Multinationals on the Periphery

Multinationals on the Periphery Edited by

Gabriel R.G. Benito and Rajneesh Narula

Multinationals on the Periphery

Also by Gabriel R.G.Benito FOREIGN OPERATION METHODS: Theory, Analysis, Strategy (with Lawrence S.Welch and Bent Petersen) PROGRESS IN INTERNATIONAL BUSINESS RESEARCH: Volume 1 (with Henrich R.Greve) Also by Rajneesh Narula UNDERSTANDING FDI-ASSISTED ECONOMIC DEVELOPMENT (with Sanjaya Lall) MULTINATIONALS AND INDUSTRIAL COMPETITIVENESS: A New Agenda (with John Dunning) INTERNATIONAL BUSINESS AND THE ECLECTIC PARADIGM (with John Cantwell) GLOBALISATION AND TECHNOLOGY: Interdependence, Innovation Systems and Industrial Policy TRADE AND INVESTMENT IN A GLOBALISING WORLD MULTINATIONALS FROM THE NETHERLANDS (with Roger van Hoesel) FOREIGN DIRECT INVESTMENT AND GOVERNMENTS: Catalysts for Economic Restructuring (with John Dunning) MULTINATIONAL INVESTMENT AND ECONOMIC STRUCTURE: Globalisation and Competitiveness

Multinationals on the Periphery Edited by Gabriel R.G. Benito and Rajneesh Narula

Selection and editorial matter © Gabriel R.G. Benito and Rajneesh Narula 2007 Individual chapters © contributors 2007 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2007 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan® is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN-13: 978-1-4039-9166-9 ISBN-10: 1-4039-9166-9 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Multinationals on the periphery / [edited by] Gabriel R.G. Benito, Rajneesh Narula. p. cm. Includes bibliographical references. ISBN 1-4039-9166-9 (alk. paper) 1. International business enterprises. 2. Industrial location 3. Globalisation—Economic aspects. I. Benito, Gabriel R. G. II. Narula, Rajneesh, 1963HD2755.5.M8457 2007 338.8⬘8—dc22 10 9 8 7 6 5 16 15 14 13 12 11

2007023074 4 10

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Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham and Eastbourne

Contents List of Figures

vii

List of Tables

viii

Notes on the Contributors

x

Preface 1

2

3

4

5

6

7

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States and Firms on the Periphery: The Challenges of a Globalizing World Gabriel R.G. Benito and Rajneesh Narula Can Domestically Owned Manufacturing Firms of Small Developing Economies Compete in a Liberalized Trading Environment? Lou Anne A. Barclay Internationalization of Estonian Manufacturing Enterprises: Are Foreign Investors Dictating the Rules of the Game? Ele Reiljan

1

25

48

The Internationalization Patterns of Norwegian Firms: Does Industry Matter? Birgitte Grøgaard and Gabriel R.G. Benito

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The Pace of Internationalization for Small and Medium-sized Enterprises Siv Marina Karlsen

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Public Policy, FDI Attraction and Multinational Subsidiary Evolution: The Contrasting Cases of Ireland and Portugal Ana Teresa Tavares-Lehmann MNCs in the Periphery: DaimlerChrysler South Africa (DCSA), Human Capital Upgrading and Regional Economic Development Jochen Lorentzen

v

131

158

vi

8

9

10

Contents

Outside the Triad: An Examination of International R&D Investments within Peripheral Economies Björn Ambos and Tina C. Ambos Moving Out of the Country: An Exploratory Study of the Impact of Country, Cluster and Firm-related Factors Carl Arthur Solberg Centre and Periphery in the WTO: The Case of TRIPS Helene Hoggen

Index

188

206

228

269

List of Figures 1.1 1.2 3.1

Core and periphery in the world economy Different types of subsidiaries Foreign direct investment inflows into Estonia 1992–2003 (millions of kroons) 3.2 Distribution of foreign investments into Estonia by their primary motive 3.3 Value added per employee in Estonian manufacturing companies between 1995 and 2001 (1,000s of kroons) 3.4 Average number of foreign affiliates in different groups of firms 3.5 Estonian exports to Russia (millions of kroons) 3.6 Speed of internationalization in Estonian manufacturing industries 1996–2002 3.7 Share of export sales in net sales in Estonian manufacturing industry (%) 3.8 Changes in the export activities of Estonian manufacturing firms 1996–2002 3.9 Cost levels in sawmills in Europe 3.10 The share of subcontracting in Estonian textile and clothing industries (%) 3.11 Distribution of Krenfolm sales by target countries 2003 5.1 Different categories for firms undergoing internationalization 5.2 Trajectories of five case firms undergoing internationalization 6.1 FDI inflows to Ireland and Portugal 1990–2003 8.1 Internationalization of R&D over time 8.2 Internationalization of R&D overtime: the role of capability-augmenting investments 10.1 Continuum of perspectives

vii

4 13 50 50 50

52 55 57 58 60 60 62 66 66 117 119 134 194 194 243

List of Tables 2.1 2.2

2.3

2.4 3.1 3.2

3.3 3.4 3.5 3.6 4.1 4.2

4.3 4.4 4.5 4.6 4.7 5.1 5.2

Selected indicators of CARICOM member states in 2002 Trade and investment agreements between the CARICOM countries and western hemisphere partners Proportional distribution of the volume of CARICOM’s intra-regional imports and exports among member states, 1990–2000 General characteristics of sampled firms Foreign share in the Estonian manufacturing industry 1995–2002 (% of all enterprises) Foreign direct investment stock abroad by main target countries 1998 and 2003 (thousands of kroons) Foreign direct investment stock abroad by field of activity 1998 and 2003 (thousands of kroons) Export to main target countries, 1995 and 2003 (millions of kroons) Foreign share in Estonian manufacturing industry 1995–2002 (% of all enterprises) Foreign share in Estonian manufacturing industry 1995–2002 (% of all enterprises) Foreign trade and investment in the Norwegian economy in the 1990s Indicators of internationalization for the 100 largest non-financial Norwegian firms 1990, 1995 and 2000 Correlations (Pearson) among dependent variables Correlations (Spearman’s Rho) among independent variables Regression results for FSALE 1990, 1995 and 2000 Regression results for FEMP 1990, 1995 and 2000 Regression results for FSUB 1990, 1995 and 2000 A summary of the key figures on dimensions that reflect the firm’s pace of internationalization Key findings viii

29

30

31 36 52

54 55 56 61 65 76

78 85 87 87 88 89 115 121

List of Tables

6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 6.10 6.11 7.1 7.2 7.3 8.1 8.2 9.1 9.2 9.3 10.1 10.2 10.3

Relative importance of motivations for investment in Portugal and Ireland Evaluation of the importance of distinct subsidiary roles/strategies Degree of decision-making autonomy of subsidiary Nationality of main manager of subsidiary (% of cases) Technological activities carried out by subsidiaries (% of respondents) Relative level of technological sophistication of subsidiaries’ activities Percentage of inputs bought from local suppliers Evolution of proportion of inputs bought from local suppliers Collaborations developed by MNEs’ subsidiaries in Portugal and Ireland (%) Future evolution of subsidiaries relative to the following factors/challenges Evaluation of relative performance measures Capital flows, competitiveness and human resources Economic and social indicators of the Eastern Cape 2002 Interviews Key data Embeddedness, coordination and control and performance of TLs and NTLs Size distribution of the sample Distribution of relocation scores by firm size and origin Regression analyses of determinants of relocation (standardized regression coefficients) Trade rounds and selected ministerial meetings 1947–2005 Complaining parties in WTO disputes Responding parties in WTO disputes

ix

143 144 146 147 147 148 149 149 150 151 152 162 164 168 195 199 216 217 218 233 236 237

Notes on the Contributors Björn Ambos is Professor of International Management at Vienna University of Economics and Business Administration. Tina C. Ambos is Assistant Professor at the Vienna University of Economics and Business Administration. Lou Anne A. Barclay is Senior Lecturer in International Business at the Department of Management Studies, Faculty of Social Sciences, University of the West Indies, Mona, Jamaica. Gabriel R.G. Benito is Professor and Head of the Department of Strategy and Logistics, BI Norwegian School of Management, Oslo, Norway. Birgitte Grøgaard works in the Haskayne School of Business, University of Calgary, Alberta, Canada. Helene Hoggen is doctoral candidate at BI Norwegian School of Management, Oslo, Norway. Siv Marina Karlsen is Lecturer in the Faculty of Social Sciences, Oslo University College, Norway. Jochen Lorentzen is a chief research specialist in the Education, Science and Skills Development research programme, Human Sciences Research Council of South Africa. Rajneesh Narula is Professor and Director of the Centre of International Business and Strategy, University of Reading Business School, UK. Ele Reiljan works in the Faculty of Economics and Business Administration, University of Tartu, Estonia. Carl Arthur Solberg is Associate Professor at BI Norwegian School of Management, Oslo, Norway. Ana Teresa Tavares-Lehmann works in the Faculty of Economics CEMPRE, University of Porto, Portugal. Currently she is Pro-Vice Chancellor in charge of Strategic Planning and Entrepreneurial Relations.

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Preface The intellectual genesis of this book goes back to a series of wide-ranging conversations in the late 1990s, most of which – for completely inexplicable reasons – happened in various bars and restaurants in downtown Oslo. When comparing the Norwegian economy and its multinational enterprises with those of the developing world, both of us came to the realization that there was much more similar than one might have expected. Needless to say, we did nothing about it at the time, preferring to pursue our own agendas, although continuing to affirm our intention to put our ideas down on paper ‘sometime soon’. Formally, the direct origins of this book go back to 2000, the year when a research programme called ‘Globalization and internationalization of the Norwegian economy’ was launched, funded by the Norwegian Research Council (NFR project 139982/510). When it ended in 2005, this programme had sponsored five students through their doctoral studies, and supported several projects about the implications of globalization for small peripheral countries. Norway was the centrepiece of attention in the programme, even though some projects took a comparative view by also including other Nordic countries. Nevertheless, we still strongly believed there was scope for an edited volume that expanded the reach of the project beyond that of small and rich Nordic countries. And so the years passed, one after another, like sand in an hour glass (accompanied by the sporadic tinkling of wine glasses), until both of us accepted appointments at the Copenhagen Business School, and work on the book began in earnest. This goal was assisted greatly by Jackie Kippenberger’s generous offer to publish it. Alas, this momentum was not to last, punctuated by Rajneesh moving to the UK, and Gabriel returning to Oslo. As anyone who has ever tried to collaborate across borders will attest to, the ‘death of distance’ attributed to globalization is a greatly exaggerated phenomenon. We would

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Preface

like to thank our contributors, who all put up with numerous requests to re-write, shorten, improve, clean up, etc., and their seemingly saintlike patience while we dithered over the writing of the introduction. We apologize! We hope that the fanfare and adulation with which this book should be received by the general public will make up for it.

Oslo London

GABRIEL R.G. BENITO RAJNEESH NARULA

1 States and Firms on the Periphery: The Challenges of a Globalizing World Gabriel R.G. Benito and Rajneesh Narula

1. Introduction One of the primary features of globalization has been the growth and spread of multinational enterprises (MNEs), and their increasing significance in the economies of almost all countries, whether large or small, developing or industrialized. MNEs have sought to spatially distribute their value-adding activities globally to not only take advantage of market opportunities but also to exploit different specialized resources and capabilities that are unique to particular locations. In other words, in response to increasing cross-border competition and rivalry, firms have increasingly sought to organize their activities internationally to achieve greater efficiency in their value-adding activities, and thereby optimizing their market share and rent generation. However, there is considerable evidence that MNEs do not regard all locations as being equivalent. Smaller economies, less-developed countries and countries that are spatially or economically on the ‘periphery’ are not as attractive as destinations for inward foreign direct investment (FDI) because of their limited market size, or other under-developed location advantages. As such, the kinds of subsidiaries and the nature of the MNEs’ value-adding activities located in more peripheral regions and countries are also different, and tend to be considerably less integrated into their global operations. MNEs that originate from peripheral economies also behave differently from those emanating from core countries when internationalizing their operations. Not all these differences are associated specifically with the peculiarities of their peripheral location. Indeed, it can be argued that some of the differences in the nature, motivation and pace of inward and outward FDI derive primarily from being at an earlier stage of economic 1

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development. However, the ‘costs of being peripheral’ accrue also to countries that are not necessarily developing. A number of smaller developed countries tend to be host to different kinds of MNE affiliates, and MNEs from these countries internationalize in decidedly different ways compared to more core countries. There is a stream of research that argues that these differences are due to the resource constraints associated with small country size (see, e.g., the contributions to Van Den Bulcke and Verbeke, 2001). Nonetheless, Benito et al. (2002) have shown that even countries of similar size, geographic location and economic development still exhibit different extents of engagement in international business. As we shall highlight in this chapter, the primary differentiating factor between the core and periphery is interdependence, and this is determined by the extent of social, political and economic integration, and the extent to which there is reciprocity. This book also seeks to develop this theme, focusing on how MNE activity both to and from peripheral economies differs from MNE activity associated with core economies. Much of the literature on international management and business focuses on MNEs to and from core economies, or examines the differences as being primarily associated with country size. Another literature (associated with development economics) argues that economic development is the primary determinant. We argue that these two arguments are closely associated, because these locations are similarly handicapped. Countries such as Trinidad or South Africa – at least with regards MNE activity – share characteristics in common with Norway and Estonia.

2. What is ‘Peripheral’? The concept of a periphery has been with us a long time, and by its very definition, implies that it is relative to the existence of a ‘core’. Researchers in the area of ‘world systems theory’ have argued that the core-periphery dichotomy (in its current sense) among nations has been with us since at least the 16th century when the foundations of the modern capitalist system and international trade led to the beginning of the process of globalization and the increasing interdependence between nations through trade (see the various works of Wallerstein, e.g., 1974, 1979). This body of work is closely linked to dependency theory (see, e.g., Prebisch, 1962), which, building on the core-periphery argument, addresses the challenges for development and catch-up for the countries in the periphery – who are, by definition, economically or otherwise poorer or less technologically advanced than countries of the core. These theories

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focus on political, sociological and economic challenges that derive from the domination by the core, of the periphery. Defining the periphery is a task fraught with difficulty, because membership of the core (and of the periphery) changes over time. For the purposes of this contribution, we refer to countries that are peripheral (or core) in the sense of economic globalization. We regard globalization as an ongoing process, rather than an event, which has influenced different economic actors to varying extents. Globalization as used here implies the growing interdependence of locations and economic units across countries and regions (Narula, 2003). The key word here is interdependence. Cross-border linkages between economic entities do not imply globalization, merely internationalization. Integration and interdependence is about reciprocity, and the extent of this reciprocity. The concept of interdependence and reciprocity are crucial to understanding globalization and, by extension, the nature of the core-periphery dichotomy. ‘Simpler’ cross-border activity such as trade does not necessarily result in interdependence. It is the growth of FDI and the multinational corporation in the modern, complex cross-border hierarchical organizational form that plays a pivotal role in fostering economic interdependence. For, while international business activity was broad based through trade, it was dominated by the development of vertical linkages, with a flow of goods between locations, in response to varying elasticities of supply and demand. Raw materials were transported from one location to another, manufactured and transported to a third location for sale. Factors of production were immobile, and although capital did in fact get relocated, these were capital flows rather than capital embodied in physical assets or personnel, and (with a few notable exceptions) there was no significant integration of operations in disparate locations within the control and management of the same individuals until after world war II. Firms were international, but not multinational. International business and economic activity was extensive in the sense that the value of goods and capital exchanged were considerable, and involved numerous countries and actors, who were all dependent upon each other’s patronage. But it was not intensive, in that activities were largely not integrated across borders, with the possible exception of the large trading companies and other state-sanctioned de facto monopolies (Held et al., 1999). As with all dichotomies such as north-south, west-east, rich-poor, etc., there are numerous shades of grey between the two extremes, in general requiring gross simplifications of a continuum of intermediate levels. This is all the more the case with the core-periphery dichotomy, since countries have been integrated into the world economy to different

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States and Firms on the Periphery

extents, and this is continuously in flux, since it is a process. Hence, as indicated in Figure 1.1, it is more appropriate to treat core-periphery as a continuum. For instance, the last three decades have seen China and some East Asian economies (such as Taiwan, Korea, Singapore, Malaysia) move closer to the core than the periphery, than, say, Laos, Vietnam, or Bangladesh. Much of Africa is firmly within the periphery (and one may even go so far as to say sub-Saharan Africa can be defined as being ‘on the periphery of the periphery’), although South Africa has moved towards the core. It is not about size, the lack of natural resources or markets. The Netherlands and Belgium are small in these terms, but are firmly in the

Circa 1977 Japan Korea Singapore Taiwan Hong Kong

Canada

‘The rest’ Denmark Italy Spain Sweden

Germany France UK Belgium Netherlands

Periphery

USA

Core

Circa 2007 Vietnam Egypt Pakistan etc.

‘The rest’

Figure 1.1

Korea Singapore Taiwan China India South Africa Russia Poland Czech Malaysia Thailand Turkey Norway Ireland Portugal

Denmark Italy Spain Sweden

Core and periphery in the world economy

USA Germany France UK Belgium Netherlands Japan Canada

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core, whereas Norway, Finland and New Zealand are in the periphery, but are at varying distances from the core, in the sense that they are less integrated into the world economy. It is not simply about the level of industrial or economic development: much of the former Soviet Union (with the possible exception of Russia), while industrially developed and of relatively high GDP levels, are firmly within the periphery rather than the core. It is worth noting that while distance has historically been an important determining factor of peripheral-ness, technological improvements in transportation and communication technologies have played a significant role in making geographic distances less significant, although the costs of transportation of physical goods and people remains non-trivial. A peripheral economy can be said to be one that plays an insignificant role as either host or home to MNEs; engages in relatively little trade in intermediate and manufactured goods; contributes relatively little to innovation and scientific progress; is weakly linked or accessible physically to the core because of poor infrastructure, transport and communication links; does not play a significant role in decision-making within supra-national organizations; and does not share a significant number of formal institutions with the core countries. Globalization implies economic, political and social integration, in the sense that there is an ongoing relationship that involves reciprocity, and creates a longer-term ongoing interdependence between economic actors. Countries with limited participation in this global milieu, and for whom reciprocity is ‘unequal’, are de facto weakly integrated and hence peripheral to the world economy.

3. Why is it Important to Understand the Periphery? There are those who wish to understand why the world evolves into a core-periphery formation, taking a more positive (rather than normative) approach. Again, the history of economics is littered with such studies, and these go all the way back to include Adam Smith, Frederich List, David Ricardo, among others. What makes a particular area, region or state into a core location rather than a peripheral one, and vice versa? Indeed, this may be argued as being the primary objective of many of the social sciences. The core-periphery concept within the field of economics has – for a rather long time – been the remit of economic geography, building very much upon the insights of Alfred Marshall (1919), and much-divorced from the mainstream literature until Paul Krugman ‘re-invented’ what is known as the ‘new economic geography’ in his influential 1991 book. This has spurred a new literature which has embraced the core-periphery

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argument at its centre to answer the question, ‘what might economic integration across countries and regions mean for the spatial organization of economic activity? Does it increase concentration of economic activity in the core at the expense of the periphery, or does it eventually lead to greater dispersion?’ (see, e.g., Forslid and Wooton, 2003; Fujita and Thisse, 2003; Krugman, 1991; Krugman and Venables, 1995). This discussion has been couched within the discussion of how globalization affects economic disparities between regions and nations. Indeed, there is now a large literature that asks whether globalization will increase or decrease the polarization and inequalities between rich and poor. The important finding in this body of work is this: when there are declining costs of transportation and communication, as are associated with globalization, the resultant increased international commerce leads economic activity to re-organize itself between the trading regions along a core-periphery structure, to the detriment of economic activity in the periphery. That is, there will be a ‘hollowing out’ in the periphery, and an agglomeration of activity in the core, because firms will concentrate production where demand is greater, and where economies of scale can be gained. There are important nuances in the various models proposed, and differences in opinion as to whether the core-periphery model holds as costs decline further with a deepening of globalization. Does the periphery become more peripheral over time, or is there a point at which patterns of concentration reverse such that the periphery converges with the core? Most of these studies acknowledge the pivotal role of the MNE in shifting production (and therefore employment) from one location to another in response to changing prices, availability of factors of production and the presence of markets. However, the way in which production shifts from core to the periphery, the structure of global production of MNEs and the differences between firms from the core and the periphery has been a matter that has mainly been addressed by the international business literature. A significant quality of the early research in international business contrasted the internationalization behaviour of MNEs from the core and the periphery, and how the redistribution of production and innovation between the core and the periphery takes place. Vernon’s product life-cycle model (1966) examines this process, based on a single core country (the US), and how, over the life of a given product, production would gradually be transferred to increasingly peripheral locations, either by the innovating core country firms, or by firms based in peripheral economies.1

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4. Outward FDI from the Periphery Vernon’s work – as with much of the earlier research on internationalization of firms and the location of production – pays scant attention to the differences in the nature of MNEs of differing home countries. Affiliates of MNEs from the core would function abroad as ‘miniature replicas’ of their home-country operations, truncated in response to firmspecific characteristics and the host country characteristics. Likewise, it was assumed that firms from the periphery – as they moved economically towards the level of the core – would operate in a similar manner, both at home and abroad. This idea was challenged in response to the growing phenomenon of MNEs from the developing countries (see, e.g., Kumar and McLeod, 1981; Lall, 1983; Lecraw, 1977). As UNCTAD’s World Investment Report 2006 attests, this literature has burgeoned quite considerably and has evolved a lot since the early work in this area. These concepts can be broadly applied beyond developing country MNEs to outward FDI from the periphery in general. The evidence on MNEs from the periphery has shown an evolution over time, and two different types of MNEs from the periphery, best described as being of two ‘waves’. Although this twowave approach was developed explicitly with developing-country MNEs in mind, the second wave in particular is associated with the characteristics of the MNEs, and their motivations apply equally to all peripheral home countries, whether developing or industrialized. The first wave sketched a description of a ‘different’ kind of MNE that – so it was argued – differed considerably from that of ‘conventional’ industrialized country MNEs, in terms of its ownership (O) advantages, motivation, geographical direction and mode of overseas activity. One of the features of developing-country MNE activity, as charted in the firstwave literature, was the direction and motivation of FDI, compared with ‘conventional’ MNEs (see, e.g., Lall, 1983). Much of the empirical work indicated a strong and marked trend for MNE from the periphery to focus their investments in neighbouring and other countries at a similar or an earlier stage of development. This preference was a direct result of their lack of international experience – these locations had offered resource endowments for markets that were broadly similar to those of their home countries. Furthermore, their O advantages were of a type most suited to these location (L) advantages (and often induced by them), and were based on technologies at the end of their product life cycles. In other words, these MNEs had few transaction-type ownership (Ot) advantages, and only the most basic form of asset-type O advantages (Oa) – those that

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derive from the efficient acquisition and adaptation of imported technologies. These O advantages were enhanced by the prevalence of importsubstituting, inward-looking policy regimes among most developing countries, which encouraged small-scale production, typical of that suited to these MNEs. The O advantages of these firms were primarily countryspecific, determined by the market distortions introduced by the home country policies, and only sustainable where similar L advantages existed in other countries. While some asset-seeking investment in industrialized countries was undertaken, it was relatively minor with many large investments representing flight capital or ‘round-trip investments’, as entrepreneurs utilized overseas subsidiaries to circumvent home country restrictions on outbound international capital movements. In particular cases, a large proportion of what is statistically recorded as outward FDI flows represented investments by the affiliates of ‘conventional’ MNEs. The growth of the ‘second wave’ of periphery MNEs can be traced to the late 1980s, and has also recently been expanded to include the growth of outward FDI from the former centrally planned economies of Central and Eastern Europe. The second-wave MNEs from the periphery tend to come from countries at a higher stage of industrial development, or those that have evolved structurally towards industrial sectors that are capital and knowledge intensive. These firms engage in outward FDI to less developed countries as a means of moving their natural-asset intensive activities to locations with appropriate comparative advantages, while, at the same time, they are engaging in both market and strategic assetseeking FDI towards the core countries. In other words, they are increasingly becoming global, demonstrating features of ‘conventional’ MNEs from the core. The evolution of the ‘second-wave’ MNEs from the periphery has been further enhanced by the fundamental (but gradual) change in the structure of the world economy, much of which is often generalized as being a direct result of globalization. These changes can be considered from the peripheral country perspective as being of two kinds. First, there are those that have been largely exogenous to these countries but that have affected their economic structure both as members of the world economic order and as individual economies. Whereas most core countries have been experiencing economic, technological and structural convergence, the majority of the peripheral countries, rather than converge with the lead countries, have tended to diverge. This simultaneous process of convergence and divergence has impacted on firms by creating broader and more competitive markets across countries due to similar consumption and production patterns. This has had two effects on the converging

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countries: (i) firms in each country are presented with larger markets, and this has led to developing global technologies that have large economies of scale and high minimum efficient scale. Firms in these industrial sectors need international markets to justify production (see Chapter 4 in this volume); and (ii) technologies have also converged, such that firms in certain sectors are now competing not just with other firms in the same country, but other firms in the same country but not necessarily in the same industry. In other words, firms need to have competitive advantages that are globally viable, rather than domestically or regionally so, and this has been further enhanced by the innovation of space-shrinking technologies (Narula and Dunning, 2000). Although the development of de facto and de jure economic blocs such as EU and NAFTA has primarily acted to enhance the positive effects of these developments for their members, they also represent barriers to entry to nonmembers and to developing countries in particular. Second, there have been structural changes within individual countries, often in direct response to these changes; as such they may be considered as endogenous to most peripheral economies. These endogenous changes are primarily associated with the actions and policies of governments. One of the most important of these changes over the past decade or so has been a fundamental shift in the policy orientation of developing countries from an import-substituting role (or a centrally planned one) to an export-oriented, outward-looking one. The extent of liberalization varies between countries: in some cases it is associated with a more proactive and market facilitating role, while in others it is simply reactive or even laissez-faire. Nonetheless, despite this broad spectrum of policy options, it is safe to generalize that the extent of government intervention embraces a much wider spectrum than was the case prior to 1990, and this variation is equally diverse regarding policy orientations towards MNE activity.

Multinationals from the periphery Certainly, the evidence on MNEs from the periphery would indicate that both waves of outward FDI from the periphery now occur simultaneously, from the same countries, regardless of their stage of economic development. The first-wave MNEs are focused towards resource-intensive activity (whether extractive, or labour-intensive), while the primary markets for the second-wave MNEs are in the core countries, and this is evidenced by the growth of FDI; there is increasing evidence that they wish to rapidly consolidate their presence in these locations. Growing competition means that these nascent MNEs do not have the privilege of

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States and Firms on the Periphery

slow and gradual overseas expansion any longer. A number of these MNEs have expanded through mergers and acquisitions, although this phenomenon is much smaller in relative terms than many observers have made out (Barnard, 2006). In other cases, they are ‘born global’, although the extent to which this is done may have less to do with their origin in a peripheral location than the industry-specific characteristics (see Chapter 5 in this volume). Whatever their reasons for doing so, a majority of these MNEs seek to present themselves not as MNEs from South Africa, India or China, but they adopt the modus operandi of ‘conventional’ MNEs from the core countries (ibid.; Mathews, 2006). Indeed, several of them relocate their headquarters to the US or the EU, and/or list themselves on stock markets there. Most peripheral economies have – as a means to overcome the inherent disadvantages and structural market imperfections associated with their home locations – nurtured state-owned enterprises and national champions as part of their economic and industrial policies. They have also often provided protection against competition and subsidized their outward expansion. Although various agreements within the WTO (combined with economic liberalization) have led to the dissolution – or at least a weakening of such state support – this has helped strengthen their O advantages, and provided these firms with the initial impetus to internationalize. However, as rents from protected home markets have dried up as a result of increased competition and privatization in a post-liberalization scenario, a number of such firms have experienced considerable restructuring of their foreign operations, sometimes withdrawing completely by selling off their foreign assets (Benito, 2005). Others have responded to the challenge by expanding abroad rapidly in a more aggressive way, and acting on commercial opportunities without fear punitive action on the part of their home country governments. These issues are discussed in greater detail in the policy section of this chapter.

5. Inward FDI to Peripheral Economies The liberalization of markets and the increasing cross-border interdependence between economies as a result of globalization has also led to a restructuring of inward FDI to these countries. The traditional picture of FDI flows has been that of capital, technology and competence moving between core countries of the Triad or to more peripheral ones within the triad, with those outside the triad largely being left out of the equation altogether (Dicken, 2003). In 2004, three-quarters of total stock of FDI in the world remained concentrated in Europe and North

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America (UNCTAD, 2005). Even though there are several cases of small peripheral countries that have been highly successful in attracting FDI – Ireland probably being the prime example in recent times (the value of the stock of inward foreign direct investment amounted to 126 per cent of Ireland’s GDP in 2004, see ibid) – there is a tendency for FDI to agglomerate in large countries, such as the United States, Germany, the UK and, increasingly, China. The United States has, over time, actually strengthened its current position as the largest recipient of FDI, closely followed by the EU, which experienced substantial inflows as a result of further economic integration throughout the last two decades. Another example of how economic integration may promote inward FDI is Mexico, which has become an increasingly important host for the operations of MNEs – partly as a result of the establishment of North Atlantic Free Trade Agreement (NAFTA). The picture has been particularly striking in the case of horizontal FDI, which to a considerable extent is of a market-seeking nature. The large markets of the core Triad economies have consequently been the main sources of FDI as well as the main recipients of such investments. Despite the high purchasing power of individual consumers, the reduction of trade costs as a result of trade liberalization should generally have made the smaller and more peripheral Triad countries less attractive as destinations for horizontal FDI: it has become easier and cheaper to serve these markets through exports. Vertical FDI, which is motivated by access to inputs and improving competitiveness through more efficient production, has historically been less prone to being concentrated among the large core countries: for example, before world war II two-thirds of the world’s FDI was located in developing countries (Dicken, 2003), and a majority of that FDI was of a vertical kind. However, in relative terms developing countries became evermore marginalized as host countries in the decades following the world war II. Less than a third of the world’s FDI stock in 2000 was located in developing countries. For small, peripheral, but rich and developed countries, such as those in the Nordic region, in Oceania and in Western and Southern Europe there has been a continuous flow of vertical FDI. Nevertheless, developments have been uneven. For example, whereas MNE industries such as shoes, textiles and apparel and various consumer goods were attracted by low labour costs in Southern Europe in the 1960–80 period, the cost advantage of that part of Europe was gradually lost in subsequent decades and much of the manufacturing capacity hence migrated to Asia. Only selected parts of production – those in which manufacturers were able to significantly upgrade local skills and

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competence – remain in the area. Other regions, such as the Nordic countries, also lost much of their traditional industrial manufacturing base (some of which was foreign owned), but in many industries their relative cost position did not deteriorate as much (see Chapter 9 in this volume); partly due to investments in technology and organization that has brought about significant productivity gains, and partly due to further specialization into areas where their cost position is less threatened. The general high cost position of the Nordic countries has been balanced by the development of good physical, social and educational infrastructures, and a well-educated workforce. Highly skilled human resources, such as engineers and scientists, have actually been relatively modestly paid. Some peripheral countries – and Ireland is a prime example – have been successful with pursuing deliberate policy efforts aimed at promoting inward FDI. Credible long-term policies that included favourable tax schemes and considerable infrastructural investment, combined with their position as a gateway to the EU, led to the creation of the Celtic Tiger (Navaretti and Venables, 2004). Finally, vertical inward FDI has in many instances been motivated by countries’ endowments of natural resources, such as energy and mineral, as testified by the presence of many MNEs in Latin America, South Africa and Oceania.

MNE affiliates in the periphery Acknowledging that FDI is not simply a commodity, but that what foreignowned subsidiaries actually do in a country matters, there is now a rich literature on various aspects of subsidiary roles and development (see, e.g., Benito et al., 2003; Birkinshaw and Hood, 1998; Holm and Pedersen, 2000). It is useful to look at the combination of activity scope and competence levels when discussing subsidiary roles. Figure 1.2 illustrates the different subsidiary roles that unfold from the various combinations of scope and competence levels. Because internationalization is inherently risky, initial investments tend to be small, perhaps in a sales subsidiary or a small-scale production unit. Subsequent development may, if it occurs, proceed along either one or both dimensions. As shown in Figure 1.2, subsidiaries with many activities but low competence levels are defined as ‘miniature replicas’, which basically mirror the parent organization. These subsidiaries are typically found in areas that are strategic for locating the entire value chain to achieve economies of scale and scope. Subsidiaries with few activities but high levels of competence, on the other hand, are highly specialized units that add value through their knowledge and competence to the rest of the MNE. Such subsidiaries are often related to R&D activities. There will, without doubt, always be several different combinations creating a

Gabriel R.G. Benito and Rajneesh Narula Level of competence High

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Strategic centre

Highly specialized unit, e.g. R&D Multi-activity unit, e.g. production and sales subsidiary

Low

Single-activity unit, e.g. sales subsidiary Few value activities

Miniature replica

Many value activities

Scope of activities

Figure 1.2 Different types of subsidiaries Source: Benito et al., 2003.

variety of roles, as illustrated by multi-activity units. That defines a ‘midground’ of subsidiary roles where probably the majority of subsidiaries can be placed. Finally, ‘strategic centres’ represent subsidiaries with a wide scope of activities as well as high competence levels. We expect that it is generally more beneficial – from the viewpoint of subsidiary development – to be located in the core than outside it. Units in the larger markets are, ceteris paribus, in a better position than those in the periphery to exploit economies of scale as well as economies of scope. Because liberalization of trade and factor movements often results in an intensification of competition, there will usually be a shakeout of lessefficient actors (see Chapters 2 and 8 in this volume). Those that remain in an industry are, hence, likely to be the most competitive ones. Of course, competitive processes are never at a standstill and units must – regardless of their location – strive to better their performance, efficiency or innovativeness. Units in peripheral locations may clearly also develop high levels of competence, especially if they are part of strong local industrial clusters or if they enjoy favourable access to unique resources of various kinds: special circumstances may make particular locations well suited for certain activities. However, whenever operations are predominantly oriented towards the local market, factors like weaker competition, smaller markets and more peripheral positions in the corporate network of the parent MNE, work against subsidiaries developing more advanced roles (see Chapter 8 in this volume). Subsidiaries in peripheral locations with the characteristics of, say, ‘strategic centres’ are hence more likely to be the ‘special case’ rather than the ‘general case’.

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Countries on the periphery suffer from their smaller markets and distance to the core. Historically, they have tended to overcome such disadvantages by instituting industrial policies that promote import-substituting type of investments by MNEs. As a result, they have tended to host subsidiaries that are ‘miniature replicas’. The MNEs have been able and willing to offset the disadvantages associated with small market size and inefficient scale economies inter alia by obtaining opportunities associated with privileged access to restricted markets. A deep regional integration scheme, of which the EU is a prime example, may considerably affect the location advantages associated with peripheral countries. Upon membership of deep integration schemes, ‘insider’ peripheral countries experience a decline of their location advantages associated with such privileges, since the state must re-orient their economies to the supra-regional norms established by the core, which is assumed to be offset by an industrial redistribution within the region based on comparative advantage, and potential access to a larger unified market. ‘Outsider’ countries, on the other hand, experience a decline in their location advantages, not because of industrial redistribution, but by virtue of being marginalized relative to neighbouring ‘insider’ countries. However, Tavares (Chapter 6 in this volume) shows that the development trajectories of ‘insider’ countries – that would seem relatively similar at the outset – may well differ.

6. Policy Issues There are a number of policy issues that arise, which can be classified as being: (1) policy issues associated with the peripheral nature of these economies per se; and (2) policy issues associated with the MNEs that invest into and from peripheral economies. These are intricately related, and we discuss two different areas of interest: those associated with domestic national policies, and those associated with supra-national policies.

Domestic policy issues Peripheral economies tend to be limited in their industrial policy space because of the inherent limitations of their economy. As discussed earlier, their economies tend to have competitive advantages in just a few sectors, and these tend to be sectors that take advantage of their natural assets. We argue here that peripheral economies – which tend to be both supplyand demand-constrained – are increasingly seeking to overcome these limitations by aggressively creating interdependencies with the core through rapid internationalization. This process has been considerably

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accentuated as countries have come to accept the new realities of economic liberalization that have necessitated an outward-looking, pro-FDI, political and economic policy orientation. The end to protectionism and state support that went well with the inward-looking import substituting stance, coupled with the resultant rapid inflow of FDI from the core economies, has forced domestic economic actors (both firms and states) to respond by looking to aggressively internationalize (Chapter 3 in this volume discusses in some detail the interaction between inward FDI and the internationalization of Estonian firms). From a demand perspective, the relatively limited domestic market size meant – in the days of inward-looking policies – that if such MNEs were to achieve economies of scale in production, they sought additional markets to that of their home location in order to increase their de facto market size (Bellak and Cantwell, 1997).2 This has not changed, except that the imperative is now greater with increased international competition. From a supply perspective, the smallness of their economies means that they have limited resources, in terms of capital (both financial and human) as well as in terms of natural and created assets, such that firms from these countries tend to specialized in a few sectors. The industrial structure of peripheral economies tends to demonstrate a ‘niche’ character, with a high level of specialization in few areas, where firms act as specialist suppliers and thereby show a low level of product diversification. Bellak and Cantwell (1997) posit that it is in such sectors that they can achieve price-setter positions. Industrial policy in these countries has often supported this specialization, because governments have a choice between spreading their limited resources thinly across many industries or concentrating them in a few targeted industries. Some governments have seen the internationalization of their firms as a ‘vote of no confidence’ in their home economy, and have actively sought to dissuade companies from internationalization. However, a problem for many firms from peripheral economies is that they need inputs that are not available locally, which they must therefore seek in foreign locations. Policies in the past have tended to involve intervention to micromanage the economy by trying to pick sectors to support, and the creation of national champions. However, this option can only be partially successful. It is expensive, and not sustainable on the long term, especially as WTO protocols such as the agreement on subsidies and countervailing measures (SCM) have reduced this avenue for intervention. Furthermore, though, despite the best intentions of governments, they cannot always pick national champions who will be ‘winners’ at the technological frontier because, by definition, the potential of one technological paradigm

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over another is very much unpredictable. In addition, peripheral country governments have limited resources, and not just financial capital. One of the primary reasons firms go abroad is to seek diversity of ideas and knowledge. This can hardly be overcome through techno-nationalism (Narula, 2003). The only real option open to policy-makers in this era of globalization is to accept the inevitable and help firms overcome market failure in markets for knowledge, as well as reduce the inherent risks of internationalization for their MNEs. This requires a proactive industrial policy, which should include allowing for the cross-border flow of new ideas through human capital: by far the most cost-effective means of such flows. Most important, it provides industry with the means to internalize and absorb technologies and ideas acquired from elsewhere, thereby developing a skilled workforce of international quality. This entails investing more in the quality of tertiary education and public institutions. Formal policies on inward FDI have to a large extent been liberalized, although considerable differences exist in the extent to which ‘MNEfriendly’ actions are de facto implemented. Given the considerable reliance of peripheral economies on FDI as a source of capital and technology, the kinds of FDI that are attracted, and the nature of MNE subsidiaries’ scope and scale is of prime importance. It is well acknowledged that the net benefits from FDI vary, by the kinds of activities undertaken in a given location, and that different subsidiaries may have widely different roles, ranging from performing relatively simple distribution tasks to having responsibility for a range of activities, including research, development and manufacturing. Although a number of peripheral economies play host to strategic subsidiaries, in general, subsidiaries in these economies tend to be less well integrated within the MNE’s hierarchy (see Chapter 8 in this volume). As Kottaridi (2005), among others, has shown, there are non-trivial benefits from being in the core rather than being in the periphery, whether in the sense of being peripheral to the core (such as say, Norway), or being peripheral within the periphery (such as, say, Laos). It is worth stressing that, except in sectors where there are important and dynamic industrial clusters, peripheral countries may experience a decline in MNE subsidiary activity both in terms of scope and competence levels (Benito et al., 2003). In general, most countries now actively seek inward FDI. However, while the potential for MNE-related spillovers is clear, the nature, level and extent of the benefits vary considerably, and the outcomes from a FDI-assisted industrial policy are not always positive (Lall and Narula,

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2004), and require considerable engagement by policy-makers in developing human capital, infrastructure and creating the appropriate milieu to promote positive outcomes from FDI inflows. As Lorentzen (Chapter 7 in this volume) implies in his South African study, the quality of the location advantages and the extent to which spillovers occur from inward FDI are crucially interrelated. It is not always sufficiently acknowledged that inward FDI can also have negative effects. For instance, in many peripheral economies, increased FDI has had negative effects on competition. First, conventional ‘crowding out’ has occurred: as MNEs increase competitive pressure on the domestic sector, domestic firms that have been unable to face this pressure choose – if they at all survive – to deskill the labour force and move to cheaper niches in the market. Those that survive, struggle to compete with foreign competitors (see Chapter 2 in this volume). Second, MNEs often acquire the most technologically competitive domestic firms. Thus, these firms can be regarded as also exiting, as ownership has been transferred from domestic to foreign. There is limited real movement of workers from the MNE sector to the domestic sector in the host country, due in part to the higher salaries paid by MNEs subsidiaries in order to keep their qualified workers and prevent dissemination of their superior knowledge (Fosfuri et al., 2001). In other cases, spillovers occur primarily between MNE affiliates and the domestic firms that they have acquired. MNEs tend to acquire the most technologically competitive among the domestic firms, with the highest absorptive capacity prior to acquisition, they would be in the best position to benefit from spillovers (Narula and Marin, 2005). The motive of investment and the structure of MNEs’ global configuration influence the extent to which subsidiaries are embedded, and the quality of spillovers. The fact that FDI activities do not always demonstrate significant spillovers to the economy at large indicates that not all FDI provides the same opportunities for spillovers and linkages. For instance, resource-exploiting investments (say, in mining) seek to provide unprocessed raw materials (a relatively low value-adding activity), which act as inputs to other affiliates that may be located elsewhere. Resourceseeking FDI may employ a large workforce and be capital intensive, but the potential for spillovers to domestic firms may be small. While potentially important, FDI is not a sine qua non for economic development. MNEs and FDI may well lead to an increase in productivity and exports, but they do not necessarily result in increased competitiveness of the domestic sector or increased industrial capacity, which ultimately determines economic growth in the long run (Lall and Narula, 2004).

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To be sure, upgrading of technological capabilities of domestic firms can no longer be pursued in quite the same way in a globalizing world. International competition is a given, and there can be no return to the infant industry model. Nonetheless, market forces cannot substitute for the role of governments in developing and promoting a proactive industrial policy (see Chapter 7 in this volume). Firms necessarily take a shorterterm, profit-maximizing view because they are largely risk averse. FDI per se does not provide growth opportunities unless a domestic industrial sector exists that has the necessary technological capacity to profit from the externalities from MNE activity (Chapter 2 in this volume). This is well illustrated by the inability of many Asian countries, which have relied on a passive FDI-dependent strategy to upgrade their industrial development. FDI, domestic capabilities and a domestic sector need to be concatenated and properly phased if positive results are to be achieved.

Supra-national policy issues An important outcome of globalization has been the increasingly blurred identity of the nation-state. On the one hand, countries remain sovereign and independent, while, on the other hand, they are increasingly swayed by extra-national developments. At the same time, there are clearly defined characteristics and patterns that are history-dependent and idiosyncratic, such as areas of specialization, technological competences, structure of markets, consumption patterns and culture. Government policies have to tread a thin line between responding to extra-national developments and to domestic priorities. This has led to what is best described as de facto economic integration. That is to say, unintended national-level economic integration has occurred, and this has gradually been acknowledged by de jure integration. The growing intensity of international production has followed a natural co-evolutionary path with that of de facto economic integration, which in turn has been reinforced by de jure integration. Supra-national agreements such as the EU, NAFTA, WTO have reinforced, accelerated and created standardized regulation for economic activity, acting as a virtuous circle with regards economic integration that had been occurring as a matter of course. While interdependence, de facto integration and economic growth allow countries to catch up, there are a wider set of issues to do with reciprocity and being politically peripheral in the international arena. This is most obviously noted within supra-national organizations such as the WTO. Agreements such as SCM, Trade Related Investment Measures (TRIMs) and Trade Related Aspects of Intellectual Property Rights (TRIPS)

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have severely limited the policy space for countries, as issues such as tariffs, subsidies, incentives and so forth are decided in a supra-national arena. Malhotra (2006) argues that multilateral and bilateral investment agreements have dubious benefits since they restrict the policy autonomy of developing countries, and may increase transaction costs, while simultaneously increasing opportunity costs. As Helene Hoggen discusses in Chapter 10, peripheral economies are in an uneven bargaining position vis-à-vis the core economies. Despite the fact that the peripheral economies dominate the membership of the WTO in terms of sheer numbers, the political and economic clout of the EU and the US tends to give them the advantage, as they are able to skew the agenda in their own favour, in many cases using a proliferation of bilateral agreements with individual countries to overcome resistance to their proposed reforms. The BRICS (Brazil, Russia, India, China and South Africa) coalition was intended to create a united front on behalf of the peripheral economies in the WTO negotiations, but its failure to get concessions from the core economies for reciprocal access underlines the relative bargaining positions of the core and the periphery.

7. Overview of the Book This book gives extensive treatments of pertinent aspects of being peripheral in an increasingly global economy. It starts with four studies of outward internationalization – by trade as well as investment – by firms from small and peripheral economies. Lou Anne Barclay (Chapter 2) examines the competitive strategies implemented by successful Trinidadian exporters in the context of a liberalized trading environment. Her starting point is that, while developing countries have been liberalizing their trade regimes since the end of the 1990s, it is uncertain whether such countries always benefit from trade liberalization. The manufacturing sector of small, developing countries is especially vulnerable to the consequences of liberalized trade. Thus, the future viability of their local manufacturing firms is questionable. Her analysis suggests that many of the firms studied might not be able to compete in a liberalized trading environment. Indeed, the future viability of Trinidad’s manufacturing sector rests on the actions of both policymakers and firms. Ele Reiljan (Chapter 3) analyzes the role of foreign owners in the internationalization of manufacturing enterprises in Estonia, one of the small emerging economies in the Baltic. Foreign investors have a significant share in several branches of the Estonian manufacturing industry

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and therefore it is likely that they influence the development of these branches by dictating the rules not only in the Estonian market but also in determining the structure of the export markets, the share of foreign activities, commitment to the foreign markets, choice between subcontracting activities and own export, and several other strategic issues that influence the overall pattern of foreign expansion. As Reiljan concludes this has had an impact on the sustainability of competitiveness of the Estonian enterprises and the whole economy. Grøgaard and Benito (Chapter 4) use data from Norway, a rich albeit small country in the northern periphery of Europe, to investigate the role of industry factors as drivers of companies’ internationalization. They argue that the bulk of literature on companies’ internationalization has focused on firm-level and country-level factors in order to explain firms’ cross-border activities. With the exception of a limited number of studies looking at rivalistic behaviour in oligopolistic industries, industry factors have been neglected as potential important determinants of internationalization. Specifically, Grøgaard and Benito look at whether differences across industries with regard to competition level, research intensity, tangibility of the products and the existence of clusters influence the impetus and opportunities to internationalize. They use an extensive data set covering the internationalization patterns of the 100 largest non-financial Norwegian companies over the period 1990–2000. The results suggest that industry factors contribute significantly to explaining the companies’ internationalization, and that the effects of industry factors remain strong when firm-level characteristics are taken into account. In contrast to Gørgaard and Benito who focus on relatively large companies, the study by Siv Marina Karlsen (Chapter 5) describes the process of internationalization of 12 small and medium-sized enterprises in Norway. Her study explores the factors that influence the pace of internationalization, in particular why some firms gradually become international while others are ‘born global’. She finds that some high value-adding manufacturing firms, in spite of their small size and lack of experience in international transactions, are capable of outrunning their larger, more resourceful counterparts in foreign markets. Firms originating from small countries seem to be more exposed to forces pushing them out: partly due to small domestic markets and partly due to fear of future competition from firms originating from larger countries. In the three subsequent chapters, the perspective is changed from an outward to an inward view of internationalization. Ana Teresa Tavares-Lehmann (Chapter 6) examines the cases of two small open EU economies (Ireland and Portugal). These two countries in

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the EU periphery have had very different performances in their FDI attraction, both in terms of magnitude of FDI inflows and regarding the quality of multinationals’ operations. Based on a survey of more than 600 foreignowned subsidiaries in Portugal and Ireland, the study highlights issues related to the quality and scope of MNE subsidiaries’ activities, providing evidence on subsidiary strategic evolution, the motivations underlying investment and characterizing the qualitative dimensions linked to observed evolutionary processes. Tavares connects different subsidiary evolutionary paths to host country development impact. She looks at subsidiaries’ value-added scope and the density and quality of local linkages as key determinants of host country impact, and makes an explicit link between subsidiary evolution and public policy towards MNEs. The policy stances of the two host economies are compared, showing that Ireland was far more focused, consistent and effective in terms of promoting and sustaining high-quality inward investment, leading to an expected greater ability to withstand future global challenges. The chapter by Jochen Lorentzen (Chapter 7) presents a South African case study looking into the relationship between human capital in host economies and international capital inflows. Lorentzen’s study describes how DaimlerChrysler upgraded human resources in the area around its East London plant in one of South Africa’s least developed provinces, where the company manufactures the Mercedes C-Class model for export. It shows the extent and depth of the upgrading along and beyond the automotive supply chain, and its repercussions on local education and training institutions. It also analyzes how and why this virtuous interaction between FDI and local industrial development in the short and medium term may, in the absence of proper regional economic planning, turn into a much less desirable outcome in the longer term. Björn and Tina Ambos (Chapter 8) look at corporate R&D, traditionally one of the most protected and most centralized activities in companies, but which has experienced a rapid internationalization over the 10–15 years. In contrast to earlier studies, which have focused on R&D activities in core Triad countries, their study also provides novel insights about R&D units in non-Triad nations. The study, which builds on survey data from 49 leading German MNEs that collectively account for two-thirds of the country’s privately funded R&D expenditures, reveals some interesting patterns. An important finding is that units in the Triad, as well as peripheral locations, are increasingly equipped with global market mandates, which indicates that the times when R&D was simply carried out for local markets are over. However, despite a steady growth of inward investment, it seems that non-Triad nations are unable to catch up with the core. The study

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also shows that the MNEs manage their units in peripheral and in core countries in different ways: units in peripheral locations display much higher interdependencies with corporate headquarters, are granted much less autonomy, and are much less innovative (measured by patents per annum) than units in core locations. Whereas previous chapters focus either at local firms’ outward internationalization or at foreign firms’ entry and subsequent development of operations in a country, the chapter by Carl Arthur Solberg (Chapter 9) looks at both domestic and foreign companies in his study of relocation. He proposes a model for analyzing relocation of business activities, with a focus on three groups of factors: country, industry cluster and company factors. His study of the Norwegian offshore supply sector indicates that country and internal company factors are particularly important in explaining firms’ relocation of business activities. However, the strength of cluster factors does not seem to play any significant direct role in this context. His findings also indicate that there is no difference between local and foreign firms in their proclivity to relocate. In the final chapter, Helene Hoggen (Chapter 10) takes the level of analysis up from that of firms and industries to that of countries and their relationships. Looking at the WTO, she argues that formal rules and dispute settlement cases are not precise indicators of which member states’ companies benefit from the WTO system. It is also debatable whether the system is beneficial first and foremost for industry or whether it protects consumers – in peripheral as well as central WTO member states. She argues that it is important to observe ongoing negotiations continuously in order to determine ‘who gets what and how’. The WTO is a very special organization and the trade rules laid down in the WTO agreements are continuously being renegotiated. The WTO system is more complex than it may seem at first glance and traditional rationalist perspectives are not necessarily the best equipped to explain WTO dynamics. In essence, her chapter deals with the challenge of being a country or a company in the periphery of the WTO system, as compared to being a central actor in the WTO. Her analysis suggests that, while coercion is a viable weapon of the strong, principled argument can be a potent asset for the weak to bring about desired change.

Notes 1. 2.

Cantwell (1995) generalizes Vernon’s ideas, extending them to include multiple core locations, and the role of technological change in this process. The issue here is to seek access to markets, which firms may do either through exports or FDI.

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References Barnard, H. (2006) ‘Investment from less to more developed countries as a mechanism for capability upgrading in developing country firms’, unpublished PhD dissertation, Newark: Rutgers University. Bellak, C. and Cantwell, J. (1997) ‘Small latecomer countries in a globalising environment: constraints and opportunities for catching-up’, Development and International Cooperation, 13: 139–79. Benito, G.R.G. (2005) ‘Divestment and international business strategy’, Journal of Economic Geography, 5: 235–51. Benito, G.R.G., Larimo, J., Narula, R. and Pedersen, T. (2002) ‘Multinational enterprises from small economies: internationalization patterns of large companies from Denmark, Finland, and Norway’, International Studies of Management and Organization, 32(1): 57–78. Benito, G.R.G., Grøgaard, B. and R. Narula (2003) ‘Environmental influences on MNE subsidiary roles: Economic integration and the Nordic countries’, Journal of International Business Studies, 34(5): 443–56. Birkinshaw, J. and N. Hood (eds) (1998) Multinational Corporate Evolution and Subsidiary Development, Basingstoke: Macmillan. Cantwell, J. (1995) ‘The globalization of technology: What remains of the product cycle model?’, Cambridge Journal of Economics, 19: 155–74. Dicken, P. (2003) Global Shift: Reshaping the Global Economic Map in the 21st Century, 4th edn, London/Thousand Oaks/New Delhi: Sage. Dunning, J.H., Narula, R. and Van Hoesel, R. (1998) ‘Third world multinationals revisited: New developments and theoretical implications’, in Dunning, J.H. (ed.) Globalisation, Trade and Foreign Direct Investment, Oxford: Elsevier. Forslid, R. and Wooton, I. (2003) ‘Comparative advantage and the location of Production’, Review of International Economics, 11(4): 588–603. Fosfuri, A., Motta, M. and Ronde, T. (2001) ‘Foreign direct investment and spillovers through workers’ mobility’, Journal of International Economics, 53(1): 205–22. Fujita, M. and Thisse, J. (2003) ‘Does geographical agglomeration foster economic growth? And who gains and loses from it?’, Japanese Economic Review, 54(2): 121–45. Held, D., McGrew, A., Goldblatt, D. and Perraton, J. (1999) Global Transformations. Politics, Economics and Culture, Cambridge: Polity Press. Hoesel, R. van (1999) New Multinational Enterprises from Korea and Taiwan, London: Routledge. Hoesel, R. van and Narula, R. (eds) (1999) Multinationals from the Netherlands, London: Routledge. Holm, U. and T. Pedersen (eds) (2000), The Emergence and Impact of MNC Centres of Excellence, Basingstoke: Macmillan. Kottaridi, C. (2005) ‘The “core-periphery” pattern of FDI-led growth and production Structure’, Applied Economics, 37: 99–113. Krugman, P. (1991) Geography and Trade, Leuven/Cambridge, MA: Leuven University Press/MIT Press. Krugman, P. and Venables, A. (1995) ‘Globalization and the inequality of nations’, Quarterly Journal of Economics, 110(4): 857–80. Kumar, K and McLeod, G. (eds) (1981) Multinationals from Developing Countries, Lexington, MA: D.C. Heath & Co. Lall, S. (1983) Third World Multinationals, Chichester: John Wiley.

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Lall, S. and Narula, R. (2004) ‘FDI and its role in economic development: Do we need a new agenda?’, European Journal of Development Research, 16: 447–64. Lecraw, D. (1977) ‘Direct investment by firms from less developed countries’, Oxford Economic Papers, 29(3): 442–57. Malhotra, K. (2006) ‘Will a trade and investment link in the global trade regime be good for human development?’, in R. Narula and S. Lall (eds) Understanding FDI-Assisted Economic Development, London: Routledge. Marshall, A. (1919) Industry and Trade; A Study of Industrial Technique and Business Organization, and of their Influences on the Conditions of Various Classes and Nations, London: Macmillan. Mathews, J. (2006) ‘Dragon multinationals: New players in 21st century globalization’, Asia Pacific Journal of Management, 23: 139–41. Narula, R. (2003) Globalisation and Technology, Cambridge: Polity Press. Narula, R. and Dunning, J.H. (2000) ‘Industrial development, globalization and multinational enterprises: new realities for developing countries’, Oxford Development Studies, 28(2): 141–67. Narula, R. and Marin, A. (2005) ‘Exploring the relationship between direct and indirect spillovers from FDI in Argentina’, MERIT Research Memorandum 2005–16. Navaretti, G.B. and Venables, A.J. (2004) Multinational Firms in the World Economy, Princeton: Princeton University Press. Prebisch, R. (1962) The Economic Development of Latin America and its Principal Problems, New York: United Nations. UNCTAD (2005) World Investment Report 2005, Geneva: United Nations. ——— (2006) World Investment Report 2006, Geneva: United Nations. Van Den Bulcke, D. and Verbeke, A. (eds) (2001) Globalization and the Small Open Economy, Cheltenham: Edward Elgar. Vernon, R. (1966) ‘International investment and international trade in the product cycle’, Quarterly Journal of Economics, 80: 190–207. Wallerstein, I. (1974), The Modern World System: Capitalist Agriculture and the Origins of the European World Economy in the Sixteenth Century, New York: Academic Press. ——— (1979) The Capitalist World Economy: Essays, Cambridge: Cambridge University Press.

2 Can Domestically Owned Manufacturing Firms of Small Developing Economies Compete in a Liberalized Trading Environment? Lou Anne A. Barclay

1. Introduction Within the past two decades, developing countries have been liberalizing their trade regimes. However, the beneficial effects of liberalized trade are still to be empirically substantiated. Yet, it is evident that small, developing countries are especially vulnerable to the consequences of a liberalized trading environment (Armstrong and Read, 1998). Moreover, it is the manufacturing sector of these economies that is particularly vulnerable to liberalized trade (ibid). This thus begs the question as to what the future viability of the local manufacturing firms of small, developing countries is in an increasingly liberalized trading environment. This chapter seeks to provide answers to this question by examining the competitive strategies implemented by local firms in the manufacturing industry of Trinidad and Tobago. It will also analyze the manner in which policy-makers, in their new facilitative role, are attempting to increase the competitiveness of these firms. The outline of this chapter is as follows. The subsequent section explores the extant literature on trade liberalization and economic development. The third section examines the trade liberalization initiatives implemented in the Caribbean Community (CARICOM), of which Trinidad and Tobago has been a member since the inception of this regional trading arrangement in 1975. It also discusses Trinidad and Tobago’s present dominance of intra-regional trade. The fourth section discusses the sampling and data collection methods used for this study. It also analyzes the characteristics of the sampled firms, including their motivations to engage in international business activity. The fifth section examines the strategies these firms used for international competition, while the sixth section discusses 25

26

Domestically Owned Manufacturing Firms

the role that the enabling home country plays in increasing the competitiveness of these firms. Finally, the seventh section presents the conclusion.

2. Trade Liberalization and Economic Growth in Developing Countries In recent times, developing countries have increasingly perceived trade liberalization to be the panacea for economic development. Indeed, the extant literature suggests that the potential benefits arising from liberalized trade are myriad. Some researchers argue that its immediate effect is improved factor allocation as resources shift from inefficient capitalintensive, import-substituting activities to efficient labour-intensive, export-oriented ones. They also posit that the long-term effects of liberalized trade are seen in the accumulation process, capital formation and the growth of real output and trade (e.g., Greenaway, 1998). Other researchers add the improved access to superior technology, imports and intermediate goods, the transfer of know-how and the development of a more economical market structure (Dornbusch, 1992). A number of empirical studies, which sought to investigate the above propositions, have been conducted. These studies reveal that trade liberalization results in a rapid growth of exports (e.g., Santos-Paulino, 2002) and a more rapid growth of real GDP (Papageorgiou et al., 1991; Wacziarg and Welch, 2003). Others concur with the growth-enhancing aspects of trade liberalization, however, they argue that this growth is not instantaneous; it is lagged (Greenaway et al., 1998). Studies have also shown that trade liberalization results in an improvement in investment (Harrigan and Mosley, 1981). In addition, others cite the improved productivity and efficiency of local firms that benefit from easier access to technology and heightened import competition (Devarajan and Rodrik, 1989; Pavcnik, 2002). However, several studies do not adopt such a sanguine perspective to trade liberalization. Indeed, it is argued that in the short term, trade liberalization does have ‘some undesirable but inevitable’ side effects; unemployment may increase and fiscal depletion may occur (Greenaway, 1998). Further, the proposed short-term effect of trade liberalization of improved factor allocation has not been supported by empirical investigation (e.g., Davis, 1996). In fact, some researchers emphasize the importance of including the effect of agglomeration economies on the location of activity among liberalized economies (Amiti, 1998). It seems that the effect of agglomeration economies is to reinforce the existing concentration of knowledge-intensive activities within countries as well as to relocate more footloose activities to large, domestic markets (Hanson, 1994).

Lou Anne A. Barclay

27

In addition, the proposition that trade liberalization results in economic growth is subject to controversy. The conclusions of some of the empirical studies supporting this claim have been challenged.1 Indeed, Greenaway et al. (1998), examining the extant literature, note that both positive and negative growth impacts have been recorded. Hence, in some instances, economic growth does deteriorate after trade liberalization. In addition, they note that several countries experience investment slumps subsequent to trade liberalization. It seems that the privatization initiatives mounted by the public sector are not accompanied by an increase in investment by the private sector since the latter questions the credibility of these reforms (Greenaway, 1998). Further, the notion that trade liberalization results in the improved productivity and efficiency of local firms has been disputed (e.g., Rodrik, 1988). Researchers also posit that these empirical studies suffer from ‘identification problems’ (ibid). Trade liberalization has been accompanied by ‘sensible’ macro-economic policies such as realistic exchange rates and fiscal discipline, which are often implemented under the auspices of the stabilization and structural adjustment programmes of the IMF and the World Bank (ibid., p. 27). Hence, it is difficult to ascertain the beneficial effects to an economy from it solely liberalizing its trade regime. Clearly, the economic consequences of developing countries implementing trade liberalization programmes are uncertain. Interestingly enough, the literature is relatively silent on the impact of trade liberalization on the smaller, developing countries, which are likely to be especially vulnerable to the consequences of a liberalized trading environment.2 It is noteworthy that one study that examines this issue also emphasizes the uncertain impacts of trade liberalization (Armstrong and Read, 1998). Most importantly, this study revealed that liberalized trade would have a negative effect on the local manufacturing sector because of the erosion of preference margins (ibid., p. 560). Other researchers prophesy the death of the local firms in smaller, developing economies, which would be unable to compete with the ‘economic juggernauts’ from the larger, more developed economies (Reubens, 2003). The vulnerability of local manufacturing firms to liberalized trade is noteworthy since many small, developing countries have implemented the strategy of trade liberalization in tandem with the World Bankinspired orthodoxy of private sector-led development. Thus, in this newly liberalized trading environment, it is the private sector, not the government, that is the agent of economic transformation. The government’s role in economic development is merely that of facilitating the activities of the private sector.

28

Domestically Owned Manufacturing Firms

From the foregoing discussion, it is evident that the beneficial effects of the trade liberalization initiatives presently being implemented by many developing countries are uncertain. Moreover, it is ironic that given the present orthodoxy of private sector-led development, it is the manufacturing sector of small, developing countries that is especially vulnerable to liberalized trade. This thus has tremendous implications for the future viability of local manufacturing firms in small, developing countries. As was earlier discussed, this chapter seeks to examine this issue. To this end, it will analyze the competitive strategies, which are being implemented by Trinidadian manufacturing firms, in response to an increasingly liberalized trading environment. It will also examine the manner in which policy-makers, in their new facilitative role, are attempting to increase the competitiveness of these firms. The following section discusses the trade liberalization initiatives implemented in the Caribbean Community, the regional integration arrangement to which Trinidad and Tobago belongs. In addition, it examines the country’s emergence as a ‘regional hub and export engine’ (CARICOM, 2000, p. 77).

