International Business Economics Lecture Notes

Christos Pitelis January 2004

Contents
1. Introduction: Globalisation (Nature, Evolution, Perspectives) 2. Why Multinational Corporations (MNCs) and Foreign Direct Investment (FDI)? 3. Strategy and Strategic Options of MNCs 4. MNCs, Government Policy and (Inter)national Competitiveness - Overall Conclusion and the Future of MNCs

International Business Economics Session 1 Introduction: Globalisation (Nature, Evolution, Perspectives)

Exhibit 1.1: A Framework

(INTERNATIONAL) COMPETITIVENESS

FIRMS (Business, Competitive)

POLICYSTRATEGY

GOVERNMENTS (Competition, Industrial)

THEORY

The Nature and Scope of International Business

International Business (IB) deals with the nature, strategy and management of international business enterprises and their effects on business and national performance (e.g., efficiency, growth, profitability, employment). IB is interdisciplinary. It draws, among others, on economics, politics, sociology, marketing, management (human resources, strategic).

Some definitions (i)

FDI is the control of production which takes place in one country (host country) by a firm based in another country (home country). FDI is the defining feature of the multinational corporation (MNC). Globalisation refers to the increasing integration of markets (exchange) and production, to include the mobility of resources (capital, labour, organization and knowledge).

Some definitions (ii)

A firm is an organisation which produces commodities for sale in the market for a profit, and allocates resources (such as capital and labour) without direct reliance on the price mechanism (the market) on the basis of internal entrepreneurial decisions (hierarchy). An MNC is a firm which controls production in countries other than (and including) its home base.

Some definitions (iii)

The market (price mechanism) is an institution of resource allocation, based on voluntary exchanges (transactions) by individuals, motivated by preferences and market prices. The state is an institution which allocates resources and influences the organization of economic activity through a legal monopoly on force.

Origins of IB (i)
IB is the result of the internationalisation of production and the emergence of the multinational corporations (MNCs), the subject matter of IB. Internationalisation of production (globalisation) involves international capital flows, international trade of commodities (exports-imports) and Foreign Direct Investment (FDI) by MNCs.

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Origins of IB (ii)
Until the 1980s, there has been a tendency towards concentration of industry, and oligopolistic market structures. Firms have observed a law of increasing size consisting of four stages: First, the owner managed and controlled small firm (nineteenth century). Second, the public limited national company (limited liability, separation of ownership from management). Third, the multidivisional (M-form) organisation (divisionbased), separation of strategic (long term) and operational (day-to-day) decisions. Fourth, multinational corporations (MNCs) with production activities outside (and including) their home-base.

Exhibit 1.2: The unitary (Uform) firm

Chief Executive Production Development Sales and Marketing Department Financial and Accounting Department Personnel Department

11

Exhibit 1.3: A multidivisional (M-form) structure

Head Office Central Services (e.g., Finance)

12

Division A Functions

Division B Functions

Division C Functions

Division D Functions

Division E Functions

Exhibit 1.4: A holding company structure

Parent Company Head Office

13

Company A (wholly owned)

Company B (wholly owned)

Company C (90% owned)

Company D (75% owned)

Company E (25% owned)

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Some facts and trends in IB (i)

International trade inside the worlds largest 350 MNCs accounts for almost 40 per cent of world merchandise trade. The worlds largest MNCs (e.g., General Motors, Exxon, Microsoft etc) have annual sales higher than the annual gross national product (GNP) of all but around 15 nation states. In the early 2000s in the USA, nearly half of manufacturing exports and around two thirds of imports were flowing within MNCs (intra-firm trade).

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Some facts and trends of IB (ii)

FDI increased by over 20 per cent between 1985 and 2000, twice the growth rate of exports or output. In the period 1991-2000, 63 per cent of global FDI flows was received by the developed countries (DCs) (down from almost 80% in 1989), around 33 per cent by developing countries and just over 3 per cent by Eastern European countries. Among the developing countries, China receives the lions share of FDI.

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Some facts and trends of IB (iii)

Within the DCs, the US, the UK, Canada, France and Germany are leading players. Since 1960 the relative importance of the US and the UK as sources of outward FDI has been declining. In the Triad (Europe, USA, Japan), total FDI between US and the EU was almost one third of global FDI in 2000. European FDI is largely due to M&As. FDI declined sharply in 2001 (over 50%, the largest drop in 30 years), 2002 and 2003.

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Some issues in IB (i)

The main issues which arise from the facts and trends of FDI concern the following:
Why international production, FDI and MNCs? How do (should) MNCs conduct their business strategies? (competitive and corporate strategies)

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Some issues in IB (ii)

What is the relationship between MNCs, nation states (in developed and developing countries) and international organisations and what is the impact of MNCs on growth and development? What is the link between MNCs and international competitiveness?

