Trade and Investment in a Globalising World (Series in International Business and Economics)

Trade and Investment in a Globalising World Essays in Honour of H. Peter Gray

Series in International Business and Economics Series Editor. Khosrow Fatemi

Titles include: BASU & MIROSHNIK Japanese Multinational Companies: Management and Investment Strategies BEANE The United States and GATT: A Relational Study CONTRACTOR Economic Transformation in Emerging Countries DUNNING Globalization, Trade and Foreign Direct Investment FATEMI International Public Policy and Regionalism at the Turn of the Century FATEMI International Trade in the 21st Century FATEMI The New World Order: Internationalism, Regionalism and the Multinational Corporations FATEMI & SALVATORE The North American Free Trade Agreement GHOSH New Advances in Financial Economics GRAY & RICHARD International Finance in the New World Order HAAR & DANDAPANI Banking in North America: NAFTA and Beyond KOSTECKI & FEHERVARY Services in the Transition Economies KREININ Contemporary Issues in Commercial Policy MONCARZ International Trade and the New Economic Order PRAKASH et al. The Return Generating Models in Global Finance Related Elsevier Science Journals International Business Review International Journal of Intercultural Relations Journal of International Management Journal of World Business World Development

Trade and Investment in a Globalising World Essays in Honour of H. Peter Gray

Edited by

Rajneesh Narula University of Oslo and The Norwegian School of Management (B.I.)

2001 PERGAMON An Imprint of Elsevier Science Amsterdam - London - New York - Oxford - Paris - Shannon - Tokyo

ELSEVIER SCIENCE Ltd The Boulevard, Langford Lane Kidlington, Oxford OX5 1GB, UK

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Contents

LIST OF TABLES AND FIGURES

vii

CONTRIBUTORS

ix

PREFACE

xi

1.

Globalization of Markets and Financial-Center Competition INGO WALTER 1

2.

Electronic Commerce: Its Effect on Service Industries CLIFF WYMBS

38

3.

Determinants of U.S. Direct Investment in the EU and Japan RAJNEESH NARULA AND KATHARINE WAKELIN 55

4.

Competitive and Comparative Advantages: The Determinants of Japanese Direct Investment Activity in Manufacturing

5.

YUI KlMURA AND THOMAS A. PUGEL

69

The Impact of Direct and Indirect FDI in Eastern Europe on Austrian Trade and Employment WILFRIED ALTZINGER AND CHRISTIAN BELLAK

86

6.

The Role of Foreign Owned Firms and some Determinants of Inward Foreign Direct Investment in the Moroccan Manufacturing Sector SAAD LARAQUI 113

7.

Incorporating Trade into the Investment Development Path JOHN H. DUNNING, CHANG-SU KIM AND JYH-DER LIN 135

8.

Evolutionary Understanding of Corporate Foreign Investment Behavior: U.S. Foreign Direct Investment in Europe JOHN HAGEDOORN AND RAJNEESH NARULA 156

vi

Contents

9.

Multinational Strategy and the Evolution of Environmental Standards in the Global Economy SARIANNA M. LUNDAN 10. Promotion of Products from Developing Countries: An Overview and Assessment of Import Promotion Efforts GEIR GRIPSRUD AND GABRIEL R.G. BENITO

185

199

APPENDIX: Curriculum Vitae of H. Peter Gray

217

AUTHOR INDEX SUBJECT INDEX

233 237

List of Tables and Figures TABLES

TABLE 1.1 Capitalization of Major Securities Markets Nominal Value Outstanding, 1998 (US$ billions) TABLE 1.2 Capital Market Activity, 1992-98 (US$ billions) TABLE 1.3 Global M&A Developments (Volume of Transactions in US$ billions and percentages) TABLE 1.4 Global Wholesale Banking and Investment Banking 1998. Full Credit to Book Running Manager Only (US$ millions) TABLE 1.5 Global Wholesale Banking and Investment Banking: Market Concentration TABLE 1.6 Global League Table of Leading Asset Managers (assets under management exceeding US$100 billion) TABLE 1.7 Financial Centers: Three Attribute Activity Matrix TABLE 2.1 Shifting from Physical to Electronic Markets: Changes in the Business Model TABLE 2.2 International Trade of Selected e-Commerce Firms, 1997 TABLE 3.1: Indicators of FBI in the Sample TABLE 3.2: Panel Results including Fixed Effects TABLE 4.1: Variables Used in the Analysis TABLE 4.2: Determinants of the FDI Intensity of Japanese Manufacturing Industries, 1981 TABLE 5.1 Share of Austrian FDI in total FDI of selected CEECs TABLE 5.2 Sales and Employment Performance of Direct and Indirect FDI TABLE 5.3 Main Differences between Austrian Direct and Indirect FDI in CEECs, 1991 and 1996 TABLE 5.4 Industrial Distribution of Austrian Direct and Indirect FDI in CEECs by Host Country Industry, 1996 TABLE 5.5 Regional Sales Structure of Parent Firms, 1995 (%) TABLE 5.6 Changes in Regional Sales Structure of Parent Firms, 1989-95 (%) TABLE 5.7 Expected Regional Sales Structure of Parent Firms, 1995-98 (%) TABLE 5.8 Regional Sales Structure of Affiliates, 1995 (%) TABLE 5.9 Intra-Firm (IF) Trade, 1996 (ATS mn) TABLE 5.10 OLS Regression Results for Parent Exports to CEECs TABLE 5.11 OLS Regression Results for Affiliate Exports to EU TABLE 5.12 OLS Regression Results for Parent Employment, 1995 TABLE 5.13 Motives of Foreign Investors in Austria TABLE 6.1 FDI by Country (in millions of Moroccan dirhams) TABLE 6.2 FDI by Industry (in Moroccan dirhams)

viii

List of Tables and Figures

TABLE 6.3 Comparisons between Different Regions: Degree of Profitability in the Different Regions TABLE 6.4 Gains from Moroccan Investments: Degree of Importance in Decision-making on EDI in Morocco TABLE 6.5 Strategic Motives for FDIs: Degree of Importance in Decisionmaking on FDI in Morocco TABLE 6.6 Firm Competitive Advantages in Morocco TABLE: 6.7 Moroccan Locational Advantages TABLE 6.8 Impact of Integration on Morocco TABLE: 6.9 Morocco/EU Relationship: Attractiveness of Morocco for FDI TABLE 7.1 The FDI Intensity of Korean and Taiwanese Imports and Exports and GNP per capita TABLE 7.2 Proportion of A, O, and B Type Imports and Exports as a Percentage of Total Imports and Exports TABLE 7.3 Inward and Outward Direct Investment and GNP per capita TABLE 7.4 Proportion of Inwards FDI (IDI) and Outwards FDI (ODI) Accounted by FDI Intensive Sectors TABLE 7.5 Proportion of A, O, and B Type FDI as a Percentage of Total FDI TABLE 7.6 The FDI Intensity of Korean and Taiwanese Trade and FDI TABLE 7.7 The FDI Intensity of Korean and Taiwanese Trade and FDI TABLE 7.8 Intra-industry Trade and FDI TABLE 8.1 FDI and Real GDP Growth Rates for Selected Periods, 1950-1990 TABLE 8.2 Imbalance Coefficient, Selected Years TABLE 9.1 Trade and Investment in Pulp and Paper (Sweden and Finland) TABLE 10.1 Establishment Year and Size of IPAs in OECD Countries TABLE 10.2 Statement of Goals of IPAs in OECD Countries TABLE 10.3 Distribution of the Support Activities of IPAs in OECD Countries FIGURES FIGURE 1.1 Distribution of International Bank Lending by Nationality of Reporting Banks FIGURE 1.2 The Foreign Exchange Market (Net Turnover, US$ trillion) FIGURE 1.3 Top 10 Financial Centers for Foreign Exchange, 1998 (estimated in billions of U.S.f) FIGURE 1.4 Centrifugal and Centripetal Locational Mapping of Financial Services FIGURE 2.1 How Changes in Information Affect Service Industry Returns FIGURE 5.1 Direct and Indirect FDI FIGURE 7.1 Four Stages in the IDP and TDPs of Industrializing Developing Countries FIGURE 8.1 Ratio of FDI Stock to Nominal GDP, 1950-90 FIGURE 8.2 Share of U.S. Manufacturing Worldwide, 1950-90 FIGURE 8.3 Trends in Relative GDP per capita, 1980 Prices, 1950-90 (U.S.A. = 100) FIGURE 9.1 Use of Chlorine in the Pulp and Paper Industry (Sweden and Finland) FIGURE 9.2 The Environmental Standards-setting Process FIGURE 10.1 A Typology of Governmental Strategies toward Internationalization

List of Contributors ABOUT THE EDITOR

Rajneesh Narula studied Electrical Engineering in Nigeria, and subsequently worked as an Aero-Electronics Engineer from 1983 to 1986. He completed an M.B.A. from Rutgers University, Newark, U.S.A., after which he worked in Hong Kong for IBM Asia/South Pacific as a Business Plans Analyst. After leaving Hong Kong in 1989, he was a Research Fellow in International Business and a visiting lecturer at Rutgers University, U.S.A., where he completed his Ph.D. He has also been a consultant for the UNCTAD, UNIDO and the European Commission as well as several international companies. From 1993 to 1998 he was an Assistant Professor in International Business and Research Fellow at MERIT, at Maastricht University, The Netherlands. He is currently a Professorial Fellow at the Centre for Technology, Innovation and Culture (TIK), University of Oslo and the STEP group, and Professor II in Strategy at the Norwegian School of Management (BI). His research interests include foreign direct investment theory, strategic alliances, competitiveness, technology, globalization, economic growth and government policy, Africa and the NICs. ABOUT THE CONTRIBUTORS

Wilfried Altzinger is Assistant Professor at the Department of Economics at the University of Economics and Business Administration, Vienna. Christian Bellak is Assistant Professor at the Department of Economics at the University of Economics and Business Administration, Vienna. Gabriel R.G. Benito is currently Professor of International Strategy and Head of the Globalization Programme at the Norwegian School of Management, BI. IX

x

Contributors

John Dunning is Emeritus Professor of International Business at the University of Reading, U.K., and State of New Jersey Professor of International Business at Rutgers University, U.S.A. Geir Gripsrud is the Tine/Gilde Professor of Marketing and Head of the Centre for Research on Cooperatives at the Norwegian School of Management, BI. John Hagedoorn is Professor of Strategic Management at the Faculty of Economics and Business Administration of the University of Maastricht, The Netherlands. Chang-Su Kim is a doctoral candidate in International Business at Rutgers University. Yui Kimura was Professor of Strategic Management and International Business at the Graduate School of Systems Management, University of Tsukuba, Tokyo, Japan. He passed away in 1999, as he and Tom Pugel were beginning work on the final draft of their chapter. Saad Laraqui is Assistant Professor in Business Administration at the Embry-Riddle Aeronautical University, Florida. Jyh-Der Lin currently works for AT&T, having recently completed his Ph.D. degree from Rutgers University. Sarianna Lundan is Associate Professor of International Business Strategy at the University of Maastricht, The Netherlands. Tom Pugel is Professor of Economics and International Business, as well as Chair of the International Business Area and Fellow of the Teaching Excellence Program, at the Stern School of Business, New York University. Katharine Wakelin is currently a Research Fellow at the Centre for Research on Globalisation and Labour Markets at the University of Nottingham, U.K. Ingo Walter is the Charles Simon Professor of Applied Financial Economics at the Stern School of Business, New York University. Cliff Wymbs is Assistant Professor at Baruch College, City University of New York.

Preface Book editing is rarely, if ever, a source of joy and ecstasy for the editor. When it is a first edited volume, he/she is motivated by thoughts of impending glory and great gobs of royalties that will accrue when the book hits the best-seller lists. One hums the melody from the Beatles' Paperback Writer incessantly, because one naively imagines that all good books go to paperback. By the second or third book, these dreams about wealth have evaporated, although a little hope lingers that some notoriety will be forthcoming, albeit only amongst one's immediate colleagues and the occasional relative. I peaked early: even my mother no longer shows any enthusiasm for my latest efforts. There are, in other words, diminishing returns on editing. This book is an exception to the rule. It has been an unmitigated pleasure to help in editing a festschrift in honour of Peter Gray. First, because Peter is a man of many parts. He combines personal charm with sparkling wit, and somehow manages to throw in some grace and a lot of warmth into everything he does. He lives life with gusto. He travels to the most remote locales and regales everyone with amazing stories. He buys drinks for impoverished Ph.D. students and prosperous professors alike at the drop of a hat, a fact that first endeared him to me. Second, because he is a scholar with a reputation that is justified. Not for him the security of a single, specialized field. He has wielded his pen without fear to tackle disparate areas of scholarship, and in almost all instances has left a indelible mark on his chosen target. His CV attests to this (which we have included as an Appendix to this volume). I have taken the liberty of only including his completed works, but it will come as no surprise to those of you who know him that the list of his 'work in progress' would make even the most prolific post-doctoral fellow green with envy, especially if one recalls that Peter is technically retired, and spends (along with Jean)

xii

Preface

a good proportion of his time doing a Jacques Cousteau impression in exotic spots. His penchant for scuba diving and a more than passing resemblance to Nautilus, are (I have heard it said) no coincidence. I shall leave it to the reader to think that one through. Ordinarily, dredging the scholarly waters for contributors to edited volumes is hard work, but not in this instance. Peter's friends and admirers span the globe. His competences and his capacity for listening with unfeigned interest to the most lame-duck of ideas (I speak from experience) thought up by his colleagues and students have won him a large fan club. More often than not, he helps to find that small gem in every bucket of hogwash. We have, for reasons of economy, decided to limit the contributions to co-authors, colleagues and former students. This too, is a large population, and covers a wide spectrum of research, until we decided to limit contributions to international trade, direct investment and macro-economic policy. Now this may appear (to the cynical reader) to provide us with categories you could drive a truck through, but it is just the sort of large canvas typical of Peter's work. Each contribution, apart from raising academic issues, also has profound (admittedly some more than others) policy implications. There is food for thought for every sort of economist and international business theorist. A veritable motley crew of contributions, contributors and ideas, all tied directly to Peter's body of work. The idea for this tome began, unsurprisingly enough, in a conversation with John Dunning as a 75th birthday tribute. With a little help from Khosrow Fatemi, we had some early contributions presented at a special session of the Annual Meeting of the International Trade and Finance Association (an organization which once had Peter as president) in Casablanca in May 1999. Sammye Haigh (as in 'heart of gold') was quick to suggest Pergamon as a possible publisher, an opportunity I am grateful for. Bob Hawkins originally came aboard as co-editor to make up for my vast inexperience with Peter's work and life. However, due to his various other commitments, he was unable to continue in this role. I'd like to thank him for his various inputs along the way. There are several people who were not, unfortunately, able to contribute for a variety of reasons, but who have provided encouragement and advice through the various phases of the book. Included in this number are Bob Stuart, Max Kreinin, John Dilyard, Lorna Wallace, Jean Gray and Bob Hawkins. Editorial assistance has been provided by Berit Nilsen Bua at the University of Oslo, and by Dolores Briante in Atlanta. I am grateful to Sudha

Preface

xiii

Menon for preparing the index. Their input has been invaluable, and I owe them a debt of gratitude. Peter, I've never done a festschrift before, but I believe the whole idea behind them is to say how grateful we are for you being who you are, and for sharing. If we were musicians, we'd have done a heavy metal concert entitled 'Peter Rocks'. But seeing as most of us aren't so gifted, we must do it the more painful way, by writing an academic tome with just the one exclamation mark. But my instinct tells me more of your friends will read this, than listen to a rock album! Rajneesh Narula Oslo, October 2000

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1 Globalization of Markets and Financial-Center Competition INGO WALTER1

I.

INTRODUCTION

Few developments in the world economy have been as dramatic or as far-reaching in their significance as the evolution of global financial markets in the latter part of the 20th century. Driven by rapid change in technologies and the attendant reduction in information and transaction costs, this has led to broad-based integration of financial markets, with great implications for efficiency in global capital allocation as well as for international macroeconomic linkages and policy-formation. Much of this activity is carried out in a limited number of financial centers, even though the ultimate sources of finance are overwhelmingly found in globally-dispersed private households, while ultimate users of finance are almost as broadly dispersed in corporate, government and individual borrowers and issuers around the world. These financial centers generate significant real economic gains for their respective national economies, gains that come in the form of improved income end employment, higher capital and labor productivity, and enhanced economic growth, as well as significant fiscal contributions. Financial services also constitute a significant sector in international service trade. Partly for this reason, the dramatic evolution of global finance has given rise to equally dramatic competition among the world's financial centers in a vigorous search for competitive advantage. The following section of this chapter defines what is meant by "globalization" in finance, and identifies the sources of value-added in the internationally-competitive financial services sector in terms of a "value-chain" that ultimately gives rise to the real economic

2

Ingo Walter

gains attributable to financial-center operations. The paper then presents available evidence as to where the relevant value-added activities actually take place, and examines the "centrifugal" and "centripetal" forces that determine the concentration or dispersal of value-added activity in financial intermediation, both inter-regionally and internationally.2 It then assesses the factors which appear to underlie the locational pattern of international financial centers that has evolved, and concludes with the outlook for the future pattern of financial centers in the global competitive environment. II.

WHAT DOES FINANCIAL GLOBALIZATION MEAN?

Globalization of finance encompasses a number of interrelated processes. These stretch across a spectrum between the principals in the generic financial inter-mediation process—between end-sources and end-users of funds. Banks fund themselves directly or indirectly with household, business or public-sector deposits that are deployed in the form of domestic and international credit portfolios (cross-border lending) that today shape globalized inter-mediated financial flows. Net savers have the alternative of purchasing insurance contracts and insurance-linked savings products, with the resulting claims and reserves deployed nationally and globally in securities portfolios, loans and direct participations, in line with the insurers' contractual obligations and actuarial reserve needs. Or net savers may purchase domestic or foreign securities, either directly or indirectly in the form of mutual funds, pension funds, trusts or other asset pools managed by fiduciaries. These are intended to optimize the balance of risk and return in line with investment objectives across asset classes whose total returns are not perfectly correlated in corporate, industry, currency, commodity or real-estate portfolios. The search for higher returns and international portfolio diversification (IPD) has long characterized asset-allocation strategies on the part of banks, insurance companies, and institutional investors, with various asset classes and associated derivatives making it possible to fine-tune portfolio profiles in conformity with specific lending and investment objectives. At the other end of the financial spectrum, businesses may borrow from banks in the form of unsecured or asset-backed straight or revolving credit facilities, or they may sell their own equities or debt obligations (e.g., commercial paper, receivables financing, fixed-income securities of various types) directly into the financial market. Consumers may finance purchases by means of personal loans from banks or by loans secured by purchased assets

Globalization of Markets and Financial-Center Competition

3

(mortgages, hire-purchase or instalment loans). These will appear on the asset side of the balance sheets of credit institutions on a fixed or revolving basis for the duration of the respective loan contracts, or they may be syndicated or sold-off to other banks or into the financial market in the form of structured securities backed by various types of bank receivables. Governments or public-sector entities can likewise borrow from credit institutions (sovereign borrowing) or issue full faith and credit or revenue-backed securities directly into the market. In turn, financing and asset portfolios can be repackaged and structured using currency and interest rate swaps and other contracts to tailor the transactions to the needs of the borrowers and issuers, on the one hand, and the lenders and investors on the other. The process easily crosses the boundaries of national financial systems so that, for example, a British corporation may be able to issue a local-currency security in Australia which, when purchased by local institutional investors and swapped into sterling, can provide lower all-in financing costs than local borrowing in the U.K. Or an American homeowner may find his dollar-denominated mortgage financed in part by a Japanese family that has invested in a yendenominated fixed-income mutual fund allocated in part to swapped U.S. asset-backed securities. Global markets for foreign exchange, debt and even equity have developed various degrees of "seamlessness" that have profoundly altered the modes and locations of world financial activity. Globalization in the financial market thus involves accessing the complete state-space of financial contracts, sources and users of finance worldwide in order to optimize the objective functions of financial end-users. In the process, significant value is added by financial intermediaries and markets—value that tends to be highly transaction-specific. It encompasses provision of price-discovery and trading services in various types of organized or OTC markets.3 It includes information utilities such as Bloomberg and Reuters, rating agencies such as Moody's and Standard & Poor's, portfolio diagnostic services such as Morningstar and Lipper Analytics, as well as securities and payments clearance and settlement services such as Euroclear and Swift. It also covers intermediaries' services in the structuring of financial contracts, underwriting and distribution of securities, and corporate finance and M&A advisory work. The value created in the inter-mediation process can be measured in the returns to the factors of production devoted to it both directly and indirectly—returns to labor, capital and land. The most successful financial centers generally employ large numbers of highly skilled, highly compensated individuals in the

4

Ingo Walter

financial inter-mediation process itself and in related sectors such as legal, accounting, publishing, consulting, and information technologies. Returns to capital involve interest and profit earned by lenders and investors resident in the major financial centers. Returns to land involve actual and imputed rents on the real estate used in financial centers, whose value is closely linked to the pace of financial activity. Related to the earnings of factors of production directly and indirectly employed in financial inter-mediation activities are tax receipts of local and regional governments. The battle among financial centers is, among other things, a battle for economic gains in one of the fastest-growing service industries in the global economy. Why do cities and countries struggle for position as financial centers? As noted, there is the direct, quantitative importance of the industry itself in terms of its contribution to economic activity, growth, employment, investment, the trade balance, tax revenues, and other economic performance benchmarks. Beyond this are indirect contributions that take into account vertical and horizontal linkages to sectors of the economy that are suppliers, users, and otherwise complementary to the financial services sector, such as travel and legal services, office equipment and the printing industry. Assessment of its overall contribution depends on the relevant input-output relationships—that is, how much each industry buys from (and sells to) every other industry in the national economy, and how much such activity would be lost if financial services were to migrate elsewhere.4 III.

WHAT FINANCIAL SERVICES ARE WE TALKING ABOUT?

It is useful to catalogue the specific kinds of financial inter-mediation services that make up the bulk of the activities in functional financial centers, from which the direct and indirect real-sector value-added derives. Each has its own mobility characteristics and locational dynamics. International Lending and Interbank Dealing

Loan syndication comprises the bulk of global wholesale lending activities carried out in financial centers, other than conventional trade finance. This involves the structuring of loans, backstops and credit enhancements, project financing and other commercial banking facilities in conjunction with clients, and then sellingdown participations to other banks. Selldowns may be quite limited (club deals) or may involve a very large number of banks in fully

Globalization of Markets and Financial-Center Competition

5

syndicated transactions. Deals are put together by lead-managers who earn origination fees and, jointly with other major syndicating banks, earn underwriting fees for fully committed facilities. These fees usually differ according to the complexity of the transaction and the credit quality of the borrower, and there are additional commitment, legal and agency fees involved as well. In some cases, loan participations are sold widely to other banks in loan-sales programs, and more recently loans have been packaged through special-purpose vehicles into securities that are sold to a broad range of institutional investors. Wholesale loans tend to be funded in the interbank market, either in domestic or Eurocurrency, through bank treasury operations' dealing desks that tend to be located in the major financial centers. While little information is available on value-added in international wholesale lending, it is clear that volume increased rapidly in the 1990s, from US$403 billion in 1992 to over US$1 trillion in 1995 and US$1.3 trillion in 1997.5 The nationality of the lending banks is presented in Figure 1.1, which shows a comparatively modest market share on the part of U.S., Canadian and Japanese banks and a very large share on the part of European banks—as of mid-1997, 55.5% of all cross-border lending was booked by European banks, 14.5% by North American Banks, 16.4% by Japanese banks, and 13.6% by banks based in other countries.6 However, the actual value-added and booking of syndicated lending transactions is North American Banks 14.5 %

Japanese Banks 16.4%

European Banks 55.5 %

Other Banks 13.6% FIGURE 1.1 Distribution of International Bank Lending by Nationality of Reporting Banks Source: Bank for International Settlements, The Maturity, Sectoral and Nationality Distribution of International Bank Lending, Basel, January 1998.

6

Ingo Walter

predominantly undertaken in London, with additional centers in New York, Hong Kong and Singapore. Foreign exchange operations are generally undertaken in a broker-dealer market structure dominated by the commercial banks, which cover both interbank and client-driven spot trades as well as foreign exchange and interest rate swaps and forward contracts. This trading activity likewise tends to be relatively concentrated geographically, and is strongly influenced by time-zone considerations—as is true of interbank funding operations. Whether it must be concentrated in the heart of a major financial center, however, is open to debate. Foreign exchange trading has expanded at a rapid pace during the 1980s and 1990s in comparison with global trade in goods and services, as Figure 1.2 indicates. According to the most recent (1999) survey of the Bank for International Settlements, London's foreign exchange volume is far ahead of competing financial centers, with almost twice the volume of New York and three times the volume of Tokyo, a market share that has grown over the years. Tokyo has suffered a significant market share loss against Singapore and Hong Kong in the Asian time-zone—see Figure 1.3.

450

402,4 400 350

321,6

300 250

229

200 131

150 100 50

35

17,5

2,7

1,5

0

1979

1984

1988

1992

1995

! Foreign Exchange • Exports of Goods and Commercial Services

Source:

FIGURE 1.2 The Foreign Exchange Market (Net Turnover, US$ trillion) Bank for International Settlements, International Trade Organization, 1999.

Globalization of Markets and Financial-Center Competition

New York $244

London $464

Copenhagen $ 29 Tokyo $161

Sydney $ 40 Paris $ 58

Singapore Frankfurt $ 80 $ 105 Hong Kong Zurich $91 $86 FIGURE 1.3

Top 10 Financial Centers for Foreign Exchange, 1998 (estimated in billions ofU.S.$) Source: Bank for International Settlements survey of 26 central banks published on October 19, 1999.

Capital Market Access, Trading and Research Underwriting new issues of debt and equity securities—both seasoned and initial public offerings—for a range of clients, including privatesector corporations, government-owned or government-controlled entities, sovereign governments and multilateral agencies, is a major area of activity of securities firms or securities departments of universal banks. The underwriting function involves purchasing the securities from the issuer and on-selling them either in public markets or to large institutional investors in the form of private placements, in the process incurring exposure to underwriting risk (market risk and event risk) and typically earning a "spread" between the buying and selling prices. In terms of the various instruments originated: Bond (fixed-income) underwriting is usually carried out through domestic and international underwriting syndicates of securities firms with access to local investors, investors in various foreign markets such as Switzerland (foreign bonds), and investors in offshore markets (Eurobonds) using one of several alternative distribution techniques. Placements may also be restricted to selected institutional investors (private placements) rather than the general public. Access to various foreign markets is facilitated by means of interest-rate and currency swaps (swap-driven issues). Some widely-distributed multi-market issues have become known as "global issues". In some markets, intense competition and deregulation have narrowed spreads to the point that the number of firms in underwriting syndicates has declined over time, and in some cases a single participating firm handles an entire issue—the so-called "bought deal".

8

Ingo Walter Commercial paper and medium-term note (MTN) programs maintained by corporations, under which they can issue short-term and medium-term debt instruments on their own credit standing and more or less uniform legal documentation, have become good substitutes for bank credits. Financial institutions provide services in designing these programs, obtaining agency ratings, and dealing the securities into the market when issued. In recent years, MTN programs have become one of the most efficient ways for borrowers to tap the capital market. Equity underwriting is usually heavily concentrated in the home country of the issuing firm, which is normally where the investor-base and the secondarymarket trading and liquidity is to be found. New issues of stock may be offered to investors for the first time (initial public offerings, or IPOs), to the general public on a repeat basis (seasoned issues), to existing holders of shares (rights issues) or only to selected institutional investors (private placements). Secondary market trading in cash instruments such as stocks, bonds, asset-backed securities, foreign exchange, and sometimes commodities such as cereal grains, pork bellies and metals—as well as derivatives on individual securities or commodities (mainly futures and options) or on indexes. Activities include customer trading (executing client orders), proprietary trading (for the firm's own account) and market-making (being prepared to quote both bid and offer prices), and arbitrage—buying and selling simultaneously in at least two markets to capitalize on price discrepancies between different markets for underlying financial instruments or derivatives, or between cash and derivatives markets (e.g., "program trading", computer-driven arbitrage between the futures and cash markets). There is also engagement in "risk arbitrage", usually involving speculative purchases of stock on the basis of public information relating to mergers and acquisitions. Brokerage, involving executing buy or sell orders for customers without actually taking possession of the security or derivative contract, sometimes including complex instructions based on various contingencies in the market. Research, into factors affecting the various markets as well as individual securities and derivatives. Securities research is made available to clients by more-orless independent analysts within the firm, whose opinion can be taken seriously. Analysts' careers depend on the quality of their insights, usually focused on specific industries or sectors. The value of research provided to clients depends critically on its quality and timeliness, and is often rewarded by business channelled though the firm, such as brokerage commissions and underwriting mandates. Closely allied are research activities—often highly technical modeling exercises—involving innovative financial instruments which link market developments to value-added for issuer-clients and/or investor-clients. Hedging and risk management mainly involves the use of derivative instruments to reduce exposure to risk associated with individual securities transactions or markets affecting corporate, institutional or individual clients. These include interest-rate caps, floors and collars, various kinds of contingent contracts, as well as futures and options on various types of instruments. It may be quicker, easier and cheaper, for example, for an investor to alter the risk profile of a portfolio using derivatives than by buying and selling the underlying instruments.

Securities market capitalization data, presented in Table 1.1 at the country level, show the U.S. with almost 47% of the global total

TABLE 1.1

Capitalization of Major Securities Markets Nominal Value Outstanding, 1998 (US$ billions) Bond Market

Country of Issuance

Government

USA

7550

EU11

4812 809

EU4 Total EU Japan Rest of the World

World Total

Source:

5621 3118

Corporations

5795 2319 692 3011

Euro & Foreign Bonds 738

1320 512

190

1212 764

1832 293 1224

16479

10782

4087

Total Bonds

Equity Market

Total Market Capitalization

14083 8451 2013 10464 4623 2178

13451

2496 4604

27534 12611 4764 17375 7119 6782

31348

27462

58810

4160 2751 6911

" o-

BIS, IFC.

n o 3

10

Ingo Walter

(outstanding bonds and stocks combined), followed by Japan with 12% and a combined European share of almost 30%. This is reflected in new-issue volume (excluding government bonds), depicted in Table 1.2 for the years 1992-98, with a U.S. share of about 64% of the global total. The European share of both market capitalization and new-issue volume should rise if introduction of the Euro leads to an increasingly integrated, capital market dominated by performance-driven issuers and investors. Corporate Finance

Corporate finance activities predominantly relate to advisory work on mergers, acquisitions, divestitures, re-capitalizations, leveraged buyouts and a variety of other generic and specialized corporate transactions: Mergers and acquisitions services involve fee-based advisory assignments to firms wishing to acquire others (buy-side assignments) or firms wishing to be sold or to sell certain business units to prospective acquirers (sell-side assignments). The M&A business is closely associated with the market for corporate control, and may involve advisories and fund-raising efforts for hostile acquirers or plotting defensive strategies and re-capitalization for firms subject to unwanted takeover bids. It may also involve providing independent valuations and "fairness opinions" for buyers or sellers of companies to protect against lawsuits from disgruntled investors alleging that the price paid for a company was either too high or too low. Such activities may be domestic, within a single national economy, or cross-border between a M&A buyer in one country and a seller in another. Re-capitalization tends to involve advice to corporations concerning optimum capital structure, increasing or decreasing the proportion of debt to equity in the balance sheet, types and maturity-structure of liabilities, stock repurchase programs, and the like. The securities firm may provide financial advice on these matters as well as supplying the required execution services through its capital markets activities. There are also advisory services regarding energy, transportation or project financing that require specialized industry expertise. Privatization became a major component of global wholesale financial services in the early 1980s, beginning with the U.K. and spreading to continental Europe and emerging market countries based on shifting political perceptions as to what types of economic activity belong in the public and private sectors, respectively. Privatizations have run the gamut from state-owned manufacturing and services enterprises to airlines, telecommunications, infrastructure providers, etc, using various approaches such as sales to domestic or foreign control groups, stock market flotation, global equity distributions, sales to employees share ownership plans, and so on. Value-added by financial services firms include buy-side and sell-side advisory assignments as well as initial and secondary public offerings and distribution of securities in the privatized enterprises. Privatization transactions are usually included in global M&A deal-flow data.

TABLE 1.2

Capital Market Activity, 1992-98 (US$ billions)

1998

1997

1996

1995

1994

1993

308.6

284.7 726.1

255.3

404.9 417.3

282.8

260.3

169.4

518.9

342.5

281.1

252.3 121.4

154.1

149.9

378 125.3

214.8

214.8

181.7

30.2 154.9

252.5 36.4

389.2 478.9

1738.4

1728.9

1329.6

International Issues Euro Medium Term Notes

598.0

420.0

Euro and Foreign Bonds

846.9

635.2

1444.9

1055.2

930

US Domestic New Issues Medium Term Notes Investment Grade Debt Collaterialized securities Below Investment Grade Municipal Debt

504.2 560.9

1992

69.5

428.2 53.7

161.3

287.8

231.7

1161.4

1075.5

1485.7

1164.1

392.6

251.6

96.9

385.1

257.2 485.2

149.8

537.4

482.7

335.9

636.7

742.4

632.5

432.8

C)

o Cr

o 3 O_

Total

Total Source:

Thompson Financial Securities Data Company, 1999.

£

n oT

o

I ru

12

Ingo Walter

Merchant banking involves financial institutions placing their clients' and their own capital on the line in M&A transactions and other equity participation. This could involve buying control of entire firms in order to restructure and eventually sell them, in whole or in part, to other companies or to the investing public. It may also involve large, essentially permanent stakeholdings in business enterprises, including board-level representation and supervision of management. Or it may involve short-term subordinated lending (bridge loans or mezzanine financing) to assure the success of an M&A transaction, intended to be quickly repaid out of the assets of the surviving entity. Other areas of significant direct investments may include real estate and leveraged lease transactions, for example.

While it is difficult to allocate value-added with respect to corporate finance and advisory services to particular financial centers, Table 1.3 provides data on the general geography of merger and acquisitions transactions. The volume of M&A deals in the 1980s was dominated by the U.S., with the European share of the global deal-flow rising dramatically in the early 1990s and both U.S. and European deal-flow expanding in the privatization and corporate restructuring boom of the late 1990s. Again, the advent of the Euro and continuing pressure for improved competitive performance at the industry level, together with a good deal of privatization left to be done in countries like France and Italy, could again raise the European share in the future. Advisory work on the bulk of major M&A transactions is carried out in London and New York, although much of the work for smaller transactions is executed in the regional financial centers. Some additional inferential evidence may be taken from the home-bases of the major firms in global finance. Table 1.4 shows the top 50 firms in terms of global deal-flow in 1998. Of the top 10, which handled 78% of the combined financial transaction volume, seven were American, three were European and none was Japanese (see Table 1.5). Of the top 20 firms, with a combined market share of over 97%, 11 were American, eight were European and one was Japanese. The Herfindahl-Hirshman index of market concentration for the top 10 firms increased from 328 in 1992 to 716 in 1998, and for the top 20 from 393 in 1992 to 764 in 1997, showing roughly a doubling of market concentration but still a very low absolute level.7 The dominance of the U.S. firms is evident. These are predominantly based in New York, although the value-added they generate occurs in various financial centers around the world. This balance could shift as the major European universal banks acquire or build significant market shares against their American rivals, especially if the Euro creates disproportionate growth in Europe's share of global transactionflow.

TABLE 1.3 1999*

Global M&A Development (Volume of Transactions in US$ billions and percentages) 1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

293.2 77.9

203.9

200.9 39.3

192.3 15.9 11.5 8.8

Transactions: US Domestic

353.5

801.8

488.3

330.7

218.5

199.8

101.1

119.3

108.5

124.9

250.1

US Cross-Border

230.5

106.5

58.4

34.9

33.5

40.5

73.0

85.6

193.3

European Cross-Border

307.5 173.1

101.9 242.4

84.5

Intra-European

292.2 305.9 291.4

151.8 72.4

85.6 57.1

59.9 33.0

91.0 43.0

US-European Cross Border All Other

(167.6) (210.3) (49.2) 116.6 118.6 116.2

(43.5)

(39.0)

(27.4)

117.2 53.8 (13.3) (22.8)

84.9

47.1

34.3

60.2

43.0

54.2

Global Total

1013.2

1599.6 978.5

713.7

552.8

406.9

261.7

316.5

78.5

73.2 (52.9)

86.4

50.2 54.9 41.4

127.2 130.1 97.7 74.3 (36.6) (46.3) 69.7 47.8

(38.2) 37.5

(28.3)

20.7 35.4 (17.4)

28.2

15.9

10.5

351.4

434.0

563.5

511.4

350.3

294.8

233.1

54.6

o Cr

(5.9)

US/Total (%)

57.6

68.4

60.3

63.5

52.0

48.3

42.4

45.6

59.6

47.4

37.3

32.8

58.2 37.3

58.8

Europe/Total (%)

40.6

35.1

35.5

42.3

48.7

51.8

36.3

72.6 27.6

72.5 27.5

81.5 19.0

89.3 8.7

US Domestic/Total (%)

34.9

50.1

50.0

46.3

39.5

49.1

38.6

37.7

30.9

28.8

44.4

57.3

58.2

68.1

82.5

* 1.1.99-8.31.99. Source: Securities Data Company.

n o

I

TABLE 1.4

Global Wholesale Banking and Investment Banking 1998. Full Credit to Book Running Manager Only (US$ millions)

Firm Rank 1998 (1997 in parentheses)

Goldman Sachs & Co (2) Merrill Lynch & Co (1) Morgan Stanley Dean Witter (4) Salomon Smith Barney/Citigroup (7/11) Credit Suisse First Boston (6) JP Morgan & Co. Inc. (5) Chase Manhattan Corporation (3) Lehman Brothers (8) Deutsche Bank/BT (15/16) Warburg Dillon Read/UBS (9) Bank of America Corp (14) Bear Stearns (12) Donaldson, Lufkin &Jenrette (13) ABNAMRO (17) Paribas/Societe Generale (25/41) Lazard Houses (18) Barclays Capital (19) Dresdner Kleinwort Benson (30) Rothschild Group (28) Nomura Securities (34) Schroder Group (22) BankBoston (38) First Union Corp (39) PaineWebber (23) HSBC (24) Top 25 Firms Top 10 as percentage of Top 25 Top 20 as percentage of Top 25

Global Securities Underwriting and Private Placements 388,765.9 549,797.3 404,497.5 366,353.8 290,502.0 250,064.7 122,602.9 264,339.6 158,681.0 201,809.6 57,975.7 140,608.7 111,498.7 127,077.6 153,649.0 -

81,236.9 54,611.5 -

58,998.1 -

24,972.3 57,604.2 57,260.5 3,922,907.5 76.41 96.44

Global M & A Advisory3 1,067,258.8 692,920.3 635,623.9 483,761.8 431,756.5 324,207.0 172,858.9 225,415.6 147,874.4 143,743.3 83,679.4 184,752.8 217,614.0 34,143.3 54,472.3 160,775.5 -

37,373.2 84,291.2 -

69,179.4 49,903.0 -

5,301,604.6 81.59 97.75

International Bank Loans Arranged

Medium Term Notes Lead Managed11

16,404.5 10,999.7

54,419.6 129,629.4 32,680.2 51,412.2 60,166.1 27,502.8 20,448.0 48,982.5 84,419.0 53,780.1 42,250.0 17,610.0

-

107,565.7 19,086.9 115,665.7 307,131.0 26,311.8 53,780.3 17,009.9 200,100.1 -

12,618.8 16,282.5 -

14,457.3 -

19,124.8 21,591.7 -

958,130.7 70.34 95.75

-

125,333.1 11,398.0 -

6,370.2 8,273.0 -

14,556.0 -

20,000.0 -

809,230.2 69.63 97.53

Total

1,526,848.8 1,383,346.7 1,072,801.6 1,009,093.5 801,511.5 717,440.2 623,040.8 565,049.5 444,754.7 416,342.9 384,005.2 342,971.5 341,731.5 302,836.5 219,519.3 160,775.5 102,064.4 100,257.7 84,291.2 73,554.1 69,179.4 69,027.8 66,564.0 57,604.2 57,260.5 10,991,873.0 77.88 97.09

Percent of Top

13.89 12.59 9.76 9.18 7.29 6.53 5.67 5.14 4.05 3.79 3.49 3.12 3.11 2.76 2.00 1.46 0.93 0.91 0.77 0.67 0.63 0.63 0.61 0.52 0.52

TABLE 1.4 Global Wholesale Banking and Investment Banking 1998. Full Credit to Book Running Manager Only (US$ millions) The Next Twenty Two: Firm Rank 1998 (1997 in parentheses)

CIBC Wood Gundy Securities (27) BANK ONE Corp Wasserstein, Perella (33) Enskilda Securities Natwest (20) RBC Dominion Securities (35) Prudential Securities (31) Bank of New York (32) Toronto-Dominion Bank and Tr (40) Commerzbank AG (37) First Tennessee Bank, N.A. Scotiabank-Bank of Nova Scotia Daiwa Securities (29) Banque Nationale de Paris (26) Fleet Financial Group Inc ING Barings (36) Bayerische H-V Bank of Montreal Trust Sakura Bank, Ltd. PNC Bank NA Wells Fargo Bank NA (50) Banque Internationale Lux SA

Global Securities Underwriting and Private Placements 12,594.8 -

39,208.6 -

26,587.5 -

11,778.3 21,357.4 -

10,623.1 -

Global M & A Advisory3 34,321.6 -

40,887.1 40,661.4 -

33,489.6 -

International Bank Loans Arranged 9,308.4 53,445.1 -

25,834.9 24,751.1 -

14,001.0 -

10,788.9 -

9,751.9 -

8,146.3 6,875.8 -

Medium Term Notes Lead Managed*3 -

10,000.0 13,500.0 11,700.0 -

10,000.0 9,124.3 -

5,744.5

Total

56,224.8 53,445.1 40,887.1 40,661.4 39,208.6 33,489.6 26,587.5 25,834.9 24,751.1 21,778.3 21,357.4 14,001.0 13,500.0 11,700.0 10,788.9 10,623.1 10,000.0 9,751.9 9,124.3 8,146.3 6,875.8 5,744.5

a Completed deals only. Full credit to both advisors to targets and acquirers. b Equal credit to both book runners if acting jointly. c To avoid overestimation, the top 25 total—US$10,991,873.0 million was used instead of the industry total—US$8,470,261.3 million. Sources: Securities Data Corporation.

Percent of Top 25C 0.66 0.63 0.48 0.48 0.46 0.40 0.31 0.31 0.29 0.26 0.25 0.17 0.16 0.14 0.13 0.13 0.12 0.12 0.11 0.10 0.08 0.07

n 0~

pOj

o. 3' n S' rt? 3 of

s>3

TABLE 1.5

Top Ten Firms % of Market Share Herfindahl Index Number of Firms from: USA

Europe Japan Top Twenty Firms % of Market Share Herfindahl Index Number of Firms from: USA

Europe Japan

Global Wholesale Banking and Investment Banking: Market Concentration

1990

1991

1992

1993

1994

1995

1996

1997

1998

40.6 171.6

46.1 230.6

56.0 327.8

64.2 459.4

62.1 434.1

59.5 403.0

55.9 464.6

72.0 572.1

77.9 715.9

5 5 0

7 3 0

5 5 0

9 1

9

9 1

8

8

7

1 0

0

2 0

3

0

2 0

80.5 392.7

75.6 478.4

78.1 481.4

76.0 439.5

81.2 517.6

93.3 620.9

97.1 764.0

8

15 4

15

14 5

14

13

11

6

7

1

0

0

8 1

11 1

1

5 0

0

Globalization of Markets and Financial-Center Competition

17

Investment Management and Investor Services

At the beginning of 1997 there was approximately US$27.4 trillion in assets under management worldwide, comprising some US$5.3 trillion in mutual funds, US$8.2 trillion in pension funds, US$6.4 trillion managed by insurance companies, and US$7.5 trillion in offshore private assets.8 This compares with roughly US$37 trillion in global banking assets and US$41.7 trillion in total capitalization of global stocks and bond markets. This enormous financial pool constitutes the market for global asset management services. There are a variety of asset-allocation services provided to institutional and individual investors, as well as technology-intensive investor services which reduce transaction costs, improve market information and transparency, and facilitate price discovery and trading: Asset management for institutions and individuals. With respect to institutions, major investors such as pension funds and insurance companies may allocate blocks of assets to be managed against specific performance targets or "bogeys" (usually stock or bond indexes). Closed-end or open-end mutual funds or unit trusts may also be operated by broker-dealers, banks, or fund management firms and either marketed to selected institutions or mass-marketed to the general investor community either as tax-advantaged pension holdings or to capture general household savings. Private banking to high net worth individuals usually involves assigning discretionary asset management to financial institutions within carefully crafted parameters. These may link asset management to tax planning, estates and trusts, and similar services in a close personal relationship with an individual private banking officer that involves a high level of discretion. Many private clients are confidentiality-driven, which makes them comparatively less sensitive to normal risk-return considerations and more sensitive to trust vested in the bank and the banker.9 Investor services and transactions infrastructure. There is an array of services that lie between buyers and sellers of securities, domestically as well as internationally, which are critical for the effective operation of securities markets. This centers on domestic and international systems for clearing and settling securities transactions via efficient central securities depositories (CSDs), which in turn are prerequisites for a range of services, often supplied on the basis of quality and price by competing private-sector vendors of information services, analytical services, trading services and information processing, credit services, securities clearance and settlement, custody and safekeeping, and portfolio diagnostic services.

In asset management, Switzerland (Zurich and Geneva) and London share the top spot, with very different businesses centered on private banking and institutional asset management, respectively. Other continental European asset management centers are far behind. As of 1992, 42.1% of pension assets under institutional

18

Ingo Walter

management were centered in the U.S., 35.1% in Japan, 10.7% in the U.K., 10.4% in France and less than 1% each in Switzerland, Germany, the Netherlands, Canada and Australia.10 Specifically with regard to equity fund management, London in 1996 ranked first with over US$1 trillion under management, followed by Zurich, Basel and Geneva combined with US$740 billion, Frankfurt with US$157 billion (excluding inter-corporate holdings), Edinburgh with US$138 billion and Stockholm with US$89 billion. None of the other European financial centers rank in the top 25. These numbers compare with US$1.5 trillion managed in Tokyo and US$896 billion in New York.11 Such rankings in the future are likely to shift as European financial integration continues, especially under a single currency, with greater polarization possible. No direct figures are available with regard to fee income generated from asset management activities. However, some evidence may be obtained from the location of the world's largest asset managers depicted in Table 1.6. Note that location is quite dispersed, and while the major financial centers such as London, New York and Tokyo are prominent, centers like Frankfurt, Paris, Boston, Munich, Zurich, Chicago, Pittsburgh and Baltimore are also important, as are unlisted specialist centers such as Geneva (private banking) and Bermuda (insurance and fund management). Investor services, notably clearance and settlement, are undertaken in the various national financial centers by central securities depositories such as the Depository Trust Company in the U.S., SICOVAM in France and Deutscher Kassenverein in Germany. Internationally, substantial cross-border transactions are handled either through bilateral links between national CSDs or through international CSDs, mainly Euroclear in Brussels and Cedel in Luxembourg. To summarize, each of the types of financial services enumerated above has its own locational attributes. Some are highly mobile and, given modern information and communication technologies, could be carried out more or less anywhere. Some are difficult to carry out effectively in isolation, or may require "bundling" with other types of financial or infrastructure services and are therefore less mobile. Still others require a high degree of centralization due to economies of scale or economies of agglomeration. IV.

LOCATIONAL MOBILITY OF FINANCIAL VALUE-ADDED

Financial intermediaries, as well as the end-users of the financial services discussed in the previous section, have access to a broad range of locational choices for carrying out their activities. Back-office

Globalization of Markets and Financial-Center Competition TABLE 1.6

Rank 1/1/99 1 2 3 4 5 6

7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42

19

Global League Table of Leading Asset Managers (assets under management exceeding US$100 billion)" Firm Kampo UBS AGa Fidelity Investments Deutsche Bank Groupb Groupe AXAC Barclays Global Investors Allianz (including PIMCO) Merill Lynch State Street Global Investors Capital Group Companies Zurich Groupd Mellon Financial Services Nippon Life Equitable Cos. Morgan Stanley Dean Witter Citigroup JP Morgan Putnam Investments Zenkyoren Vanguard Group Dai-Ichi Mutual Life TIAA-CREF Pimco Advisors Prudential Insurance Co. Bank of America Corp. Credit Suisse Group Northern Trust Company Mitsui Trust and Banking Franklin Group of Funds Sumitomo Mutual Life Fortis Group Amvescap National Westminster Banke Wellington Mgmt Co. General! Groupf Schroder Investment Man. American Express Chase Manhattan Corp. United Asset Mgmt. Group BNP Gestions8 Goldman Sachs Asset Mgmt Commercial Union

Country

AUM (US$ billion)

Japan Switzerland

1685 1167

USA

773 698 672 616 607 501 493 424 407 401 383 359 346 327 316 294 279 276 267 244 244 242 234 231 226 225 220 220 219 217 212 211 198 197 196 190 188 184 181 175

Germany France UK

Germany USA USA USA

Switzerland USA

Japan USA USA USA USA USA

Japan USA

Japan USA USA USA USA

Switzerland USA

Japan USA

Japan Belgium USA UK USA

Italy UK USA USA USA

France USA UK

20

Ingo Walter

TABLE 1.6 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76

77

Global League Table of Leading Asset Managers (assets under management exceeding US$100 billion)a Societe Generale First Union Corp. ING Groep Groupe Caisse des Depots MassMutual Aegon NV Metropolitan Life Dresdner Bank Group Lloyds TSBh Indocar (Credit Agricole) Meiji Mutual Life T. Rowe Price Assoc Mitsubishi Trust & Bank HypoVereinsbank Prudential Corp.1 Sumitomo Trust & Bank Nvest Cos. BlackRock Munchner Ruckversich Asahi Mutual Life Commerzbank Group BancOne Inv. Advisors Standard Life Daiwa Trust and Banking Yasuda Mutual Life Desjardin-Laurentian Janus Capital Corp. Fleming Investment Mgt. Federated Investors Grupo Intesa John Hanckok Deka Bank Sun Life Canada Daiwa Group Sun Life of Canada

a Includes Global Asset Management, b Including Bankers Trust Co., c Includes Guardian Royal Exchange, d Including Scudder Kemper Investments, e Includes Legal & General and Gartmore, f Includes Achener & Munchner, g Includes Paribas, h Includes Scottish Widows, i Includes Mutual & General.

