MNCs and globalization go hand-in-hand.
MNCs and globalization
MNCs and globalization go hand-in-hand. After reading this week’s lesson, find an MNC and describe ways it has been a good citizen or a bad citizen. Don’t use Nestle since it is described in the lesson.
Instructions: Your initial post should be at least 350 words. Please respond to more than 2 other students. Responses should be a minimum of 150 words and include direct questions, evidence from the literature, alternative points of view or additional insight. For more information, please review the forum discussion rubric attached below. This is the rubric that will be used for all of the forums in this class.
In this lesson we will discuss another type of non-state actor in the international system. Multinational corporations (MNCs), broadly defined, are business entities that have facilities—whether production, administrative, or distribution-related—in two or more different countries. The influence of MNCs in the international system demonstrates how foreign relations and economics are intertwined. MNCs are a relatively recent development, and although they do not have the political sovereignty or military strength possessed by states, they still exert considerable influence over the international system. MNCs also have a mixed reputation in terms of the benefits they provide and the harm they can cause, especially in the poor countries where they often locate production.
- Defining multinational corporations (MNCs)
- Types of MNCs and their characteristics
- Why MNCs exist
- How MNCs influence the international system: benefits and disadvantages
Multinational corporations are some of the most powerful non-state actors in the international system. Some researchers distinguish between a multinational corporation (MNC), which has headquarters in multiple countries, and a transnational corporation (TNC), which is headquartered in one country by operates in others as well. Because these terms are often used interchangeably in common usage, for the purposes of this lesson we will just use the term MNC to mean any company operating in multiple countries.
LOCATED IN MULTIPLE COUNTRIES
There is actually no agreed-upon definition of what constitutes a multinational corporation. Generally speaking, an MNC hosts some part of its operations in a country other than the one where it is legally headquartered. In that sense, it is literally multi-national.
A corporation is a group of people, such as a company, that is legally authorized to act as a single entity. It may be privately owned, or publicly traded—meaning that stockholders are legally the corporation’s owners. Economists and legal scholars continue to debate, however, whether there should be more narrow criteria for categorizing MNCs, and what these criteria should be.
Some argue that ownership is the key feature that defines whether a company is an MNC or not. By this narrow definition, a firm is only a multinational if it is owned by nationals of multiple countries. For example, Royal Dutch Shell (the owner of Shell Oil in the US) is multinational by this criteria, because it has mixed Dutch and British ownership. Shell would certainly be considered a multinational by other standards as well, since it operates in some form on all seven continents. By the ownership criteria, relatively few large companies are actually multinationals, since many operate as separate legal entities in different countries, thus making the ownership of each national arm uni-national.
PARENT COMPANY MANAGERS
Similarly, a few scholars suggest that the nationality of holding company, or “parent company,” managers should be part of the criteria for determining whether a corporation is an MNC or not. Because most managers in corporate headquarters are from the country where the headquarters are located, and because this feature can change based on a single individual, this is not a widely recognized criterion for identifying MNCs. By this benchmark, very few firms are MNCs.
A more widely accepted criterion for narrowing what companies are considered MNCs is production: in short, having distribution facilities in more than one country is not enough; a firm must produce in at least one country other than the one in which it is headquartered. This view is advanced by Harvard University economist Richard Caves. His definition requires production to take place in at least two countries, in facilities owned by the same firm (Caves, 1982).
Distribution, even direct distribution, without a production presence in a country is considered to be essentially a form of export by this definition. This criterion excludes, for instance, many Chinese companies that only distribute in the US.
An example of an MNC is Shandong Tranlin Paper, which is constructing a production facility near Richmond, Virginia (Wee, 2015). This is an example of a practice known as foreign direct investment (FDI) or investment made by an entity based in one country, into an entity based in another country. All MNCs engage in FDI by one method or another.
There are two primary forms of FDI. The investment can be “vertical” or “horizontal.” Horizontal FDI occurs when a firm makes an investment abroad in the same industry in which it operates where it is headquartered. For instance, Subaru, a Japanese carmaker, sets up a production facility in the United States to produce vehicles for American buyers.
A firm might choose to do this because tariffs (taxes on imported goods) make it cheaper to locate production in individual countries rather than exporting around the world. Vertical FDI occurs when a firm invests in part of its production chain abroad. For example, Intel conducts high-skilled, labor-intensive production for pieces of microchips in facilities it owns in Malaysia, where skilled labor is available but relatively cheap, but keeps lower-skilled assembly processes in other countries. Vertical FDI is often chosen because of labor costs or regulations that make it cheaper to conduct certain steps of the production process in different countries.
