‘Stuck with a Lemon,’’ Newsweek International, January 17, 2005,

available online at http://www.msnbc.msn.com; accessed July 2005.

the strategy of multinationals146

51. Investors and analysts greeted Schrempp’s surprise retirement announcement with

something approaching euphoria; the stock immediately rose more than 9 percent, the

biggest single-day increase in more than six years (data source: New York Times, July

29, 2005, p. C1).

52. Conybeare, Merging Traffic, p. 13.

53. Ibid., p. 138.

why companies invest overseas 147

7

where multinational corporations invest and don’t invest and why

Not even the largest multinational corporations (MNCs) can affordto invest everywhere or accept the risks inherent in choosing overseas production locations in a random, cavalier manner. An important phase

of the foreign direct investment (FDI) cycle is the decision that follows a com-

pany’s making a commitment to overseas expansion: where the planned foreign

subsidiary(ies) should be situated. Due diligence is required to avoid costly and

embarrassingmistakes in site selections. One of the few valid generalizations about

MNCs is that they invest in countries where their inquiries and calculations

indicate a relatively high probability that financial rewards will exceed costs and

risks by an acceptable margin in an acceptable time frame. The dynamics of those

decisions are among the least subjective and least emotional aspects of the FDI/

MNCs phenomena. Value judgments and controversy appear in far greater

amounts after subsidiaries open for business.

Viewed in a narrow sense, the geography of FDI is a simple statistical exercise

in counting buildings around the world controlled by foreign companies. In

a larger sense, insight into the MNC location evaluation process enhances the

heterogeneity theme by showing how different kinds (market-seeking, efficiency-

seeking, etc.) of direct investment each have a distinctive set of priorities when

looking for a site to build an overseas subsidiary. An understanding of where FDI

is and is not going serves to debunk the widespread myth that companies are

moving abroad in a race to the bottom. The ‘‘where’’ factor also provides valuable

lessons on the supply side: how countries, intentionally and otherwise, go about

making themselves appealing or unattractive to foreign companies.

The purpose of this chapter is to integrate these themes. It begins with a

straightforward review of the statistics showing the geographical distribution of

MNCs, that is, where FDI is going. The chapter then takes a conceptual

approach to examine the reasons FDI gravitates to some countries and avoids

148

others. The second section examines the fundamentals determining the national

climate for FDI, the thing that causes countries to win or lose the popularity con-

test that is corporate site selection. The third and fifth sections, respectively,

focus on the specific market characteristics that MNCs do and do not want to find

when evaluating overseas locations. Sandwiched in between, the fourth section

reviews the debate over the ‘‘choose me’’ governmental tactic of offering lucrative

financial incentives to attract preferred foreign companies.

Which Countries Attract FDI and Which Do Not

Statistics on FDI location can be used as a proxy for gauging the popularity of the

four basic reasons that companies establish subsidiaries in foreign countries:

obtaining natural resources, protecting or expanding sales in lucrative markets,

seeking low-cost production for an export platform, or acquiring strategic assets.

Geographic location is related to business objective. Countries with known re-

serves of raw materials or attractive corporate targets for acquisition become the

locale for the first and fourth objectives. Large, thriving economies, regardless of

labor costs, attract market-seeking subsidiaries. Poor countries with assets above

and beyond relatively low wages attract mostly (if not entirely) efficiency-seeking

factories.

Until World War II, FDI consisted mainly of companies extracting raw ma-

terials in colonies; as a consequence, most of it was located in what are now called

less developed countries (LDCs). Natural resource extraction ceased being the

largest form of direct investment after the relative surge of market-seeking in-

vestment began moving into Western Europe and Canada in the 1950s (see

chapter 3). Many of the conveyers of conventional wisdom still seem unaware of

the fact that a significant majority of the world’s FDI has been moving into

wealthy industrialized countries for more that half a century. UNCTAD data

show the North’s share of recorded worldwide incoming FDI flows averaged 58

percent annually from 1992 through 1997 and again in 2004.1 These percentages

bear no resemblance to the high-income countries’ small share of the world’s

population: below 17 percent. However, this FDI share does correlate to their 80

percent share of world GDP.2

Firms moving to countries having the lowest paid workers and the least en-

forced environmental protection regulations are, given the absence of any proof to

the contrary, rare exceptions rather than the rule. The data repeatedly and un-

equivocally show the vast majority of manufacturing and services-oriented FDI is

capital moving from one affluent country to another. Low wages (excluding

China) are inversely related to the volume of incoming FDI. Direct investment in

LDCs, remember, excludes locally owned, sweatshop-like factories producing

where mncs invest and don ’t invest and why 149

apparel, footwear, and other low-tech, labor-intensive goods. Claims by the

antiglobalization movement that FDI is a greed-based race to the bottom are

inconsistent not only with the data as to where it is going (Haiti and Afghanistan

have rock-bottom wages, but foreign companies are not building factories there)

but with basic economics as well. Labor costs are only one of several components

of total production costs; raw materials, parts, and transportation are some of the

others. Moreover, wages and benefits only partly determine total labor costs.

Unskilled, undisciplined workers with spotty attendance records are seldom

a bargain even if paid only a few cents an hour. The real cost of labor is mainly

determined by productivity—output per unit of input used, usually measured as

labor’s output per hour worked—not their hourly wages. Relatively high and

fast-growing levels of output per hour of work explain why companies can pay

much higher wages in industrialized countries than in LDCs, where worker

productivity is typically lower.

The Triad of the United States, the European Union, and Japan has been

the main source and recipient of the world’s FDI for more than half a century.

From 1998 through 2000, it accounted for 75 percent of global FDI inflows and

59 percent of inward global stock (cumulative book value of original invest-

ments).3 Those Triad countries with the world’s best-paid workers—the United

States, Canada, Germany, France, the United Kingdom, the Netherlands, and

Switzerland—dominate the list of largest recipients of FDI, whether measured as

percentage of GDP or in absolute terms. Two other major host countries,

Ireland and Spain, have only slightly lower labor costs. These countries are the

principal actors in what is a virtuous economic cycle: high but noninflationary

wage levels, rising productivity, increasing consumer buying power, and robust

economic growth. Relative efficiency, prosperity, and incoming FDI go hand in

hand. Not by happenstance, the poorest LDCs suffer from a radically differ-

ent, vicious circle of economic trends culminating, as will be noted below, with

negligible receipt of direct investment. Statistically, the number one rationale for

choosing where to invest in another country is exploiting the present and pro-

jected strength of foreign consumers’ buying power, not the weaknesses of the

host country.

The dominant North—North axis of direct investment contradicts the eco-

nomic principle that capital seeks the highest rate of return. Because the marginal

productivity of capital and therefore the marginal return theoretically are higher

in labor-intensive, capital-scarce developing countries, the bulk of FDI should

flow mainly from North to South. It doesn’t, and the result is what Deloitte Re-

search has called the ‘‘high-wage paradox.’’ Corporate executives are obviously

following a different set of metrics to determine optimal destinations for new

or expanded foreign subsidiaries. Probably it is because they know better than

the strategy of multinationals150

anyone that no positive statistical correlation has been demonstrated between

poverty in a host country and profits of manufacturing or services-providing

MNCs.

The most consistent theme in the where-FDI-is-going and where-it-is-

coming-from statistics is that in both directions it is concentrated in a relatively

few countries. The 2001 edition of The World Investment Report pointed out that

‘‘Despite its reach, . . .FDI is unevenly distributed. The world’s top 30 host

countries account for 95 per cent of total world FDI inflows and 90 per cent of

stocks.’’4 Asymmetry is especially prominent in the data for sources of outward

FDI, that is, the home countries of overseas subsidiaries. In 1980 and again in

2003, the countries classified by UNCTAD as developed accounted for 89 per-

cent of the outward stock of FDI; if nearly developed Hong Kong, Taiwan,

South Korea, and Singapore are added to this total, the share of the affluents

jumps to 95 percent. Geographic concentration is also evident when the share of

developed countries is disaggregated. Just nine countries (the United States,

the United Kingdom, France, Germany, the Netherlands, Switzerland, Japan,

Canada, and Italy) accounted for 84 percent of the $7.3 trillion in total outward

FDI stock owned by developed countries in 2003.5 About 90 of the world’s 100

largest nonfinancial multinationals were headquartered in the Triad countries.

The geographic concentration of MNCs has created an FDI divide between

haves and have-nots. Aggregated data do show a continuous and relatively sizable

increase in MNCs moving to developing and in-transition countries since 1990;

however, this is an exercise in statisticalmisdirection. A true depiction of FDI going

to developing countries requires disaggregation to reveal another case of major geo-

graphic concentration. In a word, the most advanced LDCs, often referred to as the

emerging markets, account for a disproportionate share. With recorded direct

investment inflows exceeding $50 billion in the early 2000s, China alone has been

taking more than 30 percent of the annual LDC total. The share of China and just

the next four largest recipients (Hong Kong, Singapore, Mexico, and Brazil) is 58

percent of all FDI flowing in 2003 to what UNCTAD classifies as developing

countries (nearly unchanged from their average 55 percent share in the 1992—97

time span). Inclusion of countries and territories that fall between emerging market

and developed country status—South Korea and Israel, for example—further

obscures numbers showing just how little the lower middle and lowest income

LDCs receive in FDI. The approximately 50 countries classified by UNCTAD as

least developed reported just over $7 billion in inflows in 2003, a trifling 1.25 per-

cent of the world total (as bad as this performance was, it represented a doubling of

their negligible share of average annual world inflows from 1992 through 1997).6 If

yet another statistical distortion caused by large investments by oil companies to

develop newly discovered reserves is circumvented, FDI in Africa, Central Asia,

where mncs invest and don ’t invest and why 151

and the Middle East has been minimal. The old adage that ‘‘it is better to be

exploited than ignored’’ suggests that big MNCs are doing a disservice to the

poorest, neediest countries, but not in the way that critics contend. Table 7.1 shows

how closely the magnitude of FDI flows reflect the differentiated economic

progress of East Asia, Latin America, and Africa.

Fundamentals of a Country’s Climate for FDI

Two considerations sit atop the hierarchy of factors determining where manu-

facturing FDI does or does not go. The first is the company’s best quantitative

guesstimate what the difference will be between projected total production costs

at a subsidiary and projected prices that can be charged for its output. Companies

focus on net profits—margin—not on individual items such as gross labor costs,

the need to complywith environmental protection regulations, and cost of utilities.

A second transcendent element of corporate decisions on where to invest is the

qualitative judgment as to how business-friendly or -unfriendly the investment

climate is in a potential host country. Though lacking a single, specific definition,

this term refers in general to the myriad factors (discussed in the sections to

follow) that are taken into consideration when companies balance risks and un-

certainties against expectations for positive returns. Investment climate is not a

quantifiable hard truth. It consists of perceptions by foreign enterprises about

how attractive or unattractive a country looks relative to other countries as a place

to make a long-term commitment of capital, personnel, and prestige.

table 7.1. FDI Inflows to Developing Countries* and Countries in Transition, by Region (in millions of U.S. dollars)

Annual Average

1992–97 2004

Total 130,000 268,100

Africa 6,000 18,100

Latin American & the Caribbean** 38,200 67,500

(of which: South America) (22,100) (37,900)

Asia, Pacific, and the Middle East 74,500 147,600

(of which: East, and Southeast Asia) (69,600) (130,700)

Eastern Europe and 11,500 35,000

Commonwealth of Independent States

*As classified by UNCTAD in its annual World Investment Report.

