GLOB_MNC

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The Japan Programs Working Paper Series onGLOBALIZATION

The Japan Programs Working Paper Series on

Globalization

The working papers contained in the Globalization Series were producedby EMP Financial Advisors, LLC contracted by the Inter-American Development Bank.

Globalization and the Multinational CorporationJoseph J. Savitsky

Shahid Javed Burki

Paper #3

"A world government has been emerging quietly and organically the increasingly dense ganglia of international

corporations and markets."1

-Robert D. Kaplan in The Coming Anarchy.

It has been said that the multinational corporation (MNC) is the most powerful institution in the world

today. Indeed, the process of globalization, which is radically transforming our world, is driven in large

part by the rapid growth and spread of corporations. Since the end of the Cold War in 1991, nearly all

nations in the world have reduced the role of the state in the economy and lowered barriers to the

international movement of goods, services, capital, ideas and technology. As the walls imposed by nation-

states have crumbled, multinational corporations have thrived, spreading across the globe in search of new

markets and factors of production. MNCs have expanded across national borders in two ways: trade andforeign direct investment (FDI). Each has contributed to stable, lasting benefits to the world economy.

Two major financial crises notwithstanding, the 1990s were a decade of substantial world economic

expansion, due in large part to the rapid growth of trade and FDI.i

Expansion of size and scope became the rallying cries of corporate managers as they watched the barriers

dividing the global economy fall down, yielding fewer, larger competitive arenas. The arrival of the

Information Age paved the way for a new breed of powerful corporation, dramatically altering the

competitive landscape. Compounded by economic liberalization, the digital revolution allowed

corporations to develop complex, integrated production networks spanning large parts of the globe. The

collapse of economic barriers brought formerly secluded corporations into direct competition with one

another. New managerial techniques encouraged foreign affiliates to cater to local customers and suppliers

while pursuing the strategies formulated by the home office. While new technologies and liberalization are

i Neither trade nor FDI caused the tequila crisis of 1994-95 or the Asian financial crisis of 1997-98. Ifanything, these factors contributed to recovery as export revenues and FDI helped to compensate crisiscountries for the outflow of speculative capital.

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Globalization and the Multinational Corporation 2

helping big corporations to increase their efficiency and reach, these same forces also allow small, new

firms to challenge even the most powerful multinationals for market share and the race for new products

and services.2

By the early 1990s, much of the developing world had begun to welcome foreign goods, services,

investment and technology. At the same time, liberalization contributed to the spread of developing

country corporations, and these firms began to operate across national borders, effectively becoming

multinationals in their own right. In the past decade, the multinational corporation has spread aggressively

into the emerging markets of Latin America and Asia. With the collapse of the Iron Curtain, MNCs also

expanded into Eastern Europe and the former Soviet Union. Through FDI, these MNCs the major drivers

of international trade and investment incorporated developing and transition countries into the world

trade system. As a result, developing countries have played, and will continue to play, a much larger role

in world trade in this second wave of globalization (1973 - ?) than they did in the first (1848 1914).3

But as the size and reach of multinational corporations have grown, so too has resistance to what is termed

corporate globalization or monopoly capitalism. This resistance is most acute not in the developing

world where one might expect, but in the advanced economies of the OECD, the home base of 99 of the

worlds 100 largest MNCs. The United States, home of 27 of the 100 largest MNCs, has been the epicenter

of the anti-corporate movement, as evident in the presidential campaign of Green Party candidate Ralph

Nader and the protests against corporate globalization and the international financial institutions in

Seattle, Washington DC and Prague.

The multinational corporate order is growing and spreading, weaving together distinct pieces of the global

economy that previously were separated by culture, geography or nationality. The relationship between

globalization and MNC proliferation is one of mutual causation, but neither process is inevitable. World

War One brought the first wave of globalization to a grinding halt. The war destroyed international

commerce and reasserted nationalism at the expense of international cooperation. Today, globalization is

coming under increasing attack by nation-states from above and by civil society from below. The outcome

of this struggle is far from certain. As this process unfolds, policymakers in emerging markets and

developing countries increasingly must factor the implications of globalization into their decision-making.

Should they welcome investment and trade by foreign MNCs? What type of industrial policy should they

implement in order to gain the most from globalization? Should they concentrate state resources on

building national champions? What sort of regulatory structure, at both the national and international

levels, must be in place for MNCs to flourish, but without trampling democracy, culture or the

environment?

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The purpose of this paper is to examine the rise of the multinational corporation and its effects on the

global economy, with an eye toward defining an agenda for policymakers at the national and international

levels. Emphasis will be placed on the impact of MNC activity on the developing world.

After the introduction, Part I gives an overview and brief history of the multinational corporation. We focus

on how the corporation has evolved in the United States, and how ideology has shaped its evolution. Part II

looks at the multinational corporation as it exists today. In particular, Part II covers the dominance of

MNCs, their penetration into the developing world, the evolving structure of global competition, the

relationship between MNCs and research and development (R&D) and the ongoing debate over the pros

and cons of the corporate model. The sum of this analysis should provide us with a better understanding of

the MNC, the many ways in which it is shaping the global economy and its implications for economic

development. In Part III, we study the two forces globalization and the digital revolution that will

impact heavily on the future evolution of multinational corporations. Part III also covers a range of issues

drawn from the preceding analysis that should guide policymakers as they set economic and industrialpolicy.

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Part I Evolution of the Multinational Corporation

A corporation is a legal entity that is separate from the people who own it. As such, a corporation is

viewed, in legal terms, as acting separately from its owners and workers when entering into business deals,

borrowing money and performing other business-related activities. A multinational corporation can be

defined as a corporation that engages in international production and that bases its management decisions

on regional or global alternatives.4 Sometimes, such a firm is referred to as a global corporation,

multinational enterprise (MNE) or transnational corporation (TNC), but for the sake of simplicity, we

will use the term multinational corporation (MNC) throughout this paper. It should be noted, however,

that these different terms sometimes reflect conceptual differences in the way that the firms operate. Most

notably, the terms global corporation and TNC sometimes are used to describe a firm that has shed

[its] home-nation identity and operates as [an] essentially stateless entity on a global scale.5 This is the

type of firm described by Kenichi Ohmae in his book,Borderless World: Power and Strategy in the

Interlinked Economy.6 While modern MNCs may be evolving toward this truly global reach, few, if any,

seem yet to have attained this level of sophistication.ii In fact, as we will argue later in this paper, the trend

toward regionalism encourages firms to concentrate on expanding within their region before going truly

global.

Why do we have multinational corporations? The first reason is economies of scale. As we will argue

later, new developments in information technology may reduce the importance of size in some sectors, but

for now, many commercial activities, such as automobile production, can be performed efficiently only on

a large scale; a mom and pop operation cannot build turbine engines. The second reason is comparative

advantage. The manufacture of complex products, such as personal computers or automobiles, typically

involves a number of distinct tasks (design, marketing, manufacturing), various materials (steel, copper,

glass) and a number of factors of production (workers, machinery, contacts with suppliers and customers),

all of which must be coordinated by management. To build an airplane, one needs engineers, steel,

welders, rubber and many other inputs. A plane might be built most efficiently with American engineers,

Korean steel and Mexican assembly, for example. A third reason that we have MNCs is consumer tastes.

Consumers in different countries often have similar tastes. If many consumers in New York want German

BMWs, it might make sense for BMW to establish a presence there: maybe set up a dealership, an

assembly plant, even an engineering team. The fourth reason derives from the very nature of the

corporation: its ultimate objective is profit. Shareholders (who want returns) demand that a corporation

increase profits. Workers (who want pay raises) pressure a corporation to expand costs. To keep both

parties happy, a firm needs to increase its revenue base and raise productivity. When a market for the

ii General Electric (GE) and Nestl are two firms often cited as truly global operations.

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firms product becomes saturated, a profit-seeking corporation needs to find a new consumer market (often

overseas) in order to continue expanding its revenue base.

