The ownership-specific advantage often enjoyed by foreign multinationals is their market size and power.
One consequence of this is, inevitably, the displace-ment of less efficient domestic producers. Under certain circumstances, it is sometimes argued that foreign direct investment may result in the truncation of the host economy (i.e. the gradual loss of those eco-nomic sectors critical to self-sustained growth) and its
subsequent dependence on overseas multinationals for continued growth and employment. In extremis, it is sometimes claimed that the widespread presence of foreign multinationals may lead to a loss of economic sovereignty on the part of the host country’s govern-ment. The counter argument is that, at least in the case of the UK, foreign direct investment has posi-tively benefited the UK’s economic structure, chan-nelling funds into those sectors (e.g. high technology manufacturing, car production, etc.) in which the economy enjoys a comparative advantage and thereby accelerating economic restructuring.
Taxation
Multinationals are widely accused by governments of arranging intra-company transactions in order to minimize their tax liabilities, effectively forcing coun-tries to compete to provide the lowest tax regime.
Consider a simplified example in which a multi-national’s production is vertically integrated, with operations in two countries. Basic manufacture takes place in country A and final assembly and sale in country B (see Table 7.11). In country A, the cor-porate tax rate is 25%, while in country B it is 50%.
Suppose the company’s costs (inputs, labour, etc.) in country A are $40m and it produces intermediate products with a market value of $50m; if it were to sell these intermediate products in the open market, it would declare a profit of $10m in country A, incurring a tax liability of $2.5m in that country.
However, suppose the products are actually intended for the parent company’s subsidiary in country B. In Scenario 1, the ‘transfer price’ (i.e. the internal price used by the company to calculate profits in different countries) is set at the market price of $50m in country A for the intermediate products which are now to be ‘shipped’ to country B for incor-poration into the final product. The operation in country B incurs additional costs of $40m, after which the final product is sold in country B for
$100m; thus the subsidiary will declare a profit of
$10m and incur a tax liability of $5m. The company as a whole will face a total tax liability of $7.5m in countries A and B taken together.
Consider an alternative scenario (Scenario 2), in which the company sets a transfer price above the market price for the intermediate products manufac-tured in the low-tax country, A. With a transfer price
of $60m rather than $50m and the same costs of
$40m, the subsidiary in country A incurs a higher tax liability (25% of $20m), but this is more than offset by the lower (in fact, zero) tax liability incurred by the subsidiary in country B. Because the latter is now recording its total costs (including the cost of the intermediate products ‘bought’ from the subsidiary in country A) as being $100m rather than $90m, its profits and tax liability fall to zero. As a result, the total tax liability faced by the company on its international operations is only $5m, rather than
$7.5m.
The basic issue is that the multinational has earned a total profit of $20m on its vertically integrated operation, i.e. $100m actual sales revenue in B minus
$80m costs in A ! B. However, by setting transfer prices on intra-company sales and purchases of inter-mediate products appropriately, the company can
‘move’ this profit to the lowest-tax country, thereby denying the higher tax country (in this case, country B) the tax revenue to which it is entitled. Such transfer pricing can, of course, only succeed when there is no active market for the intermediate products being traded. If the tax authorities in country B can refer to an open market price for the intermediate product, the inflated transfer price being paid can be identified.
However, to the extent that many multinationals internalize cross-border operations because they have ownership-specific advantages (e.g. control of a specific raw material or technology), it may be that comparable intermediate products are not available on the open market. For this reason, high-tax coun-tries may find they lose tax revenues to lower-tax centres as business becomes increasingly globalized.
This creates, in turn, an incentive for countries to
‘compete’ for multinational tax revenues by offering
low tax rates; the result of such competition is a transfer of income from national governments to the shareholders of multinational companies.
Multinationals play a more influential role in the UK economy than in any other major, developed country in the world. Most of the household-name companies in Britain – BP, Unilever, Ford, Kellogg, Heinz, Cadbury Schweppes – are multinationals. In the past, companies became multinational to secure resources and markets or to overcome the transport costs asso-ciated with exporting. Increasingly, multinationals are becoming genuinely global, performing different stages of an integrated productive process in different countries to exploit natural and government-induced differences in factor costs as we saw in the case of Honda. There is a fierce debate about the benefits and costs of multinational activity for individual economies such as that of the UK. What is clear, however, is that the growth of multinationals will continue into the next century and that an increasing proportion of UK companies will do the majority of their business over-seas, while an ever-higher share of UK production will be controlled by foreign companies.
