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Finance & Development, June 1979
Article

Review article: Multinationals revisited

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
June 1979
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Paul Streeten

The reasons for this lowering of the temperature are to be found in five recent trends that suggest that the role of multinational corporations in development has to be reassessed.

First, there has been a shift in bargaining power between multinationals and their host countries, greater restrictions on the inflow of packaged technology, a change in emphasis from production to research and development and marketing, among other factors, that have increased the uncertainties of direct foreign investment. As a result, there is some evidence that it has become the policy of multinational companies to shift from equity investment, ownership of capital, and managerial control of overseas facilities to the sale of technology, management services, and marketing as a means to earn returns on corporate assets, at least in those countries that have policies against inflows of packaged technology (Baranson, 1978).

“many more nations are now competing with U.S. multinationals in setting up foreign activities…”

Second, many more nations are now competing with U.S. multinationals in setting up foreign activities, which means that the controversy is no longer dominated by nationalistic considerations. Japanese and European firms figure prominently among the new multinationals. The number of U.S. companies among the world’s top 12 multinationals declined in all of the 13 major industry groups except aerospace between 1959 and 1976, whereas continental European companies increased their representatives among the top 12 multinationals in 9 of the 13 industries, and the Japanese scored gains in 8 (Lawrence Franko, Harvard Business Review, Nov.–Dec. 1978). The reasons for this are to be found in the decline of U.S. predominance in technology transfer; in the fact that foreign production follows exports, and exports from these countries steadily rose; in the steady growth of European and Japanese capacity to innovate; and in the greater adaptability—both politically and economically—of these companies to the needs of host countries. For example, Michelin’s radial tires, Bosch’s fuel injection equipment, and French, German, and Japanese locomotives, aircraft, and automobiles are more energy saving than their American counterparts.

Third, developing countries themselves are now establishing multinationals. In addition to companies from the Organization of Petroleum Exporting Countries (OPEC), and firms established in tax-haven countries, the leading countries where multinationals are being established are Argentina, Brazil, Colombia, Hong Kong, India, the Republic of Korea, Peru, the Philippines, Singapore, and Taiwan. According to Louis Wells, in Indonesia “Asian LDC investors together account for more investment than either Japanese, North American, or European investors, omitting mining and petroleum.” It may well be that these firms use more appropriate technology and are better adapted and more adaptable to local conditions. Wells notes that there is a strong preference in the developing countries for multinational corporations from similar countries. Korean companies put up buildings in Kuwait, pave roads in Ecuador, and have applied to Portugal for permission to set up an electronics plant; Taiwanese companies build steel mills in Nigeria; and Filipino companies restore shrines in Indonesia. Hindustan Machine Tools (India) is helping Algeria to develop a machine tool industry; Tata (India) is beating Mercedes trucks in Malaysia; and Stelux, a Hong Kong-based company with interests in manufacturing, banking, and real estate, bought into the Bulova Watch Company in the United States. C.P. Wong of Stelux improved the performance of the U.S. company. There are other instances of Third World multinationals that have aimed at acquiring shares in firms in developed countries (Heenan and Keegan, 1979).

The data on the extent of developing countries’ foreign investment are inadequate and the evidence is anecdotal. A partial listing of major Third World multinationals in Fortune (August 14, 1978) contains 33 corporations with estimated sales in 1977 ranging from $500 million to over $22,000 million, totaling $80,000 million.

If there is a challenge, it is no longer uniquely American; and it multinationals are instruments of neocolonialism, the instrument has been adopted by some ex-colonies, and at least one colony (Hong Kong), and is used against others. (Excluding mining and petroleum, Hong Kong is, for example, the second largest investor in Indonesia.) Neither developed nor developing countries are and longer predominantly recipients of multinationals from a single home country.

Fourth, not only do host countries deal with a greater variety of foreign companies, comparing their political and economic attractions, weighing them against their costs, and playing them off against one another, but also the large multinationals are being replaced by smaller and more flexible firms. And increasingly alternative organizations to the traditional form of multinational enterprise are becoming available: banks, retailers, consulting firms, and trading companies are acting as instruments of technology transfer.

Fifth, some multinationals from developed countries have accommodated themselves more to the needs of the developing countries, although IBM and Coca-Cola left India rather than permit joint ownership. Centrally planned economies increasingly welcome the multinationals, which in turn like investing there, partly because “you cannot be nationalized.”

Several distinguished authors, former U.S. Under Secretary of State George Ball, Professor Raymond Vernon, and Harry Johnson among them, had predicted that sovereignty would be at bay and some of these authors even suggested that the nation state, confronted with large and ever more powerful multinationals, would wither away.

Competition among nation-states for the economic favours of the corporation and the xenophobic character of the nation state itself will prevent the formation of a conspiracy or cartel of nation-states to exploit the economic potentialities of the international business in the service of national power. Therefore, the long-run trend will be toward the dwindling of the power of the national state relative to the corporation.