France USA

Netherlds France USA

Netherlds USA

Germany UK

France Japan USA

Japan Germany UK

Japan USA USA

Germany Japan Germany USA UK

Japan Japan Canada USA UK USA

Italy USA

Germany USA

Japan Canada

175 169 169 168 157 156 154 152 151 151 150 148 145 140 141 137 135 132 130 129 124 122 122 115 114 111 108 108 107 107 105 105 105 103 102

Globalization of Markets and Financial-Center Competition

21

operations (e.g., payments functions, clearing and settlement of financial transactions) can be physically separated from the marketing functions and the ultimate client interface with no loss of service quality and significant potential for cost improvement. In theory, only certain specific functions in today's technological environment still need to be carried out in direct physical proximity to the client; most others may ultimately gravitate toward the most costeffective siting. This is certainly true at the wholesale end of the industry, and it is becoming more true at the retail end of the financial services spectrum as remote-delivery (e.g., via the Internet) gradually captures a greater market-share. The financial services sector has thus become a much more "mobile" industry, one that is particularly sensitive to operating costs and regulatory burdens. Many banks, securities firms, insurance companies and asset managers—as well as their clients—today have access to a broad range of location choices for conducting their activities. Indeed, the financial services industry can be considered to cover a spectrum of activities that ranges from potentially highmobility functions such as data processing, investment management, institutional sales and trading, and remote-servicing of mass markets, to low-mobility functions that require direct and personal contact with clients such as corporate borrowers, municipal governments, investors and private individuals. The economics of high-mobility activities can be described as centrifugal, or supply-oriented. Modern information and transaction technologies make it increasingly possible to conduct such activities in remote locations in order to take advantage of lower labor or real estate costs and other production considerations that can differ widely both inter-regionally and internationally, as well as potential economies of scale and scope. Certainly, transactions processing can often be physically separated from the marketing of the financial transaction itself. Why undertake data-entry for insurance claims in Zurich, when Ireland offers plentiful lower-cost skilled and motivated labor, lower rents, and significant tax breaks, for example? Why not "pool" or "outsource" some processing-intensive activities to a vendor like IBM or Electronic Data Systems, which can do it cheaper and better with increased scale economies in low-cost locations, providing significant operating economies and at the same time liberating a large amount of capital? However, issues related to quality-control, speed, security, reliability, confidentiality and the value of information based on transaction flows may limit such rationalization of production. The economics of low-mobility financial activities can be described as centripetal—agglomeration- or demand-oriented. They are

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Ingo Walter

driven by proximity and economies of agglomeration, personal contact, social relationships and other qualitative factors. There is no way to develop a private banking relationship, or to structure a complex corporate finance transaction involving investment bankers and lawyers, without close personal interaction. Although technically feasible, it is not entirely clear that a portfolio manager or securities trader can do his or her job as well in a remote location away from colleagues and competitors, and away from the excitement and "smell" of the market. Still, modern technology can often be used to convert "front-office" to "back-office" activities, and thereby loosen ties to client-linked and agglomeration-oriented locations. Technology is a major factor affecting the balance of centrifugal and centripetal forces acting on the location of financial activities, and therefore on the underlying economics of financial centers. Traditionally, the centripetal forces have dominated in the financial services industry, and have assured the dominance of the traditional financial centers. This now seems to be changing, permitting "unbundling" of financial activities and allowing the centrifugal forces to make themselves increasingly felt. One can envisage the mobility of functions within a circle that extends from those activities requiring direct and personal contact with clients such as corporate borrowers and issuers, government entities, institutional investors and fund consultants, and private individuals all the way out to back-office functions, investment management, and remote servicing of routine retail client transactions. One can also imagine a threshold, radiating out from the center of the circle in Figure 1.4, where the supply-related centrifugal forces may outweigh the demand or agglomerate centripetal forces for specific segments in the financial-services value-chain with a given state of technology. One can argue that this threshold has traditionally been biased toward centripetal forces, with the need for substantially all functions to be carried out in-house and on-site in major financial centers. The need to locate in proximity to clients, as well as to legal and accounting services and other firms competing in the market, have tended to bias location toward the these centers. The argument is that technological change, and the ability to "unbundle" the various financial functions, appear to have moved that threshold significantly to the periphery, with back-office activities, investment management, and remote client servicing easily done from sites well removed from the center of the firm itself and away from the traditional financial agglomerations. The key question for the traditional financial centers is how much further that threshold can still move

Globalization of Markets and Financial-Center Competition

23

Transactions processing • Brokerage • Private Banking Research Risk Management Corporate Advisory Securities Underwriting Securities Trading & Sales Loan Structuring & Syndication • Forex and Money Market •Dealing • Merchant Banking • Investor Services Asset Management

FIGURE 1.4

Centrifugal and Centripetal Locational Mapping of Financial Services

to the periphery, and how sensitive that movement is to factors such as labor cost and labor quality, tax and regulatory differences, and the available economic infrastructure, as discussed below. Once management of financial firms has determined that the mobility threshold can technically be overcome, and takes on a mind-set that relocation is feasible and may indeed be desirable, mobility inherently increases as the financial firm starts looking for alternatives, as the implementational issues are discussed, and the burden of proof may then become "why not move?", as opposed to "why move?". For example, relocation of back-office and data processing (DP) operations is perhaps the most mobile of a complex process of rationalizing information and transactions processing in financial firms. Back-office capacity must be on-line to handle existing and expected future business volume, transactions security, and a variety of contingencies ranging from power failures to software problems. It does not, however, imply that a New York or London or Frankfurtbased firm necessarily has to site its information processing there. The cost and reliability of transmitting information is an important factor determining location, as are the potentially significant economies of scale and scope that exist in back-office functions, regardless of their location, and explains a number of efforts to "outsource"

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back-office functions—even "selling" back-office facilities to such firms and buying-back transactions processing services. Such efforts are likely to involve relocation of these functions to major DP "factories" serving multiple clients from remote sites. Other efforts involve "pooling" of back-office functions among a number of firms on a cost-sharing basis in order to rationalize these functions and drive down costs. This may require construction of new, high-capacity facilities, and in the course of the restructuring process the decision may be taken to locate such joint facilities at remote locations. On the other hand, measures that would achieve maximum cost economies may compromise proprietary information and complete control. For this reason, outsourcing and pooling of back-office functions has limits. It is certainly feasible for some functions, but probably not for others. Most initiatives toward back-office outsourcing and pooling in the investment banking industry, for example, have not borne fruit, unlike similar efforts in mass-retail transactions processing or securities custody. Competition among financial centers is thus in part a contest for market-share in centripetal value-added activities, and in part a battle to retain as much as possible of centrifugal value-added activities. V.

HOW DO FINANCIAL CENTERS COMPETE?

Two more or less distinct types of financial center can be identified. One is the functional center, where transactions are actually undertaken and value is created in the design and delivery of financial services. Examples of traditional functional centers include New York, London and Hong Kong across a wide range of financial activities from syndicated lending to M&A advisory services, and Boston, Chicago, Frankfurt, Paris and Tokyo in a more specialized range of activities. The other is the booking center for transactions whose underlying value is mainly created elsewhere. Examples in this category include the Bahamas, Cayman Islands, Channel Islands, Liechtenstein and Vanuatu. In order to attract financial booking business, one prerequisite is a favorable tax climate for non-residents, a benign regulatory and supervisory environment as well as (sometimes) strict financial secrecy or blocking statutes. Centers like Bermuda, Luxembourg, Singapore and Zurich might be considered among the established "dual-capacity" financial centers, combining both functional and booking dimensions, as well as several newer centers like Dublin, and Labuan in Malaysia. What kinds of factors seem to determine competitiveness among functional centers? A number of studies suggest that the following considerations seem to be of importance.12

Globalization of Markets and Financial-Center Competition

25

GNP growth. Financial services, along with labor and capital, are important resources (or inputs) determining real output, so that high-growth economies tend to become the home of important international financial centers. A large and growing economy, however, is no guarantee of exceptional performance as a financial center. Industrial base. An important national non-financial sector requiring a range of financial services may constitute the basis for a viable global or regional financial center. Again, it does not by itself assure the ability to compete for transactions generated elsewhere, or to prevent domestically-generated business from migrating to financial centers abroad. International trade-intensity. Countries that are relatively open to international competition and trade are more likely to develop financial centers than are more closed economies. Foreign direct investment- and trade-intensity. Banks and other financial firms tend to follow their clients abroad, so as to be in a better position to meet their needs (especially in the local currency). So countries with strong foreign direct investment inflows through acquisitions or greenfield projects, as well as large volumes of international trade, improve their chances of developing into financial centers. Stability. Political and macroeconomic stability have been important determinants of financial center development. Responsible fiscal and monetary policies reflected in low inflation and currency stability and convertibility, for example, are highly favorable attributes. So are perceptions of political continuity and predictability. Once lost, such characteristics can be very difficult to regain. Product range and propensity to innovate. A broad range of banking services, securities and derivatives, and strong innovative capabilities can be critical for successful financial centers. Centers which have developed into major wholesale players tend to be subject to relatively permissive regulators whose default response to a new product or a new financial structure is "yes, unless there are compelling reasons to prohibit", as opposed to "no, unless there are compelling reasons to permit". Infrastructure characteristics. This includes such attributes as time-zone overlaps, quality of the physical capital stock (transportation, communications, etc.), and efficiency of governmental services. Shortcomings in any of these areas may be impossible to overcome. Agglomeration economies and liquidity. The larger the number of financial firms already in place and the greater the volume of financial activity (market depth)—as well as the larger the percentage of the skilled work force active in the financial service industry—the more likely a financial center is to attract still more participants. A high degree of liquidity, notably for block trades and good after-hours trading capabilities, is critical for financial centers to attract significant wholesale business. It also includes a strong equity component—ranging from actively traded shares of large-cap global companies to IPOs and private equity—with significant turnover and deep institutional investor participation. Transparency. The issue here is whether transactions in a financial center are undertaken in a fair and open marketplace, and whether an adequate infrastructure exists for financial end-users and intermediaries. This includes the appropriate regulatory and enforcement infrastructure, mediation or arbitration, or

26

Ingo Walter

recourse to the courts in civil or criminal actions. Transparency applies both to dealing in financial instruments as well as in the financial instruments themselves, including making issuers as well as underwriters liable for incomplete or false information in the case of securities sold to the general public. It also includes a uniform accounting and legal infrastructure that meets global standards. Immediacy. The role of time is critical in the operation of financial centers—the time it takes to make a trade, affirmation and confirmation of the trade, as well as clearance and settlement of the trade. Basic standards that have been set by the international financial community such as immobilization and dematerialization of securities, delivery versus payment, clearance and settlement time, must be met or exceeded by a financial center that hopes to attract significant transaction volumes. Contestability. This criterion concerns whether firms are allowed to develop the access to clients and markets and the organizational forms necessary to compete effectively in a particular financial market. The presence of cartels and exclusionary market practices such as limitations on exchange membership or discrimination by regulators can do much to retard the development of a financial center. Labor force. Quality, motivation and availability especially of skilled labor critical in the supply of financial services is a determining factor in the success of financial centers. Openness to highly skilled and motivated labor and management from abroad, including attractive and hospitable living and working conditions, is an important related variable. Cost of operations. Comparative cost of labor and real estate required to produce financial services in relation to comparable costs in alternative locations is an important consideration, especially in an era of intense competition among financial firms. Low transactions costs, notably in the form of commissions and spreads, clearance and settlement services, back-office operations, custody services, telecommunications and other financial infrastructure services are critical for the success of wholesale financial centers. Taxation. Taxes enter into the competitive performance of financial centers in two ways. The first involves the taxation of capital income, and there is a long tradition of specialist financial centers that have done very well by capitalizing on tax avoidance and evasion on the part of depositors and investors under the protection of national sovereignty, financial secrecy and blocking statutes. Examples include the Channel Islands, Luxembourg, Switzerland and various Caribbean and Pacific islands. The second involves taxation of financial transactions and earnings of the financial intermediaries, where Ireland or Bermuda are good examples. Most tax-driven financial centers comprise "niche" players as against the major global wholesale centers where taxation tends to play a relatively minor role.13 Net regulatory burden (NRB). It is useful to think of financial regulation and supervision as imposing a set of "charges" and "subsidies" on the operations of financial firms exposed to them. On the one hand, the imposition of reserve requirements, capital adequacy rules, interest/usury ceilings and certain forms of financial disclosure requirements can be viewed as imposing implicit "taxes" on a financial firm's activities in the sense that they increase costs. On the other hand, regulator-supplied deposit insurance, lender-of-last-resort facilities and

Globalization of Markets and Financial-Center Competition

27

institutional bailouts serve to stabilize financial markets and reduce the risk of systemic failure, thereby lowering the costs of financial inter-mediation. They can therefore be viewed as implicit "subsidies" provided by taxpayers.14 The difference between these "charge" and "subsidy" elements of regulation can be viewed as the net regulatory burden (NRB) faced by financial firms in any given jurisdiction. Financial firms tend to migrate toward those financial environments where NRB is lowest—assuming all other economic factors are the same.13

Factors that do not appear to be important in determining the competitive position of financial centers, according to empirical studies, include the position of a particular city as a political capital, its age, or the role of the country in the shifting geopolitical environment.16 The significance of a city's role as central bank headquarters for its role as a global financial center is debatable. One can envisage a matrix, such as that in Table 1.7, which maps various financial inter-mediation activities against the attributes of financial centers and may be helpful in assessing their comparative locational sensitivity in one of the most structurally complex and dynamic industries in the global economy. It is an industry that has become truly high-tech, dynamic and capital intensive, yet remains a "people business" par excellence. The Market for Markets and the Location of Financial Activity Variations in the multi-dimensional operating conditions in financial centers—combined with the differential sensitivity of valueadded across the range of financial inter-mediation services supplied in global markets, regulatory competition and the existence of offshore markets—underscore the fact that financial services firms often face a range of location alternatives for executing transactions and performing support functions. Vigorous competition among financial services firms is today joined by equally vigorous competition among financial centers. This competition can be framed in terms of static and dynamic efficiency properties, with comparative weaknesses in efficiency, liquidity or creativity driving financial transaction-streams and the associated value-added to high-performance centers where they can form the basis of a major source of employment and economic growth. London, New York and Tokyo are battling for advantage on the world stage as financial "hubs." London (outside EMU, at least at the start) is itself vigorously competing for position against Frankfurt, Amsterdam, Luxembourg, Paris and Zurich on the increasingly level EU playing field. Meanwhile Tokyo, along with Hong Kong and Singapore, are maneuvering for competitive advantage in the Asia-Pacific region, both against each other and

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Globalization of Markets and Financial-Center Competition

29

against other countries working to keep domestic financial transactions at home and, in some cases, to become mini-financial centers themselves. In order to capture market-share, regulatory initiatives have been the key policy factors in the battle for value-added in financial inter-mediation among financial centers. They have affected all of the major financial centers, and have intensified competition among them. The development of offshore currency and bond markets in the 1960s was an early example which showed that borrowers and lenders alike could carry out the requisite market transactions more efficiently and with sufficient safety and professionalism by operating outside national financial markets, in what amounted to a parallel market.17 The U.S. interest equalization tax (IET), imposed in order to deal with the balance of payments problems at the time, was intended to force international companies to finance their expansion outside the U.S. in order to reduce capital outflows. This was accompanied by limits imposed on foreign equity investments by the Office of Foreign Direct Investment (OFDI). Together with tax and regulatory advantages (including the use of bearer securities and the absence of new-issue disclosure rules) the IET represented a policy shift that made new debt issues in the U.S. relatively unattractive for many borrowers, and Eurobond issuance developed rapidly in London after 1963. Initially considered a temporary and insignificant departure from the U.S. corporate bond market, growth of the Eurobond market over the next two decades was spectacular, especially as additional financial firms became involved and the market's infrastructure and depth matured. Eurobond issuers came to include most of the major corporate and institutional borrowers around the world, and dollar-denominated Eurobond volume for the first time surpassed U.S. domestic corporate bond market new issue volume in 1986. Despite U.S. repeal of the IET and the OFDI rules in 1974, introduction of Rule 415 (shelf) registration procedures in 1982 to streamline and enhance competition in the securities issuing process, elimination of the withholding tax on interest due to foreign investors in 1984, and adoption of Rule 144A in 1990 to liberalize trading in non-public offerings, Eurobond market activity never came back to New York to any significant extent. This suggests a ratchet effect at work. Once financial activity migrates and a demonstrably successful market develops elsewhere, it is virtually impossible to reverse its course. Similar developments occurred in the 1980s and 1990s in Europe, as local trading in various German and French financial instruments faced challenges from London, which captured significant a market share by virtue of greater efficiency,

30

Ingo Walter

transparency, regulatory advantages and ultimately market depth, with efforts to re-attract the deal-flow back to the countries of the issuers only partly successful. Sequential and perhaps competitive liberalization of onshore financial markets continued from the mid-1970s through the 1990s. Beginning with the 1975 New York Stock Exchange introduction of negotiated securities commission rates on May 1, 1975, the U.S. followed-up by liberalizing the rules governing public securities issues and private placements during this period, easing restrictions on investment banking activities of commercial banks, and tax changes designed to make its financial market more attractive to foreign issuers and investors. By the late 1990s, secure and preeminent in its domestic markets, New York nevertheless sporadically pursued reforms to address perceived competitive shortcomings—such as the so-far unsuccessful efforts to liberalize disclosure rules for foreign issuers—in an effort to avoid losing business to foreign financial centers. There followed liberalization of restrictive pricing, trading practices and market access rules in Britain's "Big Bang", announced in 1983 and implemented in 1986, having already repealed exchange controls in 1979 and later vigorously opposing various EU tax initiatives that would have diminished its competitive attractiveness. The City of London subsequently undertook a major study of its European and global role, and how to fend off challengers—and made far-reaching regulatory reforms in banking, securities and insurance in 1998 by creating a super-regulator, the Financial Services Authority (FSA) and relieving the newly-independent Bank of England of supervisory responsibility. Japan only began serious financial deregulation some 20 years after the U.S. and 10 years after the U.K. with its own "Big Bang" near the end of the century, having lost some of its early promise as Asia's pre-eminent financial hub. Tokyo, struggling against massive credit and corruption problems affecting virtually every part of the financial services sector and even its regulators, seemed for the first time committed to serious liberalization that included opening the door to participation in Japan's high-savings economy by foreign financial institutions and asset managers. Paris, meanwhile, took pride in what it had already achieved in deregulation in 1988-89 toward developing efficient and innovative markets for derivatives and local securities, and worked in the 1990s to remedy remaining regulatory and transparency shortcomings. To overcome its long-standing reputation as an "industrial giant but a financial dwarf, the world's largest importer of financial services, Germany, announced in the mid-1990s important institutional and

Globalization of Markets and Financial-Center Competition

31

regulatory changes intended to make Frankfurt the pre-eminent financial center of continental Europe by the year 2000. Amsterdam styled itself as the "financial gateway to Europe", but seemed destined to be mainly a niche-player along with Luxembourg and Dublin, and home-base for a few powerful financial institutions capable of global prominence. Along the way, there were many "mini-bangs" in Canada and Australia (both in 1984), as well as in Switzerland and a number of emerging financial markets such as Chile and Mexico—often under general programs of marketoriented economic reforms. In short, governments in one country after another sought a better balance between the efficiency of the financial markets and the stability of the financial system, with almost all of the regulatory change favoring more efficient capital markets. Not least, an important objective of regulatory reform was to support the competitive prospects of national financial centers, or at least to retard the migration of activities to financial centers abroad.18 VI.

PICKING THE WINNERS

The financial centers of the world are thus caught in a vigorous struggle for market-share in and value-creation in primary and secondary-market financial inter-mediation and transactions processing. Each of the world's financial centers embody powerful entrenched interests, as well as continuing debates between the financial services industry and its regulators, that will help identify future winners and losers. It seems clear that the changing competitive environment and its implications for value-added in the financial services sector are well recognized by the authorities, and are reflected in policy debates. For example during the regulatory debates on the 1986 U.K. Financial Services Act, the global competitive performance of financial institutions and markets in London was considered of paramount importance. American regulators at the federal and local levels have increasingly taken global competitive aspects into account in assessing proposals for financial reform. In countries like Canada, Australia, Germany, France, Japan, the Netherlands and Switzerland, discussions of conditions affecting the financial services industry are invariably set against the need to maintain competitive position against London and New York. None of these financial centers is prepared to see its significance on the global stage decline, and all are acutely aware of the benefits of achieving a greater share of financial activity. In the end, the regulatory environment plays a critical role. Regulators express legitimate concerns about financial safety and stability

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Ingo Walter

in an industry that is always susceptible to problems of insolvency, illiquidity and fraud. Over-regulation drives financial transactions away. Under-regulation is a recipe for disaster. In effect, regulators around the world are being compelled to rethink the balance between financial efficiency and creativity on the one hand, and safety and stability of the financial system on the other. They face the daunting task of designing an "optimum" regulatory and supervisory structure that provides the desired degree of stability at minimum cost to efficiency, innovation and competitiveness—and to do so in a way that effectively aligns such policies among regulatory authorities internationally and avoids "fault lines" across regulatory regimes. Compounding the geographic competition for financial services value-added is the persistent functional migration across inter-mediation channels. This again has much to do with changes in the relative static and dynamic efficiency characteristics and inter-mediation costs via traditional financial institutions, as against more direct securities market processes. For example, in Europe, with roughly twice the proportion of financial assets on the books of banks and other financial intermediaries than the U.S., is likely to go through much the same financial dis-intermediation process as has occurred in the U.S., propelled by the imperatives associated with rapidly-growing pools of professionally-managed funds and equally performanceoriented borrowers. For example, asset securitization—which, except for certain traditional mortgage-backed securities have experienced limited development in continental Europe—is likely to expand dramatically in the years ahead. This includes securitization of commercial and industrial loans which, in a lending-oriented environment like Europe, offers great potential. And the next set of developments in both the U.S. and Europe may involve direct distribution of securities to institutional investors, including automated links that have the potential of further cutting-out traditional financial intermediaries. In particular, the rise to prominence of institutional asset managers in Europe will do a great deal to enhance financial market liquidity and further intensify both geographic and functional competition—reinforced by Maastricht-type criteria that will pressure governments to accelerate the transition from pay-as-you-go pension schemes to various types of defined-contribution programs —as it already has in the U.S. and the U.K. Mutual funds, whether part of defined contribution pension schemes or mass-marketed as savings vehicles to the general public, and other types of money managers are so-called "noise traders" who must buy and sell assets whenever there are net fund purchases or redemptions, in addition to discretionary trades to

Globalization of Markets and Financial-Center Competition

33

adjust portfolios. They therefore tend to make a disproportionate contribution to capital market liquidity. One recent study suggests that the gradual shift from banking to securities transactions in Europe is likely to be accelerated by EMU, because the factors which underlie this development, by reducing transactions and information costs (both heavily driven by technology) and making available new products to end-investors and issuers, cannot be fully exploited in a fragmented foreign exchange environment, i.e., one characterized by widespread currencymatching rules bearing on issuers and investors. This includes a range of financial instruments that are broadly available in the U.S. but have been unable to reach the critical-mass needed for trading efficiency and liquidity in Europe.20 In 1997 the EU still supported a highly fragmented system of 32 stock exchanges and 23 futures and options exchanges among which only one market, London, came close to meeting the rapidly evolving needs of the large institutional asset managers and issuers. Continued fragmentation is perpetuated by differences in legal, tax and corporate governance considerations. In the presence of electronic links and low-cost transactions services to institutional investors, this market fragmentation should disappear relatively quickly, especially under pressure of a single currency. Already, the EU Investment Services Directive (ISD) has permitted national exchanges to place trading screens in other financial centers. EASDAQ in London has been in the process of creating a pan-European over-the-counter exchange patterned on NASDAQ in the U.S. to attract new, high-growth companies. National markets in Frankfurt, Paris, Brussels and Amsterdam have been trying to do the same thing and link-up in the form of EuroNM to compete with both NASDAQ and EASDAQ. Comparable initiatives are underway among the Nordic countries. Frankfurt, Paris and Zurich derivatives exchanges have banded together to compete with London's Liffe, which in turn has linked-up with U.S. derivatives exchanges. The rapid growth of institutionally-managed asset pools and major securities issuers in Europe is likely to promote a fairly rapid shakeout of these competing market initiatives—certainly under conditions of a common currency—based on how they meet efficiency and liquidity criteria, with perhaps a single order-driven electronic market dominating trading in shares of the major international companies and the regional exchanges accounting for the bulk of European trading activity in mid-cap and small-cap shares. It is useful to remember that the large, integrated U.S. capital market supports only one major stock exchange and one major OTC trading system, alongside a number of specialist exchanges in New

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Ingo Walter

York, Philadelphia, Chicago and San Francisco plus continued challenge from electronic order-driven exchanges. The U.S. structure of financial centers that has evolved may well be an appropriate indicator for a future integrated European market supporting the rapidly growing needs of global intermediaries and end-users: 1. A single wholesale market for transactions execution (New York) that is not necessarily the same as the seat of monetary policy and financial regulation (Washington), with a reasonable argument to be made that a bit of geographic "distance" between the markets and their regulators can actually be helpful. 2. Dispersed asset management centers (Boston, Chicago, Philadelphia, Stamford, San Francisco), and sometimes no distinctive centers at all in where the necessary information, interpretation and transactions services can all be delivered electronically and in real-time. 3. Specialist centers focusing on particular financial instruments (Chicago, Philadelphia) or industries (San Francisco) that have their roots in history or ongoing economic developments. As in any industry, comparative advantage and the interplay of free markets will ultimately determine who wins and who loses in the battle for supremacy among financial centers in an age of enhanced mobility of financial value-added. The name of the game in global financial services today is valueadded—creating perceived incremental value for those who need to borrow, undertake financial transactions, control risks, or manage assets—and at the same time provide a profit opportunity for the intermediary. It is a fast-moving, innovative and fiercely competitive contest on an ever-changing playing field. Those institutions judged world-class players in the years ahead will have mastered this skill. So will the successful financial centers, in the process capturing for their nations some very substantial real economic gains. The size, openness of markets, trading activity, sophistication of institutional investors, securities issuers and traders, the quality of research, transaction services, and innovative thinking that have traditionally characterized the global financial hubs will continue to be subject to challenge in specific areas by various other financial centers, even as the more mobile parts of the financial value-chain migrate to costeffective sites outside the main centers. REFERENCES Bishop, G. (1997) Bank Credit Versus Capital Markets, Salomon Brothers, London. Choi, S.P., Tschoegl, A. and YU, C.M. (1986) Banks and the World's Major Financial Centers, 1970-80, Weltwirtschaftliches Archiv, March.

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Dohner, R. and Terrell, H.S. (1988) The Determinants of the Growth of Multinational Banking Organizations 1972-86, Board of Governors of the Federal Reserve System, IFDP, No. 326, June. Goldberg, L. and Hanweck, G. (1990) The Development and Growth of Banking Centers and the Integration of Local Banking Markets, The Review of Research in Banking and Finance, Spring. ' Goldberg, L. and Hanweck, G. (1991) The Growth of the World's 300 Largest Banking Organizations by Country, Journal of Banking and Finance, June. Goldberg, L. and Saunders, A. (1981) The Determinants of Foreign Banking Activity in the United States, Journal of Banking and Finance, March. Grosse, R. and Goldberg, L. (1991) Foreign Bank Activity in the United States: An Analysis by Country of Origin, Journal of Banking and Finance, December. Helseley, R.W. and Levi, M.D. (1988) The Location of International Financial Centers, Annals of Regional Science, May. Helseley, R.W. and Levi, M.D. (1989) The Location of International Financial Center Activity, Regional Studies, January. Hultman, C. and Mcgee, L.R. (1989) Factors Affecting the Foreign Banking Presence in the U.S., Journal of Banking and Finance, November. Kane, E.J. (1987) Competitive Financial Reregulation: An International Perspective, in: Portes, R. and Swoboda, A. (Eds.), Threats to International Financial Stability, Cambridge University Press, Cambridge. Levich, R. and Walter, I. (1990) Tax Driven Regulatory Drag: European Financial Centers in the 1990s, in: Siebert, H. (Ed.), Reforming Capital Income Taxation, J.C.B. Mohr (Paul Siebeck), Tubingen. Morgan, JP (1997) EMU: Impacts on Financial Markets,]? Morgan, New York. Reed, H.C. (1981) The Preeminence of International Financial Centers, Praeger, New York. Smith, R.C. and Walter, I. (1997) Global Banking, Oxford University Press, New York. Walter, I. (1995) Financial Secrecy, in: The New Palgrave Dictionary of Finance, Macmillan, London. Walter, I. (2000) The Global Asset Management Industry: Competitive Structure, Conduct and Performance, Journal of Financial Markets, Institutions and Instruments, January 2000. Watson Wyatt P&I (1996) World 500, Pension Age, September 30.

Other Sources Euromoney Loan ware (1998). Financial Times (1997), Survey of Global Fund Management, April 27, 1997.

NOTES 1.

Paper prepared for Essays in Macroeconomics and Trade, edited by Rajneesh Narula and Robert G. Hawkins, in honour of the 75th birthday of Prof. H. Peter Gray. Helpful comments by Larry Goldberg are gratefully acknowledged. The paper relies in part on a presentation at the Institut fur Weltwirtschaft, Kiel, Germany in March 1997. Draft of January 17, 2000.

36 2.

3. 4. 5. 6. 7.

8.

9. 10. 11. 12.

13.

Ingo Walter We focus on financial services that are internationally mobile under current technological conditions, as distinct from mass-market retail financial services that are normally highly localized and dispersed. We recognize that technological change may well alter this definition in the years ahead. Over-the-counter (OTC) markets involve trading among counterparts that quote bid and offer prices in proprietary and/or client-driven transactions. The early literature on this subject includes H.C. Reed, The Preeminence of International Financial Centers (New York, Praeger, 1981). Data: Euromoney Loanware, 1998. Bank for International Settlements, The Maturity, Sectoral and Nationality Distribution of International Bank Lending (Basel: BIS, January 1998). The Herfindahl-Hirschman index is defined as H = 3/, where s represents the percentage market share and 0<s< 10,000. H increases as the number of competitors decreases and as market-shares among a given number of competitors become more unevenly distributed. Ingo Walter, The Global Asset Management Industry: Competitive Structure, Conduct and Performance, Journal of Financial Markets, Institutions and Instruments, forthcoming. For a survey see Ingo Walter, Financial Secrecy, in The New PalgraveDictionary of Finance (London, Macmillan, 1995). P&I Watson Wyatt World 500, Pension Age, September 30, 1996. Financial Times, Survey of Global Fund Management, April 27, 1997. See for example Lawrence Goldberg and G. Han week, The Development and Growth of Banking Centers and the Integration of Local Banking Markets, The Review of Research in Banking and Finance, Spring, 1990; R.W. Helseley and M.D. Levi, The Location of International Financial Centers, Annals of Regional Science, May 1988; and R.W. Helseley and M.D. Levi, The Location of International Financial Center Activity, Regional Studies, January 1989; S.P. Choi, A. Tschoegl and C.M. Yu, Banks and the World's Major Financial Centers, 1970—80, Weltwirtschaftliches Archiv, March 1986. On penetration of foreign banking organizations in domestic markets, see Lawrence Goldberg and Anthony Saunders, The Determinants of Foreign Banking Activity in the United States, Journal of Banking and Finance, March 1981; Charles Hultman and L.R. McGee, Factors Affecting the Foreign Banking Presence in the U.S., Journal of Banking and Finance, November 1989; and Robert Grosse and Lawrence Goldberg, Foreign Bank Activity in the United States: An Analysis by Country of Origin, Journal of Banking and Finance, December 1991. On comparative growth of banks, see R. Dohner and H.S. Terrell, The Determinants of the Growth of Multinational Banking Organizations 1972-86, Board of Governors of the Federal Reserve System, IFDP, No. 326 (June 1988); and Lawrence Goldberg and G. Hanweck, The Growth of the World's 300 Largest Banking Organizations by Country, Journal of Banking and Finance, June 1991. See also Edward Kane, Competitive Financial Reregulation: An International Perspective, in R. Fortes and A. Swoboda (Eds.), Threats to International Financial Stability (Cambridge, Cambridge University Press, 1987). Richard Levich and Ingo Walter, Tax Driven Regulatory Drag: European Financial Centers in the 1990s, in Horst Siebert (Ed.), Reforming Capital Income Taxation (Tubingen, J.C.B. Mohr (Paul Siebeck), 1990).

Globalization of Markets and Financial-Center Competition

37

14. Edward J. Kane, Competitive Financial Reregulation: An International Perspective, in R. Fortes and A. Swoboda (Eds.), Threats to International Financial Stability (Cambridge, Cambridge University Press, 1987). 15. Kane has argued that regulation itself may be thought of in a "market" context, with regulatory bodies established along geographic, product, or functional lines competing to extend their regulatory domains. Financial firms understand this regulatory competition and try to exploit it to enhance their market share or profitability, even as domestic regulators try to respond with ^regulation in an effort to recover part of their regulatory domain. 16. See for example Lawrence Goldberg and G. Hanweck, op cit. 17. For a discussion, see Roy C. Smith and Ingo Walter, Global Banking (New York, Oxford University Press, 1997). 18. For an early study, see Edward Kane, Competitive Financial Reregulation: An International Perspective', in R. Portes and A. Swoboda (Eds.), Threats to International Financial Stability (Cambridge, Cambridge University Press, 1987). 19. For a discussion of the overall capital market effects of EMU, see JP Morgan, EMU: Impacts on Financial Markets (NewYork,JP Morgan, 1997). 20. "If EMU has the side-effect of bringing those assets to the market, then the playing-field will tilt a little. If technology shifts the 'management expenses' goal posts as well, then we may be in a new ball game." Graham Bishop, Post Emu: Bank Credit Versus Capital Markets (London, Salomon Brothers, 1997).

Electronic Commerce: Its Effect on Service Industries CLIFF WYMBS

I.

INTRODUCTION

One of the most significant developments of the 1990s in the globalizing economy was the identification of the service industries as the fastest increasing component of Multinational Enterprises (MNEs) activity both in developing and developed countries (Dunning 1993). In 1997, services accounted for over 25% of world trade (Winsted and Patterson 1998) and global export of commercial services exceeded US$1.3 trillion (WTO 1998). Almost the opposite of manufacturing industries, service industries are commonly regarded as being intangible, perishable, and usually requiring their consumption at the same time and in the same place as their production. More specifically, a service depends to some extent on the interaction between the buyer and seller for its provisions (Grosse 1996). The services sectors are very diverse and range from knowledge and information-intensive areas performed in both public and private sector organizations to very basic services such as cleaning and maintenance. It also includes retail, wholesale, construction, transportation, communication, professional, insurance, tourist, educational, and health care (Dicken 1998). Services not only provide linkages among the segments of production within a value chain and linkages of overlapping value chains, but they also bind together the spheres of production and circulation (Dicken 1998). Services have come to play a critical role in the value chain because they not only provide geographical and transaction connections, but they integrate and co-ordinate the atomized and globalized production process of goods. In fact, Samiee (1999) asserts that 38

Electronic Commerce: Its Effect on Service Industries

39

as goods go though increasingly more complex value chains to increase firms' relative competitive advantage, services will play a more important role in their marketing. Lovelock and Yip (1996) go further and state that every tangible product necessarily contains some service because without it the exchange would be impossible. Knight (1999) asserts that the ability to process and analyze data efficiently, as well as the widespread diffusion of the Internet, e-mail, cable, satellite, fax and other telecommunication technologies have made going international a highly viable and cost-effective option for various service providers. Similarly, Aharoni (1997) found that with the advance of new information technologies (IT), many services that were thought for a long time to be not trade-able have been traded internationally, e.g., backroom operations in airlines, brokerage, insurance, and shipping industries are now located in low labor-cost countries; software designers work around the clock globally; money flows across national boundaries 24 hours a day, 7 days a week; a global network of professionals offers services to producing multinationals wherever these multinationals operate. A study by Fladmore-Linquist (1997) found that firms are increasingly using IT to enter the international marketplace without developing extensive local facilities, thus bypassing the foreign investment barrier. She then hypothesized a relationship between IT, government regulation and investment, i.e., the greater the information technology specificity of the creation and delivery of a service, the more likely that state intervention will decrease and domestic regulation will be modified to allow greater investment and trade in international services. Alternatively, the greater the cultural specificity of a service, the more likely that domestic rules and regulations will create barriers to trade and investment for foreign service providers. In summary, the dramatic increases in the globalization of services are attributed to: (1) service suppliers following manufacturers who have gone global; (2) the opening of previously closed markets such as the Soviet Union; (3) the elimination of some barriers to exporting service resulting from the Uruguay Round of GATT negotiations; (4) economies becoming developed and demanding more services; (5) technology becoming a unifying influence, making national boundaries less significant (Winsted and Patterson 1998); (6) the Internet making some services tradable or improving transaction economies of others (Dunning and Wymbs 2000); and (7) the acceptance of service outsourcing as firms increasingly concentrate on core competencies (Kotabe, Murray and Javalgi 1998). The internationalization of services has increased competition and reduced Leibenstein-like X-inefficiency inherent in legacy monopoly networks such as telecommunications, utilities, transportation

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(Leibenstein 1976). Upstart challengers are using new informationcentric business models where access to information rather than physical assets is becoming the key to competitive advantage. The lower costs associated with technology-based e-commerce business models should lead to greater product, market and international competition and lower cost, especially in heretofore protected service industries (OECD 1999). When one considers the importance of international services to the global economy and their recent, rapid growth, one is surprised at the sparsity of research in this area. In fact, Knight's (1999) search of the 31 most important marketing and international business journals over the period of 1980-98, led him to conclude that the "paucity of research on international services marketing is alarming" (p. 348). Similarly, Clark and Rajaratnan (1999) observed that international trade in services has grown significantly, yet very little research has been undertaken to understand international services. A major contributing factor to the research shortage is defining neat categories to measure services. The U.S. federal government has recently attempted to rectify the problem by replacing the Standard Industry Classification (SIC) system, with the North American Industry Classification System (NAICS) which should improve the state of international services data because it has identified 358 new industries, of which 250 are service producing (Clark and Rajaratnan 1999). This new approach includes eleven service sectors: Information; Finance and Insurance; Professional, Scientific, and Technical Services; Administrative and Support, Waste Management and Remediation Services; Real Estate and Rental and Leasing; Management of Companies and Enterprises; Educational Services; Health Care and Social Assistance; Arts, Entertainment, and Recreation; Accommodation and Food Services; and Other Services. However, until data are collected in this scheme we must rely on authors' groupings. Dunning's (1993) categorization into "Specialized MNEs Services" and "MNEs that Produce Services" provides an extremely broad grouping but is helpful in providing a historical perspective of international services. However, Gray's (1983, 1988, 1990) fivefold categorization provides a more useful framework for an Internet analysis of international services because it is more robust, particularly regarding Dunning's "Specialized MNEs Services" category, where Gray uses four separate categories, i.e., 1, 2, 3, and 5, below. His mostly non-overlapping categories include: 1. Derived Services: Services that are derivative from international trade in tangible primary goods and manufacture, e.g., freight transportation, insurance and related financing;

Electronic Commerce: Its Effect on Service Industries

41

2. Location Specific Services: Services where location-specific attributes are dominant, are people-embodied and either require the user to move to the location of the supplier, e.g., tourism, or the supplier to move to the location of the user, e.g., construction; 3. Linking Services: Services which are location^joining, e.g., transportation and communications; 4. Intra-firm Services: Services that are derived from intra-firm relationships, usually between units of a multinational corporation; 5. Traditional Services: Services which are usually provided in all countries, but which can be made available to clients in other countries by having the service transmitted over communication equipment or by being temporarily embodied in goods, e.g., professional services, banking, engineering, consultant services and data services. Samiee's (1999) 33 broad categories are the most precise and were considered, but are too complex for analysis purposes here. II.

OBJECTIVES

The study objectives are: (1) to explore how emerging informationcentric business models are replacing traditional legacy systems; (2) to examine how electronic commerce is changing the internationalization process of services industries; and (3) to provide insight on how a new type of strategic planning is required for services in a knowledge economy. The second one directly relates to the important research question proposed by Knight (1999): "What opportunities and challenges does the Internet hold for the marketing of services world-wide?" Each objective is separately addressed after the context of the analysis is established by a brief historical discussion of two types of services. III.

HISTORICAL PERSPECTIVE

Specialized MNEs Services such as location-linking telecommunications, banking, airlines, insurance, transportation, and business services have historically been protected from both domestic and foreign competition by regulation (Mester 1994). Decades of answering to government agencies rather than market forces have resulted in the accumulation of X-inefficiency, i.e., the deviation from the production efficient frontier that depicts the maximum attainable output for a given level of input (Kwan and Eisenbeis 1996). In the 1980s, Evanoff and Israilevich (1991) found bank

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X-inefficiency to be about 20-30% and Yuengert (1993) found Xinefficiencies in the insurance industry to range from 35 to 50%. Babilot, Frantz and Green (1987) found similar X-inefficiencies for other public utility monopoly industries. Liberalization and the simultaneous application of information technology severely tested incumbent firms wedded to an outdated, crumbling business model (not one minicomputer company succeeded in the personal computer business (Christensen and Overdorf 2000)) and offered tremendous opportunity for cross-industry poaching (Bower and Christensen 1995). MNEs that Produce Services have also experienced growing competitive pressures due to globalization and information technologies. Three major trends encouraged internal efficiencies: (1) firms in the 1990s began to focus on core competencies and started to out-source tangential service functions such as advertising and law; (2) the just-in-time inventory process created the need to better coordinate the supply chain functions; and (3) there was a general realization that a firm could not internally develop all aspects of the technology frontier and had to rely on collaborative alliances to keep its options open. Information technology facilitated and, in many cases, drove each of these trends, forcing firms to rethink their basic business model and creating a fertile ground for new entrants. IV.

NEW BUSINESS MODELS

The emergence of the Internet is eliminating the boundaries that once separated corporations and countries. Commerce that once took place in local or regional markets now occurs seamlessly across most borders (KPMG 1999). Bill Gates, former CEO of Microsoft, was quoted in his 1999 book, "Business @ The Speed of Thought", as saying "The Internet changes everything" (Gates 1999). Many technologists have likened the growth of electronic business to the industrial revolution of the 19th century because it is transforming most aspects of communications, the service related aspects of manufacturing and commerce (Taylor 1999a). Nathan Myhrvold, Microsoft's Chief technology officer, has been quoted as saying that "the web will fundamentally change customers' expectations about convenience, speed, comparability, price and service" (Taylor 1999b). As the number of online consumers grows, the opportunity to conduct business-to-business (B2B) and business-to-consumer (B2C) services grow consistent with Metcalfe's law; the value of the network, as measured in increased connectivity, increases, not

Electronic Commerce: Its Effect on Service Industries

43

linearly but equivalent to the square of the number of nodes connected to it. Competition today goes beyond products and groups of products and deals with the complete business model based on information technology which recreates the customer value proposition through an imaginative mix of computer, software and network technologies. For example, some authors and rock groups are posting new material on the Web and are soliciting fans around the world to sign-up for their new products (Li 2000). When they receive sufficient requests, they will cut a CD or download the novel to the customers. This process cuts out the traditional role for the record label or publisher and introduces a production to demand model rather than the more traditional model of creating demand to sell albums or books already produced. The connectivity aspect of the Web empowers customers and provides them with both the necessary information and the medium to convert intentions into purchases. This consumer outsourcing fundamentally changes the retailing business model that, in the mid-1990s, was based on locationally fixed points of sale. The webcentric business model that is emerging raises the bar with regard to customer expectations about convenience, speed, comparability, price and service (Hamel and Sampler 1998). The web business model has the added benefit of increasing rather than decreasing returns. Unlike physical goods that require production and consumption to be balanced, information goods once produced have high operating leverage and can be replicated at zero marginal cost. In theory, every individual can consume society's entire output (Aufderheide 1999). The substitution of customers using electronic means for bricks and mortar and sales people allows web-based retailers to focus on creating competitive advantage in certain aspects of the business (ordering, distribution, inventory management). Service companies that are willing and able to rethink their business model, at a minimum taking into account how information technology changes the playing field, will get to the future first. Their success will be measured by the amount of new wealth created in the equity markets, mostly in the NASDAQ through initial public offerings2 (IPOs), and how they use innovation to restructure the industry. Strategic innovation within a firm drives a rethinking about the basis of industry competition, rapidly rewrites its rules and redesigns the engine for future wealth creation (Yates 1999). What is astounding in a knowledge economy is the rapidity with which companies create and accumulate wealth. Between 1975 and 1995, 60% of the companies on the Fortune 500 were replaced (Kim and

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Mauborgne 1999). What is common to most of the new entrants was that they created new markets or recreated old ones rather than competing for market share in existing markets. The OECD predicts that e-commerce in 2005 will be approximately US$1 trillion dollars in retail sales. Assuming that 20% savings in e-commerce interaction costs are achievable (Nevens 1999), approximately US$200 billion in value would be shared by firms and consumers. Increased and fierce competition among firms will drive a disproportionate share of these saving to consumers; however, to the extent that firms can leverage first mover advantage and carve out monopolies, they and their stockholders will be the ones rewarded. Table 2.1 provides a list of sectors that will likely experience significant changes in their respective business models. V.

INFORMATION-CENTRIC SERVICES

The single most significant effect of the Internet is to cut the cost of interaction, i.e., the searching, coordinating, and monitoring that people and companies must do when they exchange goods and services, estimated to be more than one-third of the economic activity in the United States (Nevens 1999). Applications of these cost cutting measures to the international service industries include the following: Derived Services

Due to their high transaction cost component, trade related services were one of the first to realize the benefits of the Internet. Adams (1994) states that regardless of how electronic commerce is implemented, the international trading benefits are enormous. A company can eliminate or reduce ad hoc queries regarding its TABLE 2.1

Shifting from Physical to Electronic Markets: Changes in the Business Model

Sector

Degree of Business Substitution

Music Publishing Transport Information Services Retail Banking Marketing and Advertising

Radical Radical Partial Mixed Evidence Radical Mixed Evidence

Source: OECD (1999).

Electronic Commerce: Its Effect on Service Industries

45

shipping and production schedules by posting that information with its trading partners. In addition, electronic commerce is a very good vehicle for checking the status of orders, communicating back order alternatives, qualifying order conditions, or arranging insurance and financing. This lowers telecommunication costs, frees up employees' time and reduces overall friction in the transaction process. The Canadian Government's initiative to electronically standardize customs documentation has been very successful, e.g., Honda Canada calculated that it saved approximately $500,000 USD in the first year alone (Chudleigh and Sheppard 1995). Location Specific Services

Although there can be no substitution of "virtual" travel or "virtual" construction for the real physical acts, many activities that are related to these services are extremely information-intensive and can use the Internet to transfer necessary information between nations. Travel agents can receive and send country and/or hotel brochures by e-mail to prospective customers any time or any place around the world via a keystroke. Also, country tourist departments can create their own websites to stimulate interest from potential visitors from any place on the globe. Engineers have been quick to adopt the Internet to share plans and computer-aided design necessary for large scale construction projects. Design can increasingly be de-coupled geographically from construction. Linking Services

Services which are location-joining, e.g., transportation and communications, provide the facilitating infrastructure necessary both for services in general and the Internet in particular. Containerized cargo, faster ocean transport, more harmonized rail transport among economic unions, e.g., EU, and regional trade organizations, e.g., NAFTA, and economical air transport have all facilitated the record amount of goods traded between countries (Dunning 1993). However, the latest in telecommunications and computer technology has enabled firms of any size to manage business systems beyond their own boundaries (Rennie 1993). In fact, information technology industries have been characterized as the digital era's engines of economic transformation (Henry et al. 1999). Technology advances and e-commerce are causing both job creation and destruction. The 1.43 million information technology service workers, e.g., software programmers, in 1999 are expected to grow

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to 2.5 million workers by 2006 while the IT sub-industries that produce hardware are expected to shrink (Henry et al 1999). Intra-firm Services

Because the Internet is systematically reducing transaction costs, many companies are simplifying their business model and unbundling many business functions (Nevens 1999). AutoByTel effectively unbundled the sales and service roles of dealerships. General Electric (GE) and Thomas Publishing TPN Register significantly transformed the purchasing function by aggregating and electronically posting requirements (GE 1999). Member companies achieve approximately 10-20% savings associated with the US$15 billion annual flow of transactions by performing more efficient searches that provide access to a larger number of suppliers, from better coordination of the buyer and supplier through electronic requests for quotes, and from the lower error rate of wholly electronic purchasing processes. Cisco Systems, a major Internet switch and router provider, has dramatically transformed the cost and quality of interaction with its customers, who can now find prices, modify product configurations, and submit and track orders electronically. In effect, Cisco has unbundled and outsourced the procurement part of the business to its customers who integrate Cisco products with other telecommunication products to create complex company data networks. The company has reported savings in operating costs due to electronic interfaces of US$535 million on sales of US$4 billion. Over the last 10 years, ABB, the international diverse SwissSwedish heavy equipment group, increased its global services revenues from less than 10% of sales to over 25% of its 1998 sales of US$32 billion. Goran Lindahl, ABB's CEO, states that this concept is hard to instill in his predominantly European workforce because in "Europe everyone wants to be in manufacturing and engineering, while you get more entrepreneurs in the US who choose to go into services" (Nevens 1999). Dick Anderson, IBM Enterprise Web Manager, stated that IBM's internal e-business transformation is about more than e-commerce, it is about how IBM has web-enabled all of its core business processes to gain speed, efficiency, and business returns (IBM 1999). Historically, IBM has been one of the U.S.'s most international companies. It is currently focused on seven initiatives to drive productivity gains across organizations and generate cost savings and efficiencies: e-commerce, where IBM is expected to exceed US$10 billion in savings and US$15 billion in e-commerce revenue

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47

generation over the Internet in 1999; e-procurement, where IBM will procure over the web in excess of US$12 billion of goods and services and will save at least US$240 million over existing methods; e-care for customers, where IBM supports over 14 million self service user transactions over the Internet, avoiding approximately US$300 million in field specialist costs (this is expected to double in 1999); e-care for business partners, where IBM currently allows over 15,000 business partners to have worldwide access to product and market information in 10 languages; e-care for employees, where IBM in 2000 is expected do over 30% of its internal training via the web with expected savings of over US$100 million; e-care for influencers, where IBM provides the press consultant financial analysts tailored web sites for world-wide access; e-marketing communications, where IBM uses the Internet to further brand and promote its products with home pages localized for 70 countries and in 16 languages (IBM 1999). Because IBM is one of the most international U.S. multinational enterprises, a considerable proportion of these activities will cross borders. Outsourcing and/or seeking collaborative alliance partners of heretofore hierarchically performed service functions are becoming increasingly popular. By strategically outsourcing and focusing a company's core competencies, managers can leverage their firm's skills and resources for increased competitiveness (GE 1999). Ecommerce and outsourcing of products around the world are coming together to redefine how business is done and managed. Virtual global trading companies are rapidly becoming the lifeblood of most organizations and outsourcing is quickly becoming the tool of choice for getting the needed technologies and programs on-line quickly (GE 1999). Traditional Services

Electronically handling the search for life insurance, completing a bank transaction, processing a consumer or stock order or getting an answer to a customer service question can reduce transaction costs by almost 80%; however, average cost savings are in the 15-20% range (OECD 1999). A few specific examples of the power of e-commerce follow. The value of substituting electronic customer linkages for traditional retailing measures was highlighted on May 21, 1999 when eToys went public. e-Toys had US$30 million in sales and over US$28.5 million in losses but raised US$7.8 billion. Toys-R-Us, the bricks and mortar industry leader, with US$11.2 billion in sales and US$376 million in earning had a market capitalization of only US$6

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billion (Edgecliffe-Johnson 1999). Clearly, the promises of increasing returns associated with e-Toys' new business model for the industry appears to be the most likely explanation of its tremendous initial success. If you follow the McKinsey valuation logic, eToys will in 5 years be able to capture a large percentage of the overall toy market and then leverage this advantage to generate substantial after-tax profits and an NPV that would justify its current high market capitalization. Today's market psychology appears to be comfortable with these bold assumptions; however, markets and assumptions can change quickly, with dramatic swings in market capitalizations. The Internet is a potential gateway to low-cost international banking (offering domestic services to corporations abroad) through a virtual presence (almost two-thirds of the top 100 banks expect to use the Internet as a platform for global expansion (OECD 1999). Eika and Reistadbakk (1998) state that information technology will reduce the cost of producing financial services, increase the efficiency of the flow of information, create new distribution channels, make physical distance between banks and customers unimportant, weaken the position of established institutions and make banking more international. The economics of the Internet-based brokerage model are quite compelling. For example, Wit Capital offers a 1,000 share market order for only US$14.95 while a Merrill Lynch voice order costs US$428.00 (OECD 1999). Due to competitive pressures in the U.S. market, Internet brokers are being drawn to Europe; however ETrade only did approximately 3% of its trade internationally in 1997. New technologies, changes in consumer behaviors and revolutionary strategies are making yesterday's "scarce and unique" information-based resources obsolete (Tchen 1999). For example, historically, the scarce and unique resource for book distribution was the bricks and mortar associated with retail outlets. Electronic retailing through ventures such as Amazon.com have severely depreciated these assets and introduced a new set of networkcentric valuable resources. Barnes & Noble was forced to adopt a similar strategy and both did between 25 and 30% of their business internationally in 1997 (OECD 1999). See Table 2.2 for other service firms' international percentages. Electronic business information services, e.g., consultancy, advertising, legal, and accounting, are a necessary complement to transactions involving physical goods and services. Relatively inexpensive telecommunication and data transport has facilitated the provision of these service industries and of interaction among home country offices and foreign affiliates.

Electronic Commerce: Its Effect on Service Industries TABLE 2.2 Company

CD now Music Boulevard Amazon Barnes and Noble Fast Parts Virtual Dreams Dell 1-800-FLOWERS Sabre E*Trade

49

International Trade of Selected e-Commerce Firms, 1997 Segment

Music Music Book Book Electronic components Pornography Computers Flowers Travel Consumer brokerage

Online as % of Total International Revenues as % of Total 100

35

100

33

100

26

50 100

30 30 25 20

10 50 10 67

17-20 17.5

63

2.8

Source: OECD (1999).

In effect, e-commerce is built on information which exhibits many of the same properties of all service industries, namely it is intangible, perishable, and requires consumption at or about the same time its production. Because of this, it will be increasingly difficult in the future to talk about service industries without discussing e-commerce. VI.

