Politics & Economics of Multinational Corporations

1. Politics & Economics ofMultinational Corporations PS 124: International Political Economy Prof. Tyson Roberts

2. Announcements • Midterms • Grading should be done by Friday AM • Don’t talk about MT yet – makeups next week • Nov. 11 – no class (Veteran’s Day) • Nov. 20 – no class (TR out of town) • Nov. 27 – do we want class? (Thanksgiving) • For Nov. 20 & 27, online lecture

3. Goals • Development strategies (review) • International flows (review) • Multinational corporations – economics • Multinational corporations - politics

4. Classical economics development predictions • Capital flows from rich to poor => profit rates converge; industrialization • Labor flows from poor to rich => wages converge • Free trade => all factor returns converge; increased productivity during transition

5. When is free trade good/bad for an economy? • Aggregate effects vs. distribution effects • Positive vs. negative externalities • Shifts to higher growth vs lower growth sectors • State capacity to respond to displacement or address market imperfections

6. Flow alternatives • China has more people and less capital • US has fewer people and more capital What are 3 ways to take economic advantage of these differences in factor endowments?

7. Why do firms engage in FDI? • If want to sell to foreign markets, could export or license foreign firms • If want oil or cheap products to use or sell at home, could import or license foreign firms • If want to exploit cheap labor, canship in cheap workers to work at home(?)

8. Why doesn’t labor flow from poor to rich countries? • Transaction costs • Distance • Cultural ties/barriers • Restrictive policies • Security-related • Economic-related

9. Immigration restrictions contribute to international earnings gap

10. Labor mobility could provide significant efficiency gains Gains from trade & capital mobility already largely achieved

11. Next best? • For many people in poor countries, FDI is an inferior alternative to immigration … • Immigration: Labor goes to capital • FDI: Capital goes to labor • And better than other alternatives, such as subsistence farming or working for locally owned firms • Labor abundance/capital scarcity => low wages/high profits

12. More on immigration in Lecture 18

13. Foreign Direct Investment What is the difference between FDI and other forms of international capital flows?

14. Foreign Direct Investment • Firm buys/establishes firm in another country • Direct: managerial influence over investment • Indirect: investor is passive • Equity, not debt – profits if subsidiary firm is profitable, loses otherwise

15. Most FDI comes from wealthy (capital abundant) nations, but an increasing share comes from developing countries (China, etc.)

16. Most FDI (in recent decades) goes to developed economies, but an increasing share goes to developing economies

17. Why do firms engage in FDI? • If want to sell to foreign markets, could export or license foreign firms • If want oil or cheap products to use or sell at home, could import or license foreign firms • If want to exploit cheap labor, can(‘t) ship in cheap workers to work at home

18. Firms engage in FDI for OLI Advantages (Dunning) • Ownership advantages • Proprietary knowledge & managerial know-how • Capital & economies of scale • Marketing networks • Location advantages • Resources • Markets • Efficiency • Internalization advantages • Vertical integration (specific assets) • Horizontal integration (intangible assets)

19. Dunning OLI paradigm

20. Market imperfections • Intangible assets • Value derived from knowledge, know-how • Market failure: • if I don’t tell you what it is, you won’t pay full price • if I tell you what it is, you won’t pay anything • Solution: Horizontal integration • Exploit knowledge, know-how within firm across countries

21. Market imperfections • Specific assets • Investments not easily moved/re-purposed • Market failure: • Before investment, user has incentive to offer high payment for use • After investment, user has incentive to reduce payment => disincentive for others to build for user • Solution: Vertical integration • Own and operate all stages of production within firm

22. Market Imperfections, Locational Advantages, & MNCs

23. Market-seeking

24. Resource-seeking

25. Efficiency-seeking

26. A variety of options to mix & match • Companies such as Apple use a combination of FDI, licensing, and exports • Some subsidiaries (FDI) are for tax purposes, not production or marketing (e.g., Ireland) • Many of the licensed companies (such as Foxconn) use FDI (e.g., Taiwan to China & Brazil)