3. The Emergence of Trinidadian Firms in a Liberalized Trading Environment Trinidad and Tobago is a member of the 15-country grouping that comprises the Caribbean Community (CARICOM),3 which consists of a number of small states juxtaposed with micro-nations and economies (Wint, 2003)4 (see Table 2.1). Since the mid-1980s, these countries have been progressively reforming and opening their economies. The Common External Tariff (CET), which ranged between 0 and 45 per cent in the pre-1990 period, has since been standardized and lowered to a range of 0 to 25 per cent for all products, with the exception of agricultural goods, and non-tariff measures have been substantially reduced (ECLAC, 2001). Recent attempts were made to deepen the integration process through the creation of the CARICOM Single Market and Economy (CSME).5 Further, initiatives have been made towards liberalizing trade with countries outside of the Caribbean Community. CARICOM countries have formalized bilateral trade and investment agreements with the countries in the western hemisphere (see Table 2.2). Complementing these initiatives have been the continued negotiations to establish the Free Trade Area of Americas (FTAA). Notwithstanding these measures, intra-regional trade as well as trade with the western hemisphere partners has remained persistently low. In fact, for the period 1990–7, intra-regional imports comprised less than 10 per cent of

Lou Anne A. Barclay Table 2.1

29

Selected indicators of CARICOM member states in 2002

Country

Area (Km2)

Population

GDP at current market price (EC$M)

GDP per capita at current market price (EC$M)

Anguilla Antigua and Barbuda The Bahamas Barbados Belize Dominica Grenada Guyana Haiti Jamaica Montserrat St Kitts and Nevis Saint Lucia St Vincent and the Grenadines Surinam Trinidad and Tobago

91 442

11,561* 76,485

298* 1,947

25,776 25,450

13,939 431 22,966 750 345 21,4970 27,750 10,991 103 269

31,200 275,320 257,310* 71,079 102,638 774,800 8,357,000 2,618,600 4,501 46,710

8,287** 7,015 2,572 685 1,084 1,961 12,797 22,897 103 953

29,718** 25,906 9,700 9,640 10,560 2,531 1,531 8,744 22,908 20,397

616 389

159,133 109,164

1,815 975

11,404 8,931

16,3820 5,128

441,356* 1,276,000

429 29,181

1,264* 22,754

Notes: * ⫽ 2001, ** ⫽ 1995, EC$ 2 ⫽ US$ 1. Source: CARICOM, 2003.

total imports. In subsequent years, this figure barely crossed the 10 per cent barrier, with intra-regional imports totalling 11.1 per cent of total imports in 2000 (CARICOM, 2003). This trade is dominated by Trinidad and Tobago. As Table 2.3 demonstrates, during the period, 1990–1997, Trinidad and Tobago accounted for more than 50 per cent of intra-CARICOM trade, with this figure escalating to 79 per cent in 2000. This country enjoys a substantial trading surplus in manufacturing products with every CARICOM country (CARICOM, 2000, p. 92). Trinidad’s dominance is also extended to extra-CARICOM trade, accounting for 48 per cent of CARICOM’s exports to Latin America during 1996–1998 (CARICOM, 2000). Since the mid-1990s, Trinidad and Tobago, like many other developing countries, has implemented a strategy of private sector-led development (Barclay, 2004). Hence, it is privately owned firms that are driving Trinidad’s aggressive international business activity. These firms share some common

30

Domestically Owned Manufacturing Firms

Table 2.2 Trade and investment agreements between the CARICOM countries and western hemisphere partners Agreement

CARICOM-USA CARICOM-Canada CARICOM-Colombia CARICOM-Dominica Republic CARICOM-Cuba CARICOM-Venezuela Dominica RepublicCARICOM Barbados-Venezuela Barbados-Canada Grenada-USA Haiti-USA Jamaica-USA Jamaica-Argentina Trinidad and Tobago-USA Trinidad and TobagoArgentina

Date concluded

Trade agreement

1984 1986 1994 1998

X X X X

2000 1992 1998

X X X

1994 1996 1986 1983 1994 1994 1994 1995

Bilateral investment

X X X X X X X X

Source: ECLAC, 2001, Table 1.

characteristics.6 First, some of them, significantly those involved in financial services, presently operate in a large number of countries. Second, these firms are large by regional standards. Indeed, most of the major conglomerates in Trinidad and Tobago are involved in this trade. Third, in most cases, their overseas investment takes place through inter-corporate linkages, such as mergers and acquisition, rather than greenfield investment. However, it is the locally owned, export-oriented, manufacturing firms of Trinidad and Tobago that are the subject of this study. The following section discusses the sampling and data collection methods employed, and introduces the firms used for this study.

4. Method: Sampling of Manufacturing Firms and Data Collection The choice of research method was dictated by the need to provide definitive answers to the question: what is the future viability of local manufacturing Trinidadian firms in an increasingly liberalized trading environment? Hence, a qualitative method was employed. Qualitative

Table 2.3 Proportional distribution of the volume of CARICOM’s intra-regional imports and exports among member states, 1990–2000 CARICOM member states Year

Merchandise trade

1990

Imports c.i.f. Exports f.o.b. Imports c.i.f. Exports f.o.b. Imports c.i.f. Exports f.o.b. Imports c.i.f. Exports f.o.b. Imports c.i.f. Exports f.o.b. Imports c.i.f. Exports f.o.b. Imports c.i.f. Exports f.o.b. Imports c.i.f. Exports f.o.b. Imports c.i.f. Exports f.o.b. Imports c.i.f. Exports f.o.b. Imports c.i.f. Exports f.o.b.

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

CARICOM

MDCs

Barbados

Guyana

100.0 100.0 100.0 100.0 100.0 98.3 94.0 99.2 93.1 99.6 100.0 100.0 100.0 100.0 89.0 94.2 98.6 100.0 100.0 100.0 100.0 100.0

60.2 81.4 58.4 80.8 56.7 81.0 59.5 84.6 61.9 88.3 70.8 90.6 71.6 91.8 64.7 85.9 75.3 91.1 72.8 91.0 73.1 92.7

31.9 13.0 21.0 14.8 19.8 13.2 19.5 13.2 18.5 9.6 17.5 10.6 16.5 11.5 12.9 10.3 18.2 10.6 14.8 10.6 22.3 9.6

4.9 2.7 6.5 – 8.6 – 9.8 – 10.4 4.0 – – – – – – 10.8 4.8 7.0 5.0 0.0 0.0

Jamaica

17.5 13.8 14.0 13.8 13.3 13.0 20.8 11.2 23.4 8.7 35.4 7.0 37.7 6.1 32.9 4.7 34.7 4.2 33.2 3.8 38.7 3.9

Suriname

– – – – – – – – – – 6.9 1.4 6.8 2.7 8.7 3.8 0.0 0.0 6.0 4.9 0.0 0.0

Trinidad and Tobago 15.8 52.0 16.8 52.2 15.0 53.9 9.4 60.2 9.6 65.9 11.0 71.6 11.1 71.5 10.2 67.2 11.8 71.4 11.8 66.6 12.2 79.2

LDCs

Belize

39.8 18.6 41.6 19.2 43.3 17.3 34.5 14.6 31.3 11.2 29.2 9.4 28.4 8.2 24.3 8.3 23.3 8.9 27.2 9.0 26.9 7.3

2.6 1.7 1.4 1.6 2.1 1.3 1.9 0.9 1.8 0.8 1.8 8.7 1.4 0.5 1.1 0.8 1.2 1.1 1.2 0.9 1.3 0.7

31

Notes: —— not available. Source: CARICOM, 2002, Table 1.01(b).

32

Domestically Owned Manufacturing Firms

methods are specifically used in international business because of their capability to ‘study the non-linear, interactive, interdependent phenomena that make up this field’ (Wright, 1996, pp. 69–70). In this study, a case study was done of seven manufacturing firms operating in the non-oil sector of Trinidad and Tobago. One of the dangers of using case studies is the difficulty in generalizing to larger populations. Attempts were made to minimize this drawback by using more than one case and matching cases according to specific criteria (Wright, 1996). In this study, the criteria used were wholly owned, local manufacturing firms operating in the non-oil sector,7 which were exporting and/or engaging in foreign direct investment. The data for this study was obtained from the Trinidad and Tobago Export Directory Media and Editorial Project 3, 2001, which provides a comprehensive listing of Trinidad-based firms involved in international business activity. This database identified a total of 573 manufacturing firms engaging in such activity in 2001. Firms were randomly selected from this database, with every 20th firm being chosen for inclusion in the sample list. A total of 28 firms were selected. However, further analysis of these firms revealed that five of them were involved solely in distribution activities. The objective of this study is to examine locally owned Trinidadian firms that are engaged in both manufacturing and international business (exporting and/or foreign direct investment). Thus, these five firms were eliminated from the sample. This study also sought to examine manufacturing firms that operated outside Trinidad’s energy sector. Hence, eight of the firms were excluded from the list. Thus, the sample was reduced to fifteen firms, which all operated in the non-oil sector and were involved in both manufacturing and international business. However, seven of these firms declined to participate in this study, reducing the sample size to eight firms. Further, one company owned two of the selected firms.8 Hence, a total of seven firms were eventually examined. The majority of these firms are the dominant producers and exporters in their industry. The main research instrument employed in this study was a questionnaire consisting of ten semi-structured questions that required open-ended responses. Respondents were top-level executives such as chief executive officers or marketing executives. In most cases, face-to-face interviews were conducted. However, for two firms, the exigencies of time influenced the use of telephone interviews. These firm-level interviews were complemented by interviews held with key policy-makers. A questionnaire consisting of six semi-structured questions requiring open-ended responses was used for this purpose.

Lou Anne A. Barclay

33

General characteristics of sampled firms As Table 2.4 illustrates, a diverse group of firms was examined. The age of these firms varied from 23–83 years. They also varied in size: two firms were relatively large with 1,000 employees, while the others possessed between 60 and 500 employees. The products manufactured and exported were also diverse: three exported brand name food products, two brand name drinks, while the others were involved in speciality spices, plastic packaging bags, water tanks and construction-related products. Half of these firms, significantly, the smaller ones, used dedicated distributors to enter the export market. The others used inter-corporate linkages, mainly mergers and acquisitions, for this purpose. Finally, most firms had international business activities that extended beyond the CARICOM market. The majority operated in several markets including the US, Canada, Central and South America, Europe and India. It is also noteworthy that these firms had various motivations for becoming involved in international business activity. They will be examined in the subsequent section.

The drivers for international business activity Generally, most of the firms studied have been involved in international business activity for more than ten years. It seems that the favourable enabling environment of Trinidad and Tobago in the mid-1980s is what initially motivated these firms to export. As Wint (1998) notes, in the mid-1980s, the government of Trinidad and Tobago designed and implemented policies to stabilize the macro-economic environment in which the local manufacturing firms operated, as well as to encourage them to export.9 However, other factors subsequently influenced the export-led activities of the firms studied. First, for the larger firms studied, the motivation to engage in exports was part of a long-term strategic plan to dominate the CARICOM market. In so doing, some of these firms acquired other Caribbean firms to preempt foreign rivals from entering this market. Second, the majority of the firms perceived the CARICOM market to be simply an extension of the domestic market. These firms, significantly, those involved in the manufacture of brand name food, had limited prospects for expansion in the Trinidadian market. They thus became involved in export-led activity and, in some cases, foreign direct investment in the neighbouring CARICOM market. Third, it seems that the ‘opportunistic pursuit for profit opportunities’ (Farrell, 2003) also motivated the international business activities of several firms studied. Three of the larger firms, which were engaged in activities as diverse as the manufacture of brand name food to the manufacture of construction-related products, acquired privatized firms in

34

Domestically Owned Manufacturing Firms

their respective industries. Finally, there appears to be a pattern of ‘followthe-leader’ investment, especially among the smaller firms studied, which are attempting to emulate the exporting activities of the larger Trinidadian firms. This behaviour was, to a large extent, encouraged by the generous incentive programme for export-led activity, which was in place until 2003. Interestingly enough, it seems that the locational choices made by the majority of the firms examined are very similar to those suggested by theorists such as Johanson and Vahlne (1977; 1990) and used by other developing country firms (e.g., Yeung, 1997). Several of the Trinidadian firms examined initially adopted an ‘intra-regional focus’ (Farrell, 2003, p. 37) exporting to the CARICOM market, which is culturally similar and geographically close to their home market. Some of these firms, significantly, those in the food and beverage industries, subsequently acquired their Caribbean-based rivals. They extended their international business activity by exporting the products manufactured by the parent company and the acquired firms to the West Indian diaspora markets in Canada, the UK and the US.10 Further, a minority has successfully managed to penetrate the Asian and the continental European markets. It is instructive to examine the strategies these firms used to compete as they progressively became more internationalizd. In the subsequent section, we will examine the evolution of these strategies.

5. Strategies Trinidadian Firms Use for International Competition Competing in the CARICOM market The competitive strategies initially employed in the CARICOM market were based on competencies, which the firms had earlier successfully developed and leveraged in their home market. Indeed, one of the competencies that most of the food and beverage companies enjoyed was distribution. One company studied developed the competencies needed for the sophisticated management of its supply chain. In so doing, it has achieved the enviable target of having its product manufactured and consumed within 30 days. These competencies were subsequently transferred to the Caribbean market, where the firm established sales offices to manage product distribution and provided local staff with customized training. Other executives in the food and beverage industry also spoke of their ‘world class’ distribution network, which was first developed in Trinidad and later transferred to the CARICOM markets. Another competence, which was initially developed in Trinidad and later formed the basis of several firms’ regional competitive strategy, was

Lou Anne A. Barclay

35

production efficiency. This competence was realized in their ability to produce a quality product. Several firms in manufacturing activities as diverse as food and beverage, and plastics created a competitive strategy that was based on the delivery of a competitively priced, high-quality product. It is significant to note that for the food and beverage companies, this was often a brand name product. In some cases, it appears that the source of this competitive advantage can be traced to the firms’ relationships with foreign companies. For example, one firm was previously owned by a leading food multinational, which was instrumental in developing its present export product. As noted earlier, several of the firms studied had acquired rival firms in CARICOM markets. With their acquisitions in these markets, it seems that these firms sought to also use production efficiency as a source of competitive advantage. To this end, several deployed senior managerial and production staff to the acquired companies in order to improve their production efficiency. In one case, in an attempt at enhancing capitalization levels, a company made significant capital investments to upgrade the equipment and technology of its acquired plants. Yet, it is significant to note that at this stage of internationalization, the competitive strategies being developed do not seem to be part of a comprehensive plan to consolidate corporate-wide technologies, together with production, marketing and distribution capabilities into core competencies that will empower each business unit to quickly adapt to the changing business environment (Prahalad and Hamel, 1990). Rather, there seems to be little rationalization of production centres, products, including their brands, and distribution networks to match the companies’ competitive strategy. This situation partly reflects the failure of many of these companies to develop an integrated production network, which spans the CARICOM region, judiciously using the locational advantages of one country for the development of corporate-wide competencies. As Farrell (2003, p. 12) notes, the competitive strategy that several food companies use for their acquisitions has been generally to continue production and marketing using the original product brands in both the host country and export markets. Simultaneously, these companies have continued to use product quality and a superior distribution network as the basis of their competitive strategy for the exported, home-based product. Interestingly, in many instances, these products compete in similar markets.

Competing beyond the CARICOM market As Table 2.4 shows, most of the firms studied have successfully entered the extra-CARICOM market. In fact, some of these firms have been operating

36

Table 2.4

General characteristics of sampled firms

Firm

Years of establishment

Size (number of employees in 2004)

Export product

Number of foreign affiliates or subsidiaries

Export market

Firm 1 Firm 2

23 80

150 1,000

Brand name food Brand name drink

– 4 subsidiaries

Firm 3

47

300

–

Firm 4

25

60

Firm 5

50

1,000

Firm 6

27

240

Firm 7

83

500

Speciality spices, Brand name food, Natural products Plastic packaging bags Cement Construction Material slings, Paper sacks, Bulk packaging products Plastic bottles, Water tanks, Brand name drinks Brand name food

CARICOM CARICOM, Central America, Asia, Canada and USA CARICOM, USA, Canada, Europe, Indias

1 strategic partner 3 subsidiaries 2 joint ventures

CARICOM (OECS) CARICOM South America

–

CARICOM South America

2 subsidiaries

CARICOM, Canada, US Europe

Lou Anne A. Barclay

37

in these markets for more than 20 years. It is noteworthy, however, that for the majority of firms studied, the strategies used for competition in the regional market are very similar to those implemented in the international ones. Most of the food and beverage companies sought to compete on the basis of a competitively priced, brand name product, which is distributed in a timely manner to consumers. These products were generally marketed to the West Indian diaspora in the larger cities of the US, Canada and the UK. It is also noteworthy that none of these companies studied owned or operated production centres or distribution networks in these locations. Rather, the products were generally exported from the main production centres in CARICOM, and distributed by means of foreign, third parties into the international markets. Further, in general, little product modification was done to satisfy the idiosyncratic needs of the international market. Rather, these companies sought to appeal to the nostalgic sentiments of the overseas West Indian. Hence, the features of the product, including its brand name and packaging, were generally maintained to gain product recognition in the diaspora market. It is also significant that there were generally few attempts to move the exported product beyond the diaspora market. Only one of the firms examined had conducted market research in order to determine the peculiar needs of the Canadian consumer. As a result of this research, this company modified its product in order to reach the wider Canadian market. The seven firms studied are clearly competitive. They have all emerged from a small, developing country and, in most cases, managed to achieve sustained export growth. Undoubtedly, the source of their competitiveness in the CARICOM and international markets was generally based on their operational effectiveness; that is, their ability to perform similar activities better than rivals (Porter, 1996). Through efficiencies gained in production, these firms are able to deliver a competitively priced and, in some cases, brand name, quality product in a timely manner to consumers.11 Yet, is it possible for these firms to sustain their export performance in an environment that is becoming increasingly liberalized? The answer to this question partly lies in the sustainability of the competitive strategies employed by these seven firms. This is the subject of the following section.

The sustainability of the competitive strategies pursued by the Trinidadian firms Porter (ibid.) notes that while operational efficiency is necessary for a firm to achieve a superior performance, it is not usually sufficient. He

38

Domestically Owned Manufacturing Firms

posits that a firm needs to have a well-designed competitive strategy, which is essentially the deliberate choice of a different set of activities that delivers a unique mix of values to the consumer. Further, Porter postulates that the firm’s functional activities need to ‘fit’ with its competitive strategy. A ‘strategic fit’ among the firm’s activities is fundamental to the sustainability of its competitive advantage since it is more difficult for rivals to imitate an array of interlocking activities than any specific activity (ibid., p. 63). Indeed, Porter (ibid., pp. 64–5) defines a competitive strategy as follows: Strategy is creating fit among a company’s activities. The success of a strategy depends on doing many things well – not just a few – and integration among them. If there is no fit among activities, there is no distinctive strategy and little sustainability. Management reverts to the simpler task of overseeing independent functions, and operational effectiveness determines an organisation’s relative performance. [Emphasis mine] Given the above, it is questionable whether many of the firms examined have implemented strategies that will allow them to withstand competition in increasingly liberalized markets. Undoubtedly, the firms studied have devised and implemented strategies, which allowed them to compete in a home market that became progressively liberalized.12 In so doing, they achieved efficiencies in production, which resulted in a competitively priced, often brand name, quality product that was distributed in a timely manner to consumers. They subsequently managed to successfully leverage these competencies in the neighbouring CARICOM market. However, it appears that these firms are now unable to modify their competitive strategy to match changing corporate circumstances and market conditions. As noted earlier, several of the larger firms studied acquired rival firms in CARICOM markets. However, for these firms, there was little rationalization of products, including brand name ones, production centres and distribution networks to fit with a well-designed competitive strategy. Indeed, there seemed to be little attempt to rethink the existing strategy of competing in the CARICOM market. These companies appear to have made little effort to use their advantageous presence in the major markets of CARICOM to realign their functional activities in a manner that will create unique value to the consumer. There thus seems to be little attempt made at devising and implementing strategies for either lowering costs across regional operations or creating defined

Lou Anne A. Barclay

39

synergies among operations in different countries. Moreover, there appears to be little attempt to re-organize the functional activities performed in different countries in a manner that will serve the needs of a targeted segment of the industry. As a result, many of these companies seem to be presently producing disparate, brand name products in different, and sometimes autonomous, production centres scattered throughout Jamaica, Barbados and Trinidad, which are all subsequently marketed in the CARICOM and diaspora markets. A similar situation exists in international markets. It was earlier noted that several firms, specifically those in the food industry, exported their brand name products to diaspora markets in the US, Canada and the UK. It seems that these markets are simply an extension of the home market since the same competitive strategies employed at home were used in these markets. These companies all competed on the basis of a competitively priced, brand name product, which is distributed to the customers in a timely manner. However, there appear to be no attempts to move beyond the strategy of passively exporting a product, which appeals to the nostalgic sentiments of the overseas West Indian. There is little evidence of attempts made to identify the possible changing needs of this market, or to move the product beyond its safe confines. Further, there was no evidence of firms attempting to capture more segments of the value chain. They neither engaged in distribution nor operated any production centres in these countries. A few of the firms studied exported to the South American market. The source of these firms’ competitiveness was production efficiency. It is interesting to note that the products exported to the South American market were not part of these firms’ core activities. In consequence, it appears that the firms’ activity in these markets were not integrated into an overall strategy for competing internationally. In fact, in one instance, it was the firm’s surplus production that was actually exported to South America. All in all, it seems that these firms are yet to devise and implement sustainable competitive strategies. Evidently, this will affect their ability to compete with ‘economic juggernauts’ from the larger, more developed economies (Reubens, 2003). The present preoccupation of the majority of the firms studied appears to be increasing their operational efficiency. In the case of one firm, this was realized through its emphasis on quality – it presently operates a structured quality programme that is in compliance with the requirements of both the American Petroleum Institute (API) QI and ISO Standard 9002. In addition, it is implementing a ‘manufacturing excellence transformation programme’, which aims to transform performance and build capacity in its three plants. Despite these ongoing

40

Domestically Owned Manufacturing Firms

initiatives, this firm is still unable to compete against imported products from rival firms in the Far East, which the company alleges are dumping. However, one firm studied appears to have formulated and implemented a sustainable competitive strategy. This strategy is based on a realistic knowledge of its corporate strengths as well as a sound understanding of the industry in which it operates. In consequence, this company has positioned itself to be least vulnerable to competition arising from an increasingly liberalized trading environment. The focus of this strategy was creating and marketing a product for an underserved segment of the domestic, regional and international market. One executive compared this competitive strategy to peeling away layers of an onion. Indeed, the competitive strategy involved four distinct stages. The firm first sought to dominate the domestic market with a specific brand name product. Second, it sought to enter the Caribbean market with this product, creating a pan-Caribbean brand. The third stage involved it leveraging this brand name product in the extra-Caribbean market, specifically, North and South America. The final stage involved the company entering other international markets with this brand name product, thereby creating an international brand. This company, through market research, realized that there was no product in its industry that was specifically developed for children. It thus sought to enter this underserved segment of the industry. In so doing, it developed processes and operating systems, which were strategyspecific. The roots of its competitive strategy rest on four core competencies: low cost, technology-intensive production; sophisticated distribution; marketing; and social operating systems. The firm is presently the largest, low-cost producer of plastic bottles in the region, and has one of the most technically advanced soft drink plants in the Caribbean. The company sought to gain production efficiencies in both the bottling and filling aspects of its operations. It thus made significant investments in state-of-the-art plastic blowing machinery, which conferred the company with the distinct advantage of being able to produce large quantities of bottles at a high level of efficiency with a minimum wastage and low energy consumption. Undoubtedly, these production efficiencies have given the firm a competitive edge in the industry. However, the firm also sought to create a fit between its production efficiencies and its competitive strategy. In so doing, it sought to produce a lightweight, bottle that is ideally suited for children. Its brand name drink is packaged in a 250 ml uniquely designed, patented PET bottle. At present, 50 per cent of the firm’s production capacity is engaged in producing this brand name drink.13

Lou Anne A. Barclay

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The company also sought to gain efficiency in distribution. To this end, it has developed a sophisticated distribution network in the CARICOM market, which one executive claims is the best in the region. However, in an attempt to overcome the formidable costs and scale economies involved in creating its own international bottling network, this company sought to take advantage of its unique product, by franchising its bottling and distribution to a foreign company. The company has also aligned its marketing to its competitive strategy. To this end, it produces an array of drinks with flavours and colours that especially appeal to children. This strategy is buttressed by aggressive advertising and promotional campaigns, which employ a flexible localized approach that capitalizes on the culture of each country in which the brand name drink is marketed. The company also sought to tailor its operating systems to its competitive strategy. Interestingly enough, it has not adopted the approach postulated by business scholars such as Porter (ibid.). Rather, the company has introduced spirituality into the workplace. As one executive revealed, the business of this company is achieving ‘economies of souls’. This firm clearly has a sustainable competitive strategy. At present, its brand name product is marketed in more than 100 countries worldwide. The company has achieved the enviable reputation of being the first developing country with a global brand. Moreover, it has even stirred the ire of industry commentators. Indeed, one commentator stated: ‘Firms like [X] are taking their lead from American companies, and rampaging down their own little warpaths of expansion without limits’ (Norton, 2000). While this company is presently well positioned to withstand the onslaught of competition arising from liberalizing markets, many of the other firms studied may not be able to do so. This thus begs the question as to what policymakers could and should do to increase the competitiveness of the local manufacturing firms. This issue will be discussed in the following section.

6. The Role of the Enabling Home Country Environment in Increasing the Competitiveness of Trinidadian Firms As was earlier discussed, the enabling environment of Trinidad and Tobago in the mid-1980s is what initially motivated several of the firms studied to engage in export-led activity. However, it seems that as the firms became increasingly internationalized this environment has not evolved in a manner to fully support their requirements. Several of the firms studied complained about the inadequacy of the environment in which they operate, specifically, its infrastructure.

42

Domestically Owned Manufacturing Firms

Concerns were raised about the quality and costs of infrastructural services such as port, customs and utilities. The smaller firms cited the inadequacy of the existing investment incentive programme, as well as the dearth of credit facilities, as contributing to the inefficiencies of the country’s enabling environment. Other firms spoke of the need to enhance the existing legislative and regulatory framework to meet the demands of the new trading environment. One executive noted the urgency of increasing the capabilities of support institutions, such as the Bureau of Standards, which are not able to effectively deal with issues such as dumping. It is significant to note that most of the firms studied spoke of the naivety of policy-makers to the realities of their competing in a liberalized trading environment. Many spoke of the potential challenges of competing against international rivals that enjoy the benefits of subsidized inputs, economies of scale and supportive governments, which are willing to impose non-tariff barriers to protect their markets. Yet, most of the policy-makers interviewed were dubious of the ability of the local manufacturing firms to compete in a liberalized trading environment. They noted that many of these firms would need support in areas such as R&D, technological upgrade, packaging, market-related information and complying with international standards. There was also a clear recognition that several aspects of the country’s enabling environment need to be improved. First, there appears to be an absence of systems for the generation, analysis and dissemination of information in a timely manner to the local manufacturers. Indeed, many firms lacked the capability to benchmark themselves against their international rivals, or the knowledge of what is required to operate in international markets. Second, it appears that the present incentive programme and its accompanying legislation are outdated. Incentives such as tax holidays are dependent on the firm’s profitability. Moreover, these incentives favour highly capital-intensive activities, such as the petrochemical industry, not the local manufacturing industry. Nonetheless, plans are afoot to modify the existing incentive programme, which is generalized to all industries, to one that is more sector-specific. Other areas of weaknesses in the enabling environment are also being addressed. In an attempt at modernizing and improving the efficiency of customs, one local business association has introduced a computerized system for the processing of customs documents for its members. Users are now able to process their documents in less than 48 hours. In addition, the government is involved in the Inter-American Bank Trade Support programme, which started in 2005, that aims to identify weaknesses in particular industries and devise policies to correct them.

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There are other initiatives that do necessarily enhance the competitiveness of the enabling environment but are aimed at increasing the competitiveness of the local manufacturing firms. The government has established a standing committee with members drawn from the public and private sector to formulate a development plan for eight strategic industries, including the manufacturing industry. This plan will be incorporated into the national development plan. In addition, staff of selected ministries are presently receiving training on trade-related issues. Further, the government and the local business associations have launched trade missions to some of the countries with which Trinidad and Tobago has signed bilateral trading agreements. It is important to note that these initiatives are being implemented in the context of the phased liberalization of the economy. Policy-makers reveal that in the ongoing FTAA negotiations, their posture is that CARICOM products should be given a grace period of more than ten years. They suggest that the firms in the manufacturing industry will, thus, have adequate time to enhance their international competitiveness.

7. Conclusions This chapter sought to examine the future viability of local manufacturing Trinidadian firms in the context of an increasingly liberalized trading environment. This study concludes that while a few of these firms may withstand the onslaught of competition arising from trade liberalization, many would not be able to do so. The chapter suggests that there are several reasons for this. Clearly, the home environment from which these firms emerged played a critical role in the success of their initial international business activity. Since the mid-1980s, the Trinidadian government, through its programme of investment incentives, has been successfully able to reduce the risks associated with the upgrading of technological and productive capacity, accessing working capital and capital financing, and penetrating export markets (Wint, 1998). However, some of these incentives have been recently discontinued, with adverse consequences on a few of the firms studied. Further, it seems that the home environment has not been able to evolve in a manner to meet the changing needs of the successful exporters. However, several recent government-led initiatives have been implemented that seem to address some of these issues. Nonetheless, the present challenge facing the Trinidadian government is a serious, ‘managerial’ one (ibid., p. 297). It needs to implement that mix of policies that, while being WTO-compliant, still manages to catalyze the local manufacturing firms, which are already successful exporters, to

44

Domestically Owned Manufacturing Firms

implement those strategies that would ensure their sustainable international competitiveness. This evidently has tremendous implications for the capabilities (education and training) of present policy-makers. Yet, while enhancing the enabling environment is necessary for the local manufacturing firms to achieve sustainable international competitiveness, it is not sufficient. As this chapter has shown, these firms need to implement competitive strategies, which would allow them to survive in a liberalized trading environment. Many firms studied need to rethink their strategies of competing in the CARICOM and international markets. Production centres in the CARICOM markets need to be integrated, distribution networks need to be rationalized and the strategy of marketing disparate, brand name products need to be re-examined. In addition, attempts need to be made to move the exported, brand name products beyond the cocoon of the diaspora market. Indeed, these firms need to ‘fit’ their competitive strategy with the functional activities performed in the domestic, CARICOM and international markets. As this chapter has demonstrated, little attempt seems to have been made at crafting and implementing strategies for either lowering costs across regional operations or creating defined synergies among them. There was also little attempt to organize the functional activities performed in different countries in a manner that will serve the needs of a targeted segment of the industry. In consequence, the majority of the firms studied did not possess competitive strategies that will allow them to survive competition in a liberalized trading environment. However, developing a sustainable competitive strategy has tremendous implications for these firms’ emergent organizational structure, human resource requirements, technological and operational capabilities and innovatory capability. This in turn has significant implications for government’s policies on issues such as education and training, technology and the provision of venture capital. Clearly, the future viability of the local manufacturing firms in Trinidad and Tobago rests on the concerted and purposeful actions of both the firms and the government.

Notes 1. The Papageorgiou et al. (1991) study is one that has been challenged by other researchers. For example, Greenaway (1993) has found weaknesses in the methodology used in this study. 2. Small countries, as measured by population, landmass or national income, have open economies as seen in the share of trade in their GNP or GDP, which is often over 100 per cent. This high degree of trade means that these countries are extremely vulnerable to exogenous shocks in the international

Lou Anne A. Barclay

3.

4.

5.

6. 7.

8.

9.

10. 11.

12.

45

environment, and thus are highly sensitive to changes in global trading environment. Hence, they would be extremely vulnerable to the increasing liberalization of trade. For further discussion on this issue, see Armstrong and Read, 1998. CARICOM, which was formed in 1973, grew out of the Caribbean Fee Trade Association (CARITFA), created in 1968. CARICOM presently includes the following member states: Antigua and Barbuda, the Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Haiti, Jamaica, Montserrat, St Kitts and Nevis, St Vincent and the Grenadines, Surinam, and Trinidad and Tobago. Anguilla, the British Virgin Islands and the Turks and Caicos are associate members of the Caribbean Community. The commonly used measure of country size is population because it is the most easily available variable (Armstrong and Read, 1998). However, it is the threshold to be used that is the subject of debate. Some researchers use an upper limit of 3 million (ibid.), while others use less than 5 million (Demas, 1965). Countries with populations of less than 1 million are invariably characterized as micro-states (Caldwell et al., 1980). The main objective of the creation of the CSME, which was established in 2006, is to integrate the CARICOM economies into a single market in which people, goods, services and capital can move freely in a single economy governed by the same coordinated and harmonised economic policies (INTAL, 2002). This section draws heavily from Farrell, 2003. The exclusion of firms in the energy sector is a deliberate one. There is a relatively paucity of academic work that examines the competitive strategies of wholly owned, local manufacturing firms that operate outside of Trinidad’s energy sector. This study is an attempt to fill this lacuna. This firm owned two companies that were engaged in the same activity. It seemed that the competitive strategies used by these companies in export markets were designed and implemented by the firm interviewed. The government designed and implemented a comprehensive incentive programme to facilitate export activity. This included accelerated depreciation of capital equipment; flexible export allowances where the firms received tax relief in direct proportion to their exports; a marketing grant scheme for penetrating extra-regional markets; tax deductions on promotion expenses; and measures to ensure that input costs were at international levels. For further discussion on this issue, see Wint (1998). The incentives designed to promote export activity, such as the flexible export allowance, which are now considered to be not compliant with the rulings of the World Trade Organization, were discontinued in 2003. Some of the acquired Caribbean firms were exporting to the diaspora market before their acquisition by the Trinidadian firms. It is instructive to note that these firms’ ability to compete on the basis of superior production efficiency is largely a result of government’s incentives, such as the accelerated depreciation allowances, which have been implemented since the mid-1980s. Trade policy was also a crucial element of the government’s incentive programme to facilitate export activity. Since the mid-1980s, the Trinidadian government has gradually liberalized trade as well as concluded several free

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Domestically Owned Manufacturing Firms

trade agreements with neighbouring Latin American countries. For further discussion of this issue, see Wint (1998). 13. This company manufactures and distributes seven brand name drinks for the domestic and CARICOM markets. However, three of its seven drinks are also marketed internationally.

References Armstrong, H.W. and Read, R. (1998) ‘Trade and growth in small states: The impact of global trade liberalization’, The World Economy, 21(4): 563–85. Amiti, M. (1998) ‘Trade liberalization and the location of manufacturing firms’, The World Economy, 21(7): 953–62. Barclay, L.A.A. (2004) ‘FDI-facilitated development: The case of the natural gas industry of Trinidad and Tobago’, Oxford Development Studies, 32(4): 485–505. Caldwell, J., Harrison, G. and Quissin, P. (1980) ‘The demography of small states’, World Development, 8(12): 953–67. Caribbean Community (CARICOM) Secretariat (2000) Trade and Investment: Dynamic Interface of Regionalism and Globalisation. Georgetown, Guyana Kingston, Jamaica: CARICOM Secretariat Ian Randle. ——— (2002) CARICOM’s Intra-Regional Trade Volume 1, 1990–2000, Georgetown, Guyana: CARICOM Secretariat. ——— (2003) CARICOM Statistics, http://caricomstats.org/Files/Databases/ Selected. Accessed 17 March 2004. Davis, D.R. (1996) ‘Trade liberalization and income distribution’, NBER Working Papers, No. 5693. Demas, W.G. (1965) The Economics of Development in Small Countries: With Special Reference to the Caribbean, Montreal: McGill University Press. Devarajan, S. and Rodrik, D. (1989) ‘Trade liberalization in developing countries: Do imperfect competition and scale economies matter?’, American Economic Review, 79(2): 283–7. Dornbusch, R. (1992) ‘The case for trade liberalization in developing countries’, Journal of Economic Perspectives, 6(1): 60–85. Economic Commission for Latin America and the Caribbean (ECLAC) (2001) Trade and Investment Flows Between the Caribbean and the Rest of the Hemisphere in the Context of FTAA, LC/CAR/G.664, 12 November. Farrell, T.M.A. (2003) ‘Caribbean economic integration – What is happening now; what needs to be done’, paper presented at CARICOM 30th Anniversary Conference, ‘Regional Governance and Integrated Development’, 17–19 October, Mona, Jamaica. Greenaway, D. (1993) ‘Liberalising foreign trade through rose tinted glasses’, The Economic Journal, 105: 208–27. ——— (1998) ‘Does trade liberalization promote economic development?’, Scottish Journal of Political Economy, 45(5): 491–511. Greenaway, D., Morgan, W. and Wright, P. (1998) ‘Trade reform, adjustment and growth: What does the evidence tell us?’, The Economic Journal, 108: 1547–91. Hanson, G. (1994) ‘Regional adjustment to trade liberalization’, NBER Working Papers, No. 4713.

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Harrigan, J. and Mosley, P. (1981) ‘Evaluating the impact of World Bank structural adjustment lending: 1980–87’, Journal of Development Studies, 27: 63–94. Harrigan, K.R. (1983) ‘Research methodologies for contingency approaches to business strategy’, Academy of Management Review, 8(3): 398–405. Institute for the Integration of Latin America and the Caribbean (INTAL) (2002) CARICOM Report No. 1, Argentina: Integration and Regional Programs Department, Inter-American Development Bank. Johanson, J. and Vahlne, J.E. (1977) ‘The internationalization process of the firm – a model of knowledge development and increasing foreign market commitments’, Journal of International Business Studies, 8(1): 23–32. ——— (1990) ‘The mechanisms of internationalisation’, International Marketing Review, 7(4): 11–24. Media and Editorial Projects (2001) Trinidad and Tobago Export Directory, http://tnt_export_directory:4001/index.php. Accessed 23 February 2004. Norton, J. (2000) ‘Chubby made by S.M. Jaleel’, Flak Magazine, 6 October, http://www.flaxma.com/misc/chubby.html. Accessed 4 May 2004. Papageorgiou, D., Michaely, M. and Choksi, A. (eds) (1991) Liberalising Foreign Trade, Oxford: Basil Blackwell. Pavcnik, N. (2002) ‘Trade liberalization, exit, and productivity improvements: Evidence from Chilean plants’, Review of Economic Studies, 69: 245–76. Porter, M.E. (1996) On Competition, Boston: Harvard Business Review. Prahalad, C.K. and Hamel, G. (1990) ‘The core competence of the corporation’, Harvard Business Review, May–June: 79–91. Reubens, E. (2003) ‘Free trade, or countervailing power of the Americas’, Challenge, 46(4): 54–70. Rodrik, D. (1988) ‘Closing the technology gap: Does trade liberalization really help?’, NBER Working Papers, No. 2654. Santos-Paulino, A.U. (2002) ‘Trade liberalization and export performance in selected developing countries’, Journal of Developing Studies, 39(1): 140–64. S.M. Jaleel & Co. Ltd, – A Thirst for Perfection http://w2.chubbysd.com/chubby files/chubby.htm. Accessed 4 May 2004. Solow, R.M. (1957) ‘Technical change and the aggregate production function’, Review of Economic and Statistics, 31: 312–20. Wacziarg, R. and Welch, K.H. (2003) ‘Trade liberalization and growth: New evidence’, NBER Working Papers, No. 10152. Wint, A.G. (1998) ‘The role of government in enhancing the competitiveness of developing countries: Selective functional intervention in the Caribbean’, International Journal of Public Sector Management, 11(4): 281–99. ——— (2003) Competitiveness in Small Developing Economies, Kingston, Jamaica: University of the West Indies Press. Wright, L.R. (1996) ‘Qualitative international management research’, in B.J. Punnett and O. Shenkar (eds) Handbook for International Management, Cambridge, MA: Blackwell: 63–81. Yeung, H.W. (1997) ‘Transnational corporations from Asian developing countries: Their characteristics and competitive Edge’, in H. Vernon-Wortzel and L.H. Wortzel (eds), Strategic Management in the Global Economy, New York: John Wiley.

3 Internationalization of Estonian Manufacturing Enterprises: Are Foreign Investors Dictating the Rules of the Game? Ele Reiljan

1. Introduction Internationalization of Estonian enterprises started at the beginning of the 1990s. Several development plans and strategies that were suggested by Estonian businessmen and politicians at the beginning of 1990s considered Estonia’s role to be a link between East and West, namely between Western European countries and Russia. In reality, Estonia’s role has been to create a linkage between the Nordic countries and Latvia and Lithuania. Therefore, rather than acting as a mediator between two regions with a huge market potential, Estonian firms have limited their activities to meeting the demand of relatively small countries (Sweden, Finland Latvia, and Lithuania). This shift in strategies was mainly caused by the Russian crisis and implementation of double tariffs by Russia. Another reason for the selection of smaller target markets lies in the foreign owners’ strategies – they considered the risk level in the Russian market to be too high and chose to enter the Baltic countries. This chapter attempts to identify the role of foreign owners in the internationalization of the Estonian manufacturing enterprises. Foreign investors have a significant share in several branches of the Estonian manufacturing industry and therefore it is likely that they influence the development of these branches by dictating the rules not only in the Estonian market but also in determining the structure of the export markets, the share of foreign activities, commitment to the foreign markets, choice between subcontracting activities and own export, and several other strategic issues that influence the overall pattern of foreign expansion. This, in turn, has an impact on the sustainability of competitiveness of the Estonian enterprises and the whole economy. 48

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The analysis of foreign operations in this chapter is limited to export and foreign investment data, since licensing and franchising activities are almost absent and, unfortunately, there are no reliable data about all branches of the manufacturing industry that would allow distinguishing between subcontracting and own export. Another limitation of the analysis is that it exclusively concentrates on the manufacturing industry and comparisons with service industry, wherever possible, are drawn only at an aggregate level. This approach derives from the fact that most of the internationalization of service industries in Estonia is covered by the foreign activities of a few big enterprises active in Latvia and Lithuania. This choice was also motivated by lack of detailed data about the service industry that would have allowed us to identify the role of foreign investors in the internationalization pattern of Estonian service firms. The third limitation of the analysis herein derives from the nature of available data, which do not allow distinguishing between alternative organizational modes within the export and foreign investment activities. The chapter starts with discussion of the main trends and motives for inward foreign investments in Estonia at an aggregate level. Next, the international activities of the Estonian manufacturing industries are described and the role of foreign owners in shaping the internationalization pattern is analyzed. Finally, two case studies are presented in order to illustrate the role of multinational firms in the internationalization processes of the Estonian firms. The company in the first case study, Krenholm, was selected since it has the largest number of employees among the manufacturing firms belonging to the top 50 firms by their total volume of foreign investment. Sylvester, on the other hand, has attracted one of the most sizable foreign investments ever made in Estonian manufacturing industry.

2. Foreign Direct Investments Inflows into Estonia In the early 1990s, investments into Estonia were relatively modest in absolute terms (see Figure 3.1) but, compared to several other transition countries, their level per capita was high (Reiljan, 2001, p. 60). In 1998, they were twice as large as the year before, but the Russian crisis that started at the end of 1998 affected the whole region and some of the investors postponed their investment projects, considering the uncertainty level to be too high. After that no clear trend has been observable in foreign direct investment inflows into Estonia, despite the continuous development of the economy. Instead, some big investment projects (for instance, acquisition of the Sylvester Group by Stora Enso in 2003) and also integration

50

Internationalization of Estonian Manufacturing Enterprises 14,000

12,471

Millions of kroons

12,000 9,430

10,000

8,071

8,000

6,645

6,000

2,000

3,694

2,819

4,000 997

2,153

4,800

4,448

2,313 1,814

0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Foreign direct investment inflow Figure 3.1 Foreign direct investment inflows into Estonia 1992–2003 (millions of kroons) Source: ‘Structure of Direct Investment Flows’, 2004.

Naturalresourcesseeking 10%

Strategicassetsseeking 7%

Marketseeking 65%

Efficiencyseeking 18% Figure 3.2

Distribution of foreign investments into Estonia by their primary motive

Source: Reiljan, 2002: 112.

into the European Union (investments in agriculture during 2003) have mainly influenced the foreign direct investment inflows. The classification suggested by Dunning divides the motives behind foreign direct investments into four main groups (see, e.g., Dunning, 1994, p. 36). Most of the foreign investors in Estonia have reported that their main motive for entering the market was to meet the local demand (see Figure 3.2). There are several studies about other transition countries, too, that have reached similar conclusions (see, e.g., Lankes and Stern, 1998; Marinov and Marinova, 1999; Meyer, 1995; Pye, 1997). This result, however, seems somewhat doubtful, as in the case of transition countries low-cost production inputs are often pointed out as the main competitive advantage in attracting foreign investors. However, in the first years after the dissolution of the Soviet Union and opening of the

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new markets, the perceived risk level in these countries was too high for most of the companies from developed countries, who therefore preferred to establish small subsidiaries in the potential target markets, avoiding large-scale investments into production activities. Consequently, efficiency-seeking investments gained importance as the risk level related to these countries decreased. Unfortunately, there are no recent studies about the foreign investors’ motives in Estonia, but the developments suggest that most investors now have an efficiency- or strategic-assetsseeking nature. The importance of the low-cost production inputs is evident as during the 1990s most of the export in transition countries was based on low labour costs. The Central and Eastern European (CEE) countries did not have remarkable differences in labour costs between themselves, whereas the differences with the developed countries were significant. For example, in 1995 the wages and salaries in the Finnish manufacturing industry were on average 10.5 times higher than in Estonia (Reiljan and Varblane, 2001, p. 8), which resulted in the relocation of several activities from Finland to Estonia. Similarly, Swedish enterprises transferred the manufacture of many labour-intensive products into Estonia. Cost advantages made it also possible to reorient the exports to the Western European markets, especially in the case of industries that were able to provide high quality goods. However, continuous development over the years and integration with the European Union have resulted in rising labour costs and therefore several labour-intensive industries are losing their competitive edge in international markets (Tamm, 2004). Moreover, emergence of the new production opportunities in Asia facilitates this process even more. This decline in competitiveness should be compensated for by switching over to the manufacture of capital-intensive and/or high-technology products, but in this area it is not easy to compete with the highly developed countries. Therefore, drawbacks in terms of export activities and change in the prevailing motives for investing in transition countries can be expected to occur in several industries in the forthcoming years. These potential developments can have a significant influence on the whole Estonian economy since the share of companies with foreign participation is high at the moment and they can determine the trends both in the local market and international activities. Table 3.1 indicates that despite the small share of foreign-owned firms in terms of the number of companies, they constitute a high share in the number of employees, net sales and, especially, export sales. Thus, the small Estonian economy is highly dependent on the foreign investors’ strategies, sourcing and production decisions and potential relocation of activities into the Asian

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Internationalization of Estonian Manufacturing Enterprises

Table 3.1 Foreign share in the Estonian manufacturing industry 1995–2002 (% of all enterprises)

Number of companies Number of employees Export sales Net sales

1995

1996

1997

1998 1999

2000 2001 2002

12.6 9.5 25.4 20.1

10.0 16.8 32.5 26.6

9.6 18.8 32.1 27.1

9.5 20.8 35.2 28.2

9.8 27.3 44.9 34.3

9.5 25.0 43.3 32.7

10.2 30.8 48.5 36.7

9.6 32.2 51.5 38.8

Value added per employee (thousands of kroons)

Source: Statistical Office of Estonia, 2004a.

140 120 100 80 60 40 20 1995

1996

1997

1998

1999

2000

2001

All companies Companies with foreign ownership Domestic companies Figure 3.3 Value added per employee in Estonian manufacturing companies between 1995 and 2001 (1,000s of krnoos) Source: Statistical Office of Estonia, 2004a.

countries. If the labour-intensive production is transferred to Asia, unemployment is likely to increase significantly. Moreover, export sales are in this case likely to decrease; this will generate even higher pressure on the Estonian economy, which suffered a high trade balance deficit level until the beginning of the transition process. Besides the penetration of foreign-owned enterprises into Estonian manufacturing industry, the contribution of these firms to the economy is of great interest. Figure 3.3 shows that the value added per employee has been constantly lower in the domestic companies and there is no notable convergence between locally and foreign-owned firms. However, in some industries the value added by companies with foreign participation is modest. One such example is Elcoteq, which constitutes a high share of

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both Estonian exports and imports; the value added here is small and therefore the contribution to the local economy is not as high as could be expected.

3. International Activities of Estonian Manufacturing Enterprises By comparison with developed Western European countries, the differences in the internationalization processes in transition countries derive from the experience and knowledge that the enterprises have. Enterprises from Western European countries have developed sequentially (the original idea of sequential development of international operations was suggested in Luostarinen, 1982; Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977) and have had time to get used to the globalization processes of the world economy. Knowledge about foreign markets and commitment to international markets has increased step-by-step during a relatively long period of time. Most CEE countries, on the other hand, had neither private ownership nor knowledge about business routines characteristic of market economies until recent. There were differences even between the transition countries themselves – the starting positions of the CEE economies were by no means equal when the transition processes started. For example, in the case of Estonia, all foreign trade was coordinated by Moscow and there was no knowledge about foreign activities, while at the same time, the Central European socialist countries were experienced exporters. Moreover, while private enterprises were allowed in several countries (for example, Poland and Hungary), others had no experience with market economy. Therefore, there was not only lack of foreign market experience but also lack of knowledge about the local market. At the same time, due to the globalization and integration processes several firms in the transition economies, especially in small countries, were experiencing pressure to internationalize and their pace of internationalization was faster than predicted by the

traditional sequential internationalization theories (Svetlic ic and Rojec, 2003, p. xxix). To date, most Estonian enterprises have used export for entering foreign markets. The outflows of foreign direct investments are increasing but they are still significantly smaller than the volume of export. In the case of outward foreign direct investments, the composition of main target markets has not changed considerably during the years and the fluctuations in terms of the relative share of different markets have been small. The most interesting target country for foreign investments is Cyprus.

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Internationalization of Estonian Manufacturing Enterprises

Table 3.2 Foreign direct investment stock abroad by main target countries 1998 and 2003 (thousands of kroons) Country Lithuania Latvia Cyprus Italy Russia Ukraine Finland TOTAL

1998

%

612,256 1,403,143 352,956

23.0 52.7 13.3

13,905 80,949 8,860 2,660,300

0.5 3.0 0.3 100.0

2003 5,656,729 3,576,404 1,738,473 551,353 371,784 341,068 166,671 12,668,000

% 44.7 28.2 13.7 4.4 2.9 2.7 1.3 100.0

Source: ‘Direct Investment Stock by Countries’, 2004.

In this case the investments are not related with money laundering or capital flight but indicate registration of Estonian ships. However, most of the foreign direct investments have been targeted to the neighbouring countries of Latvia and Lithuania (see Table 3.2). Such a choice of the target markets could be expected, since these are Estonia’s neighbouring countries with a similar level of economic development. Also, during the Soviet period, strong linkages with these countries were established. Concentration on these markets has also been facilitated by the foreign owners of Estonian enterprises who wish to be present in all three Baltic States and have, in a number of cases, used Estonia as a platform for entering the Latvian and Lithuanian markets. However, limited scope of Estonian enterprises’ foreign experiences involves problems that may hinder further internationalization activities. As the focus of this chapter is on analyzing Estonian manufacturing enterprises, the share of outward investments into the manufacturing sector is of great interest. Table 3.3 indicates that only 7.3 per cent of foreign direct investment stock is targeted to this sector. The volume of investments has increased but the share has been stable. Over the last years, main developments have taken place in the fields of transport, storage, communication and real estate. The relatively modest position of investments into manufacturing could be the result of foreign owners’ policy, weaknesses or lack of competitive advantages and/or lack of financial resources. Data from an unpublished survey ‘Outward Foreign Direct Investment in Estonia 2001’, containing information about 70 enterprises that represent 46 per cent of the stock of Estonian foreign investments abroad, indicate some differences between locally and foreign-owned firms in

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Table 3.3 Foreign direct investment stock abroad by field of activity 1998 and 2003 (thousands of kroons) Field of activity Finance Transport, storage, communication Real estate, renting and business activities Manufacturing Wholesale, retail trade Construction TOTAL

1998

%

2003

%

1,519,350 509,100

57.1 19.1

4,822, 253 3, 211,155

38.1 25.3

199,147

7.5

2,316,725

18.3

191,777 184,933 21,537 2,660,300

7.2 7.0 0.8 100.0

925,297 933,679 135,932 12,668,000

7.3 7.4 1.1 100.0

Source: ‘Direct Investment Stock by Fields of Activity’, 2004.

Number of affiliates

3

2.6

2.4

2.2

2.0

2.3

2.0

2

1

0 All

Local capital 1997

Figure 3.4

Foreign owned

2000

Average number of foreign affiliates in different groups of firms

Source: ‘Outward Foreign Direct Investment in Estonia 2001’, unpublished survey.

terms of the number of foreign affiliates (see Figure 3.4). The number is slightly bigger in case of foreign-owned firms. An interesting result is that the number of locally owned firms’ affiliates has remained the same, while in the case of firms with foreign ownership the average number of subsidiaries has decreased. Taking into account the fact that during the period 1997–2000 the stock of outward foreign direct investments in Estonia increased, it can be suggested that firms have mostly concentrated on developing and expanding their existing subsidiaries. Decrease in the number of subsidiaries may be due to the fact that during the Russian crisis, several foreign operations were closed down (this applies especially to subsidiaries in Russia and the other Commonwealth of Independent States (CIS) markets).

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Internationalization of Estonian Manufacturing Enterprises

Table 3.4

Export to main target countries 1995 and 2003 (millions of kroons)

Country Finland Sweden Germany Latvia Great Britain Denmark Russia Lithuania Norway Netherlands USA TOTAL

1995

%

2003

%

4,431.2 2,250.3 1,388.4 1,417.9 627.6 625.8 3,114.0 852.9 362.0 827.8 482.9 19,042.6

23.3 11.8 7.3 7.4 3.3 3.3 16.4 4.5 1.9 4.3 2.5

16,203.5 9,520.3 6,177.4 4,393.7 2,610.7 2,444.8 2,439.9 2,340.5 2,245.7 1,890.1 1,552.8 62,531.4

25.9 15.2 9.9 7.0 4.2 3.9 3.9 3.7 3.6 3.0 2.5

Source: ‘General Exports and Imports by Trading Partner Countries by HS Commodity Chapter’, 2004.

Table 3.4 presents an overview of the main developments in Estonian exporting activities. As can be seen, the export volume has increased in most cases. The only exception is Russia, which has faced a significant decrease in its export volume. Accordingly, its share among Estonia’s main export partners has declined. There have been mainly positive developments in other markets. It was pointed out earlier that, in the case of outward foreign investment, Estonian enterprises have mainly concentrated on Latvia and Lithuania. Data about export activities indicate similar tendencies – 41 per cent of the foreign sales are targeted to Finland and Sweden. This concentration is in many cases inevitable, either due to the foreign owners’ policies or the limited production capacity of the Estonian enterprises that do not allow servicing several markets simultaneously. Moreover, it enables gathering of detailed market-specific knowledge, thus increasing competitiveness in these markets. On the other hand, Estonian enterprises are highly dependent on the growth of these markets and negative developments in the target markets have a wider influence than the success of foreign activities. Some industries have already faced several drawbacks in demand in these markets and have been forced to diversify their foreign activities by increasing the number of target markets. However, this is not easy under the time pressure deriving from recession in demand, since the international experience is still relatively poor and application of the knowledge gathered from the neighbouring countries that are relatively well known is difficult in other regions.

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Estonian enterprises have already faced difficulties in their foreign activities in one market they were familiar with and had strong trade linkages with, inherited from the Soviet times. A drastic fall in exports to Russia occurred in 1998–9 during the Russian crisis, after which exports have not recovered yet (see the developments in export volume in Figure 3.5). The main sectors that lost their positions in the Russian market are food manufacturing – the export of meat, fish and dairy products declined significantly. Before the crisis, these sectors constituted a high share in the exports to the Eastern market. Now, after the crisis, the Russian market is growing but it is difficult to find a competitive edge in it because the production costs in these sectors of the manufacturing industry have increased due to the investments made to meet the high sanitary standards set by the European Union. Moreover, there were double tariffs that Russia imposed on Estonian production. Taking into account these aspects, Estonian companies have no price advantages in this target market. On the basis of the country-of-origin effect, other countries have more advantages than Estonia in most product categories (one of the exceptions is dairy products, in which Estonian goods have a good reputation and are highly valued). Therefore, it is not easy to find a competitive edge and suitable niche in the Russian market. Also, a number of Estonian businessmen tend to be overly confident about their knowledge of the Russian market and overlook the changes that have taken place over the last decade (similar tendencies are also reported in the case of US firms entering

3,500 Millions of kroons

3,000 2,500 2,000 1,500 1,000 500 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 Estonian exports to Russia Figure 3.5

Estonian exports to Russia (millions of kroons)

Source: ‘General Exports and Imports by Trading Partner Countries by HS Commodity Chapter’, 2004.

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Internationalization of Estonian Manufacturing Enterprises

the Canadian market – see O’Grady and Lane [1996] for a detailed discussion). This overconfidence often results in poor analysis of the market and therefore several firms have failed to (re-)enter this market. The share of export sales in turnover varies significantly between the sectors of the manufacturing industry. Tanning and dressing of leather, and manufacture of motor vehicles and transport equipment were highly internationalized sectors already in 1996, while most other sectors and enterprises were only starting their international activities then. The speed of internationalization is also an important aspect to be taken into account. Figure 3.6 indicates that the highest speed has been reached by the textile manufacturers, followed by wood processing and office, electrical, radio and medical equipment producers. The main reason for the rapid increase in the importance of foreign markets in these sectors is the activities of foreign investors, who use the production of these industries as an input for their production plants in other countries or guarantee the market for the production through their distribution channels. In the

Textiles Wood Office, electrical, radio and medical equipment Furniture, others, recycling Tanning and dressing of leather Paper and paper products Manufacturing Chemicals and coke Machinery and equipment Apparel Metals and products Publishing, printing Rubber and plastic Motor vehicles and transport equipment Food products, beverages Other non-metallic minerals

⫺10.0

0.0

10.0 20.0 30.0 40.0 50.0

Speed of internationalization (%) Figure 3.6 Speed of internationalization1 in Estonian manufacturing industries 1996–2002 Source: Statistical Office of Estonia, 2004a.

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textile industry, Borås Wäfveri has transferred all of its production from Sweden to Krenholm, Estonia, whose production has been marketed in several foreign countries. Since Krenholm constitutes about 35 per cent of the net sales of the industry, its activities significantly influence all the data of this sector. A similar situation prevails in the two other abovementioned industries. In the wood sector, Stora Enso acquired majority ownership of the leading Estonian wood manufacturer Sylvester in 2003 and, after that, a rapid increase in international activities has taken place. In the case of office, electrical, radio and medical equipment manufacturing, Elcoteq Tallinn, a subsidiary of Elcoteq Network Corporation, determines the trends in the sector. It is interesting to note that, while, in most sectors, the share of exports in turnover has increased, there are two – food products and beverages and non-metallic minerals – where there has been a decline and focusing on the local market has taken place. In the case of the food industry, net sales rose 1.4 times during the period 1996–2002 and in the home market growth as considerable as 1.5 times was reported. During the period, the manufacture of other non-metallic minerals has faced even higher growth rates both in net sales (2.6 times) and especially in the sales on the home market (2.9 times). The home market growth and presumably also the limited production capacity have caused a decrease in the ratio of export sales to turnover. However, as pointed out above, these industries have also suffered due to the Russian crisis, without which their development would have been more impressive. Therefore, various reasons have simultaneously influenced the internationalization of these industries. It is often argued that the international activities of Estonian enterprises depend on the existence of foreign owners and on foreign owners’ strategies: see, for example, Lättemägi (2003, p. 245), Reiljan (2003, p. 150), Roolaht (2002, pp. 125–6) and Vissak (2003, p. 135). Figure 3.7 summarizes the export propensities of Estonian manufacturing firms. The data indicate that foreign firms export a higher share of their production than firms with local owners and the difference between these two groups of firms is growing. We can therefore suggest that the influence of foreign ownership can easily serve as the main explanatory variable for a more rapid pace of internationalization. The existence of differences in the internationalization processes between firms with foreign ownership and locally owned enterprises can be analyzed on the basis of the database containing the balance sheet and income statement data of 307 Estonian manufacturing enterprises for the period 1996–2002. Figure 3.8 indicates that during these years most firms, both locally and foreign owned, increased their commitment to

60

Internationalization of Estonian Manufacturing Enterprises

Share of export sales in net sales (%)

70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 1995

1996

1997

1998

1999

2000

2001

2002

Companies with foreign ownership Domestic companies All companies Figure 3.7

Share of export sales in net sales in Estonian manufacturing industry (%)

Source: Statistical Office of Estonia, 2004a.

Locally owned

Foreign owned

0%

20%

40%

60%

80%

100%

Increase both in export volume and share Export volume increases, share decreases Export volume decreases, share increases Decrease both in export volume and share Figure 3.8 Changes in the export activities of Estonian manufacturing firms 1996–2002 Source: Statistical Office of Estonia, 2004b.

foreign markets. However, calculations reveal that about 25 per cent of the locally owned firms withdrew (some of) their export activities, while in the case of foreign owners this indicator is significantly lower. Moreover, foreign-owned firms constitute only 13 per cent of the enterprises that have decreased their commitment to international markets. On the basis of these results, it can be suggested that foreign investors contribute to increasing the stability of international operations.

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To sum up, in the case of foreign-owned enterprises, their better access to foreign distribution channels, knowledge of international markets, integration into the parent company’s value chain activities and investments into updating the technology and increasing the efficiency are likely to contribute to their international activities in a way that locally owned firms cannot match. However, the role of foreign owners in the international activities of the Estonian enterprises will be further analyzed in the following parts of this chapter.

4. The Activities of Two Multinationals in Estonia Stora Enso’s acquisition of Sylvester Since independence was regained, the Estonian wood industry has undergone rapid developments. It started its international activities by exporting roundwood in the first half of the 1990s, but more recently the focus has shifted to timber refining and adding a higher value to the products. For example, over the last five years, the manufacture of sawn timber has doubled and the export of gluewood has increased significantly (‘Saetööstuse toodang, 1998–2003’, 2004). The wood industry constitutes 16 per cent of the whole of manufacturing industry and 18 per cent of exports in Estonia (Statistical Office of Estonia, 2004a); thus, it influences the whole economy to a large extent. In the world context, the production capacity of Estonia is quite small but, taking into consideration the size of the country, it constitutes a significant share as Estonian sawmills produced 1.86 million m3 in 2003 and this is around 2.2 per cent of the EU production and 0.5 per cent of the world production of sawn wood (‘EFIA presentation’, 2004). Foreign-owned companies constitute about 33 per cent in terms of the number of employees, export sales and net sales of this sector (see Table 3.5), but their influence has increased significantly after the acquisition of Sylvester by Stora Enso.

Table 3.5 Foreign share in Estonian manufacturing industry 1995–2002 (% of all enterprises) 1995

1996

1997

1998

1999

2000 2001

2002

Number of companies 7.4 Number of employees 5.7 Export sales 38.0 Net sales 28.6

7.6 9.8 12.6 11.5

5.8 12.4 18.8 15.2

5.6 11.7 24.9 16.3

5.8 18.4 30.7 22.7

5.7 18.9 32.7 24.8

5.5 21.3 32.4 23.2

Source: Statistical Office of Estonia, 2004a.

7.1 21.7 33.2 25.1

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Internationalization of Estonian Manufacturing Enterprises

AS Sylvester was the largest locally owned forestry company in Estonia until 2003. In 2002, 26 per cent of the wood industry turnover was generated by Sylvester Group, which had 7.6 per cent of the industry’s workforce, but in terms of sawn wood production its share was even larger – 40 per cent of the whole production. Before acquisition by Stora Enso, it had six production plants in Estonia and one in Latvia, the establishment of a production plant in Lithuania was in progress and the company had further expansion plans both to Latvia and Russia. The main export markets for AS Sylvester were Finland, Egypt, Algeria and Sweden, which made up 38 per cent of its net turnover. Before 2001, AS Sylvester was mainly focused on servicing the local market, Finland and Sweden, and therefore did not pay much attention to the Latvian and Lithuanian markets – the share of these markets in its turnover constituted 0.6 per cent in 1999 and 1.3 per cent in 2000. There were two main reasons for this choice of target markets. At first, the price level in all three Baltic markets was almost equal, which is why it was not easy to find competitive advantages over the local producers, whereas there were significant advantages in the markets of developed countries. Second, the developments in this industry in all three Baltic States had a similar pace and so there was a relative lack of ownership advantages. However, due to the intensive competition in the Estonian market and rising timber prices, in 2001 AS Sylvester decided to establish a new softwood sawmill in Latvia, which was launched and started its activities in March 2002. At the same time Stora Enso, one of the world’s leading paper, packaging and forest products manufacturers, was looking for investment opportunities in the Baltic States and Russia, as in these regions both the raw material and production costs are lower than in Western Europe (see Figure 3.9).