BUSINESS STRATEGIES FOR SERVICES FIRMS

Hamel (1999) defines what is needed for service firms to create a viable strategy in an information intensive world: (1) Business has reached the end of incrementalism; catching-up is not the same as getting ahead; (2) Strategy needs to be created for the future, not the present forward; (3) Never has the business community been more hospitable to revolutionaries and more hostile to incumbents; (4) Business and governmental institutions are more likely to be aspiration-constrained than resource-constrained. Similarly, Hamel (2000) asserts that the real basis for competition is industry foresight and the ability to imagine, create and dominate new opportunities and ultimately make new rules for new markets. Firms must leverage their unique skills and knowledge of the customer value proposition and competitive differential to meet this future state. Most strategy tools of today, including Porter's Five Forces, cost curves and structure-conduct-performance (SCP), are based on Marshallian equilibrium models that assume that the industry

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structure is known, that diminishing returns apply and that all firms are perfectly rational (Beinhocker 1997). For example, it was not likely that traditional strategists would have judged the value proposition of Dell, Walmart, or CNN, to be significantly different enough to rate them a sure-fire success; however, the Michael Dell, Sam Walton and Ted Turner business models were based on increasing return dynamics and the conceptualization of an industry very different from the one they entered. In fact, few, if any, of the traditional equilibrium assumptions hold in today's dynamic, technology-oriented service economy (OECD 1999). What corporate leaders need today is to realize that the Internet represents a fundamental, disruptive change and they must adopt a business model of the world where innovation, change, ambiguity, and uncertainty are the norms and equilibrium is the exception. Successful services companies today must think in terms of complex adaptive systems that dynamically interact based on institutionally determined rules and global competitor signals. This is very different from a service firm that controls its environment (or had its environment controlled by governments) and executes a predetermined business plan. By definition, systems are open and dynamic, i.e., they receive external input from around the world and change in response to stimuli, are made up of interacting agents, i.e., agents are capable of an infinite variety of actions, and are emergent and self-organizing, i.e., they are created by dynamic interaction of all participants (institutions and companies) rather than as a result of top-down, central planning (Beinhocker 1997). The Internet is a good example of such a dynamic, evolutionary system that is unleashing its destabilizing forces disproportionately on servicing firms. Complex adaptive systems (CAS) require a fundamental reconstruction of the economic world. They require the substitution of inductive for deductive logic because the number of interactions are too great for one to think through all possible combinations. CAS view markets as being dynamic versus static. The change by one agent, one firm, one web of relationships could generate a ripple effect that could fundamentally change an entire service industry. Amazon.com is one good example; once it went on-line, it forced Barnes and Noble to also go on the Web. Also, CAS looks at the would-be world, i.e., outcomes that are possible. The valuation of Internet-based stocks, e.g., e-Toys, clearly reflected this principle rather than traditional economics. However, dynamic, interrelated markets are quite likely to be more volatile than heretofore traditional markets were.

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One can use CAS to explore the interesting relationship among the availability of information, the use of the Internet and service industry returns. In Figure 2.1 we see how the Internet has allowed new entrant firms to change the economics of the industry by introducing new business models. In some cases, information asymmetry has been reduced, consumers have directly benefited and new entrants have turned the industry from one of decreasing returns to one of increasing returns, e.g., AutoTel.com and E-Trade, while in others the information symmetry has not changed, but increasing returns have replaced decreasing returns (Wymbs 2000). Dick Foster, a McKinsey Director, observed that companies do not innovate; markets do, e.g., the evolution of markets is driven more by entry and exit of firms than by any dramatic changes within the incumbent players (Beinhocker 1997). Therefore, to protect against upstarts, established service businesses must create a balance between standardizing on designs that work and seeding the population with enough variation to provide the basis for future innovation and adaption (Beinhocker 1997). This set of innovative strategies can be thought of as a portfolio of real options, and similar to financial options, the greater the uncertainty, the greater their financial or social value (Copeland and Keenan 1998). This explains the vast number of collaborative alliances created by firms using the Web to transform service industries. Consistent with real options theories, web-based alliances are different than traditional ones in three ways: (1) they involve a much larger and varied group of companies; (2) they rely on more informal business relationships; and (3) they require leadership by one or two companies to define standards for all Web members and create incentives that attract more companies to it (OECD 1999).

Increasing Returns

Decreasing Returns

Information Asymmetry Priceline.com GE Procurement R&D Alliances Auctions

Car Dealers Traditional Brokers Life Insurance Traditional Procurement

Information Symmetric Autotel.com Amazon.com E-Trade E-toys The Internet Software Airline Ticket Agents Barnes & Nobel (bricks) Toy R Us Traditional Banking Telecommunication Network

FIGURE 2.1 How Changes in Information Affect Service Industry Returns Source: Wymbs (2000).

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VII.

CONCLUSION

We have seen that service industries are responsible for over onehalf (US$3.6 trillion) of the economic activity of the U.S., yet, due to their intangible nature and past government protection, these service industries have not historically experienced productivity gains nor have they participated in international trade as much as most manufacturing industries. Liberalization and the Internet are rapidly changing this and rendering monopoly-based business models of incumbents obsolete. It seems that almost every day a start-up service firm is raising millions of dollars doing an IPO. For many of the applications, e.g., retail, reservations, banking, the network-centric business models are information-based and distance and geography insensitive. Electronic commerce lowers the transaction costs for operating in both domestic and overseas markets and provides an efficient means to strengthen customer-supplier relationships through email, remote on-line databases and video links (OECD 1999). Electronic commerce is also creating new opportunities for trade by radically changing delivery models for digitized services, e.g., music, video, software, content, and encouraging collaborative alliance relationships between emerging services firms. The dramatic increase in the availability of information and the plethora of ways to manipulate it will both increase the number and diversity of new service businesses and cause the fundamental reconfiguration of existing service industries. Network-centric, increasing return business models will likely dominate the transformation of global services industries in both the developed and developing world. REFERENCES Adams, E. (1994). Better connected World Trade. Vol. 7(8):88-100. September, 1994. Aharoni, Y. (1997) Changing Roles of State Intervention in Services in an Era of Open International Markets, State University of New York Press, Albany. Aufderheide, P. (1999) Communication Policy and the Public Interest, The Guilford Press, New York. Babilot, G., Franz, F. and Green, L. (1987) Natural Monopolies and Rent: a Georgist Remedy for X-inefficiency among Publicly-regulated Firms, The American Journal of Economics and Sociology, April. New York. Beinhocker, E. (1997) Strategy in Chaos, TheMcKinsey Quarterly, No. 1, 24-39. Bower, J. and Christensen, C. (1995) Disruptive Technologies: Catching the Wave, Harvard Business Review, January, 73 (1): 43-54. Chudleigh, M. and Sheppard M., 1995. Electronic Commerce: Revenue Canada helping Canadian companies save time and money, Cost and Management, 69(5), 1995.

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Christensen, C. and Overdorf, M. (2000) Meeting the Challenge of Disruptive Change, Harvard Business Review, Mar/April, 78(2):66—77. Clark, T. and Rajaratnan, D. (1999) International Services: Perspectives at Century's End, Journal of Services Marketing, 13(4/5). Copeland, T. and Keenan, P. (1998) How Much is Flexibility Worth, The McKinsey Quarterly, No. 2, 39-49. Desmet, D., Francis, X, Hu, A., Roller, T. and Reidel, G. (2000) Valuing dot-corns, The McKinsey Quarterly, No. 1, 148-157. Dicken, P. (1998) Global Shift, Guilford Press, London. Dunning, J.H. (1993) The Globalization of Business, Routledge, New York. Dunning, J.H. andWymbs, C. (2000) The Challenge of Electronic Markets for International Business Theory, Arthur Anderson E-Commerce Conference, Santa Cruz, California. Edgecliffe-Johnson, A. (1999) e-Toys Surges after Listing, Financial Times, May 21, 17. Eika, K, and Reistadbakk, T. (1998) The Competitive Environment in the Banking Industry - Driving Forces and Trends, Norges Bank, Economic Bulletin, December, Oslo. Evanoff, D. and Israilevich, P. (1991) Productive Efficiency in Banking: Economic Perspectives, Federal Reserve Bank of Chicago, July /August 1991, 11-31. Fladmore-Linquist, K. (1997) Government Intervention in Services: a Cultural Specificity/Information Technology Framework, in: Aharoni, Y. (Ed.), Changing Roles of State Intervention in Services in an Era of Open International Markets, State University of New York Press, Albany. Gates, B. (1999) Business @ The Speed of Thought, Warner Books, New York. General Electric. (1999) Building Virtual Global Trading Communities through Electronic Commerce Outsourcing. White Paper. Gray, H.P. (1983) A Negotiating Strategy for Trade in Services, Journal of World Trade Law, 17(5), September/October. Gray, H.P. (1988) Services in World Economic Growth. Symposium Institut fur Weltwirtschaft an der Universitat Kiel. Gray, H.P. (1990) The Role of Services in Global Change, in: Dunning, J.H. and Webster A. (Eds.), Structural Change in the World Economy, Routledge, London. Grosse, R. (1996) International Technology Transfer in Services, Journal of International Business Studies, Fourth Quarter, 27:781-800. Hamel, G. (1999) The Strategos Manifesto, Www.strategosnet.com/about/manifesto.html. Hamel, G. (2000) Reinvent your Company, Fortune,]\me 12, 2000. Hamel, G. and Sampler, J. (1998) The E-Corporation, Fortune, December 7. Henry, D., Cooke, S., Buckley, P., Dumagen, J., Gill, G., Pastore, D. and Laporte, S. (1999) The Emerging Digital Economy II, U.S. Department of Commerce, http:www.ecommerce.gov/ede IBM (1999) IBM Targets US$10-US$15bn e-business Sales in 1999, New Straits Times Press, April 6, 1999, 18. Kim, E.G. and Mauborgne, R. (1999) How to Discover the Unknown Market, Financial Times,]une 5, 1999, 12. Knight, G. (1999) International Services Marketing: Review of Research, 1980-1998, Journal of Services Marketing, 13(4/5). Kotabe, M., Murray, J.Y andjavalgi, R.G. (1998) Global Sourcing of Services and Market Performance: An Empirical Investigation, Journal of International Marketing, 6(4):10-31.

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KPMG (1999). Supply Chain Solutions, NY, NY. Kwan, S. and Eisenbeis, R. (1996) An Analysis of Inefficiencies in Banking: A Stocastic Cost Frontier Approach, Economic Review, Federal Reserve Bank of San Francisco, San Francisco. Leibenstein, H. (1976) Beyond Economic Man, Harvard University Press, Cambridge, Massachusetts. Lovelock, C. and Yip, G. (1996) Developing Global Strategies for Service Businesses, California Management Review, Winter, 38(2). Li, K. (2000) Publish Online or Perish? The Standard, March 27. Mester, L. (1994) How Efficient are Third District Banks, Business Review - Federal Reserve Bank of Philadelphia: Philadelphia, Philadelphia, Jan/Feb. Nevens, M. (1999) The Mouse that Roared, The McKinsey Quarterly, No. 1, 145-148. OECD (1999). The Economic and Social Impacts of Electronic Commerce. Preliminary Finding and Research Agenda OECD Code 93/9990 IIPI. Rennie, M. (1993) Global Competitiveness: Born Global, The McKinsey Quarterly, No. 4, 45-52. Samiee, S. (1999) The Internationalization of Services: Trends, Obstacles and Issues, Journal of Services Marketing, 13(4/5). Taylor, P. (1999a) Online Rules will be Rewritten as Speeds Rise Dramatically, Financial Times, July 4, 1999, 4. Taylor, P. (1999b) How the Internet will Reshape Worldwide Business Activity, Financial Times, July 4, 1999, 1-2. Tchen, C. (1999) Controlling the Choke Points: Strategy, www.strategosnet.com/ articles/choke_point.htm. Winsted, K. and Patterson, P. (1998) Internationalization of Services: The Service Exporting, Journal of Services Marketing, 12(4). WTO (1998) World Trade Accelerated in 1997, Despite Turmoil in Some Asian Financial Markets: Decision, World Trade Organization, Geneva. Wymbs, C. (2000) How e-Commerce is Transforming and Internationalizing the Service Industries, Journal of Services Marketing, 14(6). Yuengert, A. (1993) The Measurement of Efficiency in Life Insurance: Estimates of a Mixed Normal-gamma Error Model, Journal of Banking and Finance, April, Amsterdam. Yates, L. (1999) How do Companies Get to the Future First, Management Review, January.

NOTES 1.

2.

A service export is defined as all those business activities involved when an organization markets its services outside its main domestic base of operations (Winsted and Patterson 1998). The methodology used to value new Internet start-up is more of an art than a science. A recent McKinsey Quarterly article by (Desmet et al. 2000) has attempted to relate traditional NPV of future profits to the valuation of Internet companies by first assuming what the firm's market share will be 5-10 years in the future and then works backward to profits.

Determinants of U.S. Direct Investment in the EU and Japan RAJNEESH NARULA AND KATHARINE WAKELIN1

I.

INTRODUCTION

Despite the growth of outward foreign direct investment (FDI) from Japan and some European countries, the United States still has the largest stock of overseas direct investment in the world. In 1993 that stock was worth approximately US$549 billion; US$126 billion more than Japan's, and over double that of the U.K. Therefore U.S. Direct investment is an important feature of the world economy and of considerable interest both to policy-makers in the U.S. and in host countries. This chapter aims to evaluate the determinants of U.S. multinational activity in the manufacturing sector of seven industrialized countries. A feature of the paper is that multinational activity is taken to be a function of both the characteristics of the host country and of the home country. Particular attention is paid to how the determinants of U.S. outward investment vary according to the country of destination because of the large number of motivations that exist for FDI. In some cases FDI may be aimed at taking advantage of natural resources, or low relative labor costs, while for other locations the skills and technology available in the host country may be the main motivating factor. There is considerable variation in the economic structures of the host countries, particularly in terms of size, the availability of natural resources, and the level of technology. We present a dynamic model that looks at the determinants of FDI over time and which includes proxies for many of the factors which theory suggests are important. The analysis considers total FDI in the manufacturing sector and thus abstracts from differences between sectors. Two factors are particularly emphasized: the role of 55

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Rajneesh Narula and Katharine Wakelin

differences in technology in determining FDI, something that has often been neglected, and the relationship between FDI and exports over time. The latter has mostly been examined in a crosssection rather than a time-series framework. The chapter is set out as follows. The following part provides some descriptive statistics on the role of MNE activity in the world economy and the significance of U.S. FDI to both host and home economies. The next part outlines the empirical evidence relating to the determinants of outward FDI for industrialized countries. Then the empirical model is presented, and the following section reports the results of the model and compares them to earlier results, before we give some conclusions. II.

THE PATTERN OF U.S. FDI

One of the most distinctive features of the post-war era has been the increasing significance of multinational firms in the world economy. Indeed, UNCTAD (1996) estimates that in 1995 the sales of foreign affiliates of MNEs were US$6022 million while the total exports of goods and services by all firms worldwide was only US$4707 million. In addition, as much as 80% of world exports is conducted by MNEs. The growth and prominence of U.S. MNEs reflects this trend. In the immediate post-war period U.S. firms enjoyed a technological and economic hegemony, partly because the U.S. emerged from the war with its infrastructure and industry not only intact but strengthened, in contrast with the rest of the industrialized world. The relatively high cost of capital in the U.S., the lack of liquidity in the rest of the world, and the low competitive advantages of many competitors, contributed to the rapid growth of U.S. FDI activity in the post-war period (Hagedoorn and Narula 2001). The U.S. continued to account for almost half of all FDI stocks up to the early 1970s, despite some technological and economic convergence. Subsequently, the U.S. share of world FDI began to fall, but by 1993 it was still above 25%. Table 3.1 gives some details of the role of MNE activity in our sample of countries—France, Germany, Italy, Japan, the Netherlands, Sweden and the U.K.—which together account for 42% of U.S. manufacturing investment overseas stock. The data presented are for two years—1973 and 1993—that span the period under consideration. The level of activity has grown for all the countries, and in some (the U.K. and the Netherlands) accounted for over half of GDP in 1993. A number of features of U.S. FDI in the sample countries can be seen from Table 3.1. First, the concentration of U.S. FDI in each

Determinants of U.S. Direct Investment in the EU and Japan TABLE 3.1

Indicators of FDI in the Sample

Germany France MNEs % share of

1973 1993 % share of total U.S. 1973 FDI 1993 % share of total U.S. 1973 manu. FDI 1993 % of U.S. FDI in 1973 manufacturing 1993 % of inward FDI 1973 stock owned by U.S. 1993 GDP

7.2

7.7

16.4

22.8

7.6 6.6

4.2 4.3 6.6

10.0 10.7 58.1 56.5 58.4 28.8

57

6.7

68.5 52.5 47.2 19.4

U.K.

NL

Italy

22.9 54.9 10.9 18.6 14.9 12.5 59.9 23.3 45.8 53.0

39.1 71.9

9.2

8.1

2.9

12.7

34.5

8-10

2.2 2.3 3.1

0.8

2.6

3.7 2.8

0.4

5.6

4.0

3.8

1.0 0.6

3.2 6.9

52.4 37.5 29.4 23.9

62.9 58.0 22.1 24.3

49.9 50.2 78.1 18.8

52.4 43.0 15-200 20-255

2.3

Sweden Japan

Notes: Total GDP is based on 91 countries. Japan's 1993 inward FDI stock is authors' estimate. MNE share of GDP calculated by taking sum of inward and outward FDI stock to GDP. Source: Dunning (1993), Narula (1996), Narula and Dunning (1999), World Investment Report (1995), Survey of Current Business (vd).

economy has stayed relatively constant over this period, with the exception of the U.K. and Japan. Within the sample the level of U.S. FDI varies considerably and not just with country size. By 1993 almost a fifth of all U.S. outward FDI was concentrated in the U.K. while it was much lower in other similar sized countries such as France and Italy. Diversity is also reflected in the percentage of GDP accounted for by MNEs. This is very high for some countries—in particular the Netherlands—while much lower for Japan, Italy and Germany. Second, the role of U.S. MNEs in the total inward FDI stocks of the sample countries continues to be significant. Despite their decline since the early 1970s, U.S. MNEs account for approximately a quarter of inward FDI stocks, with the exception of the U.K. where they account for over a half. This suggests that, given the vintage of U.S. investments relative to that by MNEs of other nationalities, U.S. MNEs probably account for at least 10% of the GDP of most of these countries. Nevertheless, large drops in the proportion of FDI owned by U.S. firms have been seen in some countries, notably Sweden, but also to a lesser extent in France and Germany.2 III.

THE DETERMINANTS OF U.S. FDI

Several reviews of the literature on the determinants of FDI already exist (e.g., Agarwal 1980; Dunning 1993; Caves 1996), and it is not

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our intention to discuss them here. Instead, we focus on the possible determinants of U.S. FBI. Although the majority of empirical studies have used cross-section techniques, some time-series studies have been conducted, including those by Scaperlanda and Mauer (1969), Lunn (1980, 1983), Scaperlanda and Balough (1983), and more recently Barrell and Pain (1996) and Wheeler and Mody (1992). A particular area of interest has been the impact of the growth and formation of the European single market, including the changes in structural impediments (see Clegg 1996) .3 Our analysis tests a set of hypotheses about U.S. outward FBI, with particular emphasis on the role of differences in technology, and the relationship between FDI and exports. Some of the determinants in our model—such as technology—are formulated as relative values between the host and home countries. Theory suggests that when overseas investment is undertaken, firms engage in the selection of a location based on the advantages of that location relative to those of the home country (Lall 1980). Firms seek to internalize assets that are not available, or not available as cheaply, in their home market. Such advantages have been defined as location advantages when they are available to all firms at a given location; when only a single firm has access to them they are termed ownership advantages. The importance of home country characteristics in shaping the decision to invest overseas may decrease over time (Narula 1996). In addition, the multinationality of the investing firm may alter the relative importance of home country determinants. MNEs with a high degree of multinationality may have characteristics formed by a number of different countries other than the home country. In the case of European countries (which make up six of the seven sample countries), U.S. firms may chose to locate within the EU and then chose a particular country (Barrell and Pain 1999). As a result, we have included some explanatory variables—for instance unit labor costs—as country j relative to the rest of Europe when j is a European country. We also test whether the determinants of U.S. FDI vary by host. There are a number of reasons why we would expect variations in the results across countries. The significance of different determinants of FDI is expected to vary according to the motive for undertaking investment abroad (Dunning 1997a, b). For instance, in the case of investment which aims to exploit natural resources, host country factors are generally more significant than those of the home country. Where investment is strategic in nature, for example aiming to benefit from large clusters of existing firms in a given location, the lack of ownership advantages of the MNE in the home

Determinants of U.S. Direct Investment in the EU and Japan

59

country may be the most important determinant. If the main motivation for FDI is to simply exploit markets, relative cost advantages and market size will be the primary determinants. In addition, the economic structures of the countries in question remain individual and heterogeneous, despite suggestions of increasing homogeneity due to globalization. Countries have different resource endowments, economic sizes and socio-political backgrounds that influence economic structure and these evolve slowly over time. The technological competencies of firms also change only very slowly over time (Patel and Pavitt 1997) and for industries within countries (Cantwell 1989), since national systems of innovations are idiosyncratic. In other words, patterns of specialization exist which defy generalization across firms and countries despite similarities in income levels and consumption, which in turn result in considerable variation in the motivations and types of FDI in particular countries. The main country and firm-specific determinants of FDI are as follows: a. Market and demand-related variables: these focus on the role of demand conditions in the host markets and their implications for economies of scale and scope. Studies of U.S. FDI in the EU have often used both absolute market size, and increases in market size. With few exceptions, both have been found to be significant. Barrell and Pain (1996) found that a 1% rise in the GNP of the seven major economies leads to an increase in the real U.S. investment stock of 0.83%. On a country-specific basis, most studies have found a strong influence of market size variables (Swedenborg 1979; Veugelers 1991). b. Cost-related factors: these relate to the costs of production, and include wage costs and transport costs. Empirical studies have reported mixed results especially in the case of FDI between industrialized countries. In both Yamawaki (1991) and Froot and Stein (1991) which refer to Japanese outward FDI in Europe and the U.S. respectively, wages were found to be a significant determinant, but had a positive rather than the expected negative effect. For U.S. FDI the evidence is mixed. Barrell and Pain (1996) found that unit labor costs in the U.S. are positively related to the level of outward investment, i.e. they are a relevant 'push' factor for FDI. However, Kravis and Lipsey (1982) and Wheeler and Mody (1992) found labor costs to be a relatively unimportant factor in explaining U.S. FDI. c. Exports: exports normally precede FDI, with the firm 'learning' about overseas market opportunities initially through exports before

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Rajneesh Narula and Katharine Wakelin

engaging in FBI. Once an initial investment is made, subsequent investments tend to occur more frequently beyond a certain threshold (Yu 1990; Kogut and Chang 1996). As a result, lagged exports are often included as proxies for experience. The nature of the subsequent relationship between trade and FDI depends on the type of FDI taking place; for instance, whether the MNE is vertically or horizontally integrated internationally.4 Many cross-section studies for the U.S. find a complementary relationship between exports and outward FDI in models of export demand with FDI included as an explanatory variable. Lipsey and Weiss (1981, 1984), in separate studies using industry-level and firm-level data for 1970, report a generally positive relationship between the output of U.S. foreign affiliates in a country and U.S. exports to that country. They suggest this may be due to an increased demand for intermediate goods. d. Technology: technological differences between countries have often been neglected as a determinant of FDI, but the rise of multinational activity between industrialized countries indicates that FDI is not undertaken with the sole motive of finding a lower cost location for production. Technology can be said to consist of two different aspects. First, innovations confer ownership advantages and provide a motivation for internalizing transactions (Dunning 1993). Firms with technological advantages may prefer direct investment to arms-length transactions such as licensing in order to protect their knowledge. Second, innovations occur in the industry and country in which the firm is located and create a national system of innovation (Lundvall 1992). The technological strengths of different countries may provide an incentive for FDI. These two aspects of technology are interrelated. The ownership advantages of the firm may provide a basis for the firm becoming a MNE, and the host country's national system of innovation provides a motivation for a MNE to locate in the host country. IV.

THE EMPIRICAL MODEL

The model is based on a simple demand model, including demand in the host market, and cost differences between the host and the home market. This demand model is extended by the addition of the relative technological capabilities of the home and host countries, bilateral exports, and exchange rates. The relationship estimated is given in Equation [1]: \n(FDIUSJt] = a + ^(SIZE^) + p2 (In PATJt- In PATus>t) + - \nULCus>t ) + P4 (InA^) + £t

[1]

Determinants of U.S. Direct Investment in the EU and Japan

61

for t= l,....n, where the subscripts MS and jare for the U.S.A. and the host country respectively. Seven host countries are considered: the U.K., Germany, the Netherlands, France, Sweden, Italy and Japan. The dependent variable, the level of multinational activity in the host country, is measured as the stock of U.S. direct investment in the manufacturing sector in each country j (EDI).6 SIZE: gives the demand in the host country], and is proxied by its value added in manufacturing in the host country. Value-added is used rather than other indicators of size, such as population, as the variable aims to proxy the level of demand in the economy rather than the number of inhabitants. There is some evidence that countries with an income level similar to the U.S. are likely to receive more U.S. inward FDI than those with a lower income (Brainard 1997). The value-added variable will also capture this income effect. The size of market demand is expected to positively influence the stock of FDI in the host country, as a large market provides greater domestic demand for the subsidiary firm. Relative unit labor costs capture the cost advantages associated with the host country relative to other locations. In the case of the European countries, unit labor costs are assessed relative to the other European countries in the sample, while Japanese costs are compared to the U.S. The U.S. firms are assumed to compare European locations with each other in terms of cost, while Japan has a unique position as the most industrialized country in its region. Manufacturing unit labor costs (ULQ are measured as the host country j relative to either Europe or the U.S. If lower costs are a motivating factor for FDI this will result in a negative coefficient on the relative unit labor costs variable: with lower costs in the host country acting as an incentive for the location of production in that country. The technology variables for the home and host countries (PATUS, PAT:) are included to reflect the role of innovation and firmspecific technological advantages. In cases in which FDI is motivated by the technological advantages of the host country, we would expect a positive coefficient. When it is related to the firm-specific advantages of U.S. firms, we would expect a negative relationship. The difficulties involved in measuring technological capabilities directly prompts the need for a proxy for the technological capabilities of a country. We use a 3-year moving average of patents taken out by companies based in the host countries relative to companies in the U.S. in the manufacturing sector (PAT:, PATUS). Patents taken out in the U.S. are chosen as they provide a single administrative framework in which patents are granted. In addition, around half of U.S. patents are granted to foreign firms making it the largest

62

Rajneesh Narula and Katharine Wakelin

international patent market.7 The variable is calculated relative to the U.S. as technology reflects both the ownership advantages of U.S. firms, and the location advantage of country/ Lagged exports in manufacturing (X) from the U.S. to the host country are included in the model to investigate the relationship between FDI and exports. An export relationship between countries often precedes direct investment, indicating a positive sign. However, the countries included in this sample have experienced high levels of inward FDI for a number of years, and the earlier relationship between trade and FDI may no longer hold. When trade and FDI occur simultaneously, the two may be substitutes, so that overseas location takes place instead of trade; or they may be complements, with FDI leading to increased exports from the home country (Cantwell 1994). The coefficient on the lagged export variable could therefore be either negative or positive. There is also some evidence that, at least in the case of Austria, causation runs in both directions between exports and FDI (Pfaffermayr 1996). The potential endogeneity problem this produces is avoided by using lagged rather than contemporaneous exports. Data are available for each country annually from 1972 to 1991 (i.e. 20 years) giving a total number of 140 observations in the panel. Due to lack of data, the period ends in 1991, and as a result we do not have to deal with the data problems associated with German reunification. Furthermore, by excluding data prior to 1972 we are also able to avoid the effects of the U.S. capital control program. All the variables are in logarithms in constant U.S. dollar prices (see the Appendix for definitions and sources). We initially treat the country data as a panel including countryspecific fixed effects to capture factors that vary by country and are not included in the model, such as long-term currency misalignments and language advantages. The inclusion of fixed effects was not rejected using an F-test. Treating the data as a panel requires the restrictive assumption of common parameters on all explanatory variables across countries. In order to test this restriction, the fixedeffects model was tested against an unrestricted model allowing all the coefficients to vary by country. The panel model was rejected relative to the unrestricted model; examining the results of the unrestricted model shows that although the basic demand variables of unit labor costs and country size have similar coefficients across countries, the patent and export variables show a great deal of variation. As a result, the coefficients on relative patents and lagged exports were allowed to vary by country while a constant coefficient was imposed on market size and unit labor costs. This specification was not rejected relative to the completely unrestricted model.

Determinants of U.S. Direct Investment in the EU and Japan

63

Tests were run to check for serial correlation and heteroschedasticity. In the former, lagged estimated residuals were included in the model and the resultant coefficient was tested to see if it was significantly different from zero. This hypothesis was not rejected, indicating no significant first-order serial correlation is present. As we use the stock of FDI as the dependent variable, the residual may also trend up over time. To test for this the squared residual was regressed on a constant and a vector of time trends, starting at one for the first observation of each panel member. The overall lack of significant of the Ftest for the regression, and the insignificance of the coefficient on the time trend, indicate that there is no evidence of a time trend in the residual. As a result, the model seems to be statistically adequate. V.

RESULTS

The rejection of the first panel model indicates the first important result: that the determinants of U.S. FDI in the sample countries vary according to the country being considered. The scale and significance of technology and exports depend on the country in which the FDI is located, indicating a diverse set of motivations for U.S. FDI among the OECD countries. However, market size and relative labor costs appear to have a similar impact on FDI across countries. The results are presented in Table 3.2. First, consider the results from the basic demand variables—size of the market and relative costs. The coefficient on SIZE is approximately one and is significant. The hypothesis of unity demand elasticity cannot be rejected. Relative unit labor costs are negative and significant (though just at 10%) indicating some evidence of U.S. investment being sensitive to relative labor costs. In the case of European countries, this is their labor costs relative to each other, while for Japan it is labor costs relative to the U.S. The size of the effect is lower than that found by Barrell and Pain (1996).8 They found a long-run elasticity of around 0.5 when considering U.S. FDI with the whole world. In this model a 1 % rise in relative costs in the host country reduces inward FDI by 0.18%. This is not a surprising result as this is a sample of industrialized countries, we would expect investment in them to be less cost-sensitive than total U.S. FDI. Technology has generally been neglected as a determinant of FDI. However, as the results show, it is an important factor in determining FDI for three the seven countries. For the U.K. and Germany the relative patent variable is positive and significant, indicating that the technological assets of those two countries attract U.S. investment. In the case of Japan, Italy, the Netherlands and

64

Rajneesh Narula and Katharine Wakelin TABLE 3.2 Variable

Panel Results including Fixed Effects Coefficient (^-statistic)

a Market size Relative unit labor costs Relative patents - Germany Relative patents - France Relative patents - U.K. Relative patents - Italy Relative patents -Japan Relative patents - the Netherlands Relative patents - Sweden Exports - Germany Exports - France Exports - U.K. Exports - Italy Exports -Japan Exports - the Netherlands Exports - Sweden Within T?2 N , 117)

-16.15 (5.98) *** 0.99 (9.34) *** -0.18 (1.78) * 0.57 (3.22) *** -0.24 (0.81 ) 0.36 (1.67) * -0.05 (0.15) -0.16 (0.72) 0.16 (0.68) -0.96 (5.86) *** -0.28 (1.85) * -0.04 (0.27) -0.37 (2.71 ) *** -0.06 (0.29) -0.12(0.51) 0.18 (0.91) 0.18 (2.24) ** 0.70 140 17.30***

*** Significant at 1%; ** significant at 5%; * significant at 1%.

France, no significant relationship was found either way. For Sweden, it appears to be the technological assets of U.S. firms that most strongly influences location in Sweden, rather than Sweden's own technological assets. One relationship of particular interest is that between lagged exports and FDI. There is some evidence for substitution between FBI and exports, with Germany and the U.K. showing negative and significant relationships between exports and FDI. A US$1 rise in U.S. exports to each country reduces FDI by 28 cents in the case of Germany and 37 cents for the U.K. The results for Sweden, on the other hand, show some evidence of complementarity between exports and FDI. A US$1 rise in U.S. exports to Sweden raises U.S. FDI in Sweden by 18 cents. The negative relationship between exports and FDI for the U.K. and Germany is in contrast to much of the evidence found in cross-section studies, although it is consistent with other time-series studies (Pain and Wakelin 1998).

Determinants of U.S. Direct Investment in the EU and Japan VI.

65

CONCLUSIONS

Understanding the determinants of FDI in industrialized countries is an important contribution to the policy debate over 'competitiveness'. Many industrialized countries compete in giving particular tax and other fiscal incentives to attract MNEs. More broadly, attracting foreign capital through low wages and flexible working conditions has also become part of many countries' economic policy, and is articulated as a concern over the competitiveness of industrialized countries, given that they suffer from a comparative disadvantage in labor-intensive sectors. In this chapter we have examined FDI from a common source to a diverse set of hosts, which together account for almost half of the U.S. stock of FDI. The main conclusion is that some determinants of U.S. FDI vary according to the characteristics of the host country. For Sweden the technological advantages of the U.S. seem to be an important factor in influencing U.S. FDI. For other countries, different combinations of factors are significant. In the case of Germany and the U.K., their technological assets relative to the U.S. have a positive impact on FDI. No clear-cut relationship between FDI and exports emerges. For a number of countries the relationship is insignificant, while evidence of substitution is found for the U.K. and Germany, and complementarity for Sweden. REFERENCES Acs, Z.J. and Audretsch, D.B. (1988) Innovation in Large and Small Firms: An Empirical Analysis, American Economic Review, 78(4) :678-690. Acs, ZJ. and Audretsch, D.B. (1989) Patents as a Measure of Innovative Activity, Kyklos, 42(2):171-180. Agarwal, J. (1980) Determinants of Foreign Direct Investment: A Survey, Weltwirtschaftliches Archiv, 116:739-773. Barrell, R. and Pain, N. (1996) An Econometric Analysis of US Foreign Direct Investment, Review of Economics and Statistics, 78(2). Barrell, R. and Pain, N. (1999) Trade Restraints and Japanese Direct Investment Flows, European Economic Review, 43:29-45. Brainard, S.L. (1997) An Empirical Assessment of the Proximity-Concentration Trade-off between Multinational Sales and Trade, American Economic Review, 87(4):520-544. Cantwell, J.A. (1989) Technological Innovation and Multinational Corporations, Basil Blackwell, Oxford. Cantwell, J.A. (1994) The Relationship between International Trade and International Production, in: Greenaway, D. and Winters, L.A. (Eds.), Surveys in International Trade, Basil Blackwell, Oxford. Caves, R. (1996) Multinational Enterprise and Economic Analysis, 2nd edition, Cambridge University Press, Cambridge.

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Clegg, J. (1996) US Foreign Direct Investment in the EU - The Effects of Market Integration in Perspective, in: Burton, R, Yamin, M. and Young, S. (Eds.), International Business and Europe in Transition, Macmillan Press, London. Dunning, J.H. (1993) Multinational Enterprises and the Global Economy, AddisonWesley, Wokingham, Berks. Dunning, J.H. (1997a) The European Internal Market Programme and Inbound Foreign Direct Investment (Part 1), Journal of Common Market Studies, 35:1-30. Dunning, J.H. (1997b) The European Internal Market Programme and Inbound Foreign Direct Investment (Part 2), Journal of Common Market Studies, 35:190-223. Froot, K. and Stein, J. (1991) Exchange Rates and Foreign Direct Investment: An Imperfect Capital Markets Approach, Quarterly Journal of Economics, 106:1191-1217. Griliches, Z. (1990) Patent Statistics as Economic Indicators: A Survey, Journal of Economic Literature, 28. Hagedoorn, J. and Narula, R. (2001) Evolutionary Understanding of Corporate Foreign Investment Behaviour: US Foreign Direct Investment in Europe, in: Narula, R. (Ed.) (2001), Trade and Investment in a Globalizing World, Pergamon, Elsevier, Amsterdam. Helpman, E. (1984) A Simple Theory of International Trade with Multinational Corporations, Journal of Political Economy, 92:451-472. Hufbauer, G., Lakdawalla, D. and Malani, A. (1994) Determinants of Direct Foreign Investment and its Connection to Trade, UNCTAD Review, 39-51. Kogut, B. and Chang, S. (1996) Platform Investments and Volatile Exchange Rates: Direct Investments in the US by Japanese Electronic Companies, Review of Economics and Statistics, 78:221-231. Kravis, I.E. and Lipsey, R.E. (1982) Location of Overseas Production and Production for Export by U.S. Multinational Firms, Journal of International Economics, 12:201-223. Lall, S. (1980) Monopolistic Advantages and Foreign Involvement by US Manufacturing Industry, Oxford Economic Papers, 32:102-122. Lipsey, R.E. and Weiss, M.Y. (1981) Foreign Production and Exports in Manufacturing Industries, Review of Economics and Statistics, 63:488-494. Lipsey, R.E. and Weiss, M.Y. (1984) Foreign Production and Exports of Individual Firms, Review of Economics and Statistics, 66:304-308. Lundvall, B.A. (Ed.) (1992) National Systems of Innovation: Towards a Theory of Innovation and Interactive Learning, Pinter, London. Lunn, J. (1980) Determinants of US Direct Investment in the EEC, European Economic Review, 13:93-101. Lunn, J. (1983) Determinants of US Direct Investment in the EEC Revisited Again, European Economic Review, 21:391-393. Markusen, J.R. (1995) The Boundaries of Multinational Enterprises and the Theory of International Trade, Journal of Economic Perspectives, 9:169—189. Narula, R. (1996) Multinational Investment and Economic Structure, Routledge, London. Narula, R. and Dunning, J.H. (1999) Developing Countries versus Multinationals in a Globalising World: The Dangers of Falling Behind, Forum for Development Studies, 2:261-287. Pain, N. and Wakelin, K. (1998) Foreign Direct Investment and Export Performance, forthcoming in The Manchester School.

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Patel, P. and Pavitt, K. (1997) The Technological Competencies of the World's Largest Firms: Complex and Path Dependent, but not much Variety, Research Policy, 26:141-156. Pfaffermayr, M. (1996) Foreign Outward Direct Investment and Exports in Austrian Manufacturing: Substitutes or Complements?, Weltwirtschaftliches Archiv, 132. Scaperlanda, A, and Mauer, J. (1969) The Determinants of US Direct Investment in the EEC, American Economic Review, 59:558-568. Scaperlanda, A. and Balough, R. (1983) The Determinants of US Direct Investment in the EU: Revisited, European Economic Review, 21:381—390. Swedenborg, B. (1979) The Multinational Operations of Swedish Firms, The Industrial Institute for Economic and Social Research, Stockholm. UNCTAD (1995) World Investment Report 1995, United Nations, Geneva. UNCTAD (1996) World Investment Report 1996, United Nations, Geneva. Veugelers, R. (1991) Locational Determinants and Ranking of Host Countries: An Empirical Assessment, Kyklos, 44(3):363-382. Wheeler, D. and Mody, A. (1992) International Investment Location Decisions: The case of U.S. firms, Journal of International Economics, 33:57-76. Yamawaki, H. (1991) Location Decisions of Japanese Multinational Firms in European Manufacturing Industries, mimeo, Catholic University of Leuven. Yu, J. (1990) The Experience Effect and Foreign Direct Investment, Weltwirtschaftliches Archiv, 126:561-579.

NOTES 1.

2.

3.

4.

5.

This research was funded through the TSER programme entitled Technology, Economic Integration and Social Cohesion' financed by the European Commission, and The Leverhulme Trust under Programme Grant no. F114/ BE We would like to thank Jan Fagerberg, David Greenaway, Michel Luillard, Nigel Pain, Bart Verspagen and participants at the TSER conference in Vienna, the IESG 1998 Annual Conference in Oxford and the CEPR conference, Lund in September 1998 for their comments. Much of the growth of U.S. FDI has been in the tertiary sector, particularly in the case of the U.K. This is not addressed here as the analysis is focused on the manufacturing sector alone. Scaperlanda and Balough (1983) and Barrell and Pain (1996) also tested the effect of the U.S. capital control program that attempted to limit the outflow of U.S. direct investment capital between 1965 and 1972. Markusen (1995) in an imperfectly competitive framework with horizontally integrated MNEs predicts that exports and direct investment may become substitutes over time. However, an alternative framework considering a vertically integrated firm with 'headquarter services' (Helpman 1984) can lead to an increase in exports as a result of FDI. Similar results have also been reported for a number of other countries: Veugelers (1991) for the OECD countries, and Hufbauer et al. (1994) for the U.S., Japan and Germany. For the OECD countries, Pain and Wakelin (1998) find an important role for FDI in an export demand model, although the exact nature of the relationship depends on the country under consideration.

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6.

The U.S. FBI stock data from the U.S. Department of Commerce provides a better estimate of U.S. multinational activity than other sources; it includes not just net flows from the U.S., but also reinvested earnings by the subsidiary. 7. We use patents to create the technology variable as they represent an output from the innovation process, unlike R&D expenditure which is an input. The outcome from research expenditure can be affected by a number of factors including risk, the efficiency of the research unit and the characteristics of the technology, confusing the relationship between R&D expenditure and innovation. Patents capture additional information on the stochastic variation of technological change not estimated by R&D expenditure (Griliches 1990). Nevertheless, studies indicate that there is a strong correlation among patents, R&D expenditure and actual innovations in the U.S. (Acs and Audretsch 1988, 1989), so in practise there may be little difference between them as proxies. Any variation found occurs on a detailed sectoral basis, as we are using a proxy for innovation in total manufacturing this drawback is not relevant. 8. They also included a relative user cost of capital variable, but did not include relative technology levels. APPENDIX 3.1 Data and Sources Variable FBI

SIZE ui PATj

PAT

ULC

X

Description

Source

The stock of U.S. outward FDI in constant 1985 US$ prices. It includes reinvested earnings, equity and intercompany account outflows. Value added in country j in 1985 US$ prices 3-year moving average of the number of patents granted in the U.S. to country j, date of grant, fractional count. Unit labor costs calculated by dividing total labor costs (in local currency, divided by relevant exchange rate) by value added in 1985 prices (divided by 1985 exchange rate). For European countries is calculated relative to the EU average, for Japan relative to the U.S. Manufacturing exports from U.S. to host country j in 1985 US$ prices.

Survey of Current Business, various editions OECD STAN database OECD STAN database OECD STAN database

OECD STAN database

Competitive and Comparative Advantages: The Determinants of Japanese Direct Investment Activity in Manufacturing YUI KIMURA AND THOMAS A. PUGEL1

I.

INTRODUCTION

By the early 1990s many firms based in Japan had established farranging multinational corporate operations, which in many ways resembled those of comparable U.S.- or European-based multinational firms. However, as late as the early 1980s the foreign direct investment (FDI) of Japanese firms was viewed as being different—special and unusual—and as not fitting the mainstream theory of FDI. The mainstream theory puts major emphasis on the importance of competitive advantages, often based on internalized use of firm-specific intangible assets, in explaining the basis for successful FDI. A number of Japanese researchers have argued that Japanese FDI, at least up to the early 1980s, was based not on these competitive advantages, but rather on Japan's comparative disadvantage in labor-intensive products, a disadvantage that arose because of shifts in relative factor endowments over time. The authors of several early studies (e.g., Yoshino 1976; Tsurumi 1976; Yoshihara 1978; Sekiguchi 1979) identified what they viewed as unusual features of FDI by Japanese firms. These authors indicated that Japanese investments, particularly those in Southeast Asia, were export-oriented or resource-seeking (for low-cost labor or natural resources), and very often involved Japanese general trading firms and local firms as joint venture partners. The tendency that they identified for Japanese FDI to occur in technologically mature and 69

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less marketing-intensive industries, as well as the role of general trading firms as FDI partners, seemed inconsistent with the mainstream theoretical explanations that emphasize firm-specific competitive advantages. Based on the belief that Japanese FDI was substantially different and driven largely by the exploitation of differences in comparative advantage, Kojima (1978) and Ozawa (1979) proposed that Japanese FDI tended to enhance world and national economic wellbeing, because it tended to increase international trade in goods and services. They contrasted Japanese FDI with Western (especially U.S.) FDI, which, they argued, tended to be trade-replacing and therefore destructive of world and national well-being. H. Peter Gray (1982, 1985) was among a group of researchers who challenged the analysis and conclusions of Kojima and Ozawa about the normative effects of different types of FDI. Among other comments on their approach, Gray indicated that Kojima and Ozawa did not recognize the welfare-enhancing benefits created by the ongoing technological innovations of multinational corporations; that they downplayed the welfare-enhancing role of transfers of technology from parent to foreign affiliate as a way of overcoming impediments to the international spread of technologies; that they failed to recognize that transfer of technology through FDI can lead to lower production costs in host countries, so that world welfare increases even if the transfer also leads to lower exports from the home country; and that the root cause of welfare losses from trade-replacing FDI is often governmental barriers to imports—with FDI as only a reaction to such protectionist policies. Gray also provides the point of departure for the analysis that we present in this chapter: "Positive analyses must be judged by positive criteria. The positive analyses are the prerequisite to the normative analysis..." (Gray 1985, p. 126).

Surprisingly, there has been almost no rigorous analysis of the extent to which the actual pattern of Japanese FDI in the late 1970s and early 1980s fits one or the other of the two theories: the mainstream theory with its emphasis on competitive advantages based on intangible assets, or the comparative-advantage theory of Kojima and Ozawa. One study is that of Lee (1983), who examined Japanese and U.S. FDI into Korean manufacturing industries during 1974-78. He divided Korean manufacturing industries into four types, based on physical-capital intensity and human-capital intensity. He found that both Japanese FDI and U.S. FDI were concentrated in industries intensive in human capital. This finding does not seem to be consistent with the view that Japanese FDI was

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different and motivated by the comparative advantage of the host country, but his analysis is for only one host country and it does not present rigorous statistical tests. Another study is Clegg's (1987), which examined Japanese FDI into the world during 1965-75. He concluded that Japanese FDI was predominantly in low-technology and low capital-intensity industries, a result that supports the Kojima-Ozawa approach. His conclusions are drawn from the results of statistical analysis, but these results are based on limited data of low quality. He used only nine aggregated industries, and he measured Japanese FDI based on approvals by the Japanese government rather than actual investments. In this chapter, using statistical testing and disaggregated data, we present the positive analysis that Gray called the prerequisite. At the time that the comparative-advantage theory was being offered as an alternative to the mainstream theory, was Japanese FDI driven mostly by comparative advantage? Or did the intangible assets possessed by Japanese firms play a significant role in Japanese FDI? We examine an indicator of the size of economic activity of foreign affiliates of Japanese firms as of 1981, the earliest year for which comprehensive data with substantial industry detail are available. These foreign affiliates were established by flows of FDI by Japanese firms in the years before and including 1981, so they provide a good test of the extent to which different theories explain Japanese FDI, for the time when Kojima and Ozawa were presenting and refining their comparative-advantage theory. We use a broad sample of manufacturing industries defined at a relatively disaggregated level, and we examine Japanese FDI into the world in total as well as into each of the two major host regions at that time, Asia and North America. Our statistical analysis of the determinants of the cross-industry pattern of Japanese FDI activities shows that variables associated with mainstream theory are significant determinants of the pattern. We find that, even as early as 1981, Japanese FDI was not as unusual as is often supposed. We also find that a variable representing comparative advantage is significant, so there is some support for the Kojima-Ozawa theory as part of the explanation of the pattern of Japanese FDI in the late 1970s and early 1980s. II.

THEORIES OF FDI

Theories of FDI are attempts to understand the basis for firms to undertake successful direct investment into production facilities in countries other than their home base. A major application for these theories is to understand the patterns of FDI activities across industries and across home and host countries.

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Competitive Advantages

To explain multinational expansion of national firms, a number of researchers have proposed various theories that in one way or another place a major emphasis on a firm's possession of competitive advantages as the basis for successful FBI. Such efforts include, for instance, oligopoly theory (Hymer 1960; Caves 1971; Knickerbocker 1973), product life cycle theory (Vernon 1966, 1971; Wells 1972), transactions cost or internalization theory (Buckley and Casson 1976; Magee 1977; Rugman 1980; Hennart 1982), and the eclectic approach (Dunning 1977, 1980). To a large extent these theories can be synthesized, as Dunning does in the eclectic approach. A firm can earn profits from foreign activities in any of several ways. Our focus is on the firm deciding to engage in foreign production using FDI to establish a foreign production affiliate that it owns and controls. The output of this foreign affiliate can then be sold to foreign buyers, or it can be exported back to the home country for sale to buyers there. However, the firm has at least two possibilities other than FDI production. The firm could establish foreign production of its products by entering into a licensing or similar arrangement with a local firm in the foreign country. Or, the firm could use production in its home country to export to make sales to foreign buyers of its products. Mainstream theory attempts to elucidate key conditions under which the firm is likely to choose FDI production rather than foreign licensing or exporting. Consider first the choice between FDI production and foreign licensing, assuming that the firm has decided that some kind of foreign production is desirable. To successfully operate its own production affiliate in a foreign country, the firm must have some competitive advantages that more than compensate for the disadvantages it faces in operating in an unfamiliar environment and from a distance, and the firm must have some advantages to owning and controlling the foreign production affiliate rather than licensing a local firm in the foreign country (a firm that does not have the disadvantages of operating in a foreign environment) to engage in production using the firm's competitive advantages. The competitive advantages of most relevance are those based on technological, marketing, and management knowledge and know-how: intangible assets in codified forms or embodied in human organizations. These intangible assets have two characteristics that favor FDI production. First, the firm can use its intangible assets in foreign markets without reducing their income-generating capacity at home, so in this sense the opportunity cost of using these assets in

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foreign production is low. Second, there are infirmities to licensing an independent local firm to use these intangible assets. Transactions costs in arm's-length sales (such as licensing) of intangible assets arise from such factors as difficulties in pricing, the risk of opportunistic behavior, and difficulties in monitoring the asset's use by an independent firm. To avoid such transactions costs while still establishing foreign production, in many cases the firm decides to internalize the use of these assets, by using FDI to establish foreign production owned and controlled by the firm. The firm also has the choice between foreign production and exporting from its home base, at least for the sales that it makes to foreign buyers of its products. Locational factors influence the decision about FDI versus exporting, and about the specific choice of a country site or sites for the FDI. Locational factors that favor foreign production include tariffs and other governmental barriers to imports in the foreign country, the logistical and marketing advantages of locating production close to the foreign buyers, and production costs in foreign countries that are lower than those in the home country. Through this last influence, mainstream theory provides some role for comparative advantage as a determinant of FDI. However, comparative advantage that leads to production cost differences is only one of a number of locational factors that influence FDI, and, more importantly, it is only relevant when the firm also possesses competitive advantages that make FDI a viable possibility. Comparative Advantage

While locational factors play a role in the mainstream theory of FDI, they are the major component in the alternative theory positing the primary importance of differences in factor endowment-based comparative advantage in explaining the industry and country pattern of Japanese FDI. Kojima (1978) posits that Japanese FDI activities, especially into developing countries, are motivated by the exploitation of locational comparative advantages that arise from the economic differences between Japan and host countries, rather than by firm-specific competitive advantages. An implication of this is that Japanese FDI tends to provide export platforms for goods that embody the factors in which the host country has comparative advantage (andJapan a comparative disadvantage). Ozawa (1979) extends this theory (see also Kojima 1982; Kojima and Ozawa 1984). According to Ozawa, the Japanese industries that seek to relocate production to developing countries, particularly in Southeast Asia, are those industries that have lost comparative

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advantage in Japan. He argues that, although locational factors largely motivate Japanese FBI, Japanese firms nonetheless need some competitive advantages, even though very slight, vis-a-vis local firms to compensate for the disadvantages of operating in foreign locations. The industries that engage in FDI are technologically mature, but the Japanese firms have slight competitive advantages in such areas as general industrial knowledge and know-how in production processes. Under the pressure of shifts in comparative advantage, Japanese firms in these industries relocate production to developing countries to exploit the host countries' comparative advantage. Thus, Ozawa places Kojima's theory within the broader framework of the eclectic approach, but maintains the emphasis on factor endowment-based comparative advantage. Oligopolistic Competition

The structure of the home industry and its implications for oligopolistic competition among home-country firms in the industry represent another influence whose role varies between the mainstream theory and the comparative advantage-based theory of Kojima and Ozawa. A synthesis of the mainstream approaches suggests that FDI tends to be prevalent in oligopolistic industries—those with relatively high seller concentration. Some of this correlation represents the existence of common factors (such as the possession of intangible assets) that result in both higher domestic seller concentration and FDI. In addition, oligopolistic behavior in industries with relatively high seller concentration may be a causal factor influencing FDI decisions. Knickerbocker (1973) suggests that the theory of oligopolistic rivalry applies to FDI. He argues that a firm's move to undertake FDI threatens the stability of market shares in the target foreign market and perhaps also in other markets. As a defensive move to prevent the investing firm from gaining marketing and cost advantages, rival firms tend to undertake FDI in the same market. This results in a higher level of industry FDI, other things being equal. Also, a large firm in an oligopolistic industry may face serious difficulties in growing domestically through increases in market share, because of expected competitive retaliation by the other large rival firms in the oligopoly. Growth through FDI may then become more attractive, again resulting in a higher level of industry FDI than would otherwise be expected. In contrast to these propositions, the theory of Kojima and Ozawa does not posit a positive relationship between domestic seller

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concentration and outward FDI. Instead, the Japanese industries that engage in FDI are expected to be relatively unconcentrated and thus lack oligopolistic market power or oligopolistic rivalry. III.

