|1. Multinational Corporations|
|Definition of MNC||
Multinational firms arise because capital is much more mobile than labor. Since cheap labor and raw material inputs are located in other countries, multinational firms establish subsidiaries there. They are often criticized as being runaway corporations.
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
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. (e.g., the Smith-Corona versus Brothers case)
Smith-Corona argued that Brothers is a foreign corporation (51% is owned by Japanese), but Brothers maintained that Smith-Corona is a foreign corporation because their products are made in Asia. Ownership does not really matter. For tax purposes, Honda of America Manufacturing (OH) is an American company. Only foreign firms pay tariffs and are subject to import quotas.
|Nationality mix of headquawrters managers||
An international company is multinational if the managers of the parent company are nationals of several countries. Usually, managers of the headquarters (e.g., GM, Toyota) are nationals of the home country. This may be a transitional phenomenon.
Japan's New Business Language (Rakuten, Japan's largest online firm with 100 million users, Amazon.com has 330 million users.)
Very few companies pass this test currently.
Sabvei(Subway) in Moscow.
Global profit maximization:
some are home country oriented,
others are host country oriented.
Successful firms: world-oriented , but must adapt to local markets.
According to Franklin Root (1994), an MNC is a parent company that
(i) engages in foreign production through its affiliates located in several countries,
(ii) exercises direct control over the policies of its affiliates, and
(iii) implements transnational business strategies in production, marketing, finance and staffing in a way that transcend national boundaries.
In other words, MNCs exhibit no loyalty to the country in which they are incorporated.
Barilla has plants and offices in Greece, France, Germany, Norway, Russia, Sweden, Turkey, US, and Mexico.
Wheat is purchased from around the world.
|Reference||Howard V. Perlmutter, "The Tortuous Evolution of the Multinational Corporation," Columbia Journal of World Business, 1969, pp. 9-18.|
|2. Three Stages of Evolution|
(i) initial inquiries ⇒ result in first export.
(ii) Initially, firms rely on export agents. ⇒ expansion of export sales
(iii) ⇒ foreign sales branch or assembly operations are established (to save transportation costs)
|Foreign production stage||
(i) There is a limit to foreign exports, due to tariffs, quotas and transportation costs.
(ii) Wage rates may be lower in LDCs.
(iii) Environmental regulations may be lax in LDCs (e.g., China). Itai-Itai (meaning: ouch ouch) disease in Japan since the 1920s was caused by cadmium poisoning. Contaminated effluents leaked into rice paddies and water source.) Watch the movie, Erin Brochovich.
(iv) meet Consumer demands in the foreign countries
FDI 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 the first experience (because it is easy)
e.g.: Kentucky Fried Chicken in the U.K.
Licensing does not require any capital expenditure
Financial risk is zero.
royalty payment = a fixed % of sales
Problem: the parent firm cannot exercise any managerial control over the licensee. (it is independent.)
The licensee may transfer industrial secrets to other independent firms, thereby creating rivals.
In order to deter entry of copycat producers, MacDonalds may supply American ingredients or raw materials (e.g., beef)
| Foreign Direct Investment
It requires the decision of top management because it is a critical step.
(i) it is risky (lack of information, large capital requirement)
US firms tend to establish subsidiaries in Canada first. Singer Manufacturing Company established its foreign plants in Scotland and Australia in the 1850s.
(ii) plants are established in several countries.
(iii) licensing is switched from independent producers to its subsidiaries.
(iv) export continues (exports and FDI may be substitues or complements)
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.
How to tell whether a firm is multinational?
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
21 of top fifty firms are located in the U.S.
12 are in China
3 in Japan (shrinking)
Petroleum companies: 6/10 located in the U.S.
|3. Motives for Foreign Direct Investment (FDI)|
|Anecdote on Sunzi, who wrote "The Art of War." Sunzi (544-496 BC) was a native of Ch'i, but served under King of Wu during the Spring and Autumn period (771- 476 BC).|
|New MNCs do not pop up randomly in foreign nations. They are the product of conscious planning by corporate managers. Investment flows from regions of low 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 Bypass protection in importing countries||
Foreign direct investment is one way to expand. FDI is a means to bypassing protective instruments in the importing country.