Nordic and Central Europe ⫽ 100

100 80 60 40 20 0 Raw material costs Nordic and Central Europe Figure 3.9

Cost levels in sawmills in Europe

Note: Nordic and Central Europe ⫽ 100. Source: Hägglund, 2003.

Production costs Baltic Countries

Russia

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Moreover, this region has about a quarter of the world’s wood resources (Hägglund, 2002), hence providing good growth opportunities and being a solid base for meeting the demand in Europe. In February 2003, Stora Enso completed an acquisition of 66 per cent of the sawmilling operations and 100 per cent of the wood procurement operations of Sylvester. This was one of the main events for Stora Enso in this year, enabling it to become the world’s second-largest producer of sawn softwood and the largest producer in Europe, with an annual production of 7.4 million m3 and further processing capacity of 2.8 million m3 (‘Creating Value’, 2003). The following motivations behind the acquisition of Sylvester were pointed out by Stora Enso (Hägglund, 2003): • It was the biggest sawmilling and wood procurement company in the Baltic States; • Sylvester has modern assets and an up-to-date technological base; • It supports both expansion in the Baltic States and further expansion to Russia; • There are significant cost advantages and synergies; • It secures access to the fibre resources for Stora Enso; • This acquisition strengthens Stora Enso Timber’s position in wood products markets. There were two main reasons for the former owners’ decision to sell the shares of Sylvester Group. First, they wanted to focus on developing other industries as the sawmilling operations had reached the maximum possible capacity in Estonia. Second, the dominance of Stora Enso in the European market was obvious and therefore integration of Sylvester Group into Stora Enso’s value chain seemed to be the best opportunity for guaranteeing further growth of the enterprise. The main effects of having a big multinational company in the Estonian wood sector are twofold. First, the establishment of a pulp mill that had been planned for many years was postponed since Stora Enso has its own mills in the Nordic countries and is interested in supplying them with the raw materials. For example, the projects for the year 2006 foresee the future of the Baltic countries as suppliers of Swedish pulp- and sawmills, while the role of Russia would be to compensate for the decrease in availability of wood in Finland after 2005 (‘Stora Enso Annual Report’, 2003, p. 27). Therefore, the target markets have been determined by the parent company. Besides this redirection of trade in terms of target markets, Stora Enso’s strategy to use most of the production of its sawmills within the group

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Internationalization of Estonian Manufacturing Enterprises

has caused problems in several related industries (for example, blockhouse manufacturers) in Estonia. Many small enterprises have been forced to find new suppliers of raw materials, but it has been a difficult task as Stora Enso controls a significant part of the wood industry in Europe. One of the possible source countries is Russia; unfortunately, the Russian government has impeded wood exports to Estonia. Moreover, Stora Enso is now present also in Russia and has focused its activities mainly on the regions, which are the main suppliers of the Estonian enterprises. Thus, the problems with availability and price of the raw materials are likely to become even more serious in the near future. On the positive side, Stora Enso invests significant amounts of money to further processing activities, introducing new technologies to Estonia. As a result, value added to the products is expected to rise in the near future. Projections for the year 2006 predicted a drop of rough-sawn materials in Stora Enso’s production from the present 80 per cent to 40 per cent. After its acquisition of Sylvester, Stora Enso invested 30 million euros in enhancing the efficiency, production capacity and further production activities of its Estonian and Latvian production plants (‘Stora Enso investeerib järeltöötlemisse 470 miljonit’, 2003). Stora Enso has implemented most of the expansion strategy formulated by Sylvester Group before the acquisition, and over 2003 and 2004 it rapidly expanded its activities in the Baltic States and Russia. Opening of the new sawmill in Lithuania in September 2003 was the result of Sylvester’s activities, as the plant was almost ready for operation at the time of acquisition. Stora Enso has also established two production plants in Russia and it has further development plans both in Russia and in Latvia. Therefore, after gaining the leading position in Estonia, Stora Enso has concentrated on strengthening its positions in the other Baltic States and Russia, as these countries provide a better growth potential for the future than Estonia, where the maximum capacity of producing sawn wood has already been reached. However, the risk level in Russia is still perceived to be relatively high. Despite the potential of this market, Stora Enso prefers fewer capital-intensive investments and concentrates on gaining experience of the business environment and legislation (Härmälä, 2003).

Borås Wäfveri’s operations in Estonia The Estonian textile industry has long traditions, one of the oldest textile manufacturers, whose history goes back to the year 1857, being Krenholm. This enterprise was established by Ludwig Knoop in the Estonian town of Narva, situated at the border of Russia and Estonia. During the privatization

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Table 3.6 Foreign share in Estonian manufacturing industry 1995–2002 (% of all enterprises)

Number of companies Number of employees Export sales Net sales

1995 1996

1997

1998

1999

2000

2001

2002

18.2 26.3 64.5 40.5

14.0 55.4 69.5 76.9

16.7 55.9 60.7 70.5

14.4 55.2 49.1 62.2

17.2 54.0 54.8 58.4

15.4 63.3 62.7 55.8

15.6 71.3 82.7 75.1

18.8 58.8 72.0 78.4

Source: Statistical Office of Estonia, 2004a.

of the enterprise in 1994, the Swedish firm Borås Wäfveri AB acquired majority ownership in Krenholm. Since 1999, it has had 100 per cent ownership of Krenholm (‘About Krenholm’, 2004), which has been one of the largest enterprises in terms of net sales, exports and number of employees in Estonia for years. Since Krenholm is the biggest enterprise in the field, its acquisition influenced the whole industry (see Table 3.6). Foreign penetration in this industry is remarkably higher than the manufacturing industry average (see Table 3.1) and therefore the strategies implemented by the management of Krenholm significantly influence all textile manufacturers in Estonia. Krenholm produces finished cotton fabrics, bed-linen, towels, curtains, cotton baby napkins and several other textile products. At the time of privatization, Krenholm had a large production capacity and was able to supply large quantities at low prices. This made it possible to rapidly reorient the trade from Russia to developed countries shortly after the collapse of the Soviet Union. At the beginning of its international activities, Krenholm concentrated mainly on subcontracting and indirect export activities, but as these were not profitable enough and the domestic market did not provide a sufficient base for development, further expansion to foreign markets and introduction of new products was defined as a strategy for sustaining the competitive edge. In several sectors of the Estonian manufacturing industry, subcontracting activities constitute most exports. Subcontracting has also intensified in the manufacture of textiles (2.9 times growth during the period), but both the volume and share of these export activities are still significantly lower than, for example, in the clothing industry (see Figure 3.10). Thus, the instability arising from the dependence on foreign customers and risk of terminating contracts is smaller. Figure 3.11 presents the data about the distribution of Krenholm’s foreign sales by the main target countries in 2003. There are two main

Internationalization of Estonian Manufacturing Enterprises

Share of subcontracting in exports (%)

66

80 70 60 50 40 30 20 10 0 1996

1997

1998

1999

Textile industry

2000

2001

2002

Clothing industry

Figure 3.10 The share of subcontracting in Estonian textile and clothing industries (%) Source: ‘Eseti rõivatööstuse ja tekstiilitööstuse ü levaade’, 2003; 8.

Other 29%

Finland 9%

Figure 3.11

USA 20%

Germany 16% Estonia 11%

Sweden 15%

Distribution of Krenholm sales by target countries 2003

Source: Kängsepp, 2004a.

changes in terms of target markets that have taken place over the years. First, the share of the domestic market has increased significantly and, second, the share of the USA has dropped from 55 per cent in 1995 to only 20 per cent in 2003. In the USA, Krenholm is selling its products under the label Gerber, through a subcontracting agreement. In 2000, it held 67 per cent of the cotton napkins market there. Besides napkins, Krenholm has also exported small quantities of fabrics to this market (Rozental, 2002). Therefore, despite the fact that Krenholm was a dominant player in the US cotton baby napkins market, it concentrated its activities on developing sales in other regions rather than in North America. This was mainly the result of Krenholm’s management strategy of higher diversification of their target markets.

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Krenholm’s diversification strategy was supported by setting up sales subsidiaries in several countries. The process started with establishing sales subsidiaries in Sweden and Norway in 1995 and continued with opening an office in Germany in 1997 (Vissak, 2003, p. 85). At this time, both Krenholm and Borås Wäfveri saw the main expansion opportunities in the European markets and thus wanted to increase their production capacity and acquire well-known brand names. They considered the privatization of another manufacturing plant in Lithuania in 1997 (‘Borås Wäfveri huvitub Leedust’, 1997). In 1998 an opportunity for acquiring a well-known producer of bedclothes in the Netherlands appeared and this would have given Krenholm a chance to increase their presence in the Benelux countries, but the negotiations did not result in a positive outcome (Ranne, 1998a). However, in 1998 they succeeded in establishing a sales subsidiary in Great Britain (Ranne, 1998b). Diversification of the target markets was only one part of the strategy developed by Borås Wäfveri and Krenholm. Other actions included the transfer of production operations from Sweden to Estonia and also the diversification of production activities. The latter concept was introduced in 2002. Ambitious plans about entering the clothing market were announced and investments of about 57 million kroons were made in order to produce casual and working clothes (‘Kreenholm kavandab rõivanootnist’, 2002). Unfortunately, these plans were not realized because of intense competition in the world’s clothing market. Relocation of production from Sweden to Estonia was discussed in the newspapers of both countries. There were mainly positive comments in the Estonian media, as these processes enabled the country to avoid, or at least postpone, a social catastrophe in the North-eastern part of Estonia, where the level of unemployment is very high and Krenholm is still one of the main employers. On the other hand, closing down the production plants in Skene, Sweden, was accompanied by the laid-off workers’ demonstration and a negative campaign in the Swedish media, which criticized the working conditions in Estonia as being extremely bad and out of date (Toomsalu, 2001). However, despite these reactions, relocation of the activities continued and, at present, most of Borås Wäfveri’s activities are carried out in Estonia. In the first years of the restructuring there was a rapid increase in Krenholm’s turnover but since 1997, because of the developments in the world markets, and especially the growing importance of Asia, as well as the overly optimistic ways of management, the enterprise has experienced stagnation. The optimism and extensive expansion plans that were expressed in the earlier years are no longer characteristic of the enterprise’s

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Internationalization of Estonian Manufacturing Enterprises

statements as it faced significant losses in 2002 and 2003, but its profitability had already diminished a few years earlier. As a result, a more conservative strategy was needed and Borås Wäfveri took Krenholm under its direct control. This reaction is understandable, since all the developments in Krenholm significantly influence its parent company: Krenholm constitutes most of its turnover and losses, 60 per cent and 71 per cent respectively in 2003 (Kängsepp, 2004b). Difficult times were also reflected in extensive lay-offs (the number of employees dropped from 11,000 in the early 1990s to 5,700 in 1995 and 4,400 in 2003), and closing down those production operations that were most inefficient.

5. Discussion and Conclusions Estonia is a small country on the periphery of the European Union bordering Russia. Due to the Russian crisis and Russia’s discriminative tariff policy imposed on Estonian goods, the Russian market has been almost entirely closed to Estonian enterprises during the last decade. Therefore the latter have acknowledged an urgent need to focus on the European market. However, there are also several obstacles in the way of companies trying to enter the Central and Western European markets. For example, the distances between Estonia and these countries are great both in geographic and psychic terms. Therefore, Estonian firms have to compete with other producers from the CEE transition countries who can similarly boast low production costs and, in most cases, larger production volumes, while having lower transportation costs and smaller cultural differences. Estonian manufacturing enterprises have mostly internationalized through export activities and their flows of outward foreign investments have been modest. Therefore, their experience of operating production affiliates abroad is either small or even absent in the case of several industries. On the other hand, most manufacturing enterprises have exported their production to foreign markets, and several industries’ and enterprises’ commitment to the international market is high. Two case studies serve to illustrate that foreign investors can have a significant role in influencing the internationalization patterns of Estonian manufacturing enterprises. The above discussion indicates that Sylvester Group constituted a significant part of both the wood industry and the manufacturing industry of Estonia, and its developments influenced the whole economy. Sylvester was experienced in international markets as it had foreign sales in many countries with both small and large psychic distances. By comparison with most other Estonian manufacturing enterprises, it had also the knowledge

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of establishing and running a production plant in the foreign market. Therefore, we can conclude that Sylvester Group was one of the leading enterprises in Estonia in terms of international activities. This is remarkable, considering the fact that the firm was established in the 1990s and had local owners. Its rapid growth was the result of a clearly determined strategy, investment in up-to-date technology and favourable developments in the world markets. Acquisition of AS Sylvester provided for Stora Enso a solid base for entry to the Eastern European region as Sylvester was the biggest producer in the region, which had modern technology, control over raw material supply in Estonia and know-how about successful restructuring and establishment of sawmills in Estonia and Latvia. Therefore, in this case the positive effect of the foreign investor has been relatively modest as there was no need to update the technology, restructure the enterprise or implement a new strategy. According to the classification suggested by Dunning, Stora Enso’s investment into Estonia has the characteristic features of efficiency-, raw-materials- and strategic-assets-seeking investment. Servicing of the local market is not the objective for the parent company and therefore several other Estonian enterprises in the related industries have suffered in the new conditions due to the problems with getting access to the raw material. Consequently, while this acquisition is definitely beneficial for Stora Enso, from the viewpoint of the Estonian economy, positive effects are almost absent and negative effects seem to prevail. The activities of Krenholm and Borås Wäfveri shed light on the other side of the coin. In this case, the enterprise was privatized to the foreign owner and restructuring was the sole responsibility of the Swedish parent company. Borås Wäfveri acquired a highly inefficient firm that had lost its market in Russia. Naturally, its first task was to find at least some new markets, after which it concentrated on increasing the efficiency by restructuring the enterprise and introducing new technologies. As the business environment was at these times considered to be too risky, the local management, with modest international experience, had a strong impact on strategy development. There were three main pillars in the new strategy – expansion to the new markets, diversification of production activities and relocation of production from Sweden to Estonia. Over the years, significant amounts of money have been invested in these activities. Borås Wäfveri’s main motivation for foreign investment into Estonia was making good use of the advantage of low labour costs. This investment can therefore be classified as efficiency-seeking. This motivation is, thus, characteristic of both Stora Enso and Borås Wäfveri. However, while Stora Enso acquired an efficiently functioning enterprise, Borås Wäfveri

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Internationalization of Estonian Manufacturing Enterprises

had to concentrate on restructuring the unit. Hence, the contribution of foreign investment to the development of enterprise and also the Estonian economy is significant. Moreover, as Krenholm is situated in the region with a high unemployment rate and its influence on the whole area is remarkable, Borås Wäfveri’s efforts in applying a new strategy, searching for new opportunities and laying off as few people as possible have also significantly contributed to the advancement of the region. On the other hand, the gains of this acquisition to the parent company are not so clear, since the high growth and significant profits that were apparent during the first years have by now been replaced by stagnation and high losses. Nor are the latest developments in the world markets favourable for the textile producers who are located here and face a rapid increase in salaries. Therefore, it is a struggle to turn Krenholm profitable again. Thus, this foreign investment seems to be more beneficial for Krenholm and the Estonian economy than for the parent company. From the viewpoint of foreign owners’ impact on the internationalization of Sylvester and Krenholm, there are several differences. First, while Stora Enso acquired a company that was experienced in foreign markets, in the case of Krenholm the parent company had to transfer knowledge about international activities and was forced to find new markets. This leads us to the second distinctive feature; namely, Borås Wäfveri had the opportunity to determine the internationalization pattern of its Estonian subsidiary, but Stora Enso is reorienting its export now in order to supply its plants in Sweden and Finland. Hence, it provides a demand for the production by integrating Estonian operations into its value chain, while Borås Wäfveri does not have this opportunity and therefore instability, above, related with its international activities is significantly higher. There are also differences in terms of the autonomy that the Estonian subsidiaries have. In the case of Krenholm, the decisions about local and international strategies were made in Estonia until 2002 and Borås Wäfveri’s various lines of businesses were rather separated. On the other hand, Stora Enso was interested in creating synergies between its different lines of business and therefore a tight integration of the Estonian activities took place immediately after acquisition. To sum up, Stora Enso has dictated the rules to the Estonian subsidiary from the very start of its operations here, while Borås Wäfveri allowed relative independence for a long time but has taken the subsidiary under its close control now. It can be concluded that foreign investors have definitely influenced the internationalization processes of Estonian enterprises. The export propensity of the foreign-owned companies is significantly higher than that of the local ones and companies with foreign participation constitute

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more than a half of the export sales of the manufacturing industry, while their share in terms of the number of companies is much smaller. The above analysis of two companies indicates that there has been a shift in the foreign owner’s role in determining the strategy for the Estonian subsidiary. During the first decade of regained independence, several investors considered the risk level here to be high and, therefore, they often allowed the subsidiary to have a relatively high degree of autonomy. Since the risk level has decreased considerably and the local conditions are no longer so different from those in the Nordic countries, the foreign owners now tend to integrate the local subsidiaries tightly into their structures and dictate the strategy for both local and international markets. Estonia has been fortunate since its peripheral location in respect of the large Central and Eastern European markets has not made its enterprises confine themselves to servicing the local market and suffer because of lack of international experience and investment in restructuring. Foreign investors from Finland and Sweden were attracted by the country’s close proximity and tempting new investment opportunities. This has enabled Estonian enterprises to gather first experience from the foreign markets but has also caused their intensive concentration on servicing only nearby markets. Therefore, now it is important that Estonia, as well as other peripheral economies in a similar situation, should find new target markets and development opportunities in other regions, too. Otherwise, the positive influence of Nordic investors that facilitated its entry to the foreign markets at the beginning of the 1990s may turn into a negative experience and the downside of being situated on the periphery of the European market may prove to be a real hindrance.

Note 1. Wagner defines speed of internationalization as a change in the degree of internationalization (foreign sales divided by the total sales) during the period under examination (Wagner, 2004, p. 452).

References ‘About Krenholm’ (2004) http://www.kreenholm.ee. Accessed 7 September. ‘Borås Wäfveri huvitub Leedust’ (1997) Äripäev. ‘Creating Value – Stora Enso Key Facts’ (2003) http://www.storaenso.com. Accessed 5 September 2004. ‘Direct Investment Stock by Countries’ (2004) http://www.eestipank.info/dynamic/ itp1/. Accessed 20 August 2004. ‘Direct Investment Stock by Fields of Activity’ (2004) http://www.eestipank.info/ dynamic/itp1/. Accessed 20 August.

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Dunning, J.H. (1994) ‘Re-Evaluating the Benefits of Foreign Direct Investments’, Transnational Corporations, 3(1): 23–51. ‘Eesti rõivatööstuse ja tekstiilitööstuse ülevaade’ (2003) Eesti Rõiva- ja Tekstiililiidu Infoleht. ‘EFIA presentation’ (2004) http://www.emtl.ee/?id⫽502. Accessed 5 September. ‘General Exports and Imports by Trading Partner Countries by HS Commodity Chapter’ (2004) http://www.stat.ee/statistika. Accessed 25 April. Hägglund, B. (2002) ‘Fibre Strategy’ http://www.storaenso.com. Accessed 21 September 2003. ——— (2003) ‘Responsibility & Performance’ http://www.storaenso.com. Accessed 5 July. Härmälä, J. (2003) ‘Responsibility & Performance: Stora Enso’s Key Strategic Issues’ http://www.storaenso.com. Accessed 4 December. Johanson, J. and Vahlne, J.E. (1977) ‘The internationalisation process of the firm – a model of knowledge development and increasing foreign market commitment’, Journal of International Business Studies, 8(1): 23–32. Johanson, J. and Wiedersheim-Paul, F. (1975) ‘The Internationalisation of a Firm – Four Swedish Cases’, Journal of Management Studies, 12(83): 305–22. Kängsepp, L. (2004a) ‘Kahjumis Kreenholm koondab tänavu iga seitsmenda töötaja’, Äripäev. ——— (2004b) ‘Kreenholm teenis esimeses kvartalis 3 mln kahjumit’, Äripäev. ‘Kreenholm kavandab rõivatootmist’ (2002), Äripäev. Lankes, H.-P. and Stern, N. (1998) ‘Capital Flows to Eastern Europe and the Former Soviet Union’, EBRD Working Paper, 27. Lättemägi, R. (2003) ‘Direct and Indirect Impact of Foreign Direct investment on Export in Estonia’, Estonian Economic Policy on the Way Towards the European Union, Tallin: Mattimor, Luostarinen, R. (1982) Foreign Operations of the Firm, Helsinki: Helsingin Kauppakokeakoulun Kuvalaitos. Marinov, M. and Marinova, S. (1999) ‘Foreign Direct Investment Motives and Marketing Strategies in Central and Eastern Europe’, Journal of East-West Business, 5(1–2): 25–55. Meyer, K. (1995) ‘Direct Foreign Investment in Eastern Europe: The Role of Labour Costs’, Comparative Economic Studies, 37(4): 69–88. O’Grady, S. and Lane, H.W. (1996) ‘The Psychic Distance Paradox’, Journal of International Business Studies, 27(2): 309–33. Pye, R.B.K. (1997) ‘Foreign Direct Investment in Central Europe (the Czech Republic, Hungary, Poland, Romania, and Slovakia): Results from a Survey of Major Western Investors’, CUBS Finance Working Paper. Ranne, R. (1998a) ‘Kreenholm ostab Hollandi firma’, Äripäev. ——— (1998b) ‘Kreenholmi Valduse AS teeb oma müügiesinduse Inglismaale’, Äripäev. Reiljan, E. (2001) ‘Determinants of Foreign Direct Investment Inflows in Estonia’, Foreign Direct Investments in the Estonian Economy, Tartu: Tartu University Press: 31–90. ——— (2002) ‘Analysis of Foreign Direct Investment Determinants in Estonia’, Journal of East-West Business, 8(3–4): 103–21. ——— (2003) ‘Determinants of Export Success in the Estonian Manufacturing Enterprises’, Estonian Economic Policy on the Way Towards the European Union, Tallinn: Mattimor.

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Reiljan, E. and Varblane, U. (2001) ‘Differences in Labour Costs between Estonia and Finland as a Determinant for Relocation of Economic Activities’, States and Markets: Forging Partnerships for Sustainable Development. Proceedings of the Sixth International Conference on Global Business and Economic Development, Bratislava. Roolaht, T. (2002) ‘The internationalisation of Estonian Companies: An Exploratory Study of Relationship Aspects’, unpublished PhD dissertation, University of Tartu, Faculty of Economics and Business Administration. Rozental, V. (2002) ‘Kreenholm: USA annab endiselt ligi veerandi müügikäibest’, Äripäev. ‘Saetööstuse toodang 1998–2003’(2004) http://www.emtl.ee/?id⫽612. Accessed 5 September. Statistical Office of Estonia (2004a) ‘Aggregated data of the Estonian manufacturing industry’, database. Statistical Office of Estonia (2004b) ‘Estonian manufacturing Enterprises 1996–2002’, database. ‘Stora Enso Annual Report’ (2003) http://www.storaenso.com. Accessed 5 September. ‘Stora Enso investeerib järeltöötlemisse 470 miljonit’ (2003), Postimees. ‘Structure of direct investment flows’ (2004) http://www.eestipank.info/ dynamic/itp1/. Accessed 20 August.

Svetlic ic , M.and Rojec, M. (2003) ‘Introduction’, in M. Svetlicic and M. Rojec (eds), Facilitating Transition By Internationalisation: Outward Direct Investment from Central European Economies in Transition, Aldershot: Ashgate: xxvii–xxxv. Tamm, D. (2004) ‘Sustainability of Estonian Manufacturing Industry’s Labour Costs Based Export Competitiveness’, International Business in Transition Economies: International Entrepreneurship, Innovation and Competitiveness in the Transforming and Enlarging Europe. Proceedings of the third International Conference, Riga. Toomsalu, Ü. (2001) ‘Töö kadumine Rootsis tõi Kreenholmi tüli’, Äripäev. Vissak, T. (2003) ‘The Internationalisation of Foreign-owned Enterprises in Estonia: An Extended Network Perspective’, unpublished PhD dissertation, University of Tartu, Faculty of Economics and Business Administration. Wagner, H. (2004) ‘Internationalization Speed and Cost Efficiency: Evidence from Germany’, International Business Review, 13(4): 447–63.

4 The Internationalization Patterns of Norwegian Firms: Does Industry Matter? Birgitte Grøgaard and Gabriel R.G. Benito

1. Introduction Previous research has shown that firms from small economies are prone to internationalize quicker and to a larger extent than firms from larger countries. In general, their international activities are largely influenced by the limited size of their domestic markets (Krugman, 1991). The lack of strong local forces that retain activities at home further pushes firms to move activities, sometimes even those of strategic character, to foreign locations (Benito et al., 2002). Indeed, small and peripheral countries often actively try to attract and retain inward foreign direct investment (FDI), albeit with mixed results (see Chapter 6, this volume). It is generally recognized that both internal and external factors influence firms’ internationalization patterns. However, most of the research literature has hitherto focused on firm-specific (internal) issues and on countrylevel (external) issues. Internationalization has traditionally been seen as a reflection of home country advantages (Kogut, 1991; Porter, 1990) and of decision-makers’ (entrepreneurs’) willingness to act upon market opportunities abroad (Andersson, 2000; Cavusgil, 1980; Johanson and Vahlne, 1977). Industry factors are often overlooked, generalized too much, or inadequately measured (Makhija et al., 1997). After decades of research on the internationalization of business activities, we still have limited knowledge about the influence of industry-specific factors on firms’ internationalization patterns. External factors generate costs and uncertainties such as political and macro-economic issues, tariffs, socio-cultural differences, and competitive and industry structures (Davidson, 1980; Hirsch, 1976). They can act as both centrifugal and centripetal forces for the internationalization of firms from small economies (Benito et al., 2002). For example, oligopolistic 74

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market structures are supposed to have an especially strong impact on firms with small domestic markets since the influence on the competitive situation may be more immediate. External factors are typically analyzed from the perspective of firms and, in particular, decision-makers’ perceptions of potential costs or disadvantages of organizing and performing activities in various locations. Key economics approaches such as transaction cost theory (Hennart, 1982; 2000), internalization theory (Buckley and Casson, 1976) and the eclectic framework (Dunning, 2001) treat decisions to internationalize as being dependent on firms’ identification of relevant alternatives, awareness of uncertainties and willingness to take risks. Studies focusing on managerial behaviour and internal organizational processes also accentuate a perceptual view on external factors. The internationalization process perspective, for instance, filters the influence of external factors through the notion of psychic distance (Johanson and Vahlne, 1977). Starting from a point of strong perceived uncertainty a firm gradually increases its ‘comfort zone’ of foreign markets; its level of uncertainty is reduced through accumulation of experience and learning. Firms within the same industry may, thus, be expected to follow fairly different internationalization paths since external factors become marginalized over time and their influence is contingent on the perceptions of decision-makers. Some scholars argue that industry characteristics strongly shape firm strategies and that they constrain the strategic options open to firms (Ghoshal, 1987; Porter, 1986). Theories of oligopolistic reaction argue that firms are strongly influenced by the strategic moves of their competitors. Hence, if one competitor internationalizes, others are prone to follow (Graham, 2000; Knickerbocker, 1973). The international strategy literature also addresses industry-related characteristics in the global integration/local responsiveness framework in terms of various pressures in the firms’ competitive environment (Bartlett and Ghoshal, 1989; Prahalad and Doz, 1987). A few studies propose ways of identifying the globality of industries by looking at structural characteristics, such as research intensity (Kobrin, 1991), or outcome-oriented variables, such as international linkages and the integration of value-chain activities (Makhija et al., 1997). The main argument is that, in some industries, firms are pushed to pursue global strategies in order to capitalize on dispersed resource endowments and scale economies (Morrison and Roth, 1993; Porter, 1980). One could then expect to find many similarities in the internationalization patterns among firms within the same industry. Pursuing strategies that do not fit the industry characteristics would create disadvantages in the long run. The success of firms’ internationalization

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strategies could be highly dependent on industry characteristics: for example, Porter argues that ‘in a multi-domestic industry, company internationalization is discretionary… in a global industry, a firm must in some way integrate its activities on a worldwide basis to capture the linkages among countries’ (Porter, 1986, p. 12). In all, scarce attention has been given to the influence of underlying industry factors on the internationalization patterns of firms. The present study addresses this gap by analyzing the influence of industry characteristics on firms’ internationalization strategies. The empirical context of the study is Norwegian companies over the decade 1990–2000. We first briefly look at some indicators at an aggregate level of the degree of internationalization of Norwegian firms in that period. We then identify key internationalization measures and industry characteristics, which we analyze using a sample of the 100 largest non-financial Norwegian firms. We find that even in a small economy such as Norway, where the influence of macro-level factors is considerable, the internationalization of firms is evidently also influenced by industry characteristics.

2. The Internationalization of Norwegian Firms Moving from an inward-looking and highly protective posture in the years immediately following World War II, the Norwegian authorities gradually increased the openness of its economy. The EFTA agreement in 1960 was particularly conducive in perpetuating an increasingly liberal policy towards foreign trade and investment throughout the 1970s and 1980s. Starting from an already fairly high level in 1990, the Norwegian economy nevertheless experienced a noticeable increase in its overall degree of internationalization during the 1990s. As can be seen from Table 4.1, outward FDI as a percentage of GDP tripled and exports

Table 4.1 1990s

Foreign trade and investment in the Norwegian economy in the

Total exports as % of GDP Total imports as % of GDP Outward FDI stock as % of GDP Inward FDI stock as % of GDP

1990

1995

2000

32.0 25.7 9.4 10.7

38.3 32.3 15.4 12.8

46.6 30.4 27.3 18.8

Sources: World Investment Report, 2002, and Norwegian Statistical Yearbooks, 1991, 1996 and 2001.

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increased by 50 per cent over the ten-year period. This indicates a strong overall growth in international activities among Norwegian companies. Similarly, inward FDI and imports increased by almost 80 per cent and 20 per cent respectively, which suggests that while Norwegian firms have sought foreign markets more actively they have, at the same time, experienced more international competition in their home market.

The internationalization of large Norwegian firms, 1990–2000 Firms from small open economies (SMOPECs), such as Norway, are generally expected to internationalize quicker and more extensively than firms from larger home markets for obvious reasons, such as limited market size or their quest for scale, scope and resources (Benito et al., 2002). Table 4.2 shows aggregate internationalization measures for our sample of the 100 largest Norwegian firms over the period 1990–2000. On average, the data show an increased level of the international activity (sales) of these firms as well as an increase in firms moving value activities to foreign markets (employees and subsidiaries). Although the average figures show a steady growth in international activities, such figures mask considerable variation across the firms, as the median figures suggest. Roughly a third of the firms had more than 50 per cent of total sales outside Norway in 1990, but as much as 45 per cent of the firms studied did not have any foreign sales at all at that point. The number of firms with foreign sales exceeding domestic sales had grown to 45 per cent by the year 2000, simultaneously reducing the number of purely domestic firms to a quarter of the total sample. There has also been a considerable development in the number of employees outside Norway. In 1990, two-thirds of the firms studied did not have any employees outside Norway. In 2000, over 70 per cent of the firms had employees in foreign locations. Furthermore, foreign employees had by then become a significantly larger part of the total workforce: in over 40 per cent of the firms foreign employees exceed a quarter of their total workforce. This is an increase of more than 80 per cent in the tenyear period. Indeed, by the end of the period almost a third of the firms have more than half of their workforce located in foreign countries. While the largest growth in the number of firms with foreign sales activities occurred in the first half of the 1990s, the growth of foreign employees primarily occurred in the later part of the 1990s. The data also show an increasing development in the localization and geographic spread of activities outside Norway. Almost 80 per cent of the firms studied had established foreign subsidiaries by the year 2000, a noteworthy increase from only one third of the firms in 1990.

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Table 4.2 Indicators of internationalization for the 100 largest non-financial Norwegian firms 1990, 1995 and 2000

Percentage of firms with foreign sales Average ratio of foreign sales to total sales (median) (%) Percentage firms with over 25% foreign sales Percentage firms with over 50% foreign sales Percentage firms with foreign employees Average ratio of foreign employees to total employees (median) (%) Percentage firms with over 25% foreign employees Percentage firms with over 50% foreign employees Number of firms with foreign subsidiaries Average number of foreign subsidiaries (median) Number of firms with foreign subsidiaries located in minimum three continents (%) Number of firms localized in the Nordic region (%) Number of firms localized in rest of Europe (%) Number of firms localized in North America (%) Number of firms localized in Asia (%) Number of firms localized in rest of world (%)

1990

1995

2000

54.3 32.1 (6.0)

72.2 39.6 (30.0)

76.3 43.4 (38.0)

45.7

53.6

52.6

37.0

42.3

45.4

31.5

48.5

73.2

11.8 (0.0)

17.9 (0.0)

29.4 (16.0)

22.8

32.0

41.2

7.6

15.5

28.9

54

75

34 6.9 (0.0)

9.8 (2.0)

14.7 (5.0)

15 (44.1)

22 (40.7)

26 (34.7)

26 (76.1)

41 (75.9)

61 (81.3)

27 (79.4)

43 (79.6)

52 (69.3)

22 (64.7)

29 (53.7)

39 (52.0)

15 (44.1) 11 (32.4)

23 (42.6) 15 (27.8)

33 (44.0) 26 (34.7)

Note: *The percentages (in parentheses) are calculated from the total number of firms with foreign subsidiaries, not from the total sample.

As detailed in Table 4.2, the nearby Nordic and European markets continue to dominate the international activities of Norwegian firms, but the number of firms localizing activities in more distant markets have more than doubled in the ten-year period. The relative ratio of firms located in each geographic region has remained fairly stable, with only a small decline in the European and North American markets. Hence, the geographic spread of the firms’ international activities has not changed significantly.

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3. Industry Factors and the Internationalization of Firms A sizable part of the diversity in internationalization patterns observed among the firms in the Norwegian sample is likely to be firm-specific and reflects firms’ strategic decision-making and competitiveness. If most of the variation can be explained by firm-specific factors, one should not expect to find major differences across industries. Conversely, if industry factors do in fact influence the patterns of firms’ internationalization, similar patterns should be observed among firms within the same industries. Previous studies, albeit scarce, suggest that four industry characteristics in particular may influence firms’ propensity to internationalize and the consequent development of their foreign activities (Andersson et al., 2004; Benito et al., 2002; Contractor et al., 2003; Porter, 1990; Yu and Ito, 1988): (i) the level of competition, (ii) research intensity, (iii) tangibility of the products and (iv) existence of clusters in the domestic market. Each industry characteristic is described in more detail below.

Level of competition in the domestic market A competitive domestic arena generally helps strengthen the ways in which firms perform value activities (Grant et al., 1988). Intense rivalry is particularly effective in sharpening firms’ commercial skills (Porter, 1990). Often, however, the rivalry comes from foreign firms entering the domestic market. Based on earlier studies of oligopolistic rivalry across national borders (Graham, 1978), we could, thus, expect Norwegian firms to internationalize as a response to foreign firms entering their home market. Internationalization can also result from a direct countermove to competitors internationalizing, creating a chain of interdependent moves (Knickerbocker, 1973). While firms in oligopolistic industries tend to react vigorously to competitors’ moves, firms operating in industries with large numbers of incumbents are less motivated to follow their competitors (Yu and Ito, 1988). The motive behind internationalization is not always directly related to domestic competition (e.g., FDI motivated by efficiency seeking), but empirical studies indicate that competitive home country environments increase the probability of successful internationalization of firms (see e.g., Wan and Hoskisson, 2003). In all, we expect the degree of competition in an industry, as expressed in its concentration ratio, to positively influence incumbent firms’ propensity to internationalize.

Research intensity A firm’s ability to achieve competitive advantage is rooted in its ability to innovate. The innovative skills can be either technological or market

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oriented (Porter, 1990). By operating in a dynamic and innovationintensive environment, firms develop organizational capabilities that serve as the foundation for successful long-term strategies (Grant, 1996). Firms with the highest technological competencies would thus have the resources and capabilities needed to manage international activities (Cantwell and Janne, 1999).1 Research-intensive firms may internationalize for a number of reasons, such as seeking new markets or moving production to lower-cost locations (Vernon, 1966). A reason for internationalizing activities can also be the need to adapt goods or processes to local markets and provide local technology support (Patel and Vega, 1999). These reasons for internationalizing are not necessarily driven by high industry levels of research intensity per se, and do not sufficiently explain why research intensity would push firms to internationalize. Nonetheless, operating in a researchintensive environment may generally strengthen the firm’s competitiveness in general, which in turn could induce firms to compete outside their domestic markets (Porter, 1990). Indeed, most firms tend to internationalize technologies that made them particularly strong in their home markets (Patel and Vega, 1999). Research intensity has been identified as a key structural determinant for global integration in industries (Kobrin, 1991). Firms competing in research-intensive industries are generally pushed at some point to internationalize in order to support their R&D expenditures and access sufficient qualified personnel to further develop their complex technologies (ibid.). Barring some national differences, a positive relationship has been identified between industry average R&D and export sales due to technology spillovers (Ito and Rose, 1999). Recent studies also show an increasing tendency of research-intensive firms to engage in international activities in order to monitor and gain access to technological developments outside their home market (Patel and Vega, 1999). In all, this suggests that firms with high research intensities may also have higher propensities to seek international markets.

Tangibility of resources and product offer Service firms have traditionally remained local and, thus, been less internationalized than manufacturing firms (Contractor et al., 2003). This can be explained by a number of reasons. First, internationalization drivers and motives differ between goods and services. While the relocation of production facilities to foreign sites is largely driven by the search for lower costs and access to resources or distribution channels (Dunning, 2001; Vernon, 1966; Yip, 1989), service firms rarely compete

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across borders primarily on price or costs and depend more on simultaneous customer interaction (Lovelock and Yip, 1996; Løwendahl, 2000). Second, significant non-tariff barriers often create real and perceived difficulties for service firms in marketing outside their original local markets (Grönroos, 1999). While manufacturing firms battle with issues of balancing standardization against local customization, service firms deliver a ‘performance’ that requires customer involvement in the delivery (Lovelock and Yip, 1996). We recognize that industry-specific characteristics will influence both service and manufacturing firms (Porter, 1986), but the influence of industry factors is likely to differ between these two types of firms (Løwendahl, 2000). Increased recognition of the diversity among service firms has led some researchers to divide them further into sub-groups (Contractor et al., 2003; Lovelock and Yip, 1996). Our purpose here, however, is simply to examine whether potential differences between firms in their propensity to internationalize depend on the tangibility of their product offer.

Clusters With the increasing focus on cross-border activities, one could expect a diminishing focus on geographical location. Yet, many studies reveal that the proliferation of certain dynamic geographical areas – so-called clusters – fostering technology development and fierce competitiveness coexist with many other areas that perform less illustriously. Although several studies focus on identifying clusters, limited research has so far analyzed their impact on the internationalization of firms (Brown and Bell, 2001). The potential impact of clusters is essentially twofold. On the one hand, a dynamic local environment might attract new firms interested in learning through a strong local network. Clusters may then act as a centripetal force for attracting foreign firms (Benito et al., 2002; Porter and Sölvell, 1998). MNEs that are seeking out information, technology and/or advanced marketplaces are likely to be attracted to clusters when they locate activities to particular geographic areas (Enright, 2000). On the other hand, clusters may also act as driving forces for internationalization as firms strengthen their competitiveness and know-how by belonging to them (Brown and Bell, 2001; Mariotti and Piscitello, 2001; Porter, 1998). Competitiveness results from strong domestic rivals, aggressive home-based suppliers and demanding local customers (Porter, 1990), all of which are typically found in strong local clusters. Subsidiary research has identified that subsidiaries in leading-edge clusters are, in fact, more internationally oriented that subsidiaries in other industry sectors (Birkinshaw and Hood, 2000). Hence, we could expect a higher

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internationalization propensity among firms located within strong clusters. Some even argue that firms without this sharpened competitiveness derived from cluster environments will have greater difficulties competing internationally (Mariotti and Piscitello, 2001).

4. Methods Data The study has been designed as a longitudinal study where a database containing detailed information about the 100 largest non-financial Norwegian companies was compiled for the period 1990–2000. The bulk of the database is made up of information taken from secondary data sources, such as annual reports, websites, books and presentations. Additional data has also been collected through direct contact with selected firms. The firms were selected from Kapital’s listing of the 500 largest firms in Norway, in 2000. The list was modified to exclude (a) financial firms that have traditionally been bound by strict regulations, (b) foreignowned firms and (c) government-owned organizations with narrowly defined scope of activities and restricted strategic autonomy. Since the firms were selected from the 2000 ranking and data was collected retrospectively, the potential for survival bias needs to be addressed. Indeed, the selected sample only includes large firms that have succeeded over time and, thus, fails to capture some of the dynamics that occurred in the particular period. This could be problematic if a large portion of the firms over time actually had ceased to exist due to bankruptcies and the like. It turns out that only 6 per cent would have disappeared by the end of the observation period (i.e., in 2000) due to poor economic performance if we had used the 1990 ranking: 36 per cent of the companies appear on both lists under the same name and 38 per cent reappear under different names (mainly due to mergers and acquisitions).2 For the remaining 20 per cent of firms, majority ownership had been sold off to foreign owners. The potential survival bias3 was hence judged to be small and of little consequence, especially in comparison to the problems posed by building a dataset (based on the 1990 ranking) containing substantial amounts of industrial dynamics that lie outside the scope of this study.

Measures The study seeks to identify the influence of industry characteristics on the internationalization of firms. In order to examine such developments and whether and to what extent industry influences firms’ internationalization,

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we focus on three distinct measures that fit the objectives of this particular study.4 By using these three measures we circumvent some of the limitations and misrepresentations of one-sided measures,5 while at the same time generating a multidimensional understanding of internationality. The first measure of internationalization is the percentage ratio of foreign sales to total sales (Contractor et al., 2003; Ramaswamy et al., 1996), which primarily identifies the amount of international activities (FSALE). Foreign sales ratio is commonly used to measure the degree of internationalization. Although it has been criticized as a stand-alone measure (Sullivan, 1994), it provides a straightforward statistic of whether the bulk of the firm’s activities are aimed at the domestic or foreign markets. Because the foreign sales ratio indicator does not distinguish well between exports and deeper commitments in foreign markets, two other measures were included to better describe the extent of international activities. The second dependent variable is the ratio of foreign employees to total employees (Contractor et al., 2003), which captures the extent of internationalization in terms of physical presence in foreign markets (FEMP). Foreign employment not only confirms actual presence in foreign markets but also gives an indication of the balance between management challenges in the domestic and foreign markets. This indicator is commonly used as a structural internationalization indicator (Dörrenbacher, 2000). Finally, we use the number of foreign subsidiaries (FSUB) as a measure of internationalization, to map in more detail companies’ commitments abroad and identify to some extent the geographical spread of their activities.6 Although this does not in itself detail the geographical or cultural diversity, it indicates the degree of complexity related to whether the foreign activities are centred in one or many locations. All firms were categorized according to International Standard Industrial Classification (ISIC) (Rev. 3) codes. We use four independent variables to measure key characteristics of industries. The variable TYPE identifies whether the company is in service or manufacturing industries. Specifically, we use a dummy variable with 1 indicating manufacturing firms and 0 indicating service firms. Second, the concentration of competitors in an industry, COMP, is measured as the market concentration of the four largest firms in a given industry. The definition of an industry was taken down to four-digit level ISIC codes to ensure that the variable measured the actual degree of concentration confronting firms in their immediate competitive arena. Sales figures were collected from the annual volume Norges Største Bedrifter (Norway’s Largest Firms) for 1995 and 2000. Third, research and development intensity, TECHINT, is

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measured as the average R&D intensity in an industry at the two-digit ISIC level. Industry level data for Norway for the years 1990 and 1997 were provided by the OECD. Fourth, the variable CLUSTER identifies whether a firm operates in an industry with cluster characteristics. Our classifications are based on two large-scale studies of clusters in Norway (Reve and Jakobsen, 2001; Reve et al., 1992). These studies identify a group of strong clusters and a few additional industries that had some of the characteristics commonly attributed to clusters. The latter group was labelled ‘weak clusters’. This leaves us with a trichotomy of strong, weak and no clusters, coded 2, 1, and 0 respectively. Firm-specific variables were added as controls. The variable CONGL identifies conglomerate companies, i.e., firms operating in multiple industries with ISIC codes that are not directly related. This means that firms may have multiple industry codes without being classified as a conglomerate. For example, firms with industry codes 05 (fisheries), 15 (food manufacturing) and 51 (food retailing) were not classified as conglomerates since these activities represent different aspects of the same value chain. Firm size is measured by TSALE; the total sales for each of the companies for the years 1990, 1995 and 2000.

5. Results and Analysis We have complete datasets for almost all of the 100 firms in the original sample, which means that for most analyses there are only a few missing cases. From our previous discussion, we expected to find significant differences in internationalization patterns across the industry groups. A Kruskal–Wallis test was conducted to check for differences across industries (at the 1-digit level) in relation to the three dependent variables. It turned out that there are, in fact, statistically significant industry differences on all three dimensions of internationalization.7 This prompted further investigation into whether particular dimensions of industry characteristics influence firms’ internationalization patterns differently across industries. Specifically, we run regressions with the selected independent variables to investigate why internationalization patterns differ across industries. The basic regression model is as follows: 4

2

i⫽1

j⫽1

ykt ⫽ ␣i ⫹ ∑ bi Industryi ⫹ ∑ g j Firm j ⫹ ␧tij

(1)

where subscript k specifies the focal measure of internationalization (FSALE, FEMP, FSUB), subscript t denotes year of analyses (1990, 1995

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and 2000), a, b and g are regression coefficients, Industry refers to the set {TYPE, COMPt, TECHINT, CLUSTER} of industry characteristics of industry i, Firm represents the set {TSALESt, CONGL} of firm characteristics of firm j, and ␧ denotes the error term. Based on our theoretical arguments, we expect a positive relationship between the industry factors and internationalization patterns, i.e., bi ⬎ 0, but make no predictions about the g coefficients. Given the possibility of ‘path dependence’ effects in internationalization (Johanson and Vahlne, 1977), where the observed levels and types of internationalization in a given period partly reflect firms’ internationalization in earlier periods, we run additional regressions with variables that capture the level of the dependent variables ykt-1 in the previously measured period. In effect, these variables, called PREVSALE, PREVFEMP and PREVSUB, are lagged versions of the dependent variable, albeit we use relatively long lags of five years:8 ykt ⫽ ␣i ⫹

4

2

i⫽1

j⫽1

∑ bi Industryi ⫹ ∑ g j Firmj ⫹ ␸kt ykt⫺1 ⫹ ␧tij

(2)

A correlation matrix was generated to check whether the dependent variables in the study really reflect separate dimensions of internationalization. Some degree of correlation between the dependent variables ought to be expected, but very high values would suggest that the various measures were merely replicating each other. The correlations given in Table 4.3 indicate that the three dependent variables seem to capture different aspects of firms’ internationalization. Hence, it makes sense to examine each of them separately.9 As shown in Table 4.4, correlations among the independent variables were generally low, with the exception of research intensity, which is moderately correlated with the indicator for type of firm. One would expect these two variables to be somewhat interrelated since R&D tends to be more important for manufacturing firms. A correlation of 0.58 does not per se suggest any harmful collinearity. However, additional tests were Table 4.3

Correlations (Pearson) among dependent variables

Variables

Mean

Std dev.

1

2

3

1. FSALE 2. FEMP 3. FSUB

0.388 0.206 10.35

0.388 0.280 19.385

1.00 0.683** 0.436**

1.00 0.627**

1.00

Note: *Correlation is significant at the 0.01 level (2-tailed).

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conducted to ensure that multicollinearity was not a problem. Neither the variance inflation factors (VIF) nor the condition index indicated problems, both being within common threshold values (Hair et al., 1998).10 Both variables were therefore kept in the analyses. Separate base models for each of the three dependent variables were run for each year in the database. These base models include industry variables and firm-level variables. Table 4.5 displays the results for FSALE, whereas Tables 4.6 and 4.7 show the results for FEMP and FSUB respectively. The base model regressions have modest to moderate explanatory power: models with FSALE as the dependent variable produce the best results with adjusted R2 values in the range of 0.41–0.52. Turning to the impact of the various independent variables, although all the four industry characteristics display significant effects on internationalization patterns, effects vary, depending partly on the internationalization dimension being analyzed and partly on the year of analysis. First, type of industry influences foreign sales ratios and the number of foreign subsidiaries positively, but not the foreign employment ratio. Service firms internationalize less than manufacturing firms in terms of foreign sales and FDI, but their foreign employment ratios are comparable to those of manufacturing firms. Thus, while this generally indicates lower internationalization propensities among service firms, whenever they do move abroad it is with a personnel intensity that is equivalent to that of manufacturing firms. Second, the coefficients of COMP are consistently significant in models with FSUB as the dependent variable, but do not show any significant effects on either foreign sales or foreign employees. This suggests that while high concentration ratios in the home market lead firms to establish subsidiaries abroad, they do not necessarily provide a general impetus to internationalization. This finding is in agreement with the idea of rivalistic behaviour in oligopolistic industries, which suggests that in such industries firms tend to carefully monitor the moves of their closest competitors. The domestic market is usually the single most important market to the firms, but if key competitors venture abroad other firms may be tempted to follow to mitigate possible adverse effects on their domestic competitive position. Third, industries’ research intensity appears to have had few effects on the internationalization of the firms in the sample. The clearest results concern the effects on foreign sales ratios, where the estimated positive coefficients of TECHINT are significant for the years 1990 and 2000. TECHINT also returns a significant positive coefficient in the model predicting foreign employment ratios

Table 4.4

Correlations (Spearman’s Rho) among independent variables

Variables

Mean

Std dev.

1

2

3

1. TYPE 2. COMP 3. TECHINT 4. CLUSTER 5. CONGL 6. YEAR 7. TSALE

0.49 0.443 3.677 0.71 0.07 1934.06 5903.47

0.501 0.249 9.433 0.898 0.259 45.576 18131.18

1.00 0.283** 0.576** 0.074 0.202** 0.222** 0.092

1.00 0.321** 0.037 0.094 0.176** 0.370*

1.00 0.239** 0.303** ⫺0.139* 0.168**

4

5

6

7

1.00 0.123* 0.205** 0.062

1.00 ⫺0.107 0.214**

1.00 ⫺0.329**

1.00

Notes: *Correlation is significant at the 0.05 level (2-tailed). ** Correlation is significant at the 0.01 level (2-tailed).

Table 4.5

Regression results for FSALE 1990, 1995 and 2000 Standardized regression coefficients 1990 0.380*** ⫺0.078 0.232*** 0.466*** 0.098 ⫺0.175

0.366*** ⫺0.096 0.248*** 0.480*** 0.096 ⫺0.180** 0.077

0.427*** 0.036 0.121 0.540*** 0.033 ⫺0.187**

2000 0.102 0.073 0.018 0.234*** ⫺0.039 ⫺0.077*

0.322*** 0.049 0.209*** 0.563*** 0.015 ⫺0.117

0.719*** 95 0.41 11.865***

Note: *p ⭐ 0.10, ** p ⭐ 0.05, *** p ⭐ 0.01.

95 0.41 10.263***

97 0.52 18.172***

96 0.84 74.480***

0.012 0.008 0.110** 0.165** 0.010 0.010 0.734***

95 0.48 15.645***

95 0.75 41.014***

87

TYPE COMP TECHINT CLUSTER TSALES CONGL YEAR PREVFSALE Model statistics: n Adjusted R2 F statistic

1995

88

Table 4.6

Regression results for FEMP 1990, 1995 and 2000 Standardized regression coefficients 1990

TYPE COMP TECHINT CLUSTER TSALES CONGL YEAR PREVFEMP Model statistics: n Adjusted R2 F statistic

0.155 ⫺0.045 0.158 0.217** 0.199* ⫺0.108

1995 0.102 ⫺0.113 0.216** 0.261** 0.198* ⫺0.125 0.257**

0.153 0.080 0.107 0.263** 0.131 ⫺0.128

2000 ⫺0.017 0.119** 0.053 0.068 ⫺0.040 ⫺0.026

0.106 0.041 0.229** 0.304*** 0.044 ⫺0.092

0.848*** 91 0.10 2.615**

Note: * p ⭐ 0.10, ** p ⭐ 0.05, *** p ⭐ 0.01.

92 0.15 3.216***

93 0.12 3.072***

91 0.76 42.313***

⫺0.021 0.067 0.145** 0.074 ⫺0.026 ⫺0.011 0.756***

94 0.13 3.336***

93 0.64 24.229***

Table 4.7

Regression results for FSUB 1990, 1995 and 2000 Standardized regression coefficients 1990

TYPE COMP TECHINT CLUSTER TSALES CONGL YEAR PREVFSUB Model statistics: n Adjusted R2 F statistic

0.170* 0.191* ⫺0.045 ⫺0.022 0.372*** 0.050

1995 0.132 0.142 ⫺0.002 0.015 0.369*** 0.035 0.204*

0.191* 0.250** ⫺0.043 ⫺0.024 0.173 0.065

2000 0.056 0.103 0.021 0.001 ⫺0.169** 0.051

⫺0.003 0.259** 0.089 0.079 0.149 0.175*

0.806*** 92 0.25 6.189***

93 0.28 6.175***

94 0.16 3.962***

93 0.62 22.401**

⫺0.121 0.171* 0.078 0.079 0.095 0.108 0.507***

94 0.12 3.022***

93 0.34 7.666***

Note: * p ⭐ 0.10, ** p ⭐ 0.05, *** p ⭐ 0.01.

89

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in the year 2000. All in all, though, the results for this variable are inconclusive in the regression runs for the base models. Fourth, the existence of industrial clusters has positive effects on firms’ foreign sales as well as on their foreign employment ratios. All models with FSALE and FEMP as dependent variables display positive and strongly significant coefficients for the CLUSTER variable, with particularly pronounced effects for the foreign sales ratio. Interestingly, no effect was found for the CLUSTER variable in the FSUB models: in other words, belonging to an industrial cluster seemingly boosts the international competitiveness of its incumbent firms (Brown and Bell, 2001; Mariotti and Piscitello, 2001; Porter, 1998), but does not lead them to establish an extensive network of units abroad. This indicates, in line with other studies of industrial clusters, that clusters are successful both in attracting business to certain locations and in retaining those firms that are already established there (Enright, 2000; Reve and Jakobsen, 2001). The estimations produced few significant effects for the firm-level variables that were introduced as controls, which indicates that neither size nor diversification have clear effects on internationalization patterns. The regression runs of the base models indicate that industry factors indeed have an impact on the internationalization of the firms in the sample but only account for a fraction of the variation in the data. We took the investigation further by incorporating potential ‘path dependence’ effects. It has been noted that firms’ internationalization patterns may be ‘path dependent’ (Johanson and Vahlne, 1977); i.e., that the firms’ degree of internationalization at a given point reflects the corresponding degree of internationalization at some earlier point. We account for such potential effects by including lagged variables of the dependent variables; i.e., previous levels of foreign sales ratios, previous levels of foreign employment ratios, and the number of subsidiaries in the previous period.11 As one would expect, these lagged variables are correlated with the dependent variables. However, since we use a fairly long lag of five years, the highest correlations are in fact just about 0.7. We tested for autocorrelation in the autoregressive models by using the Durbin-Watson h-statistic,12 which does not indicate any signs of autocorrelation.13 Running regression models with the expanded set of variables demonstrates that including all variables gives a noticeable increase in the explanatory power of the models. All lagged variable coefficients are positive and strongly significant, thereby substantiating the alleged path-dependence in firms’ internationalization. More importantly,

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while some of the industry effects estimated through the base models are changed, most changes are marginal. On the whole, industry effects remain strong, which provides further support to the main thesis of this chapter.

6. Summary and Discussion This study has examined the influence of industry factors on the propensity of firms to internationalize. Based on a dataset of the 100 largest Norwegian companies over the period 1990–2000, we find that firms differ considerably in their degree of internationalization and that such differences are significantly related to characteristics of the industries in which they operate. This is particularly interesting to see in an empirical context (SMOPEC) where industry factors could potentially have been overshadowed by the impact of more macro-level issues such as the limitations of a small domestic market generally pushing firms to internationalize or local embeddedness acting as a centripetal force for international activity (Benito et al., 2002). Previous studies on internationalization have largely neglected industry-level characteristics and instead focused on firm-level and country-level factors. Our findings demonstrate that leaving out industry factors restricts our understanding of firms’ internationalization patterns. Merely using aggregate measures to identify global industries (Makhija et al., 1997) may also fail to capture important variations among different industry variables. Three distinct measures have been used to capture the scale and scope of international activities. The results indicate substantial heterogeneity in how industry characteristics influence different aspects of internationalization, hence supporting the use of multidimensional measures of internationalization (Dörrenbacher, 2000). First, in line with oligopolistic behaviour frameworks (Flowers, 1976; Graham, 1978; Knickerbocker, 1973) we find that concentrated home markets push firms to establishing subsidiaries abroad. Second, in agreement with previous studies of service firms’ internationalization (see e.g. Contractor et al., 2003) we find that service firms generally exhibit lower foreign sales levels and have fewer foreign subsidiaries than manufacturing firms. However, their foreign employment ratios are equivalent to those of manufacturing firms, indicating that the extent of their physical presence abroad (in terms of employees) is comparable to that of manufacturing firms. This supports the idea that service firms generally require substantial direct contact and interaction with their customers. Third, we find that while being part of an industry cluster drives up firms’ foreign sale and foreign employee

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intensities, indicating improved competitiveness (Porter, 1990), industrial clustering did not per se have an impact on the establishment of foreign subsidiaries. The local embeddedness generated by local clusters may, however, have prevented some relocation of units to foreign markets (Benito et al., 2002). Finally, in line with Ito and Rose (1999), there is a positive association between industries’ research intensity and sales in foreign markets. However, this variable had no clear effect on other aspects of internationalization. High research intensities have indeed been found to make all firms more competitive, regardless of whether they are local firms or MNCs (see Chapter 6 in this volume). Since local firms become equally focused on R&D activities in research-intensive industries, it seems expected that exports would increase due to new innovations in need of larger markets, but firms would not necessarily be motivated to move units to foreign locations. The inconclusive results on the effects of research intensity could be due to measuring the variable at the two-digit ISIC level, which may have been too aggregate to accurately reflect the focus on R&D facing the firm in its immediate competitive environment. The control variables indicate that the results are robust. This strengthens our argument that we may be overlooking critical internationalization factors if industry issues are ignored. Since the specific industry factors identified in this study only account for a small, although significant, portion of the explained variance in firms’ internationalization patterns, other industry variables should also be studied in future studies. Controlling for firm-specific factors further reveals that there are strong path dependencies in firms’ internationalization. Firms that already have internationalized thereby exert a greater propensity to internationalize further, and their degree of internationalization at a given point in time strongly reflects firms’ internationalization at previous points. While we agree with Porter (1986) that industry factors are essential in order to understand the propensity of firms to internationalize, our study suggests that once internationalization has been set in motion the subsequent development of firms’ international activities can be more influenced by firm-specific characteristics such as previous experiences and market perceptions. Industry factors may push or hold back firms from crossing some internationalization threshold, but we have not yet explored their impact over time once the critical initial barriers have been overcome. One avenue that could be explored further, in order to assess the influence of industry factors over time, is to examine differences across industries in internationalization strategies and subsidiary roles. According to Bartlett and Ghoshal (1989), internationalization

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strategies and subsequent subsidiary roles are highly related to industry factors and could thus be expected to vary across industries, as some industries require local adaptation and others more global integration. These issues have yet to be examined in detail. Although the results demonstrate the fruitfulness of including industry factors in models of firms’ internationalization, the limitations of the present study should be noted. Collecting the data retrospectively has advantages as well as drawbacks. The approach makes data collection somewhat easier and reduces much of the ‘noise’ arising from industry dynamics such as company restructuring and bankruptcies. This is in part positive, since such dynamics per se lie outside the scope of the study, but such an approach also introduces some degree of success and/or survival bias in the sample. An additional issue is that the data were collected for three points in time, with five-year intervals, which may introduce potentially important information gaps in the dataset. Annually collected data would have been better both in order to capture small gradual changes in firms’ internationalization, and to uncover significant disruptions in-between data collection points.

Notes 1. This does not necessarily imply that firms with high research intensities are more inclined to internationalize, nor does this suggest that R&D are activities that are often moved to foreign locations. Even though Guellec and de la Potterie (2001) have recently argued that there is an increasing trend of technology transfer across borders, there has, in fact, traditionally been a low degree of internationalization of R&D (Zander, 1999). 2. It is important to note that the 38 per cent that underwent mergers or acquisitions were largely merged into a few companies that were already on the list of the largest firms in 1990. 3. In the 2000 sample, only 6 per cent have no ties back to 1990. 4. Although there are several ways of measuring internationalization, commonly accepted measures are lacking. Previous efforts have been criticized for not being sufficiently reliable or definitive (Sullivan, 1994). A number of multi-item aggregate indices have thus been developed to avoid the limitations of single-item measures and create a multidimensional understanding (ibid.; Ietto-Gillies, 1998). It is questionable, however, whether an existing index can be theoretically justified or methodologically appropriate for subsequent studies (Ramaswamy et al., 1996). 5. For example a reduction in foreign employees may indicate increased efficiency rather than reduced international activity. Similarly, a reduction in foreign subsidiaries may merely reflect a concentration of activities with increased emphasis on fewer geographical areas rather than a reduction of international activities per se.

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6. For a given company j at time t we have; FSALEjt ⫽ (foreign salest / total salesst); FEMPjt ⫽ (foreign employmentt / total employmentt); and FSUBjt ⫽ # foreign subsidiaries. 7. The Kruskal-Wallis tests reveal that differences in internationalization patterns between industry groups related to all three dependent variables are significant at the 0.001 level. 8. For example, PREVFSALE1995 ⫽ FSALE1990, and PREVFSALE2000 ⫽ FSALE1995. Similar computations were made for PREVFEMP and PREVFSUB. 9. The three dependent variables are indeed correlated but the coefficients are in the region of 0.44–0.68, which does not indicate alarmingly strong correlations. 10. VIF values were in the range of 1.065–1.698 (2.142) and the condition index values range from 2.026–5.565 (9.310), with the values for the lagged dependent variables in parenthesis. 11. Since our dataset lacks information prior to 1990, lagged variables could not be computed for analysis of 1990 data. Instead, we use the number of years since the firm was established (YEARS) as a way of capturing path-dependence effects. 12. The more commonly used Durbin-Watson d-statistic may be unreliable for detecting first-order autocorrelations in autoregressive models (Gujarati, 1994). The Durbin-Watson h-statistic is calculated as h ⫽ (1 – 1/2d) 冑n/(1⫺n[var(␣2)]) where d is the usual Durbin-Watson statistic. 13. The calculated values range from ⫺0.11–0.03, which are safely within the 5 per cent range of ⫺1.96 and ⫹1.96.