EMPIRICAL MODEL AND DATA

The purpose of this chapter is to test the ability of competitiveadvantage and comparative-advantage variables to explain the 1981 pattern of Japanese outward direct investment activities in manufacturing. The appropriate dependent variable is thus a measure of the importance (or intensity) of FDI activity by each industry. The best single measure of the economic importance of FDI would be valueadded in production by foreign affiliates of Japanese firms. Unfortunately, data on value-added are not available. We use instead the value of sales, which we assume is substantially correlated with valueadded. The dependent variable FDI Intensity is defined as sales by foreign production subsidiaries in the industry divided by industry shipments in Japan. This variable is measured as a ratio so that the denominator controls for industry size variations as we conduct cross-industry analysis. Three measures of FDI Intensity are used representing three host regions: the world (all foreign production subsidiaries), Asia (production subsidiaries located in Asia), and North America (production subsidiaries located in the U.S. and Canada). Asia and North America were the major regions hosting Japanese FDI in 1981, with about two-thirds of affiliate sales in these two regions at that time. The theories discussed in the previous section lead to the following general model: FDI Intensity = / (Competitive Advantages, Comparative Advantage, Oligopolistic Competition). [1] The inclusion of all hypothesized explanatory concepts in a single equation is based on the ability to nest the individual influences within the broad eclectic approach to FDI. In order to estimate this model, specific variables must be chosen to represent each explanatory concept. Competitive Advantages

Many previous empirical studies of FDI have focused on the importance of two types of intangible assets—proprietary technology and marketing skills—that are major sources of competitive advantages. We follow these studies in using variables to represent these two

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sources. A third type of intangible asset—general managerial or organizational skills and capabilities—is potentially of interest for Japanese FDI, but we could find no available variable for Japan that effectively measures its relative importance across industries. Proprietary technology is an intangible asset that can be transferred internationally at relatively low marginal cost, except for possible transaction costs. The transaction costs associated with arm's-length transactions in the intangible asset give rise to internalization advantage, and the firm tends to favor internalization of its foreign use through FDI. Proprietary technology results from the firm's R&D efforts to create knowledge and know-how for new products and production processes. Furthermore, the sustained market position of a firm often hinges on continuously renewed technological capabilities through ongoing R&D. Without continued renewal the firm's advantage erodes over time. Proprietary technology arising from ongoing industrial R&D efforts is an important basis for competitive advantage, and the variation in R&D intensities across industries should lead to variation in FDI by industries. Using various measures of R&D intensity, previous researchers generally find strong empirical support for the positive cross-industry relationship between R&D intensity and the extent of FDI (see the surveys in United Nations Center on Transnational Corporations (UNCTC) 1992, pp. 8-9, 15-17, or Caves 1996, pp. 8-11). Kimura (1989) supports this relationship for Japanese FDI across firms in the semiconductor industry, and Kogut and Chang (1991), Drake and Caves (1992), Kimura and Pugel (1995), and Pugel et al. (1996) find a significant positive relationship between Japanese R&D intensity and Japanese FDI into U.S. manufacturing by the mid- to late1980s. We use the ratio of scientists and engineers employed to total industry employment in Japan to represent the importance of R&D (and perhaps related technology activities) in the industry. Our choice of variable is based mainly on the fact that more disaggregated industry data are available for this variable than for the chief alternative, the ratio of R&D expenditures to industry sales. Marketing skills and know-how can be used to create intangible goodwill assets that are another source of competitive advantage. These skills represent the firm's capability to generate and sustain product differentiation through trademarks, brand names and the knowledge and know-how of effective marketing and promotional activities. A firm can generally transfer these capabilities and goodwill assets to foreign locations at a relatively low opportunity cost. Difficulties in arm's-length transactions in these goodwill assets, again, give rise to internalization advantage, which favors FDI.

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In transferring these assets to a foreign location, the promotional activities may need to be adapted to specific local conditions, and the product itself may need to be modified to meet local demand characteristics. Local production by the multinational firm can assist these adaptations, as the foreign affiliate is better able to acquire market information and to incorporate it into improved product design and production. Local production may also signal to local buyers that the firm is committed to reliable delivery and ancillary services. Thus, the knowledge and know-how of effective marketing activities are considered to be a major driving force of FDI. Empirical research has focused almost exclusively on advertising intensity as a measure of goodwill assets and marketing skills and know-how. Advertising reflects important aspects of these skills and capabilities, and it may also be closely associated with trademarks and brand names. However, it may fail to measure the firm's capability in other important aspects of marketing activities, such as ancillary services. Previous empirical studies show general support for a positive relationship between advertising intensity and the extent of FDI (see the surveys in UNCTC 1992, pp. 10, 18, or Caves 1996, pp. 8-11). The evidence for Japanese FDI in U.S. manufacturing industries is mixed, perhaps because most previous studies use advertising intensity measured for U.S. industries rather than that for Japanese industries. Pugel et al. (1996) use Japanese data and find a significant positive relationship between Japanese advertising intensity and Japanese FDI into U.S. manufacturing industries as of 1987. We follow previous studies in using Advertising Intensity to represent one important aspect of marketing skills and capabilities. We measure Advertising Intensity as the ratio of advertising expenditure to domestically consumed output in Japan. Comparative Advantage The theory of Kojima and Ozawa posits that comparative advantage should be the major determinant of outward FDI by Japanese manufacturing industries. Industries that are at a comparative disadvantage in Japan use FDI to shift production into foreign locations that have a comparative advantage. Cross-industry analysis can utilize industry factor-use intensities to represent the role of comparative advantage. In previous research (see Deardorff 1984, for a survey), three general factors are often measured: physical capital, human capital, and "raw" labor. For cross-industry analysis the first two are often divided by the number of industry employees (as a measure of "raw" labor), to form two

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ratios representing physical-capital intensity and human-capital intensity. A fourth major important factor is land and natural resources. Our efforts (not reported here) to find links of natural resource use to Japanese manufacturing FBI using industry dummies that indicate intensive use of natural resources in the industry's production generally produced insignificant results. We choose not to emphasize this result, because the manufacturing FDI data (based on the industry of each subsidiary) do not necessarily measure backward integration into the natural resources themselves, and because several natural-resource intensive manufacturing industries (e.g. pulp) were omitted from the sample due to inadequate data. We measure physical-capital intensity by the Capital-Labor Ratio: the ratio of the book value (in tens of millions of yen) of the industry's buildings, plant, and equipment to the total number of employees. We measure human-capital (or labor-skill) intensity by the Average Annual Earnings (in tens of millions of yen) per employee in the industry. This human-capital variable is based on the proposition that earnings (above a base amount equalling the earnings of "raw" labor) represent to a large extent the returns to human capital and skill that employees use in their work. This human capital is the combination of the innate capabilities of the workers, the human capital that they acquired through formal schooling, and the human capital that they acquired on the job. If Japan is relatively well-endowed with physical and human capital (at least during the period of our data collection), industries with high physical-capital or human-capital intensity tend to have a comparative advantage in Japan, while those with low capital intensities are at a comparative disadvantage. These latter industries can be considered (raw-)labor intensive. According to Kojima and Ozawa, these labor-intensive industries should engage in FDI more intensively. We also note that each of these factor-intensity variables could be linked in various ways to the competitive advantages of Japanese firms (see, for instance, the survey in UNCTC 1992, pp. 9-10). Perhaps most important, established Japanese firms may have a competitive advantage in their access to financial capital at a relatively low cost of capital. This advantage should be useful in financing investments (including FDI) in relatively physical-capital intensive industries (see the survey in UNCTC 1992, pp. 12-13, 20). Thus, access to capital as a competitive advantage predicts a positive relationship between FDI intensity and physical-capital intensity, in contrast to the negative relationship predicted by the comparative advantage theory of Kojima and Ozawa.

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Oligopolistic Competition

We follow many previous studies of FDI (and other aspects of industrial organization) in positing that industry seller concentration is related to the nature of competition in the industry (for a survey of previous research on the relationship between FDI and seller concentration, see UNCTC 1992, p. 12, or Caves 1996, pp. 85-87). Low levels of industry concentration are related to behavior similar to that of perfect competition or monopolistic competition, with low recognition of mutual interdependence and little strategic interaction among firms. Oligopoly behavior, with recognition of mutual interdependence and strategic interactions, becomes more important with higher levels of seller concentration. We measure seller concentration by calculating an approximate Herfindahl Index using industry data reported by paid-in-capital size classes of Japanese firms. While this procedure is not ideal, it does allow calculation of a measure of concentration for most industries. Other measures of concentration—for instance, n-firm concentration ratios—that are available for Japan have many missing observations and are not easily reconciled with the industry classification system that we use. Estimation Procedure

For statistical estimation, Equation [1] is specified in linear form, using the variables discussed above to represent the broad concepts: FDI Intensity = b0+ ^ • (Scientists and Engineers Fraction) + £2 • (Advertising Intensity) + £3 • (Capital-Labor Ratio) + b4 • (Average Annual Earnings) + b5 • (Herfindahl Index) + error [2] This equation is estimated for each of the three host regions—the world, Asia, and North America. The dependent variable is a censored variable: it is bounded below by zero and includes a number of observations with zero values (no FDI in that industry into that region). Thus, ordinary least squares is an inappropriate estimation technique. All estimation is performed using the maximum-likelihood Tobit technique that is correct for this type of censored dependent variable. The sign predictions for the variables can be summarized. The theories that focus on the importance of competitive advantages predict that bl} b2, and probably b$ will be positive, while no strong sign prediction necessarily exists for b4 (controlling for other

80

Yui Kimura and Thomas A. Pugel

influences). If oligopolistic competition is important, then b5 will be positive. These sign predictions apply to all host regions. The comparative-advantage theory of Kojima and Ozawa instead predicts that bl9 b%, and b5 will be approximately zero or negative, and #3 and b4 will be negative. These sign predictions apply to Japanese FDI into Asia, and presumably also apply to Japanese FDI into the world in total, but may not apply to Japanese FDI into North America. Data

Our analysis draws on a large base of data on 143 Japan Standard Industrial Classification (SIC) 3-digit industries for 1980-81. Of these 143 SIC 3-digit industries, 88 industries can be used in the statistical analysis. Other industries were omitted from the sample due to missing values for FDI sales or inadequate data with which to estimate the Herfindahl Index. The sources of the data and the means and standard deviations for each variable are shown in Table 4.1. TABLE 4.1

Variables Used in the Analysis Standard

Name FDI Intensity—World FDI Intensity—Asia FDI Intensity—North America Scientists and Engineers Fraction Advertising Intensity Capital-Labor Ratio Average Annual Earnings Herfindahl Index

Mean

Deviation

0.025 0.014 0.004 0.026 0.008 0.389 0.273 0.024

0.031 0.023

0.008 0.024 0.009 0.342 0.070 0.030

Source JFDIJCM JFDIJCM JFDIJCM

Jio Jio JCM JCM JCM

Means and standard deviations calculated for the sample of 88 industries. Sources: JFDI: MINISTRY OF INTERNATIONAL TRADE AND INDUSTRY, JAPANESE GOVERNMENT (1983) Dai-Ikkai Kaigai Toshi Tokei Soran (Japanese Foreign Direct Investment Statistics), Tokyo, Toyo Hoki Shuppansha. JCM: MINISTRY OF INTERNATIONAL TRADE AND INDUSTRY, JAPANESE GOVERNMENT (1984) Showa 56-nen Kogyo Tokeihyo (Census of Manufacturers 1981), Tokyo, Ministry of Finance Printing Office, Japanese Government. JIO: PRIME MINISTER'S OFFICE,JAPANESE GOVERNMENT (1984) San'nyu-Sanshutsu Tokei 1980 (Input-Output Tables 1980), Tokyo, Ministry of Finance Printing Office, Japanese Government.

Competitive and Comparative Advantages

81

The FDI Intensities are measured for the year 1981. This is the first year for which Japan's Ministry of International Trade and Industry (MITI) conducted a detailed survey of Japanese FDI activities and published disaggregated industry data. We chose this year to correspond as closely as possible to the time period in which Kojima and Ozawa were proposing their theory. If the theory is useful, then it should apply to the year 1981 (even if it might not apply to the FDI pattern for more recent years). Other variables calculated from Japan's Census of Manufacturers are also measured for 1981; variables calculated from Japan's InputOutput Tables are for 1980, the closest available year. The industry classifications for the MITI FDI data and the input-output data were concorded to the 3-digit SIC. The FDI data match many of the SIC 3digit industries, but in some others the industry classification differs. For these the proportions of FDI sales that fall in different SIC 3digit industries were re-allocated to the appropriate SIC 3-digit industries using the proportions of Japanese shipments of the industries. For the advertising data from the Input-Output Tables, pro rata reallocations to the SIC 3-digit industries used the concordance tables (ratios of the value of shipment allocations of the inputoutput industries to the SIC industries) in the Input-Output Tables. For the scientists and engineers variable the data from the InputOutput Tables were assigned to the appropriate SIC industries. IV.

RESULTS

Results of Tobit estimation of Equation [2] are shown in Table 4.2. The coefficient on the Scientists and Engineers Fraction, representing the importance of proprietary technology and R&D, is positive and significant at the .02 level or better (two-tailed test) for all three areas. The coefficient on Advertising Intensity, representing the importance of marketing capabilities, is negative and insignificant at the .10 level for all three. The result for the Scientists and Engineers Fraction is consistent with a significant general role for proprietary technology as a competitive advantage on which successful Japanese FDI in manufacturing is based. The result for Advertising Intensity fails to confirm any marketing-based competitive advantage used for Japanese FDI. The coefficient on the Capital-Labor Ratio is positive but insignificant at the .10 level for all areas. This result is inconsistent with the proposition that Japanese FDI is prevalent in the low physical-capital intensity industries that have a comparative disadvantage in Japan. Instead, the result provides a modest indication of some role for access to capital as a competitive advantage favoring Japanese FDI.

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Yui Kimura and Thomas A. Pugel

TABLE 4.2

Determinants of the FDI Intensity of Japanese Manufacturing Industries, 1981

Equation:

[1]

[2]

[3]

Destination:

World

Asia

North America

0.630 (3.68) -0.536 (1.58) 0.017 (1.42) -0.175 (2.37) 0.224 (2.05) 0.048 (3.08)

0.303 (2.37) -0.297 (1.17) 0.013 (1.39) -0.115 (2.08) 0.245 (2.99) 0.029 (2.48)

0.180 (2.92) -0.004 (0.03) 0.004 (0.85) -0.070 (2.62) 0.020 (0.50) 0.014 (2.58)

Scientists and Engineers Fraction Advertising Intensity Capital-Labor Ratio Average Annual Earnings Herfindahl Index Constant

Number of observations: 88. Asymptotic ^-statistics shown in parentheses.

The coefficient on Average Annual Earnings is negative and significant at the .05 level or better for all three regions. This is consistent with the proposition that Japanese FDI is more important in low human-capital intensive industries that have a comparative disadvantage in Japan. The coefficient on the Herfindahl Index is positive and significant for the world (at the .05 level) and for Asia (at the .01 level), but insignificantly positive for North America. Controlling for other influences, oligopolistic behavior appears to influence Japanese FDI into Asia (and to the world overall), but not FDI into North America (at least as of 1981). The results for Asia and the world are inconsistent with the predictions of the theory of Kojima and Ozawa. V.

CONCLUSION

This chapter has analyzed the cross-industry pattern of Japanese FDI activities in manufacturing, for the world and for the two major host regions, Asia and North America, in 1981. The purpose of the study was to examine the relevance of two major approaches to understanding FDI—the mainstream theory that emphasizes competitive advantages and an alternative approach, developed particularly with respect to Japanese FDI, that emphasizes comparative advantage.

Competitive and Comparative Advantages

83

The results presented in the paper provide support for the relevance of the mainstream theory. Other things being equal, Japanese FBI activity is greater in industries in which R&D (and perhaps related technology activities) are larger, indicating a significant role for proprietary technology as a competitive advantage. Other things being equal, Japanese FDI activity is larger in more concentrated industries, at least for Asia and the world overall, consistent with a role for oligopolistic competition. However, the insignificant results for the advertising variable indicate that no support was found for the role of marketing capabilities as a competitive advantage favoring Japanese FDI. The results in this chapter provide some support for the relevance of comparative advantage. Other things being equal, Japanese FDI activity is larger in industries that have lower human-capital intensity: industries that are at a comparative disadvantage in Japan because they are intensive in using relatively unskilled workers in production. While this result indicates a role for comparative advantage, the insignificant results for the Capital-Labor Ratio and, more importantly, the significant results cited in the previous paragraph are contrary to the predictions of the approach advocated by Kojima and Ozawa. The normative conclusions reached by Kojima and Ozawa in their comparative-advantage theory of FDI have long been considered controversial. At the same time, the positive basis of their theory—that Japanese FDI was different and not well-explained by mainstream FDI theory—has generally been accepted, at least for Japanese FDI up to the early 1980s. The results of our analysis presented here indicate that this positive presumption is not correct. By the early 1980s Japanese FDI already showed substantial consistency with mainstream theory that emphasizes the roles of intangible assets and oligopolistic competition. It is possible that the comparative-advantage approach of Kojima and Ozawa may have been the predominant explanation of Japanese FDI activities in the late 1960s and early 1970s, but that this pattern of Japanese FDI activities was in transition. As Japanese firms upgraded their competitive advantages based on intangible assets, the FDI pattern became increasingly similar to that predicted by the mainstream theory. At least by the early 1980s, this transition was already well-advanced, as Japanese firms based a noticeable part of their FDI on their proprietary technology advantages. Implicitly, these results lend substantial support to the eclectic approach as a framework for understanding FDI and international production activity. FDI involves decisions based on a complex set of influences, and no single narrowly based theory is likely to

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Yui Kimura and Thomas A. Pugel

capture all of the important factors that influence the decisions that result in the cross-industry and cross-country pattern of FDI activity. REFERENCES Buckley, P. and Casson, M. (1976) The Future of the Multinational Enterprise, Macmillan, London. Caves, R.E. (1971) International Corporations: The Industrial Economics of Foreign Investment, Economica, 38(149):l-27. Caves, R.E. (1996) Multinational Enterprise and Economic Analysis, second edition, Cambridge University Press, New York. Clegg, J. (1987) Multinational Enterprise and World Competition: A Comparative Study of the USA, Japan, the UK, Sweden and West Germany, St. Martin's Press, New York. Deardorff, A.V. (1984) Testing Trade Theories and Predicting Trade Flows, in: Jones, R.W. and Kenen, P.B. (Eds.), Handbook of International Economics, Vol. I, North-Holland, New York. Drake, T.A. and Caves, R.E. (1992) Changing Determinants of Japanese Foreign Direct Investment in the United States, Journal of the Japanese and International Economies, 6(3):228-246. Dunning, J.H. (1977) Trade, Location of Economic Activity and the Multinational Enterprise: A Search for an Eclectic Approach, in: Ohlin, B., Hesselborn, P-O. and Wijkman, P.M. (Eds.), The International Allocation of Economic Activity, Macmillan Press, London. Dunning, J.H. (1980) Toward an Eclectic Theory of International Production: Some Empirical Tests, Journal of International Business Studies, 11(1) :9—31. Gray, H.P. (1982) Macroeconomic Theories of Foreign Direct Investment: An Assessment, in: Rugman, A.M. (Ed.), New Theories of Multinational Enterprise, Croon Helm, London. Gray, H.P. (1985) Multinational Corporations and Global Welfare: An Extension of Kojima and Ozawa, Hitotsubashi Journal of Economics, 26(2): 125-133. Hennart, J-F. (1982) A Theory of Multinational Enterprise, Ann Arbor, University of Michigan Press. Hymer, S.H. (1960) The International Operations of National Firms: A Study of Direct Foreign Investment, Ph.D. dissertation, MIT (published by MIT Press 1976), Cambridge, Massachusetts. Kimura, Y. (1989) Firm-Specific Strategic Advantages and Foreign Direct Investment Behavior of Firms: the Case of Japanese Semiconductor Firms, Journal of International Business Studies, 20(2):296-314. Kimura, Y. and Pugel, T.A. (1995) Keiretsu and Japanese Direct Investment in US Manufacturing, Japan and the World Economy, 7(4):481-503. Knickerbocker, F.T (1973) Oligopolistic Reaction and Multinational Enterprise, Harvard Business School, Boston. Kogut, B. and Chang, SJ. (1991) Technological Capabilities and Japanese Foreign Direct Investment in the United States, Review of Economics and Statistics, 74(3):401-413. Kojima, K. (1978) Direct Foreign Investment, Praeger, New York.

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85

Kojima, K. (1982) Macroeconomic versus International Business Approach to Direct Foreign Investment, Hitotsubashi Journal of Economics, 23(1):1-19. Kojima, K. and Ozawa, T. (1984) Micro- and Macro-economic Models of Direct Foreign Investment: Toward a Synthesis, Hitotsubashi Journal of Economics, 25(1):1-20. Lee, C.H. (1983) International Production of the United States and Japan in Korean Manufacturing Industries: A Comparative Study, Weltwirtschafiliches Archiv, 119(4):744-753. Magee, S.P. (1977) Information and the Multinational Corporation: An Appropriability Theory of Direct Foreign Investment, in: Bhagwati, J.N. (Ed.), New Economic Order: The North-South Debate, MIT Press, Cambridge, Massachusetts. Ozawa, T. (1979) Multinationalism, Japanese Style: The Political Economy of Outward Dependency, Princeton University Press, Princeton. Pugel, T.A., Kragas, E.S. and Kimura, Y. (1996) Further Evidence on Japanese Direct Investment in U.S. Manufacturing, Review of Economics and Statistics, 78(2):208-213. Rugman, A.M. (1980) Internalization as a General Theory of Foreign Direct Investment, Weltw irtschaftliches Archiv, 116(2):365-379. Sekiguchi, S. (1979) Japanese Direct Foreign Investment, Allanheld, Osmun & Co., Montclair, New Jersey. Tsurumi, Y. (1976) The Japanese Are Coming: A Multinational Interaction of Firms and Politics, Ballinger, Cambridge, Massachusetts. United Nations Center on Transnational Corporations (1992) Determinants of Foreign Direct Investment: A Survey of the Evidence, United Nations, New York. Vernon, R. (1966) International Investment and International Trade in the Product Cycle, Quarterly Journal of Economics, 80(2):190-207. Vernon, R. (1971) Sovereignty at Bay: the Multinational Spread of U.S. Enterprises, Basic Books, New York. Wells, L.T. (Ed.) (1972) Product Life Cycle and International Trade, Harvard Business School, Boston. Yoshihara, K (1978) Japanese Investment in Southeast Asia, University Press of Hawaii, Honolulu. Yoshino, M.Y. (1976) Japan's Multinational Enterprises, Harvard University Press, Cambridge, Massachusetts.

NOTE 1.

The authors gratefully acknowledge research funding for this project from the International University of Japan Research Grant Programs, received by Professor Kimura when he was on the faculty at IUJ. We also thank Naoya Takezawa for his research assistance. It is with great sadness and a sense of loss that we also note that Professor Kimura passed away while this chapter was being written.

The Impact of Direct and Indirect FDI in Eastern Europe on Austrian Trade and Employment WILFRIED ALTZINGER AND CHRISTIAN BELLAK1

I.

INTRODUCTION

Foreign Direct Investment (FDI) into Central and Eastern European Countries (CEECs) has taken place for more than a decade. Multinational Enterprises (MNEs) have emerged as very important agents of industrial restructuring in CEECs. The growth of FDI in the host countries was paralleled by increasing concern, particularly in home countries, about jobs and domestic investment being relocated to the newly emerging markets. Theoretical and empirical studies on the impact of FDI on the home countries, and their trade and employment, have a longer tradition. They have been partly motivated by governments or private interest groups and partly by academic researchers. At first glance, the impact of FDI on the home country seems to be a well defined subject, highlighting various aspects like trade, investment or employment issues. That is, however, not the case in practice, because the overall impact is a complex matter—both theoretically and empirically. One aspect, which has been neglected by most empirical studies, is the ownership of the investor engaging in the host country via FDI. The investor may be a domestic company or a regional headquarter of a foreign MNE.2 This aspect is especially important with regard to CEECs, since a considerable share of overall FDI is made by the latter firms. The question that arises is, whether this important quantitative phenomenon matters for the impact of FDI on the home country. In other words, does the impact on the home country differ, subject to the ownership of the investor? 86

The Impact of Direct and Indirect FDI in Eastern Europe

87

This short contribution studies FDI in CEECs of Austrian investors, since Austria has a large share of foreign-owned firms, investing in CEECs. Therefore, firms under Austrian ownership carry out only part of Austrian FDI in CEECs. More precisely, based on the sales structure and the motives for the investment in CEECs, it is analysed whether affiliates of foreign MNEs have a relatively more favorable or unfavorable impact on the home economy, when compared to domestic firms' FDI in CEECs. Empirical results confirm, that domestic firms' FDI in CEECs are relatively more strongly determined by efficiency-seeking motives and their trade structure reflects a deeper international division of labor (including production) than FDI in CEECs, made by foreign affiliates in Austria. These latter FDI are mainly market-seeking and the intra-firm trade relations reflect a vertical forward integration (sales affiliates). Similar differences prevail in the effect on labor demand at home. The analysis in this chapter suggests strongly that the impact of FDI in the home country varies according to the ownership of the investor; and that the distinction of the two groups of firms, i.e. Austrian versus foreign-owned, yields important insights on the impact of FDI on the home country. The chapter is organized as follows: The following section presents some stylized facts about Austrian FDI in CEECs. Then the existing literature on domestic employment effects of outward FDI is surveyed briefly with respect to motives and trade. Data and the methodology are described and the results are presented in the next two sections. The results point to the importance of the distinction of ownership of the investor, concerning the sales and trade structure as well as the motives for FDI in explaining different home-country employment effects of the two groups of firms. There is a short concluding section. II.

BASIC CONCEPTS AND SOME STYLIZED FACTS

A considerable number of MNEs investing in Central and East European Countries channel their foreign direct investment through an affiliate (e.g. a regional headquarter) set up in a third country. Such FDI are termed indirect FDI3 in order to distinguish them from those FDI set up by the parent (headquarters) directly: "FDI by a foreign affiliate is indirect FDI, signifying that the resulting asset-stock is owned by the parent firm via the foreign affiliate, and that it represents, therefore, an indirect flow of FDI from the parent's home country (and a direct flow of FDI from the country in which the affiliate is located)" (United Nations 1998, p. 145).

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Wilfried Altzinger and Christian Bellak

Since FBI refers to a capital flow or stock, we use "direct FBI" synonymously for Austrian-owned firms and "indirect FDI" for foreign-owned affiliates in Austria. Figure 5.1 illustrates the term "indirect FDI". Therefore, three different geographical entities are distinguished. In principle, all three should be included in the analysis, since the relation between Austria and the CEECs also depends on the activities of the MNEs in "the rest of the world". Since our focus is on the domestic employment effects this conceptual model can be applied to direct FDI by looking at the relationship between the Austrian parent and its affiliate in the CEECs. For indirect FDI the relationship between the Austrian firm and its affiliates in CEECs is also affected by the activities of the foreign MNE in "the rest of the world" (dashed arrows in Figure 5.1). The activities of the parent company and other affiliates of the MNE are the main cause for different trade patterns of direct and indirect FDI. Stylized facts on Austrian FDI in CEECs show at least three particular structural features with respect to the question of employment and trade effects of FDI which make Austria an ideal country to study. First, Austrian firms have been early investors. Austrian FDI in CEECs had reached high levels immediately after 1989. Austria's share in FDI stocks ranges from 3 to 22% in neighboring CEECs and it is an important location (bridgehead) for regional headquarters responsible for CEECs (cf. Table 5.1). The large share also stimulated (public) concern about job losses through relocation. Rest of the World

FIGURE 5.1

Direct and Indirect FDI

The Impact of Direct and Indirect FDI in Eastern Europe TABLE 5.1

89

Share of Austrian FDI in total FDI of selected CEECs

Share of FDI stocks (%) Czech Republic Slovakia Hungary Poland Slovenia Croatia CEECs total

1990

1997

1.3 -

14.7 18.2

22.0

9.8

5.4

2.4

13.2 -

13.8 11.2

10.3

5.8

Source: Stankovsky 1999, p. 117.

Second, Austrian investors in CEECs are only partly Austrian firms, as Austrian affiliates of foreign MNEs account for a large share of Austria's overall FDI in CEECs. "A great deal of Austria's FDI abroad is in fact carried out by enterprises which are in turn affiliates of foreign investors" (Neudorfer 1997, p. 56). During the period 1989-91 this type of investment had come to about 40% in CEECs. Despite the drop of this share to 26% in 1996, it remains an important part of Austria's overall FDI in CEECs. Third, during the early investment period (1989-95), direct FDI achieved better outcomes in employment growth as well as sales growth of the parent firms in Austria than indirect FDI. This result holds true even for the post-investment period (1995-98). Sales growth of direct FDI has been considerably stronger for both periods. In accordance with sales growth, parent employment of direct FDI has grown considerably stronger than for indirect FDI (Table 5.2). TABLE 5.2

Saks and Employment Performance of Direct and Indirect FDI

Type of Firm

Direct FDI

Changes of Sales 1989-95

Median N

Indirect FDI

Median N

Total

Median N

Changes of Sales 1995-98

33.3

15.4

67

21.0

67 3.8

21

21

33.3

12.4

Changes of Parent Employment 1989-95

Changes of Parent Employment 1995-98

5.9 63

0.0 65

-2.0

-10.0

21 5.3

-1.3

21

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Wilfried Altzinger and Christian Bellak

These stylized facts give rise to a number of questions, in particular concerning (labor-) cost related relocations given the large gap of labor cost between "East" and "West". In particular, we are interested in possible links between the domestic employment performance and FBI in CEECs. The reorganization of production triggered off by the opening of Eastern Europe has brought new interest to questions of employment relocation and the impact of FBI on the balance of payments. While the public discussion in home countries is based on fears of workers in marginalized industries and of politicians in regions with high unemployment, evidence on the substitution of jobs by FDI in CEECs is still rare. A separation of the total employment effect of both groups of firms should yield important insights which help to explain the stylized facts presented above on the basis of the underlying motives and the trade structures that exist between parent and affiliate. Consequently this chapter distinguishes between direct and indirect FDI and tests hypotheses concerning the links between domestic employment and job creation abroad. III.

IMPACT OF FDI ON TRADE AND EMPLOYMENT

The question whether outward FDI substitutes or complements domestic production and consequentlyjobs, has been the subject of a large number of studies (e.g., Lipsey and Weiss 1981; Lipsey 1994; Graham 1996; Barrell and Pain 1997). Blomstrom et al (1997), Agarwal (1996) and Andersen and Hainaut (1998) provide excellent surveys. One way to approach the problem is to derive substitution elasticities (relative wages) between employees in parent firms and their affiliates. Since this road of investigation is not open to us, because of the lack of firm-specific data on wage levels in CEECs by industry, we focus our analysis on trade relations between parent firms and affiliates. Trade and FDI are linked in multiple ways (see Gray 1992, 1996; Cantwell 1994). According to this strand of argument, the intra-firm trade balance, the geographical distribution of exports and the importance of local sales are important determinants of the demand for labor at home resulting from outward FDI. Most empirical studies, however, lack information about these important indicators. Consequently, the argument here is based on the relationship between the motives for FDI and their effect on trade (cf. Agarwal 1996) and on the intra-firm trade relations. According to established theory, the activities of affiliates can be related to the motives of FDI, namely 'resource seeking', 'efficiency seeking', 'market seeking' and 'strategic-asset seeking'. As Neudorfer (1997) points out on the basis of empirical data, the

The Impact of Direct and Indirect FDI in Eastern Europe

91

latter motive is not relevant for Austrian FDI in CEECs. The impact of these types of FDI on trade patterns are explained by distinguishing four kinds of trade linkages between the parent firm and her affiliates: (1) the substitution of former exports through FDI, (2) growing (re-)imports of goods and services produced abroad, (3) FDI associated exports of goods and services and (4) FDI induced exports of other product lines neither produced by the foreign affiliate nor exported earlier by the parent firm (Agarwal 1996; Altzinger and Winklhofer 1998). The overall impact of FDI on trade (and consequently on domestic employment) is the sum of negative (export substitution, re-imports) and positive effects (associated and induced exports) and can be tested only empirically. Any distinction between direct and indirect FDI is justified only if their trade linkages differ. This is conceivable, since both types of investors may develop different entry strategies in CEECs, based on their competitive advantage. The specific competence of the Austrian affiliates of foreign MNEs (indirect FDI) within the network of the MNE with respect to CEECs derives from their Austrian market supply and sometimes associated exports to CEECs. The specific competence of Austrian firms (direct FDI) arises from their long-lasting experience in CEEC markets (Bellak 1997, 1998). Empirically, if different trade linkages between parent firms and affiliates exist for direct and indirect FDI, their effect on domestic employment will differ as well. For example Blomstrom et ol. (1997) argue that rivalry for markets is one of the main reasons for a positive relationship between foreign production and domestic employment, which provides one argument to distinguish market-oriented from efficiency-oriented FDI. A related question is whether the trade linkages change from the period of entry into a foreign market and the maturing of the FDI. Several theories suggest that entry occurs first via a sales subsidiary, which may be extended into a production unit later on (e.g., Bergsten et al. 1978). As CEECs are newly developed markets and have also been low-cost production locations for 10 years, some firms may have altered their operations there over time. These considerations lead to a number of questions, such as: Do direct and indirect FDI follow different trajectories or are such strategies idiosyncratic to firms? Do they result in different trade linkages between parent firms and affiliates for direct and indirect FDI and consequently change the effect on domestic employment? These questions are now analyzed empirically. IV.

DATA

To analyze the impact of foreign affiliates on domestic employment we make use of two different sets of data: The first comprises the

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Wilfried Altzinger and Christian Bellak

results of the annual FDI survey carried out by the Austrian National Bank, covering all firms with an investment above ATS 1 million. This data set provides excellent information about the total amount and structure (geographical, industrial) of investment as well as on employment. However, these data do not provide sufficient information on trade figures. Therefore we use a second data set which presents results of a survey conducted in summer 1997. Among others, this data set includes sales, export and employment data for 1989, 1995 and expected figures for 1998. A simple model which analyses the different impact of parent and affiliate sales on domestic employment is used.4 Development and Structure of Austrian Direct and Indirect FDI in CEECs

Table 5.3 shows the main differences of Austrian direct and indirect FDI in CEECs for 1991 and 1996. This period is characterized by the opening up of the CEECs and their economic integration into the European Union. During this period the amount of capital invested has increased fourfold and was ATS 39.5 bn in 1996. Starting from zero in 1989 it accounted for nearly 30% of Austrian total outward FDI stock in 1996. Hence the importance of the CEECs for the internationalization of Austrian enterprises is clearly discernible. Even the number of investments has increased from 414 to 909. However, this increase is less pronounced than the growth in capital invested. This is mainly the result of different investment patterns during the early 1990s and thereafter. At the beginning of the economic integration between Austria and her adjacent Eastern European neighbors many small and medium-sized enterprises (SME) used their first-mover advantages which can be attributed to long lasting historical and cultural ties (Altzinger and Winklhofer 1998; Schroter 1994). However, due to weak financial capabilities of these firms capital per investment has been rather small. After this initial period the integration process has proceeded rather quickly and the economic stabilization of the transition countries has improved. These changes have attracted even some very large investments of Austrian firms. Therefore the amount of capital invested has increased from ATS 27 million in 1991 to ATS 43 million in 1996 and in 1996 the amount of capital per investment no longer differs between direct and indirect FDI. Another reason may be the cumulative learning processes of early movers (Porter 1990), i.e. small Austrian firms which expand their operations based on the positive experience after their early entry. This may also reflect the competitive advantage vis-a-vis latecomers.

The Impact of Direct and Indirect FDI in Eastern Europe TABLE 5.3

93

Main Differences between Austrian Direct and Indirect FDI in CEECs,

1991 and 1996 Direct FDI 1991 Total Capital Stock (ATS million) Parent Employment Affiliate Employment Share of Affiliate/Total Employment Number of Investments Total Capital per Investment (ATS million) 1996 Total Capital Stock (ATS million) Parent Employment Affiliate Employment Affiliate/Total Employment Number of Investments Total Capital per Investment (ATS million)

5314.7

47.1%

33893 73.4% 13437 54.4% 28.4% 75.1%

311

Indirect FDI

5973.41

Total FDI

52.9%

11288.12

12301

26.6%

11244

45.6%

46193 24681 34.8%

47.8'/O 103 17.1

24.9% 58.0

414 27.3

29042.75

73.6%

10435.52

26.4%

39478.27

92485 59419

65.7% 69.6%

48301 26006

34.3% 30.4%

75.0%

227

140786 85425 37.8% 909 43.4

39.1% 682

42.6

35.0% 25.0% 46.0

Source: Austrian National Bank; own calculations.

Employment figures increased in accordance with total capital invested. The large increase is evident for both parent and affiliate employment. Parent employment growth can be explained mainly by the strong increase of the number of parent firms investing in CEECs. The share of affiliate employment in total (affiliate and parent) employment remained relatively stable throughout the period 1991-96. However, whilst direct FDI has increased their share of affiliate employment rather strongly indirect FDI has not. Table 5.4. provides evidence about the industry structure of direct and indirect FDI.5 Differences between direct and indirect FDI arise partly from the fact that they are active in different sectors in the host countries. The sectoral distribution of total FDI shows that nearly 60% is allocated to the non-manufacturing sector and only 40% to manufacturing. Within the non-manufacturing sector the largest sectors are finance and insurance (20.5%), trade (18.1%), real estate and business activities (7.9%), which includes holding companies, and construction (6.0%). However, there are considerable differences between direct and indirect FDI. It is particularly in

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Wilfried Altzinger and Christian Bellak

TABLE 5.4

Industrial Distribution of Austrian Direct and Indirect FDI in CEECs by Host Country Industry, 1996 Direct FDI

Indirect FDI

Total FDI

(ATS mn) (Percentage (ATS mn) (Percentage (ATS mn) (Percentage Share) Share) Share) Mining Food & Beverages Textiles Wood Products Paper & Publishing Chemicals & Petroleum Non-metallic Products Metal Machinery Electrical Equipment Transport Equipment Other Manufacturing Manufacturing Sector Engineering Sector

Construction Trade Hotels & Restaurants Transport & Communication Finance & Insurance Business Services Other Services Non-Manufacturing Sector Total

504

1.7

34

2434

8.4

262

0.9 1.5 4.5

156 -

0.3 1.5 -

13 197

0.1 1.9

1.9 7.7

2470 1139

23.7 10.9

3.2 1.0

114 239

1.1

1502 3031 3380 1043

2.3

532

1.3

1120

3.9

1101

10.6

2221

5.6

38

0.1 0.8

122 40

1.2 0.4

160

0.4

285

0.7

9868 2380 1804 4026 1956

34.0 8.2

53.6 15.1

15459 3956 2382 7143 1978

39.2 10.0

6.7

5591 1576 578 3117 22

309

1.1

_

7071 3097

24.3 10.7

407

1.4

1006 31 57

18670 29043

64.3 100

4811 10436

442

1305 560

2241 929 293

245

6.2

13.9

5.5

29.9 0.2

9.6 0.3 0.5

46.1 100

538

1.4

2590

6.6 0.7

262 455

1.2 3.8 7.7 8.6 2.6

6.0

18.1 5.0

309

0.8

8077 3128

20.5

464

1.2

23482 39478

59.5 100

7.9

Source: Austrian National Bank; own calculations.

the trading sector where indirect FDI accounts for a very large share. In the finance and insurance and real estate and business services direct FDI shows considerably larger shares.6 The difference in business services can be explained only by the existence of holding companies in this sector. Within the manufacturing sector, the food and beverage industry is dominated by Austrian-owned firms while chemicals and petroleum and electrical equipment is strongly dominated by indirect FDI. Further we have aggregated an

The Impact of Direct and Indirect FDI in Eastern Europe

95

engineering sector which consists of metal products, machinery, electrical, and transport equipment and which accounts for 10% of total FDI. In this sector indirect FDI is more important than direct FDI. Main Characteristics of the Survey Data

The following analysis covers 150 firms which have engaged in at least one investment in CEECs. 112 of these firms (74.7%) are direct FDI and 38 indirect FDI (25.3%).8 Throughout the analysis we distinguish between an 'initial investment' period (1989-95) and a 'post-investment' period (1995-98). It is indeed the 'initial investment' period when almost all Austrian investors have made their first investment. Most of the recent investments have been an expansion of the earlier investments. During the post-investment period the stabilization of the transitional economies has proceeded and some very large investments have been carried out. Tables 5.5-5.8 show the differences in regional sales structure for direct and indirect FDI. Parent Firms

Table 5.5 presents the regional sales structure of the parent firms. Only 56.3% of total output has been sold on the Austrian market. The largest share of exports (24.5%) was shipped to the EU and another 12.8% to CEEC markets. A comparison of direct and indirect FDI reveals that non-Austrian-owned firms display larger export activities than Austrian ones. Their export shares are 49.2% and 42.0%, respectively. Indirect FDI exports more to the EU and CEECs alike. However, none of these differences are significant. The impact of FDI on export activities is also reflected by the changes in the regional sales structure. Diminishing market shares in CEECs point to a substitutive relationship between investments and exports and vice versa. As illustrated by several authors (Bergsten et al 1978; Lankes and Venables 1996) it might be the case that in the initial stage of investment the vertical integration aspect may dominate and therefore investment will boost exports. In later stages horizontal investment may be more important, leading to a substitutive relationship. Accordingly, we expect rising market shares of CEECs during the initial period of investment and stable or declining market shares in the post-investment period. The initial investment has been accompanied by a considerable shift of the sales structure (see Table 5.6). On average the

96

Wilfried Altzinger and Christian Bellak TABLE 5.5

Regional Sales Structure of Parent Firms, 1995 (%) Austria

Type of Firm

Direct FDI

Mean N

Indirect FDI

Mean

Total

Mean

N N

EU (except Austria)

CEEC

58.0

23.9

12.2

89

89

89

50.8

26.4

14.8

28

28

28

56.3

24.5

12.8

117

117

117

Others

5.9 89 8.0 28 6.4 117

West for Equality of Means: Mean difference

7.3

-2.4

-2.7

-2.1

lvalues

0.97

-0.41

-0.55

-0.80

This table presents results of independent-sample Wests which have been calculated to test for the significance of the mean differences between direct and indirect FDI. Before testing the significance of the mean differences a Levene Test was performed to control for the equality of variances (Norusis 1997, p. 231). Asterisks (***, **, *) indicate significance levels (1, 5 and 10%).

TABLE 5.6

Changes in Regional Sales Structure of Parent Firms, 1989-95 (%) Austria

Type of Firm

Direct FDI-

Mean

-6.4

N

80

Indirect FDI

Mean

-5.8

N

25

Total

Mean N

-6.3 105

EU (except Austria) 1.9 80 1.3 25 1.8 105

CEEC

4.2 80 3.3 25 4.0 105

Others

0.3 80 1.2 25 0.5 105

t-test for Equality of Means: Mean difference

-0.6

0.6

0.9

-0.9

lvalues

-0.31

0.38

0.44

-0.53

This table presents results of independent-sample Wests which have been calculated to test for the significance of the mean differences between direct and indirect FDI. Before testing the significance of the mean differences a Levene Test was performed to control for the equality of variances (Norusis 1997, p. 231). Asterisks (***, **, *) indicate significance levels (1, 5 and 10%).

The Impact of Direct and Indirect FDI in Eastern Europe

97

parent firms have improved their total export shares by 6.3 percentage points. The largest increase has been performed on markets in CEECs (+4.0 percentage points) but even the EU market shares have grown (+1.8 percentage points). Hence, the internationalization of these firms was not restricted to GEE markets only. Although the share of sales in CEECs improved more strongly than those in EU markets, the internationalization of the sample firms was simultaneous and geographically diversified. Hence, these results show typical patterns of globally acting firms. Moreover, the expected complementary relationship between investments and exports seems to be confirmed. 9 Again, there are no significant differences between direct and indirect FDI. TABLE 5.7

Expected Regional Sales Structure of Parent Firms, 1995-98 (%)

Type of Firm

Direct FDI Indirect FDI

Austria

Mean

-4.4

N

88

Mean

N Total

Mean

N

0.0 28

-3.4 116

EU (except Austria) 1.5 88

-0.5 28 1.0 116

CEEC

2.1 88 0.5 28 1.7 116

Others

0.9 88 0.1 28 0.7 116

Rest for Equality of Means: Mean difference

-4.4

2.0

1.6

0.8

lvalues

—3 92***

1.87*

1.40

-1.14

This table presents results of independent-sample Mests which have been calculated to test for the significance of the mean differences between direct and indirect FDI. Before testing the significance of the mean differences a Levene Test was performed to control for the equality of variances (Norusis 1997, p. 231). Asterisks (***, **, *) indicate significance levels (1, 5 and 10%).

Table 5.7 shows the expected changes in the parent firms' sales structure for the post-investment period 1995-98. Interestingly, the general pattern of the initial period of investment seems to be extended. On average it is expected that the internationalization process will continue in both directions, into Eastern and Western Europe alike. However, for this period there are differences between direct and indirect FDI. Direct FDI show a deeper international division of labor than indirect FDI. The former group improves its export activities to the EU as well as to the CEECs much

98

Wilfried Altzinger and Christian Bellak

more strongly than indirect FBI. The superior performance is only significant for exports to the EU. Further, the complementary relationship between investments and exports to the CEECs holds for direct FDI only. This pattern might be an indication that direct FDI still expands further whilst indirect FDI does not. Affiliates

Next we analyze the sales structure of the affiliates. Therefore we distinguish between two different motives of investment, i.e. 'efficiency-based1 and 'market-driven1 FDI. The first would indicate that the dominant factor of investment is to get access to a cheap industrial workforce. Such a scenario would presumably show large (re-) exports from the affiliates to the home country and also to other countries. In contrast, 'market-driven' FDI is mainly accompanied by an expansion of demand in the host country. Such affiliates are mainly self-contained production units rather than a part of an integrated network like 'efficiency-based' FDI. Therefore the production of these affiliates should be sold to a large extent on local markets. The regional sales pattern of the affiliates provides an indication of the local activities of an affiliate. Therefore the sales patterns are used as a proxy for distinguishing between 'efficiencybased' and 'market-driven' FDI. Table 5.8 shows the regional sales structure of the affiliates for 1995. On average the local markets account for 65.5% of total sales. However, 23.2% were shipped to EU markets, and thereof 10.6% to Austria. The sales structure of the affiliates differs significantly between direct and indirect FDI. First, the local market share of indirect FDI is significantly larger than for direct FDI, which is an indication that the division of labor is more advanced with the latter. Second, for direct FDI, trade relations between affiliates and their Austrian parent firms are significantly deeper than those of indirect FDI. Whilst the former group exports 12.3% of their sales back to Austria, this share is only 4.2% for indirect FDI. These patterns clearly indicate that the division of labor is more advanced with direct FDI. Finally, we can see that exports from the affiliates further East are significantly higher for direct FDI than for indirect FDI. A closer look to more disaggregated data (which are not presented here) shows that this can be mainly explained by higher export activities of direct FDI within the trading and other non-manufacturing sectors. These patterns for overall trade are also supported by data on intra-firm trade as published by the Austrian National Bank (1998).

The Impact of Direct and Indirect FDI in Eastern Europe

99

TABLE 5.8 Regional Sales Structure of Affiliates, 1995 (%) Type of Firm

Direct FDI Indirect FDI Total

Local Market

Other EU (incl. of which CEECs Austria) Austria

Mean

61.9

10.0

25.3

12.3

N

95

95

95

95

Mean

79.7

N

24

Mean

65.5

N

119

2.8 24 8.5 119

15.0

4.2

24

24

23.2

10.6

119

119

Others

2.8 95 2.5 24 2.7 119

West for Equality of Means: Mean difference lvalues

-17.7

-2.20**

7.2

2.70**=*

10.3 1.50

8.1

0.3

2.53**

0.13

This table presents results of independent-sample Mests which have been calculated to test for the significance of the mean differences between direct and indirect FDI. Before testing the significance of the mean differences a Levene Test was performed to control for the equality of variances (Norusis 1997, p. 231). Asterisks (***, **, *) indicate significance levels (1, 5 and 10%).

Intra-firm Trade

Intra-firm trade (IFT) gives an indication of the role affiliates play in relation to the parent company. Intra-firm trade patterns are dependent on the various types of investment ('market- or efficiency-based' FDI), on the sectoral composition of investment and additionally, may change substantially over time (e.g., Braunerhjelm 1998; Gray 1999). As has been demonstrated by Gray (1999), 'efficiency-seeking' FDI is the most important explanation for IFT and takes place mainly among nations with different factor endowments. IFT will be boosted further by low transportation costs and low tariffs. Finally, IFT will always be influenced by considerations of risk minimization, for political risks in particular. IFT between Austria and her adjacent countries in GEE is strongly encouraged by all these factors. Factor rewards—in particular wages—differ strongly, transportation costs are low due to the geographical proximity of these countries and tariffs have been almost abolished by the European Agreements. Finally, as has been shown by Lankes and Venables (1996, p. 336), Austrian GEE neighbours show strong political stability. The rank correlation between the political stability (measured by the EBRD transition indicator) and cumulative FDI per capita is strong and positive.

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Wi Ifried Altzinger and Christian Bellak

Neudorfer (1997) presents results on IFT which indicate clearly that the share of intra-firm exports in total exports between Austria and Hungary, Slovakia, Slovenia and the Czech Republic has grown rapidly during the period 1989-95. Interestingly, although intrafirm imports in total imports have grown, this increase is by no means as strong as for intra-firm exports. In our sample both direct and indirect FDI display large IFT surpluses seen from the Austrian perspective (Table 5.9). Total IFT surplus increased from ATS 1.2 billion in 1991 to ATS 5.5 billion in 1996, a surplus which is primarily due to indirect FDI. Although TABLE 5.9

Intm-Firm (IF) Trade, 1996 (ATS mn)

IF-Exports IF-Imports IF-Balance Petroleum, Chemicals IF-Exports IF-Imports IF-Balance IF-Exports Non-metallic Products IF-Imports IF-Balance Engineering IF-Exports IF-Imports IF-Balance Other Manufacturing IF-Exports IF-Imports IF-Balance IF-Exports Construction IF-Imports IF-Balance IF-Exports Trade IF-Imports IF-Balance Finance and Insurance IF-Exports IF-Imports IF-Balance Other non-Manufacturing IF-Exports IF-Imports IF-Balance IF-Exports Total IF-Imports IF-Balance Beverages

Source: Austrian National Bank; own calculations.

56.5 188 -131.5 97.8 96.9 0.9 352.8 83.6 269.2 2375.5 1375.9 999.6 321.9 524.9 -203.0 94.0 5.3 88.7 1105.5 52.9 1052.6 0.0 0.0 0.0 17.2 2.9 14.3 4421.2 ' 2330.4 2090.8

40.1

96.6

5.6

193.6 -97.0

34.5 687.4

624.8 62.6 87.1 44.8 42.3 813.1 511.1 302.0 193.9 31.1 162.8 25.5 28.1 -2.6 2809.8 41.7 2768.1 0.0 0.0 0.0 0.0 0.0 0.0 4656.9 1287.2 3369.7

785.2 721.7 63.5 439.9 128.4 311.5 3188.6 1887.0 1301.6 515.8 556.0 -40.2 119.5 33.4 86.1 3915.3 94.6 3820.7 0.0 0.0 0.0 17.2 2.9 14.3 9078.1 3617.6 5460.5

The Impact of Direct and Indirect FDI in Eastern Europe

101

indirect FDI accounts for only 26.4% of total capital in 1996 (see Table 5.3) these firms have achieved 51.3% of total intra-firm exports and 35.6% of total intra-firm imports. Hence, these firms realized nearly two thirds of the IFT surplus total. All sectors—except food and beverages and other manufacturing—achieved an IFT surplus. Not surprisingly, the trading sector accounts for the largest share. This surplus has been achieved to a very large extent by indirect FDI. If these exports are accompanied by similar imports to the Austrian firm (which is in fact an affiliate of a foreign MNE), the overall effect on the Austrian trade balance need not be positive. Also several other studies have shown that foreign affiliates are more import-dependent than domestic firms (Neudorfer 1997; Brenton and DiMauro 1998), especially when they are 'market-oriented' rather than 'efficiency-oriented'. IFT is particularly pronounced in the engineering sector, which accounts for one-third of total intra-firm exports and 50% of total intra-firm imports. This applies to direct as well as indirect FDI and indicates that the international division of labor is well developed within this sector. In contrast to the IFF patterns of the trading sector, this pattern can be associated with a vertical production structure where intermediate goods are shipped forwards and backwards. Contrary to the expected import surplus, even this efficiencyoriented sector achieved a considerable intra-firm export surplus.10 Summarizing, the clear difference of trade and IFF patterns give rise to the assumption that direct and indirect FDI are based on different motives. V.

