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WEEK 5
DEMAND SIDE
EFFECTIVE DEMAND, OUTWARD
INVESTMENT A N D THE THEORY OF THE
MULTINATIONAL FIRM

Multinational Firms 1

Dr Ruth Badru
 Outline:
• Quick Recap Lecture 4 & definitions
Learning Outcomes:

Week 5: • Introduce the divide and rule theory

(Sugden)
At the end of this class you should
understand

• Discuss the Marxist approach to  The main demand-side theory

capitalism explainingthe motivation of capital
Effective Demand, • We will explain its basic tenets
outflow through MNEs
 How demand-side deficiencies can
and how it applies to MNEs and,
Outward arguably, explains the motives
for international expansion of
provide an inducement for outward
investments by MNEs
Investment firms
 The role of productions costs in firms’

& • Introduce the theoryof wage decisions [to be MNFs] through

determination demand factors

The Theory Of The • We tie this to the demand-side

incentives for MNEs.
 The distinction between demand-side
(DD) and Supply-side (SS) approaches
to understand the incentives for
Multinational Firm • Discuss some evidence for the US and
the UK
multinational activity

• Revisit the Kaleckian approach

• Summarise the D D and SS sides

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• Richard Caves, Ch. 5
• Cowling K and Sugden R (1994), Beyond
Capitalism, Towards a New World
Economic Order, London, Pinter
Additional
• Pitelis, C., 1996. Effective Demand, Readings
Outward Investment and The (Theory of
the) Transnational Corporation: An
Empirical Investigation. Scottish Journal of
Political Economy, 43(2), pp.192-206.
 Recap: The Supply Side

 Pre-1960s: Dominant theory of FDI was the

 Hymer (1976) – in his PhD Thesis – developed a theory of FDI that attempted
to address the gap between earlier theories and business practice

 Structural market imperfections  Existence of firms 

exploit, increase, extend and reinforce
their market power through removal of conflict  Firms
enjoy monopolistic advantages  Structural market imperfections
 Recap: Transaction Costs, Markets &
Hierarchies

 Assumptions
i. Market is ‘original’ means of resource allocation
ii. Existence of hierarchies (e.g., firms) due to market failure

 Nature of market failure

Cognitive (natural) not structural; i.e., due to transaction costs and not monopoly power.
i. In neoclassical approach, departures from perfect competition  market failure (structural)
ii. In transaction costs approach, hierarchies (e.g. MNEs)  efficiency improving solutions to (natural)
market failure

NB: Hymer emphasized structural market imperfections rather than transactional ones, see
Dunning and Rugman (1985).
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 Recap: Transaction Costs - Internalization

Existence of firms  Economising in transaction costs  Firms more efficient than markets

In case of MNCs, choice is between market transactions (e.g., exporting, licensing) and non-
market transactions (i.e. Foreign DirectInvestment (FDI)).

The internalization theory suggests that MNEs internalize 'cognitive' or 'natural' market
imperfections, defined as those arising out of excessive market transaction costs, see
Dunning and Rugman (1985).
The basic notion that the firm exists in order to reduce the costs associated with the
operation of the price mechanism dates back to Coase (1937).
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 Recap: Eclectic Theory (Or ‘OLI Paradigm’)

• Dunning, combined the earlier approaches as well as location advantages to

provide an ‘eclectic theory’ or the Ownership, Location, Internalization (OLI)
paradigm.
• OLI explains internationalization of production, not the MNC.
• O explains why firms are able to become MNCs.
• I explains why they benefit from internalizing markets or advantages.
• L explains the choice of location.

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 Recap: SCHOOLS OF THOUGHT

• Neoclassical: Firm is ‘a production function concerned with the industry

price-output ‘equilibrium’, which maximizes profits.
• Managerial: Firms maximize utility of managers, e.g., sales revenue,
growth. Based on alleged ‘separation of ownership from control’.
• Transaction Costs: Firms are multi-person hierarchies which result
from, and give rise to reduced market transaction costs, resulting in
efficient industry structures.

• Marxist: Firms produce commodities for sale in the market for a profit,
under hierarchical control of capital over labour. Dialectic link between
competition and monopoly, for maintenance of monopoly (power).
 Recap: Some FDI Types

 Resource seeking
Includes most minerals, raw materials and agricultural products
 Market seeking
To increase the volume of sales in the foreign market
 Efficiency seeking
To exploit the comparative advantage of each location (for instance the low cost of labour in a
specific location to produce components to be re-exported).
International division of labour within the firm (network of firms)
Each affiliate specialize in a stage of the production process (or in a particular good)
 Strategic asset seeking
To obtain access to new technologies
SOME [NEW]
DEFINITIONS
Demand (D): The demand conditions firms face, in the form of a Demand Curve, derived
from ‘Theory of Demand’.