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5 The Pace of Internationalization for Small and Medium-sized Enterprises Siv Marina Karlsen

1. Introduction The purpose of this study is to describe the process of internationalization of SMEs and to explore the reasons for the differences in the pace of internationalization of firms. Empirical evidence, from many countries, supports the notion that firms often internationalize by benefiting from what they learn by experience, i.e., their market knowledge increases gradually and uncertainty and risk is reduced over time for each new country. However, in 1988 Johanson and Mattson pointed out that some firms follow other internationalization patterns. They argued that the degree of internationalization of markets (i.e., the frequency, intensity and integration of relationships across borders in the particular industry market) has an impact on the internationalization process of the individual firm. In highly internationalized markets, firms may leapfrog some of the stages in the learning process. More recently, many authors (e.g., Knight and Cavusgil, 1996; Madsen et al., 2000; Oviatt and McDougall, 1994) have found empirical evidence of yet another type. Some exporters are born global. These are firms that aim at international markets or even the global market from their inception. They do not seem to follow any kind of staged learning process leading to internationalization, i.e., their behaviour is beyond leapfrogging. Knight and Cavusgil (1996) argue that the slowness of the process described in traditional internationalization literature may be an indication of management’s aversion to risk-taking and their inability to acquire relevant knowledge and information. The fact that the process seems to be speeded up now may partly be explained by the notion that management in rapidly globalizing firms are less risk-averse and/or have better access to relevant information. The environment has changed a lot since the 98

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‘traditional internationalization theories’ were developed, e.g., the increased level of globalization in many industries may constitute an explanation for the observed increase in the pace of internationalization of firms. This increased globalization, which is believed to lead people to perceive the world as being smaller, may also induce managers to perceive the risk of entering foreign markets as being lower. One driver of globalization is believed to be the development of advanced communication technology, i.e., an industry described as having a high degree of globalization will by definition be characterized by having information transferred more easily and faster than in less global industries. This increased access to information may decrease the psychic distance between countries, which has previously been seen as a major obstacle for the international expansion of firms (e.g., Johanson and Vahlne, 1977). Oviatt and McDougall (1994) state that recent technological innovation and the presence of increasing numbers of employees with international business experience have established new foundations for multinational enterprises (MNEs). Traditionally, these were developed from large, ‘mature’ domestic firms, but the increased use of low-cost communication technology and transportation means that the ability to discover and take advantage of business opportunities in multiple countries is not the prerogative of large, mature corporations any more. Crick and Jones (2000), for instance, found that several firms were set up by managers who have experience operating in international markets from previous employment. They have experience in dealing with the complexities of international operations and have acquired an appreciation of the risks and resource implications. Finally, but not less important, they have developed a network of customers and contacts that they can use and rely upon when setting up their own firms. Whatever the reasons are, there is increasing evidence that shows that in spite of small size and inexperience in international transactions, high value-adding manufacturing firms are capable of outrunning their larger, more resourceful counterparts in foreign markets. According to Bradley (1995), there are basically two dimensions which represent the key strategic decisions in connection with a firm’s internationalization: (i) international market selection; and (ii) choice of entry mode. With regard to the market selection dimension, born-global firms (BGs) often start activities in many markets simultaneously and do not always prefer starting in those markets that are closest. The product is developed for a global/international market (Madsen et al., 2000). Bell (1995) explains this in the following way: ‘psychic distance has become much less relevant as global communication and transportation infrastructures improve and as markets become increasingly homogeneous’

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(p. 62). According to Pedersen and Petersen (1998) the pace by which firms commit resources may differ substantially, but the tendency is for firms to increase their resource commitment to a foreign market over a period of time, starting to serve foreign markets with agents and later internalizing the activity by changing to wholly owned subsidiaries. It is assumed that the internationalization process of firms is currently proceeding faster on both dimensions (Hedlund and Kverneland, 1985) than traditional theory predicts. Thus, the research questions addressed in this study are: which factors influence the pace for SMEs to gradually increase their resource commitment to a foreign market and which factors influence the pace for entering new country markets?

2. Conceptual Framework The existing literature shows no agreement regarding the conceptual framework and constructs that should be used to explain a firm’s internationalization (Andersen, 1997). The present framework will be based upon some of the most important contributions for explaining the pace of internationalization of SMEs. Bloodgood et al. (1996) argue that new ventures will seek an international presence for two reasons: (i) industry conditions (e.g., increased globalization) may require an international presence for the company to be competitive, and (ii) a venture may seek a global presence to capitalize on its unique set of resources (e.g., the management team’s experience in global markets, new technologies or innovations). According to the same authors, these conditions must be present for rapid internationalization to be viable. One reason for the differences observed in the speeds by which traditional MNEs and fast-globalizing firms become international/global, is due to different environmental conditions: ‘the slowness of the whole process is a consequence of incremental adaptations to changing firm and environmental conditions rather than the result of a deliberate strategy’ (Knight and Cavusgil, 1996, p. 13). In other words, when the environmental conditions rapidly change, as they do when there is increased globalization, the process of internationalization is likely to speed up as well. In a closed domestic industry, a company accustomed to weak competitors and undemanding customers has little to fear – there are no new competitors that might grow strong in more demanding competitive arenas. In an open global industry, new and strong competitors abound (Yip, 1992). As a consequence, it is important to understand just how the industry globalization drivers affect the competitive environment of SMEs. When moving to the industry and company level, it has been argued (by, e.g., Lindqvist, 1991) that increasing speed in the development of new

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technologies has led to shorter product life cycles (PLCs) and higher innovation intensity, which in turn leads to intensified global competition. The shorter PLCs have led to more emphasis on R&D, and on recognizing new opportunities and exploiting them as rapidly as possible with successful timing (e.g., PCs and mobile phones). In short, product characteristics are another aspect to be considered. For firms with small home markets it may be difficult to achieve competitive advantage in terms of economies of scale. In the case of some products, significant economies can be achieved only by operating in multiple countries. The shorter the PLC, the shorter the time period for returns on investments for product development. Consequently, companies with small domestic markets need global volume, so that the costs for product development can be apportioned. On the other hand, new and improved technology may aid firms with small home markets in that economies of scale are no longer a key factor to succeed globally. The improved production technology makes it possible to produce and sell smaller quantities at a profit. In addition, for the unique and differentiated products that most of the case firms sell, the price and thus cost is not vital. It is the unique features that is important and for which the niche buyers are willing to pay well. As some of the founders stated, ‘Once they have tried our product, they will not return to the older, outdated product used earlier’ (interviews with Fjerdingstad and Vedeld in 2002). The experience and background of founders and their relationships are important resources for a firm and are important drivers or facilitators of internationalization. International experience is defined as the understanding and realistic perceptions of foreign operations, risks and returns in foreign markets (Aulakh and Kotabe, 1997). The reasoning here, which is based on the organizational capability of the firm, is that firms are initially risk-averse when entering new markets, and therefore not willing to invest substantial resources in unfamiliar terrain. As a firm’s management gets a better feel for the foreign markets, it gains better understanding of the risks and returns, and becomes more confident and aggressive, but also more realistic. This may be manifested by a willingness to commit more resources, but it may also enable management to make better investment decisions. For firms, international experience has traditionally been measured by making an assessment of the geographic scope and depth of the firm’s experience. This is done by registering the number of different countries in which a firm is active and the length of experience in each of those countries (Erramilli, 1991). In the present study, the variable will be analyzed at the individual level. Information about the founder(s)’ and/or other key employees’ international experience will be collected. Several

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studies (Oviatt and McDougall, 1994; Reuber and Fischer, 1997; Ellis, 2000) show that key employees in BGs very often have extensive international experience from previous employment. Furthermore, Reuber and Fischer (1997) argue that decision-makers with more international experience are more likely to have a foreign business network in place and are more likely to have developed the skills needed to identify and negotiate with firms in a different culture. Oviatt and McDougall (1994) further argue that partnerships provide concrete critical resources, i.e., specific skills and finances, as well as more abstract resources, such as legitimacy and market power. These resources are seen as being particularly important when a new and young firm, with relatively small resources, attempts to increase foreign sales. The founders’ or other key employees’ relationships from previous employment may enable these firms to enter new markets at a faster rate than would otherwise be possible (e.g., by providing the firm with complementary resources and by opening up markets). This view is supported by Ellis’s (2000) findings, which support the notion that awareness of foreign market opportunities (which has been identified as being a critical antecedent of foreign-market entry) is commonly acquired via existing social ties. McGaughey et al. (1997) also emphasize the important role of personal networks in triggering initial export enquiries or orders. They found that the network’s key individuals importantly affected the case company’s international activities. These people were critical for both the content and direction of the company’s internationalization: ‘much of the ability of the company to initiate and carry through international operations resided in the decisionmakers’ personal networks’ (p. 179). From this discussion, a conceptual framework is proposed where four main factors are posited as having an impact upon the firm’s pace of internationalization. These factors are: (i) the experience and background of the firm’s founders or other key employees; (ii) the same person’s network; (iii) the type of industry in which a firm does its business; and (iv) different product characteristics. Boundaries between domestic and international markets are becoming less relevant as businesses increase their activities abroad. A global industry is, in this thesis, conceptualized as follows: ‘an industry in which a firm’s competitive position in one country is significantly affected by its position in other countries or vice versa’ (Makhija et al., 1997, p. 680). In this regard, the global industry ‘is not merely a collection of domestic industries, but a series of linked domestic industries in which rivals compete against each other on a truly worldwide basis’ (Porter, 1986, p. 18). In order to find an explanation as to why some SMEs still follow a more step-by-step approach, while others choose a faster and more erratic

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approach that leapfrogs over many stages, Madsen et al. (2000) argue that globalization may enable firms to more freely choose their own model for becoming international. International sales both become easier and more difficult, in the sense that international markets have become more accessible for most firms, but the level of competition and the demand for international competence have increased. There is both a ‘positive’ pressure, from the increased level of globalization, in the form of an increase in the accessibility to markets, and a ‘negative’ pressure from tougher competition, since it has become a necessity for a host of new companies to be present in many markets. Both of these pressures work to increase the pace of internationalization. The positive pressure lures the company to new territory, while the negative pressure forces the company to find new markets. These pressures may work differently depending upon the size of the home market. According to Bloodgood et al. (1996), new European firms are more likely to consider internationalizing some of their activities when their enterprise is initiated compared with new US firms. One reason is the fact that a new US firm, operating in a 500-mile radius around its base, may do so without crossing borders, a European firm, with the same operating radius around its base, may have to deal with five or six other countries. Luostarinen and Gabrielsson (2001) state that global firms from large countries globalize because of the demand-based pull forces in global markets, but global firms from small and open economies globalize because they are pushed. Small domestic markets and the fear of expected future competition, from global firms in large countries, puts a lot of pressure on these firms, pushing them to find new markets. According to Hamel and Prahalad (1985), companies that safely nestle in their home beds will increasingly experience a resource disadvantage. ‘They will be unable to marshal [the] forces required for a defence of the home market’ (p. 146).

3. Methods Research design The data have been gathered from in-depth interviews of key informants. Case studies within business research are a very demanding exercise and, for that reason, only 12 cases were chosen. The founder/CEO or another key employee (who has been in the company from the start) of the firm was contacted, with a request to participate in the study. The potential case companies were selected by using procedures that are appropriate for samples that are needed for theoretical purposes (Glaser and Strauss, 1967; Yin,

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1998). The logic that justifies the use of samples for theoretical purposes is different from the logic of sampling for statistical purposes, which often requires random selection. Purposive sampling to explore theoretical considerations does not require too great a concern for sample size. The size of the sample is relatively unimportant. What is important is the potential of each case to aid the development of theoretical insights into the dynamics of the internationalization process being studied. The interviews lasted approximately two to four hours and were, with one exception (Optoflow), tape-recorded. A semi-structured interview style was used, where the interviewees were allowed to tell their story relatively freely, but were given cues if they wandered too far off the topic of interest. After a few months, when the transcripts were made and the comparisons of the cases started, about half of the interviewees were contacted by e-mail and/or telephone in order to clarify some of the information and also to ask some additional questions. The case companies were selected from a pool of respondents to a survey that was carried out in the autumn of 2001. The population of that survey was defined as being SMEs in Norway, founded after 1990 (and registered in the ‘Kompass database’). SMEs are defined as being firms with less than 100 employees. The reason for choosing recently established firms is to ensure that the details surrounding the founding of the firm are not lost to history. The focus on SMEs is due to the fact that several studies have found that most of the rapidly internationalizing firms have far less than 100 employees (see e.g., Knight et al., 2004). In addition, Solberg (1988) found successful exporters to be significantly smaller than unsuccessful exporters. This finding led him to suggest that smaller units are better able to create the right atmosphere for successful exporting, necessitating a closeness to the market and an open-minded organization, not always present in large corporations with rigid bureaucratic decisionmaking procedures. Finally, firms that were stand-alone entities were preferred. This preference was due to the expectation that sub-units of larger firms have greater access to resources, i.e., capital, human resources and information (Harveston, 2000). Despite this, three of the cases chosen were not independent, partly because the dichotomy between dependence and independence is not always that simple to determine, and because it might be useful to have some cases that are not independent for reasons of comparison. A relatively wide population was chosen at the outset, in order to enable a continuum to be drawn with firms that have a gradual pace of internationalization, at one extreme and true born-global firms, at the other.

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Operational concerns The definition and use of concepts and measurements in empirical contexts is the primary operational concern. While measures of imprecise concepts are never completely valid or reliable, researchers strive to maximize these qualities (Knight, 1997). Measuring the pace of internationalization was achieved by identifying how many regions an SME enters during a specific time period, which types of region the firm enters and in what order (close or far away from the home market in terms of psychic distance). In addition, the export rate of the firms three years after founding was measured, since this is a common cut-off point for defining so-called born-global firms (Harveston, 2000; Junkkari, 2000; Knight, 1997; Knight and Cavusgil, 1996; Madsen et al., 2000). More specifically, these same authors define born-global firms as SMEs with an export rate of more than 25 per cent within three years of their founding. Finally, this research identified the entry mode that was initially used when the firm entered its first foreign market and the foreign operation modes that were currently being used. This was done to measure the rate of resources committed to the market over time. Globalization may be conceptualized in terms of a continuum from low to high, along which different industries fall (Porter, 1986). An industry at the very low end of globalization is highly independent of industries in other countries. An industry at the very high end is significantly linked to similar industries in multiple countries in which its various value-added activities are located. The extent to which an industry is characterized by international linkages within the industry is seen as being an important indication of its level of globalization (Makhija et al., 1997). It is rather difficult to find good measures of an industry’s global characteristics. However, according to Porter (1986) and Bartlett and Ghoshal (1989), establishing the extent to which an industry is global is a necessary first step, before one can adequately examine global strategies. Each industry’s unique blend of competitive pressures is likely to result in varying levels of globalization, which in turn are reflected in the strategies the firm utilizes in these industries (Prahalad and Doz, 1987; Yip, 1992). One way to measure this is to use the ranking of different industries in Yip (1992, p. 34), but in this study subjective measures have been used. That is, the managers in the SMEs are asked how they perceive their industry, according to a certain set of dimensions that aim at revealing the industry’s global characteristics (Solberg, 1997, p. 5). These dimensions are: industry structure (oligopoly or fragmented), which is influenced by the strength of globalization drivers (trade barriers, internationalization of customers/suppliers,

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international demand pattern) and the interdependence of national markets (international price sensitivity, intra-industry trade). Product characteristics, it has already been pointed out, are believed to be influenced by macro factors, such as the competitive conditions within an industry. Questions were asked about the product’s life cycle and about its uniqueness when compared to competitive products. (‘Is it one of a kind?’) The degree of specialization of the product (Madsen and Servais, 1997) was also queried. The research asked managers to classify the product as being either an industrial product or a consumer product. Top management experience is defined as the amount of experience that a manager has accumulated in an international context. Harveston et al. (2000) state that most studies using this construct have used the amount of time spent in foreign countries as an indicator. This indicator includes time spent at foreign assignments, at foreign educational facilities and on vacation in foreign countries, as measures of international experience. This indicator accounts for one dimension of the construct: length. The second dimension is scope. From which continent(s) do key employees have experience? Have these key employees mainly worked abroad or at home? Another measure of foreign experience gauges the extent to which the manager has engaged in foreign travel. They are asked about the number of languages that the manager speaks and how fluent he or she is in those languages. Was the top decision-maker born abroad? Has s/he lived abroad (Miesenbock, 1988; Reid, 1981)? What was the mindset of the founder at start-up (Harveston, et al., 2000)? In this study, international experience was measured by determining how long the founder(s) had been abroad, in which countries they had worked or studied and what position(s) they held while living abroad. In addition, the foreign languages that were mastered were identified. According to Solberg (1997, p. 16), the more global the industry structure is, the more important is the presence of an active and widespread network. Motives for entering a new market were investigated and the characteristics of prior relationships and the role they have played have been sought. Personal relationships, studied in this chapter, were relationships that key employees define as having an impact on their road to internationalization. These are either relationships in their home country or relationships in the target country, established when previously working or studying abroad, or developed from their previous work assignments in their home country. What types of relationships exist between the key employees and the network of people they identify as being most important? How close are these relationships? This can be measured by documenting the frequency of contact (daily, weekly, once a month) and the

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type of contact (face to face, telephone, e-mail). We assume that the more frequent the contact and the closer the type of contact is (e.g., face to face), the more trust exists between the parties. Whether the contact is formal or informal may also be of some importance. It is assumed that the more informal the contact is, the closer the relationship, and the more closeness, the more trust. The interviewees were asked to elaborate upon the relationships they considered to be important for the development of the firm: how and on what occasion the parties first met, and in what way those relations contributed to the firm’s internationalization process. In addition, interviewees were asked to characterize the type of contact they have at present.

4. Case Descriptions The analysis in this section is based on 12 cases. The analysis will be segmented into four topics: (i) experience/background of founders; (ii) personal networks; (iii) global characteristics of the industry; and (iv) product characteristics. In the interviews, the focus was on understanding the drivers for the international character of the SMEs in greater detail. Within-case analysis as well as cross-pattern search (Eisenhardt, 1989) are used to analyze the data. Data and interview notes were coded by the author using the software HyperResearch. This was done for each firm along a number of dimensions. This makes it easier to identify the different statements that represent each dimension studied, because in the left margin of the document you see the codewords and the corresponding statement is then marked. Since data displays help the researcher see patterns (Miles and Huberman, 1994, p. 433), critical events of each case’s history are drawn up (see below).

ColorMatic AS – inkdoser Year

Important events

1983

Thronrud Engineering AS (parent company) was established Two printers, Mr Randsberg and Mr Bjelland, started to develop the concept of an inkdosing machine The prototype was ready and the two printers approached Mr Thronrud

1991 1995

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1996

1997

1998 1999

2000 2001

ColorMatic 2000 presented at the Grafex and Nordgraf fair in Stockholm – no success – the machines were considered too large, complicated and expensive and thus difficult to sell (sold only five or six machines) Thronrud AS bought all the patents and ColorMatic AS was established – Thronrud AS is to produce the machines and ColorMatic AS to market and sell them The prototype of Inkdoser 2500 was presented at the Ipex fair in Birmingham The first machines were sold to England, Belgium, Denmark, Australia and New Zealand. Contact with the buyers was made in Birmingham Mr Schaefer (the interviewee) was employed to strengthen the marketing effort USA, Germany and France were entered They are presently in 22 countries, mainly using low-commitment modes such as direct export and distributors. They have one employee abroad, at a sales office in England Their focus for the future is on the US and the Japanese markets

Dolphin AS – hardware Year

Important events

1991/92

Dolphin AS was established by 20 previous employees of Norsk Data Direct export started to the US market Ownership of Dolphin AS moved abroad to the US, i.e., parent company located in the US, but the owners are the same as at the outset Buy-up in the US Dolphin AS established an agent in France Dolphin AS established an agent in England Dolphin AS established an agent in Germany Their focus for the future is on the US and the Chinese market

1992 1994

1996 1997 2000 2002

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Fras AS – fluid sampler Year

Important events

1975

Mr Fjerdingstad (founder of Fras) established a subsidiary of Parker Haneyfin in Norway Mr Fjerdingstad established a subsidiary of Hägglunds Drive in Norway The first step for the product was to follow a customer out – namely they followed Norske Skog to France Mr Fjerdingstad was employed at Veritas as a strategy to prepare a a platform for the product Fras AS was established by Mr Fjerdingstad Fras AS established contact with Lloyds of London Fras AS sold licences to Germany Fras AS followed Statoil to China Fras AS is currently looking for new investors They do not focus on country markets but on product markets: offshore, ships, process industry and energy production

1986 1990 1991 1996 1998 1999 2000 2003

ICAS AS – smoke detectors Year

Important events

1989 1990/91

ICAS AS was established by Mr Olving Legislation required that all homes in Norway have smoke detectors. ICAS AS started production in Norway All production moved to the Czech Republic (55 employees) – only marketing and sales in Norway (five employees) Established agent in Finland Started selling to Sweden – considered as the most important market for ICAS AS Some sporadic sales to Australia Some sporadic sales to South Africa Established subsidiary with one employee in England The markets they will focus on in the future are Germany and England

1991

1993 1997 2000 2001 2003

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IRTech AS – surface inspection systems Year

Important events

1980s

Elkem AS developed a system to detect cracks in the surface of steel First system sold to Germany by direct export System sold to the Czech Republic Systems sold to France, USA and Germany System sold to South Korea Systems sold to England and China Systems sold to South Korea and Japan Systems sold to England, Taiwan, Sweden, Turkey and Germany System sold to USA Systems sold to USA and Australia Last system sold to Italy. Elkem AS considered the market to be saturated and wanted out A licence agreement made with Daido Steel Ltd in Japan IRTech AS was established by Mr Hovland who had been employed in Elkem Technology AS on this system since 1981 – IRTech AS now took on the responsibility to give support to the about 20 systems around the world IRTech AS did some upgrading of a system in England. They changed the old electronics for new One plant has been closed in Australia, one in Sweden, one in South Korea and one in Taiwan Mr Hovland is currently using agents from the time in Elkem in South Korea, Japan and the Czech Republic. To the rest of the world he travels himself. Mr Hovland would like to build and sell new systems, but the firm is currently too small and lacks financial resources

1982/83 1983 1984 1985 1986 1987 1988 1989 1991 1993 1994 1995

1999 2002

Incatel AS – software Year

Important events

1959

The founder of Incatel AS, Mr Vedeld made his first computer program

Siv Marina Karlsen

1961 Early 1980s

1987

1989

1991

1992

1993/94

1997 1999 2001 2002

111

Mr Vedeld started to work for IBM There was a pilot (INKA) in what was then called Televerket – the idea was based on the fact that if you could keep track of accounts by using computers it should be possible to keep track of a telephone network as well A firm called SysScan won a bid from Televerket to deliver a computer solution that should manage the telephone network – the solution was not complete A new company with former employees from SysSan was established, it was called Amis. It was to complete the product development. IBM had entered the scene and was to supply Amis with the Unix platform on which Televerket had demanded INKA to be developed – IBM Europe agreed to funding the product development in exchange for the marketing rights all over the world Amis demanded more funding, which IBM refused – and it thus went bankrupt. The owners of Amis had put money into the project with intellectual property rights as security without IBM’s knowledge – they moved these rights into an American company called Cimage Corp IBM Europe established a new firm called Corena, which was to continue the development Mr Vedeld was employed in Televerket Cimage Corp came up with the best solution – Corena was dissolved Televerket made an agreement to buy the solution of Cimage Corp with IBM Norge as integrator Cimage Corp was closed in Norway, and Incatel AS was established – it is owned by Telenor Venture (40 per cent), IBM Europe (40 per cent), Norpet/Vedeld (10 per cent) and employees (10 per cent) Incatel AS sold their software to Tele Danmark Incatel AS sold their software to Czech Telekom (KPN) Incatel AS sold their software to Belgia Telekom Incatel AS sold their software to the Swedish Telecom, Telia They are currently working on getting a contract with the French and British telecompanies

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Kay Lindegaard Incinerators AS – incinerators Year

Important events

1932

Kay Lindegaard AS (parent company of KLI) was established KL AS started producing incinerators to local waste KL AS started producing incinerators for ships and they thus became international, since many Norwegian shipowners built ships abroad – first foreign sales were to Poland – they followed a customer out Mr Hendriksen (interviewee and CEO of KLI) started to work with this product KL AS found that it was too costly to produce in Norway and moved production to Croatia KLI AS was established and Mr Hendriksen became the CEO KLI AS has agents all over the world KLI AS is considering starting production in South Korea as it is seen as the most important future market, along with the Russian market

1960 1970s

1979 1990s 1999 2002

Nor-Reg Machine AS – packaging machines Year

Important events

1967 1997 1999

Nor-Reg AS was established (parent company) Parent company got agents in Denmark and Sweden Parent company established sales subsidiaries in Sweden, UK and Germany Nor-Reg Machine AS was established. Mr Ingeberg (interviewee) became CEO – they started production in Germany – Germany is seen as a core area in the packaging industry Merged back with parent company – Mr Ingeberg became business developer They aim to only use subsidiaries as foreign operation mode due to bad experience with agents and distributors. The most important future market is seen as the snacks market and the US market

2000

2002

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Norsk Display AS – electronic displays Year

Important events

1994

Mr Wahl establishes Norsk Display AS – they got their first sales this year to the Netherlands – they used direct export, which is the only mode used Norsk Display AS got sales to Denmark and Finland Developed their homepage on the Internet – got sales to Germany Norsk Display AS got sales to the USA Norsk Display AS got sales to Belgium and the UK Norsk Display AS currently has direct export to about eight countries. They see the US and Germany as the most important future markets

1995 1996 1997 1999 2002

Opera Software AS – software Year

Important events

1991

One of the founders, Mr Tezchner started to work for Telenor Research The Opera browser started out as a Telenor project Telenor did not wish to pursue this product and Mr Tezchner and Mr Ivarsøy founded Opera Software AS – they got permission to keep the research The first Opera browser was released on the internet Embraced emerging market of internet devices Opera Software AS teamed up with key players in the internet device market: Ericsson, Nokia, Sony, IBM and Psion Opera Software AS acquires Hern Lab (Sweden) Opera Software AS became part of Symbian (a strategic alliance of leading handset and mobile computing manufacturers: Ericsson, Motorola, Nokia, Panasonic and Psion). They aim for the mobile phone and the digital-TV market

1994 1995

1996 1998 2000

2001

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Optoflow AS – cytometer Year

Important events

1993 1994

Mr Gjelsnes established Optoflow AS Mr Gjelsnes was awarded a Reodor Prize for his invention The product is ready for sale – first sale to Norway A prototype was sold to England – it was an OEM contract (seen as least costly) The firm was sold and changed name to BioDetect BioDetect got a distributor in Japan (has waited with that market because far-away service) Optoflow has sold to 12 countries: Sweden, Denmark, Germany (distributor), England (distributor), Belgium, the Netherlands, France (agent), Italy (agent), Jordan, USA (two agents), Japan (distributor) and Singapore The founder prefers agents – he is disappointed with the performance of distributors

1995 1996/97 2000

Superject AS – seals to rotating shafts Year

Important events

1990 1992

Superject AS was founded Superject AS had its first sales to Sweden by direct export – it is considered the firm’s most important market Superject AS was nearly bankrupt and Mr Stokkan (interviewee) took over. Established contact with the largest distributor in the Nordic countries, Elof Hanson – also got sales to Finland Superject AS entered Denmark by the use of distributor Superject AS entered Germany by the use of distributor Superject AS entered France by the use of distributor They used direct export mode to USA, Italy, Poland Mr Stokkan is awaiting a takeover bid The most important future markets are seen as pulp and paper, and Sweden

1993

1994/95 2000 2001 2001

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5. Some Preliminary Remarks As one can see from the above case-study profiles, the history of a firm sometimes begins long before the firm has been established (e.g., ColorMatic, Fras, IRTech, Incatel, KLI, Nor-Reg and Opera). In many cases, the pre-history of a firm provides very useful knowledge, because the history of the founder and the experience he or she has acquired in previous jobs can be a very important key to understanding the establishment and the further development of the firm. This is also true for cases where the firm is not independent (e.g., ColorMatic, KLI and Nor-Reg), that is, in the case where the firm has a parent company. The history of the parent company has importance for an understanding of the establishment of the firms studied here. A more compact version of the key data for this research is provided in Table 5.1. The reader will note that low commitment modes prevail (i.e., Table 5.1 A summary of the key figures on dimensions that reflect the firm’s pace of internationalization* No. of employees

Founded (export)

International sales (after3 yrs) (%)

Profit 2001 (millions NOK)

Type of FOM most used

No. of market areas 2001

ColorMatic Dolphin Fras

3 10 4

1997(00) 1991(92) 1996(98)

95 (90) 90 (90) 80 (20)

0.53 ⫺21 0.35

4–5 3–4 Worldwide

ICAS Incatel IRTech Kay L

61 65 2 2

1989(93) 1993/4(97) 1995(95) 1999(99)

50 (10) 80 (50) 100 (100) 50 (50)

2.05 ⫺43 1.24 ⫺0.15

Nor-Reg Ndisplay

20 3

2000(01) 1993/4(94)

75 (75) 60 (65)

0.3 0.03

Opera

110

1995(95)

99 (99)

⫺21

Optoflow Superject

10 4

1993(97) 1990(91)

90 (85) 80 (70)

⫺5.53 0.29

Distributors Agents Follow customer out Agents Direct exp. Agents Agents production Subsidiaries Direct export Direct export Agents Distributors

2–3 2–3 4–5 Worldwide 2 2–3 Worldwide 4–5 2

Note: * All the numbers from the interviewees were verified with transcripts from the Brønnøysund Register Centre (a government body under the Norwegian Ministry of Trade and Industry consisting of several different national computerized registers), except for Nor-Reg Machine AS, where only the financial statements of the parent company were found.

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direct export, agents and distributors). The exceptions are firms that have parent companies, i.e., ColorMatic and Nor-Reg Machine prefer to use wholly owned subsidiaries abroad, and KLI is currently considering the establishment of their second production unit abroad. This, too, may be considered to indicate a high commitment (and resource demanding) mode. This research finding is in line with the resource-based argument. Pedersen and Petersen (1998) have argued that high-commitment modes (e.g., subsidiaries) require set-up costs, which may represent a capital investment beyond the financial ability of a small, newly established company. Madsen et al. (2000) also found that born-global firms make extensive use of low-commitment modes. Since entry modes do not vary much in terms of resources committed to the market, the focus here will be on the market selection dimension and export share in the further discussion of the firms’ pace of internationalization.

A discussion of the case firms’ pace of internationalization The firms studied were chosen with the expectation that differences would be found in the pace of internationalization. Finding differences would enable placing these firms in different global categories. According to several studies (Harveston, 2000, Madsen et al., 2000; Junkkari, 2000; Knight, 1997; Knight and Cavusgil, 1996), BGs are defined as SMEs with an export rate of more than 25 per cent within three years of their founding. The author finds this definition to be too broad for the 12 firms in this study. We can imagine, for instance, a Norwegian SME that exports 30 per cent of its products to Sweden and Denmark within three years of its founding. The author would not categorize that imagined firm as one that was born global. In other words, one needs to incorporate the type of market (and how many) an SME must be present in before deciding to label it a BG firm. In addition, most of the very international SMEs usually have a far higher percentage of foreign sales than 25 per cent (e.g., Luostarinen and Gabrielsson, 2001). In this study, a born-global firm is defined as an SME that exports a minimum of 50 per cent of its products within three years of its founding. However, to be defined as a ‘true born global’ (TBG), the SME has to be present in more than one continent simultaneously. To exemplify, a Norwegian SME that exports 80 per cent of its products to European countries would not be termed a TBG. The TBG is found in the upper right corner in Figure 5.1, and the firms that gradually become international ones are found in the lower left corner. The upper left corner categorizes BG firms when considering the market dimension. The lower right corner categorizes BG firms when considering the export dimension.

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No. of areas Seven Fras

Colormatic

Kay Lindegaard

IRTech Opera Optoflow

ICAS

Dolphin

Incatel

Nor-Reg Norsk Display Superject

One Figure 5.1

50%

100%

Different categories for firms undergoing internationalization

The world was divided into seven parts, with increasing psychic distance from the home market (in this case Norway); Scandinavia, Western Europe, Eastern Europe, North America and Australia, Latin America, Asia and the remaining parts of the world (Africa and Arab countries). This division is more or less in accordance with Junkkari (2000, p. 160), who classifies areas from hot (business transactions are close-by, in terms of distance) to cold (far away). The cut-off point on the market dimension for a firm to be termed born global is for the firm to be present in more than three to four market areas.

6. Findings and Discussion ICAS is the least global case and Opera is the most global case on both dimensions (i.e., export share and number of markets). Why is that so? What are the differences between these two firms that might explain their different paces of internationalization? Both ICAS and Opera produce consumer goods, but Opera also has large industrial firms as its customers. In addition, Opera has a large and powerful supporter in Telenor, where the founders previously worked. Telenor supplied Opera with locations and consultants when Opera started up, but Opera has no formal ties to Telenor today. Opera is an independent company. ICAS had no large company to support its establishment. The products of these two firms are also

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very different. Opera’s software has unique features and is very specialized, differentiating it from other similar products. Opera’s software has a very short product life cycle, demanding constant updates. ICAS’s smoke detectors are neither unique nor specialized and they have a long product life cycle. Opera’s product is also special because it can be distributed over the internet. It makes no difference where customers are located, as long as they have access to the internet. This obviously simplifies the process of internationalization. Finally, the founder of ICAS describes the industry’s level of globalization as being low, because products must meet different standards from country to country, while in Opera’s case, the industry’s level of globalization is described as being very high, with no barriers whatsoever and a demand pattern that is described as being a global one. Both founders describe their competition as being very strong, but while Opera has its competitors from a few and very large American companies, such as Microsoft, ICAS’s founder states that its competition is from many small and large companies, especially from China. Another factor that might have influenced the extremely different pace of internationalization may be the characteristics of the founders. Opera’s founder is 35 years old and he has extensive experience living and working abroad, while ICAS’s founder is 57 years old and he has neither lived nor worked abroad, although he has some experience working for international firms. There is some evidence that experience is negatively associated with psychic distance and risk, but this may only partly explain the Opera experience; the mindset of the decision-maker(s) of a firm may also offer interesting insights into the globalization process. The interviewee of Opera made it clear that they intended to become international from the start, the market they operate in is global so to reach key actors in the market they had to go global: ‘the reason we became international is that the customers we are after do not exist in Norway’. A trajectory for five of the case firms undergoing internationalization (e.g., Opera, Icas, Fras, Superject and Incatel) is shown in Figure 5.2. The first year for each firm identifies the year the firm started exporting. The second year indicates how international the case firms are on two dimensions, three years after their founding, except for the two firms that have the most gradual pace of internationalization, ICAS and Incatel. These two firms only started to export after four and three years, respectively. As a consequence, the first year shown in Figure 5.2 shows how international ICAS and Incatel are after four and three years, respectively. The last year shows how international the firms currently are (e.g., 2002). Since each software sold by Incatel amounts to the same percentage of its total turnover, it is easy to calculate the increase in export share on the basis of

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No. of areas 1995

7 6

1998

2002

2002 Opera

5

Fras

4

1999 ICAS

3 2

2002

2002 1998

1

1993

1998 1993

1991

1997

1999

2002

Superj Incatel

2001

0 25%

Figure 5.2

50%

75%

100% Export

Trajectories of five case firms undergoing internationalization

each new contract. Export share is defined as foreign sales as a percentage of total sales. When Incatel got the TeleDenmark contract, in 1997, the export share was 50 per cent. In 1999, Incatel contracted with Czech Telekom, and the export share rose to 65 per cent. In 2001, Incatel contracted with Belgia Telekom, and the export share rose to 75 per cent. The final contract, in 2002, with Swedish Telia, resulted in an export share of 80 per cent. Regarding the market selection dimension, Andersen and Buvik (2002) propose a relationship approach. Their assumption is that the type of customers that a firm aims to have will influence its approach to international market selection (IMS). The firm will either rely upon traditional selection procedures or one that is based upon relationships. The traditional approach assumes that the firm selects a country that consists of ‘faceless’ customers and that the IMS is episodic in nature. The relationship approach, however, assumes that certain markets (e.g., industrial and institutional markets) have relatively few and large customers. This assumption will lead firms that are interested in securing sales to estimate the potential demand more directly, by contacting customers. The relationship approach was confirmed in the present study. Several of the founders stated that they aimed at securing particular customers. They were not concerned about the markets in particular countries. These firms pursued relationships with suitable customers, wherever they were

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to be found, and they did not pay much attention to international borders. Firms selling to consumer markets are, by contrast, more likely to focus upon market potential at country level (ibid.). Another assumption made by Andersen and Buvik (ibid.) is that the choice of foreign market/exchange partner may influence and be influenced by the entry mode. Fras, for example, has a very fast pace of internationalization on the market dimension. Within four years of their first international steps, Fras defined itself as being a firm with worldwide scope. This may be explained by the fact that the one and only foreign operation mode that Fras uses is the ‘follow customers out’ mode, or ‘piggybacking’, which is the more common term. Fras goes wherever their customers go. At one time, they went to China in order to follow Statoil. At another time, they went to France in order to follow Norske Skog. Superject is a firm that is as global as Fras is on the export share dimension, but not as global as Fras is on the market dimension. Superject’s choice of market might be explained by the fact that their main customer and partner is located in Sweden, and is a large trading house. As a consequence, Sweden becomes an important market for Superject, and the Swedish market may be sufficient for Superject’s products. The type of product a firm sells may influence the choice of foreign market/exchange partner. Superject mass produces a standardized product and seems not to have any ambitions for entering new markets in the near future. Superject reports that Sweden is its most important current and future market. Incatel, on the other hand, is constantly forced to find new country markets in order to sell their product, since there are only a few (and in some cases only one) suitable customers in each country (e.g., established telecommunication companies). This understanding is in line with the strategy labelled ‘unique products development’, which Knight and Cavusgil (2004) found to be a frequently used one by BGs in the US. This strategy relies upon the creation of distinctive products and customer loyalty by uniquely meeting a particular customer need. The case firms and how they can be described, on the basis of five different dimensions, will now be discussed, but first a summary (see Table 5.2). In order to compactly view the similarities and differences between case firms, the data material, consisting of detailed answers from each interviewee, has been reduced, and each variable has been given relative values on a continuum, which are summarized above. The experience continuum has values that vary from some experience at the low end, to experienced, in the middle, to very experienced, at the high end. The network variable has been termed ‘relational’. The term indicates whether the founder or

Table 5.2

Key findings

Experience Relational Globality Product Pace of internationalization Experience Relational Globality Product Pace of internationalization

ColorMatic

Dolphin

Fras

ICAS

Incatel

IRTech

Some Not Low S, U, long PLC Very fast

Some Varying Very high S, U, medPLC Fast

Experienced Very Very high S, U, long PLC Fast

Some Very Low Long PLC Slow

Very Very Low S, U, longPLC Slow

Very Very Very high S,U,longPLC Very fast

KLI Some Varying Medium S, long PLC

NorReg Very Not Medium S, U, long PLC

Norsk Display None Varying Medium U, long PLC

Optoflow Experienced Varying High S, U, long PLC

Superject Experienced Varying Very high U, long PLC

Fast

Medium

Medium

Opera Very Very Very high S, U, very short PLC Very fast

Very fast

Medium

Note: S ⫽ specialized; U ⫽ unique.

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another key employee has a network of importance or not, and reflects his/her relational approach. This variable is a continuum from not relational, at the low end, through varying, when the firm occasionally uses a relational approach, suggesting placement in the middle of this continuum, to very relational, at the high end. An industry’s global characteristics are found to vary between low, medium, high and very high, based on the founder’s perceptions of the industry in which he/she does business. When characterizing the product, S means that the product is specialized, U means that the product is unique and the product life cycle is either described as being long, medium or short. The dependent variable, the pace of internationalization, varies on a continuum between slow, medium, fast and very fast. The relative values are assigned based upon the number of countries entered and the export rate measured three years after founding.

Experience/background The behavioural approach emphasizes the need for a sequential process of learning when foreign business activities are undertaken. Our findings show that all of the founders have some international experience, either from working with foreign companies at home or from travelling and visiting partners abroad and/or living abroad for some time, either studying or working. For all parties, a gradual and sequential process of learning has taken place. For some parties, much of the learning has taken place before starting the case firm under study. This finding is supported by Bloodgood et al. (1996), who wrote: ‘since international experience of a firm is confined within individuals, new firms formed by these individuals may be able to capitalise on their experience and expand internationally’ (p. 6). Johanson and Vahlne (1977; 1990) base their classification of market knowledge on Penrose’s (1959) definition of knowledge and experience. Johanson and Vahlne claim that an increase in market commitment follows as experience increases and that this claim is valid at an individual level. The current study, in part, focuses upon the knowledge and experience of key individuals in the firm. Following Johanson and Vahlne (1977; 1990), we support the idea that traditional theories are not as outdated as some claim (Melin, 1992). Bloodgood et al. (1996) argue that a new firm that has specific advantages, including special knowledge and experience of key individual employees, will probably have an accelerated pace of internationalization and a better chance of being successful in its efforts to internationalize. In light of this discourse in the literature, it seems reasonable to expect that a firm’s pace of internationalization will be affected by key employees with international experience.

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Network One surprising finding is that even though the founders state that they have a network of importance and find it rewarding to cultivate the relationships in their network, they might not have a very relational attitude towards other actors in the market, e.g., customers. Mr. Løchsen in Dolphin, for example, describes the general business climate as being ‘largely of a technical nature’. At the personal level, on the other hand, he has a network of importance – and relationships within a network created to foster European research and cooperation is emphasized. The founder of Optoflow, Mr Gjelsnes, describes the firm’s sales as ‘one-shot’ and he believes that there is no reason to build relationships with customers. Mr Gjelsnes further stated that ‘work methodology’ is the most important skill he has attained from life, not relationships. The experience that Mr Gjelsnes attained from previous work and the discovery of the particular methods that work in the business world are, in his opinion, most important for the success of the firm. This is his view in spite of the fact that a very important Swiss connection aided him at start-up. Mr Gjelsnes admits that this man was very important at the time, but he has no contact with him at present: ‘I don’t know if he’s still alive’. In addition, he has important relationships with various research organizations, such as Sintef, the Norwegian Radium Hospital and the Norwegian School of Veterinary Science, which aid him on matters when he has insufficient knowledge and cooperate with him on R&D. This downplayed understanding of the role of relationships in business is a finding that is in keeping with Uzzi’s (1997) perspective. Uzzi pointed out that any assumptions about individuals being either innately self-interested or cooperative are too simplistic. He found that individuals simultaneously act ‘selfishly’ and cooperatively with different actors in their network. The broader network perspective is believed to offer little guidance to those firms whose network horizon is limited to the local market (presumably most SMEs). For such firms, international expansion is problematic and is seen to follow the default hypothesis of psychic distance (Johanson and Vahlne, 1977; 1990). But this assumption is based upon a level of analysis that focuses upon the firm itself. The assumption in this research is that by focusing upon key individuals in the firm we will find that even newly established SMEs may have a network of importance for international expansion. As can be seen from the case firms in this study, even though there are only three subsidiaries out of the 12 cases, eight of the cases have large, well-known companies backing them and of the last four cases, three have strong relationships with at least one important actor. As the founder

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of Superject put it, it is very important for a newly started firm ‘to get associated with something bigger’. ColorMatic is the subsidiary of Thronrud Engineering, KLI is the subsidiary of Kay Lindegaard and Nor-Reg Machine is the subsidiary of Nor-Reg. The large company behind Dolphin was Norsk Data; Veritas supported Fras; Incatel was supported by IBM and Telenor; Elkem supported IRTech; Telenor was behind Opera; ICAS closely cooperates with insurance companies; Optoflow has very close relations to different research institutions; and Superject has a very strong and long-lasting relationship with a large distributor, Elof Hanson in Sweden. The remaining firm, Norsk Display, does not have a large firm backing it, but the founder expresses a wish to have closer relationships with customers. The founder of Norsk Display does have an important relationship to someone he met before starting his firm, who has since helped him to locate customers. This supports the findings of Crick and Jones (2000), who found that several firms were set up by managers with experience from international markets, and most importantly, that these managers had already developed networks and made contacts which could be built upon after setting up their own firms.

Global characteristics An underlying assumption (of the traditional models that explain the transition from a national to a global firm) asserts that firms are well established in the domestic market before venturing abroad (Bell et al., 2001). This assumption is rejected by most of the interviewees in our study, although many of the firms had some sales in the home market before selling abroad. Ten out of 12 interviewees stated that they intended to go abroad from the start. All ten pointed out that the home market is not large enough to establish their firm on its own. Market selection for rapidly globalizing firms is characterized by starting activities in many markets quickly and not always in markets that are geographically close. The product is often developed for a global/international market (Madsen et al., 2000). Bell (1995) explains this phenomenon in the following way: ‘psychic distance has become much less relevant as global communication and transportation infrastructures improve and as markets become increasingly homogeneous’ (p. 62). In other words, founders of rapidly globalizing firms perceive the world as a world that is getting smaller. In addition, it is believed that global firms from small and open economies, such as Norway, globalize because they are pushed (Luostarinen and Gabrielsson, 2001). In such economies the domestic market is often too small to justify start-up and the founders might also fear future competition from global firms in larger countries and these

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factors push these firms to find new markets. If we look at Tables 5.1 and 5.2 above, we see examples of this way of thinking in our study. Fras and Opera, which are very global on the market selection dimension and, in fact, present on all continents, have interviewees that describe their respective industries as being very global. As Mr Jebsen in Opera expressed it, ‘The industry structure is concentrated around a few large actors and there exist no trade barriers whatsoever in this industry. The customers and suppliers are extremely international!’ Both interviewees stated very clearly that they have no country borders, and that they aim at finding customers wherever they can be located in the world. We can thus assume that globalization at industry level is one of the reasons for the change found in export behaviour in small and medium-sized enterprises.

Product characteristics Almost all of the products sold by the case firms have a long or very long product life cycle, and this is true for all categories. This is quite the opposite of what was expected. Only Opera has a short PLC and they describe it as being very short. This particular product characteristic may not be as important in determining the pace of internationalization as was expected. Perhaps other characteristics of the product have more influence on the pace of internationalization. All of the very rapidly internationalizing cases (e.g., Fras, Opera, Optoflow, IRtech and ColorMatic) describe their product as being very unique, ‘one of a kind’ and highly specialized. This finding accords well with Knight and Cavusgil’s (2004) findings, that the most important strategies employed by born-global firms, in their investigation, underscore global technological competence, unique product development, quality focus and leveraging foreign distributor competence. In addition, Bloodgood et al. (1996) found that ventures were significantly more internationalized if they were seeking competitive advantage through product differentiation. This finding is consistent with their reasoning that ventures internationalize earlier on in order to exploit a distinctive competence or feature. Optoflow’s founder stated very clearly that they were careful not to step on the toes of the big actors in the industry. This concern is in line with Caves and Porter (1977) who stated that focus allows the small player to avoid head-to-head competition with larger, broadly based firms that tend to target mass markets. The finding that small firms often follow a niche focus strategy (Moen, 2000) is consistent with Solberg’s (1997) framework, which aims at analyzing the strategic options for small and mediumsized firms competing in international markets. His view implies that small firms operating in markets that are exposed to international competition

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do not have any other choice than to focus their resources on an international niche strategy targeting small customer groups. Christensen (1991) provides a similar description, linked to what he calls ‘the small and medium-sized exporter’s squeeze’ (p. 49), where mainly external factors make it necessary for small and medium-sized firms to start exporting, when they lack internal resources and export competence (Moen, 2000).

7. Conclusions and Suggestions for Further Research Most of the founders who were interviewed in this study have some international experience, either from working and/or studying abroad or from working in an international firm in Norway. The founders of the firms with the slowest pace of internationalization, ICAS and Incatel, have some and very much experience, respectively. This finding may be somewhat surprising. Both of these founders are also described as being very relational, meaning that they both recognize the importance of networks for the development of the firm. The explanation for their slow pace might be found in the two other factors. The global characteristics of the industry are described as being low, for both industries, and the product characteristics are both described as having long PLCs, and in ICAS’s case, the product is a standard one, and easy to sell, even in the home market. In contrast, IRTech’s product is so specialized and designed for such a narrow niche that potential customers in the home market do not even exist. The products of all the most global cases (e.g., Dolphin, IRTech, Opera and Optoflow) are described as being very specialized and very unique. We must assume that technological excellence helps rapidly globalizing firms to develop products that appeal to niche markets around the world. With regard to the relational variable, it seems that all firms have networks or at least a few relations of importance, but there is some variation regarding the degree to which founders are willing to acknowledge their importance. Our findings support the idea that founders should not be described as being relational or not. The founders of Dolphin, KLI, Norsk Display, Optoflow and Superject all vary with regard to whether or not they should be classified as being relational. While some, like the founder of Norsk Display, see the lack of close relations to key actors in the industry as a weakness and wish to improve this area of their performance, others, like the founders of Dolphin and Optoflow, are not very relational towards typical actors in the industry, i.e., customers and suppliers, but they both have very important relations to different research institutions, which they consider vital for the success of their firms. In other words, they are very selective regarding the parties with whom they build relationships.

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When it comes to the globalization variable, almost all firms with a very rapid pace of internationalization, on both dimensions, (e.g., ColorMatic, IRTech, Opera and Optoflow) described the industry as having very high or high global characteristics. The exception is ColorMatic. ColorMatic has a parent company and this relationship may make it easier for the firm to access resources, i.e., capital and human resources. This configuration might explain the firm’s rapid pace of internationalization despite the low global characteristics of the industry. It can be concluded that firms originating from peripheral and small countries may not be at such a disadvantage in the current globalizing environment. Globalization drivers such as improved communication and transportation technology vastly increase these firms’ ability to sell and market their products in foreign markets. Previously there has been a positive correlation between trade and proximity, but today distance is in many cases not seen as an obstacle to internationalization. The findings reveal that a change in policy is warranted by an arm of the Norwegian government. The Norwegian Industrial and Regional Development Fund (now: Innovation Norway) currently requires all new firms to have a foothold in the home market before granting them financial support for export. This requirement unnecessarily complicates matters for most of the firms affected by this ruling. The home market in Norway is too small or non-existent for many industries and there is no economic basis for establishing a large number of firms if they are primarily required to base their incomes on home sales. The markets for many newly established firms are seen as being international and, in many cases, the market is a global one. This reality should be made known to those in the Norwegian government who are responsible for creating the guidelines for fund allocation to SMEs in Norway. This study departs from other studies of firm internationalization where the focus is mainly on the increased resource commitments to foreign markets. The case firms in this study mostly use low-commitment modes for their foreign operations. They either export directly to customers or they engage agents and distributors to manage their foreign operations. This might be explained by the fact that many SMEs simply do not have the resources in place to make the investment necessary for more highcommitment modes. There may be little or no motivation to engage in high-commitment modes, since the niches they aim for are too small to justify the kind of resources needed for internalizing their activities abroad. The entry mode dimension and the possible gradual increase of resource commitment to each market may not provide us with very interesting information. The market selection dimension, on the other hand, seems

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to vary substantially for the different case companies in our study. All but two of the case firms can be categorized as being rapidly globalizing. The market selection dimension and not the entry mode provide us with more interesting information for SMEs that are undergoing internationalization. Further studies should be made to investigate a larger sample of the rapidly globalizing firms. We need to know what factors influence their choice of markets. This knowledge will deepen our understanding of those firms that rapidly undergo internationalization. Performance was not considered in this study. It was assumed that firms internationalize in order to benefit from potential profit opportunities outside of the home market or to resist competitive pressure. The assumption is that factors that influence the firm to internationalize also contribute to its increased profitability. It was assumed that the more international/global a firm is, the better it performs. This assumption may be a bit off the mark. The firms in this study are very young and a follow-up study should be made to study survival rates and how widespread de-internationalization is among the firms in the sample. It has been too short a time since establishment for some of the firms for the positive effects of sustained investments in research to be reflected in operational results. It might also be of interest to compare firms that gradually internationalize to firms that rapidly internationalize, in order to find out which ones perform better. A study of that kind would introduce a normative aspect to the pace of internationalization.

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Luostarinen, R. and Gabrielsson, M. (2001) ‘Born Globals of SMOPECS: What, where, when, why and how?’, paper presented at 27th annual conference of EIBA in Paris. Madsen, T.K. and Servais, P. (1997) ‘The internationalisation of Born Globals: An evolutionary process’, International Business Review, 6(6): 561–83. Madsen, T.K., Rasmussen, E. and Servais, P. (2000) ‘Differences and similarities between Born Globals and other types of exporters’, Advances in International Marketing, 10: 247–65. Makija, M.V., Kim, K. and Williamson, S.D. (1997) ‘Measuring globalisation of industries using a national industry approach: Empirical evidence across five countries and over time’, Journal of International Business Studies, 28(4): 679–711. McGaughey, S., Welch, D. and Welch, L. (1997) ‘Managerial influences and SME internationalisation’, in I. Björkman and M. Forsgren (eds), The Nature of the International Firm, Copenhagen: Copenhagen Business School Press. Melin, L. (1992) ‘Internationalisation as a strategy process’, Strategic Management Journal, 13(2): 99–118. Miesenbock, K.J. (1988) ‘Small business and exporting: A literature review’, International Small Business Journal, 6(2): 42–61. Miles, M.B. and Huberman, M.A. (1994) Qualitative Data Analysis: An Expanded Sourcebook, 2nd edn, Thousand Oaks, CA: Sage. Moen, Ø. (2000) ‘SMEs and international marketing: Investigating the differences in export strategy between firms of different size’, Journal of Global Marketing, 13(4): 7–28. Oviatt, B.M. and McDougall, P.P. (1994) ‘Toward a theory of international new ventures’, Journal of International Business Studies, 25(1): 45–64. Pedersen, T. and Petersen, B. (1998) ‘Explaining gradually increasing resource commitment to a foreign market’, International Business Review, 7(5): 483–501. Penrose, E. (1959) The Theory of the Growth of the Firm, London: Basil Blackwell. Porter, M.E. (1986) ‘Competition in global industries: A conceptual framework’, in M.E. Porter (ed.), Competition in Global Industries, Boston: Harvard Business School Press. Prahalad, C.K. and Doz, Y.L. (1987) The Multinational Mission: Balancing Local Demands and Global Vision, New York: Free Press. Reid, S.D. (1981) ‘The decision-maker and export entry and expansion’, Journal of International Business Studies, 12: 101–12. Reuber, A.R. and Fischer, E.M. (1997) ‘The role of international experience in the internationalisation of smaller firms’, Journal of International Business Studies, 28(4): 807–25. Solberg, C.A. (1988) ‘Successful and unsuccessful exporters: An empirical study of 114 Norwegian export companies’, Working Paper no. 27, BI Norwegian School of Management. ——— (1997) ‘A framework for analysis of strategy development in globalising markets’, Journal of International Marketing, 5(1): 9–30. Uzzi, B. (1997) ‘Social structure and competition in interfirm networks: The paradox of embeddedness’, Administrative Science Quarterly, 42: 35–67. Yip, G.S. (1992) Total Global Strategy: Managing for Worldwide Competitive Advantage, Englewood Cliffs: Prentice-Hall. Yin, R.K. (1989) Case Study Research – Design and Methods, London: Sage.

6 Public Policy, FDI Attraction and Multinational Subsidiary Evolution: The Contrasting Cases of Ireland and Portugal Ana Teresa Tavares-Lehmann

1. Introduction Nowadays most host countries, developed and developing alike, engage in an ever-increasing ‘race’ to attract FDI and MNEs’ activities (Ghauri and Oxelheim, 2003). FDI attraction is one of the main ways by which governments seek to stimulate fast-track economic growth, under the assumption that the positive spillovers from FDI outweigh possible negative effects. This generalized, unprecedented chase for MNE operations is evident in the number of pro-FDI policy measures successively implemented (UNCTAD, 2004) and in the increasing proactivity and targeting of FDI-related policies. Countries (and even subnational jurisdictions) scramble to attract projects and to boost their attractiveness by granting higher incentives than their locational competitors. By and large, relevant research has serious doubts on the long-term effectiveness of such incentives (Young, 2004). Traditionally, and still happening in a variety of host economies, public policy towards MNEs has been focused on mere attraction of inward flows (Pearce, 2001; Young and Hood, 1994), usually neglecting issues like the quality and sustainability of such investments. More often than not, an approach emphasizing home country, sector, or parent MNE is used. Such approach can be misleading and counter-productive, for it says little about the specific nature and potential of the project/operation in question. Here, it is argued that a finer level of analysis is needed to inform adequate policy-making. The adopted perspective focuses on the subsidiary for, just as subsidiaries have distinct scope and agendas, they may have differentiated impacts in their host economies (Young et al., 1994). After outlining the conceptual background supporting this investigation, the cases of Ireland and Portugal will be analyzed, first characterizing 131

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their policy approaches vis-à-vis MNEs and FDI, and then providing empirical evidence on MNEs’ operations in the two host economies. The chapter draws on a recent survey of foreign subsidiaries operating in these countries, two small open economies that seem textbook case studies of the impact of economic integration on a host country (Barry and Bradley, 1997; Tavares and Pearce, 2001). Results will be provided regarding, among other aspects, motivations underlying investment, the strategic evolution experienced by subsidiaries, their value-added scope and level of local linkages. Further considerations will be made on FDI-related and other policies, and on the ability of each of these host countries to withstand the competitive challenges ahead.

2. Conceptual Background MNE networks, subsidiary strategy and subsidiary evolution This chapter departs from the view of the modern multinational as a ‘dynamic differentiated network’ (Forsgren and Johanson, 1992), or a system including a heterogeneous group of subsidiaries with distinct scopes and roles/functions. This is one of the fastest-growing streams in the MNE literature (Birkinshaw, 1997, 2000; Pearce, 2001; Taggart, 1996; White and Poynter, 1984; Young et al., 1988), as it is more realistic in depicting the internal complexity in MNEs, simultaneously permitting a more accurate expectation of their impact and consequently a more grounded basis to appropriate and tailored policy-making. The chapter adopts this perspective, drawing on a version of the ‘scope typology’ of subsidiary roles (Hood and Young, 1988; Pearce, 2001; Pearce and Papanastassiou, 1997; Taggart, 1996; Tavares, 2001; White and Poynter, 1984), which envisages various evolutionary paths and restructuring processes, seen as interdependent with key changes in the global competitive environment. The three subsidiary types considered are characterized by three dimensions: market, product and value-added scope (as in White and Poynter, 1984). An autarkic subsidiary supplies exclusively the host country. It is a marketseeking subsidiary type, having a wide product scope and a narrow market scope. Value-added scope is limited. A rationalized subsidiary produces part of the firm’s goods or specializes in a productive stage (narrow product scope), for export markets (wide market scope), having a quite limited value-added scope (usually less than its autarkic counterpart). Finally, a product mandate subsidiary is characterized by narrow product scope, wide market scope (regional/global markets), having the resources and mandate to develop, produce and market the product(s) for which it is responsible.

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The mandate represents the most promising subsidiary type from a host country standpoint, given its high value-added activities and considerable autonomy and resources. These ‘creative subsidiaries’ (Pearce, 1999) tend to play a critical role in the overall MNE’s competitiveness (Bartlett and Ghoshal, 1989; Hedlund, 1986). Subsidiaries’ strategies are not considered in a static perspective; that would impede unveiling their dynamic development impact in their host economies. The concept of subsidiary evolution is instrumental for this purpose. Birkinshaw and Hood (1998, p. 773) define subsidiary evolution as ‘the process of accumulation or depletion of resources/capabilities in the subsidiary over time’. As implied by this notion, the scenario facing the subsidiary may be bright or bleak, depending on the interaction of three main drivers, of varying importance during the evolution process: the parent firm, the subsidiary itself and the host country environment. We suggest that the latter should be extended to encompass the supra-national competitive environment (the EU, in this case), and all relevant institutions at overlapping levels impacting on subsidiaries’ activities (Tavares, 2001). Thus, the internal and external embeddedness of subsidiaries (Andersson, 1997), as well as subsidiary initiative (Birkinshaw, 1997) are critical issues for subsidiaries’ evolutionary prospects.

Likely paths in subsidiary evolution Without integration in a larger economic space (e.g, EU membership), small economies like Ireland or Portugal would either represent too small a market to invest in or, if a certain MNE would choose to operate there, would do so through a multidomestic strategy (Porter, 1986), relying on autarkic subsidiaries, an approach not permitting specialization and taking advantage of economies of scale. Economic integration renders this approach inefficient, and two scenarios are most likely to occur: the MNE would either divest tout court from that small market or keep a presence but changing its strategic role and consequently the nature of its operations. Thus, if an MNE has an autarkic subsidiary in a country that becomes part of an economically integrated scheme there is evidence (e.g., from Canada (Crookell, 1986; Crookell and Caliendo, 1980) and from the UK (Hood and Young, 1988; Pearce, 2001; Taggart, 1996) that entry into a wider competitive environment is translated usually in a move to rationalized status. Despite some positive effects on the host economy (like on employment and exports), the dynamic, long-term competitive benefits implied tend to be fairly limited both for the subsidiary and for the host country, as a rationalized subsidiary is highly dependent on the parent’s orders and hence deprived of autonomy and functional scope. In this vein, the transition

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to more responsible and creative roles (product mandates) can yield a greater contribution for the host country, being a priori the most desirable evolutionary path (Pearce, 2001). This is a relevant element to incorporate in inward investment policy design, as policy-makers can try to incentivate higher value-added activities, including assisting existing subsidiaries to upgrade their standing in the MNE group (Birkinshaw, 2000).

3. Multinationals and Policy Approaches in Ireland and in Portugal Some key trends Although the purpose of the present analysis is mainly to characterize aspects related to the quality of inward investment (subsidiary strategies, their functional scope and their evolution over time), and not to focus on the magnitude of FDI attracted to the two economies, the differentiated performance in FDI attraction has to be acknowledged. Figure 6.1 synthesizes the evolution experienced in both economies in this regard: Ireland fared immensely better in the 1990s and in the early 2000s than Portugal, in quantitative terms. 30,000

25,000

Million US $

20,000

15,000

10,000

5,000

19 9 19 0 9 19 1 9 19 2 9 19 3 9 19 4 9 19 5 9 19 6 9 19 7 9 19 8 9 20 9 0 20 0 0 20 1 0 20 2 03

0

Figure 6.1

FDI inflows to Ireland and Portugal 1990–2003

Source: OECD, 2004.

Ireland Portugal

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The evolution of net inward flows in Ireland since 2000 is truly remarkable by any standard: after the ‘FDI bubble’ in 2000, these were years of strong contraction in FDI flows worldwide (in developed countries in particular, including the EU). In 2003, the available statistics (OECD, 2004; UNCTAD, 2004) show that Ireland attracted 25,497 million US$ of net FDI inflows, more than 25 times the corresponding figure for Portugal. Just to put that in perspective, the two main traditional FDI host economies, the US and the UK, received respectively 29,772 million US$ and 14,515 million US$ in 2003 (the latter is noteworthy – it was the first year when Ireland surpassed the UK as a FDI destination). The 1990s were also a period of outstanding economic growth in Ireland (the Celtic Tiger era [Barry, 2004]), leading to an extremely fast convergence with the EU. In 2003, Irish GDP per capita represented 133.4 per cent of EU-15 average, whereas the corresponding figure for Portugal was 74.9 per cent. Hence, the two economies fared quite differently, both in macro-economic terms, and regarding FDI attraction.

Policy approaches in Ireland Two phases regarding public policy towards MNEs can be distinguished, since Irish independence in the early 1920s. After a protectionist, marked anti-FDI approach (1930s-late 50s) consisting in outright prohibition of foreign ownership (Control of Manufactures Act), Ireland was a precursor of a pro-FDI stance in the late 1950s. Since then, MNEs’ attraction (especially targeting US companies) became the mainstay of Irish industrial policy (O’Gráda and O’Rourke, 1995). Zero profit taxes for exporters were the key incentive, originating a striking boom in export-oriented operations. In 1982, this measure (incompatible with the Treaty of Rome) was replaced by a flat rate of 10 per cent in all manufacturing, accompanied by generous discretionary financial incentives. Under the aegis of the Industrial Development Authority (IDA), a proactive ‘hands-on’ policy was adopted, focused on attracting high-tech FDI, mainly in electronics and pharmaceutical products (Ruane, 2001a). Presently, corporate tax in Ireland is 12.5 per cent, remaining among the lowest in the EU. Ireland is commonly regarded as a success story in terms of inward investment policy. Due to its proactive stance, the IDA gained an international reputation, mainly for emphasizing policy independence, continuity and consistency, helping to build a stable framework on which to take decisions (ibid.). Grant concession was tied to well-defined objectives (employment, R&D), and repayment was required in case of failure of compliance by the MNE. Policy implementation (a key determinant of

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policy impact) occurred always on a project/company basis. Explicit sectoral targeting constituted a defining feature of Irish policy. As a result of this success in FDI attraction, and on the relative weakness of the local industrial fabric, Irish industry is considerably dependent on MNEs’ activities, which account for about two-thirds of manufacturing output and half of manufacturing employment (Barry et al., 1999). MNEs also have a growing importance in the services sector, as FDI in internationally tradable services was proactively (and successfully) targeted in the 1990s. Over 90 per cent of Irish subsidiaries’ output is exported (Barry, 2004). FDI had a tangible impact in Irish industry, as it motivated a sectoral and regional shift in its structure. MNEs were not attracted to sectors where Ireland was traditionally advantaged (Barry and Bradley, 1997), but to high tech industries. Barry (2004) emphasizes that the industrial targeting practices of the IDA had an effect on the country’s factor endowments, and thus on its comparative advantage, as well as other measures implemented by the Irish government, such as a focus on science graduates with qualifications in electronics, and improving telecoms infrastructure. Ireland’s success in FDI attraction can be attributed to a variety of determinants, including economic and institutional factors. Location advantages like institutional credibility (reputed development agencies), sizable incentives, favourable costs and non-financial factors (technically skilled, English-speaking workforce, entrepreneurial local managers) played a role, in a largely supply-side phenomenon, reflecting the Irish effort in upgrading its productive factors. Obviously, a crucial aspect to boost Irish attractiveness was a clear commitment to free trade, firstly with the Anglo-Irish Free Trade Area Agreement (1966), and even more with EC entry in 1973. From the beginning, Ireland promoted itself as a basis to produce ‘weightless components’ (Ruane, 2001b), for export mainly to EU markets. Market access, generous Structural Funds and prospects opened with the Single Market were critical to promote Irish ability to woo investors in the areas targeted. But without the consistency and credibility of Irish institutions and policies, and accompanying indirect policies and measures (‘policy chain’ [ibid.]), results would not probably have been the same. One cannot also forget other ‘indirect’ (including macro-) policies that improved the investment climate in Ireland, such as rigorous stabilization measures undertaken in the late 1980s, labour market and educationrelated policies, including sizable investment in human capital and in developing credible research/scientific institutions, infrastructure programmes and promoting a ‘social partnership’ approach to wage determination (Barry, 2004).