Background 1 (pp 20-28, starts here): Firms & Industries

History
(U-form) Firm, Competitive Industry Growth Organic (Internal)-Vertical integration, External-Mergers and Acquisitions National (Public Limited) Company, Industry Concentration, Oligopoly (M-form) Firm, Diversification (Related, Unrelated-Conglomerate) Foreign Direct Investment, Transnational Corporations (TNCs), Global Firms

20

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Firm integration Strategies

Vertical Integration (VI): Backward (raw materials) and forward (distribution). Mergers and acquisitions (M&A): coming together of two or more firms. Conglomerate diversification: operations-expansion of firms in unrelated products-markets. Foreign Direct Investment (FDI) and MNCs. Hybrid (networks, clusters, joint ventures, strategic alliances )

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Main perspectives
(Market) Power: Firms pursue profit and/through (market) power. Efficiency: Firms pursue profit through reduction of production and transaction costs. Hybrid: Firms pursue profits through efficiency and (market) power.

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Theories (i)
Neoclassical: Firm is a production function, a black box; it is concerned with the industry price-output equilibrium, which maximizes profits. Price-output equilibria depend on market structure, e.g., perfect competition, monopoly. Managerial: Firms maximize utility of managers, e.g., sales revenue, growth. Based on alleged separation of ownership from control. Transaction Costs: Firms are multi-person hierarchies which result from, and give rise to reduced market transaction costs, resulting in efficient industry structures.

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Theories (ii)
Resource-Based: Firms are bundles of human and non-human resources under administrative co-ordination. There are internal and external stimuli to growth which lead to industry concentration. Behavioural: Given bounded rationality and different objectives of groups within them, firms do not maximize, they satisfice.

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Theories (iii)
Austrian - Chicago School - Schumpeterian: Alert, profit seeking entrepreneurs, enhance market co-ordination and give rise to ephemeral monopoly profits, eroded through competitive process of creative destruction (innovations). Marxist: Firms produce commodities for sale in the market for a profit, under hierarchical control of capital over labour. Dialectic link between competition and monopoly, for maintenance of monopoly (power).

Some critical elements for economic analysis (DISCO) (i)

26

Demand (D): The demand conditions firms face, in the form of a Demand Curve, derived from Theory of Demand. Industry Structure (IS): The extent of industry concentration, barriers to entry, etc, leading to competitive, imperfectly competitive, oligopolistic, or monopolistic industry structures.

Some critical elements for economic analysis (DISCO) (ii)

27

Costs (C): The cost conditions faced by the firm, in the shape of a Cost Curve, derived from Theory of Production and Costs. Objectives (O): The firms aim. It allows the derivation of price-output equilibria. Usual assumption is profit maximization (Marginal Cost equals Marginal Revenue). Others are maximization of sales revenue or growth. Alternatives are satisficing, entrepreneuring

Exhibit 1.5: Monopoly versus Competition

P

28

, minimum efficient scale PM monopoly price PC perfect competition price

PM

PC

LAC = LMC

QM MR

QC

[End of Background 1]

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Globalization: causes
Firm growth because of Use of excess internal resources at near zero marginal cost Sale of products to new markets at high profit rates (due to high fixed costs).

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Globalization: facilitators
Reductions in transportation costs. Improvements in information and communication technologies.

International Business Economics Session 2 Why MNCs and FDI?

The Multinational Corporation (MNC)

Definition MNC = firm which controls production across national boundaries through intra-firm (non-market) operations. Question Why MNCs as opposed to exports, franchising, licensing, etc. ?

32

Background 2 (pp 32-65, starts here): Perspectives on the theory of firm

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The Neoclassical analysis (i)

Simple Market Structure Analysis (Perfect Competition vs Monopoly) Perfect Competition defined: Market structure characterised by a large number of profit maximising buyers and sellers selling homogeneous products, and no entry barriers. Result: Price taking behaviour, price at minimum long run average cost (LAC) curve normal profits.

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The Neoclassical analysis (ii)

Monopoly defined: market structure characterised by a single profit maximising producer and very high entry barriers (no entry). Result: monopoly prices exceeding minimum LAC Excess (monopoly) profits. Conclusion: departures from perfect competition result in increases in prices and reductions in output. Also to welfare losses due to monopoly power.

The Neoclassical analysis (iii) Oligopoly

36

Defined: market structure characterised by interdependence of (usually a small number of) producers-firms. Duopoly is the case of two firms.

Exhibit 5: Industrial Organisation (IO) 37 and the S(tructure) - C(onduct) - P(erformance) model
IO Defined: Branch of economic theory analysing structureconduct and performance (SCP) of oligopolistic industries (set of firms producing similar products). SCP Model: Suggests there exists a (initially unidirectional) link between structure (S), conduct (C) and performance (P) of industries. Feedback relationships from conduct and/or performance to structure later allowed for. Main Focus: The concentration (S) - Profitability (P) relationship assuming profit maximisation (C). New IO analyses impact of conduct on structure and performance in oligopolistic games.

Theoretical specification of industry structures

1. Limit pricing 2. Unconstrained profit maximizing oligopoly 3. Contestable markets

38

39

1. Limit Pricing
Assumes constrained profit maximisation (maximum profits subject to no entry), barriers to entry (minimum efficiency scale) and that incumbents leave post-entry output at pre-entry levels and entrants know this. Result: Limit price derives from limit output found by subtracting the minimum efficient scale level of output from the perfect competition level.