EMPIRICAL RESULTS

The Explanatory Power of the Motives for the Trade Structure of Parent and Affiliate Firms

Previous analysis has demonstrated the predominance of 'marketdriven' motives for Austrian FDI in CEECs (Neudorfer 1997; Altzinger and Winklhofer 1998). 'Efficiency-oriented' motives, 'lowwage costs' in particular, are only of minor importance.11 However, it has been shown that the ranking of 'efficiency-oriented' and 'market-driven' motives is different for particular industries. In the analysis that follows we evaluate the impact of these different motives on the export performance of parent and affiliate firms alike. We expect that 'market-driven' motives improve exports to CEECs by the parent firms whilst the affiliates sell most of their output at local (foreign) markets and export only small amounts to the EU. In contrast, if 'efficiency-oriented' motives dominate, we

102

Wilfried Altzinger and Christian Bellak

expect strong exports to the EU by the affiliates and only small exports to CEECs by parent firms. To test for the impact of different motives on the export performance of parent firms and affiliates we specify the following model: EXCEEC = p0 +p t M + P2W + p3S + u

[1]

EXCEEC are the share of exports to CEECs by total exports and M, W and S denominates the motives 'market potential', 'wage costs' and 'strategic' considerations. To test for the possibility that coefficients differ for direct and indirect FBI we have specified a second equation: EXCEEC = Po + ftM + P2W + p3S + P4Dj + p5MT + p6WT + p7S, + u [2] In Equation [2] we introduce a dummy variable for indirect EDI (Dj) and variables of the different motives for indirect FDI only (Ml Wj, S[). Hence we test whether there still is a different impact of motives on the export performance for direct and indirect FDI. Results of Equations [1] and [2] are shown in Table 5.10.12 It can be seen that the ranking of the motive 'market potential' indeed increases exports to CEECs of the parent firms whilst 'low-wage costs' decreases exports considerably. The value of the coefficient shows that a one-point higher ranking of the motive 'market potential' improves the export performance of the parent firm by 10.8 percentage points. Furthermore, even 'strategic considerations' are of importance for the export performance of the parent firm. All three independent variables are significant. Results for Equation [2] show that these three motives explain export performance only of direct FDI. All coefficients for indirect FDI are of weak significance.13 However, the size of the coefficients P5 to P7 shows that the 'market potential' is of much higher importance for indirect FDI than for direct FDI,14 while the impact of 'wage costs' and 'strategic considerations' for indirect FDI is considerably smaller. Remarkably, the coefficients for direct FDI remain relatively stable even for specification [2]. To test the explanatory power of these motives for the export performance of the affiliates we have specified the model shown in Equations [1] and [2] for exports of the affiliates to the EU (£XEU): EXEU = P0 + ^M + P2W + p3S + u

[3]

EXEU = p., + pTM + p2W + p3S + PA + P5MT + P6W, + p7S, + u [4]

The Impact of Direct and Indirect FDI in Eastern Europe TABLE 5.10 Independent variables Equation [1] Constant M W S 7V=76; JP=0.19 Equation [2] Constant M W S

A M, W,

s,

103

OLS Regression Results for Parent Exports to CEECs f5n

lvalue

Significance

2.75 10.82 -8.50 7.27

0.11 2.31 -1.89 1.72

0.91 0.02** 0.06* 0.09*

3.71 9.68 -8.64 8.55 -18.35 9.01 5.16 -11.24

0.13 1.87 -1.65 1.85 -0.25 0.63 0.43 -0.81

0.90 0.07* 0.10* 0.07* 0.80 0.53 0.67 0.42

JV=76; /P=0.20 ***, **, * indicate significance at the 1, 5 and 10% significance levels.

Results explaining affiliate exports to the EU are encouraging (see Table 5.11). Again 'market potential' explains most. A one-point higher ranking of this motive reduces affiliate exports to the EU by 21.2 percentage points. Also, 'strategic' motives decrease exports to the EU. In contrast, 'wage costs' increase affiliate exports. However, the quantitative impact of 'wage costs' is much lower than that of 'market potential'. As Equation [4] in Table 5.11 demonstrates, the general explanation above can be confirmed for direct FDI only. However, a thorough interpretation of the coefficients shows again that for indirect FDI a one-point higher rating of the motive 'market potential' decreases exports to the EU much stronger than for direct FDI (see Note 14). In contrast to this important difference the impact of 'strategic considerations' and 'wage costs' on exports to the EU for indirect FDI is negligible. Nevertheless, we have to keep in mind that the significance level of all three coefficients (P5 to (37) is rather low. To summarize these different explanations of parent and affiliate exports we conclude that the export performance of direct FDI is strongly explained by 'market-driven' motives, and 'wage costs' and 'strategic' motives provide additional explanations, while for indirect FDI only 'market potential' explains the export performance of the affiliates.

104

Wilfried Altzinger and Christian Bellak TABLE 5.11

OLS Regression Results for Affiliate Exports toEU

Independent variables Equation [3] Constant M W S A/=76; If=0.45 Equation [4] Constant M W S

A Mr w

i

lvalue

Significance

100.36 -21.15 6.67 -7.91

5.29 -5.97 2-03 -2.50

0.00*** 0.00*** 0.05** 0.01***

93.16 -18.85 7.96 -9.63 40.74 -14.08 -5.72 9.92

4.47 -4.92 2.11 -2.82 0.65 -1.20 -0.73 0.96

0.00*** 0.00*** 0.04** 0.01*** 0.52 0.23 0.47 0.34

^ N=76; /P=0.48

***, **, * indicate significance at the 1, 5 and 10% significance levels.

Impact of Parent and Affiliate Sales on Domestic Employment Next, we look at the impact of affiliate sales on domestic employment. For that purpose we have chosen a simple descriptive model (see Blomstrom et al. 1997). Such an approach tries to evaluate the relationship between foreign sales and domestic employment for a given level of parent sales. We have tested the following relationship: PE = p0 + I^PS + PgAS + u

[5]

where parent employment (PE) is explained by both parent sales (PS) and by affiliate sales (AS). Since from our theoretical discussion above we expect different effects of direct and indirect FDI, we test for differences with a new specification of Equation [5]:

PE =

[6]

The results for Equations [5] and [6] are presented in Table 5.12. The estimation results suggest that parent sales increase parent employment whilst higher affiliate sales reduce it. The size of the

The Impact of Direct and Indirect FDI in Eastern Europe TABLE 5.12 Independent variables

105

OLS Regression Results for Parent Employment, 1995 (3n

lvalue

Significance

Equation [5] 386.82 0.26

3.82 10.40

0.00***

PS AS-

-0.75

-2.83

0.01***

Constant

0.00***

N=74; /P=0.74 Equation [6] Constant

372.04

3.38

0.00***

PS AS

0.27 -0.88

10.60

0.00***

A

-3.23 -1.25

0.00***

-410.07

PS,

0.40

1.39

0.22 0.17

ASl

0.63

0.66

0.51

A^= 74; /?=0.76 indicate significance at the 1, 5 and 10% significance levels.

coefficients imply that an increase of parent sales by ATS 1 million induces 0.26 additional parent employees. In contrast, an additional ATS million of affiliate sales reduces parent employment by 0.75 employees.15 Due to the crudeness of this relationship, a cautious interpretation of this result is appropriate. However, it seems to be the case that larger foreign affiliate production is associated with an allocation of labor-intensive value-added stages of production to foreign countries whilst capital-intensive production is performed at home. Although such a scenario is associated with a relocation of labor, such FDI are efficiency enhancing and therefore improve the overall competitiveness of the MNE. However, a separate evaluation of this relationship for direct and indirect FDI shows considerable differences (cf. Eqn. [6]).16 First, parent firms of indirect FDI are in general much smaller than parent firms of direct FDI. Second, parent sales of indirect FDI are much more labor-intensive than parent sales of direct FDI. Regarding the effect of parent sales on parent employment for indirect FDI, the evaluation now suggests an increase of parent employment of 0.6717 from an additional ATS 1 million parent sales, whilst for direct FDI this increase is only 0.27. Considering the effect of the affiliate sales on parent employment, additional sales of ATS 1 million reduces domestic employment by 0.88, whilst this negative effect is only 0.2518 for indirect FDI.

106

Wilfried Altzinger and Christian Bellak

Aspects of the Internal Division of Labor

The results of this analysis indicate that direct FDI is more of an efficiency-type than indirect FDI. It suggests that direct FDI has stronger direct linkages between the activities of the parent firm and its affiliates in CEECs. Indeed, we are able to show empirically that firms of the direct FDI-type have improved domestic and foreign employment simultaneously by improving their internal division of labor. This is mainly due to the fact that Austrian investors in CEECs include many small and medium-sized firms, which actively started to restructure their activities via FDI in adjacent countries after 1989. Geographical proximity is a driver of FDI (Martin and Velazquez 1997; Holland and Pain 1998), reflected here in the relatively deeper integration of Austrian firms when compared to other MNEs. Proximity is expressed in such terms as easier market entry, prior information, lower transport costs. Moreover, local market shares of indirect FDI are higher than of direct FDI. In addition, (re-)exports to Austria from direct FDI are higher than from indirect FDI. Our regression analysis underpins this pattern by distinguishing between direct and indirect FDI. We explain exports to CEECs by the parent firm as well as exports to the EU by their affiliates by different motives for FDI, namely 'market-driven', 'strategic' and 'efficiency-oriented'. The results reveal that direct FDI can be much better explained by these motives (i.e. they are statistically significant) than indirect FDI (where motives, except the market motive, lack statistical significance). We explain this difference by the different linkages between parent firms and affiliates of direct and indirect FDI. In Austria, most affiliates of foreign MNEs were based on 'market seeking' motives (see Table 5.13). These results are also in line with TABLE 5.13 Selected home countries

Motives of Foreign Investors in Austria, 1996 Labor-cost

Market

Germany Switzerland Netherlands U.S.A.

2.4* 1.8 0.0 0.5

Total

1.5

69.0 54.6 73.4 69.9 66.3 69.6

EU

1.7

* Percentage of affiliates. Source: Austrian National Bank, 1998, Table 5.10.2.

Sourcing

Tax

2.1 2.1 0.0 0.5

1.5 4.8 1.6 3.2

2.3

2.6

2.1

1.7

The Impact of Direct and Indirect FDI in Eastern Europe

107

other research (e.g., Taggert and Hood 1999) on the role of decisions taken by headquarters (HQs), or in other words, the extent of affiliate autonomy: The HQ's influence is usually dominant "where central resources are directly affected or drawn upon; where longterm obligations result; and where the decisions involve standardization and a common framework of organizational routines and practices." Most of these factors apply to marketing and sales activities, which points to a low autonomy of the Austrian affiliate. This in turn might imply, that production decisions concerning CEECs are taken by the parent firm directly. The propensity of HQs to use their affiliates for the collective benefit of the enterprise as a whole increases with the unique "skills" of the unit in question (see e.g. Taggert and Hood 1999, p. 228). Furthermore, a survey among foreign affiliates of multinational enterprises in Vienna shows clearly the predominance of 'market-oriented' functions (marketing, customer services, distribution) of the Austrian affiliates which operates as a HQ for the East. Only a very small percentage of their subordinated firms in the East are active in production (7%) whilst 61% are active in distribution and 32% carry out servicing activities (Mayerhofer and Wolfmayr-Schnitzer 1997). The underlying structure of the motives indicates that the parents use their Austrian affiliate in particular for sales-related activities not only in Austria, but also in CEECs, utilizing their specific market know-how. This is consistent with Porter's explanation, that "early movers gain advantages such as being first to reap economies of scale, reducing costs through cumulative learning, establishing brand names abroad and customer relationships without direct competition, getting their pick of distribution channels, and obtaining the best locations for facilities or the best sources of raw material or other inputs." (Porter 1990, p. 47).

The changes in CEECs after 1989 created unique opportunities for foreign parent firms to enter CEEC markets through their Austrian affiliate. In CEECs, Austrian MNEs intensified their international division of labor over time and moved from sales to production. The foreign MNEs located in Austria did not follow this sequence. This does, however, not imply that both groups' activities in CEECs will differ, as the latter group organizes their 'strategic' and 'efficiencyoriented' FDI not via their Austrian affiliate. VI.

SUMMARY

The linkages between trade and FDI become more strong and complex as the globalization of firms and countries deepens. The

108

Wilfried Altzinger and Christian Bellak

complexity of trade-related issues stems inter alia from the re-organization of international production triggered off by changing firmand location-specific advantages. The opening of Eastern Europe was an event that stimulated many reactions of foreign firms to enter the emerging markets and also exploit location advantages there. The privatization process provided unique opportunities—which initially were used primarily by companies of neighboring countries such as Austria—to restructure existing activities and at the same time to expand their activities. The FDI originating from these countries were either carried out by indigenous firms or by subsidiaries (sometimes regional headquarters) of foreign MNEs located there. These FDI were termed direct and indirect FDI. We have found that FDI in CEECs by direct and indirect investors are motivated by different factors. Foreign-owned firms (indirect FDI) use their Austrian affiliates as bridgeheads and engage primarily in 'market-oriented' FDI in CEECs. The fact that a large wage gap still exists suggests that direct FDI engages in a re-allocation of labor-intensive activities to CEECs. The additional fixed costs in production relocation are thus partly balanced by lower variable costs. In addition, it is most likely, that the Austrian firm enjoys cost advantages vis-a-vis local firms deriving from higher production efficiency which improves the position in the local market. Both factors contribute to sustainable competitive advantage at home, resulting in an overall (net) increase in domestic employment. This is reflected by the superior development of domestic sales and employment of direct FDI shown above. Direct FDI has much stronger trade linkages between the parent firm and its affiliates in CEECs. Generally, it seems to be that firms of the direct FDI-type have improved domestic and foreign employment simultaneously by improving their internal division of labor internationally.19 Three issues are involved here, namely the microeconomic logic behind the aggregate effect, the relationship between headquarters and affiliate, and the possible change of effects over time. First, the results derived here on an aggregated level also bear some microeconomic logic as argued in studies about the division of labor between parent and affiliates, and the autonomy of affiliates in particular. Such studies take the value-added chain as a starting point. The importance and quality of the activity of an affiliate within the internal division of labor of the MNE determines the degree of autonomy and inter alia whether the affiliate itself engages in affiliates in foreign countries (indirect FDI). The affiliates' activities range from simple assembly operations to World Mandate status. Young et al (1994) describe "developmental affiliates" as firms which are able to combine their competitive advantage (provided by the

The Impact of Direct and Indirect FDI in Eastern Europe

109

parent) and indigenous resources in a unique way. The market know-how of Eastern Europe from prior exporting is such a factor which in combination with the product or service results in a unique position of the Austrian affiliate within the whole group of the MNE. Second, from the viewpoint of a national economy, the basic difference between direct and indirect FDI is related to the aspect of the locus of decision-making (Bartlett and Ghoshal 1989; Dunning 1993; Birkinshaw and Morrison 1995). Sometimes, a "metropolitan-hinterland" relationship is suggested, where the headquarters is responsible for the strategy, the affiliate for operational sales targets. The trade structure of the Austrian headquarters and her FDI compared to the foreign affiliate in Austria and her FDI resembles this type of relationship. In particular, the Austrian affiliate can be used by the foreign parent for transit trade to her affiliate in the CEEC (indirect FDI). Where substantial business decisions are concerned, MNEs seem to manage their foreign affiliates on a very short leash. This may affect production activities of foreign MNEs in CEECs which are not organized via their Austrian affiliate, but directly from the parent abroad (see right dashed arrow in Figure 5.1). Third, the Austrian National Bank concludes that, "Austrian FDI in the CEECs has become controlled more and more by Austrian firms" (Neudorfer 1997, p. 57). Also, our survey included a question on the future strategies of investors in CEECs and although the plans of firms need not materialise in pmxi, the answers point to the same direction: the survey shows a relatively higher share of direct FDI who intend to engage in "production" in the future, while the ratio is much lower for indirect investors. On the other hand, an expansion of "distribution and services" is intended by a higher number of indirect FDI than of direct FDI. This actual or intended change is explained by several factors: (1) the specific experience of the affiliate located in Austria might have been lost towards the affiliate in CEECs;20 (2) HQs outside Austria may have already built up their own CEEC-competence, so that the Austrian subsidiary lost its unique position within the MNE; and (3) over time, the relationship between the HQ and the affiliate may change, simply because the firm- and location-specific advantages change. Indirect FDI nevertheless remain an important determinant of the domestic employment effect of Austrian FDI in CEECs. This chapter provides evidence that a division between different types of investors sheds new light on the question of production relocation. In particular, the specific argument used here is that the employment effect depends not only on the amount of FDI, but also on the ownership structure of investors.

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REFERENCES Agarwal, J. (1996) Does Foreign Direct Investment Contribute to Unemployment in Home Countries?, Kiel Working Papers, No. 765. Altzinger, W. and Winklhofer, R. (1998) General Patterns of Austria's FDI in Central and Eastern Europe and a Case Study, Journal of International Relations and Development, l(l-2):65-83. Altzinger, W., Beer, E. and Bellak, C. (1998) Arbeitsplatzverlagerung nach Osteuropa, Wirtschaft und Gesellschaft, 24(4):475-502. Andersen, P.S. and Hainaut, P. (1998) Foreign Direct Investment and Employment in the Industrial Countries, BIS Working Paper, No. 61, November. Austrian National Bank (1998) Statistische Monatshefte, No. 6, Vienna. Barrell, R. and Pain, N. (1997) Foreign Direct Investment, Technological Change and Economic Growth Within Europe, The Economic Journal, 107 (445): 1770-1786. Bartlett, C. and Ghoshal, S. (1989) Managing Across Borders: The Transnational Solution, Harvard Business School Press, Boston, Massachusetts. Bellak, C. (1997) Austrian Manufacturing MNEs: Long Term Perspectives, Journal of Business History, 39 (1) :47-71. Bellak, C. (1998) Lessons from Austria's Postwar Pattern of Inward FDI for CEECs, Research Report No. 251, The Vienna Institute of Comparative Economic Studies, Vienna. Bergsten, C.F., Horst, T, Moran, Th. H. (1978) American Multinationals and American Interests, The Brookings Institution, Washington, B.C. Birkinshaw, J.M. and Morrison, AJ. (1995) Configurations of Strategy and Structure in Subsidiaries of Multinational Corporations, Journal of International Business Studies, 26(4):729-753. Blomstrom, M., Fors, G. and Lipsey, R.E. (1997) Foreign Direct Investment and Employment: Home Country Experience in the United States and Sweden, The Economic Journal, 107 (445): 1787-1797. Braunerhjelm, P. (1998) Organisation of the Firm, Foreign Production and Trade, in: Braunerhjelm, P. and Ekholm, K. (Eds.), The Geography of Multinational Firms, The Research Institute of Industrial Economics (IUI), Stockholm: 77-97. Brenton, P. and DiMauro, F. (1998) The Potential Magnitude and Impact of FDI Flows to CEECs, CEPS Working Document, No. 116. Cantwell, J.A. (1994) The Relationship between International Trade and International Production, in: Greenaway, D. and Winters, L.A. (Eds.), Surveys in International Trade, Blackwell, Oxford: 303-328. Dunning, J.H. (1993) Multinational Enterprises and the Global Economy, AddisonWesley, Wokingham. Graham, E. (1996) On the Relationship Among Foreign Direct Investment and International Trade in the Manufacturing Sector: Empirical Results for the United States and Japan, WTO Working Paper, No. 8. Gray, H.P. (1992) The Interface between the Theories of International Trade and International Production, in: Buckley, PJ. and Casson, M.C. (Eds.), Multinational Enterprise and International Direct Investment: Essays in Honour of John H. Dunning, Edward Elgar Publishers, Cheltenham: 41-53. Gray, H.P. (1996) The Eclectic Paradigm: The Next Generation, Transnational Corporations, 5(2): 51-66.

The Impact of Direct and Indirect FDI in Eastern Europe

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Gray, H.P. (1999) Global Economic Involvement: A Synthesis of Modern International Economics, Copenhagen Business School Press, Copenhagen. Holland, D. and Pain, N. (1998) The Diffusion of Innovations in Central and Eastern Europe: A Study of Determinants and Impact of Foreign Direct Investment, National Institute of Economic and Social Research, Discussion Paper, No. 137. Lankes, H.-P. and Venables, A.J. (1996) FDI in Economic Transition: The Changing Pattern of Investment, Economics of Transition, 4(2):331-347. Lipsey, R.E. (1994) Outward Direct Investment and the U.S. Economy, NBER Working Paper, No. 4691, Cambridge. Lipsey, R.E. and Weiss, M. (1981) Foreign Production and Exports in Manufacturing Industries, Review of Economics and Statistics, LXIII(4): 488-494. Martin, C. and Velazquez, F. (1997) The Determining Factors of Foreign Direct Investment in Spain and the Rest of the OECD: Lessons for the CEECs, CEPR Discussion Paper, No. 1637. Mayrhofer, P. and Wolfmayr-Schnitzer, Y. (1997) Gateway Cities in the Process of Regional Integration in Central and Eastern Europe: The Case of Vienna, in: Biffl, G. (Ed.), Migration, Free Trade and Regional Integration in Central and Eastern Europe, Vienna: 181-213. Neudorfer, P. (1997) The Opening of Central and Eastern Europe, Focus on Transition, No. 2, Austrian National Bank: 52-68. Norusis, M.J. (1997) SPSS 7.5 - Guide to Data Analysis, Upper Saddle River, Prentice Hall, New Jersey. Porter, M. (1990) The Competitive Advantage of Nations, The Free Press, New York. Schroter, H.G. (1994) Foreign Direct Investment and Mentality: The Nearby Factor in Austrian, German and Swiss Investment, in: Pohl, H. (Ed.), Transnational Investment from the 19th Century to the Present, Zeitschrift fur Unternehmensgeschichte, Beiheft 81, Franz Steiner Verlag, Stuttgart: 205-226. Stankovsky, J. (1999) Osterreichische Direktinvestitionen in Osteuropa, WIFO Monatsberichte, 72(2):113-127. Taggert, J. and Hood, N. (1999) Determinants of Autonomy in Multinational Corporation Subsidiaries, European Management Journal, 17(2):226-236. Young, S., Hood, N. and Peters, E. (1994) Multinational Enterprises and Regional Economic Development, Regional Studies, 28(7) :657-677. United Nations (1998) World Investment Report 1998: Trends and Determinants, United Nations: New York and Geneva.

NOTES 1.

2. 3.

Earlier versions of this paper were presented at the Vienna University of Economics, Forschungsschwerpunkt "Employment and Growth in Europe"; at the INFER Workshop, (Speyer, Germany); and the "Erster Osterreichischer Arbeitsmarktworkshop" (Vienna, Austria). The authors gratefully acknowledge provision of detailed data by Mr. Rene Dell'mour (Austrian National Bank). Helpful comments were received by John Dunning, Helmuth Hofer, Michael Pfaffermayer and the editors. The term "ownership" does not refer to the shareholders' nationality. Although at first glance this may seem as a contradiction in terms it is nevertheless very important.

112

4.

5. 6. 7. 8. 9. 10.

11.

12.

13. 14.

15. 16. 17. 18. 19. 20.

Wi Ifried A Itzinger and Christian Bellak

Since we do not have sufficient information of the counterfactual scenario—which no doubt would differ between direct and indirect FDI—we use a direct estimation method in the empirical part of the paper. The industrial distribution of Austrian investment in CEECs in Table 5.4 is displayed by the classification of the host country. Two very large banks (RZB and Creditanstalt/Bank Austria) are 'market leaders' in CEECs. Indirect FDI will in fact only invest in holding companies by their parent firm which is located outside Austria and therefore is not be displayed in Table 5.4. Since not every firm replied to all questions the number of respondents in Tables 5.5-5.8 is always below the total of 150. Within the period 1989-95, 80% of the firms exhibited growing parent sales, whereas 20% of the sample had declining parent sales. However, a separate analysis of these two groups of firms does not show major differences. It should be emphasized that the industry classification is that of the host country, therefore the IFT of the engineering sector does not include a large proportion of finished goods as they would be classified under the heading 'trading sector'. Market-driven motives are, among others, market potential and proximity to customers whilst efficiency-oriented motives are low wage costs, availability of skilled labor, intermediate inputs and procurement. Questions on motives were of a close-ended variety where the degrees of importance were based on a four-point scale using irrelevant (1), of minor relevance (2), important (3), and very important (4). Results are shown only for selected motives. Certainly, the weak explanatory power of this regression is partly due to the low number of observations for indirect FDI. We have to note that for indirect FDI the impact of 'market potential' on exports can be calculated only by adding the coefficients (3j and P5. The same holds for 'wage costs' (adding (32 and (36) and 'strategic considerations' (adding (33 and (37). However, the difference of these two coefficients is mainly due to different labor-output relations between Austria and the CEECs. For a proper interpretation of the coefficients in Eqn. [6] see Note 14. =(0.27 + 0.40) = (-0.88 + 0.63-) Case study evidence presented in Altzinger et al. (1998) supports this conclusion. It has been emphasized by Gray (1996) that in a dynamic view the locationspecific advantages might change quite rapidly.

The Role of Foreign Owned Firms and some Determinants of Inward Foreign Direct Investment in the Moroccan Manufacturing Sector SAAD LARAQUI1

I.

INTRODUCTION

This chapter examines the respective determinants of French and American foreign investment (FDI) in Morocco and the way in which Moroccan affiliates are viewed by the two sets of parent corporations. Utilizing Dunning's OLI (eclectic) paradigm of international production (Dunning 1993a), this chapter seeks to determine why the FDI took place in Morocco, whether there exist substantial differences between the French and the American reasons for FDI and whether the parent corporations have much the same expectations of their affiliates.2 As the results demonstrate, there is variation across industries as well as between parent countries. The research is based on a field study of Moroccan affiliates conducted in 1994 and 1995 using questionnaires sent to the parent corporation's head office. The chapter provides a brief overview of inward FDI into Morocco over time by source country and activity. Further on it reports on the way in which the data were generated, reports the results and finally summarizes the findings. II. STRUCTURE, CHARACTERISTICS AND PERFORMANCE OF THE MANUFACTURING SECTOR IN MOROCCO

Morocco has been concerned to make its economy more attractive to foreign multinational enterprises (MNEs), largely through 773

114

Saad Laraqui

liberalization of the economy and privatizing state-owned enterprises. The proceeds of privatization are to be devoted to creation of physical infrastructure. This macro-organizational policy contrasts sharply with the policies in place in the early 1970s when the 'Moroccanization' Act put strict limits of the share of equity that could be held by foreign corporation. Table 6.1 shows inward FDI by foreign source country from 1990 through 1998. Looking at FDI by country of origin provides interesting data and allots the major roles to European and North American corporations. The total stock of French FDI in Morocco in 1980 was the greatest of any country and much of it took place under the colonial regime. While France remained the major investor in the 1990s, the U.S., Spain and Sweden are assuming greater importance. Currently, Morocco is modernizing the laws governing commercial activity in order to modernize its economy and to attract inward FDI. The new company law replaces legislation dating back to 1922. It aims to increase transparency, strengthen the financial standing of limited liability companies and to improve corporate governance. III. COMPARATIVE ANALYSIS OF U.S. AND FRENCH MNES' INVOLVEMENT IN MOROCCO

The purpose of the field study was to explore the opinions of senior executives of American and French MNEs about the reasons for and determinants of FDI in Morocco. The empirical research is based on the answers to a questionnaires completed between 1994 and 1995. In the first stage of our field research, we identified those major U.S. and French MNEs that operated in Morocco. An eight-page questionnaire was then mailed to Vice President (Middle East and North Africa, or Africa) at the parent company's head office. Responses were received from 38% of the U.S. firms and 7% of the French firms. In completing the questionnaire, executives were asked to rank, on a scale of 1 to 7, their perceptions of the significance of a group of ownership, location, and internalization (OLI) variables identified (7 representing the most important and 1 the least important). We choose 3.5 (highest number in the scale divided by 2) to be the mid-point of the scale even though 4 is the real mid-point and the mean. This corrects for the right skewness of the distribution of the answers (executives' bias). In addition to those listed in the questionnaire, executives were asked to identify other factors

The Role of Foreign Owned Firms TABLE 6.1 1990 1991

115

FDI by Country (in millions of Moroccan dirhams) 1992

1993

1994

1995

1996

1997

1998

1998 1996-98

575.9 9739 1.010.7 1.197.7 1.753.1 11.014.4 1.079.4 87.0 78.0 80.8 44.1 82.2 101.3 116.0 652.5 0.7 0.2 4.2 20.7 62.8 56.1 46.0 21.9 83.7 86.3 52.2 74.6 116.4 85.9 107.4 1.295.0 U.K. 891.6 163.4 87.4 113.4 213.9 17.4 Belgium 68.7 68.7 15.9 75.7 156.6 1.1 Ireland 337.3 225.0 Netherlands 104.9 135.1 188.4 27.9 4.0 Spain 154.8 244.5 809.8 670.5 259.9 280.2 194.2 U.S.A. - 92.7 293.3 364.6 551.1 486.2 385.9 Switzerland 98.0 325.5 274.9 920.5 325.1 514.7 111.7 Baharain 18.4 198.1 14.6 8.3 13.7 1.0 18.4 60.3 29.0 Kuwait 9.5 36.5 Saudi Arabia 171.4256.6 225.1 245.2 286.5 170.2 191.2 - 11.8 14.3 Tunez 11.1 8.5 UAE 22.7 148.2 234.2 254.2 173.1 381.7 48.8 Jordan 156.3 South Korea Libya Japan 27.7 Norway India Hong Kong 36.5 Turkey Singapore Sweden 22.3 70.5 78.7 239.1 540.0 Others 77.8 -

1.607.9 1.519.6 34.7 0.8 608.3 36.3 18.6 123.7 2.8 52.8 1.2 1.3 55.9 34.6 334.9 183.0 4.2 101.9 194.1 4.4 1.9 84.8 255.3 29.8 0.7 504.8 474.7 10.8 3.464.7 650.8 14.9 85.3 287.5 6.6

Total

France Germany Portugal Canada Italy

1872 3289 4259

4635

5186

3977

4371

20.0 3.5 3.8 0.3 0.7 6.7 2.2 0.4 2.4 5.6

21.3 2.3

-

-

0.0

0.1

11.5 82.7

20.5 82.6

0.5

0.2

1.9

1.7

-

-

0.0

0.0

107.3 71.7 243.5 288.7 766.7

62.0

1.4

0.9

-

0.0

0.3

308.5

7.0

3.4

-

0.0

1.4

-

0.0

3.8

45.0 50.6

1.0

0.2

80.1

1.2

0.6

-

-

0.0

0.0

30.6

-

0.0

0.1

-

22.1

0.5

0.1

3593.1 44.5

-

0.0

17.1

92.6

2.1

1.0

12337

4379 100%

100%

-

Source: Direction des Investissements Etrangers.

influencing their competitive advantages, the reasons for their choice of location and their preferred form of involvement. The perceived ranking for each of the variables was then averaged, standard deviation computed, and a two tailed £-test performed. As the following sections will describe, the tables reveal some interesting findings.

116

Saad Laraqui

The number of U.S. firms operating in Morocco in 1990 was about 50. We mailed questionnaires to all of them and after a second mailing achieved a 38% rate of return. Since more than 300 French firms are operating in Morocco, we sent questionnaires only to the top 100, which represented the majority of French FDI in Morocco (no exact figures were available). The French participation to this survey remained low (7%) despite successive mailings and phone follow-ups. The total survey participation of U.S. and French firms combined was about 17.3%. Not all the questionnaires were included in our analysis. We excluded those questionnaires that were less than satisfactory. Our final sample of analyzed firms was about two-thirds U.S. and one-third French. The main sectors of activities of the surveyed parent companies (Table 6.2) were Manufacturing (50%), followed by Agriculture and Commercial (10% each), Mining, Energy, Financial, and Information Technology (30% all combined). However, their FDI in Morocco is differently distributed (Manufacturing 47%, Agricultural 13%, and the remaining in Services 40%). The surveyed firms had been involved in FDI in Morocco for 27.9 years on average and prior to that, they had an economic interest for about 15.5 years on average. The U.S. firms taken separately had been involved in FDI in Morocco for 22.7 years on average and prior to that, they had had economic interests for 15 years on average. The French firms taken separately had been involved in FDI in Morocco for longer than the U.S. firms, about 37.5 years on average and prior to engaging in FDI they had been economically involved just a little bit longer than the U.S. firms, for about 16.4 years on average. This is clearly explained by the fact that Morocco was a French colony and, consequently, the French influence was prevalent much earlier than the U.S. influence. Prior involvement of U.S. firms was mostly licensing, distribution, or management arrangements while for French firms it was mainly export. The approximate size of U.S. initial FDI in Morocco was up to US$1 million for 45% of the firms, between US$1 and 10 million for another 45%, and between US$10 and 50 million for the remaining 10%. For the French firms, two-thirds had an original investment of up to US$1 million, and one-third between US$1 and 10 million. The approximate size of U.S. current FDI in Morocco is up to US$1 million for 27.3% of the firms, between US$1 and 10 million for 54.5%, between US$50 and 100 million for 9.1%, and US$100 million and upwards for another 9.1%. For the French firms, one-quarter had an original investment between

TABLE 6.2 1995

1996

1221.4 1628.7 Industry Textile 107.6 157.2 47.8 110.8 Public Works 1162.8 1125.1 Banking 130.7 189.8 Energy 268.9 169.5 Trade 297.7 399.9 Real Estate 98.7 5.8 Fishing 19.3 134.6 Crude Oil Service 22.5 61.5 Transport 23.7 Telecom 15.9 7.5 16.8 Insurance 72.4 Other Services 105.4 Tourism 89.0 46.3 17.1 13.7 Agriculture 484.7 366.3 Investment Consulting Other 126.2 136.8 4338.4 4543.7 Total (mdh)

FDI by Industry (in Moroccan dirhams)

Annual growth 1995-96

1997

Annual growth 1996-97

1998

33 46

-4 -33

1803.7 268.8 26.9 800.0

-24

1569.8 104.8 344.0 2102.1 2819.8 196.1 320.3 5.8 3616 16.4 25.3 1.9 128.3 473.7 25.2 560.3

8

129.7

-5

5

12439.5

174

132 -3 -31 -37 34 -94 597 -63 -33 -55 -31 -48 -20

Source: Ministere du Commerce et de 1'Industrie.

210 87

2057 16 -20 0 2586 -

226.7 53.2 170.1 -

-27 59 -75 77 923 84 53

201.2 270.8

Annual growth 1997-98

Averag Total Sector's Annual Annual Annual Average annual growth growth growth annual 1995-98 %of growth total 1995-96 1996-97 1997-98 growth 1 995-98 (%) 1995-98 1995-98

15

15

156

56

-92 -62 -93 38 -29

83

24.0 2.5

33 46

-4 -33

15 156

132

210

-92

7

2.1 20.0

56 83

644

12.9

87 2057

-62 -93

644

6 -5

3.5 4.8

-3 -31 -37

16

38

6

34

-20

-29

-5

0 2586 -27 59 -75 77 923 84 53

817

241

-95 -

1030

0.6

-94

0

15.3 -

597 -

-50 -51

-47 -8

0.4 0.3

47

-28

0.1

54

33 268

1.9

817 -95 -

241 1030

8.2 12.5 2.8 197.0 139.4

54.2 262.4 14.2 133.4 4645.5

-71 115 -53 3 -63

60

2.9 0.4

-8 0

6.4 0.1

-63 -33 -55 -31 -48 -20 -24 -

2 39

2.0

8 5

100

-50 -51

15

7

0 -41 -8

47 54

-28 33

-71

268 60

115

-8

-

-53 -

-5

3

174

-63

2 39

0

6223.9 638.53 532.92 5190.84 3361.76 905.09 1244.74 162.56 3971.84 107.69 77.66 27.7 503.56 757.15 110.84 1673.99 14.2 526.13 25968.89

;H (t> O rb 0_ -n 0

n3 era" 3

O 3 0) T-i

3

118

Saad Laraqui

US$1 and 10 million, one-half between US$10 and 50 million, and the remaining quarter between US$50 and 100 million. It appears that U.S. FDI growth is faster than the French; this is predictable given that U.S. firms entered the Moroccan market at a later stage. Also, we noticed that U.S. original and current FDI is greater than that of the French, the reason being that U.S. investment is more capital-intensive. Regarding the current percentage equity ownership in Moroccan affiliate, 100% of French firms have 51% and over, while only 63.6% of the U.S. firms have 51% and over. From the number of countries where U.S. and French firms have FDI outside Morocco, it appears that U.S. firms are involved in a greater number of countries than the French. Thus, U.S. firms are more global than the French ones. However, for the approximate size of their Moroccan FDI as a percentage of their worldwide FDI, it remains relatively low; between 0.1% and 3% for the French and between 1% and 2% for the U.S.

IV.

RESULTS OF THE FIELD STUDY

We reviewed the results under a number of 'headings' which have relevance to the eclectic paradigm. In addition to the distribution of the responses of the two groups of executives (French and American) , we tested to see if there is any statistically significant difference between the two means (U T = u 2 ).

TABLE 6.3

Comparisons between Different Regions: Degree of Profitability in the Different Regions French

U.S.

Morocco Other Developing Countries Home Country Other Developed Countries Worldwide

All

ml

si

m2

s2

m

3.27 3.33 5.67 5.22 4.88

1.27 1.0 1.32 1.72 1.13

4.75 3.5

1.26 0.71

6.0

0.0

6.0

1.41

3.67 3.36 5.73 5.36

5.0

0.0

4.9

s 1.4

0.92 1.19 1.63 0.99

Mest Ho: ulu2=0 -2.33 -0.36 -0.61 -0.96 -0.27

Note: m stands for means and s stands for standard deviation. Ho: vil—u2=0 is the null hypothesis.

The Role of Foreign Owned Firms

119

Relative Profitability

Both French and U.S. firms perceive FDI in Morocco as slightly above average (3.67). The responses are tabulated in Table 6.3. However, the French firms and U.S. companies are significantly different (t= -2.33) in terms of their profitability in Morocco. Given the way most questionnaires were filled in, we believe that the way that the profitability is measured against profitability in other regions is more a perception than based on actual figures. The French firms perceive their profitability in Morocco to be above average (4.75), which conforms to the traditional colonial approach of their multinational activity. However, the U.S. firms perceive themselves as less profitable (3.27). This conforms to their global multinational activity approach in North Africa where the foreign market is perceived as being an extension or part of their global market. It is also noteworthy that the French companies perceive Morocco as being more profitable than other developing countries while the U.S. firms perceive just the opposite, the rationale being that U.S. FDI in developing countries is more concentrated in Asia where profitability may be perceived to be higher. Looking at the degree of importance in decision-making in U.S. and French MNEs, gains from Moroccan FDI are weighted differently (Table 6.4). The U.S. firms are clearly concerned with their earnings before and after taxes (5.09 and 5.45), and they do not

TABLE 6.4

Gains from Moroccan Investments: Degree of Importance in Decision-making on FDI in Morocco U.S.

Gains from Moroccan investments 1. Earning before foreign taxes from the affiliate 2. Cash inflows to the parent after foreign and domestic taxes 3. Other contributions of affiliate to parent company

French

ml

si

5.09

1.76

5.45 1.64

m2

All

West

s2

m

s

Ho: ul -Vi2=0

4.6

1.76

4.94

1.61

0.56

1.13

2.2

1.3

4.67

1.76

5.49

0.81

4.0

2.12

2.38

1.71

-3.47

Note: m stands for means and s stands for standard deviation. Ho: ul-u2=0 is the null hypothesis.

120

Saad Laraqui

take into consideration other contributions of the affiliate to the parent company (1.64). Such an attitude is consistent with findings that tax and regulatory environment have an impact on FDI (Root and Ahmed 1979; Contractor 1981; Hartman 1984; Jun 1989; Shah and Slemrod 1990; Slemrod 1989; Lizando 1990; Wallace 1990; Brewer 1991; Grubertand Mutti 1991; Shell 1991; Li and Guisinger 1992). However, French MNEs have a different approach. They are concerned with their earnings before tax (4.6) but not after foreign and domestic tax (2.2). French companies have been involved economically from the beginning of the industrialization of Morocco and consequently know very well how to take advantage of the system. Consequently there is no clear relationship between the tax and regulatory environment and FDI, which is in accordance with various other studies (UNCTC 1988; IBRD 1991; Krugman 1991; Mody and Srinivasan 1991; Mody and Wheeler 1991; Bergsman 1992). This is why French firms are above average in terms of "other contributions of affiliates to parent company". It is a fact that the taxation system in Morocco is among the highest in the region but many firms are able to avoid its full impact; French firms are familiar with those practices but U.S. MNEs are extremely rigid when it comes to certain adjustments in business activities. For the U.S. firms, contributions other than financial do not weigh heavily which could be explained by the fact they do not have any flexibility in operating outside their own defined business framework. This strong rejection of the null hypothesis (t - 5.49) is a direct consequence of this difference in behavior. V.

STRATEGIC MOTIVES FOR FDI

In terms of strategic motives for FDI, Table 6.5 shows that there were some significant differences between U.S. and French MNEs' degree of market share protection (t = 3.14). By market share protection, we are referring to the fact that in some industries Morocco used to protect the foreign investor by keeping out competition from imports. The rationale behind it was the infantindustry argument, which is less accepted as a strategy in the 1990s because it allows investing firms to reap quasi-rents. The U.S. firms (5.45) strongly value this protection, and so do the French ones but at a lower level (3.8). U.S. MNEs in Morocco do not have the same in-depth knowledge of the Moroccan market as the French do and consequently require a certain level of protectionism to minimize their risk. The behavior of both groups is supported by studies that show a positive relationship between

The Role of Foreign Owned Firms TABLE 6.5

121

Strategic Motives for FDIs: Degree of Importance in Decision-making on FDI in Morocco

U.S.

1. Protection of market share of investing company versus competition 2. Increase in global sales and market share 3. Decreasing risk through geographic diversification 4. To acquire key resources/ assets 5. Gains from economies of scale and scope 6. Responding to host country's pressure to produce locally 7. Following customers into Morocco 8. Leading or following competitors into Morocco 9. Overcoming tariff or nontariff barriers imposed by host countries 10. To safeguard supplies of raw materials

Mest

All

s

Ho: ulu2=0

4.94

1.29

3.14

0.55

5.38

1.41

-0.05

3.4

1.52

3.44

1.67

0.06

1.57

3.4

1.95

2.75

1.69

-1.11

3.36

1.29

3.4

2.3

3.38

1.59

-0.04

2.91

2.07

5.0

1.0

3.56

2.03

-2.32

2.83

1.85

5.6

0.55

3.65

2.03

-3.54

2.82

1.83

5.0

1.0

3.5

1.9

-2.69

3.55

1.69

4.0

2.12

3.69

1.78

-0.49

2.8

2.35

4.8

1.3

3.47

2.23

-1.92

ml

si

m2

s2

5.45

1.04

3.8

1.1

5.36

1.69

5.4

3.45

1.81

2.45

Note: m stands for means and s stands for standard deviation. Ho: ul—u2=0 is the null hypothesis.

effective protection and FDI (Agodo 1978; Lall and Siddharthan 1982; Kumar 1990). Another strong difference between U.S. and French MNEs is in their tendency to follow their home country customers in the Moroccan market (t - -3.54). Because of the proximity of France and Morocco and the large number of Moroccans living in and visiting France, the French MNEs (5.6) can easily be aware of the potential markets in Morocco. This is not necessarily the case with U.S. MNEs (2.91) whose approach is more rational. The U.S. MNE's attitude supports a positive relationship (Papanastassiou and Pearce 1990). As for French MNEs, their attitude is line with studies of

122

Saad Laraqui

Caves (Buckley and Dunning 1976; Saunders 1982; Hollander 1984; Vahlne and Nordstrom 1992). French MNEs (5.0) have a stronger tendency than the U.S. ones (2.91) to respond to Morocco's pressure to produce locally; and the difference is statistically significant (t = -2.31). Similarly, the French firms have a stronger tendency to lead or follow their competitors into the Moroccan market. It appears that the colonial past of Morocco has given to the French MNEs a close link to the Moroccan economy. Top French management has an extensive network in Morocco that covers the highest sphere of decisions-makers. Consequently, it is easier for them to be informed about the competition and also easier to be pressured by the Moroccan government. Because of this privileged information, French investors may be less concerned with the effect of Morroco's political situation on FDI. Some research has shown that political instability does not really affect FDI decisions. (Chase et al 1988; Fatehi-Sedeh and Safizadeh 1989; Hyun and Whitmore 1989; Lizando 1990; Brewer 1991; Mody and Wheeler 1991). For the rest of the strategic motives for FDI we tested, we did not obtain any significant difference between U.S. and French firms. However for these motives they were all either above or below the 3.5 cut-off point except for the last motive tested; that is, the safeguarding of raw materials. French FDI can be described in some cases as natural resource seeking (4.8) which is not the case for U.S. FDI—none of the U.S. firms surveyed described its FDI as being instigated by natural resource seeking. The three-quarters of the U.S. MNEs surveyed were market seeking. Both U.S. and French MNEs put little weight to the following motives when elaborating their strategies: "decreasing risk through geographical diversification", "to acquire key resources/assets", and "gains from economies of scale and scope". However, they give more importance to motives such as "increase in global sales and market share" and "overcoming tariff and non-tariff barriers imposed by host countries".

VI.

DETERMINANTS OF FDI IN MOROCCO

Ownership-Specific Advantages

Applying the eclectic paradigm, our study identified several ownership (O) factors, which seek to capture the main competitive advantages of U.S. and French MNEs in seeking to service customers in Morocco or a neighboring foreign country (Table 6.6).

The Role of Foreign Owned Firms TABLE 6.6

Firm Competitive Advantages in Morocco French

U.S.

1. Size and scope of firm 2. International experience 3. Trade marks & brand image 4. Investment in training 5. Technological advantages 6. Knowledge of local tastes and requirements of business 7. Economies of scale in production or marketing 8. Economies of geographical diversification 9. Organisational capabilities 10. Entrepreneurial culture

123

Hest

All

Ho: ulu2=0

ml

si

m2

s2

m

s

4.64 5.64

1.5

6.0 5.6

1.0

2.61

5.06 5.63

6.1 4.6

1.6

5.36

1.8

4.4

1.71

-1.21 0.18 -0.54

4.3

-2.0 0.04

1.3

6.0

5.2 4.8

1.14 1.79 0.84

4.93 5.31 4.53

1.48 1.86 1.46 1.67 1.74 1.46

1.83

3.2

1.3

3.93

1.71

1.31

4.27

2.0

3.8

2.17

4.13

2.0

0.46

5.0 4.0

1.61 1.83

5.0 4.8

2.35 2.39

5.0

1.79 1.98

-0.79

1.57 1.84

5.8 5.6

4.27

0.4

0.0

Note: m stands for means and s stands for standard deviation. Ho: ul—u2=0 is the null hypothesis.

The first observation is that none of the null hypothesis has been rejected. In terms of ownership-specific advantages, there are no significant differences between U.S. and French MNEs. However, we could still look at what are the most important ownership advantages for the U.S. and French MNEs. For the U.S. firms, "trade marks and brand image" ranked number 1 (6.1), followed by "international experience" (5.64) and "technological advantages" (5.36), and the last being "entrepreneurial culture" (4.0). This seems to correspond to the traditional characteristics of a western multinational. For the French MNEs we have a slightly different picture. They ranked "size and scope of firm" first, and "economies of scale in production or marketing" last. It may look contradictory if we are dealing with capital-intensive industries where technology plays a major role in production. However, if there are no economies of scale in production, we are certainly dealing with low technology labor-intensive sectors. Given that France is the first foreign investor in Morocco, this corresponds to our findings in which our best fit was realized with our low-tech, labor-intensive cluster. The second highest ranked ownership advantage listed by the French firms is "trade marks and brand

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image" (5.8), and third were "investment in training" and "international experience" (5.6). Location-Specific Advantages The location-specific (L) advantages hypothesized by the eclectic paradigm are those which reflect the attractions offered by Morocco as a site for MNE activity (Table 6.7). Factors Affecting the Choice of Morocco as a Location for FDl Once again the null hypothesis has not been rejected for any of the determinants tested. In that respect the U.S. and French TABLE: 6.7

Moroccan Vocational Advantages

U.S.

Importance of the following factors in choosing Morocco 1. Size and growth rate of the Moroccan economy 2. Size and nature of the city in which you are located 3. General infrastructure of Morocco 4. Geographical position of Morocco 5. Government policy toward FDI 6. General political, social and economic stability in Morocco 7. Availability of good quality and low cost inputs 8. Presence of related firms (a) suppliers (b) competitors 9. Low real cost of labor 10. Availability of skilled labor force 11. Local labor force's work ethic

French

Mest

All

s

Ho: ulVi2=0

ml

si

m2

s2

5.3

1.34

4.6

1.14

5.07

1.28

3.1

2.08

4.8

1.3

3.67

1.99 -1.82

4.2

0.92

5.2

1.3

4.36

0.93 -1.9

3.8

1.62

5.0

1.58

4.2

1.66 -1.49

5.2 5.4

0.79 0.84

4.6 6.0

2.07 0.71

5.0 5.6

1.31 0.9 0.83 -1.49

5.0

1.41

3.8

1.3

4.6

1.45

3.56 4.0 4.5 4.44

1.51 0.58 1.18 1.24

3.6 4.0 3.8 4.8

0.89 1.0 1.1 1.64

3.57 4.0 4.27 4.57

1.28 -0.07 0.74 0.0 1.16 1.21 1.34 -0.52

5.11

1.27

4.25

1.71

4.85

1.41

Note: m stands for means and s stands for standard deviation. Ho: ul—u2=0 is the null hypothesis.

1.09

1.74

1.21

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125

MNEs are not significantly different. With the exception of "size and nature of the city in which you are located" (3.1 and 4.8, respectively, for U.S. and French firms) both MNEs score at the right side of scale (3.5-7). This exception is explained by the fact that French companies are more sensitive to the acute problem of congestion in the Casablanca area. This attitude shows a positive relationship between FDI decisions on grounds of quality of location. Looking at the way these determinants have been ranked by each MNE, we have two completely different profiles. U.S. corporations ranked "size and growth rate of the Moroccan economy" (5.3) as the most important factor. As such their FDI decisions are positively related to market size and characteristics (Green and Cunningham 1975; Kobrin 1976; Root and Ahmed 1979; Dunning 1990; Papanastassiou and Pearce 1990). The U.S. MNEs ranking of other factors was: second "government policy toward FDI" (5.2), third "local labour force's work ethic" (5.11), and the last "size and nature of the city in which you are located" (3.1). For the French corporations the ranking was as follows: first "general political, social and economic stability in Morocco" (6.0), second "general infrastructure of Morocco" (5.2), third "size and nature of the city in which you are located" (4.8), and the last "presence of suppliers" (3.6). The key to explaining these differences probably lies in the history of their economic involvement with Morocco. Impact of Events Related to Integration Since the end of the 1950s and the beginning of the formation of the European Union, all the countries around the Mediterranean sea have become very concerned about how the integration of neighboring countries will impact their economies. Obviously the fear of a 'Fortress Europe' triggered much anxiety among economic leaders of these countries. Even today, and especially after the Middle East and North Africa Economic Conference in Cairo (November 1996), it appears that there are plenty of doubts about the direction that many of these countries are taking. It is not clear whether the world is looking at more economic integration or at the emergence of the Nation-States. Given its past colonial relationship with France, Morocco has a lot at stake with the completion of the EU and the different possibilities of its own economic integration with neighboring countries in the area (Table 6.8). With regard to integration, no significant difference were formed between U.S. and French businesses. The integration of the EU is

126

Saad Laraqui TABLE 6.8

Impact of Integration on Morocco French

U.S. ml

Impact of the following events on your FDI in Morocco 1. Integration of the EU 4.17 2. Disintegration of the Soviet 3.5 Union and East European Bloc 3. Creation of the United 4.91 Maghreb Arab

si

m2

Rest

All

Ho: ulu2=0

s2

1.34 1.09

4.4 3.0

1.14 0.82

4.24 3.38

1.25 1.02

-0.36 0.99

0.94

3.75

2.22

4.6

1.4

1.58

Note: m stands for means and s stands for standard deviation. Ho: ul—u2=0 is the null hypothesis.

perceived as having a positive impact on FDI in Morocco (4.24). The rationale is that Morocco is an ideal place for industries that will be transferred out of Europe. Of course Morocco will be competing with Eastern European countries and the former Soviet Bloc for U.S. and French FDI. For that reason, the disintegration of the Soviet Union and the East European Bloc is perceived as having a negative impact on Moroccan FDI (3.38). The creation of the United Maghreb Arab (UMA) is perceived to be highly desirable by both groups even though some firms prefer a limited integration between North African countries; the main reason being to exclude Libya from being part of the UMA. A few corporations are neutral and do not see any additional advantage of integration, their rationale being they are already present in all these markets. The general tendency supports Morocco's application to become a member of the EU (Table 6.9; 5.18). If Morocco becomes a member of the EU, this will add commercial attractiveness to this country because home consumers' alignment with Europeans in consumption habits will enlarge home market size. We will also see a further liberalization of the Moroccan economy, and to a lesser extent possible synergy with other European markets (especially Spain, Portugal, Canary Islands). The availability of monetary assistance will enhance the commercial position of the country. Other advantages would be the alleviation of import duties and foreign exchange restrictions. We can also foresee a social security structure

The Role of Foreign Owned Firms TABLE: 6.9

12 7

Morocco/EU Relationship: Attractiveness of Morocco for FDI U.S.