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However, although Irish policy was undoubtedly a success in attracting new investment, more recently (and as a consequence of past neglect) other issues gained prominence, namely the embeddedness of MNEs’ subsidiaries in the local economy. It is now commonly accepted that MNEs, through (for instance) the creation of linkages with indigenous suppliers, can have a positive impact on the development of indigenous firms in the host economy (Markusen and Venables, 1999). Görg and Strobl (2002) have shown that such positive effects have taken place in Ireland, as they found a positive effect of MNEs on the entry of indigenous firms. However, the level of local linkages is still low, leading to concerns about over-reliance on the foreign sector due to ‘footlooseness’ of MNEs’ operations. In order to correct this overemphasis on FDI attraction per se, and promoting the development of the domestic sector, the National Linkage Programme was established in 1985 under the auspices of the IDA (but managed independently, which gave the programme more credibility in the industry [Ruane, 2001b]). This initiative also responded to criticism of potential crowding-out of domestic companies, a claim dismissed by Barry et al. (1999) by showing that foreign and domestic firms compete in distinct markets and that the former increased their linkages and R&D expenditure over time. Moreover, by assisting the economy to ‘climb the ladder of comparative advantage’, MNEs’ presence has reduced adjustment costs associated with the eventual absence or decline of FDI. It is clear that Irish policy has increasingly emphasized the importance of linkages with local companies (LCs). Assistance to LCs was provided through various programmes in order to build their capacity (in terms of scale) and capabilities (managerial, technological), in order to increase LCs’ absorptive capacity (Cohen and Levinthal, 1990). In the 1990s, a specific Linkage Division was created within the IDA, as well as an Electronics Linkage Team (Ruane, 2001b), recognizing the importance and potential of the electronics sector to generate linkages. Linkage policy in Ireland has successively intensified and was carefully accompanied and monitored. From 1998, a new approach was implemented, the International Business Linkages Division, recognizing the fact that, with globalization, linkages are more often international than confined to national spaces. In this vein, Irish authorities try to assist the globalization of local sub-supply industry, including their outward internationalization, having a more dynamic and systemic view about the process and adopting a new, potentially more prescient, interpretation of the concept of linkages. Very few countries at the moment implement capable linkages policies (there are efforts in countries like the Czech Republic and Hungary, largely inspired by the Irish case, but such policies are still rare), and seldom include an explicit

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and well-organized outward internationalization component in parallel with promoting domestic linkages and maximizing the contribution of inward investment.

Policy approaches in Portugal Portugal’s approach vis-à-vis MNEs and FDI was markedly in contrast with that of Ireland. The following phases can be discerned. The 1940s-50s were an inward-looking, nationalistic period. Manufacturing investment control was implemented, and the number of sectors where FDI was allowed was very limited. The few MNEs present in the country were involved in the exploitation of natural resources and in the supply of the domestic market. Portugal started opening up its economy in 1960, when it was an EFTA founder. The number of industries open to FDI increased, and new legislation passed in 1965 reinforced the guarantees offered to foreign investors. In the 1960s, even if the amount of FDI in Portugal was quite modest in absolute terms, FDI flows were ten to 20 times greater than in the former decade (Castro, 2000). Inward investment was mainly from EFTA countries, and usually in labour-intensive industries such as clothing and footwear (given the relatively cheap and skilled workforce available in those sectors). However, inward investment permitted new export-oriented industrial segments to take off (electrical equipment, pulp, chemicals), which had considerable impact in the future productive structure of the economy (Simões, 1985). By and large, however, these investments were concentrated in low-tech segments (Simões, 1992; Tavares, 2001). FDI declined in the revolutionary period of 1974–5, where nationalization of firms occurred. The first steps towards creating a legal and institutional framework for FDI appeared in 1976, with the promulgation of the first Foreign Investment Code, accompanied by the creation of the Foreign Investment Institute in 1977. An improvement in FDI climate since 1978 and a welcoming stance motivated several MNEs to invest. Even if these steps were favourable factors in developing a welcoming stance towards FDI, there was not an explicit, proactive and organized inward investment policy with considerable commitment from Portuguese authorities. The real tour de force in FDI attraction occurred in 1986, when Portugal formalized its EC accession. Membership of a large economically integrated space represented a major attraction pull. A close look at (net) FDI patterns shows a boom in FDI inflows in the period 1986–91 (with a contraction in 1986 justified by a ‘wait-and-see’ period [Simões, 1992]). Although other factors may have been at work, it is inevitable to consider that EC accession, aided by strategic movements induced by Single Market prospects, represented a key determinant of

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this ‘boom’. Nonetheless, and as any boom, it was shortlived, as after 1991 FDI declined and divestment increased considerably. This declining trend (which affected the first half of the 1990s very evidently) caused concerns about short-termist, footloose and opportunistic investments, made to take advantage of sizable subsidies available. Considerable resources were allocated in the context of PEDIP (Specific Programme for the Development of the Portuguese Industry, 1988–92) and PEDIP II (1994–9), contemplating measures like direct subsidies for industrial investment, for the creation of technological agencies and to incentivate training of the workforce. The declining trend in FDI flows inverted in 1996–8, when FDI retook its ascending path, to slump just after, in 1999, attaining levels as low as before EU accession. In 2000, though, FDI flows increased considerably (following worldwide trends), and in 2001 these flows were also high, despite the very severe fall in FDI worldwide in that year. The highest net inward flows ever occurred in 2000 and 2001. However, in 2002 and 2003 net inward flows decreased significantly. In all, these trends point to a very erratic evolution; that is due to a variety of factors, including world- and EU-wide economic downturn in the early 2000s, but one cannot escape noticing the dubious success in FDI attraction, if judged by net inward flows. Another issue is that net flows into Portugal lately reflect simultaneously two realities: generally speaking, gross inward FDI has been at increasing levels, but divestment is nearly as high. For instance, in 2002 and 2003, gross inflows surpassed 22,000 and 21,000 million euro, but divestment in each of these years was more than 20,000 million euro. That shows, indeed, that Portugal attracts a sizable amount of FDI, but loses almost as much, leading one to think that Portugal’s traditional location advantages (Dunning, 1977) are eroding, and possibly new ones are appearing (case evidence shows that, indeed, newer investments are more valueadded than former ones). However, on balance the result is that Portugal is not sustaining a considerable amount of FDI, and has difficulty in maintaining investment. Moreover, the vast majority of both inward and outward flows are in items such as real estate, which is not really ‘productive investment’, and undermines well-grounded conclusions. Nevertheless, in the early 2000s, mirroring the worldwide trend, the interest in FDI promotion increased, leading to the creation of API (Portuguese Investment Agency), that replaced ICEP (institution in charge of inward investment, since the 1980s). This corresponded to a more proactive stance vis-à-vis FDI (and domestic large investments, as API promotes both), never before seen in the country, with a sizable budget allocated to FDI promotion and greater autonomy from the government. A new law (Contractual Regime) was passed, making the investment process

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more agile (as API negotiates each contract and takes decisions on a project basis), at the same time increasing discretionarity over projects’ evaluation and incentives provided. API grants sizable incentives to projects it sees as having merit, mainly funded by the EU through the ERDF (physical investments) and ESF (training, R&D), and also Portuguese funds (all integrated in a support programme for the economy called PRIME). Overall, Portuguese policy has evolved towards a more proactive and discriminatory stance, and towards a stronger attention to intangible dimensions of competitiveness. Still, the institutional framework is not conducive to maximizing the potential benefits of existing investments. For instance, there is not a linkages policy, and a minimally satisfactory inter-institutional cooperation between the inward investment agency, the institution supporting SMEs and the foreign trade authority (all under the aegis of the same Ministry). Hence, a systems view like the one perceived in Ireland is non-existent. Macro-policies also lack the consistency that would be desirable. Successive Governments often make tabula rasa of measures undertaken by their predecessors, and accountability is very incipient. For instance, corporate tax was lowered to 25 per cent in 2004, and announced to be 20 per cent in 2006, but the government (from the same party) has held back that promise. Moreover, Portugal has a further drawback in terms of educational attainment and training of the workforce (Crespo et al., 2004). Public policy after EU accession, despite positive evolution in such areas, largely emphasized physical infrastructure rather than ‘soft’ factors like education and the science and innovation system. There were measures regarding that, but not to a scale that made significant difference, and changed the view that prevails about the country as a low-tech location. Even if the quality of the public education system is often high, and even if there are niches with a very attractive supply of graduates and engineers, for instance, the overall statistics cannot hide very unfavourable indicators when comparing educational attainment, science indicators and related aspects. The policies undertaken at present do not emphasize an explicit commitment to make Portugal catch up in these areas. In terms of MNEs’ impact in Portugal, and in a general evaluation, Farinha and Mata (1996) considered the effect to be clearly positive, conducive to raising productivity (a result corroborated by Flôres et al., 2000), adding to productive capacity and output levels, and also performing a disciplinary role on local competitors (they found that domestic firms in sectors with considerable foreign presence are more productive due to competition with MNEs). Nonetheless, they note that MNE subsidiaries are not more likely to undertake R&D than domestic firms, which also

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occurs because foreign presence in the industry tends to induce local firms to undertake R&D in order to remain competitive. Simões (1985) also considered that FDI had a positive contribution to the restructuring of the Portuguese industrial system, as foreign subsidiaries are more productive and more oriented towards high-technology/skill-demanding industries than their domestic counterparts. However, he also noted the existence of ‘enclave’-type operations with mere export-platform characteristics and few spillover and interaction potentials. Concerning technology transfer, the same author argues that foreign firms have in general played a positive role as a vehicle for technology inflow, but it could have been much better. In his opinion, not only foreign investors are to blame about this situation, but also inadequate government policies and weakness of the local industrial fabric.

4. Empirical Evidence on MNE Activities in Portugal and Ireland Data This evidence is based on a survey of 619 foreign subsidiaries operating in Ireland and in Portugal. These two countries were selected because they represent, as noted before, relevant case studies of the impact of economic integration on small open European economies. However, they entered the EC in different periods (Ireland in 1973 and Portugal in 1986). This fact is supposed to have important consequences, especially in terms of subsidiary evolution opportunities, which will be debated at a later stage in the chapter. However, it was decided to establish 1986 as a common benchmark for most of the questions posed to firms regarding the impact of EU integration. This is justified by two major reasons: first, 1986 represents a key landmark both in terms of deepening and widening of EU integration. On the one hand, it is the year immediately after the announcement of the Single Market Programme in the ‘White Paper’ (when the expectations of economic agents regarding the Single Market were gaining shape), and on the other, it corresponds to the Southern Enlargement (accession of Portugal and Spain). Moreover, it would be unrealistic, at the date of administration of the survey (1999–2000) to enquire about events pre-1973 in the Irish case. Part of the variation in the tables presented is attributed to the distinct dates of EC entry. One hundred and sixty-seven replies to the survey were received (27 per cent response rate), yet it was decided not to consider 26 of them, due to incompleteness. Only manufacturing subsidiaries of firms with global

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operations, and an explicitly articulated European strategy, were included in the sample. The chapter uses data from complete surveys from 95 firms in Portugal and 46 in Ireland. The majority of firms in the Portuguese sample were set up after 1986 (60 per cent), and only 5.6 per cent of respondents invested before EFTA accession. In the Irish case, only two firms (14 per cent) existed pre-1959 (‘opening’ year in terms of Irish policy vis-à-vis MNEs), and 84.4 per cent were founded after EU entry. These pervasive trends seem to support the importance of EU membership. In terms of nationality of the parent, a quite distinct situation emerges. If in Portugal EU MNEs are the majority (63 per cent), in Ireland the main investors are US firms (54 per cent). This intra-EU dominance in FDI in Portugal is associated to the timing of most of these investments, mainly after 1986, when intra-EU FDI grew considerably (Molle and Morsink, 1991). The most common sectors in the Portuguese sample were automobiles and auto components, chemicals and plastics, electrical and electronics, and textiles, clothing and footwear. The sectoral distribution in Ireland was considerably distinct, reflecting a high-tech bias (35 per cent and 22 per cent of the firms were, respectively, in pharmaceuticals and healthcare and in electrical and electronics).

Reasons to invest in Ireland and in Portugal When asked about their perception of the relative importance of the motivations underlying their investment, respondents emphasized the patterns that may be observed in Table 6.1 below. For Portugal, relatively lower input costs were the main motivation for most respondents. After that, the most frequently mentioned motivations were defence of market share and to improve competitiveness in the local market and in other EU countries. The importance of both efficiencyseeking and market-seeking motivations (encompassing the extended market-seeking hypothesis, in which the relevant market is the EU) has been corroborated by recent work on locational determinants of FDI in Portugal (Buckley and Castro, 1998). The level of qualification of the Portuguese workforce in the MNE’s sector was often considered relevant. Incentives were considered to be moderately relevant in explaining the establishment of the subsidiaries surveyed. Availability of local scientific competencies was unimportant overall, and the availability of natural resources was deemed the least important factor. Irish respondents emphasized a distinct hierarchy of motivations. Incentives given by Irish authorities were considered their main reason to invest (hardly surprising given the aggressive policy stance alluded to

Ana Teresa Tavares-Lehmann Table 6.1 Ireland

143

Relative importance of motivations for investment in Portugal and

Motivation (average response*)

Portugal Ireland

A

B

C (1)

C (2)

D

E

F

G

H

I

1.29 1.28

2.13 1.43

1.75 2.59

2.12 2.47

2.78 2.43

2.00 2.76

1.44 1.91

1.69 1.46

1.91 2.91

2.18 1.86

Note: *Respondents were asked to evaluate each motivation as (1) the only motivation, (2) major motivation, (3) minor motivation, (4) not a motivation. The average response was calculated by allocating ‘only motivation’ a value of 4, ‘major motivation’ a value of 3, ‘minor/supplementary motivation’ a value of 2 and finally ‘not a motivation’ a coefficient of 1. Motivations to establish a subsidiary: A - availability of natural resources; B - as best way to competitively access the domestic market; C - to improve our competitiveness in relevant markets outside the host country market: C(1) - Immediate neighbouring country; C(2) - Other EU; D - comparative low input costs; E - level of qualification/distinctiveness of skills of the local workforce in our particular sector of activity; F - availability of local scientific inputs; G - the existence of a local cluster of firms working on similar or complementary activity; H - the incentives we were given by the local authorities to set up this subsidiary in the country; I - to defend market share against competitors. Source: Survey of Portuguese and Irish subsidiaries.

above). The second major determinant was the level of qualification and distinctiveness of skills of the Irish workforce in their sector (consistent with a focus on the attraction of high-tech sectors, and the ensuing investments in human capital). The third main motivation was the improvement of competitiveness in the UK market, followed closely by improvement in EU competitiveness, reinforcing the relevance of free trade for such a small open economy. All non-European subsidiaries perceived this motive as relevant. Comparative low input costs were often mentioned, even though rather behind the qualification of the workforce (contrasting with the Portuguese case). The unimportance of the local market was evident, also in dissonance with the Portuguese outcomes.

Subsidiaries strategies and subsidiary evolution in Ireland and in Portugal The actual strategies of the subsidiaries surveyed constituted a crucial element of this study (Table 6.2). Based on the typology above, respondents were asked to situate their operations according to the importance of such roles. Three moments were chosen, emphasizing the dynamic nature

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Table 6.2

Evaluation of the importance of distinct subsidiary roles/strategies Roles of subsidiaries (average response*) A

B

C

Before Now 10 years’ Before Now 10 years’ Before Now 10 years’ 1986 time 1986 time 1986 time Portugal 2.10 Ireland 1.51

1.73 1.14

1.64 1.14

2.55 2.91

2.85 2.95

2.83 2.83

1.39 1.54

1.7 2.00

42.03 2.25

Notes: *Respondents were asked to evaluate each role/strategy as (1) our only role/strategy, (2) our main role/strategy, (3) a secondary role/strategy and (4) not a part of our role/ strategy. The average response (AR) was calculated by allocating ‘only role’ a value of 4, ‘main role’ a value of 3, ‘secondary role’ a value of 2 and, finally, ‘not apart of our role’ a coefficient of 1. Roles (or strategies) of subsidiaries: A - Autarkic subsidiary - the subsidiary produces some of the parent’s already existing product lines (or related product lines) for the domestic market; B - Rationalized subsidiary - the subsidiary produces a certain set of component parts or existing final products for a multicountry or global market; C - Product mandate - the subsidiary has autonomy and creative resources to develop, produce and market a restricted product range (totally innovative products) for multicountry (regional or global) markets. Source: Survey of Portuguese and Irish subsidiaries.

of subsidiaries’ activities and allowing explicitly for subsidiary development. Respondents were asked about their activities pre-1986, now (1999–2000, date of survey administration) and in the future (in ten years). The latter data ought to be analyzed with caution as they represent expectations. Nevertheless, they point to some interesting trends. For Portugal, a decline of autarkic subsidiaries is particularly noticeable. Rationalized subsidiaries, the most common role, became even more prominent after accession, and this importance is expected to stabilize in the next decade. The product mandate strategy, until now the least frequent (modest growth 1986–99), is expected to gain more significance in the future. This evolution supports our claim that economic integration de facto impacts on MNEs’ corporate integration. The more recent accession of Portugal to the EU may help to account for the fact that few mandates exist, and in particular that few rationalized subsidiaries had time to gain positive functional scope enabling them to bid for mandate responsibilities. For Irish subsidiaries, the most common role has been consistently the rationalized subsidiary, without significant change over the period of time analyzed. This aspect can be also attributed to the fact that most of the change may have occurred immediately following EU accession.

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The second main role, the product mandate, is clearly that showing more tendency to increase in relevance, which is consistent with the effort of the IDA in attracting ‘quality’ projects, and with positive qualitative moves undertaken by former rationalized operations. Given local market exiguity, the autarkic subsidiary role is the least pervasive, and its relevance declined substantially between the period prior to 1986 and now. Most subsidiaries (77.8 per cent) were set up after EC accession (in a free trade environment this role loses its raison d´être). In sum, Irish subsidiaries tend to have higher value-added and, because of more mandate subsidiaries, seem more promising. However, rationalized operations, normally regarded as ‘footloose’, are the most frequent. In fact, further evidence shows considerable export intensity in both countries, testifying in favour of the dominance of rationalization processes. The earlier opening of the Irish economy to free trade enabled MNE subsidiaries located there to be at a more advanced stage of subsidiary development than their Portuguese counterparts.

Discrepancies in functional/value-added scope Functional scope is the crucial distinction between rationalized subsidiaries and mandates, thus influencing the quality of possible subsidiary strategic transitions. This dimension is here proxied by the degree of decision-making autonomy and by the type of technological activities performed by subsidiaries. Table 6.3 presents the results on decision-making autonomy. It can be concluded that the situation in both countries differs, especially in dynamic terms. Most frequently, decisions are taken by the parent after consulting the subsidiary. The Irish case (which, pre-1986, departed from a lower basis) has throughout the period a marked increase in all criteria, especially technology. This is consistent with a marked increase in mandates and with the Irish focus on attraction of high-tech subsidiaries with R&D laboratories. It may be also related to the fact that in Ireland 75 per cent of subsidiaries’ top managers are local, and tend to be quite proactive in competing for increased scope in the group (for Portugal the corresponding figure is 51.8 per cent). The role of earlier EU accession and the ensuing scope for subsidiary-strategic change is also a factor to take into account when explaining this higher level of technological autonomy. The decisionmaking autonomy of Portuguese affiliates tends to be either stagnant or slightly increasing, reflecting a less proactive approach both by policymakers and subsidiary staff (for another study on decision-making autonomy in Portuguese subsidiaries, see Simões et al., 2002).

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Table 6.3

Degree of decision-making autonomy of subsidiary* Portugal

Market area supplied Product range supplied Broad strategic direction Technology used

Ireland

Before 1986

Now

10 years’ time

Before 1986

Now

10 years’ time

2.22 2.14 2.07 2.18

2.22 2.23 2.19 2.31

2.24 2.28 2.32 2.41

1.59 1.71 1.62 1.82

2.11 2.24 2.29 2.60

2.36 2.38 2.49 2.76

* Mean values for firms in sample. Notes: In order to calculate the respective means, the following values apply: 1) Decisions taken mainly by parent/regional HQ without consulting with/seeking advice from subsidiary; 2) Decisions taken mainly by parent/regional HQ after consulting with/seeking advice from subsidiary; 3) Decisions taken mainly by subsidiary after consulting with/seeking advice from parent/regional HQ; 4) Decisions taken mainly by subsidiary without consulting with/seeking advice from parent/regional HQ.

Related to this observation, another relevant difference emerging from the survey concerned the fact that top management in Irish subsidiaries was, in 75 per cent of the cases, from the host country. In Portugal, about half of the MNEs do not trust the leadership of their subsidiary to a local, which may harm the entrepreneurial drive of the Portuguese operation. The proactivity of subsidiaries’ top managers is a driver of subsidiary evolution (Birkinshaw and Hood, 1998; Young et al., 1994). The high incidence of national citizens in key managerial posts in the Irish case has been noted in Amin and Thrift (1994). Managers in Irish subsidiaries more often hold positions in the MNE at EU/global levels than their counterparts in Portugal. Concerning technology, the situation in Portugal is far worse than in Ireland, also reflecting different emphases and proactivity in stimulating technological development. The majority of Portuguese respondents (67.4 per cent) admit that R&D capabilities simply do not exist. However, adaptation of products to the local market is a common activity (57.8 per cent), as well as adaptation of manufacturing processes (73.3 per cent now, from 53.5 per cent before 1986). In terms of development of new and improved products for national/EU markets, this figure went from 27.9–44.4 per cent. The ability to develop products for world markets is far more limited (14 per cent before, 23.3 per cent today). Portuguese subsidiaries are not at all active

Ana Teresa Tavares-Lehmann Table 6.4

147

Nationality of main manager of subsidiary (% of cases) Portugal

Ireland

51.8 36.5 11.8

75.0 15.9 9.1

National Foreign (EU) Foreign (non-EU)

Table 6.5 Technological activities carried out by subsidiaries (% of respondents)

Customer and technical services Adaptation of products to host country/regional market Adaptation of manufacturing technology or processes (e.g., to take advantage of local factor conditions) Development of new and improved products for host country/EU markets Development of new and improved products for world markets Generation of new technology for parent (basic and applied research) None of the above

Portugal

Ireland

Before 1986

Now

10 years’ Before time 1986

Now

10 years’ time

55

58

60

55

76

71

44

60

59

55

65

67

53

77

72

52

85

82

28

47

47

26

61

67

14

26

35

23

52

67

16

33

44

18.4

2.2

1.1

12

5.1

1.6

1.1

15.0

0

in the generation of new technology for the parent (2.3 per cent before 1986, 6.7 per cent today and 9.3 per cent in ten years’ time). Furthermore, 65.9 per cent of Portuguese subsidiaries use exclusively group technology and 53.1 per cent acknowledge that subsidiary R&D does not constitute a technological source. These results confirm the widely held perception that MNEs’ operations in Portugal have a low technological content. As expected, the Irish case has a much greater high-tech bias. At the moment, 66.7 per cent of the respondents are involved in the adaptation

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Table 6.6 activities

Relative level of technological sophistication of subsidiaries’

Technological sophistication of current products Ability/freedom to acquire/use new technology Level of technological creativity in product development

Portugal

Ireland

3.26 2.96 2.76

3.53 3.31 3.33

Note: Mean values for the following categories: 1 ⫽ much lower than average, to 5 ⫽ much higher than average.

of products for local/EU markets. Adaptation of manufacturing processes was reported to be an activity undertaken by 51.6 per cent of subsidiaries (before 1986) and 84.8 per cent after that. Development of new/improved products for the country/EU market was carried out by 25.8 per cent of the firms before 1986, 60.9 per cent now and 66.7 per cent in ten years’ time, which represent much higher figures comparatively to the Portuguese case. The differences as regards the development of new/improved products for world market are even more striking. Irish subsidiaries reported figures of 22.6 per cent, 52.2 per cent and 66.7 per cent, for the three periods, respectively. Regarding new technology generation for the parent, the Irish case is quite impressive vis-à-vis Portugal. In fact, 16.1 per cent of subsidiaries carried out this activity before 1986, 32.6 per cent now and 44.4 per cent expect to be doing so in ten years’ time. Nonetheless, expectations have to be taken cautiously. Irish respondents also reported that in 22.7 per cent of the cases subsidiary R&D was their only technology source, and 45.5 per cent referred to it as a secondary source, again contrasting in a stark manner with the Portuguese situation. Moreover, as Table 6.6 shows, subsidiaries in Ireland clearly have a higher perception of the technological sophistication of their activities.

Local linkages developed by subsidiaries As noted above, the level and density of local linkages is a key determinant of host country impact. Clearly, there are other factors, and the assessment of such impact is an intrinsically complex task. Even when restricting the analysis to linkages, material linkages are just one of the various possible criteria. Intangible, knowledge-related linkages may be even more critical in some instances. However, the present research focuses on host economy purchases by the foreign subsidiaries surveyed. In the Irish case, studies of inter-firm linkages (McAleese and McDonald, 1978; O’Farrell and O’Loughlin, 1981) found that MNEs have lower levels of linkages than LCs, being the extent of linkages positively related to

Ana Teresa Tavares-Lehmann Table 6.7

Percentage of inputs bought from local suppliers

Country

0.0–10.0

10.1–25.0

25.1–50.0

50.1–75.0

75.1–100.0

Portugal Ireland

26.37 50.00

20.88 27.78

20.88 11.11

10.99 11.00

20.88 0.00

Table 6.8

Total 100.00 100.00

Evolution of proportion of inputs bought from local suppliers

% inputs bought from local suppliers

Portugal Before 1986

More The same Less

149

30.6 34.7 34.7

10 years’ time 38.8 43.5 17.7

Ireland Before 1986 16.7 38.9 44.4

10 years’ time 30.2 60.5 9.3

firm’s age. Görg and Ruane (2001), using a panel of firms in electronics, reached the same tentative conclusion of the existence of a positive time trend in linkages. They confirm that foreign firms have lower linkages than local firms, but see scope for policy intervention if the reason is the lack of indigenous suppliers capable of satisfying the demands of MNEs’ subsidiaries. Our results confirm this positive trend towards local sourcing in Ireland. Tables 6.7 and 6.8 below compare the Irish and Portuguese cases. Table 6.7 shows that Irish subsidiaries buy fewer inputs locally than their Portuguese counterparts. This can be justified due to sectoral, home- and host-country aspects. It was noted that Irish subsidiaries are more biased to the high-tech spectrum of activities, not so reliant on tangible inputs. This is relevant when assessing the potential of distinct sectors to stimulate greater levels of local sourcing. Indeed, a quite significant proportion of ‘sophisticated’ activities (software, micro-electronics) rely very little on material inputs, and, even if the development of such activities is usually welcome, its potential for stimulating local sourcing has to be qualified, from a policy perspective. A more detailed analysis of the survey data (not included in the tables above) indicates that local market-oriented subsidiaries and those with EU parent firms (both relatively more prevalent in Portugal) tend to source more inputs locally. Moreover, Portugal has an older industrial tradition than Ireland, and subsidiaries located there tend to operate in sectors for which there are established supply sources, which also explains the trends shown in Table 6.7.

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Table 6.9 Collaborations developed by MNEs’ subsidiaries in Portugal and Ireland (%) Universities Portugal Ireland Strong collaboration Weak collaboration No collaboration

13.6 47.7 38.7

22.7 47.7 27.3

Suppliers

Customers

Portugal

Ireland

Portugal

Ireland

20.4 49.5 30.1

18.6 60.5 18.6

21.4 36.9 41.7

7.3 34.1 58.5

Table 6.8 contrasts the two cases in a more dynamic analysis. A positive trend in local supply is perceptible, supporting the hypothesis that, as subsidiaries mature, they tend to establish more local linkages. As subsidiaries need time to develop, so do linkages and networks of trust. The evolution in Ireland was more pervasive than in Portugal (yet from a lower base). In about a decade, it is predictable that Portuguese subsidiaries will still have greater propensity to source locally. Only 9.3 per cent of Irish respondents expect to source less locally in the near future. However, and even if it is the most common criterion, the proportion of local purchases is not enough to assess how tight is interaction with the local economy. In this vein, subsidiaries were asked about other type of relationships, notably collaborations with scientific institutions/ universities; customers; and suppliers. Table 6.9 synthesizes the basic outcomes. Subsidiaries more often establish strong collaborations with universities in Ireland than in Portugal. Collaborations with suppliers tend to be weak in both cases. Lastly, subsidiaries in Ireland display weaker collaborative links with customers. That is plausible, as many (mainly US) subsidiaries sell abroad, especially back to the US market, so their clients are too far away to stimulate closer links. These collaborations are reported as extremely relevant for the scope of 81 per cent of the Irish subsidiaries and to have a considerable, yet less pronounced, impact on the Portuguese case (53 per cent of respondents). This shared development of capabilities internalized by subsidiaries may yield one of the keys by which peripheral regions may transcend their intrinsic limitations and acquire a relevant status in the EU and even in the global market.

Peripherality, economic integration and perspectives with EU enlargement For both Portugal and Ireland, EU accession represented undoubtedly a tour de force. These economies benefited largely from the market opening

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Table 6.10 Future evolution of subsidiaries relative to the following factors/challenges

Potential entry CEECs in EU Agreements EU with Mediterranean/North African countries EURO/Impact of the single currency

Portugal

Ireland

2.56 2.98 3.58

3.09 3.20 3.68

Note: Mean values for: 1 ⫽ under serious threat; 3 ⫽ unaffected; 5 ⫽ with great opportunity for improvement.

and the sizable funds received. At present, a new challenge exists, with the recent EU Enlargement to ten more countries (and more in the near future). That is likely to generate impacts at multiple levels, including non-economic, and at the moment there is considerable debate over this impact, especially in peripheral countries such as Portugal and Ireland, given also the increasingly tougher race for FDI projects (in which the new entrants are quite proactive and, in many ways, rather competitive vis-à-vis other EU locations). Moreover, some of the new entrants are in a level of development quite similar to Portugal and Ireland when they entered the EU (Ruane, 2001a). Although it is not our intention to review here the vast literature on the topic, we bring the issue as respondents of the survey were asked how they perceive the challenge of Enlargement, and other EU developments. Portuguese subsidiaries seem more fearful of such prospects than the Irish. Indeed, most Portuguese respondents regard Enlargement as a threat, and very few (14 per cent) anticipate opportunities for improvement. This fear is compounded by the fact that most inward investors in Portugal are EU firms (e.g., German, which will find it relatively easy to delocalize to the Central and Eastern European countries [CEECs]). The EU-Mediterranean agreements are seen as less of a danger (even though 14 per cent of the firms consider them as a threat). In Ireland, the situation regarding perspectives with CEECs’ accession is remarkably distinct (a third of respondents feel they will be unaffected and 30 per cent foresee instead an opportunity for improvement). The situation is similar in what concerns the Mediterranean countries. This can also be linked with the confidence that Irish managers have in the fact that their subsidiaries performed better than the group’s average (especially in profitability, to which tax incentives can relate). Portuguese subsidiaries are much less confident, as can be inferred from Table 6.11. Irish subsidiaries envisage Enlargement mainly as a window of opportunity and are not afraid of delocalization. The sectors and type of products

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ROI Productivity Profit

Evaluation of relative performance measures Portugal

Ireland

3.60 3.64 3.34

4.02 3.89 4.09

Note: Mean values for categories: 1 ⫽ significantly worse than the majority of subsidiaries in the group, to 5 ⫽ significantly better than the majority of other subsidiaries in the group.

in which subsidiaries in the two countries specialize is distinct, which acts against Portuguese prospects (more reliant on cost-sensitive industries: (Crespo et al., 2004)). Barry et al. (forthcoming) analyze the impact for Ireland of Enlargement: they consider it to be potentially very important, on trade, offering internationalization to Irish companies, creating outsourcing possibilities with further fragmentation of value chains, among other aspects. These authors do not consider the cut in EU funds to be critical, and have overall an optimistic perspective for Ireland’s domestic and foreign-owned sectors. Crespo et al. (2004), in a similar evaluation, express greater concerns, as the trade structure of Portugal and the CEECs is more similar, given also the low-tech characteristics of most operations, the lack of flexibility of labour markets, low level of qualification of the workforce, among other factors. Even if the vulnerability of Portugal seems more pronounced, the fact is that so far a massive delocalization to Eastern Europe has not occurred (but could happen), and the CEECs, for instance, experienced a considerable slump in FDI flows in 2003 (especially ‘star performers’ such as the Czech Republic and Slovakia). On the other hand, the challenges and the ‘race’ for FDI is now global, and focusing on what happens inside Europe these days is reductionist. In any case, there will always be several motivations to invest, and developed economies like the ones analyzed here would better focus on qualitative factors of differentiation that may attract more promising subsidiary types, with higher local value-added and more local linkages, rather on focusing just on FDI magnitudes. This depends crucially on the ability of the host country to provide an incentive structure to stimulate the positive upgrading of extant subsidiaries, and to also to improve local factors, changing its competitive attributes over time with the help of carefully designed policies, tailored to each context.

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The existence of an adequate institutional matrix is decisive (Amin and Thrift, 1994; North, 1990; Storper, 1997), and governments have a crucial role in helping to create/upgrade local competitiveness, in order to attract higher-value added subsidiaries that interact positively with the local environment. Viable upgrading processes depend crucially on the quality of local inputs a subsidiary can access, and in this vein there is a role for policy in stimulating the supply of public goods, infrastructure and knowledge/pools of technical expertise, as well as incentivizing the improvement of indigenous industry so as to enhance their absorptive capacity (Cohen and Levinthal, 1990). Indeed, spillovers need something to ‘spill into’, and one of the best ways to stimulate embeddedness and linkages/interactions with local agents is exactly by turning them into more attractive partners (Blömstrom et al., 1995). From this discussion, we conclude that competitiveness is not a datum, and comparative advantage can be engineered in peripheral regions in order to counteract negative centripetal forces that are often hypothesized. More aggressive industrialization, with either the movement into new sectors (e.g., as in the Irish case) or fundamental regeneration of existing ones aims to move the economy more towards the core. The need for a shared developmental vision looks too obvious in theory but in practice often fails to be implemented, mainly due to the lack of a systemic perspective and a consistent strategy.

5. Concluding Remarks This chapter analyzed the issues of public policy, FDI attraction and multinational subsidiary evolution, focusing on two EU small open host economies, Ireland and Portugal. Empirical evidence was provided on the quality and scope of MNE subsidiaries located in the two countries, as well as on the evolution of the strategies characterizing these subsidiaries. Clearly, and even if there is a variety of distinct cases, Irish subsidiaries tend to develop higher valueadded activities than their counterparts in Portugal. The technological sophistication of operations, decision-making autonomy, for instance, are often higher in the Irish case. Predictions about the near future support a brighter future for Ireland, according to managers. Other studies (e.g., Crespo et al., 2004) also consider that Ireland is a priori more prepared to withstand the foreseeable competition of the new EU entrants, and also at the global level. It was shown that the policy approaches (FDI-related and other) differed in the two countries. Ireland developed a more fine-grained, targeted, more

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technologically focused policy (Egelhoff et al., 1998) policy, with a remarkable consistency over decades (Ruane, 2001b) and accompanied by appropriate complementary measures. Only recently Portugal is developing a more proactive policy, with a new institutional structure that is giving its first steps. Reflecting the increasingly tough FDI race motivated by the lack of FDI rules (Young and Tavares, 2004), and that FDI attraction per se is not enough (and probably not the main issue), countries are now developing a new generation of policies incentivizing local linkages and local entrepreneurship. The Irish case was presented, showing a growing emphasis on these themes, but also a new understanding of the concept of linkages, with an international rather than with a purely domestic focus. Portugal is, so far, not undertaking serious efforts in promoting linkages, as there is a lack of inter-institutional coordination and dialogue. This chapter points to the importance of policy in shaping outcomes in FDI attraction and in forging positive outcomes in subsidiary evolution and in local impact. It stresses the relevance of an appropriate institutional matrix and the need to understand MNEs’ internal idiosyncrasy in order to design better policies, what prevents a ‘recipe’ approach to policy (for instance, Irish policies could not be purely imitated in Portugal, but there are lessons to learn too) and undermines the viability of universal prescriptions (Tavares and Pearce, 1999), but advocates the need for systemic approaches that take into account both MNEs and local factors.

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Simões, V.C., Biscaya, R. and Nevado, P. (2002) ‘Subsidiary decision-making autonomy: Competences, integration, and local responsiveness’, in S.M. Lundan, (ed.), Network Knowledge in International Business, Cheltenham: Edward Elgar. Storper, M. (1997) The Regional World: Territorial Development in a Global Economy, New York: Guildford Press. Taggart, J.H. (1996) ‘Multinational manufacturing subsidiaries in Scotland: Strategic role and economic impact’, International Business Review, 5: 447–68. Tavares, A.T. (2001) ‘Systems, Evolution and Integration: Modelling the Impact of Economic Integration on Multinationals’ Strategies’, unpublished PhD thesis, University of Reading. Tavares, A.T. and Pearce, R.D. (1999) ‘The industrial policy implications of the heterogeneity of subsidiaries’ roles in a multinational network’, Industrial Development Policy Discussion Paper No. 5, L’Institute, Birmingham, Ferrara and Milwaukee. ——— (2001) ‘European integration and structural change in the multinational: Evidence from foreign subsidiaries operating in Portugal’, in M. Hughes and J.H. Taggart (eds), International Business: European Dimensions, London: Palgrave. UNCTAD (2004) World Investment Report 2004: The Shift toward Services. New York and Geneva: United Nations. White, R. and Poynter, T. (1984) ‘Strategies for foreign-owned subsidiaries in Canada’, Business Quarterly, 48(4): 59–69. Young, S. (ed.) (2004) Multinationals and Public Policy, Cheltenham: Edward Elgar. Young, S. and Hood, N. (1994) ‘Designing developmental after-care programmes for inward investors in the European community’, Transnational Corporations, 3(2): 45–72. Young, Stephen, Hood, N. and Dunlop, S. (1988) ‘Global strategies, multinational subsidiary roles and economic impact in Scotland’, Regional Studies, 22(6): 487–97. Young, S., Hood, N. and Peters, E. (1994) ‘Multinational enterprises and regional economic development’, Regional Studies, 28(7): 657–77. Young, S. and Tavares, A.T. (2004) ‘Multilateral rules on FDI: do we need them? Will we get them? A developing country perspective’, Transnational Corporations, 13(1): 1–29.

7 MNCs in the Periphery: DaimlerChrysler South Africa (DCSA), Human Capital Upgrading and Regional Economic Development Jochen Lorentzen

1. Introduction When multinational firms shop the globe for possible investment locations, local capabilities are among the key variables influencing their decision. Everything else being equal, more highly developed human capital attracts more sophisticated foreign direct investment. But the relationship between human resources and capital flows is not confined to the situation pre-entry. Post-entry, foreign investors influence the demand for and the supply of skills. For example, they may approach a local training institution in order to obtain customized courses that produce graduates with a set of skills and competences the firms need, or influence the capabilities of their local suppliers along the value chain. The relationship between human resources and, more generally, local capabilities on the one hand and FDI on the other bears particular relevance for developing and latecomer countries because it suggests that investments in human capital help absorb foreign technologies whose exploitation, in turn, may spur growth. Thus, ensuring that people get a good basic education and lifelong training opportunities is not just a sensible goal in its own right but also contributes to a country’s ability to reap the benefits of globalization. This chapter results from a larger study that hypothesized the two-way relationship between local capabilities and FDI as alluded to above and tested the influence of FDI on human resources on a panel data set of 111 countries, 1970–2004 (te Velde, 2005). It illustrates the econometric results through a case study of Daimler Chrysler’s plant in East London in South Africa’s Eastern Cape Province. In the interest of presenting the richness of the case study, the second section reviews relevant literature 158

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only briefly. The third section compares inward direct investment (IDI) in South Africa with other developing and latecomer countries, profiles the peripheral character of the host region and describes key characteristics of the foreign investor. The fourth section presents methodology and data of the case study, followed by the analysis in the fifth section. The sixth section concludes with insights for policy.

2. FDI and Human Capital Increased competition from liberalized trade and investment regimes provides incentives for firms to upgrade their production capacities and technological capabilities. Skills and competences of people are key in this respect. Of course, openness will not lead automatically to more sophisticated local capabilities but the alternative to upgrading is what some call the low road of development, namely a specialization in low-skill-intensive production. For a summary of the main propositions of the new trade and growth theories in this regard, see te Velde (2005), who also reviews a range of empirical studies (see UNCTAD 1994). In this context, Romer (1990) describes the logic behind low-income traps. Te Velde’s (2005) own empirical analysis finds a positive link between FDI and school enrolment in countries with a higher initial skill endowment, one more result to dispute unconditional catch-up optimism. Narula and Dunning (2000) offer an evolutionary perspective through the investment development path where human capital graduates to successively higher levels of absorptive capacities, which in turn influences the kind of FDI the country attracts and the degree to which the entity benefiting from the investment can absorb and make use of it. Obviously, the motivations of multinational firms to invest in local human resources differ with respect to the rationale that lies behind the investment in the first place (Dunning, 1993). Thus, natural resource-seekers that send miners underground to dig up diamonds are less likely to invest in skill upgrading than efficiency-seekers that export electronic components to global markets. Case studies addressing the impact of multinational firms on general education, formal training, or on-the-job coaching are relatively rare. In a recent example, Carrillo (2004) analyzes the interplay between global sourcing strategies in the automotive industry and local cluster upgrading in the context of national and local industrial policy initiatives. He finds that the presence of GM and Delphi in Mexico helped bring about a network of firms in which accelerated learning benefited especially engineers and technicians. For a review of other examples from the automotive industry, see Lorentzen and Barnes (2004).

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The relevance of the case study Daimler-Benz (DB) started making cars, including commercial vehicles, in the Eastern Cape for the South African market in 1958 (for a history of the industry, see Black, 2001). In the 1990s it began to export cars manufactured in East London to Australia and also assembled passenger vehicles for Honda and Mitsubishi Colt pick-ups. At the time, annual output of Mercedes Benz was 12,000 units. Hence, similarly to the six other assemblers in South Africa (SA), DB essentially ran an operation whose economic and financial logic was predicated upon an import substitution regime in which protection against outside competition facilitated extremely low production runs. The attendant inefficiencies were passed on by way of high consumer prices for finished vehicles. When the South African government from the mid-1990s tried to promote the export orientation of the automobile industry through the Motor Industry Development Plan (MIDP), DB was among the first assemblers to react. In November 1998, after its takeover of Chrysler, it announced a US$ 146.7 million investment, later increased to US$ 182 million, in the East London operation. This was aimed at expanding capacity and to build a new paint shop (Wall Street Journal, 1998). The announcement was significant not only insofar as it reacted to an industrial policy aimed at convincing multinational assemblers to strengthen and deepen their South African operations, but also because in that year the industry was in relatively dire straits, not least because of a 25 per cent drop in sales and widespread industrial disputes. In the six years since the investment, DCSA has become one of the most successful assemblers in South Africa. The current C-Class belongs to the most popular upmarket models on the domestic market. East London has won the successor generation to this model and is poised to expand exports both in terms of volume and geographical destination. Prominently, cars produced in East London will in the future also be exported to North America. Of course, DCSA’s investment wasn’t always in for a smooth ride. Shortly after winning an export contract for 17,000 passenger vehicles a year, destined for the UK, Japan, and Australia – and, thus, for the first time, for the global market – strike action on its assembly line led to media speculation that DC might pull out of the country (Financial Times, 2001). Yet that never happened and indeed DCSA, along with BMW and VW, is a trailblazer in terms of foreign direct investment (FDI) into South Africa, defying the ‘bad neighbourhood syndrome’ occasioned by the political crisis in Zimbabwe, crime, the spread of HIV/Aids, complicated immigration procedures and the more general Afro-pessimism that appears to prevent foreign multinationals

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from committing to the continent even when host country conditions are favourable (Degli, 2000; for evidence on Afro-pessimism, see Asiedu, 2001). DCSA’s investment thus epitomizes much of what makes the analysis of the interaction between globalization and local capabilities interesting and relevant. First, on the back of a long-standing involvement in the country that was primarily aimed at the domestic market, it made a strategic decision to turn its East London operation into a global production site, thus completely altering the range of models it produced and the quality standards and cost parameters to which it manufactured them. This involved a reconsideration of the skills and competences of its own workforce, that of its suppliers, and of the human resource potential in the Eastern Cape and indeed the country at large. Since in principle DC had the option to invest elsewhere, South Africa must have had certain location-specific advantages that swayed the decision in its favour. This, in short, is the hypothesized causal link from education to globalization, namely how and why the (human) resources of a location influence the investment behaviour of a MNC pre-entry, both initially and over time. Second, historically automobiles produced in South Africa – or for that matter in any developing country – were not of the same quality as their overseas model cousins produced in Japan, Europe, or North America. With the globalization of the car industry, this is no longer the case. A Mercedes C-Class manufactured in East London is no worse – and may indeed be better – than its model cousin coming out of DC plants in Sindelfingen or Bremen in Germany. Hence, the presence of DCSA in the Eastern Cape must have contributed to an upgrading of human resources in ways both direct and indirect. This, in short, is the hypothesized reverse causality, namely from globalization to education, or, in other words, from the activities of a MNC post-entry to the quantity and quality of locally available and emerging human capital. Third, the activities of the MNC will interact more or less fortuitously with regional development agendas. In theory, the consequence of FDI may be upgrading or deskilling, and the positive effects of FDI are likely to increase with the level of local capability that is there in the first place (e.g., Blomström and Kokko, 1998). The Eastern Cape has traditionally been an important location for the car industry, but, on the other hand, it is also one of South Africa’s most underdeveloped provinces. So the larger question is how DCSA’s activities influence economic planning in the area, and how provincial development strategies constrain DCSA’s activities.

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3. Host Country and Investor Characteristics IDI in South Africa In 2002, the investment/GDP ratio was 16 per cent, significantly lower than in many other developing economies (AfDB/OECD, 2004). South Africa also has not attracted a lot of FDI inflows. The first column of Table 7.1 shows that the country’s share in global FDI flows roughly reflects its share in global GDP. In 2003, IDI flows amounted to US$ 762 million, and stocks were US$ 30 billion. Between 1992 and 2003, FDI represented about 3 per cent of gross fixed capital formation (UNCTAD, 2004). Arguably more relevant than absolute flows into a country is how well the host

Table 7.1

Capital flows, competitiveness and human resources

South Africa Botswana Zimbabwe Korea Malaysia Brazil India China

IDI Performance Index 2001–3

IDI Potential Index 2002

Competitive Industrial Performance Index 1998

Skills Index 1998

(1.069) 77 57 135 120 75 46 114 37

(0.185) 66 55 138 18 32 68 89 39

(0.108) 39 – (0.052) 51 (0.370) 18 (0.278) 22 (0.149) 33 (0.054) 50 (0.126) 37

(17.05; 0.17) 49 – (8.15; 0.09) 68 (36.10;1.65) 1 (11.10; 0.13) 59 (10.15; 0.18) 58 (8.10; 0.12) 67 (9.75; 0.10) 62

Note: • IDI ⫽ inward direct investment. • IDI Performance Index ⫽ ratio of a country’s share in global FDI flows to its share in global GDP. • IDI Potential Index ⫽ based on 13 economic and policy variables. • Figures in parentheses are computed values. Other figures reflect country rankings based on computed values. Total number of countries in UNCTAD ranking (columns 1 and 2) is 139, in UNIDO rankings (columns 3 and 4) 87. • Maximum achieved Performance Index value as in column 1: 19.807 (Belgium and Luxembourg). • Maximum achieved Potential Index value as in column 2: 0.659 (US). • Maximum achieved Competitive Performance value as in column 3: 0.883 (Singapore). • Maximum achieved Skill Index value as in column 4 (composite of two values, namely weighted average of percentage of relevant age groups enrolled in secondary and tertiary education (Harbison-Myers): 62.05, Canada; tertiary enrolment in technical subjects as share of population: 1.65, Korea). Sources: UNCTAD, 2004, columns 1 and 2; UNIDO, 2002, columns 3 and 4.

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economy manages to exploit the advantages associated with the foreign knowledge. The second column of Table 7.1 is an attempt to capture IDI potential. The index is composed of 13 economic and policy variables. While this ups South Africa’s relative world ranking, it increases the distance to a country like Korea, whose technological trajectory South Africa seeks to emulate. The third column shows a ranking of competitive industrial performance. When disaggregated, it suggests that South Africa, along with Brazil, China and India, has been relatively successful at upgrading its export but less so its industrial structure (UNIDO, 2002, p. 51). According to the fourth column, the single most negative contributor of this performance – from among skills, local technological effort, FDI, royalties realized abroad and physical infrastructure – is skills. In sum, South Africa does not attract much foreign capital. Its business environment, infrastructure and local capabilities constrain the use it may make of foreign technologies, and the biggest of these constraints is skills. This underlines the merit of studying the impact of individual foreign investors on local human resources.

Human capital and economic development in the Eastern Cape The Eastern Cape epitomizes many of the economic and social challenges facing South Africa (AfDB/OECD, 2004; Mayer, 2004; Vass, 2004; Woolard and Woolard, 2004; see Table 7.2). It is the second poorest of South Africa’s nine provinces. Poverty increased markedly from the mid-1990s. Inequality thus combined with poverty to a vicious cycle in that it deprived the poor of the benefits of economic growth. Extreme levels of rural underdevelopment contrast with industrial activity in and around the two major cities, Port Elizabeth and East London, that traditionally host the manufacture of automobiles, clothing and textiles, and food processing. The belowaverage growth performance of the province translates to all sectors, including manufacturing in general and automotive production in particular. On the other hand, transport equipment accounted for a quarter of manufacturing activity and grew faster than any other secondary subsector. In 2002 it also contributed more than two-thirds of exports and has been the fastest-growing export sector. Virtually all of this originates in or around the two urban centres Port Elizabeth and East London. This underlines the importance of automotive production to the provincial economy. In terms of gross value added, more than two out of every ten Rand originate in the automotive export sector alone, notably VW in Uitenhage outside Port Elizabeth, DCSA in East London and the component firms integrated into their respective supply chains. The globalization of the domestic car industry is also evident from the import statistics.

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Table 7.2

Economic and social indicators of the Eastern Cape 2002 Eastern Cape

Share of population, % Share of GDP, % GDP per capita, Rand Average annual growth 1996–2002, % Economically active population, % strict definition broad definition Unemployed, % strict definition broad definition People below poverty income, % Households with piped water, % Medical aid coverage, % Infant mortality rate (deaths per 1,000 live births) Life expectancy at birth in 2003, years Illiteracy 15 years ⫹, % People with tertiary education degrees, % Gini coefficient 2001 Human Development Index HIV prevalence among pregnant women

South Africa

14 7 9,883 1.9

100 100 21,664 2.5

46.6 60.0

56.7 67.7

32.5 47.6 68.3 20.5 10.0 72

30.5 41.8 48.5 39.0 15.0 59

50.5 50.0 2.5 0.651 0.62 23.6

49.2 41.0 4.5 0.635 0.67 26.5

Sources: Mayer, 2004; Statistics South Africa, 2004; UNDP, 2004; Vass, 2004; Woolard and Woolard, 2004.

Transport equipment absorbed two-thirds of all the province’s imports, roughly 1.6 times more than it exported. The emerging export orientation of the car industry reflects a more general opening up of the provincial economy. In fact, exports from the Eastern Cape grew faster than from any other province in 1996–2002 and contributed roughly a third to the gross provincial product in 2002. Education and training indicators for the province underline that human capital in the Eastern Cape in general does not constitute a location-specific advantage. This does not exclude the possibility of pockets of excellence in Port Elizabeth and East London but it does mean that foreign direct investors need to investigate the relative match between their objectives and local capabilities rather carefully. High mortality rates for infants and children due to HIV/Aids translate into lower school uptake rates; this in turn has negative implications for human resource development and replacement in the province. Lower productivity, skills erosion and higher costs to firms, individuals, households and the public purse are among the economic consequences, making

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for limited effect to veritable doomsday scenarios predicting the collapse of the economy over the next couple of generations. For firms, the impact results from direct costs such as higher contributions to medical insurance, benefits for retirement, disability, death and funeral, prevention campaigns, replacement recruitment and training, and from indirect costs such as absenteeism, sick and compassionate leave and so forth. Aids is likely to reduce economic growth, which in turn will translate into less demand for unskilled labour. Therefore, even its indirect effects are likely to exacerbate problems of poverty and inequality in the province that have nothing to do with Aids per se. Car assemblers have been very active in HIV/Aids prevention, treatment and care programmes. This appears to have led to lower prevalence rates than in other sectors. DCSA reports that the introduction of free medical treatment of infected employees and their families, initiated in the mid1990s, reaches 30,000 people, halved deaths and lowered infection rates (DaimlerChrysler, 2005). Hence, labour turnover may be contained, and perhaps there is a lower risk that valuable skills and experience will be lost. Overall, of course, HIV/Aids do compromise the capacity to address human capital deficiencies.

German-owned car assemblers in South Africa DCSA shares certain characteristics with the other two German-owned assemblers, BMW and VW, that distinguish them from their Japanese and American competitors. None of the three were ever majority locally owned; in fact VW and BMW have always been wholly owned subsidiaries, while until the early 1990s 50 per cent of Mercedes Benz’s equity was held by domestic capital, after which it reverted to total German ownership. By contrast, in 1990 the other four assemblers – Toyota, Samcor (Ford), Automakers (Nissan), Delta Motor Corporation (GM) – were (almost) completely in domestic ownership. This changed gradually, and by the early 2000s only local Delta management continued to hold equity in an assembler. All others were controlled from abroad. Hence, there is little difference in terms of ownership structures at present, but this was not the case in the mid-1990s when the MIDP kicked in. Ownership and control by globally oriented assemblers had profoundly different implications for component manufacturers supplying the German as opposed to the Japanese or American assemblers. On the one hand, trade liberalization exposed them to global competition just as their counterparts. But, unlike their counterparts, their integration into a global supply chain allowed them to reap the benefits from delivery to global markets, exploit economies of scale and absorb technological

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assistance from their parent companies (Barnes and Morris 2004). Hence the MIDP was both carrot – integration into a MNC network – and stick – the reduction of import protection, while their counterparts did face the stick from increased import competition but remained largely focused on the domestic market. Data bear out the head start suppliers to VW, BMW and DCSA had over the other component suppliers. In 2001, the German assemblers accounted for 98 per cent of all passenger vehicle exports. More than 40 per cent of component exports went to Germany in 2000, and another 28 per cent was destined to other EU markets, often through German-owned first-tier suppliers. In fact, the most important component exporters have strong German links, and German ownership links are pervasive in the two most important subsectors, namely catalytic converters and stitched leather seats, which by themselves account for more than half of all component exports (ibid.). What this means for an investigation of the link between globalization and education is that component manufacturers supplying DCSA have been facing both more challenges and more opportunities for a longer time than, say, those supplying Toyota or Delta. Producing parts or components for export vehicles meant that global quality standards had to be met. For component suppliers this had implications from management all the way to the shop floor. Management had to internalize lean production principles and institute them across all functions of the operation. Workers on the production line had to live up to zero default requirements in view of bringing down internal reject and customer return rates. In turn, this required the introduction of transparent quality management systems that allowed assemblers to hold suppliers to account for progress in process upgrading. At times it also meant the introduction of modern machinery that was more complicated to operate than the equipment it replaced. Opportunities existed to grow world mandates, or at least the prospect thereof, for select parts and components. It is obvious that these changes could only happen successfully in the context of upgrading human resources. This is the reason why in the South African context it is more interesting to investigate the German-owned assemblers, especially the two that produce luxury vehicles. Among car assemblers, DC’s worldwide presence in 48 countries is second only to Ford’s (UNCTAD, 2004, Annex Table A.I.4). Mercedes Car Group has passenger car production facilities in Germany, France, US, South Africa, Brazil, India, Malaysia, Thailand and Vietnam. In addition, a new joint venture in China is expected to start production in late 2005.

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The C-Class (including CLK, SLK and Sport Coupé) accounted for 39 per cent of Mercedes-Benz sales in 2004. Sales of these models amounted to 474,800 of which the East London plant produced just under 10 per cent, mostly for export. This made East London, with 5.6 per cent of Mercedes Car Group’s worldwide workforce, the third most important plant in the world after Bremen and Sindelfingen. For the time being, production in Asia and Latin America is limited to the assembly of completely knocked down kits (CKDs) and consists of much lower volumes. At the same time, expansion in Asia, especially in China, is a strategic focus of the Mercedes Car Group in its objective to participate in the growth of car demand in emerging markets while striving for cost advantages from larger production volumes (DaimlerChrysler, 2005).

4. Methodology and Data The case study is based on interviews with DCSA, component suppliers, education and training providers, a business association and a provincial development agency (see Table 7.3). A total of 12 interviews with 18 interlocutors took place over a period of four days in November 2004 in and around East London. Interviewees were briefed about the purpose of the study beforehand. Interviews lasted upwards of an hour. A written summary of all conversations and a draft version of this paper were made available to interviewees for verification and comment. The larger ODI project referred to in the introduction, comparative human resource data across the South African automotive supplier industry, and this case study were discussed at a workshop in East London in March 2005 with the majority of interviewees, including representatives from DCSA, plus other interested parties, including from Toyota. In sum, verification went through three iterations. The sample size is not representative of DCSA’s supply chain in South Africa, let alone of the car industry more generally. But the sample subjects include at least one stakeholder from each of DCSA’s constituencies, and an attempt was made to reflect the existing variation in the sample, for example in terms of ownership, size of workforce, and tiering of component suppliers. In addition, the expertise of the local chapter of a national automotive benchmarking initiative (www.bmanalysts.com) was used to identify sample subjects, especially as far as the private sector was concerned, that would reflect typical sentiments of the industry. With one important exception, all interviewees tended to converge in their responses to the research questions raised by this study. This may be taken as further illustration that insights drawn from the case study do indeed capture the bigger picture.

Table 7.3

Interviews

Institution Firms DaimlerChrysler SA Johnson Control Interiors Leoni Venture First National Battery Fabkomp Education and training providers Fort Hare Eastern Cape Technikon Leadership Development Institute Border-Kei Training Trust Industry associations Border-Kei Chamber of Business

Development agencies Eastern Cape Development Corporation

Activity

Tier

Ownership

Car assembly Assembly of dashboards and instrument panels Wiring harnesses Bumper fascias Batteries

0 1st

100% foreign 100% foreign

1st 1st 1st, 2nd and aftermarket 1st, 2nd and aftermarket

100% foreign 100% foreign 100% domestic

460 560 485

100% domestic

130

Truck components and miscellaneous

Size of workforce

Approx. 4,500 64

Range of (under)graduate degree courses, incl. in IT-related subjects and accounting Range of undergraduate vocational qualifications, incl. mechanical engineering Soft and hard management skills, incl. project management and production organization, for public authorities and industry Range of technical skills, incl. fitting and turning, welding, panel beating, spray painting Industry representation and lobby group, organized in thematic working groups on infrastructure, manufacturing, economic affairs and trade, employer relations, general operations

168

Investment promotion: FDI promotion, investor servicing, aftercare, industry support plus a range of other activities

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5. Analysis The three investigated relationships are the role of provincial human resources in DCSA’s decision to turn its East London plant into an export platform; DCSA’s impact post-investment on local human resources; and the fit between the investment and regional economic development. In short, the analysis finds that the local availability of skills and competences independently of the stock of experience accumulated in the East London plant over 40 years did not plausibly move DC to make its investment in South Africa rather than elsewhere. It also finds that DCSA has had a very powerful influence on local capabilities and continues to do so. Finally, in the medium term DCSA’s presence contributes significantly to the industrial development of the Eastern Cape but local development authorities appear to have no plan to exploit this potential in the longer term.

DC’s investment decision and the role of local human resources Short of having access to boardroom documents describing discussions that finally led to the decision to expand DC’s East London plant instead of locating a facility in another part of the world, the only sound way to assess if and how local human resources mattered is to pose the relevant counter-factual, discounting the carmaker’s long-established presence in the area. In other words, how plausible a case can be made that DC would have undertaken a greenfield investment in East London? There were two key problems when Daimler geared up for passenger car export production from East London. First, the plant had had a long history of adversarial relationships between management and workforce, epitomized by frequent industrial action. This changed slowly from the late 1980s, as part of a larger endeavour at transformation in the context of South Africa’s regime change from apartheid to democracy. Insofar as the legacy of apartheid in terms of human capital could obviously not be changed overnight, the transformation of the company, while certainly in full swing in the late 1990s, was by no means complete. Second, the existing product portfolio reflected the conditions of the automotive industry in an import-substituting setting, namely a large variety of vehicle platforms produced in low runs primarily for the domestic market. The strategic re-orientation of the plant, in line with the intention behind the MIDP, provided for a reduction of platforms, produced both for the domestic and the export market (and, hence, in larger unit volumes). Along with the emerging export orientation went a commitment to quality standards and cost efficiencies that were hallmarks of

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global automotive supply chains but rather new to assemblers and component producers in South Africa and other emerging markets. The East London plant was perhaps the most complex Daimler facility outside Germany. It produced its Mercedes passenger models including extremely demanding niche vehicles such as the S-class convertible, assembled passenger cars for other manufacturers (Honda and Mitsubishi) and built Freightliners for DC’s US heavy vehicle subsidiary. This was all done with a single paint shop and obviously required a lot of internal competence prior to the export drive. In fact, Daimler operated a training centre before 1994 in which it trained artisans such as turners and fitters. Without investing in these shop-floor skills, it would have been impossible to master the plant’s complexity. In other words, when the C-Class was first produced for export, human resource management had a basis of human capital to work with. But shortages existed, especially in higher-order skills. Thus, all industrial engineering recruits hired during the first large recruitment drive in preparation for the W203 launch hailed from Gauteng (i.e., University of Pretoria, Wits Technikon,1 etc.). The situation has not changed since the late 1990s and this is a problem insofar as graduates used to the metropolitan environments of Pretoria or Johannesburg rarely warm to the cultural backwater of East London. Hence, they typically leave after two to three years and join other assemblers. For obvious reasons, this is detrimental, which is why DCSA has resolved to breed talent internally. An additional problem is that by international standards South African engineering graduates are not quite as highly qualified as their counterparts from Germany. This relates mainly to the ability of the latter to hit the ground running as they transfer out of their university programme onto the shop floor. DCSA has experience with this because it is a popular place for German students to do their practical semester. The interview with the Eastern Cape Technikon (ECT) and the Chamber of Business largely confirmed weaknesses in the system. According to the interviewee at ECT, the problem of skill shortages in the Eastern Cape has two origins. First, the dysfunctional secondary system supplies cohorts insufficiently prepared for the demands of the tertiary system. Second, the technikons as such do not remedy any of these problems and arguably make them worse. For example, regarding intake ECT does not offer bridging courses or foundation years. This means that the slipping of standards is suffered rather than confronted. Teaching is largely theoretical and lacks practice orientation (whereby ‘theoretical’ is perhaps best understood as the absence of operationability rather than in the academic sense of the word). Indeed, faculty typically have no industry experience,

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nor do industry representatives make use of the opportunity to influence curriculum design and development. But interviewees suggested that the latter may be due to the lack of interest from industry in technikon graduates, or to the recognition that technikon graduates are at best raw material, not much more skilled or qualified than high-school graduates, and in need of much further training on the job. These criticisms in essence question the very existence of this part of the higher education sector. Industry’s dim view also has to do with the low motivation and commitment of technikon faculty, who only read what they have to and profess no interest whatsoever in research. In fact, the 180 faculty spread over four campuses associated with the Eastern Cape Technikon managed to publish two journal articles over the last two years. Nor are they entrepreneurial; the technikon does not offer any customized short courses, something that industry would quite likely be interested in. The location of the technikon in the Eastern Cape, headquartered in Butterworth, makes for negative spillovers and militates against standards achieved by more fortuitously located peers such as Port Elizabeth Technikon or DIT in Durban. In sum, when DC decided to invest in an export plant in East London, it was not faced with a tabula rasa but a workforce of some 3,500 employees plus the rudiments of a supplier network that also embodied at least some of the requisite human resources. Clearly the situation would have been different with a greenfield or even a brownfield investment. So within South Africa the location of the new investment was obviously influenced by the then existing investment. If one compares South Africa with other possible locations in emerging markets around the world, it would appear that ceteris paribus human capital in South Africa scored at best neutral, i.e., did not enter too negatively into the strategic calculus. With hindsight, what the unambiguous success of the East London operation proves is that a determined and relatively well-heeled multinational with a lot of experience in the region at hand plus a lot of capacity to re-engineer a whole supply chain and bestow upon it the discipline necessary for achieving continuous improvement can make things work even under adverse circumstances. It certainly does not prove that the local availability of human resources was entered under the positives when weighing the pros and cons of expansion. Hence, the effect of education on globalization appears at best tenuous in this case.