(i) European Union: imposed common external tariff against outsiders. Multinational companies circumvented these barriers by setting up subsidiaries . JBS USA is a subsidiary of a Brazilian company, the world's largest meat processor of beef and pork. (It kills 5000 heads of cattle per day.)
(ii) Japanese corporations built auto assembly plants in the US, to bypass VERs.
|3. avoid high corporate tax||US corporate tax = 35% if income exceeds $335,000, Greece = 29%, France = 33%. Corporate tax rates are lower in most other countries.|
|4 avoid high transport costs||
Build factories where consumers are.
Transportation costs are like tariffs in that they are barriers which raise consumer prices. When transportation costs are high, multinational firms want to build production plants close to either the input source or to the market in order to save transportation costs.
Multinational firms (e.g. Toyota) are better off establishing factories where consumers are located than shipping goods to faraway counries.
|5 avoid Exchange Rate fluctuations||
Japanese firms (e.g., Komatsu) invest here to produce heavy construction machines to avoid excessive exchange rate fluctuations. Also, Japanese automobile firms have plants to produce automobile parts. For instance, Toyota imports engines and transmissions from Japanese plants, and produce the rest in the U.S.
Toyota is behind GM and Volkswagen in China, and plans to expand its production in China (in addition to Tianjin and Guangzhou) and has no plans to build more plants in North America. (China's autoparts are cheaper.) It may have been a mistake for Toyota to overexpand its plants in the US. GM and Volkswagen have expanded their production plants in Shanghai.
A Komatsu machine used in ethanol production in Ida Grove, Iowa.
|6 reduce 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, Nissan, and Volkswagen. Subsequently, they became competitors. Toyota is #1 in the car industry at present. Market shares of car companies are:
Toyota: 12%, GM = Volkswagen: 11%, Hyundai-Kia: 9%.
|7 secure essential inputs||A foreign country may have the necessary resources (e.g., rare earth minerals). Since 1995, China is the dominant owner of REMs.|
|8 cheap labor|| United Fruit has established banana-producing facilities
Due to high transportation costs, FPE does not hold. ⇒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)
Komatsu first established its European factory in Belgium in 1967, and its American subsidiary in 1970. Over the years it established many other subsidiaries throughout Europe, Russia, America and Asia.
|4. Export versus FDI|
|Foreign production is not always an answer. Foreign markets can be better served by exporting, rather than by creating a foreign subsidiary if there are economies of scale. If large scale production reduces unit cost and transportation costs are not high, it is better to concentrate production in one place.|
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.
|If demand is less than MES, do not build a foreign production plant.|
|5. International Joint Ventures|
|What is JV?||JV is a business organization established by two or more companies that combines their skills and assets.|
(i) A JV is formed by two businesses that conduct business in a third country. (US firm + British firm jointly operate in the Middle East)
(ii) joint venture with a local firm, e.g., GM + Shanghai Automotive Industry Corporation (SAIC) = Shanghai GM.
(iii) joint venture includes local government.
|Why form JV?||
(i) Large capital costs - costs are too high for a single company
(ii) Protection - LDC governments close their borders to foreign companies. JV bypasses protectionism.
e.g.: US workers assemble Japanese parts. The finished goods are sold to the US consumers.
|Problem||Control is divided. The venture serves "two masters"|
(i) The new venture increases production, lowers price to consumers.
(ii) The new business is able to enter the market that neither parent could have entered singly.
(iii) Cost reductions (otherwise, no joint ventures will be formed)
(iv) increased market power => not necessarily good for consumers.
|6. Where are MNCs?|
|Their offices are located in major international cities, metropolitan areas, and port cities to meet local consumer demands and to acquire resources such as materials and laborers.|
Green Gate, Long Street (Gdansk)
Dutch (multinational company) buildings in Long Street, Gdansk, Poland. These were destroyed by Germans during WWII, but were meticoulously rebuilt in accordance with the blue print after the war.
Adolf Hitler demanded that Gdansk be given to Germany, claiming that Gdansk residents were predominantly German. Backed by France and Britain, Poland refused. With this excuse, Hitler invaded Poland on September 1, 1938.