Indeed, it is already becoming increasingly mean-ingless to think of companies as ‘British’ or ‘foreign’.
Is Ford, an ‘American’ company which designs and builds cars in the UK, ‘foreign’? Is Attock Oil, a
‘British’ oil exploration and production company which operates only in North America and SE Asia,
‘British’? As companies become increasingly global in nature, the convention of labelling a company’s nationality by reference to the nationality of its controlling shareholders will become redundant.
Imagine the Ford Motor Company, owned by Japanese shareholders, run by an American chief executive, producing components across the EU and assembling them in Turkey for sale in Russia. In what sense is such a multinational ‘American’, ‘Japanese’
or even ‘European’? The multinational of the future is likely to be genuinely ‘stateless’. Already the trend towards statelessness is well underway and the implications of this phenomenon are liable to be profound.
Table 7.11 Multinational tax avoidance.
Scenario 1 Scenario 2
$m Country A Country B Country A Country B
Costs 40 90 40 100
Sales 50 100 60 100
Profit 10 10 20 0
Tax liability 2.5 5 5 0
Total tax 7.5 5
Conclusion
Key points
■ A ‘multinational’ is a company which owns or controls production or service facilities in more than one country.
■ There are some 65,000 multinational companies, the sales revenue of which amounts to around 58% of world GDP.
Only 14 nation states have a GDP greater than the annual turnover of Exxon, Ford or General Motors.
■ Multinationals account for around 30%
of GDP in the UK and almost half of manufacturing employment.
■ Foreign multinationals account for 11%
of UK employment and 23% of UK turnover. The US dominates the scene, accounting for 42% of all foreign multi-national employment in the UK and 37%
of all foreign multinational turnover.
■ Successful multinational activity from the home base usually depends on the posses-sion of ‘ownership-specific’ advantages over firms in the host country, together
with ‘location-specific’ advantages which favour overseas production.
■ Cost-oriented multinationals focus mainly on reducing costs of production via over-seas production (often via vertical inte-gration); market-oriented multinationals focus mainly on easier sales access to over-seas markets via overover-seas production (often via horizontal integration).
■ Being both a ‘home’ country to (UK) multinationals as well as a ‘host’ to foreign multinationals results in substan-tial flows of outward and inward foreign direct investment (FDI).
■ The costs and benefits of multinational activity for the UK (or indeed any country) can usefully be assessed under six main headings:
(i) FDI and economic welfare (ii) technology transfer (iii) balance of payments (iv) employment (v) industrial structure (vi) taxation.
Now try the self-check questions for this chapter on the Companion Website.
You will also find up-to-date facts and case materials.
Buckley, P. J.(1992) New Dimensions in International Business, Edward Elgar.
Cleeve, E.(1994) Transnational corporations and internationalisation: a critical review, British Review of Economic Issues, 16(40).
Crum, R. andDavies, S.(1991) Multinationals, Heinemann Educational.
Dicken, P.(2003) Global Shift: Transforming the World Economy, 4th edn, Paul Chapman.
Duffus, G. andGooding, P.(1997) Globalisation:
scope, issues and statistics, Economic Trends, No. 528, November.
Dunning, J.(1996) Globalisation, foreign direct investment and economic development, Economics and Business Education, 4(3).
Dunning, J. H.(1993) Multinational Enterprises and the Global Economy, Addison-Wesley.
Economist(1996) Economic Indicators, 27 April.
Financial Times(1998a) West-Midlands popular as manufacturing base, Reporting Britain, 16 July.
Financial Times(1998b) Regions take an inward look at a growing problem, 21 May.
Financial Times(2003) FT Global 500.
References and further reading
Greenaway, D.(1993) Trade and foreign direct investment, European Economy, No. 52.
Kene, P. B.(1994) The International Economy, Cambridge University Press.