DCSA’s impact on the demand for and supply of skills in the regional economy DCSA affected local human resources in a number of ways. Directly, it trained its own workforce. Indirectly, it caused human resource upgrading

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along the supply chain. In preparation for the launch of the C-Class model (W203) for export, DCSA undertook a massive skill intervention programme to the tune of about R500 million per annum, approximately 20 per cent of the total wage bill. The work force grew by 1,000 employees to some 4,500. In the past it had been standard practice to solicit recommendations for new candidates from the existing workforce. In order to tap into a larger pool of talent and capture also more rural areas not in the immediate vicinity of East London, Daimler ran a newspaper ad for applicants with matric (i.e., high school)-level qualifications: 45,000 people responded. It turned out later that a considerable share was qualified to technikon level but chose not to reveal this information for fear of not fitting the demanded skill profile. This episode unsurprisingly documents that there is no shortage of labour quantity. What was different about this employment drive compared to past practice was that never before had matric been an entry requirement for a position at the operator level. Hence the advent of export production led to a premium on secondaryschool skills and certainly discriminated against illiterate and innumerate candidates. The skills programme involves all levels of employees. The introduction of modern production principles implies that workers must be comfortable working in groups; hence it is not only the skills of individuals but the aggregate skill profile required for multiskill and multitasking in teamwork assignments that determines the relative success of human resource upgrading in the plant. Technical skills are primarily trained by the in-house training centre. However, some 130 shop-floor employees have been to the Bremen plant for training. There they worked with a mentor personally assigned to them, who, upon completion of their visit, accompanied them back to South Africa where they then jointly trained other workers, thus multiplying the upgrading effect across the shop floor. At the supervisory level, DC enrols employees in further education and training institutions (FET). For managerial functions, staff are sent to Germany. For example, currently eight DCSA employees are full-time engineering students at the University of Karlsruhe. These schemes are financed out of company resources but for vocational and FET skills increasingly use is also made of government-subsidized learnerships. Examples include programmes in mechatronics and autotronics with Buffalo City FET. It is broadly true that there is no shortage of shop-floor and supervisory recruits in the Eastern Cape, albeit normally not at the desired level of competence. The situation is different with respect to higher-order skills. For reasons alluded to above, DCSA cannot simply resort to hiring young or

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experienced engineers from elsewhere in South Africa. Instead it must invest in truly local staff. Recruits originally from the Eastern Cape tend to be more ‘sticky’ than their peers from out of town and province. This is the rationale behind engaging in intense interaction with a variety of education providers in the province, and more specifically in the East London region, to help ensure that they produce graduates with the requisite skills. Where this is not yet possible, DCSA grants bursaries to local employees to study at an acknowledged institution such as Wits. During the holiday break, these grantees return to work in the East London plant. Upon graduation they join the firm and thus embody an acceptable level of technical training as well as the necessary exposure to the shop floor and the more tacit knowledge required to operate it. DCSA agrees with other stakeholders interviewed for this study that the Port Elizabeth Technikon is a much better institution that its counterparts in East London (Eastern Cape Technikon and Border Technikon). But it does not write the local technikons off. In any event, it is de rigeur at DCSA to supplant formal certificates with an internal screening mechanism. Practically this means that job applicants are blind-reviewed by the training centre, i.e., the reviewer checks skills and competences of the individual without knowing from where they graduated. In addition, regardless of provenance, students are accepted for internships. Exceptional performers may then be retained; those that leave after six months or so are hoped to take their training to related occupations along the supply chain and thus, over time, improve the upstream availability of inputs to the DCSA plant. Casting a broader net across the provincial technikons is made easier by improving quality assurance mechanisms in the education sector in South Africa. For example, although the Association of South African Engineers does not publish its evaluation of engineering faculties, it encourages employers to ask higher education institutions to make this information available to them. If successful, this practice clearly reduces information and search costs for personnel units. Among the most visible manifestations of DCSA’s indirect influence over local human resources is the presence of a number of MNC subsidiaries that are only there because of DCSA. Much like DCSA, they hire and train and are engaged in continuous improvement of their workforce. Leoni, a manufacturer of wire harnesses, established a greenfield plant in 1999/2000 because it had won a supply contract for the W203. Upon set-up, Leoni Europe seconded senior personnel in engineering, logistics and supplychain management. The ex-pat managers handed over to local personnel after 12–18 months. Formal skill requirements at the plant are such that

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all shop-floor employees must have at least a senior certificate (i.e., a high-school diploma). The certificate is taken as a guarantee of the ability to speak, read and write English, which is required in order to understand the documentation that accompanies the operation of the production line and the associated machinery. There is no premium on critical thinking or problem-solving skills; the major expectation is that employees absorb instructions and act accordingly. In terms of locally available skills, the presence of DCSA has definitely made a difference. Transfer involves a whole range of soft skills associated with lean management practices and Kaizen, such as team orientation and problem solving, and this has involved both waged and salaried employees. The latter especially benefited from modern principles of logistics, HR and supply-chain management. Johnson Control Interiors (JCI), an assembler of dashboards, also set up operation shortly after it had won a supply contract for the W203. The plant runs without expatriate staff. The minimum qualification on the shop floor is eight years of schooling (Standard 8). This reflects a relatively simple production process and technology, with a largely manual assembly aided by poke-yoke devices. Recruits are easily available and the necessary training does not involve major problems insofar as the task at hand is not especially difficult. However, there are caveats to this assessment. When the plant screened its supervisory staff for eligibility for training, only two employees were found not to be in need of a pre-training in basic literacy and numeracy, without which they would have been unable to follow the basic concepts involved in the course on offer. Subsequently, the external training provider rejigged the curriculum downward. This is a worrisome anecdote insofar as at least some of these employees are tertiary-level graduates, i.e., from technikons or FET colleges. Further, when in 2002 JCI created a dedicated HR director position, based in PE, the manager concerned undertook a thorough assessment of the match between individual capabilities and job descriptions. This revealed widespread gaps among mid-level management, especially in terms of problem-solving, independent initiative and teamwork. Since this assessment was a first for JCI, it is not possible to compare these findings to a baseline. It does suggest at the very least a contradiction between formal skills certified by the education system on the one hand and the underlying competence as perceived by industry on the other. To some extent this applies also to management where competences in manufacturing and logistics are in short supply and are in need of professionalization. The higher education system does not turn out graduates who possess these skills and could readily be plugged into ongoing

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operations. This is why recruitment for management-level positions pretty much shuns candidates straight out of university and only goes for people with experience. Senior staff are involved in six-sigma training and mentoring, widely used in the global automotive industry. Training in a project management learner programme is currently being investigated with a provider from Gauteng because JCI cannot find a suitable partner in the Eastern Cape. For Venture, a producer of bumpers and fascias, the key challenge, as elsewhere in automotive supply, is to attain zero defects. Because bumpers are highly visible and faults can be spotted even by non-experts, this is even more imperative. Meeting this challenge in operational terms necessitates keeping up with the (advancing) production technology, prominently through the establishment of quality systems, and upgrading the skills of the workforce. The carmakers assist in this regard. The adherence to total quality management systems (TQMS) is largely a top-down process whereby management transmits the principles of the system to shop-floor employees. In keeping with the need to upgrade capabilities continuously, from 2002 the minimum entry requirement of permanent employees is a three-year degree or diploma. Hence, Venture only hires tertiary education graduates; motivated exceptions, for example for employees with specific training as artisans or spray painters, must be authorized by the CEO. The company takes in roughly 18 new graduates per year at head-office level. They are put through a six-month six-sigma training at the end of which they give a presentation to the board. The board on average decides to retain some 50 per cent of the cohort. Venture also offers a practical sabbatical to technikon students who want to work in the company to get some experience. With respect to human resource development, there is not quite the desirable level of on-the-job training. This is not due to a lack of awareness or commitment on the part of the company. Instead, it reflects the simple truth that the staff that would be doing the training are very busy. While it is not easy to take employees off production for external training, a lot of this type of training does take place. In general, Venture does not perceive a dramatic skills problem. Interested graduates from the technikons are plentiful. This includes graduates from the Port Elizabeth and Border Technikons. Difficulties exist at the high end, where engineering competencies in paint technology are hard to come by. Perhaps the most interesting insight from this interview is that, contrary to many other firms and stakeholders interviewed in the course of this study, Venture is not daunted by the skills problem at shopfloor level, although it agrees that it exists in very specific applications.

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It does not even have anything negative to say about the two local technikons, which were lambasted severely by two inside interviewees that claimed that industry do not want their graduates, and for good reason. This suggests that different automotive firms have different tolerance thresholds regarding how long it takes for a new employee to earn his or her keep. Alternatively, it might be that the technikons and the education system more generally are more or less effective at producing some as opposed to other skills, or that more labour-intensive processes are easier to handle than those that require, e.g., the mastery of programmable machinery. First National Battery (FNB) is not an exclusive automotive supplier and contracts with vehicle manufacturers (DCSA, BMW, Toyota, Nissan, MAN trucks) represent only 10 per cent of its turnover. Nonetheless its integration into the automotive supply chain has had a huge impact on the quality of the operation. In short, FNB upgraded its production line (in February 2004 with a R20 million investment into a new dedicated and much more capital-intensive line) and also upskilled its workforce by hiring more artisans, putting workers without high school through adult education and training programmes, organizing apprenticeships, signing up with the Toyota Academy and engaging in downstream training activities at the retail end. The employees recruited internally were qualified artisans with some experience in automated machinery. They were sent to Austria and the UK for on-site training by the suppliers of the new production line. Hence, former artisans have now become machine operators. The new hirings were all technikon graduates and joined their colleagues for on-site training in Europe. In sum, FNB was faced with a situation where because of its exposure to demanding requirements by car assemblers it invested into process upgrading. This, in turn, required an upgrading of the skills of parts of its workforce that had so far been involved in more labour-intensive processes (leading to essentially the same product, however). Hence it had to master technical change engendered by the new production technology. This did not entail major problems either in terms of internal skill upgrading or with respect to new skill acquisition. The only serious competence bottleneck exists at the higher end, i.e. in industrial engineering. Battery manufacturing relies on the combination of metallurgy and chemistry, which as such is not embodied in any standard professional qualification. From 2006, FNB plans to sponsor students at PE Technikon and at Wits Technikon, hoping to remain on their radar screen once they graduate and are ready for the job market. Unlike the local Border Technikon, these two technikons have shown a positive

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response in terms of career development. In sum, FNB is a company that has risen to the challenge of becoming an automotive supplier, while using knowledge newly gained through exposure to this supply chain to fertilize its other business. Fabkomp manufactures a range of vehicle parts, components and accessories. It supplies 85 per cent of production to DCSA’s truck division. To date its components do not go into vehicles manufactured for exports. The long-standing involvement with DCSA has required Fabkomp to introduce quality systems and meet the challenge of continuous improvement. Internally, this refers generally to good housekeeping, safeguarding environmental standards and open book accounting. It also involves supplier development. The technical capabilities of the company evolved over the last decade from processes such as bending and welding to the operation of CNC machines, replete with the programming of associated equipment, and tool-making. Fabkomp is ISO9002 accredited and in the process of acquiring TS16949. For Fabkomp the Eastern Cape is not a good area to find skills readily exploitable on the shop floor. This puts companies in the Eastern Cape at a competitive disadvantage vis-à-vis more productive parts of the country insofar as wages mandated by the industry-wide bargaining council apply across the sector and do not take regional differences into account. It also means that companies have no choice but to train internally. Specific skills that are hard to come by – and this is borne out by evidence from the automotive industry across the country – are tool-makers and machine programmers. Fabkomp is negotiating with a local college about a customized tool-making course, but it is concerned about the cost of training in view of possible poaching of the newly-trained staff by its competitors. Fabkomp is evidently an example of the disciplining force of the carmakers even in the absence of a direct link into export supply chains. Hence, while quality requirements may be yet more onerous for supply chains geared to export markets, the exposure to global assemblers engenders learning and skill upgrading even when they stick to local markets for the time being. Furthermore, it is clearly entrepreneurial dynamism that influences how well a company rises to the challenge. Fabkomp concurs with other companies and training providers interviewed for this study that the public-sector education and training authorities (Setas) are cumbersome institutions marred by red tape. Yet unlike many of its peers, it has nonetheless succeeded to get registered for more than a dozen skill profiles. Education and training providers also address the skills deficit made more conspicuous by the presence of the automotive industry. For example, the University of Fort Hare (UFH) took over the East London campus of

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Rhodes University at the beginning of 2004. The strategic intent behind this move is to relocate part of its commerce and science faculties into a more urban setting that facilitates closer interaction with industry and enhances the attractiveness of select study programmes. From the perspective of this study the two most relevant programmes are the undergraduate degree course in information systems science and the postgraduate course in computer science engineering. The latter degree in particular is an attempt to deepen the professional profile of Fort Hare graduates. Fort Hare also trains an annual cohort of some 300 students in accounting. Fort Hare tries to capitalize on existing, and build new, links with industry. Thus, information science faculty is seconded to DCSA for stints as long as one to two years. In addition, DCSA’s HR director is a member of Fort Hare’s council. Hence, in terms of quality assurance and curriculum design and development, UFH interacts with outside stakeholders, including representatives of the Eastern Cape Provincial Legislature and Buffalo City Municipality, who are also members of the university council. As part of the national priority to promote science and technology at primary education level, the Fort Hare education faculty has joined the national utility provider and the provincial Department of Education in rolling out a science and technology programme for grades five to ten in parts of the province. Although Fort Hare does not have an engineering faculty, it does train skills and competences in the services, especially IT, that provide key support functions both to the automotive industry and to industry more generally. The attempt to build up a presence in a more urban setting, which is attractively located in the vicinity of the harbour, suggests that higher education institutions can and do pursue strategic directions that make sense in and of themselves and fit in with the regional and national human resource development priorities. UFH also reported discussions with the Eastern Cape Development Corporation about attracting strategic investment in electronics to the region and hence appears more interactive than most other interviewed stakeholders. The Leadership Development Institute (LDI), a spin-off of the East London campus of Rhodes University and affiliated with UFH, offers courses in adult education accredited by the Department of Education (DoE). It contracts mainly with public authorities and with industry. In 95 per cent of the cases employers finance these courses for their employees. The courses most relevant for the purposes of this study are those broadly aimed at project management and production organization. They are pitched at various levels (i.e., from supervisors to middle management) and last from a week to half a year. LDI also used to offer a proper diploma course on manufacturing management, sourced from the University of

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Technology, Sydney, which it had to discontinue because of the withdrawal of accreditation by DoE. The programme produced about 100–125 graduates, most of whom are employed by DCSA and component manufacturers, but also outside the automotive industry. In terms of its student portfolio, in 2004 about one sixth of the total annual enrolment (240–300 students) comes from the automotive industry. This is markedly different from 1999/2000 when training for DC accounted for 80 per cent of LDI’s business volume. Hence, other companies from other sectors have become important customers, and this is a welcome development. Compared to other training institutions interviewed for the purposes of this study, LDI appears to be a much nimbler and smarter operator. The fact that is has no problem recruiting local faculty and that its courses are in demand suggests that it is possible to harness locally available resources for globally controlled supply chains. Training providers who claim the contrary might, in fact, not be totally attuned to what sort of competences exactly employers are looking for. In conclusion – and this was borne out by all interviews conducted for this study – following expansion DCSA did affect the local supply of and demand for skills in a major way, with important repercussions for the regional economy. Importantly, this seemed to be independent of ownership, tier, product portfolio and market orientation, with spillovers into non-automotive activities. Therefore, the effect of globalization on human capital is rather clear, and in this case has been very beneficial to the region and beyond. It is not pervasive, however. Assessments of the technikons by internal and external stakeholders suggest – though there was no unanimity in this regard – that the importance of the automotive sector for the local and provincial economy is not reflected by what goes at the technikons in terms of recruitment, career development, student placements, other forms of relationships with industry, or the general strategic orientation of the institution. Furthermore, the commitment to and the implementation of quality (assurance) systems, which was brought about by the arrival of the assemblers in the automotive industry and beyond, does not automatically lead to the acceptance of this principle by stakeholders in the education sector, whose mission is in principle intimately linked to industry. Finally, there is a big discrepancy between the high degree of motivation and competence in evidence throughout the automotive supply chain and the lackadaisical attitude of some education managers.

DCSA and regional economic development in the longer term The importance of the automotive industry to economic activity in the Eastern Cape is generally recognized. This case study has shed light on

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DCSA’s role in this regard. In substance it argued that the state of human resources in the province was so deficient that the Eastern Cape would not have been an obvious choice for a multinational assembler trying to expand its global footprint. In other words, if DCSA had not had a sunk investment in East London it is difficult to imagine that it would have chosen East London as a site to develop an export platform ex novo. The analysis also demonstrated that once DCSA had committed to integrating the East London plant in its global supply chain, it set about upgrading local human resources in a major way. These findings do not contradict the hypothesized two-way causality between globalization and education but they suggest that the relationship is uneven in this case. More precisely, education was not a location-specific advantage of East London or the Eastern Cape more generally when the investment was undertaken. But because of their relative weakness, local human resources became the object of intense upgrading efforts by the multinational; this, in turn, is likely to change local capabilities over time and, thanks to spillover effects, outside the automotive sector and the province as well. Therefore, in the short and medium term – whereby medium term refers to the six to sevenyear product cycle of the new W204 C-Class model – DCSA has a positive influence on economic development in the Eastern Cape and especially the area around East London. What remains to be discussed is the relationship between the multinational and the host region in the long term, i.e., beyond the future model cycle into the next decade. This is a pertinent question for a number of reasons. Supply contracts are not set in stone and thus not written for eternity. DCSA had to compete against other parts of DC in order to win the W203 export contract. Within DC this is a zero-sum game in that cars produced in East London are by definition not produced in existing C-Class plants in Bremen or Sindelfingen and also not in other locations around the world that DC already operates or might decide to develop. In the course of 2004 DC used the option to relocate a larger part of the C-Class production to South Africa as a bargaining chip in its negotiations with German trade unions over the need to cut costs. This obviously works both ways and DCSA had indeed hinted in 2001 that the future of the East London plant might be in danger in favour of an increased output manufactured in Germany. Regardless of the nature of this brinkmanship, what counts is that relocation is indeed a real possibility. Changes in model generation open up negotiations with system integrators and first-tier component suppliers, who in turn renegotiate from whom and where to source parts and components. Some win and some lose, and it is unlikely that the workforce of an unlucky follow-source bidder who had built up a presence for a previous model gets absorbed

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wholly by the lucky successor. In the worst scenario, components that were previously locally produced but for which just-in-time production (JIT) is not strictly necessary are substituted by imports, thus pretty much ensuring that the resulting unemployment is not just frictional. Despite the fact that upwards of 80 per cent of the world’s population is not motorized, current and prospective automotive capacity outstrips demand, which is why no production facility anywhere in the world is assured a future. This is especially the case for marginal producers such as South Africa because the political fall-out from plant closures would be easier to stomach than in core locations in Europe or North America. In this sense, in anything but the medium to longer term, the most costefficient plant may not be the one whose future is politically most viable. But to the extent that efficiency considerations are becoming ever more paramount because capital markets force car manufacturers to earn an adequate rate of return or face the music, it is important to realize that, due to the sheer size and growth potential of their domestic markets, plants in India or China have scale advantages going for them that will elude operations anywhere in Africa for a long time to come. Historically, the demand for cars has varied with their relative prices and the level of income and wealth (Rhys, 2004). Everything else being equal, this militates against car plants in low-income, low-volume and low-growth environments such as southern Africa. In addition, DC is not immune against the problems that have plagued its lesser rivals for some time. In early 2005, it made headlines for massive recalls due to quality problems with E-Class models, mounting losses at its Smart subsidiary and concern about the sustainability of Chrysler’s return to profitability. This is not appreciated by policy planners in the Eastern Cape. In the conversation with the Eastern Cape Development Corporation (ECDC), the interviewees expressed the view that:

1. The automotive industry’s presence in South Africa is not much influenced by the MIDP. In other words, assemblers assess the locationspecific advantages of the Eastern Cape net of the benefits afforded by MIDP. 2. The long-term future of those assemblers not located close to ports (e.g., Ford, Nissan, BMW) is likely to be somewhere along the coast, for example in East London, in order to facilitate their logistics. 3. South Africa offers competitive labour costs vis-à-vis alternative locations, for example, in Eastern Europe. Hence, the aggressive promotion of textiles, agri- and horticulture, food processing and tourism is not

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meant to supersede the car industry but develop alongside it. To this end, the emerging provincial HRD strategy will reflect multisector requirements, and the Industrial Development Zone (IDZ) will accommodate an automotive supplier park but also tenants in electronics, agro-processing and logistics. As for the first claim, although the benefits of the MIDP for the component industry and especially for consumers are controversial, there is general agreement that the MIDP was instrumental in attracting FDI from the carmakers and that it raised the competitiveness of assemblers with export platforms relative to those that merely imported (e.g. Barnes et al., 2004). It is not clear why ECDC arrives at a different assessment. Once tariff protection is totally phased out, weaknesses of human capital will obviously become more evident. But the ECDC’s different view explains why they take it for granted that there will be a long enough time horizon for the car industry – beyond the planned end of the MIDP in 2012 – to relocate plants within the country. Regarding the third claim, even if wages were in every instance lower than in Eastern Europe or Asia (which they are not), the prevalence of HIV/Aids and the deficient skill profile of the workforce obviously affect productivity negatively and thus drive up labour costs. In sum, the automotive industry and provincial planners do not see the world through the same lens and differ greatly in their assessment of the relative competitiveness of the province nationally and internationally. This hides a larger issue. In the presence of much serious consideration that the future of the automotive industry in South Africa might not be long-term, it should be paramount to prepare for a scenario that no longer anchors local fortunes to one primordial foreign investor. Operationally, the most important question in this regard is if and how the human capital created over the last decade or so thanks to the impulses brought by the automotive industry can be brought to fruition in other sectors, and which these might be. Whether it is operational competitiveness or more tacit forms of knowledge built up through mastering sophisticated manufacturing operations and through engaging with foreign technology – and the continuous change to which they are subject – it would be a waste to lose this accumulated human capital. This already looms on the horizon. Leoni lost the successor contract for the W204 in favour of Delphi. Unless Leoni secures a contract with another assembler or perhaps as subcontractor with Delphi itself, the plant in East London will close. At present JCI seems to face a more certain future but, of course, that may well change when the new model cycle

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comes to an end, so the Leoni experience illustrates a larger point. What happens to Leoni’s workforce and the experience it embodies depends in part on whether DCSA will prevail over Delphi, currently operating only from Botswana, to set up shop in East London. The trade-off between cost and logistics in the highly labour-intensive manufacture of harnesses sees Delphi at one end of the argument and DCSA at the other. If Delphi moves, it might absorb some of Leoni’s workforce. Arguably, however, from the point of view of what would be desirable for local and provincial economic development, this human capital would find productive uses even in the absence of Delphi or DCSA, i.e., in case the assembler left South Africa following the expiration of the MIDP in 2012. Local Leoni management thinks that if or once the group leaves, it could retool the operation on the basis of the existing workforce with its skill profile and make itself available as a contract manufacturer from across a wide portfolio of industrial activities, including air conditioning, dashboards, electronics, food processing, pharmaceutical and clothing. Similarly, Fabkomp is exploring supply or assembly opportunities with a view to diversifying its order portfolio. But in addition, and perhaps equally importantly, it actively markets itself as a manufacturing partner specialized on providing flexible production runs, including for niche markets for a wide range of applications. This would include sectors in which it has no track record so far. Much like some component suppliers interviewed for this study, such as FNB, LDI seems to have capitalized on the learning challenges foisted upon the local economy by DCSA without making itself too dependent on the carmaker. In terms of sustainable human resource development it would appear, therefore, that this is much more congenial to a potential automotive-free future in the Eastern Cape than ‘hot-air’ industrial diversification strategies promulgated by regional authorities. In assessing which industrial strategies prove more or less feasible, provincial industrial policy as espoused by the IDZ in East London or the nationally driven Coega industrial park in Port Elizabeth do not appear helpful (see also the criticism in Mayer, 2004, Sections 7 and 8). The absence of anchor tenants years after these schemes were first touted suggests that even larger firms are not convinced of the viability of these industrial parks; by implication, they are not really an option for smaller outfits. Leoni’s perspective suggests that provincial development authorities pay a lot of attention to attracting new industrial investments, especially FDI, but that there is a lot less focus – or maybe none – on retaining accumulated absorptive capacities in the form of multinational firms who, for whatever reason, extricate movable capital equipment and

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strategic assets such as group-internal core competences but who leave skills and also a fair amount of tacit production and process knowledge behind. In the context of the automotive industry – indisputably the primary technological and organizational core of economic upgrading in the region – this suggests at best a lucky mid-term horizon with a high risk of running foul of events beyond the control of provincial or even national policy-makers, namely the fickleness of the key players in global automotive assembly. In other words, local development strategies with enough foresight would accompany the justified courting of DCSA with at least some brainstorming in conjunction with industry and other stakeholders about a possible post-DC world. At the local Leoni and numerous other component supplier plants, this is certainly of interest to management and employees. It is not clear that public stakeholders such as ECDC appreciate this, let alone guide attendant soul-searching. This implies that what may endanger the future of the regional economy is not so much local capabilities per se, but a failure to coordinate the setting of priorities, identification of linkages and selection of public interventions within a larger vision for local development in the face of global change (see Lall and Teubal, 2001). A final point in this regard concerns the ‘industrial atmosphere’, as Marshall put it. Automotive firms are but one industrial sector that agglomerates in the area around East London, alongside a series of education and training providers that at least in principle, however imperfectly, cater to their needs, and public sector institutions committed to uplift the economic and social fortunes of the province. For this agglomeration to generate externalities, firms and other actors must exchange information. The more they talk, the richer the ‘industrial atmosphere’ becomes that is behind the success of clusters or also more diversified regional economies in many parts of the world. In East London, it seems, there is very little talk. The automotive firms do not have a space in which conversations about economic development in the Eastern Cape more generally or problems with the operational competitiveness of the sector more specifically happen. Participants in the final workshop were unequivocal about this and identified the attraction and retention of a high-skill professional class to the area, and entrepreneurship training in higher education, as key problems warranting attention. There is generally little interaction in East London’s industrial system that links firms along a dedicated supply chain in any way other than from customer to supplier, or that makes industry engage with the public and the education sector in a more strategic context aimed at jointly addressing problems common

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to the region. The example of the Durban Automotive Cluster (DAC) illustrates that such a space has informed and animated the industrial climate, especially in view of technological upgrading, in other parts of the country (Lorentzen, Robbins, and Barnes, 2004). In fact, evidence from around the world suggests that the benefits of spatial agglomeration rarely manifest themselves fully unless helped along by joint action that commits firms to a common purpose (Schmitz, 1999). For firms to share a location is in and of itself unlikely to bring about the synergies economic development in a latecomer-country context requires, especially in terms of exploiting the full range of learning effects systemic interaction facilitates for industrial upgrading. The success of the automotive sector in East London obviously relies on the commitment of many entrepreneurs and their employees. But it could not have happened without the organization, discipline and financial backing that allowed DCSA to take charge and drive this process. Ultimately, DCSA is in the business of designing, assembling, marketing and selling cars and related services. It is not in the business of developing the Eastern Cape, and although there may be a temporary overlap between the two activities, this is unlikely to remain the case for reasons pointed out above. Put differently, the Eastern Cape and DCSA have different agendas. One fundamental difference is that DCSA can react to changes in the global economy by packing up and leaving.

6. Conclusion The most important insights of the case study are, first, that the integration into global supply chains can have a profoundly positive impact, through education and training, on local human resources and, second, that such good luck need not imply that the beneficiaries will live happily ever after. The challenge is to organize industrial development sustainably in the face of a global economy that may favour a specific location one day and abandon it the next. Addressing this challenge is a monumental task. It is pretty certain that the private sector will not rise to it by itself. It would likely require a concerted effort from provincial and local authorities in conjunction with key firms and education and training providers, perhaps assisted by a dedicated service provider. It does not bode well that no one outside ECDC remarked on the existence of such a much needed conversation in East London or elsewhere in the Eastern Cape. This poses an open question: who’ll initiate the talk?

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Note 1. Technikons are comparable to polytechnics. In the ongoing reform of the South African higher education system, they are renamed ‘universities of technology’, which implies that they are expected to do research on top of their traditional teaching-only mandate.

References AfDB/OECD (2004) African Economic Outlook, www.oecd.org Asiedu, E. (2001) ‘On the determinants of foreign direct investment to developing countries: Is Africa different?’, World Development, 30(1): 107–19. Barnes, J., Kaplinsky, R. and Morris, M. (2004) ‘Industrial policy in developing economies: Developing dynamic comparative advantage in the South African automobile sector’, School of Development Studies, University of KwaZulu-Natal, Durban [mimeo]. Barnes, J. and Morris M. (2004) ‘The German connection: Shifting hegemony in the political economy of the South African automotive industry’, Industrial and Corporate Change, 13(5): 789–814. Black, A. (2001) ‘Globalization and restructuring in the South African automotive industry’, Journal of International Development, 13: 779–96. Blomström, M. and Kokko, A. (1998) ‘Multinational corporations and spillovers’, Journal of Economic Surveys, 12(2): 1–31. Carrillo, J. (2004) ‘Transnational strategies and regional development: The case of GM and Delphi in Mexico’, Industry and Innovation 11(1–2): 127–53. DaimlerChrysler (2005) Innovations for Our Customers: Annual Report (2004) www.daimlerchrysler.com Degli I.N. (2000) ‘Car groups show wary foreigners the way’, Financial Times, 6 October: 3 (Surveys Edition). Dunning, J. (1993) Multinational Enterprises and the Global Economy, Wokingham: Addison-Wesley. Financial Times (2001) ‘German carmaker “Will not Leave S Africa” ’, 17 August: 3. Lall, S. and Teubal, M. (2001) ‘ “Market-stimulating” technology policies in developing countries: A framework with examples from East Asia’, in S. Lall (ed.) Competitiveness, Technology and Skills, Cheltenham: Edward Elgar. Lorentzen, J. and Barnes, J. (2004), ‘Learning, upgrading, and innovation in the South African automotive industry, European Journal of Development Research, 16(3): 465–98. Mayer, M.J. (2004) ‘Overview of the Eastern Cape Economy’, in A Strategic Review of the Eastern Cape’s Labour Market, Final Report, HSRC, Employment and Economic Policy Research, Pretoria. Narula, R. and Dunning, J.H. (2000) ‘Industrial development, globalization and multinational enterprises: new realities for developing countries’, Oxford Development Studies, 28(2): 141–67. Rhys, G. (2004) ‘Which way is the auto business headed?’, European Business Forum, 18: 59–60. Romer, P. (1990) ‘Endogenous technological change’, Journal of Political Economy, 98: 71–102.

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Schmitz, H. (1999) ‘Collective efficiency and increasing returns’, Cambridge Journal of Economics, 23(4): 465–83. Statistics South Africa (2004) General Household Survey (July [2003]), Pretoria. te Velde, D.W. (2005) ‘Globalisation and Education: What Do the Trade, Investment and Migration Literatures Tell Us?, Overseas Development Institute, London [mimeo]. UNCTAD (1994) World Investment Report 1994, New York: United Nations. ——— (2004) World Investment Report (2004): The Shift towards Services, New York and Geneva: United Nations. UNDP (2004) South Africa Human Development Report (2003), www.undp.org UNIDO (2002) Industrial Development Report (2002)/(2003): Competing through Innovation and Learning, www.unido.org Vass, J. (2004) ‘The Impact of HIV/Aids on the Eastern Cape’s Economy and Labour Market’, in A Strategic Review of the Eastern Cape’s Labour Market, Final Report, HSRC, Employment and Economic Policy Research, Pretoria. Wall Street Journal (1998) ‘DaimlerChrysler plans to inject $146.7 million in South African plant’, 27 November: 1. Woolard, I. and Woolard, C. (2004) ‘The Nature, Size and Composition of the Eastern Cape’s Labour Market’, in A Strategic Review of the Eastern Cape’s Labour Market. Final Report’, HSRC, Employment and Economic Policy Research, Pretoria.

8 Outside the Triad: An Examination of International R&D Investments within Peripheral Economies Björn Ambos and Tina C. Ambos

1. Introduction Corporate R&D, traditionally one of the most shielded and most centralized activities in the corporate value chain, has experienced a rapid internationalization over the last decade and a half. The risks of technology leakages, expensive double inventions, difficulties to control and a desire to reap economies of scale have traditionally led firms to concentrate their R&D activities within close proximity to corporate headquarters (see Ambos and Schlegelmilch, 2004; Pearce, 1989). A changing competitive environment, the increasing dispersion of knowledge and the concentration of competencies in so-called ‘pockets of knowledge’ around the world, has forced firms to absorb the risks of loosening control on their core competencies and to set up R&D units in overseas locations. The growing body of literature on international R&D has already provided us with valuable insights on the firms’ motivations to internationalize R&D activities, on the location of R&D activities and, to a lesser extent, on issues of coordination and control of international R&D networks. A communality of many of these studies is that they look at international R&D as a phenomenon of the triad nations (Archibugi and Iammarino, 2002; Gassmann and Zedtwitz, 1999; Meyer-Krahmer and Reger, 1999; Schmaul, 1995). As Narula and Dunning’s (2000) study shows, we do not have much information on those investments that are outside the triad. The absence of research on these laboratories is alarming for at least two reasons. First, with more and more firms deciding to establish R&D laboratories in emerging economies like China, India and Brazil, it becomes important for them to know whether management tools and techniques developed for core countries are also applicable in these new contexts. Second, as R&D arguably is the key to economic 188

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development, such research has potential important implications for policy-makers who may want to attract inward FDI in R&D to foster development of these countries. The aim of this chapter is to shed some light on international R&D activities in non-triad countries. We rely on a large-scale dataset of international R&D investments by German firms, who collectively account for two-thirds of the country’s privately funded R&D expenditures. The dataset includes 25 investments in non-triad countries, which will be in the focus of the present investigation. Given the scarcity of prior knowledge in this area our approach here is rather exploratory. In particular we aim to explore the following questions: • To what extent do MNCs invest in ‘peripheral’ (non-triad) countries? • How are these foreign R&D units managed? We will proceed as follows. In the next part, we will discuss the stateof-the-art of internationalization of corporate R&D and try to specify the research questions, which guide our analysis. Subsequently, our sample and the study are described, followed by a comparison of internationalization activities in triad and in non-triad countries. Thereafter, referring to our second research question, we analyze the characteristics of R&D units in non-triad countries and show differences in current management practices as well as performance implications. The chapter ends with a conclusion of our findings and an outlook for future studies.

2. Internationalization of Corporate R&D There have been several undertakings to investigate the motivations of international R&D (Ambos, 2005; Brockhoff and Schmaul, 1996; Dalton and Serapio, 1995; Håkanson and Nobel, 1993a,b; Pearce, 1989; Pearson et al. 1993; Zedtwitz and Gassmann, 2002). Their findings emphasize the proximity to research clusters (Kuemmerle, 1999; Pearce and Singh, 1991; Pearson et al., 1993; Porter and Stern, 2001), the proximity to lead markets (Pearson et al., 1993; Håkanson and Nobel, 1993a,b), subsidies paid by local governments (Cantwell and Mudambi, 2000; Håkanson and Nobel, 1993a) and the companies’ existing stock of knowledge (Gerybadze and Reger, 1999). And while the ultimate reasons for establishing a particular unit at a given location may be numerous and very idiosyncratic, researchers widely agree that R&D laboratories can be broadly classified into a few ‘archetypes’. In their seminal study on the internationalization of Swedish R&D units, Håkanson and Nobel, for

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example, identify more than 20 motivations, which, as the authors demonstrate, can be grouped into five distinct laboratory types: market driven, research driven, politically motivated, production support driven or driven by a combination of the above (multi-motive). Other researchers, who were less concerned with the drivers of the investment decision than with answering the question: ‘What does the R&D unit actually do?’, could demonstrate that R&D units can be usefully divided into two categories: those seeking to exploit an existing technology or capability of the firm (i.e., capability-exploiting laboratories) and those established to create, augment, or explore new knowledge, or to augment the firms’ existing capabilities (i.e., capability-augmenting laboratories) (Ambos, 2005; Ambos and Schlegelmilch, 2004; Chiesa, 1996; Chung and Alcacer, 2002; Kuemmerle, 1997; 1999; Le Bas and Sierra, 2002; Patel and Pavitt, 1991; Zedtwitz and Gassmann, 2002). While much more research remains to be done, these studies already provide important insights on where to locate and how to manage these two types of R&D. Kuemmerle (1999), for example found that capabilityexploiting laboratories are primarily located within important-led markets, whereas a firm’s propensity to invest in capability-augmenting laboratories has been linked to the quality of the human resource pool, the level of scientific achievement in the target community as well as the host countries’ own commitment to R&D. Ambos and Chini (2004) Chiesa (1996), Håkanson and Nobel (1993a;b) and Pearson et al. (1993) largely support these findings. Yet, as Ambos and Chini (ibid.) demonstrate, there are other important factors in this decision than host country characteristics. In their analysis, psychic distance and R&D intensity of the firm turned out to be more important than the local science base, for example. Following these studies, most non-triad nations shouldn’t attract much inward R&D investments at all, as they usually neither have an important market nor a sophisticated technological science base. Indeed, as Narula and Dunning (2000) point out, the FDI potential of stage 1 and 2 countries (i.e., those which are in very early stages of economic development) to attract R&D is limited to adaptive R&D. To understand (general) FDI in non-triad countries, many researchers relied on a stage model of economic development (see Rostow, 1960). However, we have to bear in mind that most of this literature originates from an economic development or foreign aid perspective. While this stream has brought important insights on investment patterns according to stages of development, these findings might not be applicable to the research question at hand. First, most research has taken an aggregate economic or institutional lens on FDI patterns and mostly ignored the motivations of

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multinational firms. Second, the specific requirements and drivers of investment in R&D might significantly differ from other kinds of FDI. Third, many studies seem to ignore the fact that competitive – or at least comparative – advantages do not necessarily develop on the country, but rather on the industry level (see e.g., Porter, 1990). As MNCs aim to tap into so called pockets of knowledge, it is evident that industry advantages provide an important basis for R&D investments. Thus, to explain R&D investments in non-triad countries, two lines of argumentation seem to prevail. The category of arguments, already put forward in some of the previously mentioned studies, is essentially Ricardian: countries will specialize in those activities in which they possess a comparative advantage. Economies in their early stages of development do not possess specialized factor endowments (i.e., highly skilled labour needed to conduct R&D), consequently the level of R&D within the country and the attractiveness to FDI will be low. According to this view the most likely candidates of inward FDI in R&D appear to be those countries that do possess a high-skilled and abundant pool of workers capable to engage into R&D. In particular this holds true for ex-communist countries like Romania, Poland or Russia, with a large labour pool of highly skilled physical engineers, or countries like India and China, who traditionally have a very good science base (Zedtwitz, 2004). Whether MNCs really base their R&D location decision on cost differentials remains controversial. Speaking to many R&D professionals we got a sense that access to cheap labour was not a prime criterion. As one R&D manager put it: ‘The times where you would go abroad to source cheap labour are over: a top-skilled R&D engineer in India almost costs as much as in the US, or Germany.’ Informed by the product-life-cycle theory of MNC internationalization and the prospects to exploit gained advantages (e.g., Vernon, 1966), the second stream of arguments indicates that FDI might be motivated by size and importance of a market. According to this school, the potential for R&D in non-triad countries would be limited to a small number of countries that do have a large enough size to attract capability-exploiting R&D, such as Brazil, India, China. Alternatively, countries that serve as hubs for a whole region might become the focal point of interest. For example, Evobus, a subsidiary of DaimlerChrysler, use their R&D lab in Istanbul to adapt and modify their coach buses to the Middle East. Among others, their activities include changing the suspension in order to make the buses more suitable for bad road conditions. The above arguments show some rationales of MNCs to establish R&D locations in non-triad countries. However, it is not clear how prevalent

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this phenomenon is and how it compares to investments in triad countries. This leads us to our first research question: ‘To what extent do firms invest in non-triad nations?’ Exploring the motivations behind MNC internationalization and the mandates they assign to their overseas R&D laboratories is the easier task; the management of dispersed innovation networks is arguably much more difficult (Ambos and Schlegelmilch, 2004; Cheng and Bolon, 1993). Literature has produced several attempts to link management and control processes to key organizational and laboratory characteristics (Ambos, 2002; Birkinshaw, 2002; Brockhoff and Schmaul, 1996; Nobel and Birkinshaw, 1998; Schmaul, 1995). Only few studies today have made a stab at examining the impact of the environment on subsidiary roles (Benito et al., 2003) or the management processes used (Ambos, 2005). Despite the recent progress in uncovering managerial issues in international R&D the field is still fragmented (Ambos and Schlegelmilch, 2004). Thus, rather than testing any explicit hypotheses, we will focus on some of the most salient attributes of R&D laboratories and investigate whether differences exist, and how they might manifest. Our investigation is guided by the question ‘How are these foreign R&D units managed?’, which affects several areas of research. First of all, it is important to investigate what kind of foreign R&D unit is established in non-triad nations. Then, questions concerning the integration of non-triad laboratories (NTLs) into the global organization arise. Other decisive factors are the embeddedness in the host country environment and, as mentioned above, the use of coordination and control mechanisms. Last but not least, we will explore the performance of NTLs compared to triad laboratories (TLs).

3. The Study Data for this study was collected via a survey conducted in 2000 on the internationalization and management of overseas R&D in German MNCs. The dataset used in this study contains detailed information on 134 overseas R&D investments by 49 German MNCs. With an average turnover of 5.5 billion euros, and an average workforce of 34,000 employees, sampled firms are among the largest corporations within our set target population (all industrial firms with overseas R&D activities listed within the German Top 500). Collectively, the surveyed firms account for about two-thirds of Germany’s privately funded R&D in 1999, indicating that international R&D is merely a large firm phenomenon. Quite typical for Germany’s industrial activities, our sample spans a wide

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range of industries, with machinery, automotive, chemical and pharmaceutical industries jointly accounting for more than half of the sample (see Ambos, 2005, for a more detailed description of the data). Motivations, pace and extent of German overseas R&D investments largely mirrors that of other nations. Similar to results in other surveys, we find most (82 per cent) of the laboratories within the triad. However, despite this concentration of R&D within only a small number of countries we also find a significant number of laboratories (25) located in peripheral (i.e., non-triad) markets. Generally, there are no apparent differences in terms of size and industry among the firms investing in triad and those investing in non-triad nations. An exception seems to be pharmaceutical companies, which do not invest in non-triad markets at all.

4. The Patterns of R&D Internationalization We start our discussion by looking at our first research question: to what extent do firms establish R&D laboratories in non-triad as opposed to triad nations? To investigate this question we first looked at the pace as well as the aggregated stock of R&D laboratories in both triad and nontriad nations (Figure 8.1). The solid line signifies the cumulative number of R&D sites established by our sampled firms within the triad; the broken line reports the same information for non-triad laboratories for the period of 1940–2000. We conducted the survey in 2000. The positive slope of both lines confirms a trend that has been observed in many recent publications, as it shows that firms are increasingly establishing R&D laboratories in offshore locations. This finding holds true for triad as well as non-triad investments. Yet, while investment in triad nations more or less exploded in the early 1990, no such acceleration can be observed for non-triad investment. Thus, despite the modest increase of inward R&D investments, non-triad nations are increasingly lagging behind, when contrasted with triad nations. To further investigate why our data reveals such an apparent divergence among investments in both sets of countries, we decided to plot the graphs differently according to type of investment (Figure 8.2). Looking at capabilityaugmenting (knowledge-seeking) and capability-exploiting investments separately clarifies a lot. Indeed, much of the accelerated trend in overseas R&D within the triad can be explained by a rapid internationalization of capability-augmenting investments throughout the 1990s. Why are non-triad nations increasingly lagging behind in attracting R&D? In the theoretical part of the paper we specified three reasons to build up R&D laboratories in non-triad nations: to appropriate factor cost

Examination of R&D within Peripheral Economies 80 70 60 50 40 30 20 10 0 19 40 19 44 19 48 19 52 19 56 19 60 19 64 19 68 19 72 19 76 19 80 19 84 19 88 19 92 19 96 20 00

R&D sites (cummulative)

194

Year of establishment Triad laboratories

Figure 8.1

Non-triad laboratories

Internationalization of R&D over time

R&D sites (cummulative)

80 70 60 50 40 30 20 10

56 19 60 19 64 19 68 19 72 19 76 19 80 19 84 19 88 19 92 19 96 20 00

52

19

48

19

44

19

19

19

40

0

Year of establishment CBA (Capability-augmenting investments)

TL (Triad laboratories)

NTL (Non-triad laboratories)

Figure 8.2 Internationalization of R&D over time: the role of capabilityaugmenting investments.

differentials; to follow and to adapt products to large or important markets; and to tap locally confined and highly specialized pools of knowledge. Our findings do not reject the first two motivations. As the following section and Table 8.1 will reveal, firms do invest in non-triad nations to leverage costs etc (Poland, Romania) and do establish centres in large (or key) markets (e.g. Brazil, China, Mexico). However, as Figure 8.2 illustrates quite clearly, the overwhelming acceleration in international

Table 8.1

Key data Country

Personnel

R&D budget

Market orientation

Research mandate

Local production

Nationality of director

Electronics A Chemical Co A Chemical Co B Electronics B Automotive Co A–1 Automotive Co A–2 Machinery Co F Semiconductor Co A–1 Semiconductor Co A–2 Optical Co Machinery Co A–1 Machinery Co A–2 Machinery Co B–1 Machinery Co B–2 Machinery Co C–1 Machinery Co C–2 Machinery Co D Semiconductor Co B Sports Equipment Co Automotive Co B Telecommunication Co A–1 Telecommunication Co A–2 Telecommunication Co A–3 Machinery Co E Chemical Co C

Malaysia India Brazil Singapore Mexico Czech Rep. Brazil India Singapore Taiwan India India Turkey Poland India Brazil Hungary China Taiwan Romania Brazil Singapore Taiwan Brazil India

21–50 0–20 21–50 0–20 ⬎200 ⬎200 0–20 21–50 51–200 ⬎ 200 0–20 0–20 0–20 0–20 0–20 0–20 0–20 0–20 21–50 51–200 0–20 21–50 0–20 21–50 0–20

12.50 1.00 n.a. n.a. 3.50 3.50 1.00 12.50 20.00 20.00 1.00 1.00 1.00 1.00 1.00 1.00 n.a. 3.50 1.00 1.00 1.00 3.50 1.00 3.50 n.a.

Global Local Regional Global Local Local Regional Global Global Global Global Regional Local Regional Regional Regional Global Global Global Global Global Global Global Regional Regional

Exploiting Exploiting Exploiting Exploiting Exploiting Exploiting Exploiting Augmenting Exploiting Exploiting Augmenting Exploiting Exploiting Exploiting Exploiting Exploiting Exploiting Exploiting Exploiting Augmenting Exploiting Augmenting Augmenting Exploiting Exploiting

Yes Yes Yes Yes Yes Yes Yes No Yes No Yes Yes Yes Yes Yes Yes Yes No Yes Yes Yes No No Yes Yes

Home country Host country Home country Home country Home country Host country Host country Host country Host country n.a. n.a. Host country Home country Home country Host country Host country Home country Host country Third country Home country Host country Host country Host country Home country Host country

195

Company

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Examination of R&D within Peripheral Economies

R&D stems from an increase in knowledge-seeking (capability-augmenting) R&D investment. And the majority of these units is located in ‘pockets of knowledge’, which are, in turn, predominantly found within the triad nations. Only very few of our sampled firms located their capabilityaugmenting activities in one of the rare knowledge clusters outside the triad. Probably even more informative in that respect is the data that we lack: not a single R&D laboratory among the surveyed units was established in Africa, and, with the exception of Brazil, not one in South America. If knowledge seeking becomes the driving force and motive in overseas R&D investments, the prospects of non-triad nations to participate in the quest for inward R&D will be relatively low.

5. Characteristics and Management of Laboratories in Non-triad Nations In this section we turn our attention more explicitly towards the characteristics and management issues related to NTLs. We start with a descriptive account of the 25 R&D units located in non-triad countries, analyze several characteristics and implications for management and, later on, contrast them to management practices targeted at triad country units. Table 8.1 shows the major characteristics of the focal units. The firms in our sample reported on a total of 25 overseas units in nontriad markets. The focal units operate in diverse industries. Firms went to these countries for a variety of reasons, partly reflected in their research mandate. India and Brazil, both large markets, are the most popular locations, with six and five R&D investments respectively in the country. Similarly preferred locations of our firms are Singapore and Taiwan, which are less important in terms of market size but count among the emerging South-east Asian tiger states with important, and highly specialized, technical capabilities. Other units are found in the Czech Republic, Poland, Hungary, Romania – all Eastern European markets that might be relatively easily accessible to German firms – as well as Mexico, Turkey and China. Compared to the overall sample, R&D units in non-triad markets are rather small, employing less than 20 people. (Only 34.5 per cent of the overall sample fall into this category.) The exceptions are the two automotive companies and the optics companies with large research units (200 people and more). There is no indication that R&D units in nontriad nations receive less funding then those in other markets. The budget size rather seems to be a function of industry and task orientation, i.e.,

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capability-augmenting versus capability-exploiting tasks. Semiconductor and optical industries typically require high budgets for their research whereas the available funds in machinery are comparatively low.

Laboratory mission, global integration and local embeddedness To further investigate the mandates as well as the internal and external relationships of triad and non-triad laboratories we conducted a series of bivariate tests. Looking at the laboratories’ mission first, Table 8.1 confirms that most investments in non-triad nations are capability exploiting rather than capability augmenting in nature. The majority of our sample, 20 units, is dedicated to capability-exploiting tasks. The remaining five units fulfill a capability-augmenting mandate. Furthermore, most NTLs are geographically attached to a manufacturing plant. While Ambos (2005) reports the same tendency for all exploitation laboratories, over time this trend seems to change towards more independent R&D laboratories. Another interesting finding relates to the responsibilities of the sampled laboratories. While it might be intuitively plausible to assume that a large share of capability-exploiting laboratories possesses only local, or at best regional, market responsibilities, evidence from our sampled units speaks a different language. While some, in particular chemical laboratories, still possess only local market responsibilities, most R&D laboratories have a global outlook. Statements such as the following seem to reflect the exceptions: The reason for setting up an R&D unit in India is due to the fact that they cannot get the same ingredients in India as in Germany and thus have to do some research to fine-tune and adjust their product using the resources available in India. This came from a manager in Chemical Company A, a specialist chemical manufacturer. But in general terms we conclude that, even in nontriad countries, R&D laboratories do not focus on the local market but concentrate on supplying the global organization. Such findings become clearer when we jointly consider the laboratories’ relationships to other internal partners. Many of them are highly integrated in the global organizational network. Exhibiting a high input and output dependence, they come close to what Birkinshaw (2002) calls modular centres. These units’ mission is to provide inputs that other units subsequently use. Evidence from the focal laboratories shows that the beneficiary of inputs from non-triad units is usually headquarters. Our

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R&D units are highly linked to the headquarters’ operations but maintain far looser ties in horizontal relationships, such as to other R&D laboratories or to manufacturing units. This observation might suggest that non-triad R&D units are rather perceived as headquarters’ agents than other units’ equals in the global organization. Interestingly, a comparison between TLs and NTLs shows that the lateral ties between TLs are much denser. This leaves room for speculation whether NTLs are not part of the MNC model as a ‘differentiated network’ (Nohria and Ghoshal, 1997) but remain ‘ancient bricks’ in the organizational model. Next to the laboratories mission and mandate, the external embeddedness has been found important to explain the management of R&D units in prior studies (Ambos, 2005; Andersson et al., 2001; Asakawa, 1996; Narula, 2005). The underlying rationale is that R&D laboratories need external inputs from the host country environment to work effectively. As we expect the host country environment to differ across TLs and NTLs, this is a potentially interesting area of investigation. To further investigate the degree of embeddedness we computed mean differences for TLs and NTLs for several internal (e.g., central R&D, production, other R&D labs of the firm) and external collaboration partners (e.g., competitors, suppliers, customers, private research institute, universities and government agencies) (Table 8.2). A direct comparison of TLs and NTLs suggests that TLs are slightly more embedded into the local community than NTLs, but – except for customers, competitors and suppliers – none of these relations significantly differs from the non-triad country sub-sample. A series of studies have put efforts into understanding which factors determine the degree of local embeddedness. One of the most prominent impact factors was found to be the nationality of the laboratory’s director (see Asakawa, 2001). While the non-triad units used somewhat higher expatriate ratios than others, this is not reflected in the position of the laboratory director. About half of the units have a local director; the other filled this position with an expatriate. The presumed purpose of these assignments is that local directors might be in a better position to negotiate and link up with external institutions. A look at mean values of embeddedness attributed to TLs and NTLs, however, does not support this argument. Laboratories run by home country nationals were throughout more externally embedded than those units with local directors. The only exception to this trend is their relation to government agencies, where host country nationals seem to score. Still, relationships with governments are generally not strong and it is questionable whether this relationship is simply not important for R&D

Table 8.2

Embeddedness, coordination and control and performance in TLs and NTLs

Internal and external embeddedness TL

NTL

Coordination and control Sig.

Competitors

0.26

0.08

028

Suppliers

1.51

0.92

Customers

2.07

Other firms Private residential institutes Universities Government agencies Central R&D lab Other R&D labs Local production Other production sites

TL

Performance NTL

Sig.

TL

NTL

Sig.

2.53

3.92

.000

Patents p.a.

10.06

2.29

.003

.041

Centralization (R autonomy) Personal surveillance

2.67

3.32

.029

77.50

82.82

.249

1.50

.026

Standardization

2.97

3.12

.589

16.08

11.96

.352

0.61

0.46

.458

Formalization

2.85

3.08

.402

16.76

19.25

.613

0.72

0.46

.271

Output control

3.39

3.76

.183

15.57

10.00

.020

1.03

0.79

.358

Planning

3.41

3.84

.081

Successful projects (%) Terminated projects (%) Inefficiency/ slack (%) Time overrun (%) Budget overrun (%)

18.24

17.37

.774

0.54

0.33

.264

Formal networks

3.40

3.17

.379

1.97 1.72 1.91 1.05

2.68 1.04 1.50 0.63

.000 .011 .201 .050

International training Expatriate Control Job rotation (researcher) Social control

3.16 2.27 2.66 3.34

2.96 2.64 2.72 3.68

.507 .170 .814 .217

Personal meetings

3.53

3.52

.958

199

Notes: (a) Measurement scale: 0 ⫽ no relationship, 1 ⫽ weak relationship, 2 ⫽ moderate relationship, 3 ⫽ strong relationship. (b) All items are measured on a five-point likert scale, with 1 ⫽ not used at all to 5 ⫽ used to a very large degree. (c) Average number of patents filed by the laboratory, all other performance indicators are relative measures, indicating the percentage of goal achievement.

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laboratories or whether managers find it hard to link up with local authorities. To understand potential hidden rationales of MNC management it might be worth looking at the number of expatriates within the R&D unit’s management team instead of overall expatriates only. On average, the ratio of expatriates to locals in the management team is quite high in the surveyed units. Although we cannot rule out other reasons, this fact might suggest that the laboratory is formally run by a local but informally controlled by parent country nationals. But this issue definitely deserves greater attention in a separate study.

Coordination and control Generally, NTLs do not deviate much from the control pattern applied to TLs. There are no significant differences for the use of socialization mechanisms, teams etc. revealed (see Table 8.2). Usually the means for NTLs are marginally higher, but do not reach statistically significant levels. The exceptions are mechanisms of personal and direct control. Table 8.2 shows that the categories personal surveillance, centralization and planning are significantly higher. An agency theory perspective underpins these findings. The central assumptions related to the agency view are a potential goal conflict among the principal and the agent and the measurability of outcomes. The latter is important in order to align the appropriate form of control. If the behaviour of the agent is easily observable (complete information), behavioural control – the equivalent of direct control in our study – is deemed more efficient (Eisenhardt, 1989). If the behaviour is not observable the recommended choice is output control (Gencturk and Aulakh, 1995). Assuming that R&D units in non-triad countries are primarily dedicated to capability-exploiting activities, deal to a relatively large extent with explicit knowledge and their behaviour is consequently observable, the use of personal and direct control mechanisms is in line with the theoretical predictions. While the small sample size does prohibit a more rigorous analysis of these findings, the relatively high values for central and direct control among NTLs as opposed to TLs suggest that headquarters tend to keep their reins tight, whereas we have evidence that some units in triad countries are let ‘of the hook’ – especially if they fulfill capabilityaugmenting mandates. Possible explanations for this behaviour include the high uncertainty in many non-triad economies, such as political, inflationary or exchange rate risks, which demand immediate action from the central organization, or cultural and psychic distance arguments (Johanson and Vahlne, 1977).

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Laboratory performance Last not but least our investigation will address the performance of TLs and NTLs. Such an analysis is important as the occurrence of significant performance differences would imply further investigations on why NTLs under- or outperform laboratories in triad nations. To shed some initial light on this question we compared triad and non-triad markets along six separate performance indicators (Table 8.2): the number of patents per annum filed by the R&D laboratory; the percentage of projects completed successfully; the number of projects terminated before completion; the degree of slack or inefficiency within the local laboratories’ operations (as judged by the head of technology at headquarters); and the amount of time and budget overruns. The most striking difference is that NTLs achieved only a fifth of the comparable patent output of TLs. These results even hold when we normalize the number of patents by the size of the laboratory, or when we examine capability-exploiting laboratories only. Thus, at least when using patents as a measure, non-triad laboratories appear to be less innovative. While there are no significant differences observable in the achievement of successful projects, the termination of projects, the inefficiency as well as the budget overrun of these units, time management was significantly better than for TLs. On average they had less than 10 per cent time overruns, compared to 16 per cent for triad country labs. The explanation might lie in the form of control they experience. As discussed earlier, NTLs are exposed to higher levels of direct control and higher planning intensity. Thus, headquarters are also likely to monitor their time management.

6. Conclusion This chapter aimed to shed some light on overseas R&D units in nontriad economies. Pursuing an exploratory approach, several questions concerning the location and the management of R&D units were investigated, mostly by contrasting operations in triad and non-triad countries. However, this study has to be seen as a first attempt, which leaves many open questions and white spots on the map. It has hopefully become evident that this is an exciting and promising field of research, which calls for further studies in several areas. By concluding our findings, we will point towards some of them. What became evident from our analysis of entry patterns in triad and non-triad economies is that, despite a steady increase in NTLs, the gap between triad and non-triad countries is widening. Judging from the slope of the curve in Figure 8.2, only an increase of capability-augmenting

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units will lead to a substantial increase in NTL establishments. As Chung (2001) suggests in his analysis, the outcome from and market choice of FDI is contingent upon market characteristics and markets, where location-specific capabilities reside, will attract capability-augmenting investments. In other words, our results tend to suggest a latent endogeneity as knowledge clusters do not only attract capability-augmenting FDI, but the same investments also contribute to the sustainability of these clusters. This is probably the most important implication for peripheral economies and policy-makers aiming to attract FDI. In order to gain more attention in the future, they have to establish pockets of knowledge which are attractive for MNCs. India’s emerging position in computer science is a good example. But in order to be able to come up with more precise recommendations and tools, longitudinal analyses of specific industries would be needed. In view of the modest increase of NTL establishments, the question arises whether this is an area of interest for managers of multinational corporations at all. However, despite the relatively small numbers to date, there is evidence that major companies in nearly all industries invest in peripheral countries and they will need to know more on how to staff and to control these labs. While our study could not detect significant differences in the local embeddedness of TLs and NTLs, we found that NTLs are less horizontally integrated, are tighter controlled and are less innovative than their counterparts in triad nations. Following recent research findings on how to control R&D units (Ambos and Reitsperger, 2004; Asakawa, 2001; Hansen, 1999) it might be advisable to give these units more autonomy in order to enhance their innovativeness. Still, to gain more insights into this field, researchers will have to conduct larger-scale analyses about the management of NTLs. One such approach appears to be selecting a sampling frame of all R&D laboratories in one country (see, e.g., Zedwitz, 2004, for China). Whereas the present study is more suited to explain the motivation for foreign R&D investments controlling for the home country, one country studies will be able to establish a larger sample and consequently hold country or even industry effects constant when analyzing the management of R&D laboratories in non-triad countries.

References Ambos, B. (2002) Internationales Forschungs- und Entwicklungsmanagement: Strategische Mandate, Koordination und Erfolg, Wiesbaden: Gabler. ——— (2005) ‘Foreign direct investment and industrial research and development: A study of German MNCs’, Research Policy, 34: 395–410.

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Ambos, B. and Chini, T. (2004) ‘Exploration vs, exploitation: An empirical retest of location pulls in international R&D investment’, presented at the European Academy of International Business (EIBA), Ljubljana, Slovenia. Ambos, B. and Reitsperger, W.D. (2004) ‘Offshore centers of excellence: Social control and success’, Management International Review, 44 (Special Issue 2): 51–65. Ambos, B. and Schlegelmilch, B.B. (2004) ‘The use of international R&D teams: An empirical investigation of selected contingency factors’, Journal of World Business, 39 (1): 37–48. Andersson, U., Holm, U. and Pedersen, T. (2001) ‘Subsidiary performance in multinational corporations: The importance of technological embeddedness’, International Business Review, 10: 3–23. Archibugi, D. and Iammarino, S. (2002) ‘The globalization of technological innovation: definition and evidence’, Review of International Political Economy, 9: 98–122. Asakawa, K. (1996) ‘The multinational tension in R&D internationalization: Strategic linkage mechanisms of distant contextual knowledge in Japanese multinational companies’. PhD thesis, INSEAD, Fontainebleau. ——— (2001) ‘Organisational tension in international R&D management: The case of Japanese firms’, Research Policy, 30: 735–58. Bartlett, C. and Ghashal, S. (1989) Managing Across Borders: The Transnational Solution. Cambridge, MA: Harvard Business School Press. Benito, G.R.G., Grøgaard, B. and Narula, R. (2003) ‘Environmental influences on MNE subsidiary roles: Economic integration and the Nordic countries’, Journal of International Business Studies, 34: 443–56. Birkinshaw, J. (2002) ‘Managing internal R&D networks in global firms: What sort of knowledge is involved?’, Long Range Planning, 35: 245–67. Brockhoff, K. and Schmaul, B. (1996) ‘Organisation, autonomy, and success of international dispersed R&D facilities’, IEEE Transactions on Engineering Management, 4: 33–40. Cantwell, J. and Mudambi, R. (2000) ‘The location of MNE R&D activity: The role of investment incentives’, Management International Review, 40 (Special Issue): 127–48. Cheng, J.L.C. and Bolon, D.S. (1993) ‘The management of multinational R&D: A neglected topic in international business research’, Journal of International Business Studies, 24(1): 1–18. Chiesa, V. (1996) ‘Managing the internationalisation of R&D Activities’, IEEE Transactions on Engineering Management, 4: 7–23. Chung, W. (2001) ‘Identifying technology transfer in foreign direct investment: Influence of industry conditions and investing firm motives’, Journal of International Business Studies, 32: 211–29. Chung, W. and Alcacer, J. (2002) ‘Knowledge seeking and location choice of foreign direct investment in the United States’, Management Science, 48: 1534–55. Dalton, D.H. and Serapio, M.G. (1995) Globalizing industrial R&D, Washington DC: Office of Technology Policy. Eisenhardt, K. (1989) ‘Agency theory: An assessment and review’, Academy of Management Review, 14: 57–75. Gassmann, O. and Zedtwitz, M. (1999) ‘New concepts and trends in international R&D organisation’, Research Policy, 28: 231–50. Gencturk E.F. and Aulakh, P.S. (1995) ‘The use of process and output controls in foreign markets’, Journal of International Business Studies, 26: 755–86.

