Week 5 – Globalisation and Multinational Business

1. Introduction

During this topic, we will review current issues in the global economy. We will define globalisation, consider
the global economic interdependences that it is creating and the implications of globalisation for business.

1.1. Topic Learning Outcomes

During this topic you should be able to achieve the following learning outcomes:

LO1. Explore the drivers of globalisation

LO2. Understand the nature of multinational corporations

LO3. Explore the role multinational corporations in the global economy

LO4. Explore current trends in international investment

LO5. Understand how multinational corporations and creating opportunities and challenges for national
growth

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2. Globalisation – Setting the scene

According to Dicken (1998) cited in Delfmann & Albers (2000, p. 16)

“Internationalization processes involve the simple extension of economic activities across national
boundaries. It is, essentially, a quantitative process that leads to a more extensive geographical pattern of
economic activity. Globalization processes are qualitatively different from internationalization processes.
They involve not merely the geographical extension of economic activities across national boundaries but
also - and more importantly - the functional integration of such internationally dispersed activities.”

Let us start by considering what is driving globalisation. According to Yip (1992) cited in Delfmann & Albers
(2000, p. 16) the main drivers of globalisation can be classified into four main categories:

Figure 5.1 Drivers of Globalisation

Source: Delfmann & Albers (2000; citing Yip, 1992)

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Market drivers include the emergence of global distribution channels, the convergence of global customer
tasted and needs, transferable marketing, where advertising is concentrated on a small number of globally
present agencies, etc.

Cost drivers are mainly related to the opportunity that globalisation is offering companies to take advantage
of economies of scale. Companies can geographically concentrate their production and deliver their products
worldwide. Also, globalisation is creating opportunities for global sourcing and companies can select their
suppliers on a global scale. Global sourcing and global distribution are supported by decreases in transport
costs and by advances in technology. Also, globalisation is allowing companies to take advantage of
differences in-country costs, including exchange rates.

Government drivers include favourable trade policies and host country institutions and regulatory
frameworks. Also, the establishment of international trade agreements is creating a global environment for
business. This category includes the compatibility of technical standards, which includes the compatibility of
information systems that support the coordination of global business.

Finally, competitive drivers include the increase in international trade volume, which has created a global
competitive field for business with global competitors from different countries (Delfmann & Albers, 2000).

There may be other drivers which do not fit in the above classifications, like for example, the globalization of
financial markets and improvement in business travel.

Supporters of globalisation argue that it has offered opportunities to countries to improve socioeconomic
conditions and reduce poverty. Globalisation has enabled countries to benefit from their competitive
advantages, promote technological innovation, strengthen national structures and institutions, offer access to
international funds and nurture and stabilise relationships with other countries (Sloman et al., 2019;
Kunnanatt, 2013; Osland, 2003).

Critics on the other hand argue that globalisation contributes to the growing inequality between richer and
poorer countries. They argue that richer countries are provided with more opportunities to exploit poorer
countries and take advantage of natural resources and low-wage labour of poorer countries. Globalisation is
accused of disrupting the socio-economic and cultural structures of host countries and of promoting over-
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consumption by rich countries, creating an unbalance in the production process. Also, critics of globalisation
argue that it has a negative impact on the environment, through the exploitation of natural resources, excessive
consumption and increased global travel (Sloman et al., 2019; Kunnanatt, 2013; Osland, 2003)

3. Multinational corporations

What is a Multinational Corporation (MNC)? Klaus and Peng (2019, p. 4) defined the multinational enterprise
(MNE) as “a firm that engages in foreign direct investment (FDI) by directly investing in, controlling, and
manging value-added activities in other countries”. MNEs are significant contributors to the world economy
and if some of the largest MNEs were independent countries, their revenues would exceed the GDP of several
countries. Walmart, which is the largest MNE according to the Fortune Global 500 rank (Figure 5.2), has
revenues which rank it among the 25 largest economies (Belinchón & Moynihan, 2018). According to Fortune
(2020) “the world’s 500 largest companies generated $33.3 trillion in revenues and $2.1 trillion in profits in
2019. Together, this year’s Fortune Global 500 companies employ 69.9 million people worldwide and are
presented by 32 countries”.

Figure 5.2 Top 10 Global multinationals

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Source: Global Finance Magazine (2021)

Although traditionally, the world’s largest MNEs have their headquarters in the U.S. the proportion of U.S.
MNEs in the Fortune Global 500 is dropping and that of MNEs with headquarters in emerging economies is
increasing (Fortune, 2020). Figure 5.3 is showing the mapping of the Fortune Global 500 companies, where
one can see the concentration of the largest MNEs in the U.S. and Europe, but also a concentration on MNEs
in Asia and presence in Latin America and the Middle East.