From where did the model for the multinational corporation emerge? The modern multinational

corporation has its roots in the Dutch and British East India Companies of the 17th century. These

companies imposed some semblance of order, often forcefully and illegitimately, on the world of

commerce, which until then was ruled by economic anarchy. Where once pirates threatened trade and

commerce, the East India companies assembled armies and erected fortresses to protect their pursuit of

profit. They often gained market share by force against rivals, including one another, and against the

inhabitants of lands they wished to colonize. Typically, the companies demanded free trade and local

monopoly rights in the markets in which they operated so as to maximize profits. These predatory

practices impacted the colonized lands for the worse. The British company led to the bloody Indian mutiny

of 1857; it also brought opium into China. In its wake, the Dutch company left, among other things,

apartheid in South Africa. But despite all these pernicious deeds, both companies were pioneering theskills and networks of modern global commerce, and advancing technology in the form of better ships and

equipment.7

Arguably, the most important lesson to draw from the experience of the East India companies is that no

matter how much harm these mighty firms caused, they also produced valuable innovations and efficiency

gains. One serious defect in the structure of 18th century corporate commerce was that the very companies

that conducted the commerce also designed and enforced the rules of commerce. The challenge for future

generations would be to harness the good that large multinationals could create, while placing checks and

balances on them to prevent abuses of power. The next step in the process was to separate economic from

military power, and allow corporations to conduct commerce, while national governments protected

commercial interests from would-be pirates. This separation of power and division of responsibilities

enabled commerce to flourish while limiting the potential for abuse of corporate power. Eventually,

governments also would assume the role of designing and enforcing the rules of commerce. In the mid-20th

century, many national governments even went a step further, assuming the role of producer.

Corporate charters were issued in the American colonies to religious and community groups, and

eventually, to aspiring businesses. It was the latter that held the greatest economic potential, and also

stirred the greatest backlash. It did not take long for people to envision the potential for a clash of interests

between government and big business. Thomas Jefferson warned against the spread of corporations as

early as 1816:

I hope that we shall crush in its birth the aristocracy of our monied corporations, which dare already to challenge our

government to a trial of strength, and bid defiance to the laws of our country.8

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In line with Jeffersons worst nightmares, the 19 th century evolved into the Gilded Age. In the US, giant

corporations emerged under the direction of the robber barons, a term used to describe the likes of

Andrew Carnegie, J.P. Morgan and John D. Rockefeller. Eventually, Standard Oil and US Steel essentially

monopolized the oil and steel industries, respectively. By the early 20th century, popular opinion began to

lean toward populism and against the mighty corporations. Workers demanded that they be allowed to

assemble labor unions, and muckrakers exposed various abuses of power by corporations. Antitrust laws

most notably, the Sherman Act of 1890 were passed. In addition, this anti-corporate movement saw

international economic liberalization as aiding and abetting the proliferation of corporate abuse. Thus, the

first great wave of globalization, which began in 1848, was blamed for growing income inequality and

insecurity.iii Disenchanted with globalization, disgruntled members of the political left set out to halt it.

The First World War quickly ended that first wave global economic integration and the nations of the world

receded into autarky in the 1920s.

The Great Depression and the Second World War cast doubts on the viability of laissez faire capitalism.Afterward, most countries, especially Japan and Germany, built their economies on a foundation of large

corporations and big government. Businessmen and bureaucrats worked together to reap the benefits of

free markets, while imposing, via regulation, some semblance of order. It was easier for governments to

regulate a few mega-corporations than a whole slew of smaller firms. As a result, large corporations spread

quickly after the war. Free trade prospered between the industrial economies as a result of the General

Agreement on Tariffs and Trade (GATT) and the Marshall Plan. Developing countries did not offer a

fertile ground for these corporations since the GATT permitted the erection of barriers to foreign trade in

these countries. The developing world was permitted under GATT to protect its infant industries, which

often led to rent-seeking and inefficiency.

Meanwhile, membership in labor unions swelled in the industrial world, and a post-war bargain emerged

between national governments, corporations and labor. National governments comforted workers by

providing pensions, welfare and unemployment and health insurance. Corporations were free to conduct

commerce and workers were free to organize. The state enforced the rights of each and attempted to ensure

that the relationship between labor and management ran smoothly. Essentially, the post-war bargain

promised workers a steady increase in wages and benefits in return for labor peace. 9 But this bargain

began to break down a generation after the end of the war. In 1967, John Kenneth Galbraith, citing the

application of increasingly intricate and sophisticated technology to the production of things, predicted

the natural tendency toward, and the dangers of, the concentration of power in The New Industrial State:10

iii The choice of 1848 as a starting point is fairly arbitrary, but that year coincides with the repeal of theCorn laws in the UK, which paved the way for liberalization of trade throughout much of the world.

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With the rise of the modern corporation, the emergence of the organization required by modern technology and planning

and the divorce of capital from the control of the business, the entrepreneur no longer exists as an individual person in the

mature industrial enterprise.11

Like many social theorists before him, Galbraith worried that the danger to liberty lies in the subordination

of belief to the needs of the industrial system, and that the inherent tendency toward concentration of

industry threatened to make this subordination into reality.12 Events that have transpired in the three

decades since Galbraith issued these warnings do not support his fears. In fact, the tendencies he described

were more applicable to the heavy industry, state-led form of capitalism popular in most of the world in the

four decades after World War Two than to the more liberal economic order that is emerging today. The

type of organization Galbraith described as essential to then-modern technology was the direct result of the

heavy state interference, segmented capital markets and large economies of scale (and consequent tendency

for natural monopoly) of the oil, steel and auto industries that dominated that time. Today, capital

markets, especially in the Anglo-Saxon world, are far deeper and more accessible than thirty years ago.

Some of the biggest industries (e.g., IT, telecom, e-commerce) rely more on human capital than heavy

machinery, and value efficiency and flexibility more than size or market share. A new deal has been struck

to replace the post-war bargain: the promise of more wealth in exchange for the readiness to change,

adjust, be alert, move people, money and resources in and out of various activities, geographic locations

and industries.13 Labor traded a measure of stability for more opportunity.

Nevertheless, the mere size of the worlds largest corporations inspires fear and suspicion among many

people even today. In spite of the pro-competitive forces of technology and worldwide liberalization,

globalization seems to have re-awakened these anti-corporate sentiments, embodied in the following

statement by Ralph Nader, which he delivered shortly after the now infamous Battle in Seattle:

The global corporate model is premised on the concentration of power over markets, governments, mass media, patent

monopolies over critical drugs and seeds, the workplace and corporate culture. All these, and other power concentrates,

homogenize the globe and undermine democratic processes and their benefits.14

Such statements illustrate that opposition to corporations remains strong even in the worlds wealthiest

nation. As policymakers in the developing world assess the many opportunities and challenges of

globalization, they must consider the impact of multinational corporations on national economic

development. Multinational corporations can bring cutting-edge technology and large sums of foreign

direct investment into a technology- and capital-scarce economy. But their entry into a market could spell

trouble for domestic competitors and the environment. In the following section, we will look at specific

aspects of these corporations, weigh the pros and cons of their expansion and attempt to provide a well-

rounded analysis of the opportunities and challenges posed to economic policymakers by multinational

corporations.

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Part II The Most Powerful Institution in the World Today

1. Power Play

The increasing power of the multinational corporation (MNC) is beyond doubt. The production of MNCs

amounts to approximately one-quarter of world output. Fifty-one of the worlds largest 100 economies are

corporations, not countries.15 The total value of foreign sales of MNCs now exceeds world exports of

goods and services, and intra-firm trade alone by MNCs accounts for about one-third of world trade. There

are now approximately 63,000 multinational corporations defined as firms that engage in international

production with over 690,000 foreign affiliates.16 In 1997, these firms controlled $12 trillion in foreign

assets, employed 30 million workers and earned $9.5 trillion in revenues larger than the annual GDP of

the United States or the European Union (EU). The rapid growth of MNCs is a direct result of the

worldwide liberalization of trade and investment. Corporations have grown larger because they now

compete in much bigger markets.