A night scene of multinational firms at Hong Kong harbor.
|Multinational firms tend to be capital-intensive and require high-skilled workers. Universities are an important source of high-skilled workers.|
|7. 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
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)
Trump argues that American firms are moving their factories to Mexico (because of high wages, corporate taxes, and currency manipulations). Some provision concerning Currency manipulation may be included in the Trans-Pacific Partnership.
|Overlapping ⇒ double taxation||
Multiple Tax Jurisdictions create 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.
|Underlapping ⇒ tax avoidance||Conversely, when underlapping occurs, an MNC falls between tax jurisdictions and escape taxation. Underlapping encourages tax avoidance.|
|Territorial Tax system||National governments may claim territorial jurisdiction
or national tax jurisdiction or both.
TT: The government taxes business income that is earned on the national territory.
|National Tax system||NT: 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.
|8. US Taxation of Foreign Source Income|
|NT||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,
|It is essential to have a low tax rate to attract FDI. Foreign investers may invest in Canada or Mexico, rather than in the US.|
|corporate tax rates||
Japan = 40.69% (2011) →30.86% (2016)
0-25%: 75 countries
25-30%: 43 countries
30-35%: 28 countries
>35%: 3 countries
US Marginal corporate tax rate: 38.9% > 34% (France) > 22.5% (world average)
|10. Transfer Pricing|
|Intrafirm trade||Transfer prices are the prices paid for imports/exports between the headquarters (HQ) and subsidiaries.|
|Why manipulate TP?||
MNCs manipulate prices between the HQ and the subsidiaries so as to realize more profits. Profits may be the highest in the countries with lowest tax rates.
Purpose: to minimize the total tax a multinational firm pays.
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.
|Example|| tp = tax rate
in the parent country
th = tax rate in the host country
If tp > th, then lower export prices to the subsidiary in the host country, and raise import prices from the subsidiary. ⇒ lower tax.
|China's investment in EU||
China's investment in EU rose from $6 billion in 2010 to $55 billion in 2014.
|MNC's Goal: report maximum profit in the country with the lowest tax rate.||
In High-Tax countries: To reduce MNC profits,
(i) lower selling prices, and
(ii) raise buying prices
In Low Tax countries, do the opposite
Total tax = $135 ($7000 × 15%)
Thus, a multinational company's overall tax could be paid at the lowest tax rate of all 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 (Martz and Thomas, 1991).
Because of abuses in transfer pricing, taxable profits were shifted to Japan. The settlement Toyota offered to IRS reportedly approached $1 billion.
|11. Taxation and Gains from Factor Mobility|
|why invest overseas||
US firms invest overseas because the returns are higher there.
|National gains||natonal gains can be higher when investment stays home.|
|Tax Wars to attract FDI|| 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% US Gains 10% (4+6) 7.2%
US Gains from domestic investment = 10% (= 4% + 6%) because tax revenues can be used to build US infrastructure.
US corporate tax rate was the second highest after Japan (40.69% in 2011, but declined to 30.86% in 2016), and is a loser in international tax wars /tax competition. ⇒ Outbound FDI > Inward FDI.
Multinationals may retain profits for investment purposes, and need not repatriate profits to the US.
Total Gains from foreign investment = 7.2% < 10% (= Gains from domestic investment, 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.
Effects of lowering corporat tax rate: (i) increase inward FDI and decrease outbound FDI, (ii) increase repatriation of foreign profits. (Foreign profits of US multinationals are not subject to US income tax if they are parked or reinvested overseas.)
|12. FDI Shares|
|Stock of outward FDI (The Economist)|
(when WWI broke out)
|1967||US 50%, Britain 14%, Japan 2%|
|2009||US 23%, Britain 9%, China 6% (and rising to 10% in 2010)|
|US FDI stock||
Inward FDI: $2.8 trillion (2000), $3.5 trillion (2011)
Outward FDI:$2.7 trillion (2000), $4.5 trillion (2011). This might be due to the fact that US corporate tax rate is higher than the world.)
source: Lucyna Kornecki, Managerial issues in Finance and Banking: A strategic approach to competitiveness, Hacioglu, Ü, Dinçer (eds.)