Exhibit 2.1: Derivation of the limit price

P

40

PL PC LAC

Q
0 Q QL

D Q

QC

PL is determined by QL, i.e. the level to which, if the MES was added, the competitive output would result, thus PC, thus no ENTRY. RULE:
QL =QC Q

2. Unconstrained profit maximising oligopoly

41

Assumes blockaded entry and joint profit maximising price-output levels (Monopoly). Entry is blockaded through strategic entry barriers, e.g., investment in excess capacity.

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3. Contestable markets
Assume free entry and costless exit. This ensures perfectly competitive price-output levels, even in the presence of economies of scale and oligopolistic market structures, as any departures from perfectly competitive prices lead to hit-and-run entry and exit.

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IO models compared
Main issue is the nature and importance of entry barriers, both innocent/structural (scale economies) and strategic (conscious actions by incumbents designed to deter entry), e.g., excess capacity, product proliferation. Well analysed strategic entry deterrence strategy, the investment in excess capacity. In the limit even monopoly pricing is sustainable if incumbents have excess capacity sufficient to produce full perfect competition output. To be credible, excess capacity investment should be optimal postentry.

Exhibit 2.2: An expository diagrammatic framework to Industrial Organisation

P

44

, minimum efficient scale P QS, strategic capacity P output P PM monopoly price PL limit price PC perfect competition price

LAC = LMC

QS

Q D

QM

QL MR

QC

Firm-industry structures and business strategy

45

Oligopoly, crucial for (competitive) strategy, which is absent in cases of both perfect competition and monopoly. Emergence and effects of oligopoly analysed by theory of Industrial Organization (IO), which is based on and extends the Cournot/Bertrand models of oligopoly. M-Form organisation is important condition for development of corporate strategy (existence of multitude of business units).

Theory of Firms & Industries: Alternative Perspectives

46

Transaction Costs, Markets and Hierarchies Resource-Based and related perspectives

Transaction Costs, Markets & Hierarchies (i)

47

Origin: Coase (1937) Assumptions i) Market is original means of resource allocation => ii) Existence of hierarchies (e.g., firms) due to market failure Nature of market failure Cognitive (natural) not structural; i.e., due to transaction costs and not monopoly power.

Transaction Costs, Markets & Hierarchies (ii)

48

(Market) Transaction Costs are costs of information, bargaining, contracting, policing and enforcing agreements. Main Proposition (Coase, Williamson, etc.): internalization of markets by hierarchies, i.e., replacement of voluntary exchanges with hierarchy => savings in transaction costs => hierarchy (firm) more efficient way to allocate resources. Horizontal and vertical integration, the M-form, and conglomeration result from pursuit of transaction cost reductions.

Transaction Costs, Markets & Hierarchies (iii)

Policy Implications In neoclassical approach departures from perfect competition => market failure (structural) => => need for government intervention. In transaction costs approach hierarchies (including M-form conglomerates and MNCs) =

49

efficiency improving solutions to (natural) market failure => => less need to interfere with the markets.

Resource-based & related perspectives (i)

Early work by Penrose (1959)

50

Firm = a collection of resources bound together in an administrative framework, the boundaries of which are determined by the area of administrative co-ordination and authorative communication (Penrose, 1995, p xi). Focus on the internal resources of the firm, then the external environment. Latter is different for each firm depending on its specific collection of human and other resources. Environment can be manipulated by firms to serve their objectives.

Resource-based & related perspectives (ii)

Dynamic interaction between internal and perceived external environment (image, and productive opportunity). Endogenous Growth, results from

51

i) resource indivisibility, ii) knowledge creation within firms, which releases resources.
A firms prospects are in terms of existing and new products; diversification as new markets become relatively more attractive than existing ones.

Resource-based & related perspectives (iii)

Knowledge is tacit. History matters, growth is an evolutionary process, based on cumulative growth of collective knowledge in the context of a purposeful firm.

52

Rate of firms growth limited by growth of knowledge within it, and a firms size by the extend to which administrative effectiveness continues to reach expanding boundaries.

Resource-based & related perspectives (iv)

53

Firm strategies result of differential capability, e.g., Vertical Integration, due to ability of firms to serve their own needs better. Diversification, due to growth and multiple applicability of resources. Mergers and Acquisitions; to acquire managerial resources for expansion. MNCs, due to differential ability e.g., in transferring tacit knowledge (Kogut-Zander).

Resource-based & related perspectives (v) (Nelson & Winter, 1982)

54

In Nelson and Winters evolutionary theory of the firm, routines, search (changes in routines) and competition are economic analogues to genes, heredity and struggle for existence in biology.

Resource-based & related perspectives (vi) (Capabilities-based)

55

Use and develop hard to imitate and costly to apply internal capabilities. Rents in equilibrium.

Resource-based & related perspectives (viii) (knowledgebased theories, Penrose, etc.)