27. Licensing: Apple’s suppliers

29. Needed! • Cool maps of Apple’s subsidiaries and export flows

30. Some potential determinants of FDI(Bolded variables more empirically robust) • Market-seeking • Market size • Income level • Efficiency-seeking • Trade openness • Education level • Skill level • Wage level • Resource-seeking • Oil reserves • Mineral reserves • General • Distance • Telephone penetration • Property-rights • Political stability • Tax rates

31. Some possible effects of FDI • Positive • Capital, technology & technology spillover, access to markets, training • Negative • Crowd out local firms, environmental damage, reduce wages, export profits • Positive if necessary conditions are present • Education, level of technology, trade openness

32. Effects of FDI difficult to measure • Some FDI is not really foreign • Roundtripping: Chinese capital smuggled to Taiwan, then “invested” in China as FDI • Some FDI is not really “invested” • Tax havens: Subsidiaries created for accounting purposes to avoid taxes • Disparate effects • FDI may be beneficial in some cases but detrimental in others

33. Takeaways • According to classical economics, all transactions can be achieved through the market, but… • Market imperfections give MNCs a strategic advantage • Location advantages & intangible assets create advantage for horizontal integration • Location advantages & specific assets create advantage for vertical integration

34. Politics of MNCs

35. Because FDI has positive & negative effects, governments face trade-off • Want • Capital • Technology • Access to markets • Taxes on FDI activities • Don’t want • Foreign monopoly controlling local market • Profits exported with no benefits for locals

36. Government Strategies re: FDI in Developing Countries • Laissez-faire • Attract FDI, but MNC interests may not align with government interests • Nationalization • Transfer ownership from MNC to government, but deters future FDI • Regulation & Taxation • Block FDI in some sectors, impose conditions in others; attempt to gain pros of FDI with few cons

37. Some Regulation Options • Local ownership requirement • Profit repatriation restrictions • Performance requirements (exports, domestic inputs, domestic R&D, restricted access to domestic capital) • Preference for licensing over FDI • Tariffs (to encourage market-seeking FDI) • Export processing zones (EPZs)

38. Class Exercise 1 • You are president of a developing country • Foreign firms own the following major companies in your country • Oil drilling • Brewery • Bank • Your country is poor, most of your people work in agriculture, the main export is oil, manufactured goods are imported • What policies will you implement re: FDI?

39. Sources of Bargaining Powerfor Governments vs. MNCs • Monopolistic control over assets the MNC values • Scarce natural resources • Efficient factors of production (e.g., skilled labor, infrastructure, industrial parks) • Technology • Fixed asset investments by the MNC

40. Sources of Bargaining Power for MNCs vs. Host Governments • Monopoly control over assets the host country values • Technology, managerial expertise, access to markets • Economies of scale & experience, especially in oligopolistic sectors • Intangible assets

41. Changes in bargaining power over time • Natural resource sector: • MNC has more power before investment (controls technology, know-how) • Host country has more power after investment (fixed asset) • Branded or high tech manufacturing: • MNC has more power before investment (technology, access to networks, know-how) • MNC retains power after investment (larger share of value in non-fixed assets)

42. Class Exercise 2 • Consider your decisions with regard to MNC-related policies • Given the relative bargaining power, which of these policies are likely to be successful? • Would you change any of those policies?

43. Exit and Taxation Decisions in the Modern Globalization Environment • Capital is mobile: can exit to avoid taxation • Labor is less mobile: cannot easily exit Source: mittromney.com

44. Apple Cash • $98 Billion total • $64 Billion abroad • $35 Billion in US • Only US money will be issued in dividends, to avoid capital gains taxes

45. Tax burden in US has shifted from capital to labor Source: McDaniel 2007

46. Capital gain tax proposals • Reduce/eliminate capital gain tax to encourage investment • Capital gain tax holiday to encourage repatriation of profits

47. Repatriation tax holiday in 2004 • Top 15 repatriating companies later cut 21,000 jobs between 2004-2007 & reduced R&D spending • 15 repatriating companies accelerated spending on stock buybacks and executive compensation after tax break

48. Welfare states (e.g., France & Germany) tax labor more than capital to finance redistribution

49. Tax options • Corporate income tax • Distortionary, deters investment • Carbon tax • Value Added Tax • Progressive Consumption Tax

50. Who (ultimately) pays corporate tax?Capital (lower dividends) & Labor (lower wages)