Effective Demand: This refers to the intersection of the and reflects the willingness and
ability to purchase goods and services in an economy, at various levels of employment.

A Commodity is a product (good or service) produced for sale rather than use – a
‘contradictory unity’, Marx says, of exchange-value (the commodity’s capacity to
command other products and money in exchange) and use-value (its capacity to satisfy a
need or desire).
 • Capitalism is an economic system
where private entities own the factors
of production.
• Capitalism emerges fromsmall-scale
commodity production when labour
too becomes a commodity.
• According to Marx, this happens
ASIDE: through a process of
dispossession that deprives
CAPITALI workers of alternative ways to
access means of consumption or
SM production, and that thus forces
workers to exchange their
capacity to work for a wage as if
this creative capacitytoo were a
commodity
 • Imperialism is the forceful
extension of a nation's authority by
territorial conquest or by
establishing economic and
political domination of other
ASIDE: nations that are not its colonies.
(NWE, 2018)
IMPERIALI • Imperialism can also arise
when increased concentration
SM of wealth leads to
underconsumption
 • Lenin’s theory of imperialism
revolves primarily around the
systematic exploitation of the
poor economies by monopoly
ASIDE: capital based principally in
the rich economies..
IMPERIALI
SM • This issue will be covered in
subsequent lectures.
DEMAND SIDE
Marx and kalecki
THE BASIC MARXIST IDEA

• Nearly all theories considered so far are based on notions of ‘efficiency’

• e.g. M N E versus exporting, specific assets
• But, there are two other, more critical, explanations
• One is the pursuit of market power (as in Hymer’s)
• The other (Marxist) is to control the labour process and hinges on the notion of power seeking

Marxist Theory (as opined by Marx) advocates that the means of production (i.e., the basis of power in
society) should be placed in the hands those who actually operated them.
Marx wrote that economic and political revolutions around the world would eventually place power in the
hands of the masses, the labourers.

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THE BASIC MARXIST IDEA: ECONOMIC
POWER
• A society is shaped by its forces of production.
• The two main classes of society are:
 The Bourgeoisie (who control the means of production and
wealth), and
 The Proletariat (who operate the means of production and are
controlled by the bourgeoisie).

Since the bourgeoisie own the means of production – and, therefore,

control the money – they can better manipulate politics, government,
education, art, and media.

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 THE BASIC MARXIST IDEA
• A central part of Marxian Economics is the question of the distribution of income
between capital and labour
• Modern Marxist economists have applied this to the question of why firms choose
to become multinationals
• Sugden & Peoples who refer to it as ‘divide and rule’ – reading list

Therefore, a Capitalist society will inevitability experience conflict between its

social classes. The owners of capital and labourers will have different ideas about
the division of the wealth generated, even though the power to make decisions
rests in the hands of the capitalists.

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The basic Marxist
idea
• Marx called on the proletariat to reject the
social structure of the bourgeoisie, the rules
that would keep them subservient forever, and
form their own values (e.g. through Unions)

• Such a course would be the only way to

escape the oppression, for the proletariat could
never defeat the bourgeoisie on its own terms.
For the workers to win, they must establish new
terms.

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Digression On The Theory Of Wage
Determination

Consider the standard neoclassical micro theory of wage determination:

• Case 1: Competitive labour market

Neo-classical Synthesis:
• Case 2: Monopoly labour union
• Case 3: Monopsonist employer
• Case 4: Bilateral monopoly

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 Case 1: Competitive Labour Market

Figure 1
• In any perfect market, price and
wage
quantity are determined at the point
where demand = supply Labour
supply

• In labour market, price is the wage

rate and quantity is the employment
Wc
level

• Equilibrium wage = Wc Labour

demand

• Equilibrium employment = Lc
Lc employment

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Case 2: Monopoly Labour Union: Higher Wage, Lower Employment

• Supply of labour is controlled by a Figure 2

monopoly trade union wage

• Union chooses employment level Labour

where ‘MR=MC’ supply

• MR = increase in the union’s (=workers’)

WMU
income from one more worker being
employed Wc
• MC =‘incremental cost’ of additional
worker
• Union’s objective is to maximise its
members’ net income Labour
demand
• It’s done at ‘price’ WMU, at that Marginal
price firm employs LMU workers revenue