**Includes Mexico.

Source: UNCTAD, World Investment Reports, 2004 and 2005; Annex Table B.1

the strategy of multinationals152

The collective results of attitudes, actions, and inactions by the national gov-

ernment is the most decisive determinant of whether an investment climate

attracts or repels nonextractive MNCs. Depending on whether government

policies are overtly accommodating, neutral, mildly discouraging, indirectly neg-

ative, or proactively hostile, over time they will affect the volume, quality, size,

and composition of incoming FDI. Quality of governance, political stability, and

presence or absence of rule of law cannot be ignored by any foreign investor. Nor

can macroeconomic policies that affect all phases of a country’s economy. Fiscal

policy includes corporate tax rates, and monetary policy includes setting the cost

of borrowing (interest rates) in a country. Intermediate, or meso-economic fac-

tors are one small step below macro factors in importance when businesses

evaluate foreign locations. They include the breadth and depth of industrial

policies that provide various forms of assistance to targeted industries (direct

subsidies, tax breaks, exemption from antitrust laws, protection from import

competition, etc.), intensity of regulation of the business community, quality of

physical and human infrastructure, import barriers, and regulation of capital

outflows.

Michael Dell, founder of Dell, alluded to most of these factors when he sum-

marized what attracted his company to Ireland in 1990: It has industrial and tax

policies that are ‘‘consistently very supportive of businesses, independent of

which political party is in power. I believe this is because there are enough people

who remember the very bad times to de-politicize economic development.’’

Transportation and logistics are very good, and Ireland has a ‘‘good location—

easy to move products to major markets in Europe quickly.’’7 Hungary’s success

in attracting FDI is closely correlated with political stability and its early com-

mitment to a reformist, liberalizing policy path. Soon after it was freed from

Soviet domination, the government set out to quickly free prices, liberalize for-

eign trade, reduce domestic subsidies, privatize state-owned enterprises, and

improve the position of the private sector in general.8

Since the 1980s, the trend has clearly been for changes in official FDI policies

to move in the direction of encouraging investment inflows. The regulatory

changes classified on the UNCTAD Secretariat’s annual scoreboard as more

favorable toward FDI accounted for 95 percent of the total between the starting

year of 1991 and 2003, meaning that changes categorized as less favorable to FDI

accounted for a mere 5 percent. In 2003, 154 countries had an international

promotion agency or a government entity assigned an investment promotion

function.9 One simple litmus test of investment climate is how aggressive

and well-financed this agency is. Another is whether the promotion function is

overshadowed by another domestic agency that conducts exhaustive, time-

consuming screenings of applications for FDI that put the burden of proof on

interested investors to prove their value.

where mncs invest and don ’t invest and why 153

UNCTAD’s annualWorld Investment Report contains two indices designed to

serve as a more accurate guide to calculating a country’s success in attracting

incoming FDI than an unadjusted total of its annual inflows or cumulative stocks.

The Potential Index is based on several quantitative indicators (other than size of

GDP) that produce an index number for the extent to which a country’s assets

should in principle attract FDI. The Performance Index is the ratio of a country’s

share of global FDI inflows in a given year to its share of global GDP, a more

precise measurement than a simple FDI to GDP ratio. If a country’s ranking in

the Performance Index is significantly above (below) its ranking in the Potential

Index, it presumably is doing something right (wrong) in making itself attractive

to MNCs.10 Of some 140 countries examined, only Japan consistently ranks

among the leaders in potential at the same time it ranks among the laggards, that

is, the bottom decile, in performance. This is the result of a booming economy

being walled off for many years from incoming majority-owned FDI by formal

barriers and more recently the continued presence of informal hurdles to foreign

companies.

The first of four broad and partially overlapping FDI strategies that a gov-

ernment can adopt is a passive open-door policy with few or no proactive programs

to support it. This is largely a laissez-faire approach, open to the idea of incoming

MNCs but not linked to any industrial policies. The United States at the federal

level is one of the few practitioners of a posture declaring that government will

leave it to the market mechanism (except in extraordinary circumstances to reject

proposed inward investments) to decide the amounts and kinds of FDI that do or

do not enter. The second option is an open-door policy backed up by official

programs designed to maximize incoming investment. This is by far today’s most

widely used policy model and comes in various degrees of intensity. The most

aggressive governments will target certain companies and sectors as particularly

attractive additions to the local economy, court them, and offer major financial

incentives (see following discussion) to avoid losing out to another country.

Moving to the other side of the spectrum, a negative set of government policies

can be off-putting to companies looking for overseas investment sites. This third

policy strategy springs from innate suspicion of the motives of large foreign

corporations and is characterized by different degrees of disincentives. Typically,

a mandatory screening process created by statute will put foreign companies

through differing degrees of inquisition to determine if their proposed invest-

ment meets the host government’s tight or flexible criteria for protecting what is

defined as the national interest. Countries with intense doubts that ‘‘acceptable’’

amounts of FDI benefits will naturally spill over into the domestic economy can

use take-it-or-leave-it demands in seeking an adequate share of the economic

gains from foreign subsidiaries. A fourth option, indirect in nature and usually

unintentional, is for a government to manage domestic policy so poorly or to

the strategy of multinationals154

pursue a political agenda so extreme that nonextractive MNCs refuse to seriously

consider investing in it. The resulting dearth of FDI (and likely poor domestic

economic performance) in such cases is seldom considered serious enough to

force the political system to alter the policy status quo.

Some variables remain outside governmental control, for example, a country’s

endowments of raw materials and the number of its consumers. Incoming FDI is

not always determined (or repelled) by the conscious behavior (or misbehavior)

of governments in would-be host countries. The quality of domestic suppliers

and the aggressiveness of local unions are just two possible swing factors linked to

the private sector. Sometimes, a government in power is burdened with decades

of deep-rooted mismanagement and investment-retarding conditions created by

predecessors. Furthermore, the best intentions of senior politicians do not guar-

antee immediate change if other parts of the government are not on board. The

legislative body may oppose reforms and delay passage of enabling legislation;

skeptical career civil servants might drag their feet on implementation and en-

forcement of new regulations. As a 2005 World Bank report states: ‘‘Investment

climate improvements are a process, not an event.’’ Everything cannot and does

not have to be fixed at once.11

What MNCs Want in a Host Country

The academic and business literature is rich in descriptions of which economic,

political, and social criteria corporate officials consider to be important when they

consider overseas investment sites. Their ultimate goal is simple: finding a lo-

cation that will allow them to make the most money in the shortest time with the

least amount of adversity. Finding such a place is more complicated. No standard

set of attributes, each with an assigned relative weight of importance, exists in the

many lists of what matters in location published by business groups, international

organizations, and scholars. Determining where to invest is a case-by-case de-

cision. No single formula exists because specific strengths and weaknesses of a

country or region might receive high priority by one team of corporate evaluators

and be ignored by another, depending on what kind of investment is contem-

plated, which in turn will determine a subsidiary’s objectives and operational

needs. Furthermore, individual corporate cultures will assign different relative

importance to what attributes they require in a country, what they would like

to see, what negatives they can work around, and what is unequivocally unac-

ceptable. Calculating trade-offs between positive and negative country charac-

teristics is an art, not a science. In short, to understand whyMNCs go where they

go, it is once again necessary to acknowledge the heterogeneity factor, disag-

gregate, and accept a modicum of uncertainty and inconsistency.

where mncs invest and don ’t invest and why 155

Only resource-seeking investments retain a short, simple, and unchanging list

of priorities for choosing where to invest. The top three priorities are: reasonably

easy access to an abundant supply of a sought-after raw material, physical in-

frastructure that will permit it to be transported out of the host country at an

acceptable cost, and less than crushing corruption and environmental protection

regulations. A company looking to establish a subsidiary to drill for oil will have a

checklist whose contents and order bear little resemblance to that of a services

company or a manufacturer of goods looking to use a new subsidiary as an export

platform or as a vehicle to maximize sales in a foreign market.

Market-seeking investment is drawn to large economies with strong consumer

purchasing power and good records of growth, countries with above-average

human capital and physical infrastructure, and members of a major regional free

trade agreement. Most countries matching this profile are located in the Triad.

Efficiency-seeking investments go to carefully screened countries, usually LDCs

in which a relatively low wage scale will not be swamped by unproductive workers

and other high production costs, such as inadequate infrastructure, intrusive and

inconsistent regulation, and pervasive corruption. Priorities in labor force charac-

teristics differ between efficiency-seeking investors trying to minimize costs of

producing labor-intensive goods and market seekers trying to increase sales of

high value-added goods in prosperous markets. Finally, a decision to make a

foreign investment for the purpose of acquiring a strategic asset by purchasing or

merging with a foreign company presumably means that corporate-specific at-

tractions outweigh country-wide factors, such as labor costs.

Negative factors also will be weighted differently depending on the objective

of a planned investment. Prohibitive import barriers should not be a major con-

cern to what was designed to be a tariff-jumping, relatively self-sufficient, local

market—seeking subsidiary. The same prohibitive barriers will preclude plans

for a plant whose task is to assemble components made in other countries with

machinery that also is imported. China has been so extraordinarily attractive as a

growth market and a low-cost production site that foreign companies have flocked

there despite numerous negative conditions, especially the lack of rule of law,

which would be deal-breakers in virtually any other country. A booming market

with relatively low production costs can hide a lot of ugly blemishes.

Surveys asking corporate executives how they evaluate foreign locations ar-

guably provide the best insights into what matters most in the selection process

(it can only be assumed that anonymous responses genuinely reflect company

thinking). Unfortunately, only sporadic efforts have been made to systematically

collect and publicly disseminate this information. The only widely cited survey

of executives’ opinions on this subject that I found in my research was conducted

in 2001 by the firm Deloitte & Touche.12 Relatively few companies returned

completed questionnaires, either unwilling to take the time or reluctant to provide

the strategy of multinationals156

proprietary information. This survey therefore represents only a minute fraction

of the world’s MNCs that may or may not be a representative sample of the

thinking of the much larger MNC universe.

Consistent with the theme of FDI/MNC heterogeneity, no one factor—even

in a limited number of replies—was unanimously rated as critical when corpo-

rations choose or reject countries. Different objectives, needs, and strategies have

caused companies to design distinctive evaluation templates. There apparently is

no such a thing as a single criterion (except perhaps the absence of ongoing major

military hostilities) or minimum evaluation score that is unconditionally required

by all companies at all times in all potential host countries. Unanimity might have

appeared if the survey had disaggregated corporate responses and collated them

by the categories of resource, market, and efficiency-seeking investors. Of the top

twenty critical location factors, the one most frequently cited as very influential in

selecting a location was access to customers; it was mentioned by 77 percent of

the 191 responses received.