These practices are both considered offshoring, because they shift (part of) production overseas. Note that when a firm shifts production to a third-party entity, this is commonly referred to as outsourcing. Thus, contracting with a third-party firm to conduct production overseas would be both offshoring and outsourcing.
This lesson will not assume any narrow criteria for considering a firm to be an MNC. As you will see, the forms of corporate organization presented in the next section may or may not meet the criteria set forward by some of the views above. What do you think the criteria for considering a business to be an MNC should be? Why?
MNCs, including those that fit Richard Caves’ robust criteria (production in at least two countries in facilities owned by the same firm) may be organized in a number of different ways. The way a firm is organized shapes both its economic impact and the political leverage it has in individual states and in the international system as a whole.
Licensing occurs when a corporation allows a firm (or multiple firms) in foreign countries to use its name, brand elements, patents and trademarks, and other elements if its business. The firms get the right or license to operate their business according to terms agreed upon in their licensing agreement. They pay a royalty or license fee to the multinational corporation that owns the brand. If the licensee violates the terms and conditions of the agreement, the license may be cancelled. This system is generally used for products that are popular in the countries where licenses are purchased. For example, the Disney brand is licensed to producers of clothing, toys, and other items worldwide.
Subsidiaries are also foreign entities granted rights to a company’s brand, trademarks, etc. They are different from licensing arrangements, however, in that franchisees are usually licensed to operate in a particular location, so that they do not compete with each other.
Subsidiaries may be wholly- or partly-owned by the parent company, but are legally separate. They are registered in the host country, and in the case of partly-owned subsidiaries, their ownership may be partly acquired by people or other entities in the host country. McDonald’s is a good example of a multinational franchise. More than 80 percent of McDonald’s restaurants worldwide are operated by franchisees (McDonald’s, 2016).
The difference between most branches and subsidiaries is also very slight, and largely based on legal distinctions rather than major differences in the ways the entities operate. Whereas a subsidiary is a legally separate entity from its parent company, a branch is not separate. The Santander Group, a banking holding company, has both subsidiaries (such as Santander Holdings USA) and thousands of branches. Very large financial institutions are among the most likely MNCs to use the branch model. Often, however, financial regulations mean that holding companies must create legally separate subsidiaries for their operations in each country. The European Union is an exception to this.
In a joint venture, an MNC establishes a company in a foreign country in partnership a local firm or multiple local firms. The MNC and local firm(s) share ownership and management of the new entity. In many cases, the MNC contributes technology not already employed in the host country, and may take a leading management role, but the running of day-to-day operations is left to the local partner(s).
Fuji Xerox Co. is a long-running joint venture between the Japanese photographic supplies firm Fujifilm Holdings and American document management company Xerox. It has sold photo and document products and services in the Asia-Pacific region since 1962. It is legally registered as a joint venture partnership, with headquarters in Tokyo.
A “turn-key” or “green field” project is a form of foreign direct investment in which an MNC parent company constructs new facilities in a foreign country, rather than purchasing or partnering with an already existing entity in the host country. These projects may involve building new production or distribution facilities, but can also involve the construction of offices and or even housing for employees. This is the form of FDI that provides the most control over operations in the host country for the MNC. Facilities are built to the firm’s preferred specifications, employees are trained to company standards, and production processes are engineered from the beginning to fit the MNC’s products and methods.
This type of investment can be risky for the host country, especially if the national economy is weak. If the MNC pulls out of the country for any reason, the facilities the firm constructed may end up sitting idle, and the economic benefits from the trade it would have generated will be lost.
Sometimes firms build turn-key facilities and then sell them to subsidiaries or local firms. In the latter case, the facility is no longer part of the MNC. MNCs in the automotive industry often use this method of expansion. For example, Audi recently finished a new production facility in San Jose Chiapa, Mexico. Mexico’s many free-trade pacts have made it a prime location for green field investments by carmakers that plan to sell to consumers throughout North America (WSJ, 2015). This is an example of horizontal FDI.
Why become an MNC?
The explanation of vertical and horizontal FDI, and the forms of MNC expansion above, hinted at why a company might want to become an MNC, or why existing MNCs might want to expand into new locations. There are four basic reasons for this.
INCREASED MARKET SHARE
First, a company may expand to increase market share. In other words, a company may have found that they are nearing a “saturation point” (the point at which they cannot sell any more) in the markets where they already sell, and so they choose to expand into new markets. This may begin with just exporting to new foreign markets, but then become true MNC expansion when production is expanded to locations within the geographic bounds of the new market. Essentially, the motivation is increased profits through greater sales volume. For example, the sporting goods company Nike is opening new stores throughout the world.