56

Firms better than markets in using, preserving, transferring and developing knowledge. Value creation growth through knowledge and value appropriation.

Resource-based & related perspectives (ix) (Richardson and co-operation)

57

Dense network of co-operation and affiliation by which firms are inter-related. Markets, hierarchy and networks are a function of degree of complementarity and similarity of activities weakly complementary activities => MARKET complementary and similar activities => HIERARCHY complementary and dissimilar activities => COOPERATION

[End of Background 2}

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Theories of the MNC

Two main types:
- Supply-side - Demand-side - Other factors theories

Supply-side theories. Mainly

- Monopolistic ownership advantage - Transaction costs and internalisation - Eclectic theory (or Ownership, Location, Internalisation OLI paradigm) - Divide and rule - Resource-based

Supply-side theories: Monopolistic ownership advantage (i)

Origin: Hymers 1960 PhD thesis Assume: Law of increasing firm size: Firms growth leads to concentration and acquisition of monopolistic advantages (MAs).
Firms pursuit of (monopoly) profit => seeking overseas markets. MAs allow firms to outcompete foreign rivals. MNCs aim at reducing conflict.

59

Supply-side theories: Monopolistic ownership advantage (ii)

60

Choice of FDI over market-based alternatives due to control potential and oligopolistic interaction. Collusion allows reduction of conflict and maintenance of monopoly profits. Conclude: Structural market failure => MNCs => (international) structural market failure

Supply-side theories: Transaction costs internalization (i)

61

Existence of firms => Economising in transaction costs => Firms more efficient than markets In case of MNCs, choice is between market transactions, e.g., exporting, licensing and non-market transactions, i.e. Foreign Direct Investment (FDI).

Supply-side theories: Transaction costs internalization (ii)

Reasons for FDI
Williamson: asset specificity => hold-up problems => need for fully owned subsidiaries (FDI). Buckley & Casson: intangible assets exhibit public goods attributes, thus result in appropriability problems => market failure. Hennart: internalization of markets due to differential ability to control (overseas) labour.

62

Supply-side theories: Transaction costs internalization (iii)

Conclusion Internalization of markets through MNCs are efficient solution to intrinsic (transaction costs-related) market failure.

63

Supply-side theories: Eclectic theory (or OLI paradigm)

Dunning, combined a and b as well as location advantages to provide eclectic theory or O(ownership), L(ocation), I(nternalization) paradigm. OLI explains internationalization of production, not the MNC.

64

O explains why firms are able to become MNCs. I explains why they benefit from internalizing markets or advantages. L explains the choice of location.

Supply-side theories: Divide and Rule (Sugden)

Builds on Marglin-Hymer Focuses on labour markets. He suggests that a reason for MNCs is their ability to divide labour (unions) in country specific groups => Reduce their bargaining power => increase their profits.

65

Supply-side theories: Resource-based

(Penrose, Teece, Kogut-Zander)

66

MNCs are due to endogenous growth and differential capabilities vis--vis market and other firms. Growth can be national (diversification) or geographical (MNC). MNCs are better in transferring internationally tacit knowledge than markets.

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Demand-side theory (i)

Cowling & Sugden, Pitelis: increased concentration => increased profits => reduced consumers expenditure (because a lower proportion of profit is consumed than of wage income). As consumption decreases so does effective demand => going overseas for demand outlets.

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Demand-side theory (ii)

The MNC as an All Weather Company Diversified national firms can ride the industry life cycle (Hymer). MNCs can ride the national business cycle, becoming All Weather Companies.

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Other factors theories

Oligopolistic rivalry
Present in most theories (except transaction costs). Can motivate - shape firms payoff matrix => crucial context within which decisions are taken. Specifically oligopolistic interaction theories (e.g., Graham), build on Hymer and emphasize role of threats and counter-threats.

Competition between states

Nation states may promote their own MNCs to affect their international competitiveness could explain some LDC MNCs.

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Synthesis (i)
Context: Oligopolistic interaction
Endogenous growth (Penrose) => monopolistic advantages (Hymer). MAs are an inducement to innovation and further growth (Penrose); they can help firms outcompete foreign rivals (Hymer). Domestic diversification due to pull factors, e.g., multiple use of resources (Penrose), or push factors, e.g., the product life cycle (Hymer).

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Synthesis (ii)
Geographical diversification also due to nationalregional business cycles (all weather company). Mode of expansion due to differential firm capabilities (Penrose, Teece, Kogut & Zander), (dynamic) transaction costs (Teece, Buckley & Casson) and overall control advantages (Hymer). Locational factors explain the choice of location. No general theory possible, but a general framework within which each case can be examined.

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MNCs impact on welfare

Monopolistic advantage theory => possibility of reduced competition due to MNCs => (Pareto) inefficiency Internalization hypothesis => transaction reductions => efficiency. Eclectic view => advantages and disadvantages => trade-off. Divide and rule hypothesis => reduced workers welfare => (Pareto) inefficiency. Resource-based => efficiency and inefficiency may coexist Synthesis => coexistence of efficiency and power => trade-off.