Other widely cited influential factors, in descending order of importance, were

a stable social and political environment, ease of doing business, reliability and

quality of physical infrastructure (transportation, telecommunications, and utili-

ties), ability to hire technical professionals, ability to hire management staff, level

of corruption, cost of labor, crime and safety, ability to hire skilled laborers, cor-

porate tax rates at the national level, costs of utilities, and quality of roads. Iden-

tified by less than 25 percent of respondents as very influential factors were access

to raw materials, availability and quality of university and technical training,

available land with connected utilities, local taxes, access to suppliers, labor

relations and unionization, and air freight and passenger service.13

Anecdotes of real world situations provide additional insights into the busi-

ness world’s approach to the question of where. The speed and rigor with which

countries in transition embarked on structural reforms to create a fully functional

market economy—liberalization, privatization, and regulatory and institutional

reforms of the economy—was especially important to the first wave of foreign

investors in Central Europe.14 When considering possible sites, Ericsson, the

Swedish-based multinational telecom equipment maker, has said it attaches

greatest weight to market size, quality of the bureaucracy, quality of infra-

structure (including customs clearance procedures), the tax system, trade poli-

cies, level of political risk, production costs including labor, and the availability of

suitable contractors and suppliers.15 Intel’s brief public recitation of its site

selection process for new factories inside and outside the United States lists the

quality of the local technical workforce, utilities, transportation capability, con-

struction and supplier capabilities, and regulatory and investment conditions.16

A General Electric business development officer introduced additional factors

when listing the criteria he would use to compare Mexico’s and China’s strengths

where mncs invest and don ’t invest and why 157

as sites for new manufacturing operations: labor and electricity costs, supplier

base, transportation costs and transit time, skill level and productivity of labor,

international telecommunications costs, protection of intellectual property, and

transparency in business regulations.17

A few more qualities need to be mentioned or expanded on to assemble a

comprehensive record of what corporations, especially in the secondary and ter-

tiary sectors, want in a host country. Good logistics mean that goods, people, and

communications can quickly, cheaply, and dependably be moved into, through,

and out of the host country. Companies want to go into markets where reasonably

transparent, predictable, nondiscriminatory, and honest legal and regulatory sys-

tems are in place. A desirable rule of law also enforces clearly enunciated rules at

the national and local levels, enforces commercial contracts, and defends property

rights, be they buildings, financial assets, or patents, copyrights, or trademarks.

The host country’s legal system should also establish and follow clear ground

rules for settling disputes between thegovernment and foreign subsidiaries.MNCs

prefer countries committed in law and spirit to the policy of national treatment,

whereby the host government is obligated to treat foreign-owned companies at

least as favorably as it does local companies in like circumstances.

A government will make itself more attractive to MNCs if political leaders and

the bureaucracy make it known that they are genuinely committed to facilitating

business development on a priority basis. Corporations look favorably on absence

of a large bureaucracy enamored with red tape and cheerfully keeping itself

powerful by requiring official approval of all manner of business activity. Clear

lines of authority among federal government agencies and between the national

and provincial governments further add to the appeal of a potential host country.

Other selling points are reasonable land prices and construction costs, a local

financial system willing and able to lend to foreign-controlled subsidiaries, and a

lifestyle attractive to expatriates from the parent company.

The ‘‘what’s already in place’’ syndrome can be sufficiently powerful in

three different ways to attract foreign investment. The first involves supplier—

customer relationships in the age of just-in-time delivery. A maker of interme-

diate goods may feel compelled to build a factory near a major overseas subsidiary

opened by an important client, lest more nimble competitors push it aside.

Agglomeration economies are another potential determinant of location decisions.

This concept refers to a company’s being able to enjoy what economists call

positive externalities by setting up business in a particular place. In plain English,

a locale may be compelling simply because companies in the same or related fields

are already there. These so-called clusters (best illustrated by Silicon Valley) arise

because a region offers an ample supply of skilled labor, excellent physical in-

frastructure, availability of raw materials, proximity to research institutions and

universities, and so on. As a cluster grows, so do the numbers of businesses

the strategy of multinationals158

supplying raw materials and intermediate goods and providing specialized ser-

vices (lawyers, venture capital, consultants, product designers, specialized ad-

vertising agencies, etc.). The burgeoning community of interests becomes an

important source of support to existing companies and new entrants alike.

Furthermore, executives value physical proximity to competitors and comple-

mentary businesses because it is helpful in recruiting new personnel and provides

an ideal observation post for staying informed about new products, technologies,

and business deals.

The third variant of the ‘‘what’s already in place’’ syndrome is the demon-

stration effect, considered by some as an offshoot of agglomeration economies.

Often a growing stock of inward FDI is itself sufficient to attract more foreign

subsidiaries; in some respects it is a corollary of Say’s Law that supply creates its

own demand. A countryside teeming with prospering and expanding MNCs

demonstrates an excellent investment climate far better than self-promoting

claims and statistics. Risk-averse companies, small firms with limited financial

resources, or larger companies with tight budgets sometimes choose to piggyback

rather than making expensive in-person inspections of various countries. In such

cases, a country is selected as the site for a new overseas subsidiary on the basis

that world-class companies with methodical site selection procedures made major

investments there, all of which thrived. Singapore and Ireland exemplify the old

adage that nothing succeeds like success (see discussion in next section).

Some countries have taken unilateral policy initiatives that propelled them to

the top of destinations lists maintained by foreign companies previously having

had no interest in them (see the discussion of Costa Rica and Intel in chapters 9

and 12). Creation of export processing zones, also called foreign trade zones and

special economic zones, has enabled some developing countries to make MNCs

an offer they could not resist. These cordoned-off districts offer attractive

inducements to foreign-owned factories built solely for the purpose of manu-

facturing goods for export or to process, test, or repackage goods for reexport.

Incentives include duty-free entry of all imports, reduced or deferred corporate

income taxes, below market prices for land, and relaxed regulatory controls. A

second initiative that has put some countries on the FDI map is announcement of

privatization of government-owned businesses and utilities on attractive terms.

Neither of these two initiatives has been as controversial or costly as financial

incentives given to MNCs, to be discussed later.

Case Studies: Countries That Attract FDI

Why Ireland and Singapore Are Masters of the Art of Attracting FDI Ireland and Singapore exhibit a surprising number of similarities. They are both

island countries with populations of about four million. Both have had their

where mncs invest and don ’t invest and why 159

economies and standards of living transformed for the better by relatively large

inflows of FDI. Success in attractingMNCs was not left to chance or the invisible

hand of the marketplace by either country. It was generated by high-priority,

popularly supported industrial policies crafted to create a probusiness milieu that

virtually shouted world-class reward-to-risk ratios for foreign investors. Both

countries created investment promotion agencies that have sufficient authority

and personnel to act as one-stop shops able to single-handedly help a foreign

company with all of the commercial, administrative, and legal details associated

with opening a subsidiary.

The book value of Ireland’s and Singapore’s cumulative FDI, valued at $229

and $160 billion, respectively, in 2004 put them at the top of the list of inward

FDI on a per capita basis (if Hong Kong and special situations like bank-laden tax

haven Caribbean islands are excluded). The two countries are also among the

world’s leaders when inward FDI is measured as a percent of GDP (126 and 150

percent in 2004, respectively).18 In absolute terms, Ireland had the sixth largest

and Singapore the thirteenth largest inward flow of FDI funds in 2003.19

Their economic histories are similar in that through the 1970s, both were

down-and-out, underperforming economies by almost anymeasure.Withno pros-

pects in sight for internally generated improvement, attracting large volumes of

high-quality FDI was designated a high-priority government objective. Market-

oriented economic policies, attractive political and legal environments, financial

incentives, aggressive marketing specifically aimed at foreign companies in high

value-added sectors, programs to boost education and technical training, and

geographical advantages made their shared quest a resounding success. Foreign

companies were accounting for about one-half of employment in the two

countries’ manufacturing sectors by the turn of the century. The evidence is

compelling that Ireland’s and Singapore’s success in attracting quality FDI was

the number one cause of subsequent higher GDP growth rates, reduced unem-

ployment, and rising standards of living. Good domestic economic policies were

an important number two cause.

For more than 100 years prior to the 1960s, one of Ireland’s principal exports

was its own people. Emigrants in search of a better life reduced its population

from roughly 8 million in the 1840s to a nadir of 2.8 million in 1961.20 In what

was a near overnight accomplishment for a national economy, Ireland became one

of the world’s major exporters of highly sophisticated technology goods, all but

entirely due to the massive presence of high quality FDI. More than 1,000 foreign

companies had established operations there by 2005, and they accounted for one-

quarter of total economic output.21 In roughly a decade beginning at the end of

the 1980s, it rose from low-income status within the European Union (EU) to

parity with the average per capita income of member countries. And it went from

being one of the slowest growing to one of the fastest growing EU countries.

the strategy of multinationals160

The Industrial Development Agency did a superb job of getting out the

message on Ireland’s many selling points as a host country: unrestricted export

access to the markets of other EU members, the lowest corporate tax rates in the

EU, and low labor costs (reflecting the union-government social partner-

ship calling for wage restraint), yet a relatively well-educated and high-skilled

workforce. It erected a first-class physical infrastructure, much of which was

financed by grants from EU structural and cohesion funds earmarked for aiding

less developed regions within the Union. The agency could also trumpet the

government’s providing tax holidays on profits earned from exporting and pro-

viding grants to defer start-up costs of new subsidiaries. Given the additional

bonus of its being an English-speaking country, a who’s who of U.S. high-tech

firms selected Ireland as their main export springboard to the massive EU

market.

Singapore is a city-state with very little land mass and no natural resources. It

also was host in 2005 to some 7,000 MNCs, a total that includes many shipping

companies, small firms, and companies maintaining only R&D and regional

headquarters facilities.22 Like Ireland, the dramatic and rapid up-market shift in

the composition of its exports from labor-intensive to skill- and technology-

intensive can be traced directly to the Singaporean government’s highly suc-

cessful FDI strategy of attracting companies that produced progressively higher

value-added goods. The Economic Development Board’s Web site boasts of

world-class physical, legal, and social infrastructure; a relatively low corporate tax

rate; tax deductions and grants for preferred business activities such as R&D

expenditures, start-up ventures, and establishment of regional headquarters of-

fices; a highly skilled, motivated, and disciplined workforce; a central location in

the booming East Asian market; an expanding network of free trade agreements

and bilateral investment guarantee agreements; the best quality of life in Asia;

and a university system whose curriculum by design was shifted to an emphasis

on technology and science.23

Why Foreign Capitalists Still Like China Better than India Troubled by prolonged slow growth and widespread poverty amidst fast-growing popu-

lations, China in the early 1980s and India a decade later set about partially and

gradually decontrolling their heavily regulated economies. The process is still

unfinished as political factors demand a measured pace despite overwhelming

data pointing to a link between economic liberalization and higher growth rates

and reduced poverty rates. Market-oriented reforms in both countries included

an opening of their previously closed economies to international trade and capital

flows. Despite the fact that the histories of China and India encouraged them to

associate MNCs with Western imperialism, step-by-step relaxation of controls

on incoming direct investment remained an important part of their deregulation

where mncs invest and don ’t invest and why 161

programs. Both were in great need of the capital, technology, and business know-

how that FDI can bring. Until the mid-1980s, only small amounts of FDI chose

to locate in China and even less flowed to India (an average of a token $62million

annually between 1980 and 1985). Now, having at least partially embracedmarket-

based reforms, both countries (on paper) are attractive candidates to host foreign

subsidiaries. Both offer overseas companies a seemingly inexhaustible supply of

extremely cheap labor and in numerical terms, the two largest consumer markets

in the world. The similarities end there.

