Difficulties of Multinationals in Carrying Out Transactions - Essay Example

Multinational Companies Introduction A Multinational Company (MNC), also called Transnational Company (TNC) is a business organisation that is headquartered in an industrialised country and has branches, subsidiaries and plants in a number of other countries.1 MNCs carry out the functions of financing, production, sales and research and development in their foreign operations. Some MNCs grant foreign companies a licence to use their technology instead of setting up plants on their own. The profit and income flows that they generate are part of the foreign capital inflows moving between countries. MNCs have developed since World War II ended in 1945. Most MNCs are based on manufacturing or minerals industries. They operate in fields that involve frequent technological change (such as the production of computers, drugs and electronic equipment). MNCs have tremendous economic power.2 BP operates in more than 100 countries. Exxon Mobil, the parent of Esso, Mobil and Exxon Mobil companies around the world is the biggest MNC; its economy is similar to that of Chile or Pakistan.3 Other large MNCs like Ford, General Motors and Royal Dutch/Shell, each has reported annual sales in excess of $ 75 billion – a figure larger than the gross national products of over 80 per cent of the world’s nations.4 In 1994, UNCTAD estimated that there were 37,000 MNCs having over 206,000 affiliates; over 90 per cent of MNCs globally were based in 1= http://www.bized.ac.uk/virtual/dc/copper/theory/th18.htm 2= The World Book Encyclopedia, 13:693 3= http://www.cafod.org.uk/resources/secondary_schools/globalisation/ multinational_corporations_factsheet_ks3_ks4 4= The World Book Encyclopedia, 13:693 advanced countries with nearly half of all affiliates in newly industrialised and developing countries.5 Thesis : Multinationals exist because of the difficulty of carrying out transactions through markets. Looking at the above statement from two perspectives (situation in the country of origin and situation in the host country) I contend that it is completely WRONG. Multinationals exist due to various other reasons that are enumerated below. 1) Liberalisation and Globalisation Liberalisation, or market orientation by many countries has led to local deregulatory policies such as reduction of tariff and non-tariff barriers,6 enhanced transparency of trade policies/regulations and trade facilitation measures (e.g. simplification of customs procedures/practices), facilitating the flows of capital and investment, and privatization of State owned enterprises. The trend towards liberalisation is not only irreversible, but the pace can only intensify and accelerate.7 Globalisation involves greater integration in world markets, and increased economic independence. It has fundamentally changed, and considerably expanded, the boundaries of the market place. Globalisation and liberalisation are linked phenomena: Liberalisation has either preceded globalisation, or has become a policy forced by globalisation. Both liberalisation and globalisation have been facilitated by the significant growth in world trade and foreign direct investment (FDI), and by information technology that has 5= http://www.ilo.org/public/english/dialogue/actemp/papers/1998/dmirglob.htm 6= http://www.ilo.org/public/english/dialogue/actemp/papers/1998/dmirglob.htm 7= http://www.jpa.gov.my/buletinjpa/bil2/globalisation_and_economic_liber.htm facilitated rapid finance transactions and changes in production and service location around the world. MNCs are organisations that engage in FDI and own or control assets in more than one country, creating very complex international production networks that distinguish globalisation from the simpler forms of international business integration in earlier periods.8 The obvious importance of FDI and MNCs in the world economy is rapidly growing. MNCs mediate most world trade flows. For example, Bernard, Jensen and Schott found that 90 per cent of U.S. exports and imports flow through U.S. MNCs, with roughly 50 per cent of U.S. trade flows occurring between affiliates of the same MNCs.9 Three quarters of international investment in developing countries is from MNCs.10 Data in 1991-1993 indicates that about two thirds of the inflow of FDI is to advanced industrialised countries, which are also the source of around 95 per cent of the outflows of such investment. The most significant sources of FDI are MNCs based in the U.S., Japan, U.K, Germany and France. In its 1994 report, UNCTAD disclosed that during the period 1981-1992, FDI of $ 203 million flowed to the ten largest developing nations (China, Singapore, Mexico, Brazil, Malaysia, HongKong, Argentina, Thailand, Egypt and Taiwan).11 MNCs are looking for countries where they can invest safely whilst gaining good investment returns in the process. Liberalisation and globalisation of countries have 8 = http://www.ilo.org/public/english/dialogue/actemp/papers/1998/dmirglob.htm 9 = http://www.nber.org/reporter/winter06/blonigen.html 10= http://www.cafod.org.uk/resources/secondary_schools/globalisation/ multinational_corporations_factsheet_ks3_ks4 11= http://www.ilo.org/public/english/dialogue/actemp/papers/1998/dmirglob.htm provided these assurances 2) Cheap Labour MNCs tend to chase the lowest wages in an effort to maximise their profits.12 MNCs look to shift low technology, labour intensive production to low wage countries.13 Such countries are endowed with potentially large, low-wage labour forces and have high levels of unemployment.14 In 1994, UNCTAD estimated that globally 73 million persons were employed by MNCs. In its 1995 report, The World Bank estimated that MNCs employ around 12 million persons in developing countries.15 In 2000, IBM produced around 60 per cent of its laptops in Mexico.16 To a MNC, the quality of the labour force is important, as is its education, skills, flexibility, availability17 and control exerted by trade unions (MNCs generally prefer not to recognise trade unions or bargain with them, but normally do so where it is required (e.g. by legislation); their relations with trade unions is influenced both by labour management relations in their country of origin and circumstances in the host country). Due to globalisation, the status quo between “capital” and “labour” in each country has been disturbed. This is because labour remains relatively immobile whereas capital is more mobile in an open international environment. As a result, labour is placed at a distinct disadvantage, allowing capital to employ labour at lower cost.18 12= http://www.cafod.org.uk/resources/secondary_schools/globalisation/ multinational_corporations_factsheet_ks3_ks4 13= http://www.jpa.gov.my/buletinjpa/bil2/globalisation_and_economic_liber.htm 14= http://sloanreview.mit.edu/smr/issue/2006/winter/03/ 15= http://www.ilo.org/public/english/dialogue/actemp/papers/1998/dmirglob.htm 16= http://www.cafod.org.uk/resources/secondary_schools/globalisation/ multinational_corporations_factsheet_ks3_ks4 17= http://sloanreview.mit.edu/smr/issue/2006/winter/03/ 18= http://www.ilo.org/public/english/dialogue/actemp/papers/1998/dmirglob.htm 3) Corporate Tax Rates One of the main reasons for a firm or company becoming international in scope is to find opportunities to earn greater returns on capital investment.19 MNCs are potentially subject to taxation in both the host and parent country. However, most parent countries are favourably inclined towards MNCs in that they adopt policies to reduce or eliminate taxation (e.g. by allowing credits or deductions). In addition, many countries have bilateral investment treaties (BIT) specifically designed to reduce withholding taxes on MNCs based in either country.20 The existence of a favourable tax atmosphere in the host country is therefore one of the crucial factors why MNCs prefer to invest in them. 4) Transfer Pricing MNCs engage in transfer pricing where they shift production between countries so as to benefit from lower tax arrangements in certain countries.21 Easy movement of factors of production across national borders has facilitated MNCs to locate different parts of their production in different countries.22 MNCs may have a few factories in one country that produce complete products to be sold in several other countries where they may not prefer to make huge plant investments. In other cases, many factories of MNCs may each manufacture different parts of the finished product.23 For example, Marks & Spencer sources its goods from more than 70 countries.24 19= http://business.baylor.edu/Tom_Kelly/CH14.htm 20= http://www.nber.org/reporter/winter06/blonigen.html 21= http://sloanreview.mit.edu/smr/issue/2006/winter/03/ 22= http://www.jpa.gov.my/buletinjpa/bil2/globalisation_and_economic_liber.htm 23= The World Book Encyclopedia, 13:693 24= http://www.cafod.org.uk/resources/secondary_schools/globalisation/ multinational_corporations_factsheet_ks3_ks4 Transfer prices are the prices that a MNC assigns to transactions of goods and services among different areas within its organisation. Bearing in mind that they operate in an increasingly globalised business arena and are subject to competing tax jurisdictions and regulatory bodies, the MNCs face a challenging task of assessing, distributing and reallocating the sources, production and distribution activities across their internal business units. The complexity and critical nature of this process are further exacerbated due to increasing vigilance of national and state tax authorities in the MNC’s own country as well as in the host countries.25 5) Exchange Rates Contrary to general belief, exchange rate movements do affect investment decisions of MNCs. It is generally assumed that a depreciation of the currency of the host country reduces the amount of foreign currency needed to purchase the asset, but it also reduces the nominal return one receives