• Higher wage (WMU) but lower LMU Lc employment

employment (LMU) than under
competitive labour markets 21
Case 3: Monopsony Buyer of Labour: Lower Wage & Lower Employment
• Demand for labour comes from a Figure 3
single monopoly firm
• Firm chooses employment level wage
Marginal labour cost
where ‘MLC=MPL=Demand’
• MLC=marginal cost to the firm of
employing one more worker
Labour
• MPL=extra revenue that the worker supply
generates Wc
• It’s done by employing LMB WMB
workers. To persuade that number
of workers, the firm offers a wage Labour
Demand (MRP)
rate of WMB
• Lower wage and lower
Lc
employment than under LMB employment

competitive labour markets

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 Case 4: Bilateral Monopoly: Depends on Bargaining Power
Figure 4
• Both sides are monopolised
• It is not obvious what happens wage
Marginal labour cost
• The firm prefers to pay the lower wage
(WMB)
• The union prefers to get the higher
wage (WMU) Labour
• A bargaining process, with the WMU supply

outcome determined by the Wc

relative bargaining strengths of

WMB
the 2 sides
• There is a vast literature on this. Labour
demand
But the basic idea is that ‘threat
points’ are crucial in deciding Marginal
revenue
which side gets the better of the LMB LMU Lc
bargain employment

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 Relevance to Multinationals?

• Most multinationals are big firms – often dominant employers in the towns in
which they’re located (remember the Amazon clip)
• So their Labour markets are not competitive
• Equally, however, they often have to deal with strong labour unions (though
not as much in recent times)
• Therefore, we have bilateral monopoly (as in figure 4)
• So the wage they pay will depend on bargaining
e.g. Amazon increased it’s minimum wage 4 months ago after workers’ protests and revelations
about its deplorable working conditions)

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Relevance to Multinationals?

• Cowling/Sugden’s key point: the firm can achieve a powerful and

credible threat by being multinational
• It can threaten the union with moving some or all of its operations
to another country
• This will lead to a lower wage (nearer to W M B )

• Obvious counter argument: ‘why can’t the union also arrange itself
along multinational lines, i.e. form an international union’
• This would redress the balance of power. How?

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Multinationals hold most of the power: more difficult for workers to
cooperate internationally
“It is difficult enough for Ford workers in one country, sharing a common language and
separated by comparatively small distances, to organise effectively against the company on
anything more than a local or shop level. Even here, major problems of communication,
sectionalism, and cumbersome national union machinery arise. On a European scale, the
problems are multiplied many times. Workers in France, Germany, Belgium, Spain and the UK
use six different languages plus those of the immigrants. It means much greater distances –
over a thousand miles from Halewood to Valencia, with disproportionately large travel and
telephone costs as a result. There are many more unions – and another layer, the
international union organisation ontop”.

- Peoples and Sugden, p. 175

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 Relevance to Multinationals continued

• Another way of putting this point is that capital is both much more mobile
and easier to organise than is labour
• Thus,‘divide and rule’: even if the multinational has to deal with unions in
each of the countries in which it operates, it can negotiate lower wages
(than if it were not MNE) by ‘playing off’one union against the others
• The argument becomes even stronger if the M N E is able to organise some
of its operations in foreign countries by subcontracting to small non-
unionised local firms

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Evaluation of the argument: Is it
really a Marxist idea?
• It is not a particularly Marxist idea to suggest that any profit-maximising
firm will locate as many of its operations as possible in countries where
labour costs are low
• E.g., it is commonly agreed that this is a large part of the explanation of
the multinationality of many European clothing and textile firms

• But this argument goes further than this. It suggests that, by going
multinational, the firm can affect or manipulate the wage rates it has to pay
in the different countries
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Evaluation of the argument: Is it really a
Marxist idea?

• In that sense, wages become endogenous,

• rather than exogenously determined by the market forces
• Again this is not exclusively a Marxist idea. It can also be justified using
standard neo-classical economics and bargaining theory.

• It’s really a matter of emphasis. The Marxists believe that the distribution of
income is the key motivation of capitalism
• More mainstream economists would argue that the labour bargain is
only one part (and quite possibly a small part) of the overall story

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The Evidence: British Experience

• Mainly anecdotal evidence of how car firms have threatened to move their
operations to other countries unless trade unions accept lower wages or tougher
working conditions

• Do M N E pay lower wages? The answer is clearly No (even Peoples & Sugden do not
deny this.)
• For example. Davies and Lyons (1991) found that average wages were 2 0 %
higher in foreign owned multinationals than in other firms
• Peoples and Sugden suggest a number of reasons why this sort of result is not
conclusive evidence against their theory

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The Evidence: US Experience

• Here, Peoples & Sugden rely on various claims by US labour unions

• Mostly, this is based on the argument that US multinationals ‘export jobs’ to
other countries
• But this is not quite the point
• One of their more interesting tables concerns a study by Greer & Shearer

• See Peoples and Sugden, pp. 180-189 for more detail of the various evidence
• See, also, their review of the Canadian experience

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 Other Theories:
Divide and Rule (Sugden)

• Dunning took more of a traditional economic perspective in

focusing on supply-side factors such as production costs and
transaction costs, rather than on market/demand conditions.