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Figure 5.3 Mappin the Fortune Global 500

Source: Fortune (n.d.)

These MNEs may be different in terms of their size. For example, as mentioned above, the revenues of some
of the largest multinationals exceed the GDP of many smaller countries across the globe. Yet, there are several
examples of smaller multinationals (for example, if you look at the Fortune Global 500 index, the
multinationals raking 400-500 are only a small fraction of the top 10 enterprises). Also, multinationals will
vary in terms of the nature of their business, from food production to energy, telecommunications, chemicals,
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electronics, health cases, etc. MNEs will differ in the proportion of their overseas business relative to the total
business. For some MNEs, a large fraction of their business will come from their global actives, which for
other MNES, the largest proportion of their business will come from their home country activities. Some
MNEs have production locations in many different countries and regions globally, while others select a small
number of countries and locations for their production activities. Also, multinationals may differ in terms of
ownership patterns, where some MNEs may choose to wholly own their subsidiaries or they may choose to
share ownership with a local entity. Multinationals may also differ in organisational structure, with
subsidiaries having less or more independence from the parent company, depending on the structure (Sloman
et al., 2019; Johnson & Turner 2003).

4. Trends in Multinational Investment

World trade was showing steady growth since 2015, but Figure 5.4 below is suggesting that world trade
dropped by 2.4%, as a result of the Covid-19 pandemic. However, trade is anticipated to pick up in 2021 and
2022 (Figure 5.5).

Figure 5.4 World Trade Growth 2007-2019

Source: UN (2020)

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Figure 5.5 World trade expected to pick up in 2021 and 2022

Source: WTO (2021)

As Figure 5.6 shows, international trade constitutes a considerable percentage of GDP and Europe has the
biggest share of world exports, followed by Eastern Asia.

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Figure 5.6 Total trade as GDP percentage by SDG regional groupings and contribution to world exports

Source: UN (2020)

Global FDI inflows also experienced a drop in 2019 and 2020, but they are expected to pick up in 2022 (Figure
5.7).

Figure 5.7 Global FDI inflows

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Source: UNCTAD (2020)

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Figure 5.8 shows the global distribution of FDI inflows by a group of economies.

Figure 5.8 Global FDI inflows by a group of economies

Source: UNCTAD (2021)

MNEs can enter a host country through directly establishing a new subsidiary (greenfield investment) or
through merging with or acquiring an existing company in the host country (cross-border M&A). An MNE
may choose to establish a new subsidiary when it is important for example to select the site where the
subsidiary will be established or when they cannot find the right domestic local company for a merger of
acquisition. On the other hand, an MNE may choose a cross-border M&A when they can benefit from the
country-specific capabilities of the domestic company (Cheng, 2006; Nocke & Yeaple, 2007, Calderón,
Loayza & Servén, 2004).

Figure 5.9 Greenfield and M&A FDI projects

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Source: UNCRAD (2020)

5. Why do businesses go Multinational?

An MNE may choose to produce the same product in different countries (possibly with small variations to
accommodate the tastes and needs of local consumers and to adjust to local production conditions). In this
case the MNE is a horizontally integrated multinational. MNEs choose this strategy if they want to grow by
expanding into new markets. Alternatively, an MNE may choose to undertake various stages of production in
different counties for a core business. In this case, the MNE is a vertically integrated multinational. MNEs
choose this strategy if they are looking to control production costs and reduce the uncertainty associated with
their production. Finally, an MNE may choose to produce a range of different products in different countries.
In this case the MNE is a conglomerate multinational. This strategy allows MNEs to exercise better control
over the risks associated with their production.

Companies choose to go multinational for two main reasons: in order to cut costs or to tap into new markets.

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By becoming multinationals companies can tap into the resources of the host country, which may not be
available (or may be available at a higher cost) in the home country. Also, companies go multinational in
order to have access to lower-wage labour. For example, many multinationals choose to locate in developing
countries where the cost of labour is lower compared to developed countries. It is not only low-wage labour
that may motivate companies to go multinational but also an attempt to have access to highly skilled labour.
Highly skilled labour can increase productivity and enhance the quality of a product and contribute to the
reduction of production costs. Also, various countries offer flexible working conditions in order to attract
multinational enterprises. Going multinational may help companies to reduce transport costs and customs
duties. Also, hosting countries may offer companies financial and cost-reducing incentives (such as favourable
tax arrangements) in order to attract multinational enterprises.