An elite few dominate the large and diverse family of MNCs. For example, the worlds largest 100 non-

financial MNCs held $1.9 trillion in foreign assets, employed 6.5 million people overseas and registered

$2.1 trillion in foreign sales in 1999.17 Presently, MNCs are based disproportionately in advanced

economies, or the Triad (US, EU and Japan), where 89 of the 100 largest MNCs are based.18 Only one

firm (Petroleos de Venezuela) from the developing world makes the top 100. This may begin to change in

the years ahead as firms based in developing countries join the ranks of the big multinationals, but the

process will be slow.

Multinational corporations are the main conduits of foreign direct investment (FDI), the annual flow of

which has grown steadily and rapidly since the mid-1980s. The unique attributes of FDI (most notably, its

long-term nature, association with the transfer of technology and foreign ownership) have made it the

subject of much economic analysis. In recent years, FDI has attracted a great deal of attention from the

economic development community as its flow into the developing world has skyrocketed. FDI, as we will

see, is one of the driving forces of globalization.

Figure 1: FDI Inflows

-100

200

300400

500

600700

800900

1,000

2*

93

94

95

96

97

98

99

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Source: UNCTAD. World Investment Report, 2000.

Foreign direct investment is defined as an investment involving a long-term relationship and reflecting a

lasting interest and control of a resident entity in one economy (foreign direct investor or parent enterprise)

in an enterprise resident in an economy other than that of the foreign direct investor (FDI enterprise or

affiliate enterprise or foreign affiliate).19 Furthermore, FDI implies that the investor exerts a significant

degree of influence on the management of the enterprise resident in the other economy.20 Development

ultimately rests on the ability to increase total factor productivity. Foreign direct investment can and has

played an important role in bringing this about. An empirical study by Romain Wacziarg suggests that a

1 percent increase in the ratio of foreign capital flows to GDP is associated with a 0.1 percent increase in

the GDP growth rate. An identical increase in FDI, however, is associated with an increase in the GDP

growth rate of 0.3 0.4 percent.21 Moreover, FDI is mostly undertaken by the worlds largest and most

technologically dynamic firms.22 This feature increases the impact of the investments positive spillover

effects the transfer of technology and training of the workforce, for example.

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As shown in Figure 1, the worldwide flow of FDI more than quadrupled tripled from 1993 to 1999. Even

in the midst of the Asian and Russian financial crises, the developing world received $165 billion in gross

FDI inflows in 1998, up from an annual average of $35b during 1987-92. China and Brazil registered the

most dramatic growth, as these two very large economies opened up to the global economy and to

multinational corporations. In 1998, China and Brazil received $45b and $28b of FDI, respectively. For

Brazil, this represented a twenty-fold increase over 1993.

As a result of a steadily increasing flow, the worldwide stock of FDI in 1997 was estimated at $3.5 trillion.

(See Table above, World FDI Stock, 1997.) Of this, 30 percent or slightly more than $1 trillion was

located in the developing world. But the corporations and markets investing there have been very selective.

As illustrated in Figure 2, 70 percent of the stock of FDI in the developing world was in just nine countries

China, Brazil, Mexico, Singapore, Indonesia, Malaysia, Saudi Arabia, Poland and Argentina, in that

order.iv China, with six percent of the total worldwide stock of foreign direct investment ($200 billion),

and 20 percent of the total in the developing world, now tops the list of emerging countries receiving this

type of investment.23 This list of countries indicates that a number of factors determines the destination of

FDI. These include size (China), natural resources (Saudi Arabia and Indonesia), openness (Singapore,

Argentina, and Malaysia), access to a major market (Mexico) and long-term growth potential (Brazil and

iv For some reason, Singapore (per capita income of $30,000) is still considered a developing country in thestatistics maintained by the World Bank.

World FDI Stock, 1997

Proportion

Region to total

World 100%

Industrial Countries 68%

Western Europe 1,277 37%

North America 858 25%Other 215 6%

Developing Countries 30%

Argentina, Brazil

and Mexico 249 7% 24%

Other Latin America 126 4% 12%

China & Hong Kong 244 7% 24%

SE Asia* 253 7% 24%

Other Asia 96 3% 9%

Africa 65 2% 6%Other developing

countries 9 0.3%

- Top 9** 21% 70%Source: World Bank. World Development Report, 1999.

* Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan (PRC), and Thailand

** China, Brazil, Mexico, Poland, Argentina, Singapore, Indonesia, Malaysia, and SaudiArabia

Amount

(Billions of US$)

3,456

2,349

Proportion to total fordeveloping countries only1,044

1%

725

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Poland).24 Later in this paper, we will take a look at how the determinants of FDI are likely to change in

the years ahead in response to the evolution of the world economy and the multinational corporations that

drive it.

Source: World Bank. World Development Report, 1999.

MNCs have expanded into new markets as liberalization has swept across the globe. In some cases,

corporations have established new affiliates or facilities overseas. In other cases, they have purchased

existing firms or assets. The latter, which is referred to as mergers & acquisitions (M&A), now constitutes80% of FDI in the advanced economies and around one-third in the developing world.25 The rise of M&A

in emerging markets was aided by the ambitious privatization drives carried out by their governments in the

1990s, especially in Latin America and Eastern Europe. M&A is also growing rapidly in the advanced

economies. Aided by the massive $182 billion merger of AOL and Time-Warner, global M&A reached

$1.85 trillion in the first six months of 2000, up 25% from the first half of 1999, according to data compiled

by Thompson Financial.26

With the breathtaking growth of M&A activity, the worlds first ever $1 trillion merger may not be too far

off. On the other hand, a re-assessment of the trend toward ever larger mergers may be in order, as variousresearchers find that approximately two-thirds of mergers fail to increase shareholder value.27 The global

M&A market will slow if the big mergers of the past couple of years fail to raise shareholder value the

number one objective of any corporation. This is a built-in feature of the marketplace that will limit the

tendency toward concentration: market share will become concentrated only to the extent that it creates

gains in efficiency.

Figure 2 - Share of total FDI stock inthe developing world

China

20%

Brazil

13%

Mexico

10%Indonesia

7%

Other

developing

countries

31%

Poland

3%Malaysia

3%Argentina

3%

Singapore

7%

Saudi Arabia3%

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As highlighted by Vodafones nearly $200 billion acquisition of Mannesman and the proposed $130 billion

merger of Worldcom and Sprint (which was subsequently blocked by the US and EU on antitrust

concerns), telecom continues to be a hotbed for M&A activity as firms position themselves to take

advantage of this high-growth sector. This is not limited to the industrial world, however. One very

important stipulation of the US-China WTO Accord, which will go into effect upon Chinas admission to

the WTO, is that China must allow foreign ownership (up to 50%) in domestic telecom firms within two

years of accession. With a national penetration rate of just 10.6%, a population of 1.3 billion and an

economy expected to continue its rapid growth, foreign direct investment in Chinese telecommunications

could skyrocket during the next five or ten years. Land-based telephone lines will be leapfrogged. The big

market will be third generation (3G) mobile telephony combined with Internet services. The telecom

infrastructure also will need massive investment in laying a fiber optic backbone. The telecom

conglomerates, such as AT&T, NTT and Cisco, will pour billions of dollars of investment into this huge

market.

The impressive statistics cited above allude to the rapid spread of multinational corporations in terms of the

resources they control and the number of markets in which they operate. Through world trade and foreign

direct investment, these firms are binding together economies throughout the world. They are integrating

production networks across borders while localizing goods and services to meet the needs of consumers in

various markets. Some firms have expanded aggressively through mergers and acquisitions in the

expectation that scale and scope will be increasingly vital for success in the globalizing economy. But as

MNCs grow in size and number, they are raising concerns about market concentration. Others fear that

large corporations have become more powerful than democratic governments and institutions, or that they

aid authoritarian regimes such as the case of Shell in Nigeria or ITTs involvement in the coup that brought

Augusto Pinochet to power in Chile. Later in this paper, we will take a closer look at these and other

concerns.