CHEAPER PRODUCTION COSTS
Second, a company may expand or relocate to secure cheaper production costs. A company may shift its production, distribution, or customer support to a country where labor costs are lower, where property is cheaper, or even where it is less costly to acquire the raw materials needed for their production processes. The motivation for this is to increase profit margins by saving money during the production process. For example, steel MNCs such as Arcelor Mittal have bought up factories in the former Soviet bloc, because these facilities are much cheaper than plants in North America or Western Europe.
Third, a company may expand or relocate to avoid taxes or trade barriers. Corporate tax rates are different around the world, as are tariffs and regulations governing business. For instance, the Japanese government restricts the sale of foreign cars in Japan in order to protect their automotive industry, which makes up a large portion of their national income each year. Many economists argue that the United States’ relatively high corporate tax rate is responsible for businesses leaving the country in recent years. Singapore, on the other hand, attracts many companies because of its low trade barriers and stable economy. This motivation for expansion is often linked to horizontal FDI.
Fourth, government grants may attract companies to expand or relocate. If a government wants to grow a particular industry—or perhaps to reduce another country’s share of that industry—it may offer grants that reduce the cost of opening a new facility in their country. The United Kingdom offered business grants in the 1980s that attracted many American-based firms.
COMBINATION OF REASONS
In reality, many MNCs expand for multiple reasons. Choosing the location of a new facility—and deciding whether it will be acquired by purchasing an existing firm and creating a branch, merging with another firm to create a subsidiary, partnering to create a joint venture, or building a turn-key facility—comes down to weighing the previous four factors.
How MNCs Influence the International System
- INTERNATIONAL SYSTEM
- FINANCIAL RESOURCES
Now that we’ve seen some of the ways that MNCs work, and why companies might want to become MNCs, let’s consider how they are able to influence the international system. MNCs are inherently international; they operate in multiple countries, and therefore have dealings with the government, workers, and potentially NGOs in those places. They are also involved, to at least some degree, in international trade and must deal with international laws and the intergovernmental organizations that enforce financial and other regulations in the international sphere.
The largest MNCs have financial resources greater than the poorer states in which they may locate their production facilities. Because of their size and resources, they are generally able to draw in the best technical and management expertise, and employ large government and public relations departments, which help to influence public opinion and policymaking in their favor.
Due to their nature, MNCs are also central to a process that has revolutionized international relations in the past two centuries, but especially in the past 40 to 50 years: globalization. Globalization refers to the integration of communication systems, transportation systems, ideas, societies, cultures and economies into a single, interdependent world system.
Advantages of MNCs
Many people are skeptical of the benefits conveyed by MNCs and globalization. Here are some of the advantages and disadvantages of MNCs, which are often felt most strongly by poorer countries, which tend to present the lowest-cost environments for production.
First and foremost, multinational firms create jobs, which help to stimulate local economies and provide a greater tax-base for governments. Because some multinational firms are very large, the magnitude of job creation can have a major positive impact on areas where unemployment was previously very high. When people have a steady income, they are able to spend more, which in turn boosts other local businesses.
MNCs may also benefit the locations they move into by bringing foreign expertise and technology. Training provided by foreign experts can help improve local workers’ skill levels, productivity, and sense of self-confidence and pride in their work, which has positive benefits for both the corporation that employs them and the individual workers. The children of skilled workers are more likely to receive education and job training, helping to end the cycle of poverty some were trapped in. Moreover, foreign technology, once brought into an area by an MNC, may spread to other local businesses, making them more modern, efficient, and ultimately more profitable.
Because of their size and resources, MNCs can also benefit from a number of “economies,” a term used to refer not to a local or national economy in the traditional sense, but to the benefits accrued from large-scale or high-quality operations. MNCs may enjoy economies of scale. In an economy of scale, the cost per unit produced or distributed is progressively lowered (for the producer) because fixed costs—such as the building and initial cost of equipment, but also labor costs when people can specialize in tasks to be more efficient—can be spread out over more units to sell. Sometimes, this provides a benefit to customers, either local or abroad, because the company chooses to reduce the sale price of the good. Alternately, these savings can be kept as additional profits by the company.
Technical economies can also be a benefit of MNCs. Technical economies are a specific type of economy of scale, which occur when large-scale businesses are able to invest in specialized machinery that makes their operations more efficient, and thus contributes to more efficient production in the long-run.