The MNC and Uneven Development(Hymer)

For Hymer (1972), the operations of MNCs tend to globalize the tendency towards concentration; generate an uneven development between the centre (developed countries) and the periphery (less developed countries); erode the power of labour unions and the nation state, and tend to shape the world to their image by creating superior and inferior countries. They are responsible for the dependent industrialization of the Newly Industrialized Countries.

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International Business Economics Session 3 Strategy and Strategic Options of MNCs

Background 3 (pp 83-99, starts here) Business Strategy

Business Strategy (i)

Firms evolution strategies
Horizontal integration (mergers and acquisitions) Vertical integration (backward and forward) Multidivisional (M-) form (business units under central control) Conglomeration (unrelated business activities) Foreign Direct Investment - multinational corporations (foreign direct investment) Networks, alliances clusters, joint ventures, etc.

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All such strategies involve future cash flows, thus require capital budgeting.

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Business Strategy (ii)

Types of strategy Competitive: Strategy of Business Units Corporate: Strategy of firm as a whole

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Competitive Strategy Porter: based on IO

Five forces model (rivalry of existing competitors, potential entrants, power of suppliers-buyers, substitute products). Rule: select and/or create attractive industries (with weak forces of competition) Three generic competitive strategies (cost leadership, differentiation, focus). Rule: do not get stuck in the middle.

Exhibit 3.1: M. Porters five forces model

POTENTIAL ENTRANTS Threat of entry Power of suppliers SUPPLIERS INDUSTRY COMPETITORS Rivalry among existing firms Power of buyers BUYERS

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Threat of substitutes SUBSTITUTES

Exhibit 3.2: M. Porters three generic strategies

Competitive advantage Lower cost Broad Narrow Cost leadership Cost focus Differentiation Differentiation Differentiation focus

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Competitive scope

Competitive Strategy Porter (contd)

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Value chains: firms primary and support activities that generate value (margin) primary: firm infrastructure, human resource management, technology development, procurement support: inbound logistics, operations, outbound logistics, marketing and sales, service Rule: align value chain to generic strategy

Exhibit 3.3: M. Porters value chain

Firm infra-structure Human resource management Technology development Procurement Inbound logistics Operations Outbound logistics Marketing & Sales Service Margin Margin

82

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Corporate Strategy
Portfolio models - Boston Consulting Group, etc. Porter Resources-capabilities

 Learning and experience gives rise to reduced unit costs as volume increases Market share increases profitability

Corporate Strategy: Portfolio 84 models - The Boston Consulting Group (i)

Portfolio matrix: to classify business units as stars, cash cows, question marks and dogs on the basis of industry growth rates and business units relative market share Rule: cash-in cash cows, to invest in stars and selected question marks, stars-to-be. Liquidate dogs.

 BCG matrix related to the industry product life cycle (introduction-question marks, growth-stars, maturity/saturation-cash cows, decline-dogs). Portfolio Models: Shell, General Electric same principle as BCG, different criteria and classifications

Corporate Strategy: Portfolio 85 modelsThe Boston Consulting Group (ii)

Exhibit 3.4: The experience curve

Unit cost

86

Cumulative volume of output

Exhibit 3.5: The BCG 87 growth/share business portfolio matrix

Relative market share position High (above 1.0) High (faster than the economy as a whole) Industry growth rate Low (slower than the economy as a whole) Stars Low (below 1.0) Question marks (or problem children)

Cash cows

Dogs

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Exhibit 3.6: The life cycle model

Industry Introduction Growth sales Maturity Decline

Time

Exhibit 3.7: The product life cycle and the Boston matrix
P u t life y le rod c -c c Introduction Growth Maturity / Saturation De cline Bos Ma ton trix Que stion m arks Stars Cash cows Dog s

89

Corporate strategy: The approach of M. Porter

Four types of corporate strategy
portfolio management (as in BCG matrix) restructuring (restructure and sell-off) transfer of skills sharing activities

90

Rule: select sharing activities or, if not possible, transfer of skills. Other two hard to implement with success.

 Diversification strategies are the result of availability of resources with potential for common use by apparently unrelated activities. Conglomerate diversification results from problem of appropriating rents from intangible assets and/or differential capabilities in transferring knowledge.

Corporate Strategy: 91 The resources capabilities perspective (Penrose, Teece, etc.)

[End of Background 3]

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Strategy of MNCs (i)

For Michael Porter industries are multidomestic (nationally responsive), requiring locally focused strategy global (linked, integrated), requiring integrated strategy

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Strategy of MNCs (ii)

For Bartlett and Ghoshal: four basic strategies emerge on the basis of cost pressures local responsiveness matrix:
international (low, low) multidomestic (low, high) global (high, low) transnational (high, high)