2. Survival of the Fittest: Competition on a Global Scale

As national barriers to trade fall, large corporations, once shielded by national borders, are coming into

direct competition with one another. A flurry of mergers and acquisitions (M&A) activity has occurred as

these corporations prepare for global competition. As competition takes place in an increasingly global

arena, national rules for competition are beginning to converge. As we will see, global competition has

important implications for economic policy.

One of the major criticisms of the multinational corporation is that its size and scope enable it to stifle

competition. When critics complain about corporate globalization or monopoly capitalism, they

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generally refer to this feature; some even contend that laissez-faire capitalism (or some similar variant of

unfettered markets) has a natural tendency toward oligopoly or monopoly. Economists understand well

that such a concentration of market share and market power, when combined with the profit incentive,

distorts the allocation of resources, raises prices, decreases output and reduces aggregate welfare (i.e.,

creates a deadweight loss or a sub-Pareto optimal outcome). Therefore, following this logic, it is in the

interest of governments and consumers to ensure the presence of competition in the markets by reining in

the dominant firms. The presence of antitrust legislation stems from this logic.

The best indicator of the loss of consumer welfare due to concentration in the market for a given good,

service or factor is the level of profit. While an exhaustive survey of profit levels across sectors and

countries is well beyond the scope of this paper, a recent study of 214 companies on the 1999 Fortune

Global 500 by Templeton College, Oxford found that these firms earned a rather underwhelming 8.3%

return on foreign assets in the mid-1990s, declining to 6.6% in 1998. In previous years, the same survey

estimated returns on foreign assets for Fortune 500 firms to range from 28%.

28

Clearly, if MNCs wereimmune to competition, one would expect much higher profit margins. Other research shows that the

worlds largest multinationals do not, over time, earn excessive profits, and that economic efficiency is

enhanced by their activities.29

Globalization is exposing corporations throughout the world to competition from which national barriers,

both man-made and natural, once shielded them. The collapse of man-made barriers accelerated with the

end of the Cold War and the spread of economic liberalism. However, one should be careful not to

exaggerate the global spread of free markets; it is true that capitalism seems to be spreading in all corners

of the earth, but different regions are cultivating different variants and threatening to polarize the global

economy into three or four regional ones.30 The proliferation of regional trade agreements is indicative of

this trend. Even so, regionalism, like full-blown globalization, increases the intensity of competition in

each market.

The largest natural barriers to new markets were culture and geography. Although both continue to play

important roles in segmenting markets, globalization is reducing the impact of each. The

internationalization of business practices allows the affiliates of MNCs to adapt to local cultures while

helping the parent corporation to pursue its global strategy, as evident in the multi-local strategy of

McDonalds.31 Dramatic improvements in technology especially in transport and telecommunications

have reduced the impediment of distance, allowing firms to compete in new markets. But far from aiding

large corporations in their bids for world domination, the digital revolution has introduced atomistic

competition to the business world.32 New technologies (IT) and the deregulation of capital markets

(venture capital) now allow small start-ups to compete with the most powerful corporations.33

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As competition among firms grows ever more intense, the interests of shareholders and customers carry

greater weight in corporate decision-making, even in countries where cross-shareholdings have been the

norm. Firms that resist this new form of corporate governance do so at their own peril, as they risk losing

access to finance and customers to their more progressive competitors. Governments must do their part to

encourage this transition to a more accountable, transparent and, ultimately, efficient form of corporate

governance within their economies. This is what US Treasury Secretary Larry Summers refers to as the

Global Structural Reform Challenge.34 Economies of all shapes and sizes including China, Germany,

France and the Asian tigers are confronting this challenge. But the clash of traditional business practices

with the Global Structural Reform Challenge is perhaps most acute in Japan, where the forces of

globalization are eroding the heavily fortified keiretsu structure, and opening up the economy to mergers

and acquisitions, including those by foreign investors. Since the Japanese experience is most striking, it is

worth exploring as a case study.

The keiretsu system was assembled in Japan after the Second World War. It involved close collaborationbetween business and government bureaucrats and led the war-torn country onto a path of rapid economic

growth for four decades. Government and business leaders allocated capital to key industries and forged a

powerful export-driven economy. Rapid growth begot high savings rates, further fueling the economy and

making Japan, Inc. self-sufficient in terms of capital. This arrangement was extremely well suited for the

world economic system governed by the Bretton Woods doctrine of fixed exchange and interest rates, free

trade and immobile capital.

In light of the widespread prosperity and stability garnered by the keiretsu system, it is easy to understand

why the Japanese were hesitant to dismantle it. However, the rules of the global economy have changed

rapidly in the past two decades. Worldwide liberalization has re-defined the role of the state; new

technologies have ushered in the Information Age, which, in turn, has accelerated the pace of change in

the business world; each of these developments has raised sharply the flow of goods, services, information

and capital across national borders.35 Cumulatively, these developments have created the embryo of a truly

integrated global economy rooted in capitalism. It appears as though the keiretsu system is ill equipped to

deal with these new rules.36 In fact, one influential Japan expert traces the origin of the present economic

problems in the design of the postwar financial system, which was part of an overall plan that gave the

government unusual power to guide the economy.37

Until recently, large banks dominated the Japanese capital markets. The industrial conglomerates relied

very heavily on these banks for access to capital. But the implosion of the bubble economy in the early

1990s, which unleashed the looming threat of deflation and a string of bankruptcies, forced a re-evaluation

of Japan, Inc. Globalization demands openness and the erection of a level playing field, both of which run

contrary to the keiretsu system.

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Risutora, the Japanese term for restructuring, is transforming the way that savers and investors interact. At

present, only 9% of Japanese household financial assets are held in stocks, bonds and mutual funds, as

against two-thirds in the US. Yet, the role of the big commercial banks is diminishing, as various forms of

direct financing take off. Consequently, greater emphasis is being placed on shareholder value, allowing

for a more efficient process of capital allocation. In September 1999, theFinancial Times wrote of these

changes:

The ice is breaking in corporate Japan What is startling about the keenly awaited restructuring plans from NEC, the

electronics group, is the language used. NEC is talking about shareholder value, and about how it is going to evaluate its

businesses in future by such un-Japanese yardsticks as free cash flow and return on equity. Its Internet service provider is

seen as the driving force behind the company over the next few years

There are still lots of companies in Japan that are not subject to foreign competition and are not in dire straits, and many of

them are still trying to pretend that their world has not changed. But the impact of deregulation and greatly improved

distribution systems will hit them too, even if it takes a little time

As Japans politicians continue to posture in much the same old familiar ways, the economy is at last beginning to be

restructured, from the ground up.38

Moreover, changes in commercial law and accounting rules are making it easier for firms, including foreign

corporations, to sell and acquire businesses. Some of the more notable deals include the acquisitions of

Nissan by French carmaker Renault and of Long Term Credit Bank (LTCB) by US private equity firm

Ripplewood Holdings. The sale to foreigners of Renault and LTCB, once among the jewels of Japan, Inc.,

is a sign of the times for a firm to compete in the global economy, it must prove that it can compete withforeign firms on its home turf. Other Japanese firms, especially banks, are preparing for increasing foreign

competition by entering into defensive mergers. To this end, the 1999 merger of Fuji Bank, Dai-Ichi

Kangyo Bank and Industrial Bank of Japan created the worlds largest bank with 140 trillion yen in assets.

Shortly after that merger was announced, Sumitomo and Sakura banks agreed to complete a merger by

2002, yielding another super-bank with nearly $1 trillion in assets.

Even so, size alone does not ensure competitiveness (in fact, in many cases, it can be detrimental, as

illustrated by IBMs failure to adapt quickly enough to stave off competition from upstarts Hewlett-

Packard, Apple and Microsoft). Firms need to be better managed in order to survive. In fact, recentresearch shows that microeconomic factors, such as the quality of management, are playing an increasingly

influential role in determining corporate profits.39 Meanwhile, the impact of macroeconomic factors the

most important being GDP growth on corporate earnings seems to be on the decline. Analysts attribute

this change to the following: One, the increasing role of international trade (one-third of earnings now

come from overseas, as against one-sixth in the mid-1980s); two, the changing composition of the Standard

& Poors Index toward companies that are less dependent on volatile commodity prices (technology and

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services firms now dominate the Index, whereas oil companies once held this position); and three,

improved managerial techniques and supply chain management (e.g.,just-in-time inventory) have slashed

costs and improved efficiency. Bruce Steinberg, chief economist for Merrill Lynch, heralds the growing

impact of management as probably the most rapid change in corporate business models in history.40 This

revolution in management will only raise the intensity of competition in the emerging global marketplace.

