____________________________________________________________________________________________________

Subject Commerce

Paper No and Title 11: International Business

Module No and Title Module 34: Multinational Corporations (MNCs in

international business)
Module Tag Com_P11_M34

TABLE OF CONTENTS

1) Learning Outcomes

2) Conceptual Framework of International Business (MNCs)

3) Host and Home Country Relations

4) Issues in Foreign Investment

5) Technology Transfers and Foreign Collaboration

6) Summary

COMMERCE PAPER No. 11 : International Business

MODULE No. 39: Multinational Corporations (MNCs in
international business)
____________________________________________________________________________________________________

1. Learning Outcomes

After studying this module, you shall be able to:

 Know the conceptual framework of International Business (MNCs)

 Evaluate host and home country relations
 Learn about issues in foreign investment
 Understand about technology transfers and foreign collaborations.

2. Conceptual Framework of International Business (MNCs)

In what follows, we will develop a conceptual framework, which will logically organize different
ideas to facilitate a basic understanding of multinational corporations. The conceptual framework
will basically distinguish between different but related concepts for the purpose in hand. It will
also provide a direction for the next round of discussion related to various issues pertaining to
MNCs.

2.1 Concept of Multinational Corporation

COMMERCE PAPER No. 11 : International Business

MODULE No. 39: Multinational Corporations (MNCs in
international business)
____________________________________________________________________________________________________

In simple words, MNC involves international relocation of

production. International relocation of production may be understood with respect to production
in the context of a domestic economy. Ordinarily, a firm undertakes a productive economic
activity by employing factor of like labour and capital which are sourced from within the
economy. The product is also is produced and normally consumed within the economy. The
organizational structure is unitary because the firm consists only of a single unit and if at all
there are any branches or subsidiaries, they also operate within the limits of national boundary.
International relocation of production, therefore, is a process in which firm which belongs to a
one country (called home country) goes abroad and invests in that country (called host country)
and employs the factor of production of that country, essentially with the help of investment that
is emanating from the domestic firm. It also ordinarily implies that such a firm employs its own
technology. So the basis of international production lies in investment and technology. The
other factors are ordinarily sourced from the country, where the production unit is re-located.

2.2 Foreign Direct Investment and Foreign Institutional Investment

The two terms FDI and MNCS are interchangeably used, but it is necessary to appreciate the
subtle difference between the two. FDI essentially refers to flow of funds, whereas MNCs are
understood as more than just flow of funds. The concept of MNCs constitutes flow of funds, new
technology and management. The concept of MNC is more inclusive than the concept of FDI. It
is distinguishable from FIIs or portfolio investment in the sense that both are foreign financial
flows, but they have different purpose. FIIs are routed through stock market with the purpose of
making quick speculative gain. In contrast FDI enters the host economy through strategic
agreements, undertakes production activity and have a stake in the management and control. FIIs
relate to the financial sector, while FDI relates to the real sector.

2.3 Multinational Corporations and Transnational Corporations

In the context of international location of productions, there is a need to distinguish between

MNC and TNC. An MNC is identified on the basis of location of production beyond the domestic
economy. With the emergence and development of stock markets across the globe, ownership of
an MNC got dispersed among persons belonging to different nations. Such MNCs are known as
TNCs. To sum up, a TNC is identified on the basis of international ownership over and above
mere international relocation of production.

3. Host and Home Country Relations

Home country is the country from where the FDI emanates and the Host country is the country
where the FDI goes. For a free flowing FDI there should be healthy relation between home and
host country. Free market view advocates that there should be no restriction on flowing of FDI
COMMERCE PAPER No. 11 : International Business
MODULE No. 39: Multinational Corporations (MNCs in
international business)
____________________________________________________________________________________________________

between countries. However, FDI always comes at some cost

to host country. Host country has to carefully analyse the cost and benefits of FDI. With FDI
there is transfer of technology and managerial skills to host county. There is relocation of
production facility. These transfers and relocations have spill–over effect in host country.
However, we should not be swayed by the positive effect of FDI. There are negative effects, as
well. We shall discuss these positive and negative factors since Host and Home country relation
depend upon the impact of these factors.

3.1 Positive Impact of FDI on Host Country

1) Inflow of Capital: There is inflow of capital in host country. As there is inflow of capital,
level of investment in the host country rises. This would automatically increases the level
of capital formation of the country since there would be more demand for investment
goods. As MNCs are efficient so there would be effective utilisation of capital thereby
increasing productive efficiency of capital in the host country. Spread of production
facilities create uniform development i.e. infrastructure as well as social development.
2) Transfer of Technology: FDI brings with itself technology and managerial skills. Now as
MNCs utilises their technology in host country, host country gain access to such
technology. After gaining access to MNC’s technology, host country can use such
technology for its own benefit. There is technology adoption and adaptation throughout the
host country.
3) Creation of Employment: FDI bring with itself lot of jobs in host country. MNCs cerate
direct and indirect employment. MNCs directly employ number of host country citizens. It
is also observed that MNCs pays better wages to their employee so this enhances the
standard of living of their employees thereby leading to indirect employment for other
citizens of host country.
4) Better Consumer Choices: MNCs’ products provide the consumer with a variety of
choices. Hence MNCs increases the level of competition in the host country’s market
which benefit the consumers. As level of competition rises in the country productive and
allocative efficiency increase thereby leading to economic growth.
5) Positive effect on Balance of Payment: When FDI arrives there would be import
substitution since consumers have foreign brands in their vicinity and there is no need to
import such brand. Secondly MNCs would also indulge in exporting of goods and services
from the host country. All these things shall strengthen the current account position of the
host country.