Such was Harry Johnson’s vision of the future. The nation state has shown considerable resilience in the face of multinationals; its demise, as with reports of Mark Twain’s death, have been somewhat exaggerated. The Colombians succeeded in extracting substantial sums from their multinationals. The Indians dealt successfully with firms that introduced inappropriate technologies and products. The Andean Group and OPEC showed that solidarity among groups of developing countries in dealing with multinationals is possible and can pay.

Still important force

This is not to say that multinationals are no longer an important force. It has been estimated that the foreign production of multinationals accounts for as much as 20 per cent of world output, and that intrafirm trade of these companies (defined narrowly as trade between firms linked through majority ownership) constitutes 25 per cent of international trade in manufacturing. There has been an increase in the proportion of U.S. technology receipts, which are intrafirm. The share of total U.S. imports accounted for by intrafirm transactions of multinationals based in the United States rose from 25 per cent in 1966 to 32 per cent in 1975. The share of these transactions from developing countries showed a rise from 30 per cent in 1966 to 35 per cent in 1975; however, this rise can be accounted for by the rise in the price of petroleum imports, which constitute the largest category of imports from developing countries. The share of U.S. intrafirm trade in manufactures from developing countries declined from 16 per cent in 1966 to 10 per cent in 1976. But control can take many forms other than majority ownership in subsidiaries. And multinationals are adept in assuming these other forms (UNCTAD, 1978).

An essential feature of the multinational enterprise is a special advantage over the local rival, who knows the local conditions and the local language better than the foreigner. This advantage must be sufficiently large to permit rents to be collected that exceed the extra costs of geographical and cultural distance. It may consist in a natural monopoly, in size, in risk-spreading, in good will, or in proprietary knowledge acquired through research and development expenditure. It may be bestowed upon a firm by what Veblen called “business methods,” like advertising, or by “production methods,” like superior knowledge or larger scale.

It was recognized quite early that it is wrong for multinationals to benefit from a natural monopoly in which know-how is widespread, such as that enjoyed by public utilities. As a result, these enterprises were nationalized early. Host countries also learned to appropriate for themselves a larger share of the monopoly rents in minerals. In manufacturing, monopoly profits for multinationals were generated partly as a result of high levels of protection, on which the companies often insisted, and excessive subsidies and tax concessions, and partly as a result of trade names, market-sharing agreements, and other monopolistic practices.

Expenditure on the creation of this advantage does not vary with the unit operating costs in a particular country, which may be quite low compared with the prices charged. The large fixed costs that arise from research and development, exploration, scale, or advertising make the allocation of these costs between operations in different countries arbitrary within wide limits. But while one school of thought has used this to justify companies charging prices substantially in excess of the incremental costs of operating in a particular country, as a way of recouping what are regarded as necessary overhead expenditures, another school has emphasized the element of monopoly profit in these pricing policies. The existence of such profits or rents (which may be concealed, for example, through transfer pricing of imported inputs, management or license fees, interest rates on intrafirm loans, and royalties) implies that the “marginal productivity of investment curve,” which relates returns to amounts invested, has vertical branches, within the limits of which the division of gains between the host country and firm is a matter for bargaining. Higher shares going to host countries would not be accompanied by reduced investment or lower operating efficiency, as the conventional theory has maintained.

This theory states that any policy that raises costs to the multinational is bound to lead to reduced capital or technology inflow. Policymakers have to “trade off” their desire for raising taxes, imposing conditions about local participation or training, or limiting remittances abroad against the advantages of more foreign capital and know-how. Though their relationship to the foreign enterprise may be a love-hate relationship, at the margin they have to make up their minds whether they love or hate the investment of the foreign company.

But the correct analysis must start from the monopolistic advantage of the firm and the monopoly rent that it yields. There will, therefore, be a range between a high “rate of return” to the company that will make the operation just acceptable to the host country and a low rate that will make it just worthwhile for the company. The maximum point of this range is determined by the host country’s ability to acquire the advantage in an alternative way, or to do without it; the minimum point being set by the operating costs to the company of conducting the activity in the country.

It might be objected that if governments were to beat down returns to such low levels that they barely covered their local operating costs and did not permit firms to recoup a contribution to their overhead expenditures (such as those on research and development), they would kill the goose that lays the golden eggs. Pharmaceutical companies, for example, would have to go out of business if they were allowed to charge only the direct costs of producing drugs, for the sources of their research funds would dry up.

But this is not a valid objection as far as developing countries are concerned. The argument may hold for advanced, industrial countries. In deciding upon its research expenditure the company usually has the large markets of the advanced countries in mind. Anything it gets from the small, relatively poor markets of the developing countries over and above operating expenses is frequently a bonus. To forgo that bonus would not reduce its research expenditure. The potential bargaining strength of the developing countries (where they have the ability, solidarity, and knowledge) lies precisely in their small size: an instance of the importance of being unimportant.