Exhibit 3.2: Bartlett and Ghoshals Options for MNCs

High
Cost Pressures

94

Global

Transnational

Low

International

Multidomestic

Low
Local Responsiveness

High

Exhibit 3.9: A summary of theory and strategy

IO-Porter Horizontal integration Vertical integration M-form reduce rivalry acquire (managerial) resources barrier to entry reduce TC differential ability for in house production facilitate unrelated internalize external facilitate unrelated diversification capital market diversification (Chandler) (Chandler) failures Conglomerate reduce dependence high TC due to asset exploit common re source diversification on product life cycle specificitybase, solve intangible (Hymer) opportunism assets appropriability problems Foreign Direct exploit ownership high TC due to asset solve intangible assets Investment advantages (Hymer) specificityappropriability problems, opportunism differential capabilities Networks facilitate market optimal use of Derive knowledge -related power market and benefits of co-opetition hierarchy Transaction costs (TC) reduce TC Resource-based

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Application: A simple decision framework Transport costs and tariffs Low Export
High Suitability of know-how for licensing Yes Foreign operation requires tight control No Know-how can be protected by licensing contract Yes Licence No No

96

Horizontal FDI

Yes

Horizontal FDI

Horizontal FDI

Based on C. Hill (2003)

International Business Economics Session 4 MNCs, Government Policy and (Inter)national Competitiveness

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Competitiveness: definition
Differential productivity, value-added wealth creation, relative to other economic units (firms, regions, nations) Can be achieved through
Business policies Government (competition, industrial and competitiveness) policies

Competition and Industrial Policy

99

Early competition-industrial policies in West derive from IO theory, in particular the issue of the welfare effects of monopoly (power). This includes analysis of i) Static effects (monopoly and reduced consumer welfare, due to high prices); ii) Dynamic effects (e.g., monopoly and innovation).

Monopoly & international competitiveness (i)

100

Main claim that large firms can exploit economies of scale and scope, therefore can compete with large firms from other countries. Idea particularly prevalent is 1960s and 1970s in Europe, in part as response to the American Challenge, e.g., ServanSchreibers claim that US multinational corporations dominate technologically European markets. If large size increases competitiveness (thus export surpluses) these could offset any static losses. The international competitiveness idea is in part responsible for the permissive (and even encouraging) attitude of European countries to mergers and large size.

Monopoly & international competitiveness (ii)

Counter arguments are:

101

i) higher X-inefficiency ii) may suppress major inventions if they result in major re-equipment iii) inflexibility

Schumpeters Differential Innovations Hypothesis, that large firms are large because they have been more successful innovators to start with.

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Monopoly and Welfare

Conclude An open question whether the dynamic gains offset the static losses. Evidence inconclusive. Focus on efficient resource allocation limited. Concentrate on resource creation?

Practice The Western approach

Theoretical Basis

103

i) Competition policy to correct market failure due to monopoly (power) and its abuse: e.g., Treaty of Rome, US Anti-Trust policies ii)Trade through (static) comparative advantage, lenient or encouraging attitude to multinational corporations (MNCs)

Practice The Western approach (EU) (i)

104

But in 1960s Recognition in Europe of the international competitiveness advantages of large size (American challenge thesis) Relatedly,
National Champions Policy (e.g., UK, France, Italy) Nationalizations of strategic sectors

1970s Lame Ducks policies

Practice 105 The Western approach (EU) (ii)

1980s Return to the market (privatisations etc) and focus on Government Failure. 1990s Entrepreneurship and small firms Horizontal measures, technology and education, tangible and intangible infrastructure, efficiency of public sector.

Practice The Western approach (USA)

Hidden industrial policy in the form of defence policy? revival of 1990s; clusters? Conclude

106

Grant Theory but no industrial strategy including adhocity, discontinuity, undue focus on (dis)advantages of size and static comparative advantage-based (free) trade.

Practice The Far Eastern approach (Japan)

Basis: Industrial Strategy by Ministry of Trade & Industry (MITI) involving: i) Dynamic comparative advantage (created comparative advantage). ii) Managed trade, with initial focus on internal competition. iii) Management of competition (the Golden Mean) and co-operation.

107

iv) Dynamic competition through innovativeness, as in Schumpeter - Hayek.

Practice The Four Tigers

108

(Singapore, Taiwan, South Korea, Hong Kong) (i)

Basis: Similar to Japan, adaptive industrial strategy involving i) Import substitution. ii)Export promotion based on labour intensive manufacturing. iii) Promotion of high technology/high value added sectors. iv) Attraction of FDI (Singapore, Taiwan), technology transfer.

Practice The Four Tigers

109

(Singapore, Taiwan, South Korea, Hong Kong) (ii)

Relative success of Far East
Result of multitude of complex factors which include culture, high saving, effective public administration, close relation between industry and finance, consensus, new (strategic) management techniques, etc.

Question: Can we exclude role of industrial strategy? Is it unrelated to the other factors?

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New theories
1. 2. 3. 4. 5. New Trade Theory New Competition New location economics New (Endogenous) Growth Theory MNCs, deindustrialisdation and Competitive Bidding

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1. New trade theory (i)

Traditional focus of Western industrial policy, the welfare effects of monopoly and the theory of (static) comparative advantage. According to this countries should specialize and trade in products in which they enjoy a comparative advantage. Benefits from trade arise when each country pursues such a strategy. Presence of monopolistic competition, economies of scale, positive externalities and first mover advantages led to conclusion that focus on high return industries can affect the distribution of benefits (and even lead to losses, Krugman) Strategic Trade.