Morocco-EU membership

French

All

West

ml

si

M2

s2

m

s

Ho: ytlu2=0

5.42

1.16

4.6

2.51

5.18

1.63

0.96

Note: m stands for means and s stands for standard deviation. Ho: pi—u2=0 is the null hypothesis.

implemented, and local companies that would have better access to EU markets. The U.S. firms unanimously scored between 4 and 7 on the scale, and their standard deviation is relatively low at 1.16. However, the French firms are spread across the entire scale with a high standard deviation of 2.51. The argument is that the French investments serve mainly the domestic market and do not foresee in the future any real advantage in having Morocco as part of the EU because they are already present all over Europe. This argument is limited in scope since it does not take into consideration the static effects of economic integration which improve the efficiency of resource allocation, and the dynamic effects which involve internal and external efficiencies that are the result of changes in market size. The rationale behind French investments in Morocco often need to be linked to the historical colonial past of these two countries. Internalization-Specific Advantages The final set of advantages—the internalization (I) advantages—address the issue of the form or modality of overseas involvement. We did not test empirically any specific variable, but it is rather interesting to note that the majority of understandable or intelligible answers came from U.S. MNEs. On the one hand, it seems that most French corporations have a pre-set relationship with Morocco dating from colonial times. Questions related to internalization were left blank, with question marks or with a few words generally about market control. On the other hand, most U.S. corporations have clearly stated their management philosophy or corporate policies and the

128

Saad Laraqui

rationale behind them. The strongest arguments were made for the 100% ownership, to better market their products, to have a development plan along the parent company criteria, and to have the ability and control to undertake large projects funded by the World Bank or other international development agencies. Some firms have clearly stated that they prefer to avoid joint ventures and strategic alliances with local partners. The absence of a well-defined and fair legal framework to protect their own interests is felt. Any other nonequity arrangements would not become more important over the next 5 years even though some firms may consider some logistical arrangements with competitors, which would provide some economies of scale. VII. CONCLUSION The Future of FDI in Morocco: Obstacles and Challenges

We could almost say that the two groups are echoing each other in their perceptions of the obstacles to future FDI in Morocco. The main obstacles are the slowness of the administration to grant permits and negotiate major issues, the unfair taxation system with little or no tax incentives, and the lack of clear, fair and respected 'rules of the game' especially regarding legal procedures. Other issues such as the lack of infrastructure and the improvement of the local education system have been mentioned. The challenges are clear. There is a need to lower or totally remove these obstacles. As stated by an executive of a U.S. MNE, "immediate action instead of lip service" is needed to improve the general investment climate. A modernized government system without corruption is required to implement the reforms needed to liberalize the economy (exchange rate, interest rate, privatization, creation of capital markets, modernized regulations). The challenge is also to make all these changes and be able to attract new investments in sectors such as infrastructure, tourism, trade, and manufacturing. According to the survey questionnaire, there are numerous economic benefits to the Moroccan economy, which arises from foreign direct investment. The main ones in the short term are higher employment, improved quality of products and services, training of local people in modern business methods, foreign exchange earnings, and supply of the local market with a state-ofthe-art technology. Subsequent benefits are development and economic growth. More specific issues have been raised such as the professional assistance to address the needs of improving the

The Role of Foreign Owned Firms

129

information infrastructure, and the privatization process that should yield higher revenues to the State. Morocco is nearing the point where it has adopted the critical mass of policies needed for a quantum jump in economic performance led by the private sector. Already, the early real devaluation, coupled with a shift in relative incentives toward exports, has helped to produce the tremendous growth in manufactured exports during the 1980s. Morocco also begins the new century with an important opportunity to deepen its integration with the industrialized nations, notably the European Communities but also North America and Japan. Thus, the vision for Morocco's future must accord with this progressively closer association with industrialized countries, with all the attendant requirements for more liberalized external trade to become more efficient, more widely used industrial norms and standards to compete in export markets, stronger auditing and better financial disclosure to compete for international capital, more active efforts to assure and promote domestic competition, and stronger measures to accelerate social development. In general, Moroccan economic growth rates in the past are a poor guide for what the future should be. During 1960-90, compared with 67 other developing countries, Morocco was average (with an annual GDP growth rate averaging slightly above 5%), despite the fact that many policies in Morocco—low inflation, a low parallel exchange rate premium, and high public expenditure on economic services—were well above average. The 1980s were generally worse—in Morocco as elsewhere in the developing world—with GDP growth 2 percentage points lower than in the 1970s; but the 1980s were a period of stringent adjustment with minimal foreign investment and continued recourse to rescheduling to deal with a substantial debt overhang. In general, Morocco has underperformed, held back by repressive financial policies, inward trade biases, non-productive public expenditures, a negative attitude toward foreign investment, and controls on private sector activities. The latter part of the 1980s provides a glimpse of what can be achieved: for example, non-phosphate manufactured exports grew by over 15% a year in constant prices during 1986-91, taking advantage of strong export incentives; and foreign direct investment increased by about 150% in 2 years, after government virtually eliminated controls. The example of other countries also shows what should be possible in Morocco. For example, GDP in the nine highest performing East Asian economies expanded an average of 2

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Saad Laraqui

percentage points faster per year than in Morocco during 1960-90. A normative vision for the future should be based on some overall targets for the beginning of the 2000s, and some benchmarks against which to monitor progress in the action program designed to achieve the targets. A sign of success would be that private investment rises from its current level of 12-13% of GDP to 15-18%. By then, the private sector should account for a substantial share of electricity generation, telecommunications services, water distribution and other municipal services, and the operation of various infrastructure installations including ports, airports, industrial zones, and highways—in contrast to its negligible share in these activities today. For industry, during the beginning of the 2000s, Morocco should aim to approach double-digit growth of private industrial output, an even faster growth of exports, a rising contribution of manufacturing to GDP and to exports, increased equity investment in industrial assets (and technology) especially from abroad, and more competitive products (as manifested in more diversified export products and markets). For tourism, the emerging growth strategy seeks to increase both the number of tourists (doubling non-Maghreb arrivals to 3 million per year by 2000 would represent less than 5% annual growth since the peak year of 1987) and the share of high-spending tourists. Tourism should be expected to rise as a share of GDP, and as a share of foreign exchange earnings. Achieving these targets, however, will require strong effort and investment to restructure the sector, aimed at diversifying the tourism product, improving quality to encourage repeated visits, and strengthening international promotional efforts. The challenge is to encourage the private sector to organize and take the lead in these tasks. Here again, MNEs can play an important role. The targets for private sector agriculture are more difficult to set, especially if closer integration with the EU reduces the protection for low-value grain crops and gives greater market access for higher value fruits, vegetables, and processed goods. Government support for the private sector should be guided by a broad principle—neutrality of macroeconomic incentives, including trade and tax policy—across sectors. Any special incentives should be aimed at encouraging more private spending in key areas, for example developing technology, and improving labor. Public expenditures should be increasingly coupled with private spending to assure high quality economic infrastructure and related services, including improved basic health and education of the work force.

The Role of Foreign Owned Firms

131

Main Findings

Given the globalization of the world economy, it is not surprising that there are no major differences between the behavior of French and U.S. multinationals. We found very few statistical differences. The rationale behind the few differences in terms of behavior are related to the fact that France has a level of understanding of the Moroccan market that cannot be duplicated by any other country due to French colonialism in North Africa and the time factor. Also, it is rather interesting to notice that the degree of importance of each variable tested in the study corresponds to the major findings in the literature of international business. In terms of Morocco as a location for FDI, U.S. and French MNEs gave a lot of weight to the "size and growth rate of the Moroccan economy" (5.07) and to the "general political, social and economic stability in Morocco" (5.6). In terms of ownership-specific advantages that U.S. and French firms possess, "international experience" (5.63), "technological advantages" (5.31), and "size and scope of the firm" appeared to be the main strengths of the surveyed firms. However, for each country the ranking of these variables is often different which is usually linked to some business behavioral differences. As the Moroccan currency is pegged to a basket of international currencies to help stabilize it, U.S. and French MNEs are not overly concerned by exchange rate stability on their foreign direct investments. Other researchers show similar findings that support this lack of relationship between the factor and FDI (Lizando 1990; Wallace 1990; Froot and Stein 1991; Mody and Srinivasan 1991). Although wages are low in Morocco, they have not been major factor pulling FDIs into the country. As such there is no real relationship between real wage costs and FDI decisions of the MNEs (Papanastassiou and Pearce 1990; Kravis and Lipsey 1982). The majority of the determinants that did not show any significant relationship outside of the realm of Gray's study of international economic involvement. In the light of our findings it appears that Gray's determinant classifications into the five categories (differences in resources; financial factors; transborder impediments to the flows of goods and investment; internal differences in the commercial environment; and cultural factors) is particularly significant (Gray 1999). This is not entirely collaborated by the Narula and Wakelin (1998) findings that show how country-level determinants affect international competitiveness of a country but that can probably be explained by the level of industrialization in Morocco.

1 32

Saad Laraqui

REFERENCES Agodo, O. (1978) The Determinants of US Private Manufacturing Investments in Africa, Journal of International Business Studies, 9(3):95-107. Bergsman, J. (1992) Private Communication, July, World Bank, Washington, DC. Brewer, T. (1991) Foreign Direct Investment in Developing Countries: Patterns, Policies and Prospects, World Bank PRE Working Paper, No. 712, Washington, DC. Buckley, PJ.C. and Dunning, J.H. (1976), The industrial structure of US direct invesent in the UKs, Journal of International Business Studies, 7, Summer, 5-13. Chase, C.D., Huhle, J.L. and Walther, C.H. (1988) The Relevance of Political Risk in Direct Foreign Investment, Management International Review, 8(2):31-38. Contractor, FJ. (1981) International Technology Licensing Compensation: Costs and Negotiation, Lexington Books, Lexington, Massachusetts. Dunning, J.H. (1990) The Globalization of Firms and the Competitiveness of Nations, The Crafoord Lecture, 1989. Lund: Lund University Press. Dunning, J.H. (1993a) Multinational Enterprises and the Global Economy, Addison Wesley, Wokingham, Berkshire. Fatehi-Sedeh, K. and Safizadeh, H.M. (1989) The Association Between Political Instability and Flow of Foreign Direct Investment, Management International Froot, K. and Stein, J.C. (1991) Exchange Rates and Foreign Direct Investment: An Imperfect Capital Market Approach, Quarterly Journal of Economics, 106, November: 1191-1217. Gray, H.P. (1999) Global Economic Involvement - A synthesis of Modern International Economics, Copenhagen Business School Press, Copenhagen. Green, R.T. and Cunningham, W.H. (1975) The Determinants of US Foreign Investment: An Empirical Examination, Management International Review, 15:113-120. Grubert, H. and Mutti, J. (1991) Taxes, tariffs and transfer pricing in multinational corporation decision taking, Review of Economics and Statistics, 73:285-293. Hartman, D. (1984) Tax Policy and Foreign Direct Investment in the United States, National Tax Journal, 37:475-488. Hollander, A. (1984) Foreign Location Decision by US Transnational Firms: An Empirical Study, Managerial and Decision Economics, 5(1):7-18. Hyun, J.T and Whitmore, K. (1989) Japanese Direct Foreign Investment: Patterns and Implications for Developing Countries, Working Paper Industry Series, No. 1, Industry and Energy Department, Washington. IBRD (1991) The Role of Foreign Direct Investment, Development Committee Meeting Paper, World Bank, Washington, DC. Jun, J. (1989) Tax Policy and International Direct Investment, NBER Working Paper, No. 3048. Kobrin, S.J. (1976) The Environmental Determinants of Foreign Direct Investment: An Expost Empirical Analysis, Journal of International Business Studies, 6:29-42. Kravis, I.B. and Lipsey, R.E. (1982) The Location of Overseas Production for Exports by US Multinational Firms, Journal of International Economics,

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Kumar, N. (1990) Multinational Enterprises in India, Routledge, London. Lall, S. and Siddharthan, N.S. (1982) The Monopolistic Advantages of Multinationals: Lessons from Foreign Investment in the US, The Economic Journal, 92:668-683. Li, J. and Guisinger, S. (1992) The Globalisation of Service Multinationals in the 'Triad' Nations: Japan, Europe and North America, Journal of International Business Studies, 23:675-696. Lizando, S. (1990) Foreign Direct Investment, IMF Working Paper, International Monetary Fund, Washington, DC. Mody, A. and Srinivasan, K. (1991) Foreign Direct Investment Study, mimeo, World Bank, Washington, DC. Mody, A. and Wheeler, D. (1991) Foreign Direct Investment Study, mimeo, World Bank, Washington, DC. Narula, R. and Wakelin, K. (1998) Technological Competitiveness, Trade and Foreign Direct Investment, Structural Change and Economic Dynamics, 9:373-387. Papanastassiou, M. and Pearce, R.D. (1990) Host Country Characteristics and the Sourcing Behavior of UK Manufacturing Industry, Discussion Papers in International Investment and Business Studies, Series B, Vol. II, No. 140, Department of Economics, University of Reading. Root, F.R. and Ahmed, A. (1979) Empirical determinants of manufacturing direct foreign investment in developing countries, Economic Development and Cultural Change, 27(4):751-767. Saunders, R.S. (1982) The Determinants of Inter-industry Variation of Foreign Ownership in Canadian Manufacturing, Canadian Journal of Economics, 15(l):77-84. Shah, A. and Slemrod, J. (1990) Tax sensitivity of foreign direct investment: An empirical assessment, Working Paper Series, Washington DC: The World Bank June. Shell (1991) Foreign Direct Investment Study, mimeo, World Bank, Washington, DC. Slemrod, J. (1989) Tax Effect of Foreign Direct Investment in the US: Evidence from Cross-country Comparison, National Bureau of 'Economic Research, July. UNCTC (1988) Transnational Corporations in World Development: Trends and Prospects, 4th Survey, United Nations, New York. Vahlne, J.E. and Nordstrom, KA. (1992) Is the Globe Shrinking: Psychic Distance and the Establishment of Swedish Sales Subsidiaries During the Last 100 Years, mimeo, Stockholm. Wallace, C.D. (1990) Foreign Direct Investment in the 1990s: A New Climate in the Third World, Martinus Nijhoff Publishers, Boston and London.

NOTES 1.

The author would like to thank seminar participants of the Ninth International Conference of the International Trade and Finance Association in Casablanca, Morocco (June 1999). In particular, I thank Peter Gray and Rajneesh Narula for helpful comments.

134

2.

Saad Laraqui

The selection of affiliates of French and the United States is designed to contrast two different business cultures as well as to identify the importance of a close historical/colonial association.

Incorporating Trade into the Investment Development Path JOHN H. DUNNING, CHANG-SU KIM AND JYH-DER LIN1

I.

INTRODUCTION

This chapter has an explicit purpose. It is to take a first step in incorporating trade levels and patterns into the notion of the investment development path (IDP)—a notion which seeks to relate the stock of inward and outward direct investment (inward FDI and outward FDI) position of countries to their stages of development and economic structures. The chapter proceeds as follows. In the following section, we present a truncated overview of the IDP, and why we believe that, by relating its trajectory to the changing levels and patterns of trade—viz. the trade development path (TDP)—we may better understand the combined interaction between the two modes of cross-border transactions and the pace and pattern of economic development. In the next section, we briefly describe the contents of the IDP and TDP and formulate a number of general propositions. Then we set out some specific hypotheses, which seek to relate the changing sectoral structure of trade and FDI in Korea and Taiwan over the last 30 years to the growth of their gross national product (GNP) per capita. The last part briefly summarizes our conclusions. II.

SOME ANALYTICAL ISSUES

The IDP

The IDP seeks to explain the international direct investment position of a country in terms of the juxtaposition between the locational 735

136

John H. Dunning, Chang-su Kim andJyh-der Lin

attractions of its endogenous resources, capabilities and markets, visa-vis those of other countries, and the ownership or competitive advantages of its firms vis-a-vis those of other nationalities. More specifically, it avers that, as countries increase their gross national product (GNP) per capita and the created asset component of their resources and capabilities,3 so the level, significance and pattern of their inward FDI and outward FDI, and the relationship between them displays a systematic change. In their earliest stage of economic development (Stage 1), countries have few location-specific (L) advantages to attract inward FDI, and their firms possess virtually no ownership-specific (O) advantages to engage in outward FDI. As countries begin to industrialize—and the focus of this paper is on two industrializing countries—the quality of their indigenous and immobile resources and capabilities, including their institutional capabilities and social infrastructure, improves, as does their domestic spending power. This starts to attract inward FDI, but, at this stage—Stage 2—apart from a limited amount of natural resource and created asset seeking investment, outward FDI is still minimal. This, however, changes in Stage 3 as indigenous firms start to generate their own O-specific advantages. They tend to exploit these firstly by exports, and then, as their foreign markets expand and/or the costs of home-based production rise, by outward FDI. At this stage too, in order to become global players, industrializing country firms begin to seek out foreign technology, management skills and organizational expertise, by means of mergers and acquisitions (M&As) or strategic alliances,4 particularly with firms from the more industrialized countries. Eventually, in the later stages of the IDP,5 outward FDI might well exceed inward FDI—at least for a time—after which there is a tendency for net outward FDI to gravitate towards, and fluctuate around zero, or at very low levels relative to the total value of inward and outward FDI.6 The countries we are considering in this chapter would appear to be entering Stage 4 of their IDPs, inasmuch as, in the 1990s, outward FDI of both Korea and Taiwan began to exceed inward FDI (see Table 7.3). Notwithstanding the fact that the recent Asian crisis has caused a reconfiguration of their international direct investment positions, notably by raising the L advantages of both countries, and lowering the O advantages of Korean and Taiwanese firms—and/or their ability to acquire foreign created-assets—there is no doubt that the time-span of their transition from Stage 1, or early Stage 2 to Stage 4 has been considerably shorter than that of their earlier counterparts in Europe and the U.S. Inter alia, the emergence of the global innovating economy, and the increasing speed at which technological and organizational advances can be

Incorporating Trade into the Investment Development Path

13 7

transferred across national boundaries has helped speed up the process of industrialization. Government policy towards inbound and outbound FDI has also played an important role. For example, for most of the period under review, the Korean government restricted, by one means or another, the amount and/or type of inward FDI allowed; while, in the case of Taiwan, no outward FDI was allowed in mainland China until the late 1980s. In addition to the general proposition that the nature of trajectory of a country's IDP will be related to its GNP per capita and to such locationspecific variables as size, economic structure, absorptive capacity, openness and government policy towards FDI,7 the character and composition of both inward FDI and outward FDI is also likely to change as development proceeds. In Stages 1 and 2 of the IDP, for example, both inward and outward FDI flows are predominantly of the natural resource and market seeking type.8 At the same time, both inward FDI and outward FDI are likely to be between different industrial sectors, i.e., FDI will be mfer-industry in character. In Stages 3 and 4, as the economic structure of countries is increasingly directed towards the production of Schumpeterian (S) goods and services,9 and tends to converge with that of more advanced industrial countries, FDI flows become more of the efficiency and strategic asset-seeking variety. Moving through these stages, the composition of inward FDI and outward FDI then becomes increasingly m£ra-industry,10 and less inter-industry in character. It also tends to become knowledge and/or information intensive. The TOP

The relationship between trade and economic development is a well-researched topic.11 In this chapter, we are primarily concerned with the product composition of manufacturing imports (M) and exports (X); and how these change—particularly in their created asset intensity—as development proceeds. Our general proposition is that, at relatively low levels of GNP per capita, an industrializing country will engage primarily in inter-industry trade, importing products with a higher created asset content than those they export. As development proceeds, the created asset intensity of both M and X increases, with that of X lagging that of M. As this occurs, the proportion of intra-industry trade to total trade increases, and particularly so in the case of those products which are themselves created asset intensive. For the most part, scholarly research on the determinants of the TDP and IDP has proceeded independently, although in a schema introduced in 1986, and revised in 1995 (see Dunning and Norman

138

John H. Dunning, Chang-su Kim andJyh-der Lin

1986; Dunning 1995), an attempt was made to show how, as countries proceeded along their development paths, and as technological progress and human resource development led to an intensification of the created asset component of all products,12 so the relative significance of both intra-industry trade and intra-industry FDI would rise. At the same time, the schema suggested that, as a result of inter-industry, inbound FDI (which, almost by definition, is created asset intensive13), the created asset intensity of the host country's exports is accelerated, and with it, the growth of intraindustry trade. Finally, as a country becomes fully industrialized (i.e., it reaches Stages 4 or 5 of its IDP), much of its efficiency and strategic asset-seeking FDI is with other industrialized, or rapidly industrializing nations; and hence is of an intra-industry FDI kind. The above paragraphs then suggest there is likely to be some interface between the TDP and the IDP both at a macro-level—with both trade and FDI increasing their significance relative to the GNP of countries—and at a sectoral level. Part of this interaction may be sequential; and it is a hypothesis of this paper that changes in the industrial structure of the IDP generally lags that of the TDP; and part may occur simultaneously, as FDI and trade either complement, or substitute for, each other.14 But, whatever the case, the paradigm underpinning the explanation of trade, FDI and economic development is that of dynamic comparative advantage, suitably modified from its initial formulation, to include (1) created immobile assets, and (2) the ownership-specific advantages of particular firms. In the following section, we seek to empirically test some of these ideas, from the experience of the Korean and Taiwanese economies between 1968 and 1997. However, prior to this, in Figure 7.1, we summarize the kinds of interaction, which we might expect to find between the created asset intensity of imports and exports and that of inward and outward direct investment flows, as development proceeds; and also how we might expect the IDPs and the TDPs of countries to interact with each other. As a proxy for created asset intensity, we have taken the FDI intensity of each of the manufacturing sectors in Korea and Taiwan (at a 2, 3 or 4 digit level, depending on the data available),15 and classified these into three groups; viz. above FDI intensity (Asectors), average FDI intensity (O sectors) and below average intensity (B sectors). Further details of this procedure are set out in Appendix 7.1. III.

SOME SPECIFIC HYPOTHESES

The first hypothesis (HI) relates to the nature of the TDP. HI consists of two parts. Hla is that the proportion of total manufactured

Incorporating Trade into the Investment Development Path

139

imports accounted for by average or above average FDI intensive goods (A and O goods) will rise quite sharply in the first two stages of Korean and Taiwanese IDP, but in the third phase it will rise less sharply or even fall. This slowing down phase reflects the fact that imports of less FDIintensive goods are likely to rise, as the domestic production of these becomes less competitive in Korea and Taiwan. The second part of HI (Hlb) is that the proportion of manufactured exports accounted for by A and O goods will accelerate as economic development proceeds, but will lag that of imports. In respect of Hla the respective coefficients and J^ values were estimated by regressing imports on GNP2 as well as on GNP, in order to take account of a possible curvilinear relationship between imports and GNP. As to Hla, the data in Table 7.1 uphold a monotonous rather than a curvilinear relationship between imports and GNP. In the case of regressing imports on GNP, the correlation coefficients are higher and the ^rs are more respectable than the coefficients and ^s between imports and GNP2. The relevant correlation coefficients, their significance, and l¥s for the whole of the 30-year period are shown at the bottom of the table. In the case of Taiwanese FDI intensive imports, the sharpest rise occurred in Stage 2 of their IDP, i.e., during the 1980s. The share of this category of Korean imports rose between 1968 and 1976, then fell back in the following 5 years. Between 1982 and 1995 it fluctuated around 60-70%, since when it has risen sharply. The second part of the first proposition (Hlb) is also broadly upheld by the data. As between Taiwan and Korea, the former seems to have more clearly followed a TDP consistent with the principle of dynamic comparative advantage. In the case of Taiwan, we see that the AX+OX/TX ratio steadily rose throughout the period. In the case of Korea, however, the AX+OX/TX ratio fluctuated, as did the Am+Om/Tm ratio. As predicted, the A^+O^/T^ ratio is seen to have consistently lagged the Am+Om/Tm ratio, although the gap between these ratios steadily narrowed throughout the period. By the mid 1990s, consistent with the proposition that, as a country reaches some maturity in its industrial development—i.e., reaches Stage 4—the export of FDI intensive products is seen to be rising much more quickly than the import of such products. Our data also show that, in spite of its relatively higher GNP per capita, Taiwan lagged behind Korea in its A+O/T ratio until the 1990s in the case of imports, and the late 1990s in the case of exports. One explanation for this lagging may be the fact that the economic transformation of the Korean economy, compared with that of Taiwan, has tended to be dominated by large conglomerates. The economies of size enjoyed by these companies may well have

140

John H. Dunning, Chang-su Kim and Jyh-der Lin TABLE 7.1

The FDI Intensity of Korean and Taiwanese Imports and Exports and GNP per capita GNP per capita ($) Korea

SI 1968 1969 S2 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 S3 1986 1987 1988 1989 1990 1991 S4 1992 1993 1994 1995 1996 1997 Coefficients

tf2

54 68 85 103 124 158 216 285 385 489 649 821 964 1176 1327 1556 1758 1943 2255 2636 3126 3485 4158 4948 5457 6009 6805 7740 8486 9046 GNP GNP2

Imports ((Am+Om)/Tm) Exports ((AX+OX)/TX)

Taiwan

Korea

304 345 389 443 522 695 920 964 1132 1301 1577 1920 2344 2669 2635 2823 3167 3297 3993 5275 6333 7512 7954 8815 10470 10852 11597 12396 12872 13198

55.8 57.0 51.1 54.6 63.9 62.2 65.3 64.6 69.1 56.7 60.4 61.8 54.4 59.2 62.1 64.7 65.5 68.7 66.1 64.0 65.1 63.3 61.7 60.4 60.4 66.0 65.4 63.9 74.8 74.7 0.0002 1.1 8e~7 0.2315

Taiwan

33.2 32.0 33.0 29.3 27.1 25.2 27.9 32.8 32.9 34.4 52.7 52.6 51.3 51.9 50.9 53.0 57.4 56.7 60.0 61.5 61.5 62.4 62.8 62.9 63.5 61.8 64.1 65.9 68.8 67.9 0.0075*** -3.1e~7** 0.6282

Korea

Taiwan

10.1 10.6 5.2 7.3 37.1 38.9 36.3 38.3 32.4 18.3 18.1 21.0 19.3 17.9 15.0 17.7 20.7 21.6 25.6 34.1 36.1 35.4 36.4 37.9 40.2 42.4 46.8 53.2 56.3 58.2 0.0038**

13.6 22.6 11.1 10.7 10.5 10.2 15.7 15.9 13.6 15.6 22.2 22.8 25.1 25.2 24.8 26.7 29.3 30.5 31.8 34.3 38.8 40.2 43.8 45.8 48.6 51.4 53.3 57.9 59.3 60.9 0.0035***

0.5967

0.9213

Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level. The relevant equations for imports (Im) and exports (Ex) were as follows. IM = a+b*GNP+c*GNP2, Ex = a+b*GNP The coefficients and R2 for the imports were estimated by regressing imports on GNP2 as well as GNP in order to examine the curvilinear relationship between imports and GNP. It is difficult to precisely identify the span of each of the stages of development based upon the_ international investment position of the two countries, as both their GNPs per capita and policies towards inward and outward FDI in any given year differ from each other. But very roughly and in both cases, Stage 1 lasted between 1968 and 1969, Stage 2, which, in fact, can be broken down into two sub-periods (1970-78 and 1979-85), 1970-85, Stage 3 1986-91, and Stage 4 1992-97.

Incorporating Trade into the Investment Development Path

141

enabled them to engage in trade and FBI with a high created asset content at a relatively earlier stage of their industrial development. In Table 7.2, we set out some details of the changing industrial structure of Korean and Taiwanese imports and exports between 1968 and 1997. We find, as predicted, that the coefficients of correlation between the most FDI intensive imports and exports (A type goods) and GNP per capita are strong and positive at a 1% or 5% level; and that—again as predicted—the correlation between the least FDI intensive imports and exports (B type goods) were strongly negative, again at a 1% or 5% level. The relationship between goods of average FDI intensity (O goods) and GNP per capita was more mixed. The second hypothesis (H2) relates to the relationship between the IDP and the level and structure of a country's economic development. As with HI, H2 is sub-divided into two parts. H2a avers that both inward and outward FDI will be positively correlated with the level of economic development (i.e. GNP per capita), and that, initially, outward FDI will lag inward FDI, but later will rise more rapidly than it, before settling into a "fluctuating equilibrium."16 H2b relates the IDP to the structure of economic development. It suggests that the proportion of FDI directed to the production of above average or average FDI intensive (A+O/T) goods will rise as countries move along their IDPs, but with the proportion of FDI intensive goods accounted for by outward FDI lagging that of inward FDI. The data on inward FDI and outward FDI—as set out in Table 7.3—though less detailed or comprehensive than that on trade, support H2a. The correlation coefficients between manufacturing inward FDI and outward FDI for Korea and Taiwan and GNP per capita are positive and significant at a 1% level. The respective coefficients for the proportion of outward FDI to inward FDI are less buoyant though still significant. This is partly because, in the early part of the period, there were large percentage fluctuations in the values in both variables (and particularly outward FDI), and partly because, at the end of the period, there was a marked resurgence in inward FDI in both Korea and Taiwan, and a cutback in outward FDI in the case of Korea. The data set out in Table 7.4 suggest that H2b is only modestly supported. The correlation coefficient between the share of above average or average FDI intensive inward FDI and outward FDI flows and GNP per capita is positive for both countries, but only significant in the case of inward FDI for Taiwan and outward FDI for Korea. The disaggregated FDI data into three degrees of created asset intensity deliver more detailed information on H2b. As Table 7.5

TABLE 7.2 GNP per head ($) Korea Taiwan SI 1968 1969 S2 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 S3 1986 1987 1988 1989 1990 1991 S4 1992 1993 1994 1995 1996 1997 Coefficients

F?

54 68 85 103 124 158 216 285 385 489 649 821 964 1176 1327 1556 1758 1943 2255 2636 3126 3485 4158 4948 5457 6009 6805 7740 8486 9046

304 345 389 443 522 695 920 964 1132 1301 1577 1920 2344 2669 2635 2823 3167 3297 3993 5275 6333 7512 7954 8815 10470 10852 11597 12396 12872 13198

Proportion of A, O, and B Type Imports and Exports as a Percentage of Total Imports and Exports

Type A Korea Taiwan Imports Exports Imports Exports 26.9 30.1 33.4 35.4 42.4 49.7 36.0 43.6 43.7 31.7 33.2 34.6 31.8 33.4 34.7 35.0 33.9 33.5 44.8 43.9 47.6 45.6 43.7 43.1 45.4 46.7 46.1 46.2 54.6 57.4 0.002*** 0.5894

0.0 0.0 0.0 0.0 28.8 30.1 26.0 22.4 20.3 10.4

9.2 10.7

8.7 7.9 8.0 10.4 12.5 13.7 20.7 25.1 27.1 25.9 25.9 27.9 30.5 33.8 38.6 45.7 49.1 52.0 0.004*** 0.6597

15.0 14.3 16.6 12.4 10.4

8.5 10.9 12.0 11.6 12.3 28.9 28.6 26.2 27.2 28.2 29.1 32.0 31.5 32.8 34.4 35.7 36.8 37.5 36.7 39.9 39.4 40.7 41.8 42.6 44.4 0.0021** 0.5412

Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level. Im (or, Ex) = a+b*GNP for each type of A, O and B.

8.3 17.6

5.8 5.8 6.2 5.7 9.5 8.8 5.9 6.4 13.8 14.0 15.4 15.3 15.2 16.4 19.0 19.8 21.0 23.3 26.4 27.1 29.9 31.2 33.2 35.2 36.7 40.8 42.9 47.1 0.0027*** 0.9410

TypeO Korea Taiwan Imports Exports Imports Exports 10.1 28.9 26.9 10.6 17.7 5.2 7.3 19.2 21.5 8.3 12.5 8.8 29.3 10.3 16.0 21.0 25.5 12.2 8.0 25.2 8.9 27.3 27.3 10.3 22.7 10.6 10.0 25.8 27.4 7.6 7.3 29.7 31.6 8.3 7.9 35.2 21.3 8.9 9.0 20.1 9.0 17.5 17.7 9.5 18.0 10.4 17.3 10.0 20.5 9.6 8.7 19.3 19.3 8.2 17.7 7.4 20.2 7.2 17.3 6.2 -0.0009* -0.0001 0.2477 0.0352

18.3 17.7 16.4 17.0 16.7 16.7 16.9 20.8 21.3 22.2 23.8 24.0 25.1 24.8 22.7 23.9 25.4 25.2 27.2 27.1 25.8 25.6 25.2 26.2 23.6 22.4 23.5 24.1 26.2 23.5 0.0005 0.2303

5.3 5.0 5.3 4.9 4.3 4.5 6.3 7.0 7.6 9.2 8.4 8.8 9.7 9.9 9.6 10.2 10.2 10.6 10.8 11.1 12.5 13.1 13.9 14.6 15.4 16.2 16.6 17.1 16.4 13.9 0.0008*** 0.7829

TypeB Korea Imports Exports 44.2 43.0 48.9 45.4 36.1 37.8 34.7 35.4 30.9 43.1 39.6 38.2 45.6 40.9 37.9 35.3 34.6 31.3 33.9 36.0 34.9 36.7 38.3 39.6 34.1 34.0 34.6 36.1 25.1 25.3 -0.0012** 0.4306

89.9 89.4 94.8 92.7 62.9 61.1 63.7 61.7 67.6 81.7 81.9 79.0 80.7 82.1 84.4 82.2 79.3 78.4 70.4 65.9 63.9 64.6 63.6 62.1 59.8 57.6 53.2 46.8 43.7 41.8 -0.0039** 0.5982

Imports

Taiwan Exports

66.8 68.0 67.0 70.7 72.9 74.8 72.1 67.2 67.2 65.6 47.3 47.4 48.7 48.1 49.1 47.0 42.6 43.3 40.0 38.5 38.5 37.6 37.2 37.1 36.5 38.2 35.9 34.1 31.1 32.1 -0.0026** 0.4685

86.4 77.4 88.9 89.3 89.5 89.8 84.3 84.1 86.5 84.4 77.8 77.2 74.9 74.8 75.2 73.3 70.7 69.5 68.2 65.7 61.2 59.8 56.2 54.2 51.4 48.6 46.7 42.1 40.7 39.1 -0.0035*** 0.9207

s

<->

3•3 I

a c 3

3'

Cro

n flj Cra In C •^ §' 3

a. s03

3' (—

TABLE 7.3 GNP per capita ($) Korea Taiwan

Inward and Outward Direct Investment and GNP per capita

Inward FDI ($ mil.) Korea Taiwan Total Man. Total Man.

Outward FDI ($ mil.) Korea Taiwan Total Man. Total Man.

54 68 85 103 124 158 216 285 385 489 649 821 964 1176 1327 1556 1758 1943 2255 2636 3126 3485 4158 4948 5457 6009 6805 7740 8486 9046

<> is cumulated value.

304 345 389 443 522 695 920 964 1132 1301 1577 1920 2344 2669 2635 2823 3167 3297 3993 5275 6333 7512 7954 8815 10470 10852 11597 12396 12872 13198

0.72 0.98 0.68 0.37 0.93 0.76 0.59 0.53 1.16 1.80 1.28 1.50 1.80 2.72 1.51 1.94 0.84

0.30 0.02 0.50 0.31 0.05 0.76 0.29 0.38 0.90 1.63 0.72 1.15 2.16 5.42 3.32 1.85 1.17 0.0004* 0.4598

0.02 0.00 0.00 0.01 0.03 0.01 0.04 0.02 0.03 0.08 0.02 0.03 0.09 0.03 0.03 0.03 0.07 0.06 0.07 0.07 0.19 0.39 0.67 0.93 0.61 1.37 0.99 0.46 0.88 0.68

0.03 0.00 0.00 0.01 0.05 0.02 0.04 0.02 0.03 0.13 0.02 0.03 0.09 0.03 0.04 0.03 0.07 0.06 0.06 0.07 0.12 0.40 0.63 0.71 0.51 1.17 0.69 0.31 0.76 0.44 0.00006*** 0.8807

Incorporating Tr

1.8 1.8 66 13 90 0.0 0.1 86 109 12 0.4 0.5 107 58 139 1.0 29 163 1.2 132 3.7 127 4.1 80 58 3.4 175 249 3.2 221 7.0 7.3 160 128 189 1.4 2.4 118 83 52 3.9 4.4 124 53 142 94 <94> 12.3 13.8 164 <800>* 80 3.0 38 138 68 213 101 5.2 98 6.3 9.3 111 329 195 232 435 97 466 131 37.2 42.0 <36> 21 7.4 11.0 34 109 263 115 396 152 233 380 9.6 12.0 121 128 2 112 9.9 83 341 404 11.0 36 72 122 67 33.7 39.0 9 29 559 193 502 35.1 219 541 42.0 8 168 236 702 184 364 584 35.9 57.0 770 477 242 71.6 367 984 103.0 109 375 1419 626 86.0 219.0 478 559 1183 894 212 742 649.8 931.0 454 943 1628 504 2418 812 915.3 1611 1445 969 1552.0 895 596 2302 885.8 677 1656.0 1511 1177 941 1778 1242 378.5 887.0 693 803 605 1461 742 1206 1044 599 1876 703. 1 1137 1661.0 527 1213 542.4 781 3581 2179 1617.0 1317 402 1630 1813 4949 1941 553.8 2939 1357.0 883 2925 622.4 817 6220 3203 1930 2460 3562 2165.0 6971 2348 4266 978.1 2737 2894.0 2245 5845 0.0718*** 0.0553*** 0.4666*** 0.156*** 0.678 0.8811 0.6317 0.7231 If Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level. The relevant equations for FDI were as follows: inward FDI (or, outward FDI and outward FDI/inward FDI) = a+b*GNP.

SI 1968 1969 S21970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 S3 1986 1987 1988 1989 1990 1991 S41992 1993 1994 1995 1996 1997 Coefficients

Outward FDI/Inward FDI ($ mil.) Korea Taiwan Total Man. Total Man.

Q. fT

3' 3" 3o> 3" fi £ 2 r3 "iu n5

o"

"0

3 3 ~o Si ^

144

John H. Dunning, Chang-su Kim and Jyh-der Lin

TABLE 7.4

Proportion of Inwards FDI (IDI) and Outwards FDI (ODI) Accounted by FDI Intensive Sectors GNP per capita ($)

SI 1968 1969 S2 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 S3 1986 1987 1988 1989 1990 1991 S4 1992 1993 1994 1995 1996 1997 Coefficients rf

Korea

Taiwan

54 68 85 103 124 158 216 285 385 489 649 821 964 1176 1327 1556 1758 1943 2255 2636 3126 3485 4158 4948 5457 6009 6805 7740 8486 9046

304 345 389 443 522 695 920 964 1132 1301 1577 1920 2344 2669 2635 2823 3167 3297 3993 5275 6333 7512 7954 8815 10470 10852 11597 12396 12872 13198

ODI ((A0+O0)/T0) Korea

53.8 75.0 84.5 55.2 84.8 47.4 59.7 60.4 85.2 91.0 94.1 89.1 92.7 82.8 89.3 93.1 93.0 94.6 93.4 93.9 92.2 91.3 94.3 95.3 84.4 90.2 88.0 80.1 91.2 85.2 0.0017 0.1226

Taiwan

75.1 88.9 83.7 40.8 87.1 71.0 60.6 77.9 78.9 83.4 86.0 67.6 47.0 77.1 70.2 90.6 94.5 86.6 87.9 78.7 79.8 80.8 80.0 80.8 87.9 75.0 81.6 94.8 83.6 56.3 0.0009* 0.2346

Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level. IDI (or, ODI) = a+b*GNP.

Korea

<59.5> 6.8 56.2 89.9 79.8 80.1 31.0 30.5 35.6 34.5 66.6 53.6 55.5 64.4 67.4

71.2 75.6 65.6 0.0033* 0.5415

Taiwan

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shows, throughout the period, for each of these types, there were relatively large percentage fluctuations for both inward FBI and outward FDI for both Korea and Taiwan. Nonetheless, taking the A and O types together, the data modestly upholds our predictions, and the expected minus coefficients for the least FDI intensive products (B/T) ratio, though not significant, provide a consistent support for the idea that, as development proceeds, the structure of inward FDI and outward FDI undergoes systematic change. The conclusive remarks for H2b, however, should be reserved at this point. The classification of FDI into A, O and B types is conducted at the 2-digit SIC level, which is less detailed and hence less reliable in examining sectoral compositions and their patterns of change. We now turn to examining the relationship between the pattern of the IDP and TDPs. What might this relationship be? Our hypothesis (H3), following the discussion of the two paths set out earlier in the paper and in Figure 7.1, is that both inward FDI and outward FDI flows in above and average FDI intensive sectors will be positively correlated with their counterparts in trade; but that (A+O) inward FDI will lag (A+O) imports but lead (A+O) exports while (A+O) outward FDI will lag (A+O) exports. As set out in Table 7.6, both inward FDI and outward FDI flows in FDI intensive sectors are positively related to the trade flows in FDI intensive sectors, with surges in the FDI intensity of inward FDI and outward FDI broadly corresponding to those of exports and imports. Moreover, the positive coefficients of all the equations support the proposition that imports leads inward FDI, that inward FDI leads exports; and also that exports lead outward FDI, though only two out of the six coefficients were statistically significant.17 We checked the proposition on a sequence separately for trade and FDI. As shown in Table 7.7, the A+O imports ratio led the A+O exports ratio. When it comes to the FDI data, however, these did not support the leading and lagging sequence between the inward and outward FDI A+O ratios. This may be explained by the fact that an industrial upgrading of both economies has been directed intentionally by government policy which, in the early stages of the IDP, made a conscious attempt to attract FDI towards more capital-intensive sectors, and in the later stages, towards more technology-intensive sectors. These complexities might have prevented us from obtaining a more robust result in practice with respect to the sequencing of imports, inward FDI, exports and outward FDI in Table 7.6. Our fourth hypothesis (H4) is based on the idea that, as countries develop, the determinants of trade and FDI become less closely

Incorporating Trade into the Investment Development Path

147

Low Resource and Capability Base - Small Domestic Markets (GNP per capita < $1000 (1994 values)) Exports (X) mainly in less FDI intensive sector (B) Imports (M) mainly in medium FDI intensive sector (O) Intra-industry trade relatively low

Stage 1 ^

Modest inward FDI, and mainly in less / medium (B and O) FDI intensive sector Virtually no outward FDI Intra-industry FDI low

Improving Resource and Capability Base - Rising Domestic Markets (GNP per capita $1000 - $3000) Exports (X) still mainly in B sectors but increasing in O sectors Imports (M) as in stage 1, but some also in A sectors Intra-industry trade still low but increasing

Stage 2

More inward FDI, mainly in B and O sectors outward FDI beginning mainly in B and O sectors Intra-industry FDI low

Created Asset Intensity and Indigenous Base Now Becoming Significant - Rising Domestic Markets (GNP per capita $3000 - $10000) Exports (X) now largely O but some A. B type exports becoming relatively less important Imports (M) increasing % of O and A type products Intra Industry trade now becoming significant

Stage 3

inward FDI now being concentrated in O and A sectors outward FDI increasing in O type products and some asset-seeking outward FDI in A sectors Intra industry FDI beginning to increase

Approaching Mature Industrialization: Relatively Rich and Sophisticated Markets (GNP per capita $10000 ) Exports (X) now mainly of FDI intensive products (O and A) Imports (M) are mixed as some B and O products cheaper to import than produce domestically. But imports of A type products rising. Intra-industry trade has a high % of total trade.

Stage 4

inward FDI increasingly concentrated in O and A sectors outward FDI rising faster, and sometimes exceeding inward FDI concentrated in O and A sector Intra-industry FDI is an important component of all cross-border FDI flows.

FIGURE 7.1 Four Stages in the IDP and TDPs of Industrializing Developing Countries Note These stages, and the GNP per capita data, assume that there is no, or relatively few, restrictions on either inward or outward FDI and trade flows.

related to the comparative advantages of their natural resource endowments, and more to that of their created assets; and also the presence or absence of firm specific scale economies, including those which result in inward FDI or outward FDI. Figure 7.1 has

TABLE 7.6

The FDI Intensity of Korean and Taiwanese Trade and FDI •

SI 1968 1969 S21970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 S3 1986 1987 1988 1989 1990 1991 S4 1992 1993 1994 1995 1996 1997 Coefficients tf2

Imports ((A m +O m )/T m ) Korea Taiwan 55.8 33.2 57.0 32.0 51.1 33.0 54.6 29.3 63.9 27.1 62.2 25.2 65.3 27.9 64.6 32.8 69.1 32.9 56.7 34.4 60.4 52.7 61.8 52.6 54.4 51.3 51.9 59.2 50.9 62.1 53.0 64.7 65.5 57.4 68.7 56.7 66.1 60.0 64.0 61.5 65.1 61.5 63.3 62.4 61.7 62.8 60.4 62.9 60.4 63.5 66.0 61.8 65.4 64.1 63.9 65.9 74.8 68.8 74.7 67.9

Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level. IDI = a+b*Im, Ex = a+b*IDI, ODI = a+b*Ex.

Korea 53.8 75.0 84.5 55.2 84.8 47.4 59.7 60.4 85.2 91.0 94.1 89.1 92.7 82.8 89.3 93.1 93.0 94.6 93.4 93.9 92.2 91.3 94.3 95.3 84.4 90.2 88.0 80.1 91.2 85.2 0.1623 0.0047

Taiwan 75.1 88.9 83.7 40.8 87.1 71.0 60.6 77.9 78.9 83.4 86.0 67.6 47.0 77.1 70.2 90.6 94.5 86.6 87.9 78.7 79.8 80.8 80.0 80.8 87.9 75.0 81.6 94.8 83.6 56.3 0.2345* 0.1054

Exports ((A^+OJ/TJ Korea Taiwan 13.6 10.1 22.6 10.6 11.1 5.2 10.7 7.3 10.5 37.1 38.9 10.2 15.7 36.3 15.9 38.3 13.6 32.4 15.6 18.3 18.1 22.2 22.8 21.0 25.1 19.3 17.9 25.2 24.8 15.0 26.7 17.7 29.3 20.7 30.5 21.6 31.8 25.6 34.3 34.1 38.8 36.1 35.4 40.2 43.8 36.4 45.8 37.9 48.6 40.2 51.4 42.4 53.3 46.8 57.9 53.2 59.3 56.3 60.9 58.2 0.0157 0.1866** 0.0048 0.2066

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<59.5> 6.8 56.2 89.9 79.8 80.1 31.0 30.5 35.6 34.5 66.6 53.6 55.5 64.4 67.4 71.2 75.6 65.6 0.6904 0.0201

Taiwan 65.6 n.a. 24.2 56.7 42.8 54.9 56.5 32.7 41.4 88.6 69.3 71.8 96.1 44.3 0.0 36.6 82.1 86.7 81.5 87.3 87.9 89.9 74.5 38.5 63.3 62.3 71.9 57.5 59.5 65.2 0.3425 0.0339

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Notes: * Significant at 0.1 level, ** 0.05 level, *** 0.01 level Ex = a+b*Im, ODI = a+b*IDI.

The FDI Intensity of Korean and Taiwanese Trade and FDI Exports ((A x +O x)/T x ) Taiwan Korea 13.6 10.1 22.6 10.6 11.1 5.2 10.7 7.3 10.5 37.1 38.9 10.2 15.7 36.3 15.9 38.3 32.4 13.6 15.6 18.3 18.1 22.2 22.8 21.0 25.1 19.3 17.9 25.2 24.8 15.0 26.7 17.7 29.3 20.7 30.5 21.6 31.8 25.6 34.3 34.1 38.8 36.1 35.4 40.2 43.8 36.4 45.8 37.9 48.6 40.2 42.4 51.4 46.8 53.3 57.9 53.2 59.3 56.3 60.9 58.2 0.3993** 0.7301*** 0.1711 0.2565

IDI ((Aj-t Korea 53.8 75.0 84.5 55.2 84.8 47.4 59.7 60.4 85.2 91.0 94.1 89.1 92.7 82.8 89.3 93.1 93.0 94.6 93.4 93.9 92.2 91.3 94.3 95.3 84.4 90.2 88.0 80.1 91.2 85.2

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already suggested that in their early stages of development, countries will primarily engage in inter-industry trade. This is followed by inter-industry FDI. Later, and partly as the result of inward FDI, intra-industry trade will start to rise, and then eventually—usually much later—intra-industry FDI will also take place. The fourth hypothesis, like the first two, can also be broken into two parts. The first (H4a) is that the proportion of intra-industry trade18 for A and O type products will be positively related to GNP per capita. The second (H4b) is that the growth of intra-industry FDI for A and O type products will also be positively correlated with GNP per capita, but will lag the growth of intra-industry trade. As the data in Table 7.8 and respective correlation coefficients and F^s show, there is some support for H4a, i.e., that intra-industry trade is positively related to economic development. In respect of H4b, there is also some suggestion that the growth of intra-industry FDI lags that of intra-industry trade. However, there is no real evidence that intra-industry FDI for A and O type products grows as economy develops. Again FDI sectoral classification at a 2-digit level hampers any definitive analysis of these issues. IV. CONCLUSIONS

The main conclusion of this chapter is that the understanding of the contents and determinants of the IDP is considerably enriched when trade levels and patterns are encompassed within its ambit. Statistical data from the Korean and Taiwanese economies generally support the idea of an integrated TDP and IDP, and that the growth of each tends to be positively correlated with GNP per capita, and with the created asset intensity of the manufacturing sector. As development proceeds, the composition of both trade and FDI becomes more FDI-intensive, with intra-industry trade and intraindustry FDI, assuming an increasing proportion of all trade and FDI, but with intra-industry FDI lagging that of trade. These results are consistent for both Korea and Taiwan. Indeed little country variance exists, which supports the idea that the two economies have followed similar economic development paths. There is also a strong suggestion that changes in the sectoral composition of exports lag those of imports. However, there is no evidence that the FDI intensity of outward FDI follows that of inward FDI. Interestingly, for both Korea and Taiwan, the A+O/T ratio of FDI was consistently higher than that of trade. This may imply that both Korea and Taiwan are special cases of truncated, FDI-centered economic development—the explanation of which is somewhat different from what our general theorizing would suggest.

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REFERENCES Balassa, B. (1980) The Process of Industrial Development and Alternative Development Strategies, Princeton Department of Economics, Essays in International Finance, Vol. 141, December. Chenery, H. (1979) Structural Change and Development Policy, OUP, Oxford. Chenery, H., Robinson, S. and Syrquin, M. (1986) Industrialisation and Growth: A Comparative Study, Oxford University Press, Oxford. Dunning, J.H. (1981) Explaining the International Position of Countries: Towards a Dynamic or Developmental Approach, Weltwirtshaftliches Archiv, 117:30-64. Dunning, J.H. (1992) The Global Economy, Domestic Governance Strategies and Transnational Corporations: Interactions and Policy Implications, Transnational Corporations, l(3):7-46. Dunning, J.H. (1993) Multinational enterprises and the global economy. AddisonWesley, Wokingham. Dunning, J.H. (1995) What's Wrong—and Right—with Trade Theory? International Trade Journal, 2(9):153-202. Dunning, J.H. and Narula, R. (2000) Industrial Development, Globalization and Multinational Enterprises: New Realities for Developing Countries. Oxford Development Studies, 28(2):141-167. Dunning, J.H. and Norman, G. (1986) Intra-industry Investment, in: Gray, H.P. (Ed.), Uncle Sam asHost,]Al Press, Greenwich, Connecticut. Gray, H.P. (1998) Free International Economic Policy in a World of Schumpeter Goods, International Trade Journal, 3(12):323-344. Gray, H.P. (1999) Global Economic Involvement, Copenhagen Business Press, Copenhagen. Helleiner, G. (1989) Transnational Corporations, Direct Foreign Investment and Economic Development, in: Chenery, H. and Srinivasan, T.N. (Eds.), Handbook of Development Economics, Elsevier, Amsterdam. Narula, R. (1996) Multinational Investment and Economic Structure, Roudedge, London. Narula, R. and Dunning, J.H. (1996) (Eds.) Foreign Investment and Governments, Routledge, London and New York. United Nations (1999) World Investment Report, United Nations, Geneva and New York.