Kobrun, S. J.(1991) An empirical analysis of the determinants of global integration, Strategic Management Journal, 12.
Norman, G.(1995) Japanese foreign direct investment: the impact on the European Union, in N. Healey (ed.), The Economics of the New Europe: from Community to Union, Routledge.
Thomsen, S.(1992) Integration through
globalisation, National Westminster Bank Quarterly Review, August.
UNCTAD(1996) World Investment Report:
Investment, Trade and International Policy Arrangements, Geneva.
UNCTAD(2002) World Investment Report 2002, Geneva.
Winters, L.(1991) GATT: the Uruguay Round, Economic Review, 9(2), November.
Young, S., Hood, N. andHamill, J.(1988) Foreign Multinationals and the British Economy, Croom Helm.
Chapter 8 Privatization and deregulation
Public ownership of industries is now in retreat throughout the world as governments privatize. Since the early 1980s the UK has
provided a model of privatization which has been influential in policy making, both in other industrial countries and in developing
countries. The collapse of the Soviet Union and the Eastern
European Communist regimes has led to privatization programmes which totally dwarf those of the UK. This chapter summarizes the original case for nationalization and considers the arguments for and against privatization. There is also a discussion of the case for regulating the activities of the privatized companies as well as the contrary view in favour of less regulation (i.e. deregulation).
Public (or state) ownership of industry in the UK has mainly been through public corporations, which are trading bodies whose chairpersons and board members are appointed by the Secretary of State concerned.
These nationalized industries, as they are often called, are quite separate from government itself. They run their businesses without close supervision but within the constraints imposed by government policy. These constraints include limits to the amounts they can borrow and therefore invest and may also include limits to the wages and salaries they can offer. Not all public corporations are, however, nationalized indus-tries. There are some public corporations, such as the BBC, which are not classed as nationalized industries.
Public ownership can also take the form of direct share ownership in private sector companies. So, for example, after the collapse of the DAF motor vehicle group in 1993, the Netherlands government provided 50% of the equity and loan capital for DAF Trucks NV which took over some of the failed group’s activities. In a similar way the UK government held a majority holding in British Petroleum for many years prior to its complete privatization in 1987.
Privatization in the UK has reduced the number of nationalized industries to a mere handful of enterprises accounting for less than 2% of UK GDP, around 3%
of investment and under 1.5% of employment. By contrast, in 1979 the then nationalized industries were a very significant part of the economy, producing 9%
of GDP, being responsible for 11.5% of investment and employing 7.3% of all UK employees. The scale of the transfer of public sector businesses since 1979 to private ownership is further indicated in Table 8.1 below, which lists the businesses privatized by sector.
Looking back from the perspective of the new millen-nium, the reader may well ask why the state ever became so heavily involved in the production of goods and services. Yet between the 1940s and the 1980s this was one of the most contentious issues in British politics, both between the major parties and within the Labour Party. The first post-war Labour
government (1945–51) achieved a major programme of nationalization which was opposed by the Conservative Party at the time but broadly left in place by subsequent Conservative governments. The apparent consensus on the scale of the nationalized industries was, however, broken after 1979 as Conservative governments under Mrs Thatcher devel-oped the policy of privatization. We now consider a range of arguments used in favour of nationalization.
Political
The political case for nationalization centred on the suggestion that private ownership of productive assets creates a concentration of power over resources which is intolerable in a democracy. Until 1995 the Labour Party appeared to embrace this idea in Clause 4 of its constitution which promised public ownership of the means of production, distribution and exchange. The founders of the Labour Party saw public ownership as a necessary step towards full-scale socialism and one which would aid economic planning. This developed into a policy of nationalizing the ‘commanding heights’
of the economy which the 1945 Labour government identified as the transport industries, the power industries and the iron and steel industries; the Post Office had always been state owned and at that time also included telephones. There were always many in the Labour Party who were opposed to a literal inter-pretation of Clause 4 and saw that there were other means of regulating economic activity besides outright public ownership. By the 1990s, after the collapse of the Eastern European socialist economies, there were few remaining advocates of economic planning and the Labour Party abandoned the old Clause 4 by a large majority at a special conference in 1995.