China remains a political dictatorship and officially retains a communist,

largely state-owned economy. Its rule of law standards fall far short of Western

practices. Its officialdom is accountable only to each other, and its regulatory sys-

tem is still opaque. These conditions encourage official corruption. The country

holds the reputation in the United States and elsewhere of being the world’s most

prolific and brazen violator of foreign companies’ intellectual property rights.

Some foreign companies have discovered partners illegally selling counterfeit

versions of products produced by their joint ventures. In the early years, it was

common for Beijing to demand that foreign companies team up with a local

partner and transfer up-to-date technology. Yet another negative factor is Chi-

na’s banking system being insolvent by Western standards because of extensive

nonperforming loans.

India, on the other hand, is a democracy with a capitalist economic system. Its

growth rates have been above the world average for several years. Its legal system

and capital markets both function much better than those of China. India’s av-

erage wage rates are only slightly higher. Many Indians are fluent in the inter-

national business language, English. And the country has direct access to sea

routes, just like China.

Ironically, China is miles ahead in attracting FDI. China’s $280 billion of

aggregate FDI inflows from 1998 through 2003 were more than fifteen times

greater that that of India—$18 billion.24 At year end 2004, the book value, or cu-

mulative stock of China’s FDI had passed the $500 billion mark,25 a figure well

above India’s $39 billion. (A data disaggregation is necessary here: China’s FDI

inflow can be called inflated because much of it is not ‘‘foreign’’ in the strictest

sense of the term. Consensus estimates suggest that in a typical year, 60 percent

or more of the value of FDI inflows come from investors in Hong Kong and

Taiwan and from mainland Chinese firms engaging in round-tripping to take

advantage of tax breaks given only to foreign investors.)

China, as already noted, is by far the largest recipient of FDI among emerging

market countries and in most recent years has been the second largest destination

(after the United States) for direct investment flows. Ultimately, the reason for

this improbably big and quick success is that China wanted FDI badly, needed

the strategy of multinationals162

it badly, and eventually created an extremely attractive environment for both

efficiency-seeking and market-seeking investments. Leaders of the Chinese Com-

munist Party continue to believe that a major MNC presence is an indispensable

part of history’s biggest social contract: 1.3 billion people consenting to the

Party’s continuing to monopolize political power in return for a stronger econ-

omy capable of raising living standards on a sustained basis for large numbers of

people.

China first stuck its foot into the waters of attracting FDI by establishing

special economic zones (discussed in the next section) in the early 1980s. Pleased

with the success of what was a bold experiment for Beijing, not an official embrace

of a new economic ideology, the government added more zones and designated

‘‘open’’ coastal cities for relative policy autonomy in recruiting FDI. The

physical separation of the special zones allowed the Chinese government to

radically depart from socialist philosophy and provide a genuinely business-

accommodating environment. Foreign-controlled subsidiaries were given a wide

variety of tax concessions, including reduced rates and deferred taxes for several

years, an ultra low-wage but relatively educated and disciplined workforce, ex-

cellent infrastructure that was constantly upgraded, low cost power, duty free

or low tariff imports of capital equipment and intermediate goods, promises of

expedited regulatory procedures, and last but not least, absence of unions.

By the second half of the 1990s, China’s partial acceptance of market eco-

nomics had unlocked its enormous economic potential. In terms of attracting

FDI, the equivalent of a perfect storm resulted. Few major manufacturing com-

panies anywhere in the world could ignore the incredible combination of China’s

rapid growth, the perception that China was becoming the world’s low-cost

producer of thousands of labor-intensive and medium-technology goods, the

potential size of its consumer market, and the growing number of foreign com-

panies setting up subsidiaries there. Fears of the potentially lethal consequences

of being marginalized in such an incredibly attractive market led to spreading

boardroom chants of ‘‘we cannot afford not to be producing in China’’ and to

annual FDI flows of $40 to $50 billion.

India chose a different path. Politicians and civil servants could not shake

deeply held beliefs dating back to the country’s independence. The most im-

portant were the virtue of achieving economic self-sufficiency, the vices of un-

regulated markets, and the unfairness and indignity of being taken advantage of

by big Western companies. Thanks to democracy, mass discontent was only a

threat to the tenure of ruling parties, not a threat to trigger civil war as in China.

The Indian government for much of the 1970s and early 1980s became a case

study of how rightly or wrongly to antagonize foreign companies with unusually

intrusive demands and regulations. Some disinvestment resulted as several

where mncs invest and don ’t invest and why 163

companies, including IBM and Coca-Cola, shut down their operations in frus-

tration and literally locked the doors.

A big remaining problem for India is that good intentions, for good reason,

have fallen well short of convincing foreign corporate executives that the real ad-

vantages of choosing the country as a site for a manufacturing facility now out-

weigh the perceived disadvantages. A kind of perfect storm in reverse prevails.

India’s regulatory burden and the paperwork that goes with it are viewed as

excessively time-consuming, expensive, and unjustifiable in a country trying to

adopt a business-unfriendly mentality. What is needed, suggested The Economist,

is a major reform of the ‘‘inspector Raj’’ and the ‘‘license Raj’’—‘‘a creaking

edifice of central planning held together by miles of red tape.’’26

The country’s physical infrastructure is viewed as beingwoefully inadequate—

far behind that of China—with clogged roads, trains, and ports delaying ship-

ments and causing unacceptable increases in production costs. According to the

World Bank, India in 1980 had higher infrastructure stocks—power, roads, and

telecommunications—than China. However, the latter has invested so heavily in

infrastructure that it has overtaken India and is still widening the gap. Its lead in

infrastructure stocks ‘‘is now so large that for India to catch up only to China’s

present levels of stocks per capita, it would have to invest 12.5 percent of GDP

per year through 2015.’’27 Financial incentives are still minimal in relation to

comparable cost countries. Tax regulations are burdensome. Furthermore, labor

laws are restrictive—even more restrictive than those of communist China.

Foreign companies in the secondary sector have no use for the law prohibiting

any manufacturing company with 100 or more workers from laying off employees

without the seldom granted permission of the local or state government.28 Con-

tract labor is forbidden. Domestic investment is discouraged even more than

foreign, as seen by the nominal effort of the Indian textile industry to increase

production after termination of export ceilings imposed by the lapsed Agreement

on Textiles and Clothing.29

A consulting company report provides a good summation: ‘‘When asked to

describe what differentiated these two countries as investment destinations, most

respondents considered China to be ‘more business oriented’ than India.’’ The

majority also were of the view that ‘‘China has more FDI-friendly policies.’’30

That none of these weaknesses is insurmountable given adequate policy changes

is suggested by India’s impressive advances in the services sector, especially

information technology. Government regulation is less intrusive, a skilled labor

pool is available, and the telecommunications infrastructure has been adequate to

the task of supporting a boom in the arrival of subsidiaries of foreign business

services companies and outsourcing contracts received by Indian providers of

business services from foreign companies.

the strategy of multinationals164

The Thorny Issue of Government Incentives for MNCs

Corporate executives are like everyone else: They like to receive handouts from

governments. A can’t-miss stratagem to attract FDI, at least in theory, is for a

government to provide millions of dollars (or the equivalent) in up-front grants to

a foreign company that will reduce the costs, limit the risks, and increase the rate

of return on its investment. However, corporate decisions on where to invest

overseas are usually based on multiple factors; hence incentives in practice can be

viewed as an expensive government program whose necessity and true value

cannot be calculated with exactitude. It would be just another obscure unknown

aspect of the FDI/MNCs phenomena if not for impassioned opposition by some

to the idea of using tax revenues collected from middle and lower income people

to the fatten the bottom lines of big, rich foreign companies. The act of shifting

welfare from citizens to foreign multinationals becomes even more contentious if

a poor developing country is making the transfer of financial wealth to a well-

heeled MNC from the North.

Incentives to attract FDI are a component of industrial policy. The latter is an

umbrella term for various government policies and programs used by govern-

ment officials in the belief that they can create the best of all worlds by stuffing a

very tangible fistful of money into the invisible hand of the marketplace. As-

sistance is provided to targeted companies or sectors, such as information tech-

nology or biotechnology, to influence the private sector to engage in investment

and production activities to a greater degree than what they presumably would

have done in a free market situation with no government intervention.

The mix and magnitude of FDI incentives included in the final package

offered by a would-be host government to an interested MNC are determined on

a case-by-case basis by the relative leverage and negotiating skills each party

brings to the table. The standard benefits offered to foreign investors can be

divided into three categories. Fiscal incentives reduce a foreign corporation’s tax

liabilities by means of any or all of the following: reduction in the standard

corporate tax rate, tax holidays in which corporate income and property taxes are

deferred for a fixed number of years, accelerated depreciation allowances, tax

credits for domestic reinvestment of profits, and exemptions in the value-added

tax for capital goods and raw materials purchases. Income derived from exports

may be exempted indefinitely from corporate taxes or assessed at a preferen-

tial rate.

The second category, financial incentives, consists of direct grants that defray

one or more of an MNC’s expenses in getting a subsidiary up and running. These

nonrepayable subsidies can reduce the costs of land acquisition, construction,

worker training, and capital goods (factory equipment) purchases. Other financial

where mncs invest and don ’t invest and why 165

incentives provided by governments are subsidized loans and loan guarantees.

The third category of incentives is the catchall category of other. Modernized or

expanded transportation and telecommunications infrastructure, subsidized

power and water, exemption from import duties on raw materials and capital

equipment, preferential access to government contracts, closing the domesticmar-

ket to future direct investment by competing foreign companies, and preinvest-

ment feasibility studies are included here. So, too, is official commitment to raise

import barriers to protect the output of the new subsidiary from foreign com-

petition. Although seldom used, this policy can puncture the generalization that

MNCs are unwavering advocates of free trade.

Though the gross monetary outlays for incentives are fairly easy to calculate,

determining their net costs/net benefits is not. At worst, incentives can be a total

waste of government funds if a corporate recipient would have invested in a

country without them, perhaps because it was judged to offer the best chance for

long-term competitiveness of the new subsidiary.31 At best, the short-term costs

of inducements eventually will pale relative to long-term benefits. Increases in

jobs and tax revenues may eventually exceed original estimates by wide margins.

The financial success of a foreign subsidiary lured by generous incentives can

trigger a positive chain of events that includes a major expansion of the facility’s

operations (e.g., Intel in Costa Rica), arrival of direct investments by suppliers,

and a succession of minimally subsidized competitors and other companies.32

Under this scenario, the latter are drawn in by the original investment’s finan-

cial success and happiness with its governmental host, improved infrastructure,

and the arrival of firms providing specialized business services. In other words,

the demonstration effect and agglomeration economies just discussed come into

play.

Estimating in advance the cost/benefit ratio of any given incentives package is

a very imprecise art because one cannot predict its future effects, cannot know

the well-being of a domestic or regional economy if an investment had not

been made, and seldom can give precise answers to gray-area variables. For

example, would a country or region have been better advised using taxpayers’

money to create long-term economic strengths—better human and physical in-

frastructure—rather than dispensing short-term financial rewards to favored

companies? On the favorable side, it is possible that part or all of the costs of in-

centives might be recovered in the form of social goods, that is, positive spillovers

of superior knowledge and technology possessed by many MNCs (see chapter 12)

that would not have occurred in a free market environment. Economic theory

states that governmental assistance to a company can be justified if it is necessary

to convince management to establish the kind of subsidiary that maximizes social

benefits, for example, increases skill levels of workers, teaches domestic busi-

nesses to increase their productivity, and so on.33

the strategy of multinationals166

Not surprisingly, consensus does not characterize inquiries into the overall

merits of incentives. UNCTAD has concluded, ‘‘How to measure the cost and

benefits of incentives is complex and problematic; even when this can be done, the

implementation and administration of a calibrated incentives programme is often

very difficult and can be distorted by political objectives.’’ Also difficult to answer

is the larger question as to whether national welfare gains enhance world welfare

or come at the expense of other countries.34 Because studies are based largely on

interviews with a limited number of corporate executives, the selection of com-

panies for the sample, and the willingness of the executives interviewed to be

candid about a potentially touchy subject can skew the results in either direction.