• Some additional theories however tried to bridge the gap

between both approaches:
Builds on Marglin-Hymer; Focuses on labour markets.
A reason for M N C s is their ability to divide labour (unions) in country
specific groups  Reduce their bargaining power  increase their
profits.

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Kalecki’s Marxist Demand-driven
Approach

• Originates in “theories of imperialism” of Luxemburg, Lenin, on the

inherent tendency of capitalism towards crisis.

• The potential importance of effective demand on firms' decisions to

seek 'external markets has also been acknowledged by Steindl
(1952), Baran and Sweezy (1966) and, of course, Kalecki (1971) in a
critique of Rosa Luxemburg.

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Kalecki’s Marxist Demand-driven Approach
Domestic markets driven by large firms
who want to increase their mark-ups
(profits) by reducing production costs

To reduce costs, variable costs (such as

labour costs) can be more easily
decreased

Since workers consume more of their

income than capitalists, Total/effective
demand also decreases.

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 Kalecki’s Marxist Demand-Driven
Approach
• The main point of these authors was that most domestic industries of advanced
industrial countries today are dominated by giant firms (aka MNEs), which
jointly attempt to charge the joint profit-maximizing (monopoly) price.

• This pricing policy generates a tendency for deficient effective demand by

reducing consumers expenditure.

• This in turn reduces the incentive for domestic investment, leaving outward
investment as a distinct possibility.

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Following Kaleckian Thought
• Cowling & Sugden, Pitelis: increased concentration  increased profits 
reduced consumers expenditure (because a lower proportion of profit is
consumed than of wage income).
• As consumption decreases so does effective demand  going overseas
for demand outlets.

• The M N C as an All Weather Company

• Diversified national firms can ride the industry life cycle (Hymer).
• M N C s can ride the national business cycle, becoming All Weather Companies.

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In Sum: Supply-Side
To summarize,
• Supply-side theories of the MNF tend to emphasize the exploitation of
monopolistic advantages by firms, the internalization of market
transaction costs, an eclectic synthesis of the two (an eclectic theory), or
the increased power over labour markets (‘divide and rule’ theory).
• In principle, all these theories can be integrated within the general
concept of internalization. MNFs can be argued to arise in order to
reduce ‘natural’ and structural market costs
In Sum: Demand-Side
To summarize,
• Demand-side deficiencies are claimed to be a reason (general incentive to firms) for the
internationalization of production.
They can arise from a competition-driven tendency towards monopolization.

• This demand-side argument helps to counter-balance the focus on the supply-side, even
though as it stands it fails to address directly the issue of the choice between institutional
forms.

• However, it provides a partial answer to the question 'Why internationalization?' but has
little to say on 'Why MNFs?' as opposed to exporting, licensing and/or subcontracting.
To answer these questions, it is necessary to go back to the supply-side theories.
 In the lecture, we:
 Introduced the ‘divide and rule theory’
 We examined the micro theory of wage
determination [competition, monopoly
and bilateral monopoly cases]
 Introduced the Marxian post-Keynesian
approaches and how they serve to explain
Quick recap FDI outflows
 Included the Cowling-Sugden explanation
of MNEs within this framework
 Critically judged whether theiropinion
holds in terms of the Marxist viewpoint
 Considered some empirical evidence.
 Summarised the key D D and SS
frameworks
 ENTRY, C O M P E T I T I V E N E S S & E F F I C I E N C Y
i. Modes ofEntry
NEXT WEEK ii. Mergers and Acquisitions ( M & A)
Before moving on, it is interesting to make a brief note on the surprising
consistency between Hymer’s market power view of FDI and the mainstream
Marxist approach to foreign investment, or neo-imperialism.
• The Marxist argument is that the level of concentration (“monopolisation”) of the
industries in capitalist countries generates very high profits. However, since
oligopolistic collusion imposes restrictions on the re-investment of those profits at
home, they must be invested abroad.
• Despite the difference in emphasis, this does not differ much from Hymer’s
explanation of the role of oligopolies in the existence of FDI. Nevertheless, the
Marxist theory tends to ignore the competitiveness of oligopolies that was central in
Hymer’s approach. Instead, they emphasise the collusive anti-competition aspect of
market power.
• As a result, the two approaches reach rather different conclusions: the neo-
imperialists (Marxist) conclude that the expansion of MNEs (mostly from developed
countries) into new (usually less developed) locations is nothing else but one more
vector of the expansion of imperialism and yet another vehicle for the
underdevelopment of the “Third World”.