3. The Developing World: Open for Business

Globalization is producing profound changes in the way multinational corporations are operating, and

generating new opportunities as well as challenges for the developing world. Reduction in barriers to entry

and the programs of privatization carried out by many developing countries in particular, those in the

regions of Latin America and Eastern Europe have significantly increased the presence of multinational

corporations (MNCs) there. This has happened as a result of greenfield investment as well as by theacquisition of assets from both the public and private sectors. In the past, mergers and acquisitions (M&A)

activity in the developing world was relatively rare; it increased significantly as a consequence of the

opening of the Latin American countries in the late 1980s. This trend was continued by the Eastern

European countries as they abandoned communism and adopted capitalism. Following the severe

economic crisis of 1997-98 in East Asia, the countries in that region have also begun to welcome

multinational corporations. These firms, in turn, acquired domestically owned assets.

As illustrated in Table 7, the value of cross-border M&A has risen dramatically in recent years from $81

billion in 1991 to $720 billion in 1998, including a 59 percent jump from 1997 to 1998.41 The share of

developing countries in this activity was insignificant at the start of the 1990s. In 1991, M&A by

developed countries into developing countries amounted to less than $6 billion. Seven years later, in 1998,

it increased to $81 billion. In other words, the share of total M&A that took place in the developing world

amounted to only 7.2 percent in 1991, but rose to 21.2 percent in 1997.42 By the end of the 1990s, the

MNC had established a significant presence in the developing world.

The role of multinational enterprises in economic development has been controversial for many years.

From the end of the Second World War until the 1980s, most developing countries, fearing exploitation,

TABLE 7 - Cross-border M&A sales (Billions of US$) Average for

Region 1991 1992 1993 1994 1995 1996 1997 1998 1999 1991-99World 80.7 79.3 83.1 127.1 186.6 227.0 304.8 531.6 720.1 260.0Advanced economies 74.1 68.6 69.1 110.8 164.6 188.7 234.7 445.1 644.6 222.3Developing economies 5.8 8.1 12.8 14.9 16 34.7 64.6 80.8 64.6 33.6Asia 2.2 3.6 7.3 4.7 7 13.4 21.3 16.1 25.3 11.2Latin America & Caribbean 0.63 2.1 2.3 2.6 2.1 3.6 15.7 17.1 2.9 5.4Source: UNCTAD. 2000. World Investment Report.

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foreign influence and the potential for increased market concentration, sought to prevent multinational

conglomerates from penetrating their markets. This began to change in the 1980s, as many nations came to

recognize the benefits of attracting investments by MNCs. These benefits include FDI, transfer of

technology, and in many cases, substantial export earnings.43 Emerging markets can also use

multinationals to gain a foothold in the global economy, where multinationals act as units of integration.

Their global-scanning capacity enables them to divide their operations among the many countries in

which they operate, sourcing production in each country according to its comparative advantage. It is for

these reasons that the exploitation ofcorporate advantage by a multinational corporation often promotes

the exploitation ofcomparative advantage by its host countries.44 In other words, the interests of both the

multinational corporation and the host country often overlap, producing an outcome of advantage to both.

Integration of national economies into larger regional economies, and even into a single global economy,

increases the potential efficiency gains that can be achieved by economies of scale. MNCs often catalyze

the export of complex, technology-intensive products made by small- and medium-size firms (SMEs)located in host countries. For example, approximately two-thirds of consumer electronic products made in

Korea and Taiwan are sold to MNCs such as GE, IBM and Toshiba on an original equipment

manufacture basis.45 In addition, research indicates that the presence of foreign multinational affiliates in

an economy stimulates competition and raises productivity levels of all firms that is, not only the

affiliates, but also domestic firms, presumably in response to increased competition and transfer of

knowledge.46

Most MNCs now exercise much tighter control over their foreign affiliates than in the past. They have

implemented increasingly complex integrated international production systems, which now comprise

close to one-third of world trade.47, 48 The term integrated international production describes the

decoupling of production of a good into its subcomponent parts and processes, which in turn are

distributed across countries on the basis of comparative advantage.49 Thus,

firms split up the production process into various specific activities (such as finance, R&D, accounting, training, parts

production, distribution), or segments of these activities, with each of them carried out by affiliates in locations best suited

to the particular activity. This process creates an international intra-firm division of labor and a growing integration of

international production networks.50

Thus, a Toyota automobile can be built by the cumulative efforts of Toyota affiliates in scores of countries

across the globe. A car might be designed by Japanese engineers; the upholstery could be produced in

Argentina; the engine might be built in Mexico; and the car might roll off the assembly line in Brazil and

shipped to a dealership in Canada. This type of specialization the integrated international production

system allows each economy to contribute to the final product according to its comparative advantage. It

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is a fundamental component of globalization, as it integrates the efforts of several economies to produce a

single product. Integrated international production increases efficiency by exploiting economies of scale.

Driven by the overwhelming need to turn profits, MNCs are becoming increasingly dependent on

developing countries for low-cost labor and new markets, just as developing countries are dependent on

MNCs for capital and technology. Thus, the world is entering a period of growing interdependence

between MNCs and the developing world in which both parties will benefit from greater interaction.51 The

challenge is for developing countries to structure their economies in a way that gives them much to offer

MNCs in the way of human capital and other resources supported by a strong macroeconomic, legal and

institutional framework.

The exports of many developing countries are concentrated among a few types of products, particularly

natural resources and agricultural goods. This is especially true in Latin America and Africa. Exports from

East Asia and now, increasingly from India are technologically more sophisticated.

52

The reliance oncommodities for export earnings leaves these nations more susceptible to external shocks. Developing

countries that lack the capital and technology necessary to compete in global markets can diversify their

export bases by attracting investment by MNCs, thereby hedging against unfavorable movements in the

world prices of certain exports. The capital, technology and management methods contributed by MNCs,

when combined with low-wage labor and abundant natural resources provided by developing countries,

results in a symbiotic relationship stable, long-term investment is stimulated, technology transferred, new

types of goods and services produced, jobs created, profits earned, tax revenues generated to the host

country government and the host countrys export base diversified.

Finally, MNC investments, whether they take the form of privatization, greenfield FDI, or M&A, will

result in substantial benefits for the developing world only if supported by smart, effective regulation. This

involves antitrust legislation, environmental oversight, protection of fair labor standards, and removal of

distortions such as local content requirements and labor market rigidities.

Despite the potential benefits of attracting multinational corporations, many countries have, especially prior

to the 1990s, been reluctant to accept them. This is the result of a number of concerns, mostly related to the

potential for exploitation of the host country by the MNC a point that is covered in more detail later in

this section. This is partly political in that control of economic assets by foreigners tends to be unpopular.

The potential for increased pollution and erosion of worker rights are two more examples of possible

manipulation by MNCs. In addition, the fear of exploitation has a macroeconomic dimension. Insofar as

the presence of powerful multinational corporations renders existing and potential domestic firms

uncompetitive, the efforts of local entrepreneurs will be stifled. MNCs are also known to take advantage of

the differences in tax regimes among countries, thus contributing to leakages in tax revenues. Moreover,

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most of the profits earned by MNCs are repatriated to their home countries, usually OECD nations. Of

course, without the infusion of capital and technology made possible by MNCs, these profits would not

exist in the first place; neither would a number of productive jobs.

Traditionally, developing countries have been more reluctant to welcome capital inflows resulting from

M&A than from greenfield FDI. The major concern is that, unlike greenfield investment, M&A involves

not the establishment of new production facilities, but the acquisition of existing facilities, often

accompanied by payroll cuts. This is an uninformed view. Greater integration of the developing worlds

enterprises in the global economic system through mergers and acquisitions serves an important purpose.