NOTES 1. 2. 3.

4.

We are most grateful for some helpful comments on an earlier draft of this chapter made by H. Peter Gray. The most recent exposition of the IDP is set out in Narula (1996) and Dunning and Narula (1996). See Dunning (1992) for a fuller discussion of the difference between natural assets—the fruits of the earth and unskilled labor—with created assets e.g., technological and organizational capacity, skilled and professional labor, the fund of individual and corporate experience. Created assets may be tangible or intangible; they represent the intellectual capital of firms and sources, be they embodied in goods or services. What in Dunning and Narula (1996) we have referred to as strategic assetseeking FDI.

Incorporating Trade into the Investment Development Path

5. 6. 7.

8. 9.

10.

11. 12. 13. 14.

15.

16.

17.

18.

153

That we have elsewhere (Dunning and Narula 1996) referred to as stages 4 or 5. As for example is shown in the case of the U.S. and the U.K. See United Nations (1999) and earlier editions of the World Investment Report. The significance of these variables is discussed at some length in Dunning (1981), Narula (1996), Dunning and Narula (1996) and Narula and Dunning (2000). Here, we would simply observe we include unskilled labor as a natural resource. For a full examination of the different types of FDI, see Dunning (1993), Chapter 3. Schumpeterian (S) products are those which have a relatively high content of such assets as technology, skilled labor, managerial and organizational expertise. These are to be distinguished from those dependent on national resources, e.g., land and unskilled labor. For a detailed examination of S type goods and services—sometimes called 'dynamic' or 'advanced' goods and services—see Gray (1998, 1999). Our nomenclature for S-type products throughout this chapter will be created asset intensive products. Of course, in part, the extent of this switch depends on the fineness of the SIC classification of the products traded. Generally, the degree of inter-industry trade will decrease, as the SITC classification becomes more detailed. See e.g., Balassa (1980), Chenery (1979), Chenery, Robinson and Syrquin (1986), and Helleiner (1989). As e.g., shown by the increase in the R&D/sales ratio and by the number of patents annually registered. See too our later discussion of FDI intensity. Even though we propose that, in general, the creative asset intensity of FDI follows that of trade, more specifically, by dissecting trade and FDI into imports, exports, inward FDI and outward FDI we propose the sequence of imports, inward FDI, exports and outward FDI. The FDI intensity is defined as the proportion of sales of U.S. foreign affiliates to the sales of their U.S. parent companies. The rationale for this measure (and, we recognize there are several others, but these mainly relate to the technological content of goods) is that the MNE is, first and foremost, an exporter of proprietary created assets (which not only include technology but trade-marks, managerial and marketing know-how, organizational capabilities etc.) in the markets for which it internalizes through FDI. Since the relative significance of these exports is, in part at least, industry-specific, FDI intensity, as measured at the sectoral level, may be taken as a useful proxy for created asset intensity. The higher this ratio—which reflects the extent to which the MNE perceives it can best exploit its O-specific advantages from a foreign location—the more we assume the created asset intensity will be. See Appendix 7.1 for further details. i.e., with outward FDI sometimes rising faster than inward FDI and vice versa, (e.g., as occurred in the case of the U.S. international direct investment patterns over the last two decades or so). We tried with lag structures ranging from 1 to 10 years to find the best statistical fit. The auto-correlation problem arising from equations with lagged variables, however, prevented us from obtaining any consistent patterns. i.e., the ratio between the exports and imports of a particular product or group of products, viz. l-^Xj-MjJ/^Xj+Mj), where ( t = a particular product, or group of products).

154

John H. Dunning, Chang-su Kim and Jyh-der Lin APPENDIX 7.1

The data

Trade: Data for manufacturing exports and imports are available at a 3 or 4 digit level for each year from 1966 to 1997 in the case of Korea and 1968 to 1997 in the case of Taiwan. The source for Korea is the Bank of Korea and the source for Taiwan is the Ministry of Finance of Taiwan. FDI: FDI flow data are less comprehensive. For total inward FDI and outward FDI, there are data for each year from 1968 to 1997 in the case of Taiwan, and for 1978 to 1997 in the case of Korea. For manufacturing inward FDI and outward FDI data are data 1968 to 1997 in the case of Taiwan, and 1981 to 1997 in the case of Korea. Sectoral data are limited to a 2 or 3 digit level in the case of both Korea and Taiwan. The source for FDI data for Korea is the Bank of Korea for "outward" FDI and the Ministry of Finance of Korea for "inward" FDI and the source for FDI data for Taiwan is the Ministry of Economic Affairs of Taiwan. Both sets of data are for 'approved' investments and exclude reinvested profits. FDI intensity. We use FDI intensity as a proxy for created asset intensity of particular products or sectors. It is measured by the proportion of the foreign sales of U.S. MNEs to their domestic sales in 1994 as revealed in the U.S. Department of Commerce Benchmark Survey 1998. We checked similar data for the 1982 and 1989 Benchmark surveys and the industrial composition of FDI intensity was broadly the same. We recognise this ratio reflects both the locational (L) advantages (or, disadvantages) of host countries and the ownership (O) advantages of U.S. MNEs, but we think it gives a better indication of created assets than those which are purely innovatory based e.g., RandD, patents, etc. For example, it incorporates such O-specific advantages as trade-marks and also proxies those advantages resulting from multinationality per se. We first calculated the ratio between the sales of overseas affiliates and the domestic (U.S.) sales of U.S. MNEs in all manufacturing industry. We then did the same for each of sector (classified by 2, 3, and 4 digit SIC). For sectors up to 5 percentage points above or below the average for manufacturing industry in 1994, we classified as O - average FDI intensity. For those above 5 percentage points we classified as A - above FDI intensity. For those below 5 percentage points we classified as B - below FDI intensity. We then applied these gradings to the Korean and Taiwanese classifications of exports and imports, and inward FDI and outward FDI flows as best we could.

APPENDIX 7.2 Equations

Auto-regression of GNP per capita, Trade, andFDI Coefficient

Table 7.1 Im = a+b*GNP+c*GNP2 Ex = a+b*GNP Im = a+b*GNP2 Table 7.2 Im (or, Ex) = a+b*GNP

Table 7.3

Table 7.4 Table 7.5

Table 7.6

Table 7.7 Table 7.8

Note:

GNP GNP2 Exports (A X +O X )/T X Imports (type A) Imports (type O)Imports (type B) Exports (type A) Exports (type O) Exports (type B) IDI (Manufacturing) IDI (or, ODI and ODI/IDI) = a+b*GNP ODI (Manufacturing) ODI/IDI (Manufacturing) IDI ((Aj+OjVTj) IDI (or, ODI) = a+b*GNP ODI ((A 0 +O 0 )/T 0 ) IDI (type A) IDI (type O) IDI (or, ODI) = a+b*GNP IDI (type B) ODI (type A) ODI (type O) ODI (type B) IDI = a+b*Im IDI ((Ai+OJ/T;) Exports ((A X +O X )/T X ) Ex = a+b*IDI ODI = a+b*Ex ODI((A 0 +0 0 )/T 0 ) Exports ((A X +0 X )/T X ) Ex = a+b*Im ODI = a+b*IDI ODI ((A 0 +O 0 )/T 0 ) Intra-industry Trade (A) Intra-industry Trade (O) Intra Trade (or, Intra FDI) Intra-industry Trade (B) = a+b*GNP Intra-industry FDI (A) Intra-industry FDI (O) Intra-industry FDI (B)

* Significant at 0.1 level, ** 0.05 level, *** 0.01.

Taiwan

Korea

Variables 0.0002 3.18e'7 0.0015** 0.0038** -0.0009* -0.0012** 0.0040*** -0.0001 -0.0039** 0.1560*** 0.4666*** 0.0004* 0.0017 0.0033* -0.0002 0.0011*** -0.0016 0.0044*** -0.0014 -0.0022 0.1623 0.1866** 0.6904 0.7301*** 0.0847 0.0082** 0.0022** 0.0032** -0.0009 0.0002 -0.0012**

fl2

0.4254 0.2315 0.5967 0.5894 0.2477 0.4306 0.6597 0.0352 0.5982 0.7231 0.8811 0.4598 0.1226 0.5415 0.0005 0.2853 0.0391 0.5738 0.0451 0.0713 0.0047 0.2066 0.0201 0.2565 0.0006 0.5719 0.5791 0.4492 0.1288 0.0146 0.4714

Coefficient 0.0075*** -3.17e-7 0.0025** 0.0021** 0.0005 -0.0026** 0.0027*** 0.0008*** -0.0035*** 0.0718*** 0.0553*** 0.00006*** 0.0009* 0.0019 -0.0020** 0.0003* -0.0003 0.0001 -0.0010 -0.0120 0.2345* 0.0157 0.3425 0.3993** -0.3413 0.000 0.0028*** 0.0029*** -0.0002 0.0007 -0.0026***

tf2

0.4687 0.6282 0.9213 0.5412 0.2303 0.4685 0.9410 0.7829 0.9207 0.6317 0.6780 0.8807 0.2346 0.2031 0.1711 0.1445 0.0175 0.0002 0.0682 0.0209 0.1054 0.0048 0.0339 0.1711 0.0658 0.0009 0.7846 0.9263 0.1494 0.4433 0.7272

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8 Evolutionary Understanding of Corporate Foreign Investment Behavior: U.S. Foreign Direct Investment in Europe JOHN HAGEDOORN AND RAJNEESH NARULA

I.

INTRODUCTION

Recent theoretical developments in different fields such as economics, organization and strategic management stress the importance of organizational learning and theoretically sub-optimal conduct as key characteristics of a more evolutionary understanding of company behavior. Contrary to, for instance, economic textbook models of profit-maximizing strategies, an evolutionary understanding of firm behavior to a large extent follows the assumptions of the behavioral theory regarding the general implications of bounded rationality with firms demonstrating a 'satisficing' behavior under conditions of 'imperfect knowledge'. In particular, notions such as routinized behavior, learning and satisficing strategies oppose more orthodox economic theories that explain firm behavior in the light of maximizing strategies and rational choices that lead to an optimization of investment decision rules. In the 'older' strategic management literature, similar 'orthodox' approaches are found in somewhat outmoded models in which rational decision-making procedures combined with elaborate information gathering would lead to allocative decisions exploiting competitive advantages through calculated rationality (Levinthal and March 1993). Modern theories of strategic management often implicitly recognize the importance of bounded rationality and learning capabilities in both an analytical and a prescriptive context. Analogous concepts and 756

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topics for an evolutionary research agenda are found in recent contributions to the understanding of the dynamics of organizational change from a modified population ecology perspective (Baum and Singh 1994). Many studies inspired by these groups of theories embrace an evolutionary understanding that, contrary to the classical Darwinian understanding of efficiency, concentrates on understanding the inefficiencies of history and the many ways in which evolutionary processes generate sub-optimal outcomes (March 1994). So far a substantial part of modern evolutionary theory, as well as the empirical analyses inspired by these new contributions, pays attention to the implications of technological change where the 'tension' between routinized behavior and radical change is most obvious (Nelson and Winter 1982; Dosi et al. 1988; Cantwell 1989). Gradually other aspects of corporate behavior and organization, such as diversification strategies, are also being studied from a more evolutionary perspective (Ginsberg and Baum 1994; Teece et al. 1994). We understand foreign investment behavior of firms to be of a somewhat similar level of complexity regarding strategic changes as those that reflect innovation and diversification. In the present contribution we will relate the general evolutionary understanding of basic characteristics of company behavior to corporate foreign investment strategies. This approach complements some of the 'older' contributions to the theory of foreign investment (Aharoni 1966; Vernon 1971; Knickerbocker 1973) and ties in with some recent evolutionary contributions to the literature (e.g. Kogut 1988). In the next section evolutionary understanding of basic properties of firms is explained in terms of routines, satisficing behavior and learning capabilities. This is followed by a further theoretical exploration of the literature on foreign direct investment and the implications for an evolutionary understanding of foreign investment strategies. The section on propositions and methodology provides the reader with both the leading questions for this contribution as well as a clarification of how these topics will be researched in the empirical part of the chapter. The section with major findings provides an empirical analysis of 40 years of U.S. foreign direct investment in Europe and the U.K, Germany and the 'older' European Union member states in particular. The final section discusses some of the major conclusions in terms of an evolutionary understanding of corporate foreign investment behavior. II.

ROUTINES, SATISFICING AND LEARNING

In their seminal contribution to modern evolutionary theory, Nelson and Winter (1982) introduce the concept of 'routine' to

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describe the regular and more or less predictable pattern of corporate behavior. These routines refer to a wide variety of characteristics of firms, the so-called 'operating characteristics' that deal with organizational aspects of production and investment behavior. Companies are expected to follow such routines in their standard behavior as well as when they are adapting their internal strategies to their environment. Following this evolutionary line of thinking, we understand routinized behavior to imply that firms are usually better equipped to do more of the same, in particular in different or changing market environments, than to fundamentally change their strategies on one or more of their operating characteristics. Therefore, we can expect that there is some similarity between present and future behavior of companies. Routines that firms have employed in the recent past will have a rather strong tie to routines to be applied in the near future. Changes in the behavior of firms, for instance in their investment strategies, are guided by heuristics that reduce the number of alternatives through a quasi-stable commitment to a particular set of alternatives for investment project selection. These organizational routines and the large degree of interdependency between past, present, and the search for new investment opportunities places company behavior in the light of evolutionary path-dependency (Teece et al. 1994). This pathdependency that governs a wide range of corporate strategies and routines is not so much of a deterministic nature, but of a more complex quality as it is placed in a dialectic process of the overall business opportunities and competitive forces on one side and the search processes and satisficing behavior of the company on the other. In other words, this evolutionary path-dependency implies that the ex ante selection process of potential investment projects within companies, guided by existing routines and search procedures, already limits the number of 'potential' projects with competitive forces in the market, once again reducing the number of successful projects. Through experience, companies learn about the potential benefits of investment projects, limiting themselves to a number of alternatives. To a large extent the assumption of satisficing behavior of firms in much of modern evolutionary and population ecology theory is borrowed from the behavioral theory as mainly inspired by Simon (1956, 1987). Contrary to, for instance, orthodox economic theory, the behavioral school has placed its concept of the firm as a coalition of groups within an organization aspiring, on the basis of limited information and uncertainty, a set of more or less vaguely specified and often contradictory goals (Devine et al.

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1979). Under these assumptions rationality can no longer be perceived in the light of maximizing behavior, but as both Simon (1956, 1987) and Cyert and March (1963) have put forward, rationality is bounded and thereby just aimed at an aspiring level at a certain moment. Firms are assumed to strive to an acceptable level for a particular corporate objective, not a maximum level. If the attainment does not reach an acceptable minimum level, sequential search will be urged. Alternatives for existing routines, first as minor modifications and, in case these are unsuccessful, more 'radical' alternatives are employed until the aspired level is satisfied. These satisficing strategies of companies are also to be understood in the context of a corporate learning process that has two major characteristics. One characteristic is its repetitive nature, the other characteristic is the local scope of experimentation (Teece et al. 1994). The local scope of learning implies that 'near neighborhood learning' is preferred (Levinthal and March 1993). We contend that this neighborhood learning has a temporal dimension, i.e. short-term learning is preferred to long-term learning, as well as a spatial dimension, i.e. local learning is preferred to longdistance search for learning opportunities. The repetitive nature of firms' learning is directly related to their existing organizational routines that turn their learning experience into cumulative learning, building upon what was learned before. This usually also restricts the degree of experimentation in which companies are involved because most search for new opportunities and company experimentation is assumed to be local in scope. This particular understanding of corporate learning processes allows us to differentiate between routinized learning that involves gradual changes, which governs the majority of learning experiences of companies, and the much more unusual process of learning that implies radical changes in company routines. Routinized learning can be further characterized as 'exploitative learning' which adds to the existing knowledge and competencies of a firm without fundamentally changing the nature of its activities. Non-routinized learning, or 'exploratory learning', involves changes in company routines and experimentation with new alternatives (see for example March 1991; Dodgson 1993). As explained by Levinthal and March (1993) the satisficing strategy of firms implies that, in order to survive, firms have to find a balance between exploitative and explorative learning. Effective learning combines both forms, as exploitative learning ensures current viability, whereas explorative learning creates possibilities to ensure the future viability of firms.

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III. FOREIGN INVESTMENT STRATEGIES AS SATISFYING BEHAVIOR IN AN EVOLUTIONARY CONTEXT

The particular evolutionary understanding of corporate behavior, as discussed above, is quite compatible with the literature on the evolution of foreign direct investment. The basic understanding of the evolutionary changes in the spatial distribution of foreign investment made by a gradually growing population of firms goes back to classics such as Aharoni (1966), Vernon (1966, 1971), Hirsch (1967), and Stopford and Wells (1972). A common element in these contributions is the discussion of foreign investment decisions in terms of increased experience and involvement with foreign markets and production. Davidson (1980) found that companies first enter so-called primary foreign markets that are nearby in terms of spatial distance or similarity in product-markets, human resources, production technology and similar consumer tastes or similar culture in the more general sense. Scale economies, learning benefits and reduced uncertainty initially lead to increasing investment in those countries relative to other countries. Kogut (1983) also stresses this point of increasing investment when he refers to the sequential flows of foreign direct investment through incremental investment in already established subsidiaries. Davidson (1980) demonstrates that step-by-step other countries become more attractive for foreign direct investment as companies build up more foreign experience and the uncertainty premium of so-called secondary markets gradually disappears. The understanding of the strategic aspect of this behavior was introduced by Knickerbocker (1973) who analyzed foreign direct investment in the context of risk-reducing and defensive corporate strategies in an oligopolistic game that results in a temporal and spatial concentration of foreign investment. This line of theory, linking foreign direct investment to oligopolistic competition, has been further developed by Graham (1978). The behavioral-based approach by Johanson and Wiedersheim-Paul (1975) and Johanson and Vahlne (1977) introduced the notion of 'psychic distance' of foreign market conditions and stressed the incremental character of foreign investment strategies of firms through increased learning based on a step-by-step growth of experience abroad (see also Strandskov 1986; Turnbull 1987; Welch and Luostarinen 1988). This positive impact of cumulative learning on foreign direct investment through foreign operations, beyond a threshold of experience, is also reported in Yu (1990). Recent contributions by Dunning (1993a), Dunning and Narula (1994), Ozawa (1992) and Tolentino (1993) emphasize the general evolutionary context in which stages of economic development of

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countries interact with trends in foreign direct investment leading to an investment development cycle.1 Central to these contributions is the examination of the evolution of foreign direct investment activities in terms of both geographic and sectoral distribution affecting the economic growth and structural adjustment of the home and host countries. These studies emphasize how the characteristics of home and host country dynamically influence the competitiveness of firms and affect the process of learning with regard to innovatory activities as well as the familiarity with particular locations. As firms are increasingly becoming internationalized, sequential investment may also become more strategic asset seeking (Dunning and Narula 1996). Instead of defensive, asset exploiting, foreign direct investment to improve the profit position by searching for comparative cost advantages, strategic asset seeking investment is undertaken to improve the long-term market positioning of firms. In that context it is worth noting that advanced stages of economic development, for instance influenced by strong indigenous technological competences, can attract sophisticated foreign companies. This is referred to as the 'agglomeration effect' with a particular country or region having highly concentrated technological competences (Casson 1991). Such strategic asset seeking foreign investment is generally associated with firms engaged in technologically intensive sectors, typically from advanced industrialized countries (Dunning and Narula 1994). The competitiveness of indigenous companies creates technology spillovers that attract foreign direct investment from technologically well developed competitors. In a process of internationalization of corporate strategies and the international diversification of assets, this agglomeration effect indicates that international competition has become a complex process where advantages are not only cost-based and related to exploitative learning but also related to explorative learning about the strategic advantages of countries in particular industries. Recent examples of this strategic effect can be found in Silicon Valley and the U.S. biotechnology industry that both attract research-related foreign direct investment. Chesnais (1995), Dunning (1993a) and Kogut (1988) combine this understanding of general evolutionary aspects of country and location advantages with the 'inter-temporal dependence' of companies in a sequence of investment decisions and strategic moves. It is this attention paid to the behavior of individual firms that creates the link with elements of evolutionary theory introduced above. This evolutionary understanding of corporate behavior complements the existing literature on the development of foreign direct investment through the attention that is paid to

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satisficing strategies in the context of a changing international environment. The attention is somewhat refocused from the importance of country-specific experience, through either one-time investment or continuous investment, to the possible effect of satisficing behavior and different learning economies on sub-optimal levels of foreign direct investment. The evolutionary perspective that we suggest in this chapter indicates that as companies have no complete information about production and market opportunities abroad they follow a piecemeal investment strategy. Based on their existing routines they satisfice their corporate objectives by investing in those countries that do not necessarily have the highest theoretically possible returns but which demonstrate a certain similarity that enables them to follow as much of their existing routines as possible. Gradually companies learn about foreign opportunities as they apply and improve on their local search. However, the characteristic of their satisficing strategy—the slack due to exploitative learning by most firms building on existing routines, with only a few following more exploratory strategies—implies that foreign direct investment behavior lags behind what could be expected under conditions of profit maximizing behavior. It is important to stress that from an evolutionary perspective, economic and cultural similarities can only explain part of the initial irregularities in foreign direct investment. They can demonstrate the preference of companies for primary markets and the sequence of investment based on installed foreign capital. However, these economic and cultural similarities cannot explain the still existing lag with which foreign direct investment is dispersed over a larger group of countries once the uncertainty premium of secondary markets has faded. Based on the assumptions of an evolutionary understanding of company behavior we can clarify why firms stick to investment routines and relatively slow local learning that obstructs sudden changes and thereby causes 'sub-optimal' levels of foreign investment. In other words, from an evolutionary perspective we expect firms to gradually adapt their investment strategies with a prolonged preference for countries in which initial investments were made as they stick to their existing routines creating sequential flows of foreign direct investment. In addition to this we have to stress that the selection environment of companies and the competitive pressures that constitute this selection environment are also changing, although step-by-step and not parallel. This implies lags in matching evolutionary adjustment to changing environments, so called 'lagged coevolution'. Evolutionary processes do improve the match between the current state of companies and their environment, although convergence will not necessarily be achieved by any particular time

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(March 1994). In more concrete terms and related to the empirical context of this paper: the complex, combined processes of macroeconomic developments, economic policies, and strategies of large groups of companies lead to a gradually more integrated global economy. This implies that, despite the lag in the process of internationalization of individual companies, the environment for companies is becoming more international. As both domestic and foreign markets and industries become more international, the spatial distribution of foreign investment opportunities is also changing. With companies gradually increasing their foreign investment over a larger number of countries, the population of primary and secondary markets changes as well. Over time the locus of foreign investment changes when firms adjust their organizational routines and search for investment opportunities in their gradually changing environment. Our theoretical framework should also acknowledge the role of national institutional specifics, just as the evolutionary theory of technological development acknowledges the role of 'national systems of innovation' (Nelson 1993). For instance, the U.K. and some small European countries, such as the Low Countries and the Nordic countries, have an institutional history marked by a high degree of international orientation, whereas other European countries have an institutional history that is more inward-looking. These institutional specifics can affect the process of lagged co-evolution. Together with institutional aspects of the agglomeration effect, the incremental change of national institutions, under different national conditions of economic 'openness' and different degrees of the international orientation of companies from various countries, has a mitigating effect on the convergence of the spatial distribution of foreign direct investment. Finally, we have to mention the importance and theoretical relevance of structural breaks in the evolution of foreign direct investment such as those caused by World War II. The restoration of a prewar share of foreign direct investment is clearly different from a gradual evolution of de novo foreign direct investment. The inclusion of structural breaks in our theoretical framework indicates that we cannot assume that the previous level of foreign direct investment is a starting point for a new phase of a further development of foreign direct investment. However, the choice for companies to invest in countries with which they had experience in the past is expected to be easier than investing in completely unknown regions. The gradual restoration of pre-war foreign direct investment levels in West Germany during the 1950s is an example and recent developments regarding investment by German firms in

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former East European countries that were traditionally within the German sphere of influence suggest a somewhat similar pattern in terms of a partial restoration of investment levels (Economist 1995). IV.

PROPOSITIONS AND METHODOLOGY

Our theoretical framework based on theories of the evolution of company behavior and foreign investment strategies enables us to formulate a number of propositions that will guide our empirical analysis in the next part. 1. Due to satisficing behavior, quasi-stable commitment to a limited number of investment alternatives, and a preference for exploitative learning, foreign investments of companies from a particular country will initially be concentrated in those countries of an international region that most resemble the home market, i.e. during the early stage of foreign direct investment growth, this increase is concentrated in primary foreign markets. 2. With companies gradually increasing their experience in foreign operations and routinized learning being paralleled by non-routinized, explorative learning of foreign investment opportunities, there will be a gradual diffusion of foreign investment across a wider economic and geographic space. That is, the international distribution of foreign direct investment within a particular geographic region will diffuse, leading to investment in secondary markets. However, this growth of investments in secondary markets will initially be sub-optimal relative to the increase in primary markets of the same region. 3. As companies acquire experience with foreign production, the motives for foreign investment will become more complex, moving away from asset exploiting activities, that are aimed at exploiting comparative costs of production in order to supply markets, towards strategic asset seeking foreign investment with explorative learning to play a larger role. 4. As economic and de facto market integration takes place within a given economic region, foreign investment activity moves from sub-optimal levels, in terms of market growth potentials, towards less sub-optimal levels. This will result in a narrowing of the distinction between primary and secondary markets. In illustrating these propositions we shall focus on manufacturing foreign direct investment of U.S. companies and limit our analysis to a comparison between their activities in the U.K. and in the six countries that originally formed the EEC, with a special emphasis on Germany.2 These six countries are France, Germany, Italy, the

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Netherlands, Belgium and Luxembourg. We put particular emphasis on Germany since Germany and the U.K. have similar economic features, both in terms of population and GDP, and provide a more direct comparison than between the U.K. and the EC6 as a group. The EC6 countries represent the 'secondary markets' while the U.K. represents the 'primary market'. We shall focus on U.S. foreign direct investment manufacturing activities in the post-World War II era due to the severely limited data prior to 1950. In order to avoid the effects of German reunification, we shall limit our analysis until 1990. It should be noted that, given the role of World War II as an exogenous shock, the study of U.S. foreign investment in continental Europe, and especially Germany, represents a special case of 'secondary markets' where U.S. foreign investments do not represent de novo investments but sequential investments. Therefore, even though U.S. firms 'relearned' about old markets, the rate of growth of foreign investment may have been enhanced in this case. For reasons of consistency and comparability, the foreign direct investment data used throughout this chapter is based on U.S. Department of Commerce estimates as published in the Survey of Current Business. Unless otherwise specified, foreign direct investment data refers to U.S. foreign direct investment manufacturing stocks on a historical cost basis (i.e. book values) which are nominal in nature. Sales data would have been preferred but these are unavailable at the level of industrial and sectoral desegregation for the entire period in question. Sales data, being flow figures, can be re-evaluated to provide real values. However, we follow the generally accepted practice in the foreign direct investment literature (see Dunning 1993a for a review) of using stock levels which are regarded as a monotonic function of sales data. The use of stock data on a historical cost basis is inhibited by the fact that it leads to underestimation because of different age distributions of stock. Although recently several attempts have been made to estimate U.S. foreign direct investment stock levels in 'real' terms by re-estimating them on a market or replacement cost basis, data generated by these methods are not available on the required level of desegregation for our purposes, and tend to require restrictive assumptions that introduce biases of their own (see Cantwell and Bellak 1994, for a review). In evaluating satisficing behavior in foreign investment, some measure of profitability would have been desirable. Several authors including Krause (1968), Dunning (1969, 1993b) and Dunning and Narula (1994) have proxied profit with rate of return, which is calculated by dividing the net income (after taxes) by the average of

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the stock levels at the beginning and end of that year. This has several limitations. Firstly, by using historical stock figures a bias is introduced, since the assets are not depreciated, given that different countries have different ages of U.S. foreign direct investment stock. Secondly, due to transfer pricing practices by multinational companies to minimize tax burdens, net income is not always accurate, unless adjustments are made to allow for royalties and license fee payments. While it can be useful to evaluate the changes in profitability at a single location over time, it cannot be used without great caution to compare profitability between countries. Instead, we will assume that the domestic growth rate of the country in question proxies the profit potential for companies operating in that environment. If multinational firms seek to maximize, they should, ceteris paribus, seek locations where the profit potential is highest. In evaluating the growth of the domestic economies of the host countries it would be preferable to use real value-added activity or gross output in manufacturing. These are also unavailable in a sufficiently long time series. We shall therefore proxy these by GDP. GDP in 1980 prices is derived from estimates in Maddison (1991), while nominal GDP is based on OECD estimates. Population and exchange rate data are derived from various issues of the IMF—International Financial Statistics. Furthermore, GDP is used as an indicator of market size, which is a primary determinant of market-seeking investment. However, GDP also provides an indirect proxy of the extent of domestic production capacity. To circumvent data restrictions we shall use the following relative measures of foreign direct investments: •

We evaluate the share of U.S. foreign direct investment stocks in a given country to the total U.S. foreign direct investment stocks in a given year. • We take a ratio of the growth rate of U.S. foreign direct investment stock to the growth rate of real GDP in 1980 prices. It is important to realize that foreign direct investment is a nominal number, such a ratio is primarily meant to examine the trend over time, rather than to indicate the significance of the absolute value of this ratio. • The ratio of U.S. foreign direct investment stocks to nominal GDP provides a proxy for the significance of the activities of U.S. internationally operating companies in the domestic economy.

Another important indicator used in this paper is the so-called foreign direct investment 'imbalance coefficient'. If we take the quotient of the ratio of real GDP of any two regions to the ratio of foreign direct investment stocks in the same two locations, we are

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able to calculate an estimate of the imbalance coefficient in the relative levels of foreign direct investment. A ratio of one would indicate that, for instance, U.S. investment activities in the two locations were proportional to the market potential, and a figure less than one indicates that the level of foreign direct investment is suboptimal relative to their market sizes. In the following we will analyze data that refer to foreign investment behavior of U.S. firms as a collective. Although the changes in foreign direct behavior are the result of investment decisions by individual firms, we can only 'measure' the results of these decisions in terms of trends in foreign direct investment for the population as a whole. Individual firm data would have been preferred but the lack of these data forces us to analyze the more generalized data that are available. However, these more general data still enable us to reconstruct historical patterns in U.S. corporate foreign direct investment behavior and illustrate our propositions. We use the term 'illustration' deliberately to indicate the exploratory nature of our contribution. The semi-quantitative nature of our study in combination with the level of aggregation of our data does not allow for a more formal testing of hypotheses. However, in a somewhat positivist line of thinking, we contend that even aggregated data can 'do the job' in this exploratory context as they demonstrate the outcome of a complex process with relatively straightforward indicators. V. U.S. FOREIGN DIRECT INVESTMENT IN EUROPE SINCE WORLD WAR II

At the end of World War II, the U.S.A. enjoyed a technological and economic hegemony vis-a-vis Western Europe, and especially the EC6 and the U.K. With the partial exception of the U.K., a substantial part of the infrastructure as well as the production capacity in these countries was damaged or disorganized. This is apparent from a comparison of productivity in 1950 (as measured by GDP per manhour at 1985 prices), which was US$11.39 for the U.S., compared to US$6.49 for the U.K. and US$3.5 for Germany, while the average of the EC6 was US$4.3 (Maddison 1991, pp. 274-275). The competitive advantages of U.S. companies were at their peak at this juncture, and given the liquidity problems of the European economies after the war and the consequent strength of the U.S. dollar, U.S. firms were, on the whole, increasingly eager to exploit their competitive advantages through foreign direct investment. Although U.S. firms had been engaged in international production prior to the war, the significance of their European operations

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declined considerably relative to other regions. U.S. production in Europe was at least as badly damaged by the war as European domestic production. The share of U.S. foreign direct investment manufacturing stocks in Western Europe as a percentage of total U.S. manufacturing foreign direct investment worldwide fell from 35.7% in 1936 to 24.3% in 1950 (U.S. Department of Commerce 1953).3 This suggests that, if we base our estimates on the historical demand for the output of U.S. affiliates, there was considerable opportunity for the expansion of U.S. foreign direct investment. The U.K. has historically been the preferred destination for U.S. foreign direct investment in Western Europe, and the single most important destination outside North America. Even as early as 1929, the U.K. was host to 6.44% of U.S. foreign direct investment stocks worldwide, and 35.9% of foreign direct investment stocks in Europe, compared with Germany, which was host to less than half that amount. By 1950, there had been a recovery of U.S. foreign direct investment stock levels: total U.S. foreign direct investment in the U.K. as a percentage of the worldwide foreign direct investment stock of U.S. companies was 7.1%, and as a percentage of U.S. foreign direct investment in Europe the U.K. took 49.2% of the total. On the other hand, U.S. foreign direct investment in Germany had fallen in relative terms, from about half that invested in the U.K. in 1929, to a quarter in 1950. The situation was similar for all the other countries of what later became the EC6. Although these figures include foreign direct investment in all sectors,4 they are nonetheless indicative that in 1950 the significance of U.S. manufacturing foreign direct investment in the U.K., was at least as great as it had been prior to the war, if not greater. They also indicate that U.S. foreign direct investment in the EC6 countries had not recovered to the same extent, and had even declined relative to their pre-war levels. However, it is important to realize that the opportunities for growth of U.S. foreign direct investment were considerably greater in the EC6 than in the U.K., where the significance of U.S. companies in the domestic economy was much greater. One of the measures of the significance of U.S. investment to the domestic economy is the ratio of foreign direct investment stocks to GDP in current prices. The ratio of the U.S. foreign direct investment stocks in manufacturing to GDP of the host country (see Figure 8.1) were 1.5%, 0.5% and 0.4% for the U.K., Germany and the EC6, respectively, in 1950.5 Although the GDP of the U.K. as well as its GDP per capita was greater than those of the individual EC6 countries, this difference is not sufficient to explain the difference in the significance of U.S.

Evolutionary Understanding of Corporate Foreign Investment Behavior 0.05

169

T-

0.04 0.03 0.02 0.01

0

I I!I I II IIII IIIIII IIIIIII IIII II I!I I III II H 1950 1956 1962 1968 1974 1980 1986 FIGURE 8.1

Ratio ofFDI Stock to Nominal GDP, 1950-90

foreign direct investment activities to the host economies, especially so in the case of Germany. Apart from the fact that U.S. foreign direct investment in the other countries was starting from a lower base, there are several other reasons why, under conditions of maximizing investment behavior, U.S. foreign direct investment should have been at a higher level then it actually was in 1950: •

The opportunities for growth were higher in the EC6 relative to the U.K. Firstly, the extent of reconstruction was much lower in the U.K. Secondly, U.S. multinational companies had maintained their operations in the U.K. during the war, while those in other countries had been sequestered or destroyed. This holds especially for Germany and France, where U.S. companies had a significance presence prior to the war (U.S. Department of Commerce 1953, p. 7). The 'window of opportunity' appears to have been most promising for Germany, which had the highest potential for post-war growth given its technological competence before the war,6 and which also offered many opportunities created by the Marshall Plan. Although the argument has been made (e.g., Dunning 1988b, 1993b; Bostock and Jones 1994b) that higher level of investment in the U.K. may have partly been to supply continental Europe from a U.K. base, this does not take into account the demand for 'non-tradable' and perishable goods such as metals and food products, which could not efficiently have been supplied from the U.K. • The level of competition faced by U.S. companies in almost all European economies after the war was lower than prior to the war due to the destruction of the plant capacity of their domestic competitors and the shortage of capital. Thus, U.S. companies faced a more competitive environment in the U.K. than in the EC6 countries.

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The Pre-EEC Years 1950-1957

The higher potential for growth suggested in the previous section was borne out by the higher growth rate of the EC6 economies during the period 1950-57, when real GDP (1980 prices) grew at an annual average rate of 6.6% in the EC6, 9.3% in Germany and 3.2% in the U.K. The growth rate of U.S. foreign direct investment in these same three locations was 14.8%, 16.3% and 12.5%, respectively. While the growth rates of U.S. foreign direct investment were much higher than those of real GDP, it should be noted that foreign direct investment is measured in current terms. Furthermore, the differences in growth rates between locations provide some evidence of the sub-optimal level of U.S. foreign direct investment. The differential between the GDP growth of Germany and the U.K. was almost 6%, while the differential in foreign direct investment growth was less than 4%. As Table 8.1 demonstrates, foreign direct investment grew at 1.7 and 2.2 times the rate of real GDP in Germany and the EC6, respectively, while in the U.K., foreign direct investment grew at an average of 4.2 times that of real GDP between 1950 and 1957. The ratio of foreign direct investment to GDP in Germany and the EC6 increased marginally (see Figure 8.1) from TABLE 8.1 FDI and Real GDP Growth Rates for Selected Periods, 1950-1990 Annual average US mfg FDI growth rates

Annual average real GDP growth rates

Ratio of FDI to GDP

EC6

FRG

UK

EC6

FRG

UK

USA

EC6

FRG

UK

1950-57

14.8

16.2

13.5

6.6

9.3

3.2

4.3

2.2

1.7

4.2

1957-72 1957-62 1962-67 1967-72

17.6 19.7 19.4 14.1

17.8 23.6 17.4 13.1

11.1 15.0

5.0

4.9

2.9

3.5

3.5

3.6

3.8

5.5

5.8

2.7

2.8

3.6

4.1

5.6

8.4

4.8

3.7

2.8

4.8

4.0

4.7

3.0

8.4

4.7

4.2

2.7

2.9

3.0

3.1

3.1

1972-90 1972-77 1977-82 1982-90

10.4 13.8

9.6

2.3 2.7

2.3

1.8

4.0 4.3 2.3

3.7 3.9 5.5

5.9

7.2

2.2

1.2 3.1

3.2 2.9 1.9

4.2 5.5

5.7

8.5 8.6 6.6

2.6

14.8

3.8

3.8

5.2 8.3

3.2 2.3

2.2

2.2

3.2 2.7

2.3

Notes: FDI growth for 1950-57 are 1951-57. Sources: FDI data derived from Survey of Current Business, various issues, GDP data based on Maddison (1991), and updated for 1990 from IMF data.

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171

0.4% and 0.53% in 1950, to 0.63% and 0.61% in 1957, respectively, while in the U.K. it increased from 1.5% to 2.01% in the same years. More significantly, however, the share of U.S. manufacturing foreign direct investment in the U.K. as a percentage of total worldwide foreign direct investment increased from 14.1% in 1950 to 15.5% in 1957. In the case of Germany the corresponding figures were 3.21% and 4.3%, while those for the EC6 as a group were 8.3% and 11.2%. The fact that the share of the EC6 excluding Germany increased by as large a share as that of the U.K. and Germany together indicates that Germany, despite its high growth rate and market size was not the preferred destination of U.S. foreign direct investment among the EC6. The fastest growth of manufacturing foreign direct investment in the EC6 countries was in Italy and Belgium (Dunning 1969). The data in Table 8.2 provide further confirmation of this. The imbalance coefficient in the case of EC6 relative to the U.K. decreased from 0.38 in 1950 to 0.27, suggesting that foreign direct investment in the EC6 not only was not at equilibrium level, but had actually declined relative to its market size. A similar trend is observed for Germany relative to the U.K. However, the imbalance coefficient between the 'EC5' countries (i.e., EC6 excluding Germany) and Germany increased from 0.67 to 0.74. The high (and increasing) level of this coefficient relative to the other two not only indicates that the 'EC5' and Germany were closer to an equilibrium level, but confirms the observation that within the EC6, U.S. firms had a preference for the other countries apart from Germany. This suggests that the investment strategy of the U.S. companies were sub-optimal in terms of the potential market opportunities. Why then did U.S. companies not engage in more foreign direct investment in the EC6, and especially Germany, instead of the U.K. TABLE 8.2

Imbalance Coefficient, Selected Years

(lj (2)(2)-r(l) (3) (4)(4)7(3) ( 5 ) ( 6 ) (6)-(5) Real GDP US FBI imbalance Real GDP US FDI imbalance Real GDP US FDI imbalance ECG^Real ECG^US coefficient FRG -f Real FRG-H US coefficient ECS -=- Real EC5 -=- US coefficient GDP UK FDI UK GDP UK FDI UK GDP FRG FDI FRG

1950 1957 1965

1.95 2.47 2.89

1972 1982 1990

3.32 3.73 3.51

0.58 0.67 1.13 1.65 2.03

0.30 0.27 0.39 0.50 0.54

2.12

0.60

Source: as for Table 8.1.

0.58 0.85 1.02 1.12 1.18 1.11

0.23 0.28 0.47 0.62 0.85 0.7

0.40 0.33 0.46 0.55 0.72 0.63

2.36 1.88 1.85 1.96 2.16 2.15

1.57 1.39 1.39 1.63 1.39 2.05

0.67 0.74 0.75 0.83 0.64 0.95

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FIGURE 8.2 Share of U.S. Manufacturing Worldwide, 1950-90

given the opportunities it represented? The literature on foreign direct investment (see Dunning 1993a for a review) suggests that the U.K. had market conditions with which U.S. firms were familiar—these include language and business practices—as well as the fact that the GDP per capita of the U.K. was more similar to that of the U.S. than that of Germany. Given the finite capital available for foreign expansion and the correspondingly high costs of establishing plant capacity in the EC6 relative to the U.K., U.S. companies preferred to exploit markets with which the net start-up costs were lower, rather than where the opportunity for growth was highest. In other words, the opportunities for higher growth in the EC6 were not exploited, with U.S. companies preferring to invest in their primary market (the U.K.) with which they had prior experience rather than exploit their secondary markets where growth and profit could be maximized. The 1957-1972 Period

By the second half of the 1950s, U.S. foreign direct investment in secondary markets, such as Germany and the other EC6 countries, began to increase significantly, both in terms of the share of U.S. worldwide manufacturing foreign direct investment, as well as in terms of the share in GDP of the host economies (Figures 8.1 and 8.2). Several factors played a role in this changing importance of secondary markets. Firstly, the economies of the EC6 and the U.S., as measured by real GDP per capita of the host countries relative to that of the U.S., as well as in absolute terms, began to converge (see Figure 8.3). In other words, economic conditions were becoming more similar between the EC6 (especially Germany) and the U.K. Furthermore, the level of productivity of these countries, and the quality of the

Evolutionary Understanding of Corporate Foreign Investment Behavior

o FIGURE 8.3

o

o

c

>

o

o

o

o

1 73

o

Trends in Relative GDP per capita, 1980 Prices, 1950-90 (U.S.A. = 100)

infrastructure were also becoming increasingly similar. In fact, the situation was much better in Germany relative to the U.K. in terms of capital stock: the average age of capital stock in 1960 was 19.4 years in Germany compared with 24.8 in the U.K. By 1970, these figures were 14.4 and 19.3 (Wolff 1994). More important, however, U.S. companies were becoming increasingly familiar with the business conditions in these countries, and were beginning to exploit the EC6 markets, and their continuing high growth rates, which continued to outperform that of the U.K. Secondly, the setting up of the Common Market by the EC6 acted as an additional incentive to U.S. companies to establish or expand their operations there. This had serious, albeit delayed, consequences for U.S. investment in the U.K., where the share of investment started to decline in the early 1960s, and continued to do so during the rest of this period. The fact that U.S. companies relocated some of their foreign direct investment activities to the EC6 only several years after the establishment of the Common Market may in part be because they had expected the U.K. to join the EEC (Bostock and Jones 1994a). Furthermore, the U.K. growth rate of real GDP stayed relatively steady at just under 3%, while that of the EC6 and Germany averaged almost 5% between 1957 and 1972. This may also explain why U.S. manufacturing foreign direct investment growth rate after 1962 in the U.K. declined to almost half of its level between 1957 and 1962. It is interesting to observe that the growth rate of foreign direct investment in the EC6 remained at a higher level than in Germany from 1962 to 1972, indicating that U.S. companies were to some extent treating the other EC6 markets

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as substitutes for investment in Germany (Table 8.1). However, their slower GDP growth relative to that of Germany resulted in similar foreign direct investment to GDP ratio (Figure 8.1). Towards the end of this period, U.S. foreign direct investment growth rates in the EC6 and Germany declined. This is probably a result of two factors: •

The imminent entry of the U.K. into the Common Market may have slowed down the establishment of new capital flows towards the EC6, since membership of the Common Market would have extended the privileged access to the markets of the EC6 for U.S. companies from their U.K. plants. • The high growth rates of the economies of the EC6 were symptomatic of the recovery of the domestic competitors of U.S. companies in these countries. The average annual rate of total factor productivity between 1960 and 1970 in Germany, France and Italy was 2.58, 3.4 and 3.93, while that of the U.S. and U.K. was 1.49 and 1.65 (Wolff 1994). As such, the window of opportunity for U.S. companies was closing, as European competitors began to catch up technologically (OECD 1992). By 1972, the high growth rates of the EC6 economies, which were partly a result of the Common Market, meant that the ratio of the real GDP of the EC6 against the U.K. was 3.32, up from 2.47 in 1957 (Table 8.2). The ratio of U.S. foreign direct investment comparing these two locations had increased from 0.67 in 1957 to 1.65 in 1972. The imbalance coefficient increased from 0.27 to 0.5 (Table 8. 2), indicating that U.S. foreign direct investment in the EC6 was now closer to equilibrium level relative to its market size. As such, it would seem that the reluctance of U.S. companies to invest in the EC6 had been gradually overcome, as they acquired more experience in operating in the EC6, and they began to learn more about the market potential of these countries. This increased participation was also due in part to the growth of the EC economies relative to the U.S., and the increasingly homogeneous market conditions amongst the EC6 countries as well as compared to the U.S. As Figure 8.3 shows, by 1972 the GDP per capita of Germany and the EC6 was closer to that of the U.S. than that of the U.K. relative to the U.S. The slowing of U.S. foreign direct investment growth towards the end of this period and the increased level of participation of U.S. companies are by no means contradictory. On the one hand, the increasing competitiveness of EC6 firms may have driven out the less competitive U.S. firms, or discouraged existing U.S. affiliates from increasing their investments. On the other hand, highly competitive U.S. firms may have strengthened their presence to

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175

exploit the economies of agglomeration that derive from the presence of clusters of highly competitive domestic firms. This is in accordance with the gradual and evolutionary process of internationalization of firms as they move from engaging in assetexploiting, market seeking investments to efficiency seeking internationally integrated foreign direct investment whereby firms engage in both asset-seeking (defensive) and asset-exploiting activities. The above suggests that during this period, it is probably the first effect that was predominant. The 1972-1982 Period

The U.K. entered the Common Market in 1973, but despite this there was no subsequent increase in the growth rate of U.S. foreign direct investment in the U.K. Throughout this period, U.S. manufacturing foreign direct investment increased at an annual average rate of 8.5%, and this was significantly less than investment growth rate into the EC6 of 9.5% (Table 8.1). Nor indeed, was there any discernible effect on the growth rate of its domestic economy vis-avis the EC67 as the U.K. was growing at a slower rate than the EC6 or Germany until the early 1980s. This slowdown was, inter alia, due to exogenous changes in the world economy during this period, the two most significant were the devaluation of the dollar and introduction of the floating exchange rate regime, and the oil crisis. These had a more adverse effect on the domestic growth rate of the U.K. than it did on the EC6 countries. As Table 8.2 shows, GDP growth rates declined for Germany, the EC6 and the U.K. However, the U.K's growth rate averaged 1.7% during this period, a full percentage point less than the EC6. It is interesting to note that both the GDP growth rate and foreign direct investment growth rate of Germany were higher than the EC6 as a whole, indicating a preference of U.S. companies to invest in Germany rather than the other members of the EC6, with foreign direct investment growing at over 4.3 times the rate of real GDP growth during this period, compared with 3.3 times in the case of the EC6 as a whole, and that U.S. multinational firms were now treating Germany as a primary market. The share of U.S. foreign direct investment in manufacturing in the U.K. declined from 14.9% in 1973 but subsequently reached an 'equilibrium' level, while that of Germany rose for a while, before leveling out (Figure 8.2). Furthermore, despite the low levels of GDP growth, the ratio of foreign direct investment to GDP in the U.K. declined throughout this period, falling from 3.7% in 1973 to 2.2 % in 1982, while that of Germany and the EC6 remained at

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about the same level. This clearly suggests that from the point of view of U.S. companies, the U.K. had lost its preferential significance despite its entry into the EEC. Nonetheless, the imbalance of investment between the U.K. and the EC6 did not substantially improve despite the high growth rates of foreign direct investment. From Table 8.2 we see that the imbalance coefficient increased marginally from 0.5 to 0.54 over this period. However, the imbalance coefficient between Germany and the U.K. did increase significantly from 0.55 to 0.72. This indicates that although U.S. companies had begun to invest more extensively in Germany, they also now preferred to invest in Germany rather than the other EC6 countries, implying that the attractions of European integration were not that great, despite the fact that the GDP growth rates of these countries were individually greater than that of the U.K. In fact, the imbalance coefficient between Germany and the other EC6 countries declined from 0.75 to 0.64 between 1972 and 1982. The implication of these facts is that Germany was increasingly regarded as a primary market, and that the U.S. companies now preferred the U.K. over the other EC6 countries now that the U.K. was a part of the EEC. Investment in the U.K. and Germany was to some extent a substitute for investing in the other EC6 countries. Therefore, while U.S. foreign direct investment in the U.K. may not have grown immediately after its entrance into the EEC, it eventually led to some growth in the second half of this period. Between 1977 and 1982, for instance, U.S. foreign direct investment grew faster in the U.K. than in the EC6 or Germany (Table 8.1), despite the U.K. GDP growth rate being less than that of the EC6 and Germany during the same period. Furthermore, there are indications that the declining competitiveness of the U.K. relative to the EC6 countries, and the concurrent increasing competitiveness of these countries vis-a-vis the U.S. may have resulted in the increase in U.S. foreign direct investment activity in the U.K. during the second half of this period. Indeed, GDP per capita of the U.K. continued to diverge away from that of the U.S. as well as the EC6 and Germany (Figure 8.3). U.S. foreign direct investment in the EC6 may have grown much more slowly than expected because of two factors. First, the entry of the U.K. into the EEC made existing U.S. production facilities in the U.K. more viable than the establishment of new facilities in the other EC6 countries apart from Germany. Second, as U.S. multinational firms moved towards increasingly globalized (or regionalized) production, the role of the U.K. as an international business center from which to engage in internationally integrated investment activity continued to be important. Such activities include defensive and strategic

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177

asset-seeking investments. Furthermore, from an industrial or technological perspective, there were also economies of agglomeration given the U.K.'s leading position in Europe as a center of excellence in sectors such as food products and pharmaceuticals. These economies of agglomeration due to centers of excellence also applies to Germany, but there was little sectoral overlap between these two countries. The 1982-1990 Period

The most recent period of U.S. foreign direct investment in Europe analyzed in this paper demonstrates that the significance of U.S. foreign direct investment to the U.K. economy, as measured by the ratio of foreign direct investment stocks to GDP, halted its decline during this period, and stabilized at about 2.5%. Despite the high growth rates of U.S. foreign direct investment activity, as Figure 8.1 shows, the ratio of foreign direct investment to GDP in Germany as well as in the ECS as a whole also stabilized. This suggests that the economies of the EC6 and the U.K. were growing at about the same rate as that of U.S. firms. Indeed, the foreign direct investment growth rate in the U.K. was 7.2% between 1982 and 1990, greater than in Germany (5.9%) but lower than in the EC6 as a whole (8.3%) (see Table 8.1). Some of this growth may have been due to the higher rate of U.K. GDP growth (3.1%) relative to the EC6 (2.2%). Despite the high growth of U.S. foreign direct investment activities in the U.K., the fact that the ratio of foreign direct investment to GDP remained at the same level indicates that the U.K's competitive position may have experienced some recovery. Total factor productivity growth in the U.K was 0.92% between 1973 and 1989, the same level as in France, but higher than in Germany (0.88%) or the U.S. (0.32%) (Wolff 1994). The share of U.S. manufacturing foreign direct investment in both the U.K. and Germany stabilized and seemed to fluctuate around an equilibrium level of 13.4% and 8.7%, respectively.8 The share of the EC6 as a group began to rise significantly, from 26.1% in 1982 to 29.1% in 1990, while the share of Germany rose from 8.9% to 11.1% in the same years, indicating that much of the increase in U.S. production activities occurred in the other EC6 countries (Figure 8.2). Also, the imbalance coefficient between the EC6 and U.K rose from 0.54 to 0.60, while the coefficient between Germany and the U.K fell during this period from 0.72 to 0.63. This helps support our earlier contention that U.S. firms were seeking alternative locations to Germany. In fact the imbalance coefficient between Germany and the

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other EC6 countries reached 0.95 in 1990, indicating that the EC6 countries were increasingly regarded as substitutes for each other. The above shows that the process of integration had really begun to have some effect on U.S. multinational firms in Europe. Apparently they were no longer demonstrating a preference for engaging in production in large markets such as Germany or the U.K., with which they had most experience, but they were expanding the locus of their operations to other countries. U.S. companies had begun to diversify their production activities to take advantage of the single market. The distinction between primary and secondary markets was beginning to blur. The fact that during much of this period, U.S. real GDP growth outpaced that of the EC6 and the U.K., which did not lead to a decline in U.S. foreign direct investment growth in these countries, indicates that, in that respect, U.S. companies were not seeking to maximize profits. VI.