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Gerybadze, A. and Reger, G. (1999) ‘Globalization of R&D: Recent trends in the management of innovation in transnational corporations’, Research Policy, 28: 251–71. Håkanson, L. and Nobel, R. (1993a) ‘Foreign research and development in Swedish MNCs’, Research Policy, 22: 373–96. ——— (1993b) ‘Determinants of foreign R&D in Swedish MNCs’, Research Policy, 22: 397–411. Hansen, M. T. (1999) ‘The search-transfer problem’, Administrative Science Quarterly, 44: 82–111. Johanson, J. and Vahle, J.E. (1977) ‘The internationalisation process of the firm – a model of knowledge development and increasing foreign market commitments’, Journal of International Business Studies, 8(1): 23–32. Kuemmerle, W. (1997) ‘Building effective R&D capabilities abroad’, Harvard Business Review, March–April: 61–9. ——— (1999) ‘The drivers of foreign direct investment into research and development: An empirical investigation’, Journal of International Business Studies, 30: 1–24. Le Bas, C. and Sierra, C. (2002) ‘ “Location versus home country advantages” in R&D activities: Some further results on multinationals’ locational strategies’, Research Policy, 31: 589–609. Meyer-Krahmer, F. and Reger, G. (1999) ‘New perspectives on the innovation strategies of multinational enterprises: Lessons for technology policy in Europe’, Research Policy, 28: 751–76. Narula, R. (2005) ‘Globalisation, EU expansion and consequences for MNE location’, MERIT Research Memorandum Series, 2005–003. Narula, R. and Dunning, J.H. (2000) ‘Industrial development, globalization and multinational enterprises: New realities for developing countries’, Oxford Development Studies, 28(2): 141–67. Nobel, R. and Birkinshaw, J. (1998) ‘Innovation in multinational corporations: Control and communication patterns in international R&D’, Strategic Management Journal, 19: 479–97. Nohria, N. and Ghoshal, S. (1997) The Differentiated Network: Organizing Multinational Corporations for Value Creation, San Francisco: Jossey Bass. Patel, P. and Pavitt, K. (1991) ‘Large firms in the production of the world’s technology: An important case of “non-globalization” ’, Journal of International Business Studies, 22(1): 1–22. Pearce, R.D. (1989) The Internationalisation of Research and Development by Multinational Enterprises, London: Macmillan. Pearce , R.D. and Singh, S. (1991) Global Strategy and Innovation: The Role of International Research and Development, working paper, University of Reading. Pearson, A., Brockhoff, K. and Boehmer, A. (1993) ‘Decision parameters in global R&D management’, R&D Management, 23: 249–62. Porter, M.E. (1990) The Competitive Advantage of Nations, New York: Free Press. Porter, M.E. and Stern, S. (2001) ‘Innovation: Location matters’, Sloan Management Review, 4 (3–4): 28–37. Rostow, W.W. (1960) The Stages of Economic Growth: A Non-Communist Manifesto, London: Cambridge University Press. Schmaul, B. (1995) Organisation und Erfolg Internationaler Forschungs- und Entwicklungseinheiten, Wiesbaden: Gabler.

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Vernon, R. (1966) ‘International investment and international trade in the product cycle’, Quarterly Journal of Economics, 80: 190–207. Zedtwitz, M. (2004) ‘Managing foreign R&D laboratories in China’, R&D Management, 34: 439–52. Zedtwitz, M. and Gassmann, O. (2002) ‘Market versus technology drive in R&D internationalization: Four different patterns of managing research and development’, Research Policy, 31: 569–88.

9 Moving Out of the Country: An Exploratory Study of the Impact of Country, Cluster and Firm-related Factors Carl Arthur Solberg

1. Introduction Small countries are in general considerably exposed to international economic activity. For instance, Scandinavian countries with some 4–8 million inhabitants export between 40 and 50 per cent of their GNP; foreign direct inward investments represent between 3 and 9 per cent (Benito et al. 2002). The corresponding figures for large countries like US and Japan are in the region of 12 per cent and 0.5–1.0 per cent; for UK, Germany and France with between 60 and 80 million inhabitants they are in the region of 30 per cent and 1–3 per cent respectively. Small countries also have a more specialized technological and a leaner industrial base, and therefore depend to a great extent on international markets and foreign investors prospering. Hence, it is thought that this class of countries need to develop some location advantage such as low labour cost, competitive tax regimes, strong industrial clusters or other benefit in order to attract and further retain investors. One issue in this context becomes increasingly manifest: relocation or offshoring of economic activity from Western economies to countries that can offer a combination of the above advantages – most often low cost (labour and/or taxes). For example, a recent survey of Norwegian industrial firms indicates that about one fifth of all firms have shifted key subcontracting operations to foreign firms in the last few years; in the mechanical industry this ratio is as high as 37 per cent (NHO, 2004). Although some would attribute the de-industrialization of Western economies to factors such as currency, trade and fiscal policies (see, for instance, Hersh and Weller, 2003), the most evident factor causing this relocation of manufacturing capacity seems to be that of low labour cost. It is indeed hard to compete against hourly salaries ranging from less than 206

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half a euro to maybe a couple of euros, when the normal rate in the home country is varying between 10 and 20 euros or even higher. At first, lowtechnology tasks were typically moved out, but gradually, as the technology transfer progressed from Western countries, more complicated processes have also been taken over by the new generation of industrial nations. Discussing US-Chinese economic relations, Gilboy (2004) maintains that: low-cost Chinese imports (mainly textiles, shoes, toys, and household goods) have saved US consumers about $100 billion since China’s reforms began in 1978 … US industrial firms such as Boeing, Ford, General Motors, IBM, Intel, and Motorola also save hundreds of millions of dollars each year by buying parts from lower-cost countries such as China, increasing their global competitiveness and allowing them to undertake new high-value activities in the United States. In an effort to save 30 percent on its total global sourcing costs, Ford imported about $500 million in parts from China last year. General Motors has cut the cost of car radios by 40 percent by building them from Chinese parts. The purpose of this chapter is to explore a model that examines some of the forces lying behind the relocation not only of productive capacity, but also of headquarter functions and research and development activity. More specifically, it endeavours to study the impact on such transfers at three distinct levels: country, cluster and firm levels. The chapter uses the offshore oil industry in a small peripheral country, Norway, as its empirical setting. This sector of the Norwegian industry harbours a number of world leaders within their specific market segments (Benito et al., 2003; Reve et al., 1992; Reve and Jacobsen, 2001). However, representatives within the industry fear a gradual relocation to other countries not only of productive capacity but also of critical competence centres in the wake of a strong Norwegian currency and of what they claim to be a lack of a coherent industry policy by government. The rest of chapter is structured as follows. First a brief theoretical background is presented, followed by a model and a number of propositions. Next the methodology is described including a presentation of the data, followed by presentation and discussion of the results. The chapter ends with implications for government and for further research.

2. Theoretical Background The relocation of MNE (multinational enterprise) activity can be studied from various perspectives, including the OLI framework (Dunning, 1981),

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cluster theory (Porter, 1990) and organizational perspectives on companies’ globalization; see inter alia Bartlett and Ghoshal (1989), Hedlund (1986), Narula (2002) and Zander (2002), Zander and Sölvell (2000). Offshoring part or all of a firm’s activity is an integrated part of the globalization of markets and industries, whereby technology, products and services, capital and – to a lesser extent – labour cross borders at a rate never experienced before. In Krugman and Venables’ (1995) analysis this new trend of globalization is divided into four distinct features: • Growth in intra-industry trade, whereby trading countries exchange products and services in the same industries. Complex industrial and differentiated products lead to intensified international trade within the same product areas. • Breaking up the manufacturing processes that previously were concentrated in one location. Need for flexibility and more complex product designs have led to increased use of subcontractors and/or relocation of assembly units nearer the markets. • Breaking up the value chain invariably leaves the firm with an increased set of options as to where to locate different links in the chain. The fragmentation of the industrial processes has given ground for specialization in certain countries, such as, for instance, Hong Kong, Singapore, Malaysia, Belgium, Netherlands and Ireland. For many of these countries, exports represent between 50 and 100 per cent of GNP. • This disintegration of industrial processes has, furthermore, allowed transfer of certain operations to low-cost countries, thereby creating the embryo of industrial clusters in the same countries. Narula and Dunning (2000) claim that in such an environment the competences of MNEs are becoming increasingly mobile and knowledgeintensive. MNEs thus pay more attention to the availability and quality of the created assets of alternative locations. The OLI – or eclectic – framework (see, e.g., Dunning 1981; 1988; 2001) is relevant in this context: (i) ownership advantages of the firm (O); (ii) location advantages (L) of host countries, such as technological centres, market attractiveness or cheap labour; and (iii) internalization advantages (I) determine the structure of firms’ international activities. Although absolute cost advantages are important in this context, other factors as well may have impact on the decision to move manufacturing capacity and other activities out of the home country of the firm. One such factor is cluster strength (or weakness) in the home country. Porter’s (1990) now classic diamond of industry clusters is believed to play an important role in withholding industrial capacity

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even in a high-cost country. The argument is that value is created in a network of players that enrich each other in interaction. Such clusters are often originally based on natural resources or other competitive advantages, such as cheap labour, that have been exploited for considerable time, whereby the technology gradually has developed and an undergrowth of suppliers, users and subcontractors emerge little by little. Such a process sways the localization advantages to other factors of production, such as a dense network of competence links. Multinational enterprises derive their global competitiveness not only from their ability to identify superior location advantages, and economically exploit these advantages (by internalization or outsourcing), but also by effectively coordinating between the different units of activity. Porter (1990) maintains that, as the main rule, a firm would have only one home base since it derives its competitive advantage from the strength of the cluster it originates from: ‘A firm can only have one true home base for each distinct business or segment’ (ibid., p. 606). The ability of players in the home country to foster the strengths of the cluster will then be critical for participating firms in their decision to maintain and expand their business activities in the country. Other scholars (see, e.g., Bartlett and Ghoshal, 1989; Rugman and Verbeke, 1993) argue that in order to nurture their global competitiveness the MNEs need to leverage the advantages of multiple ‘home’ locations. Over the last two decades, scholars have increasingly sought answers to the question of how and why firms develop their international network of subsidiaries, competence centres, alliance partners, subcontractors etc. In the heterarchic organization (Hedlund, 1986), the MNE defines a strategic role for the local strategic business unit (SBU), not only dealing with matters for that specific unit, but also for the whole MNE. A distinction can be made between experimentation, where the objective is to seek new opportunities involving an active learning process, and exploitation, where the main feature is effective utilization of capabilities gained through the experimentation period and in locations that can offer the best competitive advantages. It is particularly in the exploitation phase that offshoring of value-added activities may be expected, whereas the experimentation phase would be anticipated to be carried out based on the home cluster. In sum, one would expect that the relocation of activities from the firm’s home base could be seen in the context of globalization of markets and the opportunities offered by different location advantages. As firms grow internationally, their ability to leverage advantages offered by different locations will determine their competitiveness in global markets. However,

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the cluster strength of the home base may constitute a barrier to relocation and retain the activity in the home country of the firm.

3. Conceptual Framework Our main contention is that factors at all three levels, i.e., country, cluster and firm, will have an impact on the decision to relocate key components of the value chain: in particular, manufacturing, research and development activities and headquarter functions. The framework suggests that relocation is not only due to country-level factors, such as, for instance regulations, infrastructure, cost level, tax level, etc. Potentially equally important are factors such as cluster strength, for example, the relations with suppliers and strength of competition and so forth (Porter, 1990), and factors internal to the firm, such as its international orientation, the strength of R&D efforts, managerial attitudes, governance structures etc. The three levels are described in more detail below.

Country-level factors This category includes factors such as labour costs, tax level, government regulations of the industry sector, R&D support, exchange rate development, access to and cost of engineers and other highly educated employees. These factors may be considered general for the country in question, although some of them may represent borderline cases relative to clusterspecific factors – such as cost levels, government regulations or R&D support. When discussing cost levels, for instance, this factor is generally understood at the national level. However, cost level in one industry cluster may be different than the cost level in another cluster in the same country; the differences mainly stem from the nature of the cluster. Also, within the cluster, the relative (to other countries) cost may vary from one kind of labour to the other. For instance, in Norway highly skilled engineers are considered to be relatively cheap, whereas offshore operators are relatively expensive compared to other countries (Håbrekke, 2003). Still, these factors are deemed to belong to the realm of general political and economic forces at the national level since they are shaped to a large extent by forces outside the cluster itself, such as, for instance, political priorities, state finance and economic policies.

Cluster-level factors This group of factors comprises foremost the elements of Porter’s (1990) competitive diamond, such as competitive intensity, industry dynamics and related industries. Moving beyond Porter’s main emphasis on the

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existence of competitors at the national level, the network approach, as it is described by Håkanson and Snehota (1995), gives additional insights about the crucial elements of a cluster, especially the roles played by buyerseller relations and R&D relations. Here, we intend to tap into the essence of buyer-seller relationships in the industry, representing more or less competitive technological milieus that advance the cluster strength forward.

Company-level factors The literature on national competitiveness tends to disregard companylevel factors. However, it is companies that actually compete, identify needs, develop products, market them and service their customers; not nations or clusters. Companies may find strengths operating in a cluster or a nation, but at the end of the day it is still them that have to report the results of their operations. What may then be the essential internal factors of a company that influence its decisions to relocate its productive capacity or other parts of its operations? In the present study we propose the following factors: (i) attitudes towards keeping the operations in the country and attachment of key managers and owners to the local community, i.e., bonding the operation to the country and region; (ii) the company’s research and development activity (which links it to the cluster); (iii) the financial and market performance of the company (making it worthwhile to continue operations at home); (iv) the degree of agreement between the board of directors and management (the higher the level of agreement, the more it is expected that relocation does not represent a critical issue in internal discussions); and (v) the international commitment of the firm, which is supposed to have an impact on its propensity to move abroad (Johanson and Vahlne, 1977; 1990).

4. Relocation of Productive Capacity Country factors, for instance cost and tax levels, or political regulations of the industry are supposed to have a direct bearing on management’s evaluation of cost of production. Since parts of the production may be performed at high quality in low-cost countries, production is possibly more vulnerable to cost differentials than, for instance, HQ functions or R&D activities. In order to carry out the latter activities in a satisfactory way, a closer contact with a dynamic industrial infrastructure – or in other words a strong cluster – is required. In contrast, production or assembly activities, which can be licensed out, outsourced or transferred to a wholly foreign-owned unit operating in a low-cost country, seem less critical. This

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is, in fact, what has been suggested by Buckley and Casson (1998). They predict a system of multinational enterprises with regional hubs and a more flexible set of subcontractors to be drawn upon whenever it is deemed cost efficient. Also, as the value chain may be broken up into smaller units (Krugman and Venables, 1995), it seems less dramatic for management to move part of their productive capacity to other countries in order to safeguard their cost competitive position at home, than, for instance, to relocate the headquarters or the R&D function. Still, one would expect that allegiance to the local community and general attitudes towards production in the home country may constrain management from moving productive capacity out of the country. This leads us to the first proposition: P1. The decision to move the manufacturing capacity out of the country is more affected by country factors and company factors than by cluster factors.

5. Relocation of Headquarters The decision to move out the headquarters of a company is dramatic, and seemingly fairly uncommon (Benito et al., 2002; Forsgren et al., 1995). It involves, to some extent, the uprooting of a company’s heart and veins from the sources of its original competitive advantage. As such, we argue that company factors, will weigh more in the assessments leading to this decision than country factors. In particular, factors such as the attitudes of management and its attachment to the local community are likely to play a central part in this decision. The power position of different units in the MNE also tends to determine the location of different activities of the MNE (Forsgren et al., 1995). On the other hand, as companies get increasingly involved in international markets they also seem to lower the threshold of taking larger international investment steps (Forsgren et al., 1995; Johanson and Vahlne, 1977; 1990). Moving headquarters out of the country is a viable proposition for those companies with higher international experience and involvement. This is particularly true for companies operating in small, open economies (such as Norway) with limited market expansion opportunities at home (Bellak and Cantwell, 1998; Benito et al., 2002; Narula, 1996; Walsh, 1988). If market opportunities seem much more promising in foreign countries than at home, it may undoubtedly be tempting to move headquarters, including the marketing, research and development and finance functions, closer to more attractive national

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clusters. In the offshore industry, this could, for instance, be Houston (Texas) or London. In fact, a number of Norwegian firms have moved certain key functions to these locations, but the movement has also gone in the other direction, such as FMC Kongsberg and Petroleum Geo Services ASA (the latter closing down its regional headquarters in the US in 2003 as part of a major restructuring plan). Furthermore, recent research on headquarter relocation suggests that firm-level (and even micro levels [groups and individuals] within the firm) factors play a role in this context (Barner-Rasmussen et al., 2004). Through in-depth case studies, Barner-Rasmussen et al. show how two Finnish MNEs at first were attracted by the ‘hype of EU’ and relocated divisional HQ to Brussels and Strasbourg, only at later stages to repatriate them. The corporate philosophy shifted from centralization to decentralization to recentralization in the course of the 1990s and early 2000s. A variety of forces were at play in these processes: EU hype, need to be considered ‘international’ by main customers, need to be closer to acquired firms on the Continent and desire to attract international talent led the company to relocate; the costs of operations (communication), control and management preferences led to the subsequent repatriation. Barner-Rasmussen and his colleagues conclude that the issue of relocation of divisional HQ is not straightforward and does not necessarily follow a predetermined path towards foreign locations. Also cluster factors are deemed to be more important than country factors in the HQ relocation decision. The essence in Porter’s (1990) cluster argument is that tough competition and close cooperation between industry players foster dynamism of innovation and competitiveness in the industry. He introduces the concept of related industries, epitomized by companies that share activities in the value chain or that involve complementary products, stating that ‘nations succeed not in isolated industries, but in clusters of industries connected through vertical and horizontal relationships’ (ibid., 1990, p. 73). He also maintains that: ‘clustering works best when the industries involved are geographically concentrated’ (p. 157), invoking agglomeration affects as described by, for instance, Marshall (1920). Krugman’s (1987) concept of concentration of economic activity also shares many common features with that of Porter’s cluster, although his concentration theory is based on other factors like imperfect markets and economies of scale. On the other hand, Porter’s concept of geographically confined clusters has been much criticized (see, e.g., Cartwright, 1991; Martin and Sunley 2003; Reich, 1992; Rugman, 1991; 1992), since product development and distribution of value-chain activities often take place not only across borders, but also across continents.

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This opens for the possibility of belonging to more than one national cluster Rugman and Verbeke (1993). The core competence of the MNE is then considered to be its ability to coordinate and control operations, which are globally dispersed as a result of a wide variety of location advantages associated with individual nations or regions. Håkanson and Snehota (1995) delve more deeply into the nature of the relationships created in clusters, suggesting that companies operate within networks of actors, activities and actor bonds. It is not straightforward for company management to break out of such networks, relocating to another country its head office or other functions critical to strategic development of the company, such as R&D. In other words, the stronger the cluster, the closer the networks between key players in the industry, and the more likely it is that the company will not relocate its headquarters. Since headquarter functions are less vulnerable to industrial policies affecting the costs of production (e.g., economic policies or worker protection) and investments in productive capacity (for instance, environmental regulations or production quota systems), it is suggested that country factors are less important for the decision to relocate headquarters. This gives us the second proposition: P2. The decision to move headquarters out of the country is more affected by cluster factors and company factors than by country factors.

6. Relocation of R&D Considerable research has been targeted at investigating the drivers of and barriers to internationalization of R&D. Knowledge exchange within the MNE in general is claimed to improve quality of innovation gained from integrating and recombining geographically dispersed technological capabilities. According to Bartlett and Ghoshal (1989), innovation activity is expected to move from local-for-local to local-for-global, and to a more limited extent towards global-for-global or globally linked innovation processes. For instance, internationalization of innovative activity is claimed to give the MNE a: flexibility that allows the efforts of multiple units to be combined, whereby a company can create synergies that can significantly leverage its innovation process. Like locally leveraged innovations, the globallylinked process captures the MNC’s [multinational corporation’s] potential scope economies and harnesses the benefits of world-wide learning. (Ibid., 1989, p. 222)

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However, the general conclusion relevant to the present study is that MNEs seem to exhibit certain reluctance to move critical innovative capabilities to locations outside its home base (Narula, 2002; Zander, 2002). Two forces (at least) seem to come into play. First, at the firm level, the economies of scale in R&D warrant a threshold level of this activity. This will, therefore, constitute a prohibitive factor in that duplication of R&D activities only will be relevant for larger firms that have both the necessary resources to overcome those critical threshold levels and the need to develop new R&D centres. Even in cases of diversification of R&D tasks, which would be the case of diversified MNEs as a result of, for example, international mergers and acquisitions, Zander and Sölvell (2000) suggest that ‘most of the technological capabilities will be located in the country of origin, close to strategic decision-making and the core manufacturing operations’. (p. 52). Also, at the more general level, as stated by Narula (2002), ‘firms are by definition loath to radical change’ (p. 799). Second, at the cluster level, the initial investment in innovation systems in the geographical vicinity of the firm – operating in a network of technological partners – will also constitute an exit barrier for the firm. In the words of Narula (ibid., p. 798): firms and the knowledge infrastructure interact to innovate through institutions … Frequently the most significant issues are the ‘knowwho’. Government funding agencies, suppliers, professors, private research teams, informal networks of like-minded researchers take considerable time to create, and once developed, have a low marginal cost of maintaining. Even where the host location is potentially superior to the home location … the high costs of becoming familiar with, and integrating into the SI [system of innovation] of the new location may be prohibitive. In other words, the strength of the cluster works against moving R&D activity out of the home country. Nevertheless, MNEs with extensive international networks may try to link on to these through their partners, exchange information and create research teams with them in order to solve intricate technological problems. In particular, it is believed that close R&D bonds with foreign technological milieus will affect positively the decision to relocate R&D closer to these environments. However, in the same vein as argued above for headquarters, country factors such as cost level, inflation, trade policies, worker protection or taxes seem less critical in the relocation decision of R&D activities. Hence we posit that: P3. The decision to move the research and development out of the country is more affected by cluster factors and company factors than by country factors.

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7. Methodology In order to test these propositions a questionnaire was developed in close contact with representatives of the offshore supply industry in Norway. The questionnaire was sent to members of TBL (Teknologibedriftenes Landsforening – The Federation of Technology Companies) and OLF (Offshore Leverandørenes Forening – The Federation of Offshore Suppliers) comprising altogether 250 firms. After a follow-up round, we received 71 usable questionnaires that constitute our database, i.e., a response rate of 28 per cent. Table 9.1 gives an overview of the distribution of the sample according to firm size (sales). The dependent variable was constructed as a composite measure, which takes into account two core aspects of the relocation decision. First, we asked whether the company had recently (last six months) considered relocating part or all of its operations to another country. Second, we asked whether management considered relocating part (large part – no part) of the production capacity, headquarters functions or research and development. We then created a ‘relocation index’ as the product of the two measures. This is possibly a stronger measure than either of its constituents individually, as it takes into account a greater part of the process that is the basis for the evaluation of relocation opportunities.1 Table 9.2 shows the relocation scores of the firms in the sample distributed by size and by country of origin (Norwegian or foreign). The data suggests that the tendency to move is not very pronounced among Norwegian firms. Interestingly, a t-test did not reveal any significant differences between the groups. In other words, the proclivity to relocate is not higher (or lower) in larger or foreign firms. The independent variables were mainly developed through factor analysis, which identified two particular factors at the cluster level and five at the firm level. Appendix I gives a summary of the items used, their factor

Table 9.1

Size distribution of the sample

⬍50 million NOK* 51–200 million NOK 201–1,000 million NOK ⬎1000 million NOK Mean sales (million NOK)

24.30% 28.60 32.80 14.30 609**

Notes: *1 euro ⫽ 8.20 NOK (2003). ** One firm with sales exceeding 78 billion NOK is excluded from the sample in this calculation.

Carl Arthur Solberg Table 9.2

217

Distribution of relocation scores by firm size and origin*

Number of firms Relocation of – Headquarter functions – Production – Research and development

Size (employees)

Origin

⬍200 34

⬎200 35

Norwegian 37

4.8 5 4.7

4.9 4.9 4.2

Foreign 24

5 4.5 5.1

5 4.5 4.6

Note: *Scores range from 1 ⫽ consider total relocation of the activity, to 6 ⫽ does not consider any relocation.

loadings and their Cronbach-alpha values. The Cronbach alphas vary from 0.62–0.89. The reliability is satisfactory given the exploratory nature of the research, but it is indicated that more work has to be carried out in order to adequately map the phenomena under study. We also included one additional single-item variable at the firm level (attachment to local industry), one additional variable at the cluster level (level of competition) and four items at the country level (wages, access to R&D funds, exchange rate developments and tax level). A Pearson correlation analysis was run in order to test for discriminant validity (see appendix II). None of the constructs are highly correlated, which suggests that they are distinct from one another.

8. Results Table 9.3 shows the results of the regression analyses. A positive regression coefficient value indicates that the factor will push the company to relocate to another country, whereas a negative coefficient suggests that the factor contributes to withhold the company from relocation. The results from the regression analysis provide some support for P1. Both country factors and company factors count more than cluster factors in explaining relocation of productive capacity out of the country. However, P2 and P3 are not supported since cluster factors do not appear to play any important part in explaining relocation of headquarters and the R&D function. Contrary to expectation, one country factor (currency) seem to influence the decision to move headquarters as well as R&D out of the country. However, it should be noted that at the time of the study, the Norwegian currency was particularly strong as a result of high national interest rates. Labour costs – in spite of the impression generally held that

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Table 9.3 Regression analyses of determinants of relocation (standardized regression coefficients)

Country factors Wage-level skilled workers R&D government support Currency Tax Cluster factors Technological milieu in Norway Network with foreign competence environments Competition Company factors Attachment to local community Dominant owner Innovative activity of the firm Internationalization commitment Accord between board and administration Performance

Production

HQ

0.04 0.02 0.45*** ⫺0.03

0.09 0.09 0.39** ⫺0.16

R&D

0.1 0.14 0.35** ⫺0.14

0.03

⫺0.09

⫺.01

⫺0.05

0.09

0.09

0.09

0.11

⫺0.17 0.09 ⫺0.2 0.2*

⫺0.19 0.11 ⫺0.23* 0.16

⫺0.02 0.33*** ⫺0.22 0.06

⫺0.24*

⫺0.16*

⫺0.16

⫺0.2*

⫺0.18

⫺0.25**

0

Adjusted R2

0.397

0.313

0.342

F-value

4.984***

2.996***

3.141***

Note: *p ⱕ 0.10; ** p ⱕ 0.05; *** p ⱕ 0.01.

Norway is a high-cost country – do not seem to constitute a decisive deterrent to activity in Norway in the present study.

9. Discussion and Implications The results reveal that exit barriers at the firm level seem to outweigh most other explanatory factors in accounting for relocation of business activity. It is particularly thought provoking that cluster strength does little or nothing to withhold the industrial base in the country. This is in contradiction to Porter (1990) and generally accepted conventional wisdom and should indeed spur discussions on the directions of government industrial policies. One possible explanation is that the variation of the factors constituting cluster strength is rather limited. In fact, the standard variation of one of the constructs (technological milieu) is quite narrow, leaving little room for impact in regression analysis (see Appendix III). However,

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this is also the case with one factor at the firm level (accord between board and administration) yielding significant beta values in two of the regressions (production and HQ). One reason for the insignificant impact by clusters on the offshoring decision may be sought in the way in which the cluster construct itself has been operationalized. It has, indeed, been alleged that this is an elusive concept that is difficult – if not impossible – to clearly define (Martin and Sunley, 2003). Another reason may also reside in the fact that country and firm factors outbalance the strength of cluster factors in the regression analysis. Running separate regressions with cluster factors only reveals that linking on to foreign competence networks positively impacts on the decision to offshore all three functions. However, the national cluster factors (technological milieus and competition in Norway) still remain with insignificant beta values. Looking further into the internal factors, the results suggest that firm performance is the best predictor of company relocation. Firms that do well will not relocate, whereas firms that fare poorly relocate to other countries. This relation is particularly evident concerning location of production and research and development. Also, the more dominant the ownership, the less the firm seems to maintain its R&D activities at home. Many of the firms in the sample with dominant owners are, in fact, owned by other industrial firms with links to international networks. R&D and ownership dominance correlates quite strongly (0.37, p ⬍ 0.01), which suggests that dominant owners have a higher R&D intensity and that they therefore may also need to interact more deeply with international competence centres. On the other hand, attachment to the local community – although negatively correlated with the offshoring decision – does not seem to play a significant role in this context. International commitment of the firm seems to push production out of the country. This poses a challenge to government, as most firms, in order to stay competitive in an open economy, need to orient themselves towards international markets. Doing so, they not only discover interesting opportunities in other markets, but also take the first steps on the ‘internationalization ladder’, leading to increasing international commitments and reducing the threshold to relocate some of their activities ( Johanson and Vahlne, 1977; 1990). In order to stay competitive in a globalizing market, they may need to relocate, and thereby trim down – or at least contribute to restructure – the industrial capacity of their home country. Finally, a focus by management on innovative activities positively affects the intention to keep headquarter functions in the country. However,

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emphasis on innovation does not per se retain R&D functions in the home country. Firms that are active in their R&D pursue both local and international avenues for their technological development. Indeed, there is a relatively strong correlation between firms’ innovation activities and their international R&D network (0.28, p ⬍ 0.05). Even though international R&D network does not impact directly on the decision to relocate R&D activities, the findings indicate that it may have an indirect influence through these activities. This is a signal to government that its policies with regard to internationalization of innovation and research could be a key element in keeping (and further increasing) the industry base of the country. Turning now to the implications for research it seems evident that this study needs to be refined and further improved. The model itself accounts for only some 30–40 per cent of the variance in the dependent variables. Better measures for existing variables as well as the inclusion of additional variables would increase the explanatory power of the model. Another step is to enlarge the scope of the research to embrace a larger part of the industry base – and not only one limited sector in one particular country. The phenomenon of relocation is a general feature in most Western countries and should therefore be studied both in many industrial sectors as well as in different countries.

10. Conclusions This analysis investigates factors promoting relocation of industrial activity within the offshore supply sector from a small country by use of a model with three levels of impacting factors: country, cluster and firm. The study revealed that country- (and more specifically, currency-) and firm-level factors are particularly important in explaining the international relocation of business activities. Cluster factors seem to be less vital in this context. This was unexpected and leaves us with a number of questions about the desirability of spending public funds to build specific clusters. Clusters may be attractive to investors, not necessarily in their own right, but perhaps because some specific advantage (subsidies, tax relief, R&D support, access to raw material, etc. – although many of these did not affect the relocation variable in our study) is related to them. It is therefore important to understand the critical factors, other than tautological explanations, leading to cluster strength. We have also shown that there is no systematic difference in relocation behaviour between foreign owned and domestically owned firms, or large and small firms. Another study (see Chapter 6 in this volume) indicates

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that foreign-owned firms in Ireland tend to have greater operational autonomy and a higher level of technological sophistication than their counterparts in Portugal, linking this to a more proactive stance towards further investments in Ireland as compared to Portugal. The present (Norwegian) study does not specifically investigate the subsidiary mandate of MNEs. Notwithstanding the mandate of the operations, our results clearly suggest that internal factors such as research and development and accord between the administration and the board of directors tend to retain the operations in the country. Although not directly comparable, these factors are to some extent linked to technological sophistication and operational autonomy (of subsidiary). Small countries, with limited albeit specialized industrial base, face special challenges in an increasingly globalizing industrial environment. For Norway, which is not only geographically but also politically (non EU-member) in the fringes of Europe, the challenge is to retain and further develop her industrial base in competition with countries that apparently are better placed, economically, politically and geographically. Clusters may help, but only indirectly as a function of other factors. Internal factors to the firm seem more prominent in explaining the relocation decision. The study has some weaknesses: some of the measures used in the study needs to be improved in order to better capture the phenomena under investigation. Also our study is confined to one industrial sector only, calling for further substantiation to lend credence to these conclusions.

Note 1. In any event it is only a measure of intention and not of action, which of course is a weakness. However, the advantage of this measure is that the evaluation embedded in it is done simultaneously with the evaluation of the other measures in the study. Since this assessment is flavoured by the context, and since the context is constantly changing, it seems reasonable to try and capture the ‘sentiment of the day’, rather than measuring the action or decision happening at one point in time and the sentiment/assessments at some later stage – maybe more than a year after the decision.

References Barner-Rasmussen, W. Piekkari, R. and Björkman, I. (2004) ‘Motives for relocation of MNC divisional headquarters’, paper presented at the 30th EIBA Annual Conference, Ljubljana, Slovenia, 6–7 December. Bartlett, C. and Ghoshal, S. (1989), Managing across Borders: the transnational solution. Cambridge, MA: Harvard Business School Press.

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Bellak, C. and Cantwell, J. (1998) ‘Small latecomer countries in a globalising environment: Constraints and opportunities for catching-up’, Development and International Cooperation, 13: 139–79. Benito, G.R.G., Berger, E., de la Forest, M. and Schum, J. (2003) ‘A cluster analysis of the maritime sector in Norway’, International Journal of Transport Management, 1(4): 203–15. Benito, G.R.G. Larimo, J., Narula, R. and Pedersen, T. (2002) ‘Multinational enterprises from small economies: internationalization patterns of large companies from Denmark, Finland, and Norway’, International Studies of Management and Organization, 32(1): 57–78. Buckley, P.J. and Casson, M.C. (1998) ‘Models of the multinational enterprise’, Journal of International Business Studies, 8(1): 21–44. Cartwright, W. (1991) ‘An independent test of the “Diamond” theory and development of a revised model for land-based industries’, paper presented to the Academy of International Business, Southeast USA Chapter, Miami, October. Cheng, J.L.C. and Bolon, D.S. (1993) ‘The management of multinational R&D: A neglected topic in international business research’, Journal of International Business Studies, 24(1): 1–18. Dunning, J.H. (1981) International Production and the Multinational Enterprise, London: Allan and Unwin. ——— (1988) ‘The eclectic paradigm of international production: A restatement and some possible extensions’, Journal of International Business Studies, 19: 1–32. ——— (2001) ‘The eclectic (OLI) paradigm of international production: past, present and future’, International Journal of the Economics of Business, 8(2): 173–90. Forsgren, M., Holm, U. and Johanson, J. (1995) ‘Division headquarters go abroad: A step in the internationalization of the multinational corporation’, Journal of Management Studies, 32(4): 475–92. Gilboy, G.J. (2004) ‘The myth behind China’s miracle’, Foreign Affairs, 83(4): 33–49. Granstrand, O., Håkanson, L. and Sjölander, S. (1993) ‘Internationalisation of R&D – a survey of some recent research’, Research Policy, 22: 413–30. Hedlund, G. (1986) ‘The hypermodern MNC: A heterarchy?’, Human Resource Management, 25(1): 9–35. Hersh, A. and Weller, C. (2003) ‘Does manufacturing matter?’, Challenge, 46(2): 59–72. Håbrekke, Ø. (2003) ‘Er det en fremtid for den norske oljearbeider i Norge?’ (‘Is there a future for the Norwegian oil worker?’), Odinarkiv Oslo: Norwegian governmental papers, http://odin.dep.no/oed/norsk/aktuelt/taler/taler_politisk_ ledelse/026031-090080/index-dok000-b-n-a.html Håkansson, H. and Snehota I. (eds) (1995) Developing Relationships in Business Networks, London: International Thomson Business Press. Johanson, J. and Vahlne J.E. (1977) ‘The internationalisation process of the firm: A model of knowledge development and increasing foreign market commitments’, Journal of International Business Studies, 8(1): 23–32. ——— (1990) ‘The mechanisms of internationalisation’, International Marketing Review, 7(4): 11–24. Krugman. P. (1987) ‘Industrial organization and international trade’, in R. Schmalensee and R.D. Willig (eds), Handbook of Industrial Organization, Amsterdam: Elsevier Science NV.

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Krugman P. and. Venables, A.J. (1995) ‘The seamless world: A spatial model of international specialization’, CEPR Discussion paper no. 1230. Marshall, A. (1920) Principles of Economics, 8th edn, London: Macmillan. Reprint, 1994. Martin, R. and Sunley P. (2003) ‘Deconstructing clusters: Chaotic concept or policy panacea?’, Journal of Economic Geography, 3: 5–35. Narula, R. (1996) Multinational Investment and Economic Structure: Globalisation and Competitiveness, London: Routledge. ——— (2002) ‘Innovation systems and “inertia” in R&D location: Norwegian firms and the role of systemic lock-in’, Research Policy, 31: 795–816. Narula, R. and Dunning, J.H. (2000) ‘Industrial development, globalization and multinational enterprises: New realities for developing countries’, Oxford Development Studies, 28(2): 141–67. NHO – Næringslivets Hovedorganisasjon (Federation of Norwegian Industries) (2004) Halvårsrapport (Half Year Economic Report). Porter, M.E. (1990) The Competitiveness of Nations, London: Macmillan. Reich, R.B. (1991) The Work of Nations: Preparing Ourselves for the 21st Century Capitalism, New York: Alfred Knopf. Reve. T, and Jacobsen E.W. (2001) Et verdiskapende Norge, Oslo: Universitetsforlaget. Reve, T., Lensberg, T. and. Grønhaug, K. (1992) Et konkurransedyktig Norge, Oslo: Tano. Rugman, A.M. (1991) ‘Diamond in the rough’, Business Quarterly, 55(3): 61–4. ——— ‘Porter takes the wrong turn’, Business Quarterly, 56(3): 59–64. Rugman, A.M. and Verbeke A. (1993) ‘Foreign subsidiaries and multinational strategic management: An extension and correction of Porter’s single diamond framework’, Management International Review, 33 (Special Issue 2): 71–84. Walsh, V. (1988) ‘Technology and the competitiveness of small countries: A review’, in C. Freeman and B.-A. Lundvall (eds), Small Countries Facing the Technological Revolution, London: Pinter. Zander, I. (2002) ‘The formation of international innovation networks in the multinational corporation: An evolutionary perspective’, Industrial and Corporate Change, 11(2): 327–53. Zander, I. and Sölvell, Ö. (2000) ‘Cross-border innovation in the multinational corporation: A research agenda’, International Studies of Management and Organization, 30(2): 44–67.

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Appendix I:

Items constructs and their Cronbach alphas

Country factors To what extent do you feel that the following factors hinder your competetiveness? (single items) Wages of skilled labour Access to R&D funds Development in the exchange rate Tax level Cluster factors Technological milieu in Norway Our firm has a strong relation to technological milieus in Norway Our technological innovations are the result of a close cooperation with other Norwegian milieus In our industry there is an undergrowth of firms to support our innovations The growth of our firm is largely due to our strong links to technological milieus in Norway

.636 .754 .597 .735

Network in foreign competence environments Foreign personnel give us access to networks to foreign networks Our innovations are the result of close cooperation with foreign networks

.901 .895

Competition in the industry (single item) Competition in our industry is the major reason for innovation Company factors Attachment to the local industry (single item) Our board members are well embedded in the local milieu

.62

.79

.82

Dominant ownership Many independent shareholders – one dominant shareholder Many nationalities – one nationality

.922 .922

Innovative activity in the firm We have an active research agenda It is innovation that drives the development of our firm We consider our firm to represent the state of the art in our industry Patenting of our innovations is critical

.831 .862 .851 .785

Accord between the administration and the board No disagreement between admin and board The board seldom opposes the admin recommendations The admin easily gets its agenda accepted by the board The board is composed of highly skilled persons

.765 .653 .682 .665

Internationalization commitment We spend considerable resources to internationalize our firm Survival of our management depends on our success in international markets Lack of resources constitute a serious obstacle to our internationalization

.862 .904 .500

Performance Financial goals have been achieved the last three years Market objectives have been reached the last three years

.833 .816

.89

.70

.76

.66

225

226

Appendix II: Discriminant validity – Pearson correlations 1 Country factors 1 Wages 2 R&D support 3 Exchange rate 4 Taxes

2

3

4

– .46**

–

6

7

8

9

10

11

12

– .18 – .23 .21 .31* .19

Cluster factors 5 Technical milieu ⫺.06 .25* ⫺.09 6 Technical international network⫺.10 ⫺.02 .28* 7 Competitionional ⫺.08 .14 ⫺.49**

⫺.09 ⫺.13 ⫺.11

Company factors 8 Local attachment 9 Dominant owner 10 Innovation 11 International commitment 12 Role of board 13 Performance

.26* ⫺.03 ⫺.35** ⫺.08 .17 ⫺.01

Note: * p ⱕ .05; ** p ⱕ 0.01

5

⫺.03 .18 ⫺.02 ⫺.07 ⫺.09 .12 ⫺.20 .02 .00 ⫺.24 .27 .34** .08 .04 ⫺.05 ⫺.12 ⫺.07 ⫺.20

– .00 – .26* ⫺.16 ⫺.12 ⫺.06 .03 ⫺.04 .18 ⫺.07

–

⫺.17 .04 – .18 ⫺.17 ⫺.08 – .28* ⫺.11 ⫺.07 .37** .38**⫺.27* ⫺.20 .08 ⫺.20 ⫺.02 .23 ⫺.07 .06 .07 .02 .05

– .00 .00 .00 .00 .00 .00

227

Appendix III: Means and standard deviations of independent variables Mean

Standard deviation

Country factors Wage-level skilled workers R&D government support Currency Tax

2.13 3.10 2.20 2.42

1.34 1.32 1.46 1.23

Cluster factors Technological milieu in Norway Network with foreign competence environments Competition

2.99 3.09 2.59

0.83 1.30 1.25

Company factors Attachment to local community Dominant owner Innovative activity of the firm Internationalization commitment Role of board of directors Performance

2.75 5.17 3.13 3.14 2.11 2.56

1.54 1.45 1.12 1.21 .083 1.09

10 Centre and Periphery in the WTO: The Case of TRIPS Helene Hoggen

1. Introduction The World Trade Organization (WTO) is a trade regime that could be seen as one of the driving forces behind globalization of trade. The WTO is also one of the most efficient regulators of international trade. It therefore represents both a catalyst of, and a limitation on international trade. Since the Uruguay Round the WTO has become increasingly important for member states and their industry, as it has expanded to new areas such as intellectual property, services and even some investment. The WTO is the host of 1481 vastly diverse member states. The multilateral principle of the WTO has, however, on many occasions been challenged by the unilateral actions of the US and the EU.2 Rugman (2001) claims that these two actors are situated, so to speak, at the power-centre of the WTO because of the vast size of their domestic economies and the absence of effective regional groups in the rest of the world. However, the expectation was that the creation of the WTO dispute settlement procedures in 19943 would provide peripheral as well as central member states and their companies with greater incentive to bring cases to the WTO (Croome, 1999; Schott and Buurman, 1994; Whalley, 1996). The question is therefore: who benefits more from the WTO system: companies from central, or companies from peripheral WTO member states?4 Exploring this question, this chapter will argue that formal rules and dispute settlement cases are not precise indicators of which member states’ companies profit from the WTO system. Furthermore, is the system beneficial first and foremost for industry or does it protect consumers in peripheral as well as central WTO member states? It will here be argued that it is important to observe continuously ongoing negotiations in order to determine ‘who gets what and how’. The WTO is a very 228

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special organization and the trade rules laid down in the WTO agreements are continuously being renegotiated. Therefore, this chapter will argue that the WTO system is more complex than it may seem at first glance and that traditional rationalist perspectives are not necessarily best equipped to explain WTO dynamics. In essence, this chapter deals with the challenge of being a country or a company in the periphery of the WTO system, as compared to being a central actor in the WTO. Susan Sell (2004) argues that while coercion is a viable weapon of the strong, principled argument can be a potent asset for the weak to bring about desired change. This is a proposition that this chapter will support. The puzzle of this chapter is answered by reference primarily to the theoretical perspective of Social Constructivism within the International Relations (IR) tradition. Nevertheless, other central theoretical perspectives are presented as a first step, namely perspectives belonging to the rationalist camp of the IR tradition. The strength of this type of approach is that it provides possibilities for clear predictions about international institutional settings like the WTO. However, this chapter will argue that there are gaps in the empirical reality that such perspectives are not able to cover. Such traditional perspectives have no problems when it comes to explaining the empirical area of formal rules and disputes related to them in the WTO. However, negotiations and the power of ideas is an essential ingredient in the WTO system, and it is not sufficiently explained by these perspectives. The social constructivist perspective will be proposed in order to fill these gaps, and sets out to explain and identify different types of learning and consequent changes of expressed preferences in the WTO. Preferences are here defined as expressed preferences as opposed to real preferences, which are very difficult to identify (see the CheckelMoravcsik debate, 2001). More precisely, social learning is here defined as involving change of a state’s expressed preferences as a result of persuasion through epistemic community collective value-based adjustments. On the other hand, simple learning merely involves a strategic change of a state’s expressed preferences as a result of persuasion through unilateral arm-twisting. Thus, social learning involves changes in a state’s expressed preference or position regarding internal values and policies. Simple learning, on the other hand, merely involves strategic changes in a state’s expressed preference or position not involving internal values and policies. This chapter will start out with a rationalist perspective on the Trade Related Aspects of Intellectual Property Rights (TRIPS) area. This application will highlight the weaknesses of such an approach. Subsequently, this chapter will move on to apply the social constructivist perspective to the same area – illustrating which gaps that this perspective is able to fill.

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Belonging in the rationalist camp, a neo-realist perspective would argue that the central countries in the WTO system always profit more from international interaction. They will always exercise their power, whether the framework is an international institution or not. Furthermore, another rationalist perspective, namely neo-liberalism, would be more confident that all states have mutual interests and could gain from cooperation. Thus, this perspective promotes regimes and institutions as the most effective means of managing the globalization process. However, critics of this perspective have argued that looking at the formal rules of the WTO it could clearly be seen as an undemocratic organization representing the rights of global corporations. The WTO has consistently ruled against governments that pass legislation that impede the free flow of goods, services and capital (Lamy, 2001, p. 195). Consequently, these rationalist perspectives are operating at the structural macro level and would primarily focus on formal rules and dispute settlement when observing the WTO system. It will here be argued that formal rules and dispute settlement display only a superficial image of the WTO. The truth about central and peripheral states’ ability to promote their own interests is more complex than is recognized by rationalist approaches in their focus on formal rules and processes. The social constructivist perspective would argue that peripheral as well as central states are able to shape institutions and persuade other actors into supporting their positions throughout the negotiation process – as long as the right ideational learning conditions are in place. Referring to the social constructivist perspective, which operates at the process-oriented micro level, it will be argued that the most important aspect of the WTO system is not the end result, in terms of formal agreements and rules. Micro-processes taking place between individual actors during negotiations are more important when we want to understand the WTO logic. It will be argued that the logic and dynamic of the WTO as a forum of continuous negotiations is best understood from a social constructivist perspective. Furthermore, it is not sufficient to look at how institutions shape actors, as the neo-liberal approach would argue, but vice versa, how actors shape institutions, is equally important. The long and sometimes painful ongoing negotiation processes are in themselves important, as they contribute to the shaping and reshaping of actors’ expressed preferences. These processes have driven central as well as peripheral actors to change their positions as well as expressed preferences throughout the process. Negotiation processes might, in fact, be seen as the most important contribution of the WTO as an institution.

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The European Union (EU)5 could be described both as a peripheral and as a central actor on the multilateral trade arena. When compared to the United States (US), it would certainly be seen as a peripheral actor in terms of geopolitical weight. However, the EU is an actor of central importance in terms of its proportion of world trade,6 which is calculated to be exactly the same as that of the US, namely 20 per cent (Eurostat Yearbook, 2004).7 The US, on the other hand, is an actor that historically has preferred to act unilaterally, both in trade and other matters. George Soros (2002) argues, in On Globalisation, that the WTO is practically the only international organization that the US has agreed to be subjected to, especially considering the last years’ US disrespect for the UN in geopolitical affairs. In this chapter the US and the EU will be defined as ‘central’ WTO actors – although this definition is not totally unproblematic. Central here means that they are at the power-centre of the WTO system. It is an unwritten rule of the WTO that you need to get at least one of these two actors on board in order to reach a WTO decision on any matter. On the other hand, the WTO consists of a large number of members that will here be defined as ‘peripheral’ states. This is a broad definition including a diversity of countries: industrialized countries (e.g., Norway), transition countries (e.g., Eastern European countries), developing countries (e.g., India and Brazil) and least developed countries (e.g., African countries). In the WTO system these countries are all dependent on supporting each other in formal or informal groups in order to make their voices heard. The centre-periphery definition is useful for the purpose of this chapter, by drawing a line between the two most powerful and the other less powerful actors in the WTO system. This chapter also to some extent deals with non-state actors, but merely as participants, who provide support for certain member states’ position through the use of publications, public actions or lobbying activity. Pharmaceutical multinational corporations are important in this respect, as are non-governmental organizations (NGOs). Furthermore, in this chapter the focus is on a relatively new area of trade in the GATT/WTO context, namely Trade Related Aspects of Intellectual Property Rights (TRIPS). The reason for this selection is that the shaping of new policy areas in the WTO will make actors’ differences of interests appear even more clearly. An additional advantage is the fact that case law and negotiation material in this trade area of the WTO is still relatively limited, and therefore not too complex to review. The empirical material consists of formal decisions, dispute settlement cases, negotiation process documentation and media reports.

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2. The WTO: Centre versus Periphery and TRIPS The WTO was established at the end of the Uruguay Round, early in 1994. Its predecessor, the GATT was established in 1947 and became a forum for negotiations on trade liberalization, independent of the UN. The central trading principle of the WTO is non-discrimination – meaning that any barrier to trade should be applied equally to all member states. The non-discrimination principle has two components: the Most Favoured Nation (MFN)8 and National Treatment.9 Their precise scope and nature differ across areas, although they both apply to goods, services and intellectual property. The change of name from GATT to WTO involved the inclusion of new areas of trade, like services (GATS) and intellectual property (TRIPS), in addition to the already existing trade in goods (GATT). Thus, negotiation rounds have become increasingly time consuming, detailed and encompassing (see Table 10.1).

Negotiations Hoekman and Kostecki (2001) contend that negotiation is the driving force of the multilateral trading system. Negotiations are used to agree on rules and procedures, to periodically reduce trade barriers in instances when new countries want to join the club and to resolve trade conflicts. The WTO is in essence a permanent negotiating forum in which trade issues may be discussed and agreed upon against the background of the provisions of the already concluded agreements. Negotiations take place in permanent and ad hoc fora and are formal as well as informal. Although the WTO is a multilateral institution, it relies very much on bilateral and plurilateral interactions among members. The major formal meetings have since 1982 been called ‘Ministerial Meetings’. In the WTO the ministerial meetings have been negotiating sessions, whereas in the GATT ministerial meetings were more stock taking exercises.

Dispute settlement With the establishment of the WTO, a more efficient dispute settlement procedure has been established. The Dispute Settlement Body (DSB)10 can settle trade disputes that arise between the member states. A more timely compliance can be ensured, as compared to the basically voluntary procedures of the GATT. Decisions made by a WTO Dispute Settlement Panel (DSP) cannot be vetoed by any party or member state, as it could under the GATT. The rules of the game are laid out in the Uruguay Round Dispute Settlement Understanding (DSU).11 The DSU covers all disputes arising under WTO agreements, relating to goods, services and intellectual property.

Table 10.1

Trade rounds and selected ministerial meetings 1947–2005

Name of round or meeting

Period and number of parties

Subjects and modalities

Outcome

Geneva

1947 23 countries

Concessions on 45,000 tariff lines

Annecy

1949 29 countries

Torquay

1950–1 32 countries

Geneva

1955–6 33 countries

Dillon Round

1960–1 39 countries

Kennedy Round

1963–7 74 countries

Uruguay Round

1986–94 103 countries (1986) 117 countries (end 1993)

Tariffs: item-by-item offer-request negotiations Tariffs: item-by-item offer-request negotiations Tariffs: item-by-item offer-request negotiations Tariffs: item-by-item offer-request negotiations Tariffs: item-by-item offer-request negotiations, motivated in part by need to rebalance concessions following creation of the EEC Tariffs: formula approach (linear cut) and item-by-item talks. Non-tariff measures: anti-dumping, customs valuation Tariffs: formula approach and item-by-item negotiations Non-tariff measures: all Tokyo issues, plus services, intellectual property, pre-shipment inspection, rules of origin, trade-related investment measures, dispute settlement, transparency and surveillance of trade policies

5,000 tariff concessions; 9 accessions 8,700 tariff concessions; 4 accessions Modest reductions 4,400 concessions exchanged; EEC proposal for a 20% linear cut in manufactured tariffs rejected Average tariffs reduced by 35%, some 33,000 tariff lines bound; agreements on customs valuations and anti-dumping Average tariffs again reduced by one A third on average. Agriculture and extiles and clothing subjected to rules; creation of WTO; new agreements on services and ntellectual property; majority of Tokyo Round codes extended to all WTO members

233

(Continued)

234

Table 10.1

(Continued)

Name of round or meeting

Period and number of parties

Subjects and modalities

Outcome

Doha Development Agenda

2001-144 countries (2001) 150 countries (Jan 2007)

Tariffs: formula approach and item-by-item negotiations. Non-tariff measures: services; intellectual property; implementation issues; Singapore issues: trade and investment; trade and competition; government procurement transparency; and trade facilitation; WTO rules: anti-dumping; subsidies; regional trade agreement; dispute settlement understanding; trade and environment; electronic commerce; small economies; trade, debt and finance; trade and technical transfer; Technical cooperation and capacity building; least developed countries; special and differential treatment

yet to be concluded

Source: Based on Hoekman and Kostecki, 2001, p. 101.

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Accordingly, the dispute settlement mechanism is often seen as the cornerstone of the WTO, as it lacks any ordinary executive body. Professor John Jackson has said, during a hearing before the US Congress, that the Uruguay Round was worthwhile doing if only for the new Dispute Settlement System it has created (Paemen, 1995, p. 39). The expectation was that the creation of the WTO dispute settlement procedures would provide small and peripheral member states with greater incentive to bring cases to the WTO. Empirical evidence regarding the use of the DSP would appear to support the optimistic expectations (see tables below). However, more frequent use of the DSP also reflects the great expansion in the coverage of multilateral disciplines and the larger membership of the WTO as compared to the GATT. The Tables 10.2 and 10.3 illustrate that the heaviest users of the dispute settlement system have been the US and the EU. However, the statistics also show that the number of complaints brought by the US and the EU has declined in recent years, and that other WTO members have been consistently active in WTO disputes. It will here be argued that the rationalist focus on the part of the picture display by these tables only provides a superficial understanding of the WTO.

TRIPS Intellectual Property Rights (IPRs) were, as already mentioned, one of the new areas of trade introduced in the Uruguay Round. Hoekman and Kostecki (2001) hold that it became a trade issue for a number of reasons. International trade in goods embodying IPRs has increased substantially in recent decades as the share of manufactures in total merchandise trade has expanded, and within manufactures, the share of ‘high-technology’ goods has increased. Starting in the 1980s, a number of industrialized country governments increasingly perceived inadequate enforcement of IPRs in importing countries to reduce the competitive advantage of their exporting firms. As technologies for duplication became both more advanced and cheaper, trade in goods embodying stolen knowledge became an increasingly contentious issue. Intellectual Property (IP) can be defined as information that has economic value when put into use in the marketplace (Maskus, 2000). Ownership rights to intellectual assets span those ideas, inventions and creative expression on which there is a public willingness to bestow the status of property (Sherwood, 1990). Legal IPRs include industrial property,12 copyright and so-called neighbouring rights. These all fall within the broad category of knowledge goods and are the result of research and development (R&D). This chapter focuses on industrial property in

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Table 10.2

Complaining parties in WTO disputes*

Brazil Canada Chile EU India Japan Korea Mexico US Other – Developed Other – Developing Other – Least developed Total

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Total

1 5 1 2 1 1 0 2 6 0 9 0 28

0 3 0 7 4 3 0 3 17 2 12 0 51

4 1 1 16 0 1 2 0 17 5 3 0 50

1 4 0 16 3 1 0 0 10 2 4 0 41

0 2 0 6 1 2 1 3 10 3 6 0 34

7 1 1 8 2 1 3 1 8 1 9 0 42

4 3 3 1 2 0 0 1 1 0 9 0 24

5 4 2 4 2 2 1 0 4 4 9 0 37

0 1 1 3 0 0 3 3 3 1 11 0 26

0 2 0 5 1 1 2 0 4 0 3 1 19

22 26 9 68 16 12 12 13 80 18 75 1 352

Note: *Because some complaints were brought by multiple members, the number of complaining parties exceeds the number of responding parties for some years.The classification of developed countries, developing countries or least developed countries is based on the Agreement Establishing the Advisory Centre on WTO Law. See Agreement Establishing the Advisory Centre on WTO Law (30 November 1999) http://www.acwl.ch/e/toold/doc_e.aspx

Table 10.3

Responding parties in WTO disputes

Brazil Canada Chile EU* India Japan Korea Mexico US Other – Developed Other – Developing Other – Least developed Total

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Total

1 0 0 8 0 4 3 0 4 2 3 0 25

4 1 0 4 1 4 2 1 8 2 12 0 39

2 5 3 4 7 3 3 1 10 7 5 0 50

1 3 0 9 4 1 0 1 6 8 8 0 41

1 1 0 3 1 0 3 0 11 1 9 0 30

2 0 2 2 0 0 0 3 11 1 13 0 34

1 1 4 3 0 0 0 1 6 0 7 0 23

0 1 1 6 1 1 1 0 19 2 5 0 37

0 0 0 8 1 0 0 3 6 1 7 0 26

0 1 0 4 2 1 1 2 7 0 1 0 19

12 13 10 51 17 14 13 12 88 24 70 0 324

Note: *These figures do not include complaints brought against individual EU member states. Source: Leitner and Lester, 2005, or http://www.worldtradelaw.net

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general, and more particularly on patent rights in the pharmaceutical industry, which is a good example of centre-periphery conflict in the WTO. The US and the EU were the major net exporters, whereas the developing countries were all net importers of intellectual property (Hoekman and Kostecki, 2001, p. 284). As this chapter will explore, free riding on others’ IP is an attractive option for developing countries. On the other hand, IP protection in the US and the EU tends to put limitations on competition and increase prices for consumers.

The pharmaceutical industry in peripheral developing country and TRIPS Under TRIPS (WTO, 1994), patents grant an inventor or author a temporary monopoly over the use of the invention or the reproduction of a work and prevent competitors from sharing and using their knowledge without payment. At least 20-year patent protection is to be provided for almost all inventions, including both processes and products. TRIPS (ibid.) is subject to different transitional periods for various groups of peripheral countries to bring their legislation and practices into conformity; developing countries and economies in transition had a fiveyear period; least developed countries had eleven years (until 2006).13 Developing countries that did not provide patent protection in an area of technology had up to ten years (until 2005) to induce such protection. However, in the case of pharmaceutical14 products, peripheral countries and their pharmaceutical industry had to accept the filing of patent applications from the beginning of the transition period. Though the patent need not be granted until the end of that period, the novelty of the invention is preserved as of the date of filing the application. If authorization for the marketing of the relevant pharmaceutical product is obtained during the transition period, the developing country concerned must offer an exclusive marketing right for the product for five years, or until the product patent is granted or rejected, whichever is shorter (Zutshi, 1998, p. 40). Historically, the evolution of IP protection shows that, except for one of the central actors, the US, other developed countries practised protection regimes commensurate with different stages of their economic development. Providing some examples from member states within the EU, representing the other central actor in this chapter, pharmaceuticals patents were not protected in the Federal Republic of Germany and France until 1967 and Italy until 1979. In Spain and Portugal, chemicals and pharmaceuticals became patentable only in 1992 (Raghavan, 1990, p. 123).

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3. Theoretical Perspectives International relations (IR) literature The international relations (IR) approach was dominated by idealism (see Zimmern, 1939, and practitioner Woodrow Wilson) in the interwar period (1919–39). These writers focused on common interests shared by nation-states and believed in the capacity of humankind to overcome the scourge of war. With the outbreak of World War II the rationalists (see Hoffman, 1966; Morgenthau, 1948) claimed that idealists had been proved wrong and realism became the dominant IR perspective (1939–79). In 1979, the debate turned into a neo-neo debate between neo-liberalism and neo-realism. These two perspectives differ in that neo-realists (see Waltz, 1979) are concerned with issues of states’ survival and focuses on issues of military security and war. Neo-liberals (see Keohane, 1984), on the other hand, counter with claims that all states have mutual interests and can gain from cooperation and focus on issues of cooperation, international political economy and the environment. Smith (2001, p. 183) argues that some see this debate as not much of a debate after all, as it is a debate about refining common assumptions about the future effectiveness of international institutions and possibilities of cooperation. It is a debate between ‘rule-makers’ (here: central WTO members) and it leaves out the voices of the ‘rule-takers’ (here: peripheral WTO members). Furthermore, both neo-realists and neo-liberalists neglect the fact that the political activities may be shifting away from the state (see ibid., p. 193). Social constructivism (see Wendt, 1992; 1994) appeared in the IR tradition as part of a reflectivist-rationalist ‘third debate’ in the early 1990s. This approach focuses particularly on concepts that aforementioned rationalists see mainly as indirectly relevant (as explained by other phenomena and concepts). These concepts are, for instance, ideas, deliberation, persuasion, learning and preference changes (see Checkel, 1998; 2001a; 2001b). The social constructivist approach is seen as particularly useful for the purpose of explaining the TRIPS case because of its understanding of learning as social as opposed to rationalist simple learning. Furthermore, this approach is seen as useful because of its understanding of preference-shaping as a complex process and driven by forces external as well as internal to the individual state. Rationalists, in contrast, see preferences mainly as shaped bottom-up from within states.