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1. New trade theory (ii)

This led to concept of dynamic comparative advantage; i.e., attempts by countries to create (not accept the existing) comparative advantages. Best known case of dynamic comparative advantage policy is Japan.

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2. The New Competition (i)

Based on observation of successful industrial districts, in North Italy, Germany, USA, Cambridge UK, etc. Such districts consist of small and medium sized, highly innovative, customer oriented firms, with a hands-on approach to management, which cooperate on issues of infrastructure, technology etc and compete in the market for customers. Often rely on support by state/local authorities, are based more on trust than hierarchical relations, try to exploit the dispersed knowledge of their labour, suppliers etc and use new production methods such as Just-in-Time, etc.

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2. The New Competition (ii)

Success of industrial districts questions benefits of large size and provides a different (Post-Fordist) model of industrial development. However, such methods are also adopted by major, particularly Japanese, MNCs, through e.g., subcontracting.

3. New Location Economics (Krugman, Porter)

115

Importance of location in generating external economies, reducing transaction costs through trust, and further innovation.

4. New Endogenous Growth Theory (Lucas, Romer)

Importance of human resources and technological change in effecting (endogenous) macroeconomic growth.

116

5. MNCs, Deindustrialization and Competitive Bidding

117

Link between multinational corporations and deindustrialization questions link between large size and international competitiveness Main idea is that countries like the UK which suffer from deindustrialization tendencies are home bases of privately successful MNCs. This questions the benefits of large size for the case of MNCs home base. In era of multinational corporations name of the game that of competitive bidding, i.e., attempt by governments to attract investments by home and foreign firms (MNCs).

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Theory and Practice

Question: New approaches support/explain Far Eastern miracle? New Industrial Strategy for Democracy (Cowling & Sugden)
MNCs give rise to multinationalism, centipetalism and short termism. Needed is a shift of power to communities and regions, e.g., through appropriate flexible specialization policies.

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Preliminary Conclusion
Possibility for Machiavellian scenario i.e., adaptive industrial strategy (in partnership with corporate sector) including i) dynamic comparative advantage ii) managed competition and co-operation iii) managed trade iv) playing the competitive bidding game and/or v) tackling the challenge of MNCs vi) considering alternative forms of competitiveness, like flexible specialization

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Developing countries
Some common features: small internal size of market, lack of large national MNCs (over-) reliance on small family run businesses, and foreign MNCs, relatively underdeveloped industry. Possible Strategy: i) follow the four tigers and ii) consider appropriate focus on small and medium sized enterprise, flexible specialization, clustering. Main issue: selection, suitability, transferability and feasibility of policies.

The Importance of Institutions (i)

121

Main problem of implementation, government failure. Although a general problem, often more acute in developing countries. Indeed underdevelopment may be the effect of inefficient property rights, and incentive mechanisms? (North) Culture, consensus, other institutional constraints. Need for promoting an institutional framework conducive to development. This includes addressing the problem of capture of the state by MNCs.

The Importance of Institutions (ii)

122

Government can be enabling (reduce private sector transaction and production costs) to increase output. It can also be developmental, i.e., try to improve the revenue side. Analysis of the state suggests that problem of capture reduced through pluralism of institutional forms (large and small firms) and competition in the political market. Capture effects support a competitiveness strategy favouring smaller firms (potential competition to established giants).

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Conclusions (i)
Possible and necessary to devise a competitiveness strategy which learns from economic theory and international practice and addresses the issue of implementation (e.g., institutions and capture of the state) and for the EU its declared needs to promote Competition and Convergence

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Conclusions (ii)
Developing countries should consider their policies in the above framework, striving for an emphasis on dynamic competition, value creation and supply-side convergence. Internally they should address the issue of the institutional constraints. Identification and development of distinct capabilities and competencies of a nation and governments important condition for effective, implementable strategy.

Anti-trust today: some problems

125

Potential problems with current policies i) Downplay lessons from the Far East and the new approaches. ii) Do not address the problem of MNCs (as a potential threat to competition). iii) Ignore distribution issues, intra-EU and between EU and The South, which undermines sustainability. iv) Fail to provide supply-side incentives for convergence. v) Fail to distinguish between policies that re-distribute resources and policies that generate resources. Need to move from competition to competitiveness policies

From competition to competitiveness policies: models of competitiveness

Neoclassical model
Competitive markets Free trade

126

Japanese Porters Diamond Productivity-Competitiveness Wheel

127 Exhibit 4.1: Competitiveness the neoclassical model

P Pm

A common expository diagrammatic framework for neo-classical Austrian and Marxist approaches to industrial organization.

PL PC LAC1 = LMC1 E QS Q LAC2 = LMC2 D

Qm

QL MR

QC

, minimum efficient scale; QS, strategic capacity output, , monopolists disincentive to invent; E, efficiency gains; Pm monopoly price; PL limit price; PC perfect competition price

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Competitiveness (i)
The Japanese approach ? High knowledge intensive sectors

Exhibit 4.2: Competitiven ess the Japanese approach?