Purchasing economies, similarly, occur for large companies that are able to buy in bulk. Doing so means a lower cost per unit for supplies, but requires the financial resources to pay for a large quantity of materials at once. Purchasing economies thus require high-volume production to actually convey benefits, which means economies of scale and purchasing economies go hand in hand for well-managed MNCs.
isadvantages of MNC’s
- HOST COUNTRY ISSUES
- PROFITS NOT SHARED
- HUMAN RIGHTS VIOLATIONS
- RACE TO THE BOTTOM
In practice, however, not all of these benefits may be passed along to the host country. Unfortunately, MNCs’ influence enables them to sometimes take advantage of governments and workers that are desperate for economic opportunities. Many MNCs have been criticized for overstating the economic benefits they provide to poorer areas where they are located. They have also faced serious charges regarding their human rights and environmental records.
To begin with, there is no guarantee that profits made from production at a plant in, for instance, Indonesia, will be kept there. Earnings leftover after paying for costs and potentially investing further in a facility are more likely to be sent back to the parent company based in, for instance, the United States.
Even more serious charges of human rights violations are not uncommon. Accusations that MNCs exploit workers by paying them the lowest amount possible and requiring them to work long hours are frequent. This is possible because some countries have very weak labor laws to protect workers, so the practices are not technically illegal by local standards, although they go against international protections for human rights.
Nevertheless, states with already relatively low standards for worker or environmental protection may end up competing with each other in what is referred to as a “race to the bottom.” Governments are enticed by the prospect of attracting MNCs to make their restrictions on companies’ behavior as loose as possible.
Human Rights Violations
Human rights violations may even be as serious as using forced labor or child workers. In 2015, for example, it was discovered that a number of major US food retailer MNCs were selling shrimp that came from processing facilities in Thailand that were using children and enslaved migrant workers. Although these facilities were not owned by the MNCs, today it is widely accepted that MNCs should be responsible for ensuring that no human rights violations occur within their supply chain.
MNCs have also been responsible for using sites with lax environmental regulations to save money by using polluting or otherwise unsafe practices that would not be allowed in other countries. In other cases, MNCs have been accused of using cutting corners even in locations with more robust environmental protection standards, because they can simply use their considerable resources to pay any fines or clean-up costs that they might incur if their violations are detected.
LAX ENVIRONMENTAL STANDARDS
An MNC in this situation might also hope, realistically, that a government would choose to overlook less severe violations, or opt for the least-severe punishment, for fear of driving the MNC to relocate their operations. This is another way in which an MNC can use its economic impact and resources (both legal expertise and financial resources) to influence a state’s behavior.
The Bhopal chemical disaster, widely regarded as the worst industrial disaster in history, is one illustration of how horribly wrong things can go when an MNC cuts corners on safety. On December 2, 1984, a tank failure at a Union Carbide pesticide plant in Bhopal, India released 30 tons of toxic gas into the air, exposing more than 600,000 people.
HUGE DEATH TOLL
Thousands died in the days after the accident, and the death toll rose to 15,000 over the years that followed. Toxic materials may also remain buried under the site, although it is no longer in operation. There has also been a high incidence of birth defects in children born to survivors of the disaster. In 2010, eight low-level executives at Union Carbide Bhopal were convicted of negligence, but Union Carbide’s American leadership escaped prosecution.
DEEPWATER HORIZON OIL SPILL
A more recent instance in which an MNC was held responsible for the disastrous consequences of a failure in their equipment was the Deepwater Horizon oil spill. On April 20, 2010 an explosion on the British Petroleum (BP) and Transocean oil rig in the Gulf of Mexico killed 11 workers and started a steady leak of oil into the ocean.
WORST SPILL IN HISTORY
Over the 87 days it took to cap the well, an estimated 3.19 million barrels, more than 130 million gallons, of oil leaked into the Gulf. The spill, the worst in history, killing sea life and damaging ecosystems. Dolphin, sea turtle, and seabird populations all experienced elevated annual death rates in the years after the spill. Shrimp fisheries in the Gulf were closed for a year after the spill. BP pledged to pay millions for clean-up, and committed to fund a $500 million research program to study the environmental impacts of the spill.
Some people, however, felt the company was not treated harshly enough for the alleged negligence that led to the accident in the first place. The accident had environmental impacts that affected multiple countries, and may have caused long-term damage to ecosystems.
Environmental, human rights, and some development NGOs are some of the most vocal critics of single-minded profit-seeking by MNCs. Virtually the entire purpose of many NGOs is to serve as ‘watchdogs’ for MNCs practices, and to raise awareness among voters and lobby governments to hold MNCs responsible for the outcomes of their operations.
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