Toward a policy

Any developing country has to ask itself four questions in evolving a policy toward multinationals—a positive answer to each giving rise to the next question. (1) Are foreign enterprises wanted at all? Some countries, though their number is declining, may reject outright the idea of foreigners making profits in their country. (2) Is the particular product or product range wanted? Many products of multinationals are overspecified, overprocessed, overpackaged, over-sophisticated, developed for high-income, high-saving markets, produced by capital-intensive techniques and, while catering for the masses in richer countries, can cater for only a small upper crust in poorer countries. (3) Should the product be imported or produced at home? Home production could be for the domestic market or for export. (4) Is direct foreign investment the best way to assemble the package of management, capital, and know-how? The host country has a variety of choices. It can borrow the capital, hire managers, and acquire a license; use domestic inputs for some components of the “package”; or use consultancy services, management contracts, importing houses, or banks. If it is decided that direct foreign investment in the form of a multinational subsidiary is the best way of assembling the package, the terms of the negotiation will have to be settled, so that the host country strikes the best bargain, consistent with efficient operation of the multinational. This is an area in which international organizations, like the World Bank, could give technical assistance to host countries. (Bilateral technical assistance would be suspected of taking the side of the companies.)

“cost benefit analysis is useful in ranking the bargains…”

The correct approach is therefore a combination of cost-benefit analysis and a bargaining framework. In one sense, though not a very significant one, the two approaches amount to the same thing. It is always possible, formally, to regard forgoing the second-best bargain to any given bargain as an element in the “opportunity cost” (the cost of forgoing the alternative) of the bargain in question. If, then, all bargains are ranked in order of preference, only the best bargain will show an excess of benefit over cost. But this is a purely formal way of getting round the difficulty of distinguishing between cost-benefit and bargaining issues. It would be more illuminating to say that cost-benefit analysis is useful in ranking the bargains, so that the host country knows what it should go for and what it will sacrifice with any concession, whereas the bargaining framework is necessary to strike the best bargain within the numerous items for negotiation. Here a number of issues may arise; do elements in the bargain in one country affect bargains in other countries? Can concession on one front be traded for counter-concessions on another? Are there clear areas of common interests that can be delineated from areas of conflicting interests? More fundamentally: can the government negotiators take a truly independent position that reflects the interests of their country, or do they not represent partial group interests within their own countries, that are aligned with the interests of the foreign company?

Bergsten, Horst, and Moran in their book American Multinationals and American Interests distinguish between four conventional schools of thought. The imperialist and mercantilist school argues that there is a joint effort by U.S. multinationals and the U.S. Government to dominate the world both politically and economically. The sovereignty-at-bay thesis (Raymond Vernon, 1971) holds that multinational firms have become dominant over all nation states, both host and home, with largely beneficial effects on all concerned. The global reach school (Barnet and Müller, 1974), while agreeing that the firms have become dominant, concludes that the effects can be detrimental for both home and host countries. There is also the view espoused by labor unions in the United States that multinationals hurt the United States and benefit foreign countries.

Bergsten, Horst, and Moran find that none of these (somewhat oversimplified) models really fits and propose a policy to get the best out of these firms. They find that the main distortions to be corrected arise from competitive government policies, by both host and home governments (with respect to tax policies, for example) and from the structure and behavior of the companies. The type of rules and procedures that we have evolved in the area of trade and money need also to be negotiated in the area of foreign investment and multinational behavior.

Can multinationals make a contribution to meeting basic human needs? Since it follows from the above argument, about the special advantage, that the multinationals from the developed countries are likely to produce and market rather sophisticated products on which oligopoly rents can be earned for some time, they are not likely to make a contribution to the simple producer and consumer goods that a basic needs approach calls for. (They may, however contribute to intermediate goods, capital goods, and exports.) Such products would be readily imitated by local competitors and the rents soon eroded. There can be a conflict between the basic goods the poor need and the advertised consumer goods of the multinationals.

The chairman of a multinational food company writes in the Columbia Business Journal on the subject of marketing in developing countries:

How often we see in developing countries that the poorer the economic outlook the more important the small luxury of a flavored soft drink or smoke… to the dismay of many would-be benefactors the poorer the malnourished are, the more likely they are to spend a disproportionate amount of whatever they have on some luxury rather than on what they need…. Observe, study, learn. We try to do it at [our company]. It seems to pay off for us. Perhaps it will for you too.

It is probable that the new multinationals from the developing countries will be more adapted to local needs. The costs to the host country are likely to be lower and the technology and product design more appropriate to local conditions. They often are of smaller scale, use more capital saving techniques, create more jobs, are better adapted to the supply and social conditions in the host country, are more responsive to requests for exporting, local participation, joint ventures, or local training, and design products more adapted to the consumption and production needs of the poor—hoes, simple power tillers, and bicycles, rather than air conditioners, expensive cars, and equipment for luxury apartments. Their special advantage would consist not in the monopolistic package of capital, technology, and marketing, but in special skills. Their costs of overcoming geographical and cultural distance are often less than those of multinationals from industrial countries. Their relative bargaining power is weaker. The visible hand of these multinationals is less visible than that of U.S. companies. Because of these characteristics, their ability to survive in a world in which developing countries become increasingly interdependent among themselves is increased.

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