Pope's speech at St. Peter's Basilica


Economists are not in agreement as to how multinational or transnational corporations should be defined. Multinational corporations have many dimensions and can be viewed from several perspectives (ownership, management, strategy and structural, etc.) The following is an excerpt from Franklin Root (International Trade and Investment, 1994)

Ownership criterion: some argue that ownership is a key criterion. A firm becomes multinational only when the headquarter or parent company is effectively owned by nationals of two or more countries. For example, Shell and Unilever, controlled by British and Dutch interests, are good examples. However, by ownership test, very few multinationals are multinational. The ownership of most MNCs are uninational. (see videotape concerning the Smith-Corona versus Brothers case) Depending on the case, each is considered an American multinational company in one case, and each is considered a foreign multinational in another case. Thus, ownership does not really matter.

Nationality mix of headquarter managers: An international company is multinational if the managers of the parent company are nationals of several countries. Usually, managers of the headquarters are nationals of the home country. This may be a transitional phenomenon. Very few companies pass this test currently.

Business Strategy: global profit maximization

According to Howard Perlmutter (1969)*:

Multinational companies may pursue policies that are home country-oriented.

or host country-oriented or world-oriented. Perlmutter uses such terms as ethnocentric, polycentric and geocentric.However, "ethnocentric" is misleading because it focuses on race or ethnicity, especially when the home country itself is populated by many different races, whereas "polycentric" loses its meaning when the MNCs operate only in one or two foreign countries.

According to Franklin Root (1994), an MNC is a parent company that

  1. engages in foreign production through its affiliates located in several countries,
  2. exercises direct control over the policies of its affiliates,
  3. implements business strategies in production, marketing, finance and staffing that transcend national boundaries (geocentric).
In other words, MNCs exhibit no loyalty to the country in which they are incorporated.

*Howard V. Perlmutter, "The Tortuous Evolution of the Multinational Corporation," Columbia Journal of World Business, 1969, pp. 9-18.

Three Stages of Evolution

1. Export stage

2. Foreign Production Stage

There is a limit to foreign sales (tariffs, NTBs)

DFI versus Licensing

Once the firm chooses foreign production as a method of delivering goods to foreign markets, it must decide whether to establish a foreign production subsidiary or license the technology to a foreign firm.


Licensing is usually first experience (because it is easy)

e.g.: Kentucky Fried Chicken in the U.K.
Problem: the mother firm cannot exercise any managerial control over the licensee (it is independent)

The licensee may transfer industrial secrets to another independent firm, thereby creating a rival.


Direct Investment

It requires the decision of top management because it is a critical step.

3. Multinational Stage

The company becomes a multinational enterprise when it begins to plan, organize and coordinate production, marketing, R&D, financing, and staffing. For each of these operations, the firm must find the best location.

Rule of Thumb

A company whose foreign sales are 25% or more of total sales. This ratio is high for small countries, but low for large countries, e.g. Nestle (98%: Dutch), Phillips (94%: Swiss).
Examples: Manufacturing MNCs
24 of top fifty firms are located in the U.S.
9 in Japan
6 in Germany.
Petroleum companies: 6/10 located in the U.S.
Food/Restaurant Chains. 10/10 in the U.S.

US Multinational Corporations Exxon, GM, Ford, etc.

Motives for Direct Foreign Investment

New MNCs do not pop up randomly in foreign nations. It is the result of conscious planning by corporate managers. Investment flows from regions of low anticipated profits to those of high returns.

  1. Growth motive A company may have reached a plateau satisfying domestic demand, which is not growing. Looking for new markets.

  2. Protection in the importing countries
    Foreign direct investment is one way to expand bypassing protective instruments in the importing country.

    • European Community: imposed common external tariff against outsiders. US companies circumvented these barriers by setting up subsidiaries.

    • Japanese corporations located auto assembly plants in the US, to bypass VERs.

  3. Market competition
    The most certain method of preventing actual or potential competition is to acquire foreign businesses.

    GM purchased Monarch (GM Canada) and Opel (GM Germany). It did not buy Toyota, Datsun (Nissan) and Volkswagen. They later became competitors.

  4. Cost reduction
    United Fruit has established banana-producing facilities in Honduras.

    Cheap foreign labor. Labor costs tend to differ among nations. MNCs can hold down costs by locating part of all their productive facilities abroad. (Maquildoras)

Supplying Products to Foreign Buyers

Export versus Direct Foreign Investment

MES is the minimum rate of output at which Average Cost (AC) is minimized. If minimum efficient scale (MES) is not achieved, then export.