in the foreign currency, thus not changing the rate of return for the foreign investor. This is not true. Firm-specific assets (like patents or managerial skills) involved in FDI are typically tangible and easily transferred across a firm’s operations. Thus the purchase price of such assets through FDI are in the host country’s currency, but returns can be generated anywhere the MNC operates and are not necessarily tied to the home country’s currency. As a result, the host country’s currency depreciations can lead to increased acquisition of FDI, particularly of MNCs that have firm-specific assets.26 6) Adequate and Specific Information As an MNC’s investment in a host country is substantial, it places great 25= http://www.prnewswire.co.uk/cgi/news/release?id=87841 26= http://www.nber.org/reporter/winter06/blonigen.html importance on obtaining adequate and specific information about the host country to decide whether it should invest in it. For example, the Japanese have an efficient information sharing system called keiretsu where groups of firms across a wide range of industries are centred around a main bank that owns significant shares in these firms; the firms get together regularly and share information, particularly about FDI. In another scenario, a MNC may increase FDI into a designated host country if a “foreign” CEO, born and brought up in that designated host country, takes over. This is attributable to better information about the host country market by the new CEO.27 7) Significant Government Influence MNCs bring money to a country through employment and investment. Their activities drive growth and development. A MNC investing in an area provides jobs directly or through the growth of local ancillary businesses such as banks and insurance. Management and entrepreneurial skills learned from MNCs are an important source of human capital. MNCs contribute tax revenues and other revenues (e.g. they purchase national assets as in the case of Zambia during the privatisation process).28 Secure and complacent in their role as saviours to a host country, and buoyed by the sense of greater worldwide acceptance and commitment to the free trade principle and market economy and dismantling of planned economies,29 MNCs are frequently able to subvert host country political processes by co-opting the local elites and using their influence to keep host governments and authorities in line. They even have more leverage in playing one country against the other for government concessions.30 27= http://www.nber.org/reporter/winter06/blonigen.html 28= http://www.bized.ac.uk/virtual/dc/copper/theory/th18.htm 29= http://www.jpa.gov.my/buletinjpa/bil2/globalisation_and_economic_liber.htm 30= http://business.baylor.edu/Tom_Kelly/CH14.htm The global power of MNCs is well illustrated in the recent statement of Kofi Annan, UN Secretary General: “The UN once dealt with only governments. But now we know that peace and prosperity cannot be achieved without partnerships involving governments, international organisations, the business community and civil society. In today’s world we depend on each other.”31 8) Long Term Planning Perhaps the most important reasons for a firm or company becoming international is to respond to domestic market satiation and find new markets for its products and services with an aim to have a long-term relationship with such countries. Due to the huge investment involved, MNCs do not (except for very few incidences of ‘fly by night’ MNCS) consider short-term commitments as worthy business propositions.32 MNCs look at not only the current conditions in a host country, but also at the plans of the economy’s policy-makers. The logic behind this is just as the MNCs needs change over time, so too does the host economy change. The MNC looks at its own strategic development and determines what long-term competitive advantage a host country can offer to complement that. The big question is whether or not the MNC and host economy can grow together compatibly; otherwise the MNC could pay a premium to chase the cheapest labour around the world every few years.33 “Savvy multinationals opening up overseas operations should look for more than just a low-cost environment. They should look for a long-term relationship,” advised three researchers at the Irish Management Institute in 2005, after surveying the 31= http://www.cafod.org.uk/resources/secondary_schools/globalisation/ multinational_corporations_factsheet_ks3_ks4 32= http://business.baylor.edu/Tom_Kelly/CH14.htm 33= http://sloanreview.mit.edu/smr/issue/2006/winter/03/ executives of 200 largest foreign-owned companies operating in Ireland. For example, Apple Computer which has been manufacturing in Ireland since 1978, did not migrate away (like others did) to lower-cost countries; they kept faith in their long term planned goals, and advantages eventually started emerging from areas like services, Research & Development (R&D), and innovation. Today, Apple