Interestingly, there are indications that the importance accorded incentives

differs according to what kind of investment is being considered and what its

objectives are, a central theme of this study.35 When a site is being selected for

an efficiency-seeking export platform or for servicing a relatively small national

market, incentives are likely to be more important than for a subsidiary intended

to exploit a large, growing national market. Another reasonable conclusion is that

the value of any incentive package is likely to be most decisive when a company

has compiled a short list of two or three acceptable host countries relatively

evenly matched in economic and political fundamentals—and therefore need

something extra to stand out.

The desire to offer something extra has led to bidding wars in which national

and regional governments of rich and poor countries alike sometimes go to

dubious lengths as they seek to outbid one another to land attractive investment

projects. Examples abound of incentive packages that came close to deferring all

of a company’s plant-opening expenses or equated to hundreds of thousands of

dollars for every job initially created.36 Dow Chemical received a $6.8 billion

subsidy from the German government in 1996 to invest in a petrochemical plant

in the depressed eastern region of the country; it set a still unequaled record of

equating to $3.4million for each job created.37 Despite (or maybe because of) the

absence of any FDI incentives from Washington, an economic war of the states

periodically erupts in the United States. The most notable have involved South-

ern states aggressively vying for foreign-owned automobile plants. Alabama has

won four of these bidding contests. One consisted of a reported incentive package

worth $253 million to get a $300 million Mercedes-Benz plant in 1993, about

$169,000 for every job promised; a comparable $253 million in incentives was

given to Hyundai in 2002, about $125,000 per job promised.38

The monetary costs of these incentives need to be weighed against the German

government’s priority effort to revive the economy of the old East Germany, and

Southern states need to offset the steady erosion of jobs in the declining textile

and apparel industries that once were the mainstays of the region’s economy.

Expensive incentives, however, are not an absolute requirement even for an LDC

where mncs invest and don ’t invest and why 167

with solid economic and political attributes to attract quality direct investment.

This was the case with Costa Rica and Intel in the 1990s. The former granted the

latter ‘‘no special favors . . . , no side deals or firm-specific concessions.’’ The

concessions they did make—schools, transportation enhancements, free trade

zones, and so on, were ‘‘not unreasonable or capricious,’’ all were ‘‘generalizable

to other investors—and generally good for Costa Rica’s economy.’’39

A negative or positive attitude toward FDI incentives as a whole is going to be

linked to one’s answer to a much larger question: How much good or harm do

MNCs impart to host countries? Persons who believe they are exploitive likely

would find no redeeming qualities in incentives to attract them.Those who believe

MNCs surpass domestic companies in technology, management know-how, en-

hancement of worker skills, wages and benefits, and so on, likely would favor them.

If one believes that the impact of MNCs on host countries depends on case-by-

case company and country variables, the answer to the question of whether FDI

incentives are wise or foolish, necessary or unnecessary is likely to be: it depends. In

any event, in a perfect world the controversy over incentives could be easily

resolved, and the bidding wars quickly ended. Governments need only sign an

agreement to halt the process and let economic fundamentals be the selling points,

and then not violate the spirit or letter of self-restraint (see chapter 15).

What MNCs Don’t Want in a Host Country

The more successful economies do not lack for FDI. The more unsuccessful ones

do. Dozens of moderately successful economies are dissatisfied with the quantity

and quality of the direct investment they get and would like to upgrade on both

counts. Before examining deliberate and inadvertent government behaviors that

cause MNCs to write off countries as sites for their foreign subsidiaries, two over-

arching points need to be emphasized. First, a small amount of FDI in a country is

not necessarily unequivocal evidence that its economic performance and policies are

substandard. Whatever economic benefits MNCs might bring, the majority of

citizens may place abstract values, for example, control over national destiny and a

social status quo, ahead of material wealth and be happier without an influx of

foreign companies. Second, by discouraging incoming manufacturing and services

subsidiaries, however justified and admirable the motives, an individual country

cannot stop the proliferation of MNCs, nor can it humanize their practices. The

main result is generating gratitude by the countries where FDI is redirected. With

more than 200 countries and territories to choose from, manufacturing and services

corporations seldom have a problem finding locales where governing authorities roll

out the red carpet and meet company demands to seal the deal.

the strategy of multinationals168

The most effective policy to repel FDI is to ban it outright or at least in sectors

where sensitivity to foreign control is especially acute. In democracies, this can be

done either through constitutional amendments (as the Philippines did with min-

ing) or national legislation. Nearly every country, from the richest to the poorest,

has enacted statutes that specifically prevent foreigners from having controlling

interests in a relatively few stipulated business sectors. An absolute, across-the-

board ban on incoming FDI is a policy no longer being used. It has universally been

judged prohibitively expensive, though this verdict is subject to change without

prior warning. Not even North Korea has a total prohibition because it accepts

investment from South Korea, which it perceives to be a foreign country.

Various federal statutes in the United States limit foreign participation in

domestic airlines, radio and TV stations, nuclear energy, coastal and inland wa-

terway shipping, and certain segments of mining, among others. States have their

own series of restrictions, chiefly involving land ownership. A Congress alarmed

at the putative selling of America passed legislation that resulted in establish-

ment of an interagency Executive Branch committee that can stop foreign in-

vestors from acquiring or merging with U.S. firms if it determines the transaction

threatens to impair U.S. national security.40

A very effective means of discouraging incoming FDI is for a government to

engage in mass expropriation (nationalization) of foreign-held companies with

inadequate or no compensation. This practice has largely been phased out from

its peak popularity in the early 1970s as contemporary heads of government,

except for the occasional bellicose dictator, have come to view it as a short-sighted

and self-defeating.

Regulatory hassles are the most overlooked of the top reasons why MNCs are

disinclined to invest in certain countries. Most business regulations tend to be

obscure to everyone except those directly affected by them. Even if such burdens

are imposed in equal measure on locally owned business, MNCs view onerous

regulations, surprise announcements of new ones, and capricious, unpredictable

reinterpretations of existing regulations as aggravation they most definitely do

not countenance. Nor do they need to, with so many alternative destinations. The

World Bank emphasized the perils of a burdensome regulatory regime in its

Doing Business 2005 report. Businesses in poor countries were found to face much

greater regulatory burdens than those in rich countries: three times the admin-

istrative costs and nearly twice as many bureaucratic procedures and delays as-

sociated with them. Businesses in LDCs on average receive less than one-half the

property rights protections provided to them by the industrialized countries.41

Defined broadly, burdensome regulations also include import barriers that would

restrict shipments between an MNC’s subsidiaries and the need to pay bribes to

expedite cooperation by officialdom.

where mncs invest and don ’t invest and why 169

Existing investments are not immune from regulatory and governance prob-

lems. Sony closed a major audio equipment plant in Indonesia in 2004, allegedly

due to frustration with inconsistent regulation, corruption, and labor unrest.

RWE Thames Water withdrew in the same year from a water treatment project

that it had built and operated in Shanghai when the Chinese government changed

the rules on the rate of return for such investments. Disinvestment has become

common in countries achieving pariah status and becoming the target of official

sanctions. A number of multinationals decided that discretion was the better part

of valor and withdrew from South Africa, Burma, and Sudan when human rights

groups loudly complained that their corporate presence helped repressive re-

gimes stay in power.

Performance requirements are another means by which host countries make

themselves less attractive to foreign investors. The term refers to any of several

publicly announced operational limitations that a government can demand as the

price of admission for a proposed foreign subsidiary. The economic objective of

performance requirements is to constrain pursuit of profit in a manner that makes

the foreign company’s operations more compatible with a country’s development

goals and strategy. Some governments, mostly in LDCs, appreciate the potential

value of FDI but do not subscribe to a pure free market philosophy that assumes

a company acting in its own self-interest automatically promotes the national

interest.

One of the most common stipulations in the past was a local content require-

ment that required a minimum percentage of the final value of a subsidiary’s

output be produced locally, thereby further increasing domestic production and

jobs. The Trade-Related Investment Measures (TRIMs) Agreement concluded

in 1994 at the Uruguay Round of multilateral trade negotiations bars member

countries of the World Trade Organization from invoking this measure. The ra-

tionale is that local content requirements distort and interfere with market-

directed trade flows. The occasionally invoked requirement that the annual value

of exports be at least equal to a subsidiary’s total imports (known as trade bal-

ancing) also was banned by the TRIMs agreement because of its distorting

impact on trade. A still-used performance requirement requires a subsidiary to

export a minimum agreed-on percentage of the value of its annual output

(thereby guaranteeing foreign exchange earnings for the host country). Other

examples of mainstream performance requirements are stipulated transfers of

technology, agreement on how many local citizens will be placed in management

positions, limitations on repatriations of profits, a minimum level of taxation, and

demand that a factory will be built in a depressed, high-unemployment region of

the host country.

Below-average rates of economic growth rank near the top of the list of

things not wanted by companies scouting sites for overseas subsidiaries. A close

the strategy of multinationals170

statistical relationship has long existed between the LDCs having the lowest per

capita incomes and relative absence of FDI (see previous discussion and chapter

8). This is a connection whose root cause in virtually every instance is economic

policy mismanagement and poor governance, and in some cases, social unrest.

Although economic malaise inflicted by governments is seldom intentional, it is a

failing that extinguishes desire by nonextractive, risk-averse foreign companies to

invest. When developing countries do abysmally in the widely read rankings of

national economic and business performances, the odds are overwhelming that

they have long been absent from the radar screens of major MNCs. A positive

three-way statistical correlation frequently appears between countries with high

and growing standards of living, good grades in these international comparisons,

and high rates of FDI. The same three-way correlation exists in reverse for the

poorest countries. Direct investments by oil and mining companies often have a

strong financial incentive (and sometimes no alternative) to tolerate adverse con-

ditions that would scare off manufacturing and services companies. The poorest

countries typically have dysfunctional economies and an inconsequential number

of foreign-owned factories. As the next section points out, the least developed

countries do not have a monopoly on economic policies that scare off inward

manufacturing investment.