Like greenfield FDI, it also brings capital, new technology and managerial practices. M&A can salvage

existing facilities that otherwise would not survive liberalization or other competitive pressures. Of course,

the greatest benefit resulting from M&A may be that it improves efficiency and international

competitiveness.53 This is especially true of the privatization of loss-making, state-owned enterprises.

Policymakers from East Asia and Latin America can learn a great deal from each other in terms of how to

gain the most from multinational corporations. Each region has had very different experiences with MNCs,

although both began to attract large flows of investment from foreign corporations only recently.

Latin America began to attract large flows of FDI from foreign investors and MNCs when nations there

began to liberalize their markets in the late 1980s. Large-scale privatization drives continue to attract very

large flows of FDI. Even more encouraging is the fact that the privatization movement is showing signs of

creating a self-generating flow of FDI as a growing share of inward FDI is directed toward the restructuring

and expansion, rather than the purchase, of former state-owned enterprises. In 1998, Latin America

received $73.7 billion of FDI, $29b (39%) of which went toward the purchase of state-owned enterprises

while in 1999, it received $90.5b of FDI, with just $21b (23%) going toward the purchase of state-owned

enterprises.54

On the downside, most of the investment by MNCs in the region has gone into non-tradable services,

manufactures for the domestic market and natural resource-intensive industries.55 Thus, investment by

MNCs in many Latin American countries has done relatively little to upgrade or diversify their export

sectors. This is natural, however, in light of the regions present stage of structural reform. Former state-

owned enterprises, particularly those which served the domestic market (i.e., the legacy of import-

substitution industrialization), tended to be vastly inefficient and lacked the resources and incentives to

maintain an adequate level of investment. At this stage of Latin American structural reform, a great deal of

foreign investment is now going into these recently privatized industries to make up for the upgrade and

expansion foregone. As the process of structural reform continues further, a greater share of foreign

investment will go into the export industries. Major Latin American governments are taking steps to hasten

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and strengthen this process by passing measures to improve competitiveness. Brazil, Chile, Peru and

Mexico now allow their currencies to float freely, thus reducing the burden of an overvalued exchange rate,

while Argentina, which lacks the former option, has passed numerous measures to balance the federal

budget and make labor markets more flexible.

In contrast, a large share of investment by MNCs in East Asia goes into the export sector, especially into

technology-intensive and manufacturing activities. This is a testament to East Asias international

competitiveness and deep linkages with the global economy. Like Latin America, East Asia, until fairly

recently, largely ignored the potential for economic benefits that foreign corporations could bring. Of

course, with very high savings rates and a wealth of human capital (in stark contrast to Latin American

economies), the tigers were not particularly dependent on foreign capital and expertise. This changed in

the 1990s, especially when the financial crisis struck. Korea, Thailand and other Asian tigers found

themselves in need of foreign investment to restructure and re-capitalize ailing domestic firms. Table 8

shows a dramatic increase in the value of cross-border M&A sales by Southeast Asian firms, albeit from a

low starting point, from $2.6 billion in 1996 to $14.7 billion in 1999. Most of this investment has gone into

the secondary sector, which consists mainly of manufactures. The electronics industry, which drew over $2

billion of M&A sales in 1999, was particularly attractive to foreign corporations. By opening further to

foreign direct investment by MNCs in the years ahead, the economies of East Asia will reap substantial

benefits in the form of faster productivity growth, greater transparency, more stable capital inflows and

more intense competition.

In sum, the entry of multinational corporations into the developing world has the potential to raise

efficiency, facilitate integration with overseas markets and bring new technologies and management

methods. The challenge for policymakers will be to harness this vast potential while limiting the scope for

abuse, particularly in the realms of market share, politics and environment.

TABLE 8 - Sales of cross-border M&A by sector classification (millions of US $)1991 1992 1993 1994 1995 1996 1997 1998 1999

Southeast Asia* 1,093 1,180 866 1,567 2,468 2,558 6,308 10,866 14,719- Primary 46 93 59 76 3 367 146 47- Secondary 648 285 196 248 457 935 5,134 5,087 8,125- Tertiary 400 895 577 1,260 1,935 1,619 807 5,633 6,547

Latin America 3,529 4,196 5,110 9,950 8,636 20,508 41,103 63,923 37,166- Primary 159 599 304 2,337 211 560 1,445 829 287- Secondary 982 1,060 1,971 2,807 2,918 8,497 11,184 19,285 20,422- Tertiary 2,388 2,538 2,835 4,806 5,508 11,451 28,474 43,268 16,456

* Indonesia, Korea, Malaysia, Philippines and Thailand

Source: UNCTAD. World Investment Report, 2000.

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4. Developing Country Corporations Go Multinational

The penetration of the developing world by Triad-basedv MNCs is not the only result of trade and

investment liberalization. Another, more recent, phenomenon has been the emergence of MNCs based in

the developing world. The growing international presence of developing country corporations is evident in

their rising share of global FDI flows, from just 3% ($1.7 billion) in 1980 to 8% ($66 billion) in 1999.56

While only one developing country firm made the 2000 UNCTAD list of the top 100 MNCs, more may be

on the way, particularly if these countries sustain the momentum of structural reform.vi With that caveat in

mind, one could predict an increasing number of large MNCs emanating from India, as that country gives

rise to a plethora of fast-growing IT firms such as Infosys and Satyam Infoway, both of which are now

listed on the Nasdaq. Old economy types of Indian firms also have begun to acquire assets abroad, most

notably, Tata Teas acquisition of Tetley. However, it is in the IT sector that the Indian firms will create a

space for themselves in the global arena.

Beginning in the late 1980s, most Latin America nations began stripping away the many layers of the

import substitution model they had piled on since the 1960s. Essentially, four forces embodied this

revolution.57 Two of these were driven by policy, one by technology and the fourth by demographics. The

adoption of the Washington Consensus placed new emphasis on fiscal prudence and competition.

Privatization and liberalization of trade and investment constituted the means to obtain these objectives.

Led by Argentina, Latin American governments privatized large, inefficient state-run enterprises in power,

water, telecom and transportation, opening these sectors to competition. The liberalization of trade via

the sharp reduction of tariffs and non-tariff barriers and foreign investment via opening of the capital

account and relaxation of taxes and investment regulations dramatically increased the role of triad-based

MNCs in the region. MNCs from Spain, in particular, expanded aggressively into South America, while

US firms responded to NAFTA by stepping up relations with Mexico. Perhaps more importantly, Latin

American firms, as a result of trade liberalization, gained an outlet to the global marketplace, and the

insatiable American consumer market, in particular. This opens up an incredible opportunity for Latin

American firms to expand abroad to grow into what one observer calls multi-Latinas. Mercosur is

acting as an incubator for emerging multi-Latinas, allowing firms to achieve economies of scale and to

develop regional strategies. Now that macroeconomic stability, democracy and some level of labor market

flexibility are fairly well rooted in much of the region, the pieces are falling into place for Latin American

corporations to go global.

In addition to the reforms enacted as part of the Washington Consensus, the third and fourth major forces

reshaping the Latin American business landscape are, respectively, the emergence of information

v The Triad refers to the United States, European Union and Japan.vi Actually, UNCTAD uses the term transnational corporations or TNCs.

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technology (IT) and youth. The former allows Latin firms to implement very sophisticated digital systems,

which cut costs by improving relations with suppliers and streamlining supply chains and increase revenues

by improving customer relations. A recent study by IDC, an IT consultancy, forecasts the annual growth of

Internet commerce revenues in Latin America to exceed 100% for each of the next three years, reaching

$11 billion in 2003.58 Over the same period, the number of Latin American Internet users is expected to

grow from 7 million to nearly 20 million.