3.2 Negative Impact of FDI on Host Country

1) Suppresses Domestic Enterprises and Product: The growth of MNCs in the host country
creates complexities for domestic enterprises and product. MNCs due to their better
efficiencies began to dominate the consumer market. As a result there is decrease in
COMMERCE PAPER No. 11 : International Business
MODULE No. 39: Multinational Corporations (MNCs in
international business)
____________________________________________________________________________________________________

demand for domestic product and due to this there is

substantial decrease in market share of domestic firms thereby affecting them seriously.
2) No ‘Workers Safety Net’: MNCs use capital intensive technology and this leads to
massive labour displacement in traditional industries leading to unemployment and
underemployment. As a result there is labour unrest and many social problems in host
country. There is no workers safety net.
3) Increase in Income Inequality: MNCs pay wages and salaries to their employees at a
higher rate than domestic firms. As a result there is increase in income inequalities.
Increasing inequalities give rise to social unrest and many social evils. If there is gross
inequality in any country then people in the lower income group is highly affected during
the time of inflation.
4) Creation of monopoly power: Mega mergers and acquisition in host country by MNCs
result in creation of monopoly power. Creation of monopoly power in economy distorts
efficient allocation of resources and substantial loss of consumer surplus. This can
undermine national goals and welfare.
5) Pollution Haven Hypothesis: The pollution haven hypothesis is the concept of relocation
of MNCs in the countries that have lesser stringent environmental laws and regulations.
Countries with weaker environmental laws and regulations are ‘pollution havens’ .These
countries shall attract polluting industries from other countries. As a consequence
companies shall relocate itself in countries that are ‘pollution havens’ and pollute the
environment of such countries at a vast scale.
6) Undermining National Sovereignty: Some MNCs are so large that they are in position to
dominate national sovereignty. They are in position to influence the political parties that
are governing host country in their favour. Such kind of behaviour on the part of MNCs
and corrupt politicians plays havoc on national sovereignty.
7) Adverse Effect on Balance of Payments: MNCs also creates adverse effect on balance of
payment. These MNCs pass on royalties to their parent company in home country. There is
transfer pricing issue also. Due to irrational transfer pricing MNCs can pay less tax on one
hand and create negative effect on balance of payments on other hand. There is also
repatriation of profits in the form of interest and dividend. These all factors create adverse
effect on balance of payment of host country.

It can be seen from above discussion that there are both positive and negative effect of FDI in
host country. Now host country has to analyse all these factors to make decision about allowing
FDI. If positive impacts of FDI outweigh negative impacts of FDI then it is beneficial for the host
country to allow FDI. However, if negative impacts of FDI outweigh positive impact then FDI
should not be allowed. If host country is under pressure by worldly bodies such as IMF, World
Bank, WTO, etc, to free trade and investments in their countries then it can allow FDI but with
certain caveats. Host country should ensure minimum level of workers safety net, no creation of
monopoly power, no undermining of domestic firms and product, no transfer of hazardous
substances, no unreasonable transfer pricing so as to cost exchequer of the host country and
balance of payment, etc. But all these things depend upon political will. FDI can be allowed in

COMMERCE PAPER No. 11 : International Business

MODULE No. 39: Multinational Corporations (MNCs in
international business)
____________________________________________________________________________________________________

favour of free trade policy but with certain conditions that shall
ensure economic development for all in host country. Most importantly there should be sufficient
awareness among the nationals of host country about FDI and its impact so they can properly
analyse and pressurise their government for formulation of adequate policies in respect of FDI.

4. Issues in Foreign Investment

The diagram given below depicts type of FDI and its target.

FDI may be in form of vertical integration and/or horizontal integration. Vertical Integration
occur when firm goes for backward integration (upstream) and/or forward Integration
(Downstream). Each and every firm specializes only in some stages of production. As a
consequence firm has to buy its inputs from other firms or sell its output to firms other than final
consumers. Due to this reason firm incurs certain costs. Therefore it is sometime beneficial for
the firms to integrate vertically. Backward integration (Upstream) happens when firm integrate its
input supplying units. Forward Integration (Downstream) happens when firm integrates its output
selling units. Internalization is a process of vertical integration. There is difference between
internationalization and internalization. Internationalization means internalizing taking place
across the borders. If the firms want to internalize across borders the following decision
framework may be useful to it.