Country Case Studies: Why Nigeria and Venezuela

Are Masters of the Art of Repelling FDI

Nigeria and Venezuela live in parallel universes located many light years away

from the Ireland-Singapore galaxy. They are in a class by themselves as serial

underachievers in converting massive wealth earned from exports of their natural

resources into sustained economic progress. In the thirty-three-year period from

1974 (the initial year of the first oil shock) through 2006, Venezuela earned an

estimated $518 billion, and Nigeria earned an estimated $500 billion from oil ex-

ports.42 Poor governance and economic policy mismanagement in both countries

have resulted in a nearly total absence of incoming FDI in manufacturing or

services for many years, their oil bonanza notwithstanding. This should not be

the situation when a country on paper offers foreign companies relatively low-

cost labor, a large domestic market, or both.43 Nigeria and Venezuela both did

poorly in the Heritage Foundation’s 2005 Index of Economic Freedom (numbers

141 and 146, respectively, out of 155 countries evaluated). Interestingly, Vene-

zuela ranked first and Nigeria third in the list of countries exhibiting the greatest

decline in economic freedom over the eleven-year history of the index.44

Nigeria’s noxious economic environment has caused steady deteriorations in

per capita incomes and living standards since the late 1970s. A good clue as to

how this happened is the World Bank’s estimate that approximately 80 percent of

where mncs invest and don ’t invest and why 171

the country’s oil and natural gas revenues have gone to just 1 percent of the

population.45 A Nigerian government official, quoted in a 2005 International

Monetary Fund publication, estimated that corruption andmismanagement, even

after reforms, still swallowed as much as 40 percent of the country’s annual oil

income while nearly 75 percent of the country’s population continues to live

below the poverty line.46 Most extractive companies operating there must pro-

vide their own electricity, water, Internet, and telephone facilities rather than rely

on substandard and erratic public utilities.47 The country’s economic and po-

litical shortcomings and the resulting negative business environment are mani-

fested in a perennially dismal showing in major rankings of comparative national

economic performance:

� The bottom 10 percent of the 135 countries included in the World Bank’s

estimates of per capita gross national income in purchasing parity terms.

At $900, Nigeria’s per capita income in 2003 was well below the average

of $2,190 for low-income countries. � Number 98 out of 140 countries on UNCTAD’s index for potential

inward FDI in 2000–2002. � The 144th most corrupt country out of 146 listed in Transparency In-

ternational’s (an NGO) Corruption Perceptions Index for 2004. � Number 81 in the 103 countries included in the World Economic Fo-

rum’s Business Competitiveness Index for 2004–2005. � The eighth most risky (politically and economically) emerging market

country in 2004 according to the Economist Intelligence Unit’s rankings.

‘‘Nigeria is an insecure environment for commercial operations.’’48

Venezuela’s per capita income has held steady at a higher level than Nigeria’s,

but its recent economic development has been woeful given its oil wealth. It was

the third riskiest emerging market on The Economist’s 2004 list, the 88th country

in the World Economic Forum’s competitiveness list, and 114th in Transparency

International’s corruption perceptions list. Venezuela’s current problem attract-

ing manufacturing FDI is neither absence of prospective consumer buying power

nor relatively high wages, but its mercurial political leader, Hugo Chavez. His

anticapitalist rhetoric, the unremitting turbulence and political polarization that

followed shortly after his inauguration in 1999, and decay of political institutions

have devastated the atmosphere for nonoil FDI.49 The Economist Intelligence

Unit’s assessment that ‘‘most non-oil FDI will continue to be put off by the

uncertain legal and regulatory regimes’’ is classic understatement.50 Disaggre-

gated data (not available for Nigeria) show that FDI inflows in the manufacturing

sector were effectively zero from 1994 through 2002, the latest year data is

the strategy of multinationals172

available. The country’s accumulated stock or book value of FDI in the sec-

ondary sector was $3.9 billion in 2002, exactly the same as it was in 1993.51

In contrast to the vicious cycles and poor rankings of Nigeria and Venezuela,

the masters of attracting FDI fared much better. Singapore ranked 10th, 2nd,

and 5th on the above-mentioned competitiveness, economic freedom, and

(non)corruption perception indices, respectively. Ireland’s standings in the same

indices were 22nd, 5th, and 17th.

Notes

1. Data sources: UNCTAD,World Investment Report 2004, p. 370, andWorld Investment

Report 2005, p. 303, both available online at http://www.unctad.org; accessed No-

vember 2005.

2. Data source: World Bank, Word Development Indicators database, statistics are for

2003, available online at http://devdata.worldbank.org/wdi2005/Cover.htm; ac-

cessed November 2005.

3. UNCTAD, World Investment Report 2001, p. 9.

4. Ibid., p. xv.

5. Data source: UNCTAD, World Investment Report 2004. I have ignored the large

numbers for inflows into and outflows from Luxembourg because of the distortions

caused by ‘‘trans-shipments’’ of FDI by holding companies and extensive investments

in thinly regulated banking offices.

6. Data source: UNCTAD, World Investment Report 2004.

7. As quoted in Thomas Friedman, ‘‘The End of the Rainbow,’’ New York Times, June

29, 2005, p. A23.

8. The Economist Intelligence Unit, ‘‘Hungary—Country Profile 2005,’’ p. 31, available

online at http://www.eiu.com; accessed September 2005.

9. UNCTAD, World Investment Report 2003, p. 29.

10. The UNCTAD Secretariat compares national performance in the two indices in detail

by presenting a fourfold matrix of inward FDI performance and potential: (1) front-

runners: countries with high FDI potential and performance; (2) above potential: coun-

trieswith lowFDI potential but strongFDIperformance; (3) belowpotential: countries

with high FDI potential but low FDI performance; and (4) underperformers: coun-

tries with both low FDI potential and performance.

11. The World Bank, World Development Report 2005, p. 15, available online at http://

www.worldbank.org; accessed May 2005.

12. The survey was conducted on behalf of the Multilateral Investment Guarantee

Agency, an affiliate of the World Bank.

13. ‘‘Foreign Direct Investment Survey,’’ January 2002, p. 19, available online at http://

www.ipa.net/documents/WorldBank/databases/survey/FDIsurvey/fdisurvey.pdf;

accessed April 2005.

where mncs invest and don ’t invest and why 173

14. Magdolna Sass, ‘‘FDI in Hungary—The First Mover’s Advantage and Disadvan-

tage,’’ European Investment Bank Papers, 9(2), 2004, p. 72.

15. UNCTAD, World Investment Report 2002, p. 137.

16. Source: http://www.intel.com/pressroom; accessed March 2005.

17. U.S. International Trade Commission, ‘‘Industry Trade and Technology Review,’’

July 2002, p. 19, available online at http://www.usitc.gov; accessed April 2005.

18. UNCTAD, World Investment Report 2005, Annex tables B.2, B.3.

19. Data source: Ibid., pp. 367–70. Data for 2003 are used here because Ireland and

Singapore had unusually low and high FDI inflows, respectively, in 2004.

20. Eileen M. Doherty, ‘‘Evaluating FDI-Led Development: The Celtic (Paper?) Tiger,’’

Working paper, Columbia International Affairs Online, January 1998, available online

at http://www.ciaonet.org; accessed November 2004.

21. Data source: http://www.idaireland.com; accessed May 2006.

22. Singapore Economic Development Board, available online at http://www.edb

.gov.sg; accessed November 2004.

23. The URL for the board’s exhaustive Web site is http://www.edb.gov.sg.

24. Data source: UNCTAD, World Investment Report 2004, p. 370.

25. Data derived from http://www.uschina.org/china-statistics.html and various press

reports.

26. ‘‘Can India Work?’’ The Economist, June 12, 2004, p. 67.

27. TheWorld Bank, ‘‘India—InclusiveGrowth and ServiceDelivery: Building on India’s

Success,’’ May 29, 2006, p. 106; available online at http://siteresources.worldbank

.org/SOUTHASIAEXT/Resources/DPR_FullReport.pdf; accessed July, 2006.

28. Business Week Online, ‘‘India’s Manufacturers in Shackles,’’ October 20, 2003,

available online at http://www.businessweek.com; accessed February 2005.

29. ‘‘India Plays Catch-Up in Textiles,’’ Wall Street Journal, December 1, 2005, p. A15.

30. A. T. Kearney, ‘‘FDI Confidence Audit: India,’’ February 2001, p. 16, available

online at http://www.atkearney.com; accessed June 2005.

31. This is no way implies that government officials can or should know at the time they

are negotiating an incentives package that the company has made such a determina-

tion.

32. I could find no data or articles providing estimates on the extent of follow-up jobs

created in the years after major foreign subsidiaries began production in various

countries.

33. The theory is based on the concept that because a company does not consider the

possibility of favorable spillovers to society at large in the home country when cal-

culating returns on investment, social returns can exceed private returns. The rest of

society in a host country can free ride on certain benefits provided by a new subsidiary.

In theory, incentives can be formulated to convince an MNC to invest in a manner

that maximizes positive externalities and social returns, that is, spillovers of knowl-

edge and technology are maximized. Converting these variables into hard, convincing

numbers is seldom possible.

34. UNCTAD, World Investment Report 1995, p. 299.

the strategy of multinationals174

35. For a good survey of studies on FDI incentives, see Theodore H.Moran, Foreign Direct

Investment and Development (Washington, DC: Institute for International Economics,

1998), pp. 98–104; also UNCTAD’s World Investment Report 1998, p. 103.

36. For a scoreboard of the cost of incentives per job created in a number of major FDI

projects, see UNCTAD, World Investment Report 2002, pp. 204–5.

37. Ibid.

38. Data sources:Wall Street Journal, April 3, 2002, p. 1, and FDi Magazine,December 2,

2002, available online at http://www.fdimagazine.com; accessed April 2004.

39. Debora Spar, ‘‘Attracting High Technology Investment—Intel’s Costa Rican Plant,’’

Foreign Investment Advisory Service Occasional Paper 11, April 1998, p. 23.

40. The so-called Exon-Florio provision was contained in trade legislation enacted in

1988. It has resulted in only one known direct rejection of a proposed takeover as of

2004. It may have discouraged some contemplated takeovers or mergers from moving

forward.

41. ‘‘Removing Obstacles to Growth: An Overview,’’ available online at http://

www.worldbank.org/Documents/DoingBusiness/Intro.pdf#search; accessed March

2005.

42. Calculated from unpublished data provided to the author by the Energy Information

Administration, U.S. Department of Energy, June 2005.

43. With a population well in excess of 100 million people, Nigeria was ranked as the

world’s tenth most populous country in 2003 by many estimates.

44. Heritage Foundation, ‘‘Executive Summary,’’ 2005 Index of Economic Freedom,

available online at http://www.heritage.org; accessed May 2005. Venezuela ranked

fifty-third and Nigeria fifty-ninth, respectively, in an evaluation of the business en-

vironment in sixty countries by the Economist Intelligence Unit’s World Investment

Prospects, 2001.

45. U.S. Department of Energy, ‘‘OPEC Revenues: Country Details,’’ January 2005,

available online at http://www.eia.doe.gov/emeu/cabs/orevcoun.html; accessed

February 2005.

46. IMF Survey, February 7, 2005, p. 22.

47. The Economist Intelligence Unit, ‘‘Nigeria Risk: Risk Overview,’’ June 2005, avail-

able online at http://www.eiu.com; accessed June 2005.

48. Data sources: http://www.worldbank.org, http://www.unctad.org, http://www

.transparency.org, http://www.weforum.org, The Economist,May 29, 2004, p. 98, and

the Economist Intelligence Unit, 2006, as quoted at http://www.tmc.met.com/

usubmit/2006/06/14/1683314.htm; accessed June, 2006.

49. The Economist Intelligence Unit, ‘‘Country Report—Venezuela,’’ May 2005, avail-

able online at http://www.eiu.com; accessed June 2005.

50. The Economist Intelligence Unit, Executive Briefing, ‘‘Venezuela: Foreign Invest-

ment,’’ October 2003, and ‘‘Venezuela Risk: Risk Overview,’’ June 2005, available

online at http://www.eb.eiu.com; accessed June 2005.