100%
Medium capital-and labourintensive industries (light machinery, motor cars)

129

Knowledge-intensive industries (computers, instruments, heavy machinery)

100% West Germany (1974) Japan (1985)

Japan (1974) 100%

Medium capital- and rawmaterial-intensive industries (Steel, plastics, fibers)

Japan (1959)

100%

Source: Best (1990)

Unskilled-labour-intensive industries

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Competitiveness (ii)
Porters diamond Factor and demand conditions, clusters

Exhibit 4.3: The determinants of 131 national competitive advantage (Porters Diamond)
STRATEGY STRUCTURE AND RIVALRY

FACTOR CONDITIONS

DEMAND CONDITIONS

RELATED AND SUPPORTING INDUSTRIES

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Problems with existing models

Absence of commonly agreed upon conceptual framework. Absence of links between competitiveness at the firm-regional and national levels. Insufficient analysis of determinants of productivity and competitiveness. Insufficient treatment of the issue of sustainability.

Sustainable Competitiveness 133 and Development: a conceptual framework

The Productivity-Competitiveness Model Competitiveness <=> Productivity - Value Creation Determinants of Productivity - Value
Firm level infrastructure human resources technology and innovation unit costs economies Regional and National levels: As above plus Industry structure - conduct and regional - locational milieu macroeconomic environment - policy mix institutional environment - governance mix

The Productivity 134 Competitiveness Wheel for Firms, Regions and Nations
Institutional context Governance mix Macroeconomic environment Policy mix - Effective demand Industry conduct - structure and regional-locational milieu

Infrastructure

Unit Cost Economies

Productivity-ValueWealth

Human Resources

Technology & Innovativeness

Main routes to competitiveness

Firm size & FDI by MNCs Clusters of Small and Medium-Sized Enterprises (SMEs)

135

136

What are Clusters?

(Geographical) agglomerations of firms (and other organizations-institutions) linked horizontally (and/or vertically) intra- (and/or inter-) sectorally, in a facilitatory socioinstitutional and cultural milieu, which compete & co-operate (co-opete) in (inter)national markets.

137

Clusters and the Wheel

Clusters => innovation reduced unit cost economies (economies of scale, scope, transaction costs, learning, external, diversity, etc.) better human resources strong regional infrastructure more facilitatory institutional context (through co-opetition, etc.)

Despite problems, clusters are important

138

Clusters improve innovation, productivity & competitiveness at the regional & national levels, they create employment and can lead to convergence. Clusters are more bottom-up, thus help deepen democracy. Problems include identifying nature, boundaries, strategies for sustained successful performance.

Foreign Direct Investment and Clusters

139

Large firms and (through) foreign direct investment (FDI) can improve determinants of productivity, yet:
Hard for developing countries to attract FDI Risk of FDI flight, given options, and flexibility of operations

Clusters have advantage over large firms and FDI because of local base and coopetitive nature. Clusters attract FDI and embed it in localities.

Three agents of productivity, value and wealth creation

Large firms, FDI
Institutional context Governance mix Macroeconomic environment Policy mix - Effective demand Industry conduct structure and regionallocational milieu

140

SMEs, Clusters

(Infra)structure & Strategy

Unit Cost Economies

Productivity-Value-

Human

Wealth

Resources

Technology & Innovativeness

Government

Cluster Creation versus Cluster Development

Clusters are mainly the result of history, and (thus) are hard to create top-down. However, theory and international experience suggest that cluster development can be facilitated

141

Clusters can be upgraded at the individual, regional or national levels. This presupposes cluster identification, (diagnosis), audit, upgrading, control-evaluation, re-diagnosis

Strategy for Sustainable Competitiveness

According to the Productivity-Competitiveness model all the following measures can improve productivity and competitiveness

142

horizontal measures (soft and hard infrastructure) inter- and intra-firm sectoral restructuring for innovative value for money products and services clusters of SMEs

Regions of Excellence (mega-clusters) can encapsulate all three aspects, thus serve as Strategy for Productivity and Competitiveness.

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Prerequisites and Mechanisms

Sustainability requires macro-policy - supply-side compatible institutional framework remove (anti)incentives competition policy co-opetition for innovativeness environment distribution of income

144

Conclusions
Possible and desirable to identify and develop (mega) clusters, for productivity, competitiveness, regional development, convergence and deepening of democracy. The state can be a catalyst and facilitator. Method and tools developed can help in this direction.

International Business Economics Overall Conclusion and the Future of MNCs

146

Conclusions
Value creation, through
firm productivity and competitiveness government enabling policies, national productivity and competitiveness

Under conditions, MNCs and FDI, SME clusters and government policy can help achieve this objective

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The Future
The MNC, like competition and cooperation itself, is both god and devil. MNCs will be a great force of economic growth, yet a threat to diversity, equity and democracy. Policy and polity should aim at identifying routes that deliver the goods at least cost this can include painful trade-offs.