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THE PRACTITIONERS' VIEWPOINT

2 November, 2015 - 16:27

The role one plays in the MNC-nation-state interaction is likely to influence the explanation one develops of the firm's rationale for investing abroad. Following are brief outlines of the explanations offered by labor unions, MNC managers themselves, and the U.S. Department of Commerce.

Labor unions look upon an MNC's decision to invest abroad as an excuse to avoid unionization, exploit cheap labor abroad, and, in general, export jobs to what are called "runaway plants."

MNC managers and their associations view the decision to invest abroad as a managerial response to a complex set of social, political and economic forces which, if not adjusted to, would seriously inhibit the future profitability, growth and survival of the firm. After reviewing the findings of the Emergency Committee for American Trade (ECAT), the Williams Commission, the Department of Commerce, and the National Foreign Trade Council, the National Association of Manufacturers offered the following reasons for a firm's decision to invest abroad: 1

  1. MNCs make foreign investments to get behind tariff and non-tariff barriers which make it impossible for them to serve a foreign market from the outside. These barriers combined with the rate of domestic inflation and high transportation costs seem to be a major incentive for U.S. direct investment abroad, especially in the European Economic Community. For example, a U.S. pharmaceutical firm must produce in France or lose the French market since pharmaceutical standards are regulated in France through periodic inspection of the production process. This method of providing consumer protection has resulted in a virtual embargo on the importation of pharmaceuticals into France.
  2. Many companies view international investment as a means of serving a foreign market more effectively and more efficiently than could be done through exportation. In addition to transportation and time savings, one of the main advantages of being close to the market being served is that the company can get a "better feel" of the market. This may enable them to tailor better their products to the purchasing patterns and customs of the local market and in this way increase sales over and above what would have been possible from export alone.
  3. Direct foreign investment may also be part of a defensive strategy to diversify and protect the firm from the risks and uncertainties of domestic business cycles, strikes and threats to its source of supply.
  4. Considerable foreign investment is made by MNCs in response to increased foreign competition. To meet the competition, a company may have to adopt a "follow thy competitor" strategy into the local market. In this case, direct foreign investment is made to prevent market pre-exemptions by competitors or to keep market outlets and sources of supply open. Today, with the challenge of Japanese products and increasingly large sophisticated European producers, this motivation is particularly strong. Service companies often invest abroad for defensive reasons because their competitors have also done so. This is particularly true of banks, insurance companies, and management consulting firms as well as manufacturing firms.
  5. Another motivation for direct investment abroad is the reduction of transportation and production costs. Many firms in the extractive industry are finding that given the rapidly rising cost of transportation it is cheaper to process raw materials on site and ship the processed, high value product than it is to ship relatively low value unprocessed raw materials.
Some manufacturing firms are able to reduce their cost of goods sold by combining U.S. technology with foreign labor and raw materials. In addition, production costs may also be reduced by spreading R&D expenses as well as certain other fixed costs between U.S. and foreign subsidiaries. The fact that the largest increase in U.S. direct investment over the last ten years has been in relatively high-wage, high-material-cost areas (Canada and Europe) indicates that this motivation, although important, is by no means the only factor which is considered when the decision is made to produce abroad.
  1. Many MNCs which license abroad find they can take better advantage of their technological advantage by manufacturing rather than licensing. Often, licensees are limited by their ability to raise capital to expand their facilities to take advantage of expanding markets.
Further, by operating abroad, a MNC can better monitor the technical innovations of other countries. For example, in the recent National Foreign Trade Council survey, several large firms indicated their foreign operations often enabled them to acquire new technologies and products which frequently stimulated domestic manufacturing and sales. It is likely if U.S. firms were not operating abroad, other foreign MNCs would have reaped the benefits of these technological breakthroughs.
  1. A number of experts, including Judd Polk, have argued that in order to protect foreign investment already made, many corporations are forced to continue to invest abroad in order to protect the value of the capital already employed. In other words, unless there is a continuous flow of foreign investment funds, the existing stock of capital would run down, jeopardizing the value in competitiveness of the whole foreign investment.
  2. Many firms are attracted to invest abroad by foreign incentives such as tax holidays, unlimited remittances, 100% foreign ownership and duty-free import of needed materials and machinery. Although these incentives are often pointed to with disdain by groups which oppose MNCs, they demonstrate the importance which certain foreign countries attach to attracting foreign investment.

In addition to many of the reasons cited above, the Department of Commerce offers the following motivations for investing abroad: 2

A need to diversify product lines to avoid fluctuations in earnings

A desire to avoid home-country regulations, such as antitrust laws in the United States