Also, companies may seek growth opportunities in new markets overseas. Multinationals can enter a new
overseas market through internal or external expansion. The internal expansion involves creating new
facilities from scratch, while external expansion involves merging with or taking over an existing company
in the host country.

By going multinational, a company’s business is not tied to one specific country and this allows companies
to spread the risks of their operation. Also, in many cases, companies can get access to more advanced
technologies by expanding overseas and they can boost their research and development capabilities.

A multinational that enters an overseas marker the four stages of the product life cycle: the launch phase; the
growth phase; maturity; and late maturity and decline.

In addition to all the benefits that multinational enterprises may enjoy when they expand overseas, there are
also various challenges that multinationals face as a result of their geographical expansion. One issue that
multinationals may face is the language barrier. Language is less of a challenge when expansion takes place
in developed host countries, but it may be a significant barrier when entering developing countries. Selling
and marketing may be a challenge as well, as social and cultural differences may impact how a product is
perceived or how it is marketed in a different country. Relations with host governments may create challenges
since host countries will try to get the highest benefit for their country from the multinational company. In
some cases, for example, host governments may insist to have some degree of ownership of the multinational
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or they may set certain rules that the multinational will have to follow in order to expand to the host country.
Also, relationships between subsidiaries may create challenges with lines of communication becoming longer
and more complex or where structures between the parent company and the subsidiary blur the lines of control
between the parent company and the subsidiaries.

6. MNC investment and the host state

Host countries are looking to attract multinational enterprises in order to enjoy the benefits of foreign direct
investment. Investment by MNEs in the host country generates employment in the country. The multinational
employs workers, but they may also benefit the local economy, which may grow and generate more
employment as well. Also, investment by MNEs will generate an inflow of capital in the host country
improving the host country’s balance of payments. In addition, the multinational is likely to change the host
country’s trade balance, by resulting both in import substitution and export promotion, impacting positively
the country’s balance of payments. Also, MNEs will bring their technology and technological knowledge with
them, offering opportunities to domestic producers to benefit from technology transfers and from training
opportunities for workers. Finally, host countries generate tax revenues from MNEs, and multinationals
contribute to public finances.

But there are also disadvantages for the host countries from the expansion of MNEs. MNEs bring uncertainty
to the host country as they can choose to close their operations and/or move to another country at any time.
Because of the size of some multinationals and the contribution potential they can generate for the host
countries, MNEs can exercise considerable control over the host countries. This control may be strong the
more significant the contribution of certain multinationals is to the host country economy. Multinationals will
attempt to reduce the taxes that they pay to host countries by engaging in transfer pricing. Transfer pricing is
a practice that allows MNEs to present higher profits in lower-tax countries and lower profits in higher-tax
countries by manipulating their internal accounts. As a result, host countries will not be able to benefit from
tax revenues. Finally, MNEs have been accused of over-exploiting host countries’ natural resources and of
contributing significantly to the degradation of the host country natural environment. Many countries are very
keen to attract foreign direct investment and they are prepared to oversee environmental considerations and
concerns.

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7. MNCs and Developing Countries

MNEs are considered as an opportunity for developing countries’ economic growth. Foreign direct investment
creates prospects for developing host countries to alleviate poverty and enhance the living standards of the
people. FDI can help developing counties improve their finances by filling four key gaps resulting from the
shortage of funds in these countries, namely, the saving gap; the foreign exchange gap; the public finance gap;
and the skills and technology gap.

Along with the benefits they may create, MNEs has created disadvantages to the host country. For example,
MNEs may use their size and access to resources to drive domestic firms out of business. They may generate
limited demand for local components and import their components from outside of the host country – for
example, from suppliers who supply the MNE in the home country or from their subsidiaries. Multinationals
may choose to reinvest the majority of their profits to the home country, generating little or no benefit for the
host country. Or they may repatriate profits to shareholders in the home country or in rich countries. Finally,
as discussed earlier, the MNE may engage in transfer pricing impacting the host country’s ability to benefit
from tax revenues.

If the objective of the host country is short term – e.g. a quick growth of national income – and there are no
broader objectives on the agenda – such as alleviating poverty, generating long-term growth, enhancing
production capabilities in the domestic economy, equality, etc. – then developing host countries will not be
able to generate long-term benefits from FDI.

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