COMMERCE PAPER No. 11 : International Business

MODULE No. 39: Multinational Corporations (MNCs in
international business)
____________________________________________________________________________________________________

In Horizontal integration firm invests abroad at the same stage

of production process as it is in home country. As against vertical integration, in horizontal
integration there is expansion but horizontally (i.e. at same level of production process). FDI
(Whether vertical integration or horizontal integration) targets differently. These are various
targets of FDI:
(1) Green Field Investments: Green field investment means establishment of a new production
facility in the host country from ab–initio. It is direct investment in new production
process/facility such as offices, buildings, plant & machinery, etc. Due to green field
investment there is flow of capital in host country. As new production facility and process
is developed so there is transfer of technological and managerial know–how. Due to new
establishment of production facility there is generation of employment.
(2) Brown Field Investments: Brown field investments means establishment of production
facility on the existing production facility i.e. exploited for other commercial purpose. Thus
brown field investment also entails development of production facility but at exploited or
used place. For example a steel mill or oil refinery is cleaned up and used for office
purpose by MNCs.
(3) Acquisitions: It implies the purchase of the existing company or amalgamation with the
existing company in the host country. Acquisition may be minority (i.e. 10% to 49%),
majority (i.e. 50% to 99%) or an outright purchase (i.e. 100%). Cross border acquisition are
quicker to execute than green field investments. It is also an easier and perhaps less risky
than green field investment. In certain cases, only acquisition is realistic option for FDI
entry. However acquisition represents a change in ownership so there is no immediate
capital flows and employment generation in host country.

5. Technology Transfer and Foreign Collaboration

MNCs effect international relocation of production with the help of capital, technology and
management. However, the factor endowment in the host countries favours labour. Therefore, it
makes sense for developing countries to use labour intensive techniques of production. The host
country, on its own, is capable of manufacturing only low value added goods with the help of
labour intensive technology. If they want to come out of this low-level equilibrium trap, foreign
investment in the form of FDI or induction of Multinational Corporation becomes an imperative.
This creates a contradictory situation for a developing country to use the technology without
which they cannot hope to increase productivity and growth. The host country needs to make a
choice of continuing with the old technology and reconciling to a lower growth rate and
continuing with a static industrial structure, or inviting FDI and adopting new technology which
is likely to step up the growth rate. The scenario is biased against the host economy, Firstly, FDI
comes as a package, ruling out any negotiation or bargaining with the home country. Secondly,
the terms and conditions under which the host country imports the technology along with capital
are sometimes very strict and the payment of royalty and fees for such technology is often very
high. Thirdly, developing countries do not have the economic and bargaining power to be able to
modify conditions by which they invite MNCs to invest in their country.

COMMERCE PAPER No. 11 : International Business

MODULE No. 39: Multinational Corporations (MNCs in
international business)
____________________________________________________________________________________________________

The idea is that developing economies would expect that they

would be able to attract MNCs to ensure that all the years they are not keeping back the
technology to themselves but they began to share the technology with the developing countries.
This is called transfer of technology. In the process it is very often possible that through technical
collaboration agreements the developing countries are able to get such technologies which can
be adapted to the domestic conditions. Improving technological capability is one of the solutions
through which developing countries may mimic the technologies. It however involves strict
vigilance on the part of MNCs who cannot permit such mimicking. The point is that developing
countries mimic the technologies of the MNCs and make them adaptable to domestic economy.
The issues in technology transfer are three fold: relevance of technology, adaptability of the
technology and technological capability.

Types of Foreign collaborations are as follows;

COMMERCE PAPER No. 11 : International Business

MODULE No. 39: Multinational Corporations (MNCs in
international business)
____________________________________________________________________________________________________

6 Summary

In this module, initially conceptual framework behind the new face of international business i.e.
MNCs is explained. MNCs are fundamentally characterised by international relocation of
production facility with the help of investments and transfer of technology in host country.
Distinction is made between FDI and FII. A subtle difference is that FDI is made for international
relocation of production by taking the management and control of acquired firm. However in FII
funds are routed through stock markets so as to make quick gain on investment. Distinction is
also made between Multinational Corporations and Transnational Corporations. The main
difference between the two is that MNCs are characterised on the basis of location of production
beyond host country whereas TNCs are characterised on the basis of ownership in different
countries.

Free flow of funds depends upon the relationship between home and host country. While
developing policy framework for FDI, host country must take into account the positive and
negative impact of MNCs in their economy.

Issues in foreign investment pertain to types of investments to be made. It may take the form of
vertical integration or horizontal integration. Vertical Integration means integrating vertically
whether backward or forward. Horizontal Integration implies expanding horizontally. FDI targets
differently i.e. it can be Greenfield or Brownfield or Acquisition.

At the end, issues about transfer of technology are discussed. An important feature of MNCs is
transfer of technology. MNCs bring sophisticated technologies with them. With this host country
now has an access to sophisticated technology. After having access to new technologies, there is
technology adoption and adaptation throughout the host country which put them on path of
economic development and growth.

COMMERCE PAPER No. 11 : International Business

MODULE No. 39: Multinational Corporations (MNCs in
international business)