51. Data source: UNCTAD, ‘‘FDI Country Profiles,’’ available online at http://www

.unctad.org/templates/page.asp?intItemID¼3198&lang¼1; accessed May 2005.

where mncs invest and don ’t invest and why 175

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PART III

Impact on the International Order

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8

effects of foreign direct investment on less developed countries Vagaries, Variables, Negatives, and Positives

The most contentious single point regarding the merits of foreigndirect investment (FDI) and multinational corporations (MNCs) is whether on balance they help or hinder the economic development of less

developed countries (LDCs). A resolution of the polemics is not in sight. Sup-

porters of international business argue that the efficiency and know-how of pri-

vate enterprise allow foreign subsidiaries to play a uniquely valuable role in

accelerating economic growth and raising living standards and workers’ skill lev-

els in low-income countries. Critics maintain that venal efforts by foreign com-

panies to maximize profits are so overwhelmingly detrimental to the economic

and social fabric of LDCs that MNCs should be tightly regulated if not banned

outright. A third assessment is that in some cases, economic and political con-

ditions in a host country are the independent variables determining the effects of

incoming direct investment, not the other way around. The absence of a clear

answer leaves policy makers in LDCs with mixed signals in deciding how much

or how little FDI they should allow to enter.

The structure of this chapter conforms to the integrating themes of this

book—the importance of disaggregation, the fallacy of generalization, and the

ability of perceptions to define reality. These themes are directly applicable to the

many layers and manifold ambiguities of the LDC–FDI relationship. The first

section discusses the context for the argument that uncertainties and conceptual

obstacles are too great to allow a definitive, black or white—and accurate—

answer to the contentious question of how well or poorly FDI has affected the

economic well-being of LDCs. The remainder of the chapter discusses four

179

credible answers. The second and third sections summarize, respectively, two

mutually exclusive but plausible views on whether incoming FDI on balance has

harmed or bolstered economic development in LDCs. These perspectives are

presented in the form of two aggressive, conflicting legal briefs that aim to do

justice to the pro and con sides without injecting any of the author’s value

judgments as to which is preferable and where the holes are in the arguments.

(Neutrality in this case should come easily because the author is not enamored

with either of these two sides.)

The fourth section is a lengthy examination of the many variables that justify

yet another call for disaggregation. A number of credible assessments of the net

impact of FDI on LDCs are possible; the facts depend on circumstances. Dis-

aggregation is essential to control for the range of conditions that exist within

host countries and for the diverse characteristics associated with the many forms

of FDI and MNCs. The ‘‘it depends’’ mantra, repeated throughout this chapter,

has the additional credibility of being consistent with the findings of a majority

of widely cited academic studies produced over the past twenty years on the

FDI–LDC interface. The chapter’s last section argues that due to the pervasive

murkiness of the issue, a fourth legitimate response is that we simply do not know

for sure whether the cumulative net effects of FDI on LDCs as a group should be

labeled positive or negative.

Eight Obstacles to a Clear-Cut, Definitive,

and Accurate Assessment of the Effects

of FDI and MNCs on LDCs

The much contested issue of how FDI and MNCs have affected the economic

development, living standards, poverty reduction efforts, and growth rates of

LDCs is arguably the single best validation of this study’s thesis on how best to

analyze and assess these international business phenomena. The ongoing em-

phases on complexity, heterogeneity, multiple versions of ‘‘the truth,’’ uncer-

tainty, and inconsistency apply to virtually all aspects of FDI and MNCs, but

especially so in this case. Generalizations lacking qualifications about their effects

on the economies of LDCs brazenly ignore the existence of very credible con-

flicting arguments. ‘‘Determining exactly how FDI affects development has

proven to be remarkably elusive.’’1

The conflicting schools of thought on whether FDI is a meaningful catalyst of

economic growth in LDCs are graphically displayed in a table appearing in a

nongovernmental organization (NGO) monograph containing a review of the

scholarly literature. Next to a list of fifteen published studies is a column that lists

which of four different answers each gave to the overriding question of FDI

impact on the international order180

being an engine of LDC growth: yes, mainly yes, no, and maybe.2 A second col-

umn summarizes the main variables cited by each of these studies as determi-

nants of whether FDI promotes growth. No two sets of variables are identical!

Conflicting results should not be a cause for angst because they are natural out-

growths of studies examining subjects short on simplicity and hard facts. Eight

major obstacles to a single unambiguous, unassailable, and all-inclusive assess-

ment of FDI’s impact on lower income countries can be easily identified.

The first is agreeing on the best criteria to determine which countries to

designate as developing or LDCs. It is far from clear what countries this chapter

deals with. The terms third world and the South make sense only in political

terms. With the exception of Thailand, all countries designated third world at

some time were forcibly colonized or made spheres of influence (e.g., China) by

industrial countries, mainly in Western Europe. All of them believe, with dif-

ferent intensities of resentment, that the few rich countries exercise great power

in the international arena and account for a large percentage of the world’s wealth

that in both cases are grossly out of proportion to their small share of the world’s

population.

In the realm of economics, the terms third world and South lack substance. The

countries of Africa, East and South and Western Asia, Eastern Europe, and Latin

America and the Caribbean collectively share economic diversity. The only other

thing they have in common economically is the status of not being among the

twenty-seven sovereign countries (plus Taiwan and Hong Kong) classified by the

International Monetary Fund (IMF) as relatively wealthy industrialized coun-

tries, that is, the North. For purposes of economic analysis and comparison, the

countries colloquially designated as third world should be divided into six sep-

arate categories. Countries in each of these groupings share similarities in terms

of both their levels of economic prosperity and relationships with MNCs. The

six should be discussed as parts of two larger classifications. The first includes

two subgroups of countries that definitely meet the economic criteria for being

considered relatively poor and below average in terms of economic development.

The second classification consists of four subgroups whose statistical profiles

suggest that they have graduated to a status somewhere between intermediate and

low-level developed. The true LDCs can be divided between those that are

moderately well-off countries (e.g., India, Peru, and Mauritius) and the least

developed countries (a category including most Sub-Saharan countries and some

in South Asia and Central America, e.g., Afghanistan and Honduras).

Value judgments determine whether the other four subgroups of countries

truly belong in the LDC category and in this chapter. The first subgroup consists

of several oil-rich countries in the Persian Gulf region that are among the

countries having the highest per capita incomes. Emerging markets has become a

phrase applicable to countries that have unofficially graduated from developing

effects of fdi on ldcs 181

status by virtue of their relatively high standard of living compared to truly poor

LDCs and their ability to attract considerable inflows of private capital, including

FDI in the manufacturing sector. Emerging market countries account for two

subgroups, one appropriately labeled emerging and the other entry level developed.

Thailand, Brazil, and Malaysia exemplify the former, whereas Korea, Singapore,

and Israel exemplify the latter category. The fourth subgroup consists of former

communist bloc countries and former Soviet republics, plus China. Perhaps they

have now passed the deadline for continued designation as countries in transition

from communism to market-based economies. Given their wide range of eco-

nomic development and standards of living in these countries, an argument can

be made for eliminating this subgroup and reassigning them to the categories of

least developed, moderately developed, emerging market (Russia, for example),

or entry level developed (Central Europe).

A second formidable obstacle in constructing an accurate blueprint of the

LDC–FDI relationship is an outgrowth of the first obstacle: finding consistencies

among heterogeneous FDI/MNCs (see chapter 4) as well as consistencies within

the heterogeneous economies of up to 160 countries. The domestic economies of

the nonrich countries display no significant common characteristics. They epito-

mize heterogeneity. They are not even all poor in the conventional sense. Indi-

cators of economic diversity begin with the wide arithmetic spread that LDCs

display in basic development indicators such as per capita GDP, average level

of education, and life expectancy. The developing country category includes

countries with fabulous oil wealth and well above-average per capita incomes

along with those having relatively sophisticated manufacturing and services

sectors. The category also includes countries suffering pervasive and entrenched

poverty that is literally life-threatening to a significant percentage of their pop-

ulations. The relatively prosperous economies of countries like Kuwait (per

capita income in excess of $16,000 in 2003) and Malaysia have nothing in com-

mon with the backwardness afflicting Ethiopia (per capita income of $90 in 2003),

Afghanistan, or Malawi. China and India, each with populations equivalent to

about one-fifth of humankind, stand in sharp contrast to several island countries

in the Caribbean and Pacific having populations numbering only in the tens of

thousands.

The hierarchal nature of economic performance and living standards among

‘‘LDCs’’ broadly defined creates a third conceptual obstacle to a hard-and-fast

determination of how FDI affects them as a group. Statistics have long shown a

very concentrated geographical distribution of FDI in the developing countries

as measured by both amounts and kinds. This distribution closely correlates with

relative economic performance. The result is that LDCs as a collective have

registered a skewed set of experiences with incoming MNCs. Many of the least

developed, resource-poor countries to this day have received negligible FDI and

impact on the international order182

therefore have recorded no statistically meaningful effects, good or bad, from it.

Other countries, principally in the Middle East and Africa, have mainly or ex-

clusively attracted resource-extracting companies. Many of the latter have com-

piled a long historical record of acting in an imperious fashion and generating

only a few jobs for locals but lots of under-the-table cash for local political leaders

and power brokers. A second group of countries, most of which are in South

Asia, possess large numbers of unskilled labor and consequently attract mainly or

exclusively labor-intensive manufacturers needing relatively low-paid workers

for relatively simple tasks. Finally, a third category is mostly composed of East

Asian and South American countries where much of the South’s FDI in so-

phisticated manufacturing and services is located, along with the relatively high

wages associated with skilled labor.

The asymmetrical country-by-country distribution of FDI among LDCs/

countries in transition creates a situation in which a single set of statistics can be

interpreted in two different ways. On one level, it is factually correct to argue that

inward FDI has become an increasingly important source, in relative and ab-

solute terms, of much-needed convertible hard currency for LDCs.3 According

to UNCTAD data, FDI as a percentage of total capital flows to LDCs rose from

6 percent in 1980 to 60 percent in 2000.4 The book value of FDI in developing

and transition countries jumped from an estimated $302 billion in 1980 to $2.4

trillion in 2004. Annual inward flows in these countries grew at an even faster

rate, from an estimated annual average rate of just over $13 billion in the years

from 1981 through 1986 to an unusually strong $268 billion in 2004.5 Annual

inflows of FDI to LDCs now dwarf the totals for official aid flows; the former

were ten times as large as the latter in 2000. As recently as the early 1990s, these

two categories of capital flows were about equal.6

Although FDI is very important for developing countries in arithmetic terms

as a means of earning hard currency, a disaggregation of investment flow data

is essential to provide a better depiction of reality. The fact is that inward FDI is a

major source of potential benefits (or costs) to a relatively small number of

economically advanced LDCs. For many years, they have accounted for a dis-

proportionately large percentage of new FDI in the South. One country, China,

has typically accounted for about 30 percent of FDI flows to all developing

countries since the mid-1990s. China together with the next four largest nonin-

dustrial country recipients of FDI accounted for 50–60 percent of total flows in

each year from the mid-1990s through the early 2000s. In 2001, the last year that

UNCTAD published these numbers in their annualWorld Investment Report, the

share of the top thirty host developing countries was 95 percent of the total. This

means that more than 130 LDCs and countries in transition on the middle and

lower rungs of the economic development hierarchy received minimal FDI. In

2004, identified FDI flows to the more than fifty countries in Africa were $18

effects of fdi on ldcs 183

billion, only 0.07 percent of flows to all developing countries and a mere 0.027

percent of world totals.7

One more clarification is needed to erase any and all obfuscation in the sta-

tistics on geographical concentration of FDI in LDCs. There is more symmetry

than meets the eye when it is noted that the largest recipients of FDI have

an approximately equally large share of the GDP, employment, and exports of all

countries categorized as less developed. A less skewed picture results if

UNCTAD’s recently devised Inward FDI Performance Index is used; it calcu-

lates the ratio of a country’s percentage of global FDI inflows to its share of global

GDP. When absolute receipts of FDI are adjusted for a country’s relative eco-

nomic size, the results are surprising: Some relatively obscure developing poor

countries rank near the top. The explanation is that a small number of high-cost

incoming foreign subsidiaries can be statistically significant in a country with

a small GDP. Because of booming foreign-owned oil drilling ventures, Azer-

baijan, Angola, Gambia, and Brunei were among the top seven performers in

UNCTAD’s GDP-adjusted FDI Performance Index rankings for 2001–2003.