The fourth component of the Latin American business revolution is the entry of youth, which is remolding

the corporate culture. For decades, powerful, closely knit family groups, known as grupos, wielded

heavy influence over Latin American business in much the same way as the chaeboldid in Korea. One key

difference is that thegruposproduced mainly for the domestic market, while the chaebolproduced mainly

for export. Whereas the chaebol were disciplined by international competition, thegrupos instead devoted

their efforts to lobbying government to insulate them from foreign competition.

Even after the economic and regulatory overhaul conducted as part of the Washington Consensus, the

founding fathers of thegrupos remained firmly in place atop their businesses and continued their

dominance in corporate affairs. But demographics are changing all that. The heads of thegrupos are now

retiring and being replaced by a younger generation of more sophisticated and well-educated executives

who are keen to prosper in a more liberal economic environment. This culture is in stark contrast to that of

thegrupos, which evolved within a closed and heavily regulated economic system. The new generation of

Latin American executives are bringing modern management techniques, financial accounting systems and

business strategies to their corporations.

These developments, which are reshaping the corporation in Latin America, are by no means restricted to

that region. The decline of the keiretsu in Japan, the unwinding of cross-shareholdings in Germany and

increasing emphasis on corporate governance in places as diverse as Southeast Asia and Amsterdam all

point to the global corporate revolution that is occurring in response to globalization. Clearly, it is the

developing world that is most backward in this regard, and hence, has the most to gain from reform. The

need to implement international best practices at the corporate level was one of the major lessons of the

financial crisis that erupted in Southeast Asia three years ago. Consequently, the Korean chaebol, such as

Hyundai and Samsung, are restructuring, reducing leverage and improving transparency.

In response to the liberalization of the developing world, the corporations based there are growing and

expanding abroad. FDI outflows (a measure of foreign investment by MNCs based in a given country)

from the developing world accounted for 14% of global FDI outflows in 1997 (up from 5-7% in the 1980s),

but fell to just 8% the following year, due to the financial crises in East Asia, Russia and Brazil.59 In all

likelihood, the 1998 slump was nothing more than an anomaly and FDI outflows from developing countries

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will continue to grow both in absolute terms and as a share of the world total. In general, FDI outflows

from developing countries tend to go to other developing countries.60 Of course, this increasing flow of

investment between developing countries does not yield a zero-sum outcome. Rather, it represents a more

efficient allocation of capital, as developing country firms invest not according to legal constraints, but

wherever the risk/return relationship is most favorable. Liberalization and structural reform have

encouraged the proliferation of developing country multinationals, as the erosion of protection in the home

market forces these companies to take a more global approach in locating customers and factors of

production. The trend toward regional trade pacts also gives these firms a larger home market and allows

for greater diversification. Finally, the widespread adoption of export processing zones (EPZs) has

stimulated the growth of Third World multinationals, as these firms constitute approximately 16-22% of all

foreign investors in EPZs worldwide.61

Even as privatization and liberalization gain steam, there remains the temptation for policymakers in

emerging markets to focus on industrial policy and to build national champions. Indeed, this approachwas instrumental in several very successful Asian economies most notably, Korea and Japan, where the

economy was dominated by the close relationship between government and big business. Bureaucrats

steered capital toward the chaebols in Korea and toward the keiretsu firms in Japan. For over three

decades, this industrial policy brought rapid growth and widespread prosperity to both countries. But the

potential for corruption and inefficiency was always very high. Eventually, this system of allocating capital

collapsed. Throughout the 1990s, Japan struggled to recover from the bursting of the bubble economy

and Koreas chaebols suffered dearly in the Asian financial crisis. In both cases, the cozy relationship

between bureaucrats and business obscured mounting evidence of financial mismanagement, allowing non-

performing loans, debt-to-equity ratios and unhedged liabilities to grow. In the past, this same arrangement

produced fantastic results, but the rules of the global economy have changed. Economies that favor

transparency, free markets, openness and vibrant competition will gain the most from globalization.

Economies that favor a select group of firms, where the public sector extends implicit guarantees to protect

these firms and where bureaucrats, not free markets, determine the allocation of capital will suffer as

international investors and consumers demand openness and efficiency.62

Policymakers in the developing world should consider the new demands of international investors and

consumers when designing policy. They should concentrate on setting the conditions for the most efficient

firms to succeed, rather than pin the economys hopes on a few chosen firms. Allow the firms that best

navigate the markets to succeed. They will be leaner and more competitive. Many will find a niche or

comparative advantage that enables them to grow internationally. Allow foreign firms to provide the goods

and services that they can produce more efficiently. Policymakers should not appoint national

champions; they should try to provide an enabling environment and allow the markets to pick the winners.

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5. About Face: MNCs in the Court of Public Opinion

Shortly after the end of the Second World War, numerous colonies from India to Indonesia and elsewhere

gained independence. These newly autonomous nations entered the global economy as developing

countries. But with fresh memories of their colonial past, most of these nations viewed the advanced

countries with suspicion. As the troops from Britain, France, Japan and other nations withdrew from their

soil, many of these newly independent countries planned to insulate themselves from any future penetration

of the corrupt influence of foreign hegemony. As the economies of Europe, Japan and the US roared back

to life after the war, many developing countries saw the mighty corporations (which, at the time, were

based in America for the most part) as a fleet of Trojan horses. These suspicions were not totally

unfounded. After all, colonialism arrived in India and the East Indies on the backs of multinationalcorporations. Countries in Latin America and Africa, in particular, sealed off their economies and focused

their energy on import substitution industrialization (ISI).

Meanwhile, the advanced nations set about building a liberal world economic order, buttressed by the IMF,

World Bank, the GATT and the United Nations. By lowering barriers between nations and pooling

resources to foster prosperity and stability throughout the free world, these countries enjoyed the fruits of

liberalization and the beginning of the second great wave of globalization.

In the late 1980s and early 1990s, a number of important developments occurred throughout the world:

Eastern Europe abandoned communism; the major Latin American nations abandoned ISI and embraced

democracy and free markets; China continued to make steady and impressive progress toward integrating

with the global economy; India, buried by a balance-of-payments crisis, began to liberalize its economy;

and finally, the Soviet Union collapsed. These events brought about 3 billion more people into the world

economy, precipitating an acceleration of globalization. As autarkic, state-led industrialization fell out of

favor, much of the developing world changed course and welcomed the investment and technology offered

by MNCs. Indeed, governments in the developing world quickly came to view multinational corporations

as the embodiment of modernity and the prospect of wealth: full of technology, rich in capital, replete with

skilled jobs.63

The euphoria of the early 1990s dissipated rather quickly once it became evident that the transition to a

truly global economy would be a long, bumpy ride with little understood implications. Just as the

developing world in the late 1980s quickly reversed its stance toward economic integration and

multinational corporations, so too did large (or at least, loud) factions within the industrial countries. Labor

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unions, sunset industries (e.g., textiles), environmentalists, isolationists and all sorts of civil society groups

in the United States and Western Europe began to agitate against globalization. This agitation has been

illustrated most vividly in the anti-corporate, anti-globalization protests in Seattle and Washington, DC; in

the hoopla surrounding Jos Bov, the French farmer who destroyed a McDonalds restaurant; and in the

populist rhetoric of Ralph Nader, the Green party candidate for US president. Jagdish Bhagwati of

Columbia University describes this strange role reversal:

If the poor countries once worried about the outflow of their skilled the brain drain to the center, scholars like George

Borjas and Orlando Patterson and the [labor] unions now fear the inflow of the unskilled from the periphery. Poor

countries once worried that trade with the center would harm their nascent industrialization and development; today, trade

with the periphery strikes terror into the hearts of the centers unions, who believe their wages will be reduced to Chinese

levels. Whereas the periphery once resisted the inflow of FDI, rich-country unions now resist its outflow. If the periphery

once opposed being dominated by the center, the center now fears losing its identity to the periphery. 64

The fireworks at the 1999 WTO ministerial meeting in Seattle came as a rude awakening for anyone whothought that these groups were too disjointed, paranoid and ignorant to fulfill any objective other than to

annoy. The follow-up to the Seattle protests took place in Washington, DC at the 2000 IMF-World Bank

Spring meetings. But one should be careful when attempting to pinpoint the target of the protestors.