CONCLUSION

Before drawing some conclusions, it is necessary to note two limitations to this study. First, our analysis uses aggregated data across industrial sectors which conceals a number of aspects of the evolution of U.S.-owned production activities. Apart from the obvious lack of information on individual firms, the aggregated data also obscure some of the changes in investment patterns and the extent to which investment may be due to the changing comparative advantages of EC countries vis-a-vis the U.S., as well as amongst each other. As the EC6 and U.K. have gradually moved from being laborintensive towards being capital-intensive,9 the nature of U.S. production activities within these countries has probably also changed. In other words, we can expect that as these countries have undergone structural adjustment, there has been a concurrent structural adjustment of multinational activities. Production activities that were situated in these countries that required high content of labor have gradually been shifted to countries with the appropriate comparative advantage, either amongst these countries, or to other non-EC countries. The expansion of the EC to include lowerincome (and more labor intensive) countries such as Spain and Portugal has undoubtedly hastened this redistribution. Second, this chapter is not meant as an encompassing analysis of foreign direct investment considering all possible effects as for instance we abstract from changes in the U.S. economy and the role of government intervention. Changes in the U.S. economy and competitiveness relative to those of the host economies, such as exchange rates as well as other macroeconomic factors have no doubt

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179

played some role in affecting the extent and pattern of foreign direct investment. Also, non tariff barriers and government restrictions on the participation of foreign firms may explain some of the investment activity in certain sectors and in particular countries. Keeping in mind these limitations in our analysis, as it can only reveal some general trends and patterns, we are still able to demonstrate the overall evolutionary pattern of corporate foreign direct investment behavior. The previous sections do illustrate some particular traits of an evolutionary pattern of foreign direct investment behavior as explained by our theoretical framework. As 'predicted' by the first proposition, our analysis of foreign direct investment by U.S. companies both before and during the first decade after World War II shows that a remarkably large share of foreign investment in Europe was concentrated in the U.K. A clear pattern of evolutionary path-dependency is found in what appears to be a more or less routinized and stable commitment to investment projects in the U.K. This preference for the U.K. as a primary market due to investment strategies that can be characterized as satisficing behavior must have led companies to exploit existing and familiar opportunities. Despite the many opportunities in other European countries, U.S. foreign direct investment outside the U.K. remained at sub-optimal levels for some decades after the war. These sub-optimal levels of foreign direct investment do not imply that U.S. firms did not gradually learn more about the investment opportunities in Europe outside the U.K. As mentioned in the second proposition, it was expected that gradually U.S. firms would explore possibilities in secondary markets through non-routinized investment behavior that paralleled some of their existing investment routines. These new investment projects should result in a gradual diffusion of foreign direct investment across Europe. However, the existing preference for the U.K. would still lead to suboptimal levels of investment in the light of the growth potential of these secondary markets. The late 1950s and early 1960s show this expected pattern of increasing, albeit sub-optimal, U.S. foreign direct investment in the other European countries. As for our third proposition, while our aggregated data only provide some indirect evidence, there seems to have been a shift in the internationalization strategy of U.S. companies. Their investment strategy has evolved from being motivated primarily by comparative costs of production, towards more complex motivations that increasingly reflect a strategic and/or defensive intent with increased explorative learning. These reflect both the increasing globalization due to de facto and de jure economic

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integration, as well as the increasing international experience of these firms and the growing competitiveness of EC firms. In particular during the 1980s U.S. companies began to diversify their production activities to take advantage of the single market, as well as developing an internationally integrated foreign direct investment strategy towards global (or regional) rationalization by spatially distributing their activities to exploit both the economies of agglomeration and those of scale and scope, due to the various national systems of innovation. Our fourth proposition expressed the idea of the expected learning economies through which U.S. foreign direct investment in Europe would gradually narrow the gap between their primary and secondary markets. This process has to be understood in the context of so-called lagged co-evolution in which gradual changes in the environment of companies are both affecting and being affected by the investment strategies of groups of individual firms. At the end of the 1960s, with the EEC being well established, U.S. foreign direct investment in the EEC had clearly become less suboptimal if compared to the growth potential of these economies. During the 1970s this development not only led to a narrowing of the gap between primary and secondary markets, to some extent this evolution of U.S. foreign direct investment indicated that Germany had become the primary market for U.S. investors instead of the U.K. However, from the perspective of the direction of U.S. foreign direct investment the continuing process of economic integration in Europe further assimilated the markets of countries that established the EC. At the end of the 1980s U.S. foreign direct investment had no particular preference for either the U.K. or Germany and the distinction between primary and secondary markets for the U.K. and within the EC6 had largely disappeared. It should be noted that while the process of globalization of production and the increasing convergence of the economies of the developed economies has led to a similarity in country-specific characteristics, there continued to be considerable differences in the national systems of innovation. Furthermore, the national institutions and the level of competitiveness of countries change only incrementally over relatively long cycles (Cantwell 1989; Hagedoorn 1995; Narula 1996). It is for these reasons that we believe that complete convergence in foreign direct investment patterns is unlikely to ever happen. In a profit satisficing scenario where decisions are strategic as well as cost based, the complex and changing motivations of foreign direct investment will lead to a continuously shifting extent of foreign direct investment.10

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Dunning, J.H. and Narula, R. (1994) Transpacific Direct Investment and the Investment Development Path: The Record Assessed, Essays in International Business, 10, May. Dunning, J.H. and Narula, R. (Eds.) (1996) Foreign Direct Investment and Governments: Catalysts for Economic Restructuring, Routledge, London. Economist (1995) The Return of the Habsburgs, November 18. Ginsberg, A. and Baum, J.A.C. (1994) Evolutionary Processes and Patterns of Core Business Change, in: Baum,J.A.C. and Singh, J.V. (Eds.), Evolutionary Dynamics of Organizations, Oxford University Press, Oxford, pp 127-151. Graham, E. (1978) Transatlantic Investment by Multinational firms; A rivalistic phenomenon? Journal of Post-Keynesian Economics, Vol 1, pp 82-99. Hagedoorn, J. (Ed.) (1995) Technical Change and the World Economy, Edward Elgar, Aldershot. Hirsch, S. (1967) The Location of Industry and International Competitiveness, Oxford University Press, Oxford. 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, 8:23-32. Johanson, I and Weidersheim-Paul, F. (1975) The Internationalization of the Firm—Four Swedish Case Studies, Journal of Management Studies, 12:305-322. Knickerbocker, F.T. (1973) Oligopolistic Reaction and the Multinational Enterprise, Harvard University Press, Cambridge, Massachusetts. Kogut, B. (1983) Foreign Direct Investment as a Sequential Process, in: Kindleberger, C.P. and Audretsch, D. (Eds.), The Multinational Corporation in the 1980s, MIT Press, Cambridge, Massachusetts, pp 38-56. Kogut, B. (1988) Country Patterns in International Competition: Appropriability and Oligoplistic Agreement, in: Hood, N. and Vahline, J-E (Eds.), Strategies in Global Competition, Groom Helm, London, pp 315-340. Krause, L. (1968) European Economic Integration and the United States, The Brookings Institution, Washington, DC. Levinthal, A.D. and March, J.G. (1993) The Myopia of Learning, Strategic Management Journal, 14:95—112. Maddison, A. (1991) Dynamic Forces in Capitalist Development, Oxford University Press, Oxford. March, J.G. (1991) Exploration and Exploitation in Organisational Learning, Organizational Science, 2:71-87. March, J.G. (1994) The Evolution of Evolution, in: Baum, J.A.C. and Singh, J.V. (Eds.), Evolutionary Dynamics of Organisations, Oxford University Press, Oxford, pp 39-49. Narula, R. (1996) Multinational Investment and Economic Structure, Routledge, London. Nelson, R.R. (Ed.) (1993) National Innovation Systems, Oxford University Press, New York. Nelson, R.R. and Winter, S.G. (1982) An Evolutionary Theory of Economic Change, Belknap Press, Cambridge, Massachusetts. OECD (1992) Technology and the Economy, OECD, Paris. Ozawa, T. (1992) Foreign Direct Investment and Economic Development, Transnational Corporations, 1:93-126.

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Schumpeter, J.A. (1942, 1975) Capitalism, Socialism and Democracy, Harper & Row, New York. Simon, H.A. (1956) Rational Choice and the Structure of the Environment, Psychological Review, 63:129-138. Simon, H.A. (1987) 'Satisficing', in: Eatwell, J., Millgate, M. and Newman, P. (Eds.), The New Palgrave: A Dictionary of Economics, No. 4, pp 243-245. Stopford,J. and Wells, L.T.Jr. (1972) Managing the Multinational Enterprise—Organization of the Firm and Ownership Subsidiaries, Basic Books, New York. Strandskov, J. (1986) Towards a New Approach for Studying the Internationalization Process of Firms, Working Paper 4, Copenhagen School of Economics, Copenhagen. Teece, D.J., Rumelt, R., etal. (1994) Understanding Corporate Coherence—Theory and Evidence, Journal of Economic Behavior and Organization, 23:1-30. Tolentino, P.E.E. (1993) Technological Innovation and Third World Multinationals, Routledge, London. Turnbull, P. (1987) A Challenge to the Stages Theory of the Internationalisation Process, in: Rosson, P. and Reed, S. (Eds.), Managing Export Entry and Expansion, Praeger, New York. U.S. Department of Commerce (1953) Direct Private Foreign Investments of the United States: Census of 1950, Office of Business Economics, Washington. U.S. Department of Commerce (1959) US Overseas Direct Investment in 1957, Office of Business Economics, Washington. Vernon, R. (1966) International Investment and International Trade in the Product Cycle, Quarterly Journal of Economics, Vol 80, pp 190-207. Vernon, R. (1971) Sovereignty at Bay: the Multinational Spread of US Enterprises, Basic Books, New York. Welch, L. and Luostarinen, R. (1988) Internationalization: Evolution of a Concept, Journal of General Management, 14:36—64. Wolff, E. (1994) Technology, Capital Accumulation, and Long-run Growth, in: Fagerberg, J., Tunzelmann, N. and Verspagen, B. (Eds.), The Dynamics of Technology, Trade and Growth, Edward Elgar, Aldershot, pp 53-74. Yu, C-M.J. (1990) The Experience Effect and Foreign Direct Investment, Weltwirtschaftliches Archiv, 126:561-579.

NOTES 1.

2. 3.

The analysis of general economic conditions and the broad evolutionary changes in them reminds us of Schumpeter's (1942) classical evolutionary theory of the effect of long waves on economic development. It is to be noted that all data for Germany explicitly focuses on the former West Germany. Although U.S. manufacturing foreign direct investment stocks in Western Europe actually increased in value from US$611.4 million to US$878 million between 1936 and 1943 (U.S. Dept of Commerce, 1953, p. 49), this is accounted for in great part due to the movement of refugees, primarily from Germany, who subsequently became citizens of the U.S. However, by the end of the war, much of these refugee holdings had been liquidated or written off (U.S. Department of Commerce, 1959, p. 13).

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Foreign direct investment manufacturing stock data on a comparable basis prior to 1950 is unavailable. 5. These figures are calculated on the basis of current prices. It is important to realize that foreign direct investment is a nominal number, and although it is possible to compare growth rates of foreign direct investment with those of real GDP, the use of such a ratio is primarily as a means to examine the trend over time. On the other hand, it is not possible to compare real GDP in 1980 prices with nominal foreign direct investment figure, and we must necessarily do so with nominal GDP. 6. For instance, of the 146 major innovations between 1915 and 1939, 13% originated in Germany, the same percentage as that of the U.K., and second only to the U.S. In terms of U.S. patents, Germany recorded almost twice as many U.S. patents as the U.K. in 1939, and four times that of France in 1939 (Dunning 1988b,pp 90-91). 7. Growth rates of both GDP and foreign direct investment both declined considerable in the early 1970s due to the effect of the introduction of the floating exchange rate system as well as the oil shock. However, this affected all countries within Europe to more or less the same extent, and since we are examining relative growth rates it does not influence our argument. 8. These are averages for 1982-1990, the standard deviation for the U.K. was 0.65% and for Germany it was 1%. 9. For instance, between 1950 and 1979 the comparative level of capital labor ratio in Germany and the U.K. increased from 46 for both to 105 and 64, respectively, with 100 being equivalent to the U.S. (Abramovitz and David 1994). 10. This is amply illustrated in the various country studies in Dunning and Narula (1996).

Multinational Strategy and the Evolution of Environmental Standards in the Global Economy SARIANNA M. LUNDAN1

I.

INTRODUCTION

The purpose of this chapter is to offer a practical framework for evaluating the strategic issues arising from the growing role of multinational enterprises (MNEs) in the political process. The perspective adopted is that of the multinational firm as opposed to that of the national regulator or international bodies such as the World Trade Organization (WTO), and the central question is how the firm will respond to the changing configuration of environmental decisionmaking in the global economy. Empirical evidence of such a challenge is presented using the case of the introduction of the chlorine-free bleaching process in the pulp and paper industry. The case is illustrative of an increasingly common dynamic whereby non-governmental organizations (NGOs) as representatives of diffuse consumer interests have stepped into the political process and instigated changes in business practices. It is argued that multinational environmental strategy has changed the way in which MNEs respond to regulation as well as the way in which national governments approach the issue of regulation, and to a growing extent the creation and maintenance of environmental standards has turned into a three-way balancing act between governments, MNEs and NGOs. II.

THE EMERGENCE OF ENVIRONMENTAL STRATEGY

While it may be too soon to predict what the long-term impact will be of the events in Seattle in December 1999, it seems clear that the 785

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unrest that took place at the intended opening of a new round of trade negotiations under the auspices of the WTO was a concrete manifestation of the new status acquired by NGOs as well as MNEs in the global economy. Seen in this light, the recent events are the next step in a process that has included the 1992 United Nations (UN) conference on the environment in Rio, the Kyoto agreement on curbing greenhouse gases,2 and most importantly the derailment of the talks for the multilateral agreement on investment (MAI) under the auspices of the Organization for Economic Co-operation and Development (OECD). In all four cases, the concerns of the large and increasing number of NGOs, framed in terms of eroding national sovereignty, as well as the interests of the of MNEs, framed mostly in terms of effects on competitiveness, were to be at the forefront of the discussions. In addition to being affected as producers and consumers, MNEs also now play a decisive role in helping the United States (U.S.) to meet its Kyoto obligations, since the agreement allows for a reduction in greenhouse gases by U.S. multinationals (irrespective of location) to be counted as a reduction in the U.S. target. The aim of this section is to show how MNEs have come to occupy such a position with regard to environmental matters, and how in the process they have been confronted by the increasing importance of NGOs as representatives of the marketplace. The evolution of thinking about the environment as a strategic issue can usefully be split into three periods. The first phase gained momentum from the first UN conference on the environment held in 1972 in Stockholm, which was accompanied by the publication of some alarmist reports concerning population growth and the depletion of key natural resources (e.g. Paul Ehrlich in The Population Bomb' and the Club of Rome in 'Limits to Growth'). From the business perspective, the first phase was characterized by large-scale investment in pollution control with the objective of meeting new tougher emissions requirements, such as those imposed by the clean air (1970) and clean water (1977) acts in the U.S. The second phase in environmental thinking began sometime in the mid-1980s on the heels of corporate restructuring and the introduction of Total Quality Management (TQM) into the business vocabulary.3 This phase was characterized by the emergence of a new winwin rhetoric concerning the effects of environmental standards on the competitiveness of firms. The most notable proponent associated with this line of thinking has been Michael Porter (Porter 1991), who has argued, consistent with his home country influenced diamond model of national competitiveness, that firms resident in countries with tough regulations do not suffer, but in fact benefit from the discipline imposed by strict regulations. To capture such benefits, firms will have

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to think of regulation as providing a long-term benefit at a short-term cost, and to move from a static conception of regulation as a cost to treating it as a strategic (resource) challenge.4 The long-term payoff from such investments was subsequently labeled as 'innovation offsets' by Porter and van der Linde (1995). Alongside the argument of beneficial regulation, there is a less controversial technological side to the win-win argument, which states that if firms move away from a reactive response to regulation and adopt a proactive stance towards environmental challenges, the possibility of capturing first-mover benefits will emerge. The essential change in thinking is one that moves firms away from end-ofpipe solutions (i.e. addressing pollution problems once they have occurred) to process redesign, whereby all unwanted by-products and waste are eliminated. This process is analogous to that advocated in TQM, and has led many firms to institute a system of TQM for environmental management (sometimes labeled TQEM) where pollution is seen as evidence of inefficient use of resources. The aim of such a process redesign is to create a closed facility, where all flows of materials and product are intentional, and any by-products are captured and re-used. Not surprisingly, the third phase in the evolution of environmental concerns is something of a critical review of the win-win rhetoric. Studies such as the one conducted by Levy (1995) on 80 MNEs found no evidence of a relationship between environmental performance and subsequent financial performance, whereas Russo and Fouts (1997) found a positive relationship between environmental performance and profitability for a sample of 243 U.S. multinationals. Sharma and Vredenburg (1998) did not directly assess the link between environmental performance and profitability, but looked instead at identifying environmentally related corporate capabilities that could be competitively valuable for the firm. Both Russo and Fouts (1997) and Sharma and Vredenburg (1998) rely on the resource-based theory of strategy, the basic tenet of which is that assets that are inimitable and difficult to acquire in the marketplace can generate value for their owners. In the environmental context, such assets can include a technological advantage in cleaner technology, as well as intangibles such as a corporate culture predisposed to accepting environmental responsibility, or a capability for generating a long-term vision of competitiveness and sustainability.5 As regards the role of multinationals and environmental standards, Rugman and Verbeke (1998b) provide a general framework for assessing the strategic implications for MNEs, which essentially depend on whether multinationals will opt for global or local standards and whose standards will form the benchmark. The process of

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standards setting within the multinational can either be a race to the top (also called 'trading up' by Vogel (1995)), or it can be a race to the bottom, depending on the extent to which the multinational is exposed to tough standards either through regulators or consumers. What is of course notable about MNEs in this context is the extent to which they are influenced not only by the conditions in their home base (the original Porter case), but also by the conditions in important markets globally. The second central question concerning MNEs, which is how should governments interact with MNEs as both home and host countries to achieve their desired environmental objectives, is also addressed by Rugman and Verbeke (1998a), and will be discussed later on in this chapter. While most of the discussion on MNEs and environmental performance today recognizes the possibility of improved environmental standards brought about by MNEs, there is, of course, a literature that pre-dates the win-win rhetoric, which investigated the conduct of MNEs in light of the so-called 'pollution haven hypothesis'. The basic prediction of the pollution haven hypothesis was that as environmental regulations were tightened in the MNEs' developed home markets, they would gradually move pollution-intensive production to the less regulated developing countries. The empirical and theoretical case against the pollution haven hypothesis is reviewed in Lundan (2000), and will not be discussed here, except to note that the dynamic underlying the winwin scenario is also the primary component missing in the static conception of the pollution haven hypothesis. III.

ENVIRONMENTAL STRATEGY IN THE PAPER INDUSTRY

There exist a set of conditions arising from the capital intensity of some of the most pollution intensive industries, which have the potential to result in a virtuous cycle of improved environmental quality and better performance. Particularly in sectors such as pulp and paper, steel, and chemicals, there is growing evidence of the capital intensity of these operations rendering investment decisions subject to careful scrutiny initially in terms of financing, as well as during the lifetime of the investment, typically extending to 20-30 years. The sheer size of a new investment is often such that a significant degree of debt financing must be used, bringing along with it an increasingly stringent set of environmental impact assessment criteria on behalf of the lenders. Whether these preconditions lead to good environmental performance is dependent on the existence of triggers that force firms to improve their performance. Traditionally, the triggers have come from regulation, but increasingly the

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push to change is coming from consumers, or other interested parties, such as NGOs. The empirical evidence discussed in this chapter was collected in 1995-96, and involved interviews with 18 Vice Presidents or Senior Vice Presidents in charge of Environmental Management, as well as a questionnaire survey, which was administered both to the firms already interviewed, as well as to 14 other companies in the industry (Lundan 1996). The original study covered pulp and paper producers in Finland, Sweden, Canada, and the U.S., and since the connection between globalization and environmental strategy lay at the heart of the study, the selection of countries (and firms) was based on their contribution to world trade in pulp and paper. In the end, the share of world sales accounted for by the firms in the sample amounted to 43%.6 Three broad questions were addressed in this research. Firstly, whether the relative importance of consumers had increased in comparison to regulators as instigators of environmental change since the 1970s, and whether, with increasing globalization, foreign, rather than domestic sources (whether consumers or regulators), had become more important over time. Secondly, the study tried to estimate whether the 'innovation offsets' discussed by Porter and van der Linde (1995), arising from cleaner and leaner technology, were a reality in the paper industry. Thirdly, the study tried to assess the possibility that in addition to a technological payoff, the marketplace could reward firms by an increased market share or a price premium for green products. The overall results will be reviewed here briefly, after which the case of the development of chlorinefree pulp will be discussed in some detail. The respondents were asked to evaluate several propositions over two time periods; before and after 1985, which was taken to be the inflection point when the industry moved from pollution control and compliance to proactive environmental management. The overall results indicate that as the industry has become more global, the influence of foreign consumers and regulators on environmental decisions has significantly increased. Additionally, the influence of consumers (whether domestic or foreign), has increased significantly over time in relation to that of regulators. However, the importance of government regulation has not diminished over time, and in fact domestic regulatory authorities, although rated slightly lower in the latter period, still outranked the other options, including foreign consumers, which came in a close second. Overall, consumers were ranked higher in influence than regulators in the second period, which was a reversal of the situation 10 years earlier. Foreign regulators were predictably the least influential in both periods.

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While the results obtained in this manner fall short of measuring the true change in opinions over time, in many cases the executives had been in the industry for the entire period (1970-96), and were able to address issue of change from a personal perspective. It is particularly notable in this case, that the growing influence of changes in tastes and regulation in foreign markets had taken place mostly through export trade, and to a much lesser extent, through foreign investment. As will be seen in the chlorine-free paper case, the demands of German consumers have shaped not only the way in which paper is made in Germany, but the way in which it is made in Finland and Sweden as well, illustrating how foreign product standards can travel and affect process standards domestically. The results regarding the presence of 'innovation offsets' in the paper industry were mixed, but a few clear reasons can be given to explain why some of the 'green' technological options did not receive a more enthusiastic response in the survey. First, the period from the early 1970s onwards was one of great improvements in the environmental performance of pulp mills, and in some sense by the 1980s the obvious problems had already been addressed with a considerable degree of success. The 'low hanging fruit' having been picked, what remained were much more intractable issues, and a long-term process was begun which would ultimately lead to the development of the 'closed mill' concept. Second, most of the new process innovations are no longer thought of as environmental investments per se, but rather, environmental considerations are among the parameters that are taken into account in designing the technological options for a new mill. This being the case, the likelihood of such investments paying themselves back is small and difficult to substantiate, since a holistic approach to environmental management almost inevitably implies that environmental gains (and costs) are but one of the factors accounted for in a system designed to improve performance on a number of dimensions, such as shareholder value, product quality, and health and safety issues. In contrast, relatively small improvements at the consumer end, such as the development of packaging designs which require less space, or materials which have improved strength with reduced weight, can generate more immediate payoffs. It is in such applications that the benefits from going 'green' can most easily be accounted for, while the benefits from a more fundamental change in corporate vision are much more difficult to trace. As to the final question of how well the marketplace had rewarded the activities of firms that had engaged in significant environmental investments, the answers provided by the respondents

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provided a revealing picture. The reactive option of shielding oneself from an adverse consumer reaction received the highest ranking in the survey, but almost equal was the perceived gain from a first-mover image and voluntary efforts to exceed regulations. This apparent contradiction, of firms wanting to get carrots while trying very hard to avoid getting the stick, is critical to understanding the evolving relationship between MNEs, consumers and NGOs. As indicated earlier, pulp and paper is an extremely capital-intensive industry, which places a significant constraint on the extent to which a firm faced with a 20-30 year lifetime for a capital investment can effectively respond to 2-3 year cycles in consumer tastes. (Keeping in mind that any gains from a process re-design are likely to accrue in the long run, and a re-design would not be undertaken multiple times for the same facility.) For their part, the consumers engage in a limited search for information when making purchasing decisions, and are often heavily influenced by non-governmental organizations (NGOs) such as Greenpeace, who help to surface environmental concerns and to frame the alternatives. (Indirectly this also extends to intermediaries, who have more technical knowledge than the final consumer as regards the environmental performance parameters of a product, but who are also swayed by what the consumers appear willing to buy.) Furthermore, while consumers express a great deal of concern for the environment in opinion polls, there have been very few instances in which they have voted with their money, and actually paid a premium for 'green' products (see Lampe and Gazda 1995). One solution to the problem of asymmetry between the information held by the firms and consumers is the use of eco-labels, where the issuers of the labels are supposed to guarantee a product's environmental performance to a specified level. In the European paper industry, there are more than a dozen eco-labels in place, and consumers who are quite skeptical when it to comes to any claims made by industry, have not been particularly well served by the proliferation of different eco-labels. From the industry's perspective though, the lack of common standards is testament to the lure of the market payback, however elusive. If no firm could conceive of a proprietary gain from the adoption of a particular environmental standard, agreeing upon common industry standards would not be complicated. It is precisely because environmental concerns have become a part of the overall strategic management of firms, that the pursuit of proprietary gains remains viable, and that arriving at common standards is virtually impossible.

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The Case of Chlorine-Free Paper

There have been three major areas of environmental concerns in the paper industry, namely water and air pollution arising from the pulping process, the use of recycled fibers, and forestry practices. Over the past two decades, public interest has shifted from chlorine in the wastewater to recycled content in paper, and presently to forest certification schemes. In all three cases firms have had individual reasons for preferring one standard over another, thus for example at the European level, Scandinavian firms would not agree to high recycled content as a measure of environmental performance, given that there is little recycled fiber available domestically but an abundant supply of virgin fiber. Similarly, Finland and Sweden have developed two parallel forest certification schemes (FSC and PEFC), but only the Swedish one (FSC) is likely to be acceptable to the German buyers.7 These ongoing concerns aside, the environmental issue dominating the past 20 years and requiring unprecedented levels of new investment was the removal of chlorine from the pulp mill wastewater. Following the first wave of environmental investment in the early 1970s in response to clear air and clean water laws, a second wave of investment was initiated when concerns emerged about the effects of chlorinated organics in the mid-1980s, particularly in Sweden and Germany. In Germany, Greenpeace campaigned actively for the removal of chlorine in the bleaching process for fear that the residual chlorine in the wastewater would combine with organic matter and form highly toxic substances, such as dioxins. The impact of this (market-led) action on the industry was substantial, as it was not possible to allay such concerns though the use of end-of-pipe technology, which in this case would have meant multiple layers of water treatment facilities. Instead, two new pulping processes were developed; the Totally Chlorine Free (TCF) pulping process, which eliminated the use of chlorine, and the Elementally Chlorine Free (ECF) process, which eliminated the use of elemental chlorine (C12), and replaced it with chlorine dioxide. Prompted by the importance of the German market to Scandinavian producers, the industry in these countries invested heavily in the new technologies, and by the early 1990s, chlorine use in the Swedish and Finnish industries had been reduced ten and five fold, respectively. (Table 9.1 illustrates the importance of the German export market to Finnish and Swedish producers, and Figure 9.1 presents a comparison of chlorine use in Sweden and Finland.) Over the next 10 years, ECF became the standard adopted by the equipment suppliers in the industry, although a few firms invested

Multinational Strategy and the Evolution of Environmental Standards TABLE 9.1

193

Trade and Investment in Pulp and Paper (Sweden and Finland) Finland

Sweden

Exports of pulp (by value; 1992/3) Germany United Kingdom France Outside EC Exports of pulp as % of production Exports of (bleached) Kraft pulp as % of production Source: SPPA (1994), FFA (1993)

38% 17% 10% 18% 16% 25%

33% 8% 13% 24% 29% 55%

Exports of paper and board (by value; 1992/93) United Kingdom Germany France Outside EC Exports as % of production Source. SPPA (1994), FFA (1993)

16% 15% 9% 37% 91%

21% 20% 24% 24% 81%

9%* 21%*

5% 11%

Inward foreign direct investment stock as % of total (1988/9) Outward foreign direct investment stock as % of total (1988) Source: UN (1993) Note: * Other manufacturing, including pulp and paper.

heavily in TCF, and for a while a Swedish producer was able to derive a price premium for TCF pulp. In this example of 'trading up' (cf. Vogel 1995), a window of opportunity was created for the industry to make substantial investments in a technology which, although known in principle, was not adopted earlier despite its significant efficiency and quality improvements, due to the difficulty of undertaking significant capital investments when no concerted demand for such improvements existed in the marketplace. The adoption of the standard in Scandinavia, and its technological superiority, resulted in the subsequent adoption of ECF in the U.S. and Canada. These processes represent the dominant technology on offer from the major equipment suppliers, and mills such as those operated in a joint venture by UPMKymmene of Finland and the Indonesian APRIL in Indonesia (1998) and China (1999) employing the new technology are said to meet European emission standards. The technological superiority of the ECF process was also a probable contributing factor to the positive profit performance of first-mover firms within the paper industry observed by Nehrt (1996).

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300

V

V

FIGURE 9.1 Use of Chlorine in the Pulp and Paper Industry (Sweden and Finland) Source: SPPA (1994), FPA (1993).

IV.

THE EXPANDING POLITICAL ROLE OF MNES

Much of the research on the political role of multinationals to date has tended to concentrate on government-MNE relations, with an emphasis on the desirability of policies to attract foreign investment, or the role of political risk in the operations of MNEs, as in cases of expropriation and bribery. In such studies the MNE typically responds to prevailing conditions or chooses between them (e.g. Boddewyn 1988), and even in the framework presented by Rugman and Verbeke (1998a) the focus is on MNE-government interaction, but not on MNE-(host) market interaction or MNE-NGO interaction. It is suggested here, that as a complement to the kinds of interactions envisaged by Rugman and Verbeke (1998a), which include 'bad' firms lobbying governments for shelter and 'good' firms lobbying in favor of their proprietary standards, MNEs must learn to effectively deal with the challenge posed by NGOs. In general, the picture that is beginning to emerge regarding the environmental actions of multinationals is one of increased political involvement at multiple levels of influence. At the supranational level, the issue of sovereignty has been revisited in the drafting of multilateral agreements, like NAFTA, or the defunct Multilateral Agreement on Investment (MAI). The NAFTA environmental side

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agreement explicitly rejects the objective of harmonization in favor of a (market-led) process of gradual convergence; and even in the European Union, domestic and community measures complement each other under the principle of subsidiarity (Ziegler 1996). The political role of the MNE now encompasses elements which were previously solely the domain of national governments, as well as involvement in 'grass-roots' issues in response to consumer demand, and in particular, in response to demands by NGOs. The changing configuration of environmental decision-making is illustrated in Figure 9.2. At the top level, there are supranational issues such as climate change, and multilateral negotiations to curb the use of CFCs, for instance. At the level below are the bodies specifically designed to establish rules and codes of conduct in the international domain. The WTO rules (and those of a possible environmental subsidiary organization) are operative at this level, as are codes of conduct for multinationals crafted by the OECD, and the provisions of the MAI, should it ever come to pass. Below this level are the national policy-makers, who set the basis for industry standards in their geographical area. While a few decades ago, the entire chain of environmental policy would have consisted of the bottom two, or at the most, bottom three levels, today we find not only four levels of governance, but also two new entrants to the table, the MNEs and environmental NGOs. V.

CONCLUSIONS

This chapter has employed evidence from the paper industry to illustrate a dynamic increasingly recognized by researchers in the environmental area, whereby MNEs have learned to operate in the new era of negotiated regulation and target setting (rather than command and control), and are increasingly taking their signals from the market rather than regulation. The marketplace is in turn Levels of environmental decision-making Supranational Negotiations Montreal Protocol (CFCs) Climate Change GATT/WTO Rules OECD (PPP; MAI?) MNE Trade and Investment Environmental strategy

National Governments Environmental policy

Non-Governmental Organizations (NGOs) Consumer action

Industry Standards!

FIGURE 9.2 Source: Lundan (2000).

The Environmental Standards-setting Process

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increasingly influenced by NGOs, and the growing tendency of the technological solutions to environmental problems to reside within the MNE coincides with an overall trend towards trade and investment liberalization, and a recognition of the role of the MNE as a political entity. It is suggested here, that while multinationals may have grown increasingly comfortable with their role as negotiating partners with national regulators, it is not clear whether multinationals are ready for their new role in the global economy. It seems that firms doing what firms do, which is to allocate resources to their most efficient uses, and governments doing what governments do, which is to oversee that various social objectives are met, does not necessarily apply. To the firms this may mean that they will increasingly learn to shape their environmental visions in a defensive manner with an eye to minimizing future liability. While on the technological front this can result in a favorable outcome, such as in the design of the minimum impact or closed mill, as a corporate objective it has some troubling implications. Without a framework provided by the active role of regulatory authorities in the standards-setting process, there is a risk of a vacuum being created, where the pressure put on firms by NGOs will be the primary driver of the firms' strategy. Adopting the lowest cost strategy of meeting the NGOs requirements may result in an inability on behalf of the multinational to concentrate on a longterm strategy of sustainability, as much as command-and-control regulation resulted in end-of-pipe solutions and turned the firms' focus on short-term costs. Such a state of affairs is untenable, and either the national regulators have to step in to alleviate concerns that essential aspects of the economy have been handed over to the multinationals, or the MNEs have to start to reconsider their role as virtual state actors, willing to be open and responsive about their long-term vision for sustainability, and willing to take on the NGOs to justify their policies. This would mean a rather radical departure for many multinationals content over the past few years on being led by market forces and being responsive to the marketplace, but not necessarily to society as a whole. NGOs should not guide but should inform policy, and whether MNEs should guide or inform policy will depend on how comfortable they can get with solving the stick-carrot dilemma. The MNEs used to be able to take refuge in demonstrating compliance with national regulations to avoid looking bad in the eyes of the NGOs. To the extent that MNEs are now increasingly a part of setting the national and international standards, that refuge has lost much of its effectiveness. If MNEs are to be responsive to society's needs, they

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need a long-term vision of corporate sustainability, which might mean a confrontation with the NGOs and risking the stick. If they pander to the NGOs, they risk being blackmailed out of their own policies, but might win short-term approval in the marketplace. While there is no evidence to warrant undue concern, and the case presented here could well be considered a model of the desired outcome from such an MNE-NGO interaction, there is a distinct possibility that multinationals might be moving towards risk limitation or damage control as their predominant environmental strategy. Such a shift, were it to happen, would open up new areas of enquiry to assess whether in the end bad markets would be preferable to bad regulation. REFERENCES Berry, M.A. and Rondinelli, D.A. (1998) Proactive Corporate Environmental Management: A New Industrial Revolution, Academy of Management Executive, 12(2):38-50. Boddewyn,J. (1988) Political Aspects of MNE Theory, Journal of International Business Studies, 19(3):341-363. Finnish Forestry Association (FFA) (1993) Metsdteollisuuden Vuosikirja (Annual Yearbook), FFA, Helsinki. Lampe, M. and Gazda, G.M. (1995) Green Marketing in Europe and the United States: An Evolving Business and Society Interface, International Business Review, 4(3):295-312. Levy, D.L. (1995) The environmental practices and performance of transnational corporations. Transnational Corporations, 4(l):44-67. Levy, D.L. and Egan, D. (1998) Capital Contests: National and Transnational Channels of Corporate Influence on the Climate Change Negotiations, Politics and Society 26(3):337-361. Lundan, S.M. (1996) Internationalization and Environmental Standards in the Pulp and Paper Industry, PhD dissertation, Rutgers University, NJ. Lundan, S.M. (2000) Environmental Standards and Multinational Competitiveness: A Public Policy Proposal, in: Fatemi, K. (Ed.), International Public Policy and Regionalism at the Turn of the Century, Elsevier, Amsterdam. Nehrt, C. (1996) Timing and Intensity Effects of Environmental Investments, Strategic Management Journal, 17:535-547. Nehrt, C. (1998) Maintainability of First Mover Advantages when Environmental Regulations Differ between Countries, Academy of Management Review, 23(l):77-97. Porter, M.E. (1991) America's green strategy. Scientific American, (April): 168. Porter, M.E. and Van Der Linde, C. (1995) Toward a New Conception of the Environment-Competitiveness Relationship, Journal of Economic Perspectives, 9(4):97-118. Rugman, A. and Verbeke, A. (1998a) Multinational Enterprises and Public Policy, Journal of International Business Studies, 29 (1): 115-136.

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Rugman, A.M. and Verbeke, A. (1998b) Corporate Strategies and Environmental Regulations: An Organizing Framework, Strategic Management Journal, 19:363-375. Russo, M.V. and Fouts, P.A. (1997) A resource-based perspective on corporate environmental performance and profitability. Academy of Management Journal, 40 (3):534-559. Sharma, S. and Vredenburg, H. (1998) Proactive corporate environmental strategy and the development of competitively valuable organizational capabilities. Strategic Management Journal, 19:729-753. Swedish Pulp and Paper Association (SPPA) (1994) A Search for Sustainable Forestry—The Swedish View, SPPA, Stockholm. United Nations (1993) The World Investment Directory, United Nations, New York. Vogel, D. (1995) Trading Up: Consumer and Environmental Regulation in a Global Economy, Cambridge, MA, Harvard University Press. Ziegler, A.R. (1996) Trade and Environmental Law in the European Community, Clarendon Press, Oxford.

NOTES 1.

2. 3.

4. 5.

6. 7.

The research discussed in this chapter has benefited greatly from the helpful comments by Peter Gray. To the extent that the chapter manages to be succinct and readable, credit is also due to Professor Gray for setting a good example. Any errors or misguided flights of fancy remain the responsibility of the author. See Levy and Egan (1998) on an analysis of corporate interests in the climate change negotiations. It should be noted, that while there is little disagreement over the movement from reactive to proactive environmental thinking, the time-line is dependent on geographical location, so that e.g. Berry and Rondinelli (1998) identify the same process in the U.S. as lagging the European time-line presented in this chapter by 5-10 years. A good summary of the old versus new thinking on environmental regulation is presented in Nehrt (1998). It may be a sign of maturity that at this stage the discussion begins to resemble the perennial debate on whether multinationality improves performance, with analogous problems relating to the measurement of performance on one hand, and of the independent variables on the other hand. If Japan (whose paper production is mostly domestic) is included, the share (based on sales in 1989) is 37%. As reported in Suomen Kuvalehti (Finland) on 20 August 1999. The same article quoted Finnish forest officials as saying that (any) European forest certification scheme was done for marketing reasons, and had no impact on the (global) preservation of forest resources.

10

Promotion of Products from Developing Countries: An Overview and Assessment of Import Promotion Efforts GEIR GRIPSRUD AND GABRIEL R.G. BENITO1

I.

INTRODUCTION

Increasing exports is of utmost importance in order to achieve economic growth in developing countries (Bhagwati 1990; Krueger 1990). At the same time, it is quite clear that the route towards export growth is paved with obstacles. First, many barriers to international trade exist due to macroeconomic policy measures. Some of these barriers are linked to specific policies regarding trade and economic activity pursued by individual countries, while others exist as a result of agreements made between countries at a bilateral, regional, or even a global level (Gray 1995). Second, producers from developing countries may face a range of market barriers when considering whether and how to enter foreign markets, in particular highly developed market economies. Such barriers include limited information about foreign market opportunities in general (Egan and Mody 1992), lack of specific knowledge about foreign markets (Dominguez and Sequeira 1993), and foreign customers' perceptions of products originating in developing countries (Egan and Mody 1992; Crawford and Lumpkin 1993). While such barriers may be overcome, companies with limited resources may be unable to surmount the obstacles if left to themselves. Governments in several developing nations have established various kinds of export promotion organizations (EPOs) which provide assistance to actual and potential exporters (Cavusgil and 199

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Czinkota 1990; Seringhaus and Rosson 1990, 1991). The focus of this chapter is on a complementary, and seemingly less known type of institution, established to facilitate imports from developing to developed countries. This type of institution is established in a number of developed countries and they are usually referred to as import promotion agencies (IPAs). While a case study of the Norwegian import promotion office—NORIMPOD—has been reported by Gripsrud and Benito (1995), no comprehensive review of the import promotion agencies in developed countries is available. This chapter is a first step towards a better understanding of these offices. The aim of this exploratory paper is to establish a framework for evaluating the work carried out by the IPAs and to report the results of a survey carried out among them to map their organizational structure, goals and activities. II.

THE DOMAINS OF EXPORT AND IMPORT PROMOTION

To assess the scope of import and export promotion in facilitating international trade, a distinction should be made between external and internal barriers to trade. The external barriers to trade may be divided into policy barriers and market barriers, respectively. The internal barriers are primarily dependent upon the resources available to the company, and for simplicity we distinguish between limited resources on the one hand and considerable resources on the other. This procedure leads to the simple 2 x 2 matrix shown in Figure 10.1 To start with, firms in a developing country may have limited resources and at the same time face severe policy-based trade impediments such as high tariff barriers or very restrictive quotas. In this situation, which is depicted in quadrant I, little export, if any at all, is likely to take place. Historically, this has been the case with many less developed countries which, apart from exports of raw

Policy barriers External barriers

FIGURE 10.1

Market barriers

Company resources Limited (insufficient) resources Considerable (sufficient) resources II I "national development "international trade regime negotiations" strategy" III IV "export and import no clear role: "laissez-faire" promotion strategy"

A Typology of Governmental Strategies toward Internationalization

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201

materials and certain commodities, have only had limited access to markets in the developed countries for many of their products, especially manufactured goods. An illustrative example is the quotas imposed on the import of textiles through the Multifiber Agreement. Removal of such barriers is, in general, expected to foster international trade. Still, even if barriers due to trade policy were to be lifted—as many of them have been through the recent GATT agreement and the subsequent establishment of the World Trade Organization (WTO)—it is quite possible that the amount of export taking place from developing countries would remain at a rather low level because producers in these countries are insufficiently prepared for competing in foreign markets (Dominguez and Sequeira 1993). Governments have attempted to deal with such problems by developing the physical, financial, and educational infrastructure of their countries, and by pursuing active policies of industrial development (Aggarwal and Agmon 1990; see also Mclntyre, Narula and Trevino 1996). As a result, a gradual move towards quadrant II may take place, as in Japan in the 1950s and 1960s and in South Korea and Singapore in the 1970s and 1980s. Although individual exporters may have sufficient resources to compete internationally (quadrant II), trade restrictions could of course still be present, thereby reducing the total volume of trade. The quantitative restrictions on imports of Japanese cars that, until quite recently, existed in the U.S. and the European Community serve as an example. These restrictions made it difficult to pursue an exclusively export-based strategy even though Japanese car manufacturers were, without question, fully capable of competing successfully in these markets. Instead, several Japanese companies opted for a combination of local production strategy (i.e. foreign direct investment) and exports in order to serve the markets (Womack, Jones and Roos 1990). In general, however, the recent developments towards freer trade—in particular the recently established WTO—have substantially reduced the barriers to trade created by policy measures at the national, regional, and global levels. Trade liberalization can be expected to be beneficial to developing nations since fewer formal barriers to entry should, in principle, make foreign markets more accessible to them. However, as suggested in the lower half of Figure 10.1, producers from developing countries may still experience severe difficulties in entering foreign markets. Some of the problems they may encounter are as follows: they may not know which markets to enter, how to establish contact with a distributor in a foreign market, which specifications (including design) of a product are most likely to succeed in a

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market, and how to communicate a product offer (Egan and Mody 1992; Dominguez and Sequeira 1993). The point is well taken by Gray (1999, p. 120), who states that: "Third World exporters are likely to lack both familiarity with consumer values in industrialized countries and expertise in M&D [marketing and distribution] activities." These problems are basically of a marketing nature, in the sense that they are related to the various activities that companies must undertake in order to serve customers successfully. Such problems are to some extent common to all export companies regardless of whether they are from a developed or a developing country, but they may be more difficult to overcome for companies from developing countries due to the often less favorable perceptions of products from developing countries held by many potential customers (Crawford and Lumpkin 1993; Wang and Lamb 1983). In addition, these problems are likely to be compounded by the limited resources available to many companies in developing countries (Dominguez and Sequeira 1993). Thus, while there certainly are companies in developing countries that can be classified into quadrant TV (one example is the Philippine brewery company San Miguel), the majority of direct exporters in the developing countries probably face the combination of trade barriers given in quadrant III. This chapter deals with strategies aimed at the problems associated with quadrant III, that is the various measures that can be—and are being—applied in order to alleviate the international marketing problems encountered by small and inexperienced companies from developing countries. While there is an increasing interest in the role of micro-level factors (Dominguez and Sequeira 1993; Mclntyre et al. 1996), most of the literature on trade and development has focused on trade policy at a macro-level (i.e. quadrants I and II; see, for example, Krueger 1990).2 III.

TRADE PROMOTION STRATEGIES

To achieve exports from a company in a developing country to an importer in a developed country an exchange relationship has to be established. A necessary requirement for such a relationship to develop is that the two parties involved consider it mutually beneficial. Bagozzi (1975) maintains that the analysis of how exchange relationships are established and maintained may be regarded as the core of the marketing discipline. In this particular context, the issue is how an outside agent may facilitate an exchange relationship between exporters and importers.

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A number of studies have analyzed the barriers to exporting perceived by managers, and discussed how such barriers can be dealt with (Bilkey and Tesar 1977; Cavusgil 1984; Gripsrud 1990; Benito, Solberg and Welch 1993). Seringhaus and Rosson (1990) argue that the three main types of barriers are; (1) motivational, (2) informational and (3) operational/resource based. Much research has been devoted to how such barriers may be overcome by export promotion activities carried out by governmental or semi-governmental institutions (Elvey 1990; Seringhaus and Botschen 1991). In developing countries, national EPOs as well as the United Nations' International Trade Center (ITC) are sponsoring programs that basically follow the same pattern as similar trade promotion agencies in developed nations. Since two parties—an exporter and an importer—are involved in international trade, the implicit assumption seems to be that there are few, if any, barriers to importing (Welch and Luostarinen 1993; Katsikeas and Dalgic 1995). This may explain why the efforts are concentrated almost exclusively on the exporting side of the relationship (Korhonen, Luostarinen and Welch 1996). It is, however, likely that obstacles to importing from developing countries do exist and are based upon the same motivational, informational and operational factors as is the case for export barriers (Deng and Wortzel 1995). An importing company in a developed country may lack knowledge about the opportunities available in developing countries and regard the risks involved in importing from such countries as prohibitive (Egan and Mody 1992). Given that the objective is to increase exports from developing to developed countries, it is suggested that two complementary strategies are feasible for governmental agencies. The first strategy seeks to overcome barriers perceived by exporters by offering adequate export promotion measures. The second strategy is to reduce the obstacles perceived by importers by offering suitable assistance (Gripsrud and Benito 1995; Korhonen et al 1996). In principle, the mix of strategies pursued should rest upon an analysis of the barriers present on the exporter and importer sides respectively. Limited information is available on the activities performed by the IPAs located in various developed countries. Gripsrud and Benito (1995) report a case study of the Norwegian import promotion office that shows that this particular office focuses mainly on providing assistance to importers. The framework outlined in that study argues that support activities may be grouped according to the main target groups: (1) exporters in the developing countries, (2) importers, and (3) final buyers and consumers. The discussion undertaken in Seringhaus and Rosson (1990), on the other hand, indicates that the IPAs,

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in general, offer the same type of assistance as the ITC and the EPOs; that is, assistance is mainly provided to the exporters. The actual natures of the IPAs, their goals and activities have not, however, been explored in any depth so far. Therefore, the research questions addressed in this paper are how these offices are organized in the various countries, what their objectives are, and what strategies they pursue in order to promote exports from developing countries. IV.

DATA COLLECTION

The International Trade Center regularly publishes a directory of import promotion offices based upon information provided by individual governments. The directory contains the names and addresses of each office in operation, as well as the name of a contact person in each office. In addition, a brief description of the services offered to developing countries by each office is given. The 1993 edition (International Trade Center 1993) lists 26 offices representing 24 countries, of which eight countries are former socialist countries and 15 countries are OECD member countries.3 While the information in the directory gives a rough outline of the activities performed by the different IPAs, it is clearly not sufficient for an in-depth analysis of the tasks performed by the offices. Furthermore, the directory does not provide any background information concerning the organization and size of each office. Hence, to explore such issues it was necessary to collect information directly from each IPA. Data collection, which took place in 1994, resulted in responses from 18 of the offices.4 When the data from the Norwegian office—previously collected—is included, we conclude that we have information on 19 of the 25 IPAs that existed at the time.3 The nonresponding offices include the IPAs in four former socialist countries: Belarus, Poland, the Russian Federation and Yugoslavia. In addition, the IPA in Israel as well as one of the two import promotion offices in Australia did not respond to our survey. An inquiry made to the ITC indicated that this organization does not possess any more information about the various IPAs than what is published in its directory. As the ITC relies upon information received from individual governments, the directory may not cover all the import promotion offices in operation.6 V.

ORGANIZATIONAL ASPECTS

Broadly speaking, the IPAs seem to belong to one of two categories with regard to organizational affiliation. Seven of the 19 IPAs from

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205

which we have information (Australia, Germany, Italy, Japan, the Netherlands, Norway, and Sweden) stated that they are affiliated with a Ministry in the government. Typically, these IPAs are affiliated with the Ministry of Foreign Affairs, but variations exist depending on how the government is structured. The remaining IPAs from which we have received information are not directly affiliated with a Ministry (Australia, Austria, Canada, Czech Republic, Denmark, Finland, France, Hungary, Romania, Slovakia, U.K. and Switzerland). In the former socialist countries (Czech Republic, Hungary, Romania, and Slovakia) import promotion from developing countries is—or perhaps more correctly, had been—part of the general activities of the Chambers of Commerce (or Chambers of Economy). The latter organizations are based upon individual membership by companies and entrepreneurs, and import promotion activities constitute only a minor part of their mission. The government is the main source of funding for the IPAs, regardless of whether they are directly affiliated with a Ministry or not. There are nevertheless some exceptions to this general rule: membership fees basically finance the Chambers of Commerce in Eastern and Central Europe. Also, the Austrian import promotion office—being part of a public corporation called the Federal Economic Chamber—is financed by a fee levied on all foreign trade. Apart from the former socialist countries and possibly Austria, the distinction between IPAs affiliated directly with a Ministry and those that are not may be less important, as government sources provide close to a 100% of the funding in all cases. Nominal fees for publications and other services are charged by some IPAs, but they do not contribute much to the total budget. Still, the environment in which an IPA operates may have implications for the way the efforts to promote imports are carried out. The Swiss office is an interesting case. In Switzerland the IPA is a unit within the Swiss Office for Trade Promotion—a private institution in charge of the promotion of Swiss exports. This institution is only partly financed by the government, while the IPA unit is 100% financed by the government. Two of the issues we wanted to explore were the length of time the various IPAs had been in operation and the size of their activities as measured by the number of employees and their annual budget. Table 10.1 provides information concerning these issues. The former socialist countries in Eastern and Central Europe are not included in the table. From the information we received from these offices (the Czech Republic, Hungary, Poland, and Romania),

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Ceir Gripsrud and Gabriel R.G. Benito TABLE 10.1

Establishment Year and Size