Computer uses its Irish centre as a base for non-manufacturing European activities like financial accounting, call centres and order management.34 Globalisation is accelerating economic interdependence between countries and encouraging similarities in approach by individual enterprises in competitive markets. This is leading to convergence in industrial relations arrangements around the world.35 Improvements in transport, communication and information technology networks have led to lower cost of transactions and of doing business globally.36 MNCs look for their subsidiaries in the host country to access to the availability of strong and durable relationships with host country partner organisations such as suppliers, key clients and research institutes.37 MNCs consider all such factors bearing in mind that they are looking to a long-term relationship with the host country. For example, a MNC might look for marketers who can tap into future domestic or regional consumer markets. Or, an automobile manufacturer might not look only for cheap labour, but also at the technical capabilities of local suppliers and the host government’s infrastructure investment projects. Similarly, a pharmaceutical company will not only look for patent protection and cheap labour, but also at whether the host 34= http://sloanreview.mit.edu/smr/issue/2006/winter/03/ 35= http://www.ilo.org/public/english/dialogue/actemp/papers/1998/dmirglob.htm 36= http://www.jpa.gov.my/buletinjpa/bil2/globalisation_and_economic_liber.htm 37= http://www.druid.dk/ocs/viewabstract.php?id=66&cf=1 country’s universities can effectively produce medical associates who could staff a world-class environment in the future. Or, the development of a cluster of companies from a related industry can make a location attractive by amplifying both short-term and long-term efficiencies; over time, a cluster’s companies can all access a common pool of trained labour, marketing expertise, research capabilities, suppliers, service companies and transport links.38 Most MNCs place great importance on R&D activities in their foreign subsidiaries, focusing on adapting products to host country markets, or developing new products for local, regional or even global markets; there are certain mechanisms (such as incentives or subsidies for R&D, macroeconomic policy, competition and factor prices) that can create cost incentives that can stimulate MNCs to carry out R&D activities in a particular country.39 Conclusion It is clear that there are many crucial factors (as discussed above) that play prominent roles in influencing whether a MNC should exist in a particular host country. In the evaluation of all these factors there does not exist or imply any claim that MNCs exist due to difficulties of carrying out transactions through markets. 38= http://sloanreview.mit.edu/smr/issue/2006/winter/03/ 39= http://www.druid.dk/ocs/viewabstract.php?id=66&cf=1 References used: Anon. No date. The Impact of Multinational Enterprises: Bized.ac.uk. [Online]. Available: http://www.bized.ac.uk/virtual/dc/copper/theory/th18.htm [14 April 2006]. Anon. 1996. Multinational Corporations. The World Book Encyclopedia, 13:693 Anon. No date. Multinational Corporations Factsheet: KS3, KS4: Cafod.org.uk. [Online]. Available: http://www.cafod.org.uk/resources/secondary_schools/globalisation/multinational_corporations_factsheet_ks3_ks4 [14 April 2006]. Anon. 9 July 2002. Practical Solutions for Intercompany Pricing. NERA Release. [Online]. Available: http://www.prnewswire.co.uk/cgi/news/release?id=87841 [14 April 2006]. Blonigen, Bruce A. 2006. Foreign Direct Investment Behaviour of Multinational Corporations: National Bureau of Economic Research. [Online]. Available: http://www.nber.org/reporter/winter06/blonigen.html [14 April 2006]. Boehe Dirk & Zawislak Paulo A. 1 May 2004. R&D Roles in Subsidiaries of Multinational Companies: When does the Institutional Environment matter? Danish Research Unit for Industrial Dynamics.. [Online]. Available: http://www.druid.dk/ocs/viewabstract.php?id=66&cf=1 [14 April 2006]. Kelly, Tom. No date. Chapter 19: International Dimensions of Public Policy : Baylor.edu.. [Online]. Available: http://business.baylor.edu/Tom_Kelly/CH14.htm [14 April 2006]. Macdonald, David. 5 May 1997. Industrial Relations & Globalisation: Challenges for Employers: ILO/EASMAT. [Online]. Available: http://www.ilo.org/public/english/dialogue/actemp/papers/1998/dmirglob.htm [14 April 2006]. Mangan John, Honnigen Kevin & Culler John. 2006. Behind the Cost-Savings Advantage: Matching MNC Subsidiary Location & Host Economy Development: MIT Sloan Management Review . [Online]. Available: http://sloanreview.mit.edu/smr/issue/2006/winter/03/ [14 April 2006]. Suppermanian, M. 12 November 1999. Globalisation & Economic Liberalisation: Ministry of International Trade & Industry (Malaysia). [Online]. Available: http://www.jpa.gov.my/buletinjpa/bil2/globalisation_and_economic_liber.htm [14 April 2006]. Read More