Although the protestors gathered at the meetings of international institutions, multinational corporations

and capitalism itself drew much of their ire. While this anti-corporate lobby remains a small minority,

albeit a very loud one, its demands reflect real concerns and a general lack of understanding about

globalization that might well be shared by quieter, more mainstream members of society. Their actions and

rhetoric were enough to persuade US President Bill Clinton to call for the inclusion of labor standards in

WTO procedures. If these protests were enough to sway President Clinton the same president whofought for NAFTA and for permanent normal trade relations with China it would not be outrageous to

think that they might gain a critical mass of public opinion. But while many of the various concerns about

globalization are legitimate (some, of course, are absurd), many of the remedies proposed by the protestors

stem from poor understanding or garbled logic.

In many cases, civil society feeds off of anti-corporate and anti-establishment sentiment. Several consumer

rights groups have concluded that since trade liberalization benefits big business, it necessarily does so at

the expense of consumers nevermind the inherent contradiction of protecting the rights of consumers by

denying them wider selection and lower prices.65 Few dispute that protecting public goods such as the

environment is important, but for the most part, the downsides of doing so among others, that the pace of

economic development would slow have been largely ignored by popular media. Let us take a closer

look at some of the issues raised by the anti-corporate lobby in Seattle as they pertain to MNCs.

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Multinational corporations have become too powerful in absolute terms as well as relative to

governments. The enormous resources controlled by multinational corporations (See Section 1: Power

Play) give them a tremendous amount of power, especially relative to individuals and governments.

The ongoing reduction of national barriers to trade and investment enables these firms to close shop

and head overseas if government, workers or NGOs place restrictions (e.g., minimum wage, taxation,

labor standards, fines for pollution, etc.) on them or otherwise inhibit their ability to earn profits.

The criticism stated above is the focal point of the presidential campaign of Ralph Nader, long-time

consumer advocatevii and critic of large corporations. Certainly, there is a danger that any organization

that controls resources and market share on a par with giant conglomerates like Nestl or General

Motors may abuse its power, perhaps in ways that undermine democratic processes or hurt consumers.

But these corporations earn their profits through efficiency and innovation, without which they would

quickly lose market share to rivals. They employ millions of workers with competitive wages, provide

relatively low-cost/high-quality goods and services to consumers and enrich shareholders. Moreover,they must accomplish all of this without stepping beyond the boundaries of antitrust law in the

countries in which they operate. If they fail to meet all of these objectives, they will be bought out or

bankrupted by more competent rivals. The antitrust case against Microsoft, the blocking by the US

and EU of the proposed Worldcom-Sprint merger and the enormous penalty imposed on the US

tobacco industry by jurors in the state of Florida all serve as evidence that the power of MNCs remains

firmly in check by national governments.

The confusion concerning the power of corporations to influence government, perhaps at the expense

of the social good, stems from the fallacy of equating economic power with political power (i.e.,

MNCs can use their considerable financial resources to undermine democracy). In light of the profit

motive, it is rational for a firm to spend money to influence legislation to its favor if doing so is likely

to enhance profitability in fact, this is essentially just a form of investment. Hence, the

pharmaceutical company Schering-Plough has lobbied US Senators and contributed political donations

to legislators in order to win a renewal of its patent on the popular allergy drug Claritin. Therefore,

argue anti-corporatists, the rights and privileges of corporations must be scaled back for the sake of

democracy and the greater social good. Of course, doing so would impose on the economy hefty costs

in efficiency, employment, output, investment and trade. But economic power is not equivalent to

political power. There must be a link for one to translate into the other. In some countries, this link is

stronger (i.e., it is easier to leverage one type of power to attain the other) than in others. Governments

must work to sever this link in order to improve the social good while also maintaining the economic

benefits that only corporations can bring. The means to this end are greater transparency, anti-

vii Actually, Nader represents only 150,000 (0.06%) the membership of Public Citizen of the 270million US consumers, although he claims, without our consent, to speak on behalf of the other 99.94% aswell.

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corruption measures, conflict of interest laws (e.g., the President cannot use his office for personal

financial gains), limits on political donations by corporations and individuals, and independent checks

and balances to ensure that these rules are complied with. The solution is not to destroy one power to

prevent abuse, but instead to separate the powers. In the US, the drive for campaign finance reform

aims to break the link.

Multinational corporations put profits before people. Critics contend that too much emphasis is placed

on attaining profits and enhancing shareholder value. The sharp focus on shareholder value causes

firms to undertake activities that reduce the level of social welfare in order to make a buck.

It is true that the sole focus of a corporation is to earn profits. However, the simplicity of the corporate

incentive system facilitates regulation while encouraging efficiency. For example, a firm will not

pollute if the cost (e.g., a fine, for instance) is greater than the benefit (e.g., money saved by bypassing

proper disposal). That is why legislation based on the polluter pays principle is so effective and soefficient. A corporation will not abuse its workers, consumers or shareholders, lest these parties

abandon the corporation for one of its competitors. Collective action by competing corporations could

allow them to circumvent this outcome, but laws, penalties and surveillance are, in most cases,

sufficient to prevent such collusion. Moreover, the rapidly growing capacity of civil society,

particularly NGOs, places a heavy check on corporate practices. The increasing sophistication of

telecommunications and the scope of media coverage ensure that harmful corporate practices are

revealed to millions of people. In this way, mobilization by citizens, fines levied by governments,

class-action lawsuits and scrutiny in the media all adversely affect the single objective of any

multinational corporation: profit. Consumer boycotts, fines and other penalties cut into a firms

bottom line. Consequently, corporations attempt to avoid activities that might draw the ire of civil

society groups, government and consumers. Finally, empirical evidence shows that multinational

corporations typically use the more environmentally-friendly technology, which can be transferred to

developing countries via FDI, even when not required, and there is little evidence that governments

lower environmental standards in order to attract investment.66

Another contention is that multinational firms are too powerful in relation to workers and even unions.

Worldwide liberalization magnifies this mismatch. Fleet-footed multinationals can simply pick up and

move jobs overseas to a place where unions are weak or illegal, wages are low and working conditions

are horrific. Workers, on the other hand, cannot just pick up and head overseas in search of better

wages and working conditions. The result, according to this logic, is a race to the bottom in terms

of labor standards and wages. This is a deeply flawed argument. First, many, though certainly not all,

workers are mobile enough to move about in search of better work. Second, a firm cannot necessarily

reduce labor costs by trampling labor standards. It is only marginally more expensive (as a result of

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training expenses) for a firm to employ 100 workers, each working eight hours, than to employ 50

workers each working sixteen hours. And since the types of positions that are usually discussed in this

regard tend to require low skills, training costs are likely to be minimal, anyway. Moreover, a healthy,

happy worker is much more likely to be productive than one who is unhealthy, undernourished,

overworked and who despises his/her employer. Finally, labor costs represent only a fraction of total

production costs, and returns on labor represent only a fraction of total returns on factors of production.

Other factors that impact the choice of firm location include, but certainly are not limited to: proximity

to suppliers and markets; local costs of inputs such as raw materials, land and capital; the quality of

regulation; protection of property rights; and quality of the macroeconomic environment.

Multinational corporations abuse workers. The liberalization of trade and investment, critics contend,

allows MNCs to move operations from rich countries with high labor standards to poorer countries

with lower or non-existent labor standards, producing the giant sucking sound described by Ross

Perot in reference to free trade between the US and Mexico. The result is a race to the bottom inwhich workers worldwide must accept lower wages and increasingly unpleasant working conditions.

In poorer countries, MNCs employ heinous tactics such as child labor, abuse of female workers and

sweatshop labor.

Jagdish Bhagwati presents the other point of view:

Rich country labor unions as also some of the rich country NGOs such as Public Citizen in the United States have

become obsessed by the notion that outward flow of FDI is a source of harm to the working class there and,

remarkably, that these multinationals exploit the workers (by giving them low wages) in the poor countries. These

contentions are basically illogical. In the US, for example, in the 1980s at least as much FDI has come in as gone

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