(Another statistical anomaly is Luxembourg-Belgium’s being ranked first since

the performance index started, a consequence of extensive financial and holding

company investments lured by minimal regulations; trans-shipped FDI capital

flows; and a relatively small GDP.)8

A fourth obstacle arises from conflicting views on how to define economic

development. The question in qualitative terms is whether in fact it is first and

foremost an economic process. Some have made the case that a country’s pro-

gression to advanced industrialized economy status must be preceded or at least

accompanied by social modernization. Defining development in quantitative

terms poses a separate set of dilemmas. ‘‘Per capita’’ data are averages of a sta-

tistical universe that can be distorted if a country’s population is divided between

a few extremely wealthy persons and a majority of very poor citizens.

The more narrow term economic growth is largely defined through commonly

used quantitative indicators. However, a larger, more important question is what

are the economic, social, political, and psychological forces that have elevated a

limited number of countries to comparative affluence? Which of these forces are

essential and which are optional? Is a separate configuration needed for every

country to complement unique national characteristics? If we knew the correct

answers, we would know what actions to take, and the number of poor countries

would progressively shrink as would the more than one billion people currently

living subsistence lives on incomes equivalent to $2 a day or less. Until and unless

the abstruse wiring in the black box of economic development is fully mastered, it

is safe to assume that no one will be able to devise a beyond-a-reasonable-doubt

method of determining how diverse kinds of FDI andMNCs affect the economic

impact on the international order184

well-being of a large number of economically, politically, and socially diverse

developing countries.

The methodological difficulties of correctly identifying cause and effect and

distinguishing between cause and correlation constitute a fifth obstacle to de-

finitively assessing FDI’s impact on LDCs. Knowing in which direction lines of

causality flow in this case is problematic because they can run in two directions:

inward FDI stimulating economic growth and economic growth stimulating

incoming direct investment. A host country’s internal conditions are a decisive

factor in corporate decisions on where to invest and what kind of manufacturing

facility to build. A demonstrable record of successful growth, most likely the

result of a favorable economic and political domestic environment, in theory can

‘‘cause’’ FDI to be established in particular LDCs. The extent to which lines of

causality run in this direction cannot be pinpointed with precision due to dis-

agreement among researchers over the proper statistical means of controlling

‘‘endogeneity biases,’’ that is, preexisting conditions in a host country or sector

that encouraged or discouraged the arrival of FDI. If countries or sectors are ex

ante relatively productive, then statistical observations of ex post high produc-

tivity are not proof that entry of foreign companies was the cause of above-

average productivity.9

Dani Rodrik has argued that ‘‘much, if not most’’ of the correlation between

FDI and superior economic performance seems to be ‘‘driven by reverse cau-

sality: multinational enterprises tend to locate in the more productive and profit-

able economies.’’10 In cases where favorable internal economic conditions and

strong growth rates persuade foreign-based companies to establish operations in a

particular LDC, new FDI is a lagging indicator that a government has im-

plemented an effective economic development and growth plan.

A convincing argument could be made in the early 2000s that in only two

countries can inward FDI be clearly identified as being directly responsible for

most of the accelerated rates of increases in a home country’s GDP, national

income, average per capita incomes, and technological sophistication. Singapore

and Ireland are the major exceptions to the rule that no relatively low-income

country has yet attracted the sheer volume of high-quality, nonoil FDI relative to

population and GDP that the influx of foreign-owned factories can unequivocally

be identified as the number one source of accelerated economic growth. For all

other developing countries, the data are insufficient to assert categorically that

FDI is the major cause of accelerated economic development and to proclaim that

it produced results superior to what an equivalent amount of well-designed

domestic investment could have accomplished.

Certain motives for FDI are more likely than others to exemplify reverse

causality. Incoming subsidiaries are most likely to follow economic growth when

effects of fdi on ldcs 185

they are market-seeking in nature (see chapter 4). By definition, they are attracted

by the buying power of potential customers in foreign markets. When the sub-

sidiary is resource-seeking, incoming FDI is least likely to be generated by a

country’s rate of economic growth because the presence and accessibility of

natural resources are the most important variables. Efficiency-seeking, vertically

integrated foreign subsidiaries would be somewhere in the middle in view of their

need to weigh a number of variables, for example, labor costs, regulatory envi-

ronment, and absence of trade restrictions. Finally, it is possible that in some

cases causality is not unidirectional. New inward FDI and a host country’s track

record of economic success might equally induce increases in the other. The

causal process is ‘‘bidirectional’’ if both incoming FDI and domestic economic

growth are mutually reinforcing.11

Obstacle number six to a clear-cut assessment of how FDI affects economic

development is the presumption that at least some of the researchers examin-

ing this sometimes emotionally charged question have been overly influenced

by their conscious or unconscious ideological values (see chapter 5). One of the

most respected academicians specializing in the study of MNCs, Richard E.

Caves, was uncharacteristically blunt when writing that the empirical research on

the effects of FDI on the LDCs’ economic fortunes has suffered both from a lack

of ‘‘theoretical guidance and in some cases from special pleading by the re-

searchers. . . .The statistical studies of this issue, it must be said, bear strong

imprints of their authors’ prior beliefs about whether a negative or positive

relationship would emerge.’’12

Yet another conceptual problem is the absence of proof inherent in coun-

terfactual conjecture. Looking backward, it cannot be known how a host coun-

try’s economy and social and political systems would have fared if some or all

foreign subsidiaries had stayed away or acted differently. Similarly, when looking

forward, forecasts about future trends in existing direct investment in LDCs are

pure guesswork. There is no way of knowing if the positive growth effects of

newly arrived FDI are temporary or long-term. It cannot be known if a given

subsidiary will expand or by how much, and the extent (if any) to which its

success attracts other companies to establish job-creating production facilities.

Neither can it be known if foreign companies will get frustrated with the results

of an investment, drop good-citizen strategies, and switch to a strict emphasis

on self-serving, profit-maximizing actions that harm the interests of the host

country.

The eighth and final impediment to a clear-cut assessment is that many if not

most of the factors that shape the impact—favorable and negative—of foreign-

owned subsidiaries are equally relevant in shaping their impact on wealthy, mid-

dle-income, and poor countries. The nature and business objective of a foreign

subsidiary in most cases will be at least equal in importance to the average income

impact on the international order186

and education levels in the host country. Consequently, it is not appropriate to

consider LDCs in complete isolation as if they were a fully autonomous subset of

the generic issue of the costs and benefits of FDI/MNCs on host countries.

Accordingly, the next two sections, the first presenting the potentially deleterious

effects and the second the potentially beneficial effects, are relatively brief. They

will focus only on LDC-specific issues, not a broader discussion of praise and

then of condemnation of incoming direct investment for all host countries as will

be presented in chapters 12 and 13.

Potential Harm of FDI to Developing Countries

It is almost self-evident that some subsidiaries ‘‘can have an adverse effect on

development.’’13 MNCs can be harmful to developing countries for rea-

sons proven and perceived, and both economic and social (see chapters 3, 4, and

13). Antipathy toward them was and is a natural reaction in countries trying to

permanently erase memories of the colonial experience and still angry at the one-

sided long-term deals that foreign-owned, raw materials-extracting companies

negotiated with compliant local governments or colonial rulers. Attitudes toward

MNCs are still affected by recollections of the United Fruit Company’s impe-

rious reign early last century as a kind of government within a government in

some Central American countries. A classic case study of corporate misbehavior

was the company’s role in bringing about the U.S. government–engineered coup

in 1954 that ended the elected presidency of Jacobo Arbenz in Guatemala and

started a prolonged period of political unrest in the country. The illegal inter-

ference by ITT Corporation in Chilean politics during the early 1970s (see

chapter 13) led to a barrage of negative publicity and a one-way downward spiral

in the company’s position in Chile.

These events sustain the mistrust that is a natural reaction for those who see

the relatively fragile political and economic systems of LDCs as no match for the

big money, power, and ruthlessness of MNCs, many of whom are adept at play-

ing governments off against one another. The zeitgeist of the 1960s and 1970s

portrayed multinationals as exploiters that removed far more wealth from de-

veloping countries than they added. Furthermore, multinationals were typically

perceived in the third world as vehicles used by their home-country governments

to project political power and influence in other regions.14 A popular view in

both developing and industrialized countries was that the average LDC on bal-

ance would be the victim of long-lasting economic harm by allowing foreign-

controlled, monopoly-bent corporations to enter and dominate the undeveloped,

imperfectly competitive domestic market. Hence the hypothesis that because

MNCs operating in LDCs frequently mean increased unemployment, unequal

effects of fdi on ldcs 187

income distribution, and capital outflows, there ‘‘can be little doubt’’ that the

eventual impact of inward FDI ‘‘can only contribute to the further impover-

ishment of the poorest 60 to 80 percent of Third World populations.’’ The ‘‘clear

message’’ was that the continued and unchecked expansion of MNCs into the

third world would increase the instability of these societies.15

What this study repeatedly refers to as low quality FDI (see chapters 4, 13,

and 14) can inflict enough financial harm on a developing country that it could

credibly be claimed that the host country would have been far better off without

it. The heterogeneity of FDI and MNCs undermines the assumption that the

inherent virtues of a foreign-controlled subsidiary mean net benefits automati-

cally ensue. Locally owned companies in developing countries are especially sus-

ceptible to being crowded out in any of several ways by larger, wealthier, andmore

competitive foreign companies. MNCs’ financial clout, for example, can give

them priority access to loans from local banks and relatively low interest rates.

They might also secure preferential access to locally held balances of foreign

exchange, usually in critically short supply in an LDC, for use by the subsidiary

to pay for imports and to repatriate profits. When FDI takes place in the form of

an acquisition, wholesale eliminations of jobs may take place in connection with a

restructuring by the foreign purchaser.

In the external sector, the balance of payments position of a host country can

be adversely affected by incoming FDI. A low-income country could see an

especially painful diminution of its already limited holdings of convertible for-

eign exchange that otherwise could be used to pay for needed imports of capital

goods like factory machinery and telecommunications and transportation equip-

ment. The costs of components and machinery imported by a foreign subsidiary

could exceed its export earnings, assuming it has any. Profits repatriated over

time by subsidiaries to their headquarters countries could be geometrically