Rationalist approaches According to one strand of the IR tradition, the state is the pre-eminent actor and all other actors are of lesser significance. Survival is the primary

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goal of international politics and states interact in an anarchic world. This theoretical strand originates from realists like Hans J. Morgenthau and E.H. Carr writing in the 1930s and early 1940s. Neo-realists like Waltz (1979) have followed on and, more recently, writers like Andrew Moravcsik (1993; 1998), promoting his liberal intergovernmentalism, have further developed this perspective. This perspective draws on rationalist explanations for international cooperation. Moravcsik (1998, p. 24) argues that preferences are formed nationally – outside institutionalized settings – as they are ‘exogenous to a specific international political environment’. Decisions and preferences are portrayed as bottom-up processes and international negotiation processes are not seen as shaping preferences significantly. Realists and liberal intergovernmentalists would argue that companies from central countries in the WTO always profit more than other actors, from international interaction. These actors will exercise their power on the international scene, independent of the existence of international institutions like the WTO. Consequently, the WTO will to a large extent be the vehicle of the central powers. According to Moravcsik (1993), the interests of these central powers will be determined by their domestic dynamic situation rather than by international interaction and negotiation. Thus, the WTO will be applied to promote the interests of the central member states and their companies, whose interests will not be considerably shaped or reshaped through international negotiation processes. Another strand in the IR tradition originates from the idealism of practitioners like Woodrow Wilson and researchers such as Alfred Zimmern in the interwar era (1919–39). Neo-liberalism is sometimes referred to as neo-liberal institutionalism (Keohane and Nye, 1977). While not denying the anarchic character of the international system, neo-liberals argue that realists and neo-realists have overemphasized this aspect and underestimated the common interests of states in cooperating with each other. This perspective differs from realists in that institutions or regimes provide processes, rules and norms that provide a measure of governance and mediation in a formally anarchic world. Keohane and Nye (ibid.) referred to ‘complex interdependence’ between international actors as the central feature of international relations. According to neoliberal institutionalism, peripheral states would have a better chance of achieving cooperation with central states within the institutional setting of the WTO than they would on the outside. To summarize, this perspective recognizes the centrality of international institutions like the WTO, as well as including some of the concepts that are central in the social constructivist perspective, like norms and ideas. However, it is

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clearly a rationalistic perspective which emphasizes actors as egoistic value maximizers and would not open up for the possibility of top-down processes of social learning originating at the international level and resulting change of states’ expressed preferences. It will here be recognized that these rationalist perspectives do provide important insights, but nevertheless lack explanatory power regarding some of the central aspects in the WTO. Critiques would state that such ex post analysis of the actor’s prior positions holds the danger of being tautological and static. This chapter will, in line with the social constructivist perspective, contend that the power of ideas, persuasion, social learning and change of expressed preferences are important components in WTO negotiations. Thus, we need to analyze negotiations dynamically rather than statically. Rationalist perspectives operate at the structural macro level and emphasize the rationality of actors (bounded rational choice) as well as the formal rules. State preferences are assumed to be given prior and exogenously to the negotiation setting. Accordingly, rationalist or rather simple learning (see Checkel, 2001a; 2001b) will here be identified as either a result of a strategic change of position or expressed preferences as a result of persuasion through arm-twisting on the part of the central actors towards the peripheral actors in the WTO.

Social constructivism The theoretical perspective of social constructivism has been one of the influential theories within the IR tradition since the early 1990s. Two of the most central figures of modernist social constructivism in IR are Wendt (1987; 1992; 1994; 1999) and Ruggie (1993; 1998). This is a theoretical perspective, which has not to my knowledge been applied convincingly to the context of the WTO. This perspective has primarily been applied in the IR tradition to security/geopolitical studies (Adler 1997; Evangelista, 1999; Hemmer and Katzenstein, 2002; Hopf, 2002; Price, 1998; Wendt, 1992); human rights (Keck and Sikkink, 1998; Risse et al., 1999) and has recently been introduced in the EU integration literature (Checkel and Moravcsik, 2001; Christiansen et al., 2001; Eriksen and Fossum, 2000; Schimmelfennig, 2001). Wendt is often referred to as the ‘founding father’ of constructivism. In order to avoid having to choose between agency (see Waltz and his ontological individualism, 1979) or structure (see Wallerstein and his structuralism, 1974), Wendt imported Giddens’ (1984) social structuration theory and Bhaskar’s (1979) critical realist theory to IR. Checkel (1998) states that all social constructivists would agree that the structures of the world are social rather than material. This means that, for instance, the

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Centre and Periphery in the WTO

so-called ‘anarchic world structure of nation states’ is merely socially constructed (Wendt, 1992). State behaviour does not just derive from the anarchic environment but also helps make it. This is what is meant by the concept of ‘mutual constitution’ between agent and structure (Wendt, 1987). Moreover, actors are, to varying extents, knowledgeable about the settings within which they are located and are potentially able to change them (Hay 1995, p. 200). According to social constructivists, peripheral as well as central states are able to shape institutions and persuade other actors into supporting their positions. Institutions or structures provide valuable arenas where actor preferences may serve to change others’ interests or to be, themselves, changed. This means that the interests of all actors, central or peripheral, could potentially be changed in the WTO. The focus is directed towards the more micro level of negotiations between member states, and even including non-state actors like multinational companies and humanitarian organizations. Furthermore, meetings, negotiations and discussions related to dispute settlement in the WTO are at least as decisive as formal rules and dispute settlement case law, in shaping the WTO regime. Thus, the social constructivist perspective is useful in order to grasp the WTO as a permanent negotiating forum. Susan K. Sell (1995; 2004) has contended in her writings about TRIPS that she would not like to privilege the rationalist or constructivist perspective, or say that ideas matter more than interests. Her arguments go some way in the direction of saying that ‘ideas matter’, but never mention preference change. This chapter builds on Sell’s neo-liberal institutionalist arguments.

Social constructivist mechanisms However, this chapter will apply social constructivist tools in order to go further and contend that preferences, at least expressed preferences, may actually change during negotiating processes. Thus, learning and preference change is more of a top-down process according to this approach. Accordingly, the social constructivist approach would predict that pharmaceutical industry and consumers in peripheral as well as central WTO countries could potentially benefit from the WTO system. It will here be argued that learning could be portrayed as ranging from the rationalist end to the social constructivist end of a scale (see Figure 10.1). A rationalist type of learning will, in line with Checkel (2001a; 2001b), be labelled simple learning and social constructivist learning will be termed social learning. Simple learning is here identified as a result of persuasion through unilateral arm-twisting, which does not involve changes of expressed preferences including adjustments of states’ internal

Helene Hoggen Realism

Social constructivism

Simple learning

Social learning

Figure 10.1

243

Continuum of perspectives

values or policies. Social learning, on the other hand, is identified as a result of persuasion through epistemic community, which involves states’ adjustment of internal values and policies. In this chapter, identifying social learning processes will be inspired by definitions provided by Checkel and Moravcsik (2001). Social learning will accordingly be deemed as most effective in situations (i) when the persuader does not lecture or demand, but, instead, acts out principles of serious deliberative agreement; (ii) where the persuader has support from well-developed social structures or epistemic communities (Haas, 1992) and the persuadee has less support; and (iii) there is less politization and more private setting.

4. Analysis: Intellectual Property Rights (IPRs) in the WTO On the surface, the IPR area of trade in the WTO seems to be a classic example of a rationalist approach and the strength of central states. The central WTO actors, EU and US, are hosts of powerful pharmaceutical giants like GlaxoKleinSmith and Pfizer, respectively. In the Uruguay Round, the US and the EU successfully transformed their industrial interests into the institutional framework of TRIPS, which the peripheral developing countries, led by India, opposed. Regulations put down in the WTO framework (1994) promote the interests of companies from the central WTO countries. Moreover, it seems that countries like India, China and Brazil, with massive markets and huge industrial capability, were the principal targets of the WTO TRIPS agreement. Furthermore, it seems that the interests of the consumers, in terms of affordable prices, were afforded very little consideration in this agreement. Thus, WTO institutions have apparently done little to protect the interests of peripheral WTO states in this case. The Indian pharmaceutical cases (WTO, 1997a; 1997b) confirm this picture.15 These are cases where a peripheral developing country, although not the weakest one, was taken to court by the central WTO states – by the US in 1996 and by the EU in 1997. The dispute settlement system thus reaffirmed the anarchic world order, where the interests of the central states dominate. The WTO ruled that peripheral India had to

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Centre and Periphery in the WTO

do more to comply with WTO patent regulations. However, at this point terminates the suitability of the rationalist perspective. The TRIPS development since these two WTO cases is better grasped if observed through a social constructivist lense. This was the starting point of an ongoing dialogue between central and rich states, on the one hand, and peripheral and poor ones, on the other hand. This dialogue takes place within the WTO framework and clearly involves argumentative persuasion, social learning and change of expressed preferences, which can be seen as indications of social constructivist processes being at play.

A rationalist approach applied to case law Primarily reference must be made to Susan K. Sell (1995) who wrote about IP cases in the GATT era when the central WTO actor of the US unilaterally made numerous efforts at coercing peripheral developing WTO countries into protecting intellectual IPRs.16 The US argued that the road to development is paved by the free play of market forces. In the absence of any WTO dispute settlement mechanism, the US on several occasions used its ‘Section 301’ and ‘Section 337’ in order to coerce foreign governments to modify their practices. The EU has similar instruments to address foreign trade partners, but has traditionally been much less activist than the US (Bronckers, 1996). Furthermore, Sell described how peripheral developing countries, according to a realist or rationalist perspective, adopted new laws and policies as a result of such unilateral coercion. However, when it came to implementation and enforcement of such policies these countries were hesitant. Thus, the findings of Sell (1995) led her to question the rationalist logic. It will here be argued, in line with Sell, that simple learning as a result central countries’ unilateral arm-twisting or international case law rulings in favour of central countries seems to have been inefficient in the TRIPS case. What has produced real results is social learning as a result of collective deliberation and persuasion in the epistemic community. This illustrated by a change of expressed preferences involving adjustments of central countries’ internal values and policies. The first dispute (1997) involving the TRIPS issue in the WTO did indeed highlight the most disturbing elements of the TRIPS agreement. One of the central WTO member states, the US, brought this complaint based on the fact that peripheral India had not created a sound system for filing patent applications for pharmaceutical products;17 nor had India created any mechanism for granting exclusive marketing rights for such products.18 With the coming into force of the Uruguay Round agreements, the Indian parliament had hesitated to make the necessary changes to

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domestic legislation, and the relevant patent application filings had been allowed to take place under the authority of an executive order. This was not formally notified to the WTO. The Indian intention was to store the relevant applications separately, until its patent law was changed to reflect TRIPS provisions. The TRIPS transition period was set to last until 2005. During this period of legal ambiguity, India continued to receive and store patent applications, although Indian law retained its prohibition against the patentability of these socially and economically sensitive products. The US argued that India had not created an adequate mechanism for recognizing these applications and, thus, had failed to preserve their novelty. The outcome was that India lost this case, but did nothing to comply with the ruling (Dillon, 2002). So far, this story has dominantly rationalist characteristics – except the fact that India did not comply with US and WTO demands. Thus, social constructivist dynamics are at play. Simple learning through arm-twisting was largely inefficient in terms of changing the expressed preferences involving internal values and policies on the part of India. Moreover, the central EU brought an identical case against peripheral India in 1998, arguing that India had not acted to alter its domestic legal regime in the light of the earlier rulings. India maintained that successive complaints based on the same facts and legal claims were unprecedented in GATT/WTO law. India lost again and, having lost twice on the same issue, against important trading partners, the cost of non-compliance had risen substantially for the Indian government. India subsequently announced that they would be complying with the rulings against them. The Indian pharmaceutical case sent a clear message to other countries at which the TRIPS agreement was aimed, that a transition period does not mean the same as non-compliance. Dillon (ibid.) writes that the political resistance in peripheral countries like India to altering foundational beliefs concerning the relationship between fairness and IPRs was the ultimate target of these actions. However, social learning was never achieved and the persuasion applied by the central WTO members was mainly arm-twisting. Consequently, the story seems even more rationalist of nature, as the central states now appeared to get their opinions through to the more peripheral ones. However, there are no signs of any social constructivist change of expressed preferences, as India did little by way of changing its policy in this area. Solely a change of position is apparent, on the part of India, in order to formally comply with the WTO ruling. Until this point in TRIPS history a rationalist analysis has been useful, but moving on to explain what happened later on, this chapter argues that we need to take a social constructivist perspective.

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Centre and Periphery in the WTO

Social constructivism applied to negotiations This chapter will argue that the underlying logic of TRIPS history, from 1998 onwards, is social constructivist rather than rationalist. Peripheral India has acquiesced on paper and has done just enough to free itself from the pressure of the central WTO states (US and EU) – but no more. Thus, simple learning has so far been identified, but not social learning. While India at the international scene expressed changed preferences regarding its IPRs policies, it did not change its internal values and policy preferences regarding the perils of IP protection. Free riding on others’ IP and the profits from piracy still outweighed the liberal norm of respect for property rights. Thus, rationalist perspectives can solely explain what are put down in formal rules and disputes, but are not interested in thorough explanations of why changes in the WTO system occur. The social constructivist perspective will contribute to a deeper understanding of TRIPS. To discourage peripheral developing countries from invoking compulsory licensing, the IP industry has aggressively pursued litigation. As this chapter will demonstrate, the IP industry in the central states, have asked for trade sanctions, for instance, by the United States Trade Representative (USTR) against peripheral countries such as South Africa and Brazil for allegedly violating TRIPS (Sections 301 and 337). These cases were actually dropped and recently the US approach has been softened considerably. The EU went from a position that promoted IP industry interests, to one where access to medicines, public health and reform of TRIPS is set first on the agenda. Thus, some form of learning could be identified in the central countries, but a deeper dive into negotiation processes has to be taken in order to discern whether it was social or simple learning. Sell argued, in 1995 and 2004, that although the US had invested enormous amounts of time and energy in its coercive strategy, it had very little to show for it in intellectual property protection. However, for peripheral developing WTO countries it will here be argued that argumentative persuasion seems to have produced results in terms of learning and changes of the expressed preferences in the central countries.

Social learning Politization. One of the elements facilitating social learning is, according to Checkel and Moravcsik (2001), low degree of politization – or rather domination of private dialogue. Politization is when an issue becomes controversial and is discussed publicly, rather than being discussed in a private and quiet setting. In 1997, some controversies came about as the peripheral WTO member South Africa drafted laws that

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would give it more flexibility in procuring medicines either from homegrown sources or from cheaper foreign exporters. In response 39 multinational pharmaceutical firms, in 2001, sued the government. These firms claimed that the 1997 ‘Amendment Act’19 violated TRIPS and the South African constitution.20 This type of learning is here identified as simple learning, as a result of unilateral arm-twisting. Throughout this case the central WTO member US put unilateral pressure on peripheral South Africa by withholding trade benefits and threatening further trade sanctions aiming to force the South African government to repeal the Amendment Act (Omnibus Act, 1999). In 1998, the European Commission joined the US in pressuring South Africa to repeal the legislation (European Commission, 1998a). Pharmaceutical firms, in the US and the EU, were anxious at the prospect of generic copies entering South Africa. They feared that these would leak out of the public health service and into the more lucrative private market in South Africa, or as far away as Europe or Africa (Economist, 8 March 2001). In September 2001, the drug industry started an attempt to rally support for their view. An unofficial Commission paper calling for the rules to be implemented ‘in such a way as to ensure access to affordable medicines for all’, spread fear in the industry. However, the drug industry received no support from the music and computer software industries. These traditional defenders of IPRs, said they had been put off from intervening by drug firms’ handling of disputes over drug patents (European Voice, 27 September 2001). Thus, politization seemed not to disrupt learning processes in this case. Furthermore, epistemic community support was increasingly with the peripheral rather than the central WTO member states. The peripheral South African government’s argument was that hundreds of thousands of South Africans die every year from diseases such as Aids, tuberculosis and malaria that could be cured, prevented or alleviated with drugs. Many of these are unaffordable, because of patents, which allow the inventors a monopoly of 20 years from the date the patent is filed. In order to save lives, the government said it should sometimes be allowed to infringe these patents (Economist, 8 March 2001). Demonstrators in major cities asked the companies to drop the case. Additionally, several governments and parliaments around the world, including the European Parliament (EP), demanded that the companies withdraw from the case. As a result, the legal action turned into a public relations disaster for the drug companies (Cooper et al., 2001). Pharmaceutical companies received very little sympathy – not even other industrial actors supported their IP protectionism. Consequently, social learning was identified, as a result of persuasion through the epistemic

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community leading to a change of expressed preferences regarding internal EU IPR values and policies. The values of the EU were changing, as expressed by public opinion in the streets as well as the EP. Thus, it was established that both protection of ethical values and economic consumer interests could be questioned in this case. Eventually, the strong international public outrage caused the companies to unconditionally drop the case in April 2001. When brought to light through public action and media attention, the use of economic coercion to reduce access to medicines can become ‘politically unpalatable for US and EC government and corporate elites’ (Sell and Prakash, 2004; Shaffer, 2003, p. 21). Thus, the issue of TRIPS and public health became a highly politicized issue. This chapter argues that these public protests and politization of the TRIPS issue initiated the following developments of position and expressed preference change on the part of the central WTO actors, the EU and the US. However, by themselves these public actions were not enough to convince the EU and the US. The public actions or politization of this issue would actually not be deemed to facilitate, but rather inhibit social constructivist argumentative persuasion. Nevertheless, they put this issue on the agenda, and politization might not be as negative for social constructivist processes as previously assumed by social constructivist authors like Checkel. The issue has, since these calamities, never become a low-key issue, although it has not reached the same level of politicized conflict again. It will here be argued that as long as the actors manage to argue in friendly and socially constructive manner and refrain from hostile demands or coercion attempts, politization might actually serve to promote social learning processes.

Epistemic community.

Social constructivists would argue that social learning is more likely when the persuader has support from well-developed social structures or epistemic communities. Well-developed epistemic community in this case means NGOs; multinational companies and public opinion at large. This type of support was established by NGOs after the South Africa case. Several NGOs did research and wrote reports in support of the peripheral developing countries’ position in TRIPS negotiations. The TRIPS issue has been successfully linked by NGOs with public health and human rights. Pharmaceutical companies had in the Uruguay Round successfully framed the TRIPS issue as ‘patents ⫽ free trade ⫹ investment ⫽ economic growth’. This became one of the normative building blocks of the TRIPS agreement (Sell and Prakash, 2004). Executives in the pharmaceutical industry boasted about their close relationship with and extensive access to the WTO Secretariat (Basu, 2003,

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p. 7; Forbes, 2003). Thus, social learning was facilitated as a result of NGOs’ persuasion resulting in value change regarding IPRs in the epistemic community. By contrast, NGOs have now reconstructed the policy problem as one of excessively stringent IPR norms that make HIV/Aids medicines unaffordable, thereby working against public health objectives. ACT UP Paris, a health policy advocacy group, frames the NGO position as ‘copy ⫽ life’. This underscores the point that through copying many lives can be saved (Sell and Prakash, 2004). Several studies and reports have been written on the topic, providing new knowledge and making the case easier for developing countries to promote in a non-contentious manner. In 1998, Zimbabwe’s Minister of Health asked Bas van der Heide of the NGO Health Action International (HAI) to produce a draft resolution for a ‘Revised Drug Strategy’. These recommendations included authorizing parallel importation21 and granting compulsory licences22 where appropriate (Abbott, 2002). This incensed the multinational pharmaceutical industry because the document endorsed the very practices that this sector was fighting through the USTR (’T Hoen, 2002, p. 36). Furthermore, the Dutch Socialist MEP Dorette Corbey argued that the argument about patents ultimately benefiting the poor does not hold up to scrutiny. ‘Despite the fact that innovative pharmaceutical companies argue that their patents must be sacrosanct in poor countries for the sake of research and development, private sector research and development have long neglected the major killers of the world’ (European Voice, 25 July 2002). Accordingly, social learning was facilitated as a result of redefinition of epistemic community values. As early as in 1999,23 McCalman (2001) estimated that the losses due to TRIPS for a number of developing countries are similar in magnitude to the benefits that studies suggested they would obtain from the market access part of the Uruguay Round. In short, the TRIPS agreement would involve a sizable transfer to the central US and EU – as the primary producers of knowledge, while the peripheral developing countries are the major contributors to these transfers. James Love of American consumer activist Ralph Nader’s Consumer Project on Technology and Ellen ’T Hoen of Médicins Sans Frontières have both consistently attacked the US-based lobby group Pharmaceutical Research and Manufacturing Association (PhRMA) on these issues. Ellen ’T Hoen points to strong intellectual property protection as one important barrier to access; she argues that patent protection leads to high prices and limited access (2002, p. 27). Medicins Sans Frontiers and other NGOs have expressed a number of concerns about TRIPS, including: high drug prices; reduced

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availability of quality generic alternatives; inadequate R&D into tropical diseases; and bilateral pressures on developing countries to adopt patent protection that exceeds the requirements of TRIPS (ibid., pp. 29–30). Furthermore, Love has challenged PhRMA’s claims that companies spend US$ 500–800 million developing each new drug. Love has argued that the majority of important HIV/Aids drugs were actually developed by the public national institutes of health, and funded by taxpayers’ dollars (see Consumer Project on Technology, 2005). Human rights organizations increasingly have devoted their attention to intellectual property issues. These bodies would like to see human rights concerns prevail over intellectual property rights. Under a human rights rubric, intellectual property is recast as ‘a social product with a social function and not primarily as an economic relationship’ (Chapman, 2002, p. 867). The organizations adopt resolutions, declarations and reports that are not legally binding. In July 2000, an NGO consortium composed of the Lutheran World Federation, Habitat International Coalition and the International NGO Committee on Human Rights in Trade and Investment submitted a statement to the Chair of the SubCommission on the Promotion and Protection of Human Rights (Helfer, 2003, p. 44). The statement underscored fundamental conflicts between TRIPS and human rights. In November 2000 the UN Committee on Economic, Social and Cultural Rights held a day-long session on intellectual property rights that led to the adoption of a statement in November 2001 endorsing a normative framework for intellectual property rights. The UN High Commissioner’s report on the impact of TRIPS on human rights addressed the medicines issue (UN High Commissioner, 2001). This report endorsed the public health and developing country activists’ position on TRIPS, and highlighted the high cost of patented drugs as a barrier to health (Helfer, 2003, p. 41). NGOs have, through reasoned arguments, developed a valuable knowledge base and gathered support in public opinion. NGOs have, thus, created social structures to support the positions of developing countries in the WTO. As a result, peripheral developing countries have not felt the need to use coercive or demanding language in order to frame TRIPS to their own interest. As a consequence of the NGOs’ framing of the TRIPS as a health concern, public support for the developing countries was acquired automatically. Demanding and lecturing language was never deemed as a necessary strategy by the peripheral countries. It seems that the only actors in the public sphere not supporting the cause of the developing countries in TRIPS were the pharmaceutical industry. The arguments of the pharmaceutical industry have, since the

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Uruguay Round, not carried the weight that they used to. Thus, social learning in the epistemic community, including value readjustments, could potentially have an impact on the central as well as the peripheral WTO countries. Multinational pharmaceuticals, for their part, highlight potential health dangers of widespread generic production, ‘piracy’ and the use of drugs without the supervision, dosing instructions and regulatory controls covering global PhRMA’s products. Further, they attribute the problems in accessing HIV/Aids medicines to poverty and governance issues in developing countries, rather than stringent IPR norms for HIV/Aids medicines (Sell and Prakash, 2004, p. 145) Advocates of PhRMA’s position object to any weakening of intellectual property protection through public health exceptions. They reject compulsory licensing as a policy tool to bring the costs of essential medicines down and they reject parallel importing.24 However, in the eyes of public opinion pharmaceutical companies fighting this sensitive battle could not be reconciled with an image as a caring industry. Thus, the arguments of the pharmaceutical industry have weaker and weaker support in the epistemic community.

Deliberative arguments.

According to social constructivists, social learning is facilitated by way of deliberative argument and agreement, rather than lecturing and demanding. This chapter holds that the peripheral developing countries have managed to refrain from nagging demands. The reason for this is, in large part, due to the support provided by NGOs’ and public opinion. Furthermore, the NGOs’ development of a more solid knowledge base regarding IP, in the aftermath of the Uruguay Round, was important for the deliberative argumentation of the peripheral WTO members. Additionally, these countries have, since the Uruguay Round, apparently learned that cohesion and cooperation between themselves gives strength. Hoekman and Kostecki (2001) argue that at the time when the TRIPS agreement was negotiated in the Uruguay Round, insufficient knowledge existed to allow developing country concerns to be embodied in the drafting of an agreement. As a result, the initial learning of the epistemic community during the Uruguay Round had been biased towards favouring the central WTO member states’ interests. It will here be argued that knowledge development formed part of the persuasion that the peripheral developing countries engaged in. New knowledge about the consequences of TRIPS was provided by several NGOs. This new knowledge supported and legitimated the interests of developing countries. The content of this new knowledge has already been mentioned,

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but we will now look at how this knowledge was applied by the developing countries. Deliberative argumentation and new knowledge eventually contributed to a redefinition on the part of the EU, regarding cause and effect, linking developing countries’ access to medicines with public health issues. The proposals of the peripheral WTO countries have been kept at a deliberate level. They have not resorted to accusations or threats in WTO negotiations. Naturally, it was a great advantage for peripheral countries to talk about TRIPS in relation to public health. In April 2001, the peripheral ‘African Group’ made a statement to the TRIPS Council about the need to confront the access to medicines issue. Two months later, in June 2001, the TRIPS Council held its first session devoted to TRIPS and access to medicines. It was the first time that the TRIPS Council discussed intellectual property issues in the context of public health. At that meeting, the African Group proposed issuing separate declarations on access to medicines. In September 2001 the African Group, joined by 19 other countries, presented a draft text for a ministerial declaration on TRIPS and Public Health (WTO, 2001d). This proposal addressed political principles to ensure that TRIPS did not undermine the legitimate right of WTO members to formulate their own public health policies. In these TRIPS negotiations (WTO, 2001e) Zimbabwe, the representative of a group of peripheral developing countries and India, referred to ‘recent statements made by a large number of NGOs on the matter’ to argue that these countries were not ‘operating in a vacuum’. Furthermore, they stated that expectations were high, not only within the WTO but also outside the organization. The fact that developing countries were able to draw upon a more solid knowledge base developed by NGOs seems to have helped them in building up reasoned arguments and refraining from the use of threats. During paragraph 6 negotiations in 2003 several of the developing countries’ delegations mentioned public health as a legitimate reason for reforming TRIPS. The representative of peripheral Lesotho said that this was an area where the WTO, ‘which for a long time had been accused of not having a humane face, could prove doomsayers of the multilateral trading system wrong’. The representative of peripheral Thailand voiced serious concern about ‘the public health issue posed under paragraph 6’ and he reported that his delegation ‘had received requests from various non-profit foundations and charities for HIV patients and other patients suffering from serious diseases’ (WTO, 2003e). These arguments could not have been forwarded with the same ease had it not been for NGOs like ACT UP Paris introducing IP conceptions of the sort ‘copy ⫽ life’.

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The most contentious wording applied by the developing countries in the 2001 TRIPS Council negotiations was that ‘Nothing in the TRIPS Agreement shall prevent Members from taking measures to protect public health’ (WTO, 2001f). Ellen ’T Hoen (2003, p. 51) argues that some developed countries saw this wording as a new rule that would override the present rules of TRIPS, which do not allow for health exceptions that are inconsistent with TRIPS (WTO, 1994). However, this being the most contentious phrasing of the developing countries, their argumentation could not be deemed as especially coercive but rather deliberative and promoting social learning.

Social learning and change of expressed preferences It will now be illustrated that the two central WTO members, the EU and even the US, have, since the Uruguay Round, not only changed their positions but additionally changed their ranging of values regarding TRIPS-related health problems. The central actors have also to some extent changed their internal policies and regulations regarding IPRs. Looking back at the early beginning of the Uruguay Round, the TRIPS issue was put on the agenda by the central WTO member US, and its pharmaceutical, entertainment and information industries (Bradley, 1987). The peripheral developing countries were opposed to defining substantive rules regarding intellectual property in the GATT context. In their view, this was the responsibility of individual governments, who were best placed to decide what was in the ‘public interest’. This concept of public interest was of particular relevance to pharmaceutical products. The peripheral developing country opposition was led by India. The central WTO member EU envisaged an intellectual property agreement within a multilateral ambit – i.e, signed by all participants and firmly anchored within the GATT. While the central WTO member US, on the other hand, seemed to have in mind an ambitious and detailed agreement, or even a code, subscribed to by perhaps a far smaller number of countries. This code should include even a fine print of IP norms (Paemen and Bensch, 1995, p. 165). The view of the Indian negotiator was that a discussion on intellectual property, and especially the contents of such rights, was out of place in the GATT/WTO context. It was a matter for the World Intellectual Property Organization (WIPO). However, WIPO had no dispute settlement mechanism and therefore could not offer the guarantees sought by the central and industrialized WTO countries (ibid., p. 137). However, this chapter will demonstrate that some of these initial positions were to be transformed throughout negotiations.

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In 1999, at the Seattle Ministerial, which failed, President Clinton declared a change in US policy with regard to intellectual property rights and access to medicines. This policy change contributed to breaking the taboo on the use of compulsory licensing in the health field. Furthermore, in May 2000, the US government issued an Executive Order25 to help make HIV- and Aids-related drugs and medical technologies more affordable and accessible in sub-Saharan African countries. The order prohibits the US government from using section 301 to seek the revocation or revising of IPR policies of beneficiary peripheral sub-Saharan African countries that regulate HIV or Aids pharmaceuticals or medical technologies, if such policies promote access to HIV and Aids pharmaceuticals or medical technologies for affected populations. This was one step in the right direction – no more and no less. Nevertheless, the order indicates that the US has started to adjust its expressed preferences in terms of internal policies – indicating social learning processes being at play in the US. However, the order does not preclude use of WTO dispute settlement mechanism. In February 2001, one of the central WTO members, the US, took action against peripheral Brazil in the WTO over Article 68 of the Brazilian intellectual property law.26 The US argued that the Brazilian law discriminated against US owners of Brazilian patents and that it curtailed patent holders’ rights. The US claimed that the Brazilian law violated Article 27.1 and Article 28.1 of TRIPS (WTO, 2001b). Brazil argued that Article 68 was in line with the text and spirit of TRIPS.27 Brazil had, since the mid-1990s, offered comprehensive Aids care, including access to retroviral treatment. Like in the South African case, the US action came under fierce pressure from the international NGO community, which feared it would have a detrimental effect on Brazil’s successful Aids programme. This case continued the trend of the South African case, as the US decided to withdraw the WTO panel with Brazil in June 2001. This case was therefore not mentioned in the rationalist section, as it rather illustrates a change of strategy in the US. Although the US appeared to have a less coercive approach towards peripheral developing countries regarding TRIPS, it did not lead to immediate change of position or preferences in WTO negotiations. US statements and actions in the TRIPS area are not completely coherent. The fact that the US dropped these two cases indicates a change in the US behaviour towards peripheral developing countries in TRIPS. This was only a few years after the India case in the WTO and numerous unilateral 301 and 337 actions throughout the years. Thus, the US has adjusted its policy in order to be more in line with public opinion and new knowledge, but it has not experienced substantial preference change.

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Engaging in unilateral coercive actions as late as in 2001 illustrates that the US still is an ardent defender of own its industrial interests. Social learning identified as a change expressed preferences regarding internal policies as Clinton, in 1999, prohibited use of the Section 301. Focusing on the other central WTO member of the EU, in 1998 the European Directorate General for Trade (DG Trade) concluded28 that ‘No priority should be given to health over intellectual property considerations’ (European Commission, 1998b). This was in line with the EU position in the Uruguay Round. The following years there was a transformation away from this policy of the European Commission. First, in February 2001, the EU adopted the Programme for Action (European Commission, 2003), a programme that accelerates action on HIV/Aids, malaria and tuberculosis in the context of poverty reduction. The EU programme recognized the potential problems of TRIPS and the need to rebalance its priorities. In this Communication the Doha Declaration (2001) is mentioned, and it is claimed that the EU played a decisive role in achieving agreement on ‘the WTO members’ right to protect public health and in particular to promote access to medicines for all’ (European Commission 2003, p. 9). The Communication also emphasizes the defence of human rights as important in this respect (ibid., p. 10). This programme represented a turning point in the EU approach towards peripheral developing countries. The EU admitted the link between TRIPS and health, and TRIPS and human rights, thus addressing the central issue of causality with regard to the effects of IP protection. Second, several European Parliament resolutions reflected a shift in support of a pro-public health approach to TRIPS (European Parliament, 2001) and in October 2002, while negotiations still went on in the TRIPS Council, the EP adopted amendment 196 to the EU Directive29 relating to medicinal products for human use. The Amendment stated that: Manufacturing shall be allowed if the medicinal product is intended for export to a third country that has issued a compulsory licence for that product, or where a patent is not in force and if there is a request to that effect of the component public health authorities of that country. The EP’s amendment had no immediate impact on the EU position in the TRIPS Council in 2002, but was an important symbol of the EU approach to WTO negotiations. Social learning was identified as change of EU-expressed preferences involving some internal EU policy changes. Third, DG Trade changed its policy to acknowledge the concerns of developing countries. Reflecting this change, DG Trade dropped its

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objection to the use of compulsory licensing to overcome patent barriers to medicine access and became an advocate for a global tiered pricing system for pharmaceuticals (ibid.). Ellen ’T Hoen (2003) writes that these policy changes are in stark contrast to previous European Commission policies, which closely track the pharmaceutical industry’s agenda. These policy changes signalled a change of expressed preferences regarding solutions and value judgements in the TRIPS area. The compromise text that was finally agreed in the Doha Declaration (2001) actually acknowledges the unmitigated rights of countries to take measures to protect public health. The Declaration lays out the flexibilities within TRIPS that can be used to overcome intellectual property barriers to access to medicines. The Doha Declaration makes it clear that the use of compulsory licences is in no way confined to cases of emergency or urgency; in fact, the grounds for issuing a compulsory licence are unlimited. In addition, the Declaration leaves members free to determine for themselves what constitutes a national emergency or urgency, in which cases the procedure for issuing a compulsory licence becomes easier and faster (WTO, 2003d). In addition, the Declaration grants least developed country (LDC) members an extra ten-year extension – until 2016, instead of 2006 – to the implementation deadline for pharmaceutical product patent protection. The Declaration postponed the politically contentious issue of parallel import. This was deferred to the so-called paragraph 6 negotiations at the TRIPS Council. The WTO deadline for resolving that issue came and went in December 2002. One of the central member states, the US, reflecting the wishes of its pharmaceutical industry, stood alone and used its veto to block the interpretations that 140 other countries have supported (Denny, 2003). In the following months, both central WTO members, the European Commission and the US, tabled similar and constructive proposals to the TRIPS Council (WTO, 2003a; 2003b; 2003c). Anti-poverty activists, however, were dismayed as these proposals closely resembled arguments put forward by the drugs industry (European Voice, 25 July 2002). More importantly, it was evident that the small and poor states were not satisfied with the proposal. In 2002, the European Commission stretched far in terms of changing the position as well as indicating a change of expressed preferences on the part of the EU. A European Commission paper (WTO, 2003c) recommends that the TRIPS agreement would require amendments if the objectives agreed at the November 2001 Doha ministerial conference of the WTO are to be achieved. Furthermore, with respect to the issue of affordable medicines, the EU adopted a regulation on 26 May 2003 that prevented pharmaceutical

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products sold to developing countries at reduced prices to be re-imported into Europe. This regulation provided an additional measure of protection and applied to both medicines that were protected by IP and others. This was intended to encourage companies to supply medicines at reduced prices and was an important contribution to a global partnership to provide cheap yet sustainable supply of key medicines to the populations of poor countries (WTO, 2003d). This regulation represents a ‘Winnie the Pooh solution’ to the TRIPS of preferring to continue protecting IPRs and, at the same time, providing lower prices for medicines to the poor. The EU still holds the same position and preferences regarding the importance of protecting intellectual property in the WTO. However, there has been a change of position as well as preferences regarding the effects that TRIPS has on poor countries and regarding the prices for drugs that the developing world should have to pay. The US has recently also adhered to the price concern raised in the TRIPS negotiations, and various efforts are now under way in America to assess the cost effectiveness of pharmaceutical products (Economist, 17 March, 2005). In Cancun (2003) it finally seemed like ‘the paragraph 6 problem’ had a solution. The Doha Declaration (2001) affirmed a country’s right to copy these drugs but it did not, however, give countries the right to export them – parallel export. In August 2003, the WTO member states finally approved a deal on access to cheap drugs struck a few days earlier by the central US and four peripheral and much poorer countries: India, Brazil, South Africa and Kenya. It seemed that the US motivation was that they did not want to be accused of blocking poor countries’ access to essential drugs. Nevertheless, they were keen to set limits on which drugs are seen as essential and which countries can count themselves as poor. There is no doubt that, the USTR was under considerable pressure to change the American position and come to a deal (Economist, 1 September 2003). The peripheral developing countries were standing united and could have walked out on the entire Cancun trade summit. WTO members adopted an interpretive decision that permits developing countries that lack sufficient domestic manufacturing capacity to meet their public health needs by importing patented drugs from other WTO members without restriction as to type of disease or type of emergency (WTO, 2003f), thus, that parallel import of patented drugs is permitted. The peripheral countries exercised mild pressure by standing united and linking the TRIPS issue to the success of the rest of the issues in the Doha agenda. This mild pressure was, however, more deliberative than coercive and thus promoted social learning. However, the peripheral developing world should not yet celebrate this victory. Drahos (2001) argues that the informal coalition of developing

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countries and NGO actors that brought the Doha Declaration into being on the subject of access to medicines may well prove ineffective at managing the longer-term campaign of securing a global patent regime to better serve public health goals. The gains that this group achieved at Doha are slowly ebbing away as developing countries sign bilateral agreements that impose higher standards of intellectual property protection than those to be found in TRIPS. Thus, distrust has divided developing countries. In a sense it is this distrust that creates conditions that enable the central states to promote their own interests. Evidence is provided from the Uruguay Round negotiations between 1991 and 1992. While India’s position on most of the issues remained unchanged, most developing countries had, under bilateral pressure, substantially changed their negotiating position in regard to most of the contentious issues in the TRIPS agreement. This was particularly true of patents. Therefore, it is important for the peripheral developing countries to continue to stand united and trust each other regarding TRIPS.

5. Conclusion This chapter set out to answer the question: who benefits more from the WTO system: companies from central, or companies from peripheral WTO member states? It must be concluded that peripheral countries and their companies can benefit from the WTO system, in the same manner as central WTO countries. Although it is not possible to generalize from one case, it has illustrated that it is indeed possible for the peripheral countries to persuade the central countries into supporting their arguments. However, in order to be influential in the WTO peripheral countries should use positive ideational framing, rather than threats or negative language. Furthermore, the setting of negotiation processes provides better conditions than the dispute settlement mechanism for accomplishing social learning on the part of the central countries, through peripheral countries’ persuasion in the epistemic community. The rationalist approach provided limited but suitable analysis of the first years of the existence of the TRIPS. Rationalism would predict that the dispute settlement system and formal rules would be the most significant indicators of TRIPS developments; however, this analysis has illustrated that it was rather negotiations and collective learning in the epistemic community, which proved the most powerful drivers of TRIPS developments. Accordingly, social constructivism did prove useful in order to understand the WTO as a permanent negotiation forum, and in order to analyze different types of learning through changes in expressed

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preferences and argumentation of peripheral as well as central WTO members. Thus, both social and simple learning was identified. Simple learning was identified on the part of the peripheral developing countries as a result of persuasion through unilateral arm-twisting from the central countries in the WTO. Simple learning was identified as changes of official positions absent any change of internal values or policies regarding IPRs. Social learning was identified on the part of the central countries of the US and the EU as a result of collective learning in the epistemic community (and some politization) induced by humanitarian interest organizations as well as peripheral developing countries. Social learning was identified as changes of official positions accompanied by change of internal values and policies in the EU first and foremost, but some signs of it are found also in the US. The executive order issued by the US in May 2000 prohibiting the use of Section 301 towards peripheral country industry on the IPRs issue was clearly one first step towards changing internal policies regarding that issue. Moreover, the pharmaceutical price issue seems to have been picked up by forces in the US desiring lower prices for US consumers and could potentially provide the rationale for further policy changes in this area. The US also, at last, changed its position regarding compulsory licence, parallel trade and extension of TRIPS implementation deadlines. However, this was only on paper and did not include considerable changes of expressed preferences regarding internal values and policies. Preferences in the US regarding the link between TRIPS and health and, furthermore, the need to protect IPRs stands unaltered. In the EU, several EP resolutions and amendments of directives indicated a real adjustment of internal values and policy in the EU from a market-oriented approach to a more health- and moral-oriented approach. But an EU regulation issued in May 2003 reflected a ‘Winnie the Pooh’ solution to this problem, wishing to at the same time protect IPRs at home and provide lower prices for the poor. The EU came around to NGO argumentation about the link between TRIPS and health as well as human rights and has embraced such phrasing in its own internal policy. Thus, the EU went from preferring to see TRIPS as separate from health issues, to apply argumentation of TRIPS reform having positive public health effects in the developing world. The EU has issued regulations in order to ensure low prices for some of the pharmaceutical products that the EU exports to these countries, but at the same time keep prices in the EU at the same level. However, the EU has not altered its preference for protecting IPRs and therefore wants to preserve the TRIPS

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regime. Thus, social learning on the part of the EU has changed expressed preferences regarding internal values and policies somewhat, but not completely as yet. This chapter identified social learning as a result of the peripheral developing countries’ persuasion in TRIPS negotiations. Primarily, epistemic community in support of peripheral countries’ positions were developed by NGOs and supported by public opinion. NGOs reframed the TRIPS understanding ideationally – from an economic focus to a health focus, thus, paving the way for developing countries’ arguments of protecting public health and human rights, rather than IPRs. Second, the peripheral countries resorted to deliberative argumentation instead of attempting to apply threats or coercion. Reasoned arguments and informed deliberation characterized their proposals in TRIPS negotiations, as a result of the knowledge base provided by NGOs. Third, politization led to different findings than expected from a social constructivist perspective, as politization was high rather than low in several phases of the TRIPS negotiations. Consequently it seems that the peripheral developing countries were able to turn politization to their own advantage. Politization of this issue seems to have served as a catalyst rather than a limitation on the argumentative persuasion efforts of the peripheral countries in the WTO context. Moreover, the developing countries supported each other as a group and thus created a large group of peripheral countries, which it was more difficult for central countries to ignore than if they were split and disagreed on this issue. This chapter set out with a statement that the WTO could be seen as both a catalyst and a limitation on trade. However, the TRIPS agreement is a special case within the WTO framework. TRIPS has, by numerous voices in the social environment of the WTO, been portrayed as an aspect that should not be treated purely in trade terms and that consequently does not belong in a trade organization. However, as TRIPS has already been included in the WTO, we should make the best out of it. It seems that countries like India, China and Brazil, with massive markets and huge industrial capability, were the principal targets of the formal rules put down in the WTO TRIPS agreement (1994) and ruled upon in dispute settlement procedure. So far, formal WTO rules have done little to protect the interests of peripheral WTO states in the case of TRIPS. The Doha Development Agenda is the chance that the WTO has of ‘righting this wrong’. However, the Doha Development Agenda has yet to be concluded and it is dangerous to draw early conclusions on these negotiations. Nevertheless, it will be extremely difficult for the central countries to move back to their original positions or expressed preferences regarding

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TRIPS, both in the face of the peripheral countries if they manage to stand united and in the face of public opinion and NGOs.

Notes 1. As of May 2005. 2. Note that the unilateral actions are not always in conflict with multilateral ones as the EU and the US often are the agenda-setters in the WTO system. 3. By the conclusion of the Uruguay Round. 4. The concepts of centre and periphery should not be confused with their application according to Galtung’s peace research and Structural Theory of Imperialism (1971). Galtung (1971) defines the centre-periphery relationship as one where the centre nation has power over the periphery nation. Consequently there is a condition of disharmony of interest between them. Furthermore, this theory outlines the need for a change in the structural relationship between the haves and the have-nots in the centre-periphery relationship. 5. The EU will be referred to as one state, as it acts as a unitary actor in the WTO in the same manner as the US. 6. Regarding only trade in goods. 7. Additionally the EU’s share of the world population contributes to its international weight, particularly after eastern enlargement. 8. The MFN rule requires that a product made in one member state should be treated no less favourably than a like product from another member state. 9. The National Treatment rule requires that foreign products be treated no less favourably than competing domestically produced products. This is a wideranging rule. 10. This is essentially the WTO Council. 11. As the Dispute Settlement Understanding makes clear, in cases where a violation is found, removal of the inconsistent measure is the goal. Otherwise, a mutually agreed solution is the preferred result. 12. Patents and trademarks. 13. Extended in Doha (2001) until 2016. 14. And agricultural chemical products. 15. Similar cases were at the same time brought against Argentina by the EU and the US, but as these cases were similar, this paper will focus on the India cases. 16. See for instance US versus South Korea (1985); US versus Argentina (1988); US versus Thailand (1990); US versus India (1991); US versus China (1991). 17. The same complaint regarded agricultural chemical products. 18. Under the conditions laid down in the section of TRIPS dealing with transition rules for products previously unpatentable under national law. 19. Medicines and Related Substances Control Amendment Act No 90 of 1997. 20. Case no. 4183/98, 18 February 1998 (as referred in ’T Hoen, 2003). 21. Parallel importing is cross-border trade in a patented product, without the permission of the manufacturer or publisher. Parallel imports take place when there are significant price differences for the same goods in different markets. 22. Compulsory licensing is a flexibility written into the TRIPS Agreement – governments can issue compulsory licenses to allow other companies to make a patented product or use a patented process under licence without the

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23. 24. 25. 26.

27. 28. 29.

Centre and Periphery in the WTO consent of the patent owner, but only under certain conditions aimed at safeguarding the legitimate interests of the patent holder. But it was not clearly set out in the TRIPS how this would be interpreted. Published in the Journal of International Economics in 2001. The TRIPS does not spell out whether parallel imports are legal. Executive Order No 13, 155 65 Fed Reg 30, 521, 2000, as referred by ’T Hoen, 2003, p. 47. Under that provision Brazil requires holders of Brazilian patents to manufacture the product in question within Brazil – the so-called ‘local working’ requirement. If the company does not fulfil this requirement, the patent shall be subject to compulsory licensing after three years, unless the patent holder can show that it is not economically feasible to produce in Brazil or can otherwise show that the requirement to produce locally is not reasonable. If the company is allowed to work its patent by importation instead of manufacturing in Brazil, parallel import by others will be permitted. Including Article 5.4 of the Paris Convention, which allows compulsory licensing if there is a failure to work a patent. In response to the draft World Health Assembly’s resolution. EU Directive 2001/83/EC.

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Newspapers Economist server: Archive: 29 October 1998. ——— Archive: 8 March 2001. ——— Archive: 4 September 2003. ——— Archive: 4 September 2003. ——— Archive: 9 December 2004. ——— Archive: 7 October 2004. ——— Archive: 20–6 November 2004. European Voice server: Archive: 25 July 2002. ——— Archive: 27 September 2001. Forbes: Archive: 28 January 2003.

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Index absorptive capacities 159, 183 advantages 7–8, 10 agreements 10, 18–19, 22, 28, 30, 43, 151, 229, 230, 232–3, 244, 258 AIDS 160, 164–5, 182, 247, 249–51, 254–5 Algeria 62 Ambos, B. 188–205, 21 Ambos, T. C. 188–205, 21 Amin, A. 146, 153 Anglo-Irish Free Trade Area Agreement 136 assets 3, 8, 10, 14–15, 50–1, 63, 69, 184, 208, 235 assemblers 160, 165–6, 170, 176–7, 179, 181–2 autocorrelation 90 automotive industry 159, 169, 175, 177–9, 181–2, 184 bad neighbourhood syndrome 160 Baltic countries 48, 62–3 Barclay, L. A. A. 19, 25–27 Bartlett, C. 75, 92, 105, 133, 208–9, 214 Barry, R. P. 135–7, 152 Bellak, C. 15, 212 Benito, G. R. G. 1–24, 74–97 Birkinshaw, J. 12, 81, 132–4, 146, 192, 197 Bloodgood, E. et al. 100, 103, 122, 125 BMW 160, 165–6, 176, 181 Boras Wafveri 59, 64–5, 67–70 born global(s) 10, 20, 98–9, 105, 116–17, 125, 128 born global on export dimension 98 born global on the market dimension 117 born global (true) 104, 116 Bradley, C. 99, 132, 136, 253 BRICS coalition 19 brownfield 17

Canada 4, 30, 33–4, 36–7, 39, 133, 162, 236–7 Cantwell, J. 15, 212 capabilities 1, 18, 35, 42, 44, 80, 133, 137, 146, 150, 158–9, 161, 163–4, 169, 174–5, 177, 180, 184, 190, 196, 202, 209, 214–15 capability-augmenting laboratories 190 capability-exploiting laboratories 190, 197, 201 Caribbean community (CARICOM) 25, 28–39, 41, 43–4 CARICOM Single Market and Economy 28 Cavusgil, S. T. 98, 100, 105, 116, 120, 125 Celtic tiger 12, 135 Central and Eastern European countries 151 Central and South America 33 centrifugal 74 centripetal 74, 81, 91, 153 cluster(s) 13, 16, 20, 22, 76, 81–2, 84–5, 87–92, 143, 159, 184–5, 189, 196, 202, 206–21, 226–7, common external tariff (CET) 28 competitive 8–9, 11, 13–14, 17, 19–20, 25–6, 28, 34–5, 37–41, 43–4, 48, 50–1, 54, 56–7, 62, 65, 74–5, 79, 83, 86, 92, 100–2, 105–6, 125, 128, 132–3, 141, 151–2, 162–3, 177, 181, 188, 191, 206, 209–12, 219, 235 Competitive Industrial Performance Index 64 competitiveness 11, 17, 20, 25–6, 28, 37, 39, 41, 43–4, 48, 51, 56, 79–82, 90, 92, 133, 140, 142–3, 153, 162, 182, 184, 207, 209, 211, 213 component manufacturers 165–6, 179 concentration ratio(s) 79, 86

269

270

Index

constraints 2, 163 continuous improvement 171, 173, 177 coordination 96, 154, 188, 192, 199, 200, 263 control 3, 64, 68–70, 84, 90, 92, 135, 138, 165, 168, 179, 184, 188, 192, 199–202, 213–14, 227, 251, 261 Control of Manufactures Act 135 core countries 1, 2, 5, 8–11, 22, 188 core–periphery dichotomy 2, 3 cross border competition 1 cross border linkages 3 Chrysler/Daimler Chrysler/DC 21, 158, 160, 165, 167–8, 181, 191 (see also Daimler-Benz) curriculum design and development 171, 178 Czech Republic 109–10, 137, 152, 196 Daimler-Benz (DB) 160 DCSA 158, 160–1, 163–5, 167, 169–74, 176, 180, 183–5, determinants 20–1, 136, 142, 218 developing countries 7–9, 11, 19, 25–9, 231, 236, 243–4, 246, 248–55, 257–60, 265, 267 DG Trade 255 (see also European Directorate General for Trade) Dispute Settlement Body (DSB) 233 Doha Declaration 255, 256–8 Doha Development Agenda 260 Drahos, P. 257 Dunning, J. 9, 50, 69, 159, 188, 190, 208 Durbin–Watson h-statistic 90 dynamics 22, 82, 93, 104, 210, 229, 245 East Asian economies 4 Eastern Cape Technikon (ECT) 170 Eastern Europe 8, 51, 69, 71, 117, 151–2, 181–2, 196, 231 EC 136, 138, 141, 145, 248, 153, 262 economic development 2, 5, 9, 17, 24, 25–7, 46, 54, 73, 157–8, 163, 169, 179–80, 183–5, 190, 238, 265

economic integration 2, 6, 11, 18, 23, 46, 157, 132, 133, 141, 144, 150, 203, 265 education 12, 16, 21, 44, 130, 136, 140, 158–9, 161–2, 164, 166–8, 171–80, 184–6 EFTA 79, 138, 142 Elcoteq 52, 59 embeddedness 91–2, 130, 133, 137, 153–4, 192, 197–9, 202–3 engineering 107, 124, 168, 170, 172–3, 175–6, 178 Estonia 2, 15, 19–20, 54–73 Europe 8, 10–11, 20, 33, 36, 62–4, 78, 111, 117, 152, 161, 173, 176, 181–2, 221, 247, 257 EU 18–20, 51, 50, 57, 61, 68, 72, 133, 135–7, 139–54, 166, 204, 213, 221, 228, 231, 235–9, 241, 243–9, 252–3, 255–7, 259–62, 265–6 European Comission 247, 255–6 European Directorate General for Trade 255 (see also DG Trade) experience 7, 10–11, 14, 16, 20–1, 27, 64, 67–71, 75–7, 92, 102–3, 106–7, 112, 115, 118, 120–4, 126, 132, 134, 152, 165, 169–71, 173, 175–6, 183, 188, 201, 208, 121, 254 Farrell, H. 33–5, 148 Federation of Offshore Suppliers 216 Federation of Technology Companies 216 Finland 5, 48, 51, 54, 56, 62–3, 66, 70–1, 109, 113–14 first-tier component suppliers 180 First National Battery (FNB) 176 Fischer, E. 102 Ford 165–6, 181, 207 foreign direct investment (FDI) 1, 3, 7–12, 15–18, 21–2, 32–3, 49, 50, 53–5, 74, 76–7, 79, 86, 138–9, 141–2, 151–4, 158–9, 163, 168 182–3, 189–91, 202 attraction 21, 131, 134–9, 153–4 policy 131 foreign employment ratio(s) 86, 90–1

Index foreign investment 49–50, 53–4, 56, 68–70, 138 Foreign Investment Code 138 Foreign Investment Institute 138 foreign investor 69, 159, 182 foreign sales ratio(s) 83, 86, 90 Free Trade Area of Americas (FTAA) 28 GATS 232 GATT 231, 232, 235, 244–5, 253 Ghoshal, S. 75, 92, 105, 133, 208–9, 214 Gilboy, E. 207 GlaxoKleinSmith 243 global integration 75, 80, 93, 198 globalization 231 GM 159, 165 Görg, H. 137 greenfield investment 30, 169, 171, 173 Hamel, G. 103 headquarter functions 207, 210, 214, 217, 219 Health Action International (HAI) 249 Hedlund, G. 100, 133, 208–9 Hoggen, H. 19, 22, 228–67 hollowing out 6 home country environment 41, 79 Hood, N. 12, 81, 133, 146 human capital 16–17, 21, 136, 143, 158–9, 161, 163–5, 169–71, 179, 182–3 human resources 12, 21, 104, 127, 158–9, 161–3, 166, 169, 171, 173, 180, 185 Hungary 53, 137, 195–6 ICAS 109, 115, 117–19, 121, 124, 126 IDI Performance Index 162 IDI Potential Index 162 IMF (International Monetary Fund) 27 Incatel 110–11, 115, 117–21, 124, 126 India 4, 10, 19, 33, 36, 162–3, 166, 181, 188, 191, 195–7, 202, 231, 236–7, 243–6, 252–4, 257–8, 260 Industrial Development Authority/IDA 135–7, 145

271

industrial policy 14–16, 18, 135, 159–60, 183 industrial upgrading 185 industry specific 10, 74, 81 industry(ies) 16, 18, 19, 20, 22, 25, 32, 34, 39–44, 48–9, 51–2, 57–62, 64–6, 68, 71, 74–6, 79–86, 90–3, 98–100, 102, 105–7, 109, 112, 118, 122, 125–7, 136–7, 139, 141, 153, 159–61, 163–4, 167–71, 174–9, 181–2, 184, 191, 193, 196, 202, 206–8, 210–11, 213–14, 216–17, 220, 224–5, 228, 238, 242, 246–51, 256, 259 industrialization 153, 206 inequality 163, 165 innovation 5–6, 9, 99, 101, 140, 192, 213–15, 220 innovative activity 214, 218, 225, 227 Inter-American Bank Trade Support programme 42 international business activity 3, 25, 29, 32–4, 43 international commitment 219, 226, 211 International Standard Industrial Classification (ISIC) 83 internationalization 6–7, 12, 14–16, 19–23, 35, 48–50, 52–4, 56, 58–60, 62, 64, 66, 68, 70, 74–86, 90–3, 98–108, 110, 112, 114–22, 124–8, 137–8, 152, 188–9, 191–4, 214, 218–20, 225, 227 pace of 20, 53, 59, 98–100, 102–6, 108, 110, 115–16, 118, 120, 122, 125–8 investment behaviour 161 inward-looking 8, 15, 76, 138 Ireland 4, 11–12, 20–1, 131, 133–8, 140–53, 208, 221 Johanson, J. 34, 58, 74–5, 85, 90, 99, 122–3, 200, 211–12, 219 Karlsen, S. M. 20, 98–130 Knight, G. 98, 100, 105, 116, 120, 125 Korea 4, 110, 112, 162–3, 236–7 Kottaridi, C. 16 Krenholm 49, 59, 64–70

272

Index

Krugman, P. 5–6, 74, 208, 212–13 Kruskal–Wallis test 84 L advantages 7–8 laboratory mission 197 lagged variable(s) 90 latecomer countries 158–9 Latin America 12, 29, 117, 167 Leadership Development Institute (LDI) 178 learning 75, 81, 98, 122, 159, 177, 183, 185, 209, 214, 229–30, 239, 241–9, 251, 253–5, 257–60, 262 level of competition 79, 103, 217 licence 11, 109, 249, 255, 256, 259 List, F. 5 local capabilities 158–9, 161, 163–4, 169, 180, 184 local companies (LCs) 137, 148 local linkages 21, 132, 137, 148, 150, 152, 154 localization advantage 209 locally owned firms 55, 60–1 Lorentzen, J. C. 17, 21, 158–87 Malaysia 4, 162, 166, 195, 208 mandate 21, 132–4, 144–5, 166, 177, 192, 195–8, 200, 202, 221 manufacturing 11–12, 16, 19–20, 25–30, 32–5, 38–44, 48–61, 64–8, 70–1, 80–1, 83–6, 91, 99, 135–6, 138, 141, 146–8, 163, 168, 174, 176, 178, 182–3, 197–8, 206, 208, 210, 212, 215, 249, 255, 257 manufacturing companies 52 market size 1, 14–15, 77, 196 Marshal,l Alfred 5 Médicins Sans Frontières 249 Mercedes 21, 160–1, 165–7, 170 Microsoft 118 Most Favoured Nation (MFN) 232 Motor Industry Development Plan (MIDP) 160, 165–6, 169, 181–3 multidomestic strategy 133 multinational companies (MNCs) 92, 158, 161, 166, 173, 189, 191–2, 198, 200, 202, 214, 242, 248 (see also MNEs)

multinational enterprises (MNEs) 1–2, 5–12, 14–17, 21–2, 81, 99–100, 131–2, 135–8, 140, 142, 144, 146–50, 154, 208–9, 212–13, 215, 221 conventional 7–8, 10 developing country 7 second wave of periphery 7–9 NAFTA 9, 11, 18 Narula, R. 1–24, 159, 188, 190, 208, 215 national competitiveness 211 National Treatment 232 Netherlands 4, 56, 67, 113–14, 208 networks 35, 37–8, 44, 102, 107, 124, 126, 132, 150, 188, 192, 199, 214–15, 219 New Zealand 5, 108 Nissan 165, 179, 181 non-financial 20, 76, 78, 82, 136 non-triad countries 189–191, 196–7, 200–2 non-triad laboratories 192–4, 197, 199, 201–2 Nordic countries 12, 48, 63, 71, 114 Norway 2, 4–5, 16, 20, 56, 67, 76–7, 82–4, 102, 109, 111–12, 114, 117–18, 124, 126–7, 207, 210, 212, 216, 218–19, 221, 231 Norwegian Radium Hospital 123 Norwegian School of Veterinary Science 123 offshoring 206, 208–9, 219 oligopolistic 20, 74–5, 79, 86, 91 oligopoly(ies) 105 Opera 113, 115, 117–19, 121, 124–7 Optoflow 104, 114–15, 117, 121, 123–7 outsourcing 152, 209 path dependence 85, 90 Penrose, E. 122 performance 13, 21, 37–9, 81–2, 114, 126, 128, 134, 152, 162–3, 189, 192, 199, 201, 211, 218–19, 225–7

Index peripheral countries 8, 11–12, 14, 16, 74, 151, 202, 238, 245–6, 250, 252, 257–8, 260–1 peripheral economies 1–2, 6, 9–10, 14–17, 19, 71, 202 periphery 1–10, 12–4, 16, 18–22, 68, 71, 158, 228–32, 238, 261 Pfizer 243 pharmaceuticals 135, 142, 183, 193, 231, 238, 242–5, 247–51, 254, 256–7, 259 pockets of knowledge 188, 191, 196, 202 Poland 4, 53, 112, 114, 191, 194–6 Porter, M. E. 37–8, 41, 74–6, 79–81, 90, 92, 102, 105, 125, 133, 189, 191, 208–10, 213, 218 Portugal 4, 20–1, 131, 133–5, 138–54, 221, 238 Portuguese Investment Agency (API) 139, 140 poverty 163–5, 251, 255–6 Prahalad, CK 103 private-sector-led development 27–9 process upgrading 166, 176 product characteristics 101–2, 106–7, 125–6 product life cycle 6–7, 101, 118, 122, 125, 191 product life cycle theory 191 production and process knowledge 184 production capacities 159 Programme for the Development of the Portuguese Industry (PEDIP) 139 PEDIP II 139 public policy 21, 131, 135, 140, 153 quality assurance 173, 178–9 quality systems 175, 177 regional development 127, 161 regional integration 14, 28 Reiljan, E. 19–20, 48–73 relocation 22, 51, 67, 69, 80, 92, 180, 206–21 research and development (R&D) 12–13, 21, 42, 80, 84–5, 92, 101,

273

123, 135, 137, 140–1, 145–8, 191–202, 207, 210–12, 214–15, 217–20, 235, 249, 250 corporate 21, 188–9 research intensity 20, 75, 79, 80, 85–6, 92 Reuber, R. 102 Ricardo, D. 5 Romania 190, 194–6 Ruggie, J. 241 Rugman, A. 209, 213–14, 228 Russia 4–5, 19, 48, 62–5, 68–9, 54–7, 191 SCMs (subsidies and countervailing measures) 15, 18 Sell, S. K. 229, 242, 244, 246 service industry(ies) 49 Singapore 4, 114, 162, 185, 196, 208, 234 Single Market 28, 136, 138, 141 Sintef 123 skill upgrading 159, 176–7 Smith, A. 5 Solberg 22, 104, 106, 125, 206–27 Soros, G. 231 South Africa 2, 4, 10, 12, 17, 21, 109, 158–67, 169–73, 180–3, 246–8, 254, 257 Southern Enlargement 141 Soviet Union 5, 50, 65 spatial agglomeration 185 spillover effects 180 Stora Enso 63–4, 69–70, 81 Strobl, E. 137 subsidiary 12–13, 16, 21, 59, 67, 70–1, 81, 92–3, 109, 124, 131–4, 141, 143–8, 152–4, 170, 181, 191–2, 221 autarkic 132, 133, 144, 145 evolution 21, 132–4, 141, 143, 146, 153–4 product mandate 132 rationalized 132, 133, 144 roles 12–3, 92–3, 132, 144, 192 strategy 132 supplier 15, 63–4, 81, 105, 125–6, 158, 161, 166–7, 171, 176–7, 180, 182–4, 198–9, 209–20, 215–6

274

Index

Sweden 4, 48, 56, 59, 62, 66–7, 69–71, 109–10, 112–14, 116, 120, 124 Sylvester 49, 59, 61–4, 68–70 system integrators 180 systemic interaction 185 Taiwan 4, 110, 195–6 tangibility 20, 79–81 tariff 19, 28, 42, 48, 57, 68, 74, 81, 182, 209, 233–4 Tavares-Lehmann, M. T. 14, 20–1, 131–57 technical change 176 technological capabilities 18, 159, 214–15 technology transfer 141, 207 textile industry 59, 64, 66 Thrift, N. 146, 153 Toyota 165–7, 176 trade liberalization 11, 19, 25–8, 43, 165, 232 Triad laboratories 192, 194, 199 TRIMS (Trade Related Investment Measures) 18 Trinidad and Tobago 25, 28–30, 32–3, 41, 43–4 TRIPS (Trade Related Aspects of Intellectual Property Rights) 18, 228–9, 231–2, 235, 238–9, 243–261 UNCTAD 166

7, 11, 131, 135, 159, 162,

universities 150, 198–9 University of Fort Hare (UFH) 177 upgrading 18, 21, 43, 110, 136, 152–3, 158–9, 161, 163, 166, 171–2, 175–7, 180, 184–5 Uruguay Round 232–3, 235, 243–4, 248–9, 251, 253, 255, 258 USA 4, 6, 10, 19, 29–30, 33–4, 36–7, 29, 56–7, 66, 103, 108, 110, 112–14, 120, 160, 162, 166, 134–5, 142, 170, 191, 206–7, 213, 228, 231, 235–8, 243–50, 253–7, 259 Uzzi, B. 123 Vahlne, J.- E. 34, 58, 74–5, 85, 90, 99, 122–3, 200, 211–12, 219 value chains 152 Venables, A. J. 208 venture capital 44 Vernon, H. 6–7, 80, 191 Vissak, T. 59, 67 VW 160, 163, 165–6 Wallerstein, I. 2, 241 wood industry 61–2, 64, 68 World Bank 27 world mandates 166 World Trade Organization/WTO 15, 18–19, 22, 43, 228–48, 250–60

10,