In other words, if there exists excess capacity, why not utilize it and export outputs to other countries? There is no point in creating another plant overseas when domestic capacity is not fully utilized.

If foreign demand exceeds the minimum efficient scale, then FDI.

Figure 1. Minimum efficient scale and FDI.

International Joint Ventures

JV is a business organization established by two or more companies that combines their skills and assets.

  1. A JV is formed by two businesses that conduct business in a third country. (US firm + British firm jointly operate in the Middle East)
  2. joint venture with a local firm
  3. joint venture includes local government.
    Bechtel Company, US
    Messerschmitt-Boelkow-Blom, Germany => Iran Oil Investment Company
    National Iranian Oil Company


Control is divided. The venture serves "two masters"

Welfare Effects

The new venture increases production, lowers price to consumers.
The new business is able to enter the market that neither parent could have entered singly.
Cost reductions (otherwise, no joint ventures will be formed) increased market power => not necessarily good.

A view from the mountain top. Many multinational companies are housed in tall buildings in Hong Kong.

US Tax Policy towards MNCs

Operating in many countries, MNCs are subject to multiple tax jurisdictions, i.e., they must pay taxes to several countries. National tax systems are exceedingly complex and differ between countries.

Differences among national income tax systems affect the decisions of managers of MNCs, regarding the location of subsidiaries, financing, and the transfer prices (the prices of products and assets transferred between various units of MNCs)

Multiple Tax Jurisdictions creates two problems, overlapping and underlapping jurisdictions. When overlapping occurs, two or more governments claim tax jurisdictions over the same income of an MNC. The overlapping may result in double taxation.

Conversely, when underlapping occurs, an MNC falls between tax jurisdictions and escape taxation. Underlapping encourages tax avoidance.

National governments may choose a territorial jurisdiction or national tax jurisdiction or both.

Territorial Tax Jurisdiction: The government taxes business income that is earned on the national territory.

National Tax Jurisdiction: Both domestic and foreign source income of national companies are subject to income tax. US government taxes both domestic and foreign source incomes of US MNCs.

Remark: Most governments that exercise NTJ also claim a Territorial Tax Jurisdiction. This creates the problem of double taxation.

US Taxation of Foreign Source Income

1. In general the US government does not distinguish between income earned abroad and income earned at home (NTJ).

However, to avoid double taxation, the US government gives credit to MNEs headquartered in the US for the amount of tax paid to foreign governments.

2. Foreign Trade and Investment Act of 1972 (Burke-Hartke Bill) was defeated.

According to this plan, foreign taxes would be treated as business expenses. For example,

Assume: t = 46% t* = 30%

Pretax profit = $1,000

MNC's profit after foreign tax = 1,000 - 300 = 700

If foreign tax is treated as business expense, then

MNC's tax to IRS = 700 x 46% = 322.

Total taxes = 300 + 322 = 622

Current method:
Taxes to foreign government = 1000 x 30% = 300

US taxes = 1000 x 46% = 460

but foreign tax credit = 300

Net tax to IRS = 460 - 300 = 160.

Total taxes = 300 + 160 = 460.

Transfer Pricing

MNCs try to reduce their overall tax burden. An MNC reports most of its profits in a low-tax country, even though the actual profits are earned in a high tax country.

tp = tax rate in the parent country

th = tax rate in the host country

If tp > th, then underprice its exports to the subsidiary in the host country, and overprice its imports from the subsidiary. => lower tax.

Purpose: manipulate prices between the headquarter and the subsidiaries so that profits are highest in the low tax country.

Example: Figure 2. Choosing transfer prices to minimize tax

Total tax = $150

Thus, a multinational company's overall tax could be paid at the minimum of all tax rates of the countries in which it operates.

Abuses in pricing across national borders are illegal (if they can be proved). MNCs are required to set prices at "arms length" (set prices as if they are unrelated).

IRS argued that Toyota Inc. of Japan had systematically overcharged its US subsidiary for years on most of trucks, automobiles and parts sold to the US.

Because of abuses in transfer pricing, taxable profits were shifted to Japan. Toyota recently agreed to pay $1 billion to IRS.

Taxation and Gains from Factor Mobility

US firms invest overseas because the returns are higher there.

Assume both countries have the same corporate tax rates = 40%

                 US                    Canada
Pretax profits   10%                   12%
Tax               4%                    4.8%
Net to investors  6%                    7.2%

Total Gains from domestic investment = 10% (= 4% + 6%)
because tax revenues can be used for public purposes.
Total Gains from foreign investment = 7.2% (because US government gets nothing). The tax revenue which could have been used to build US highways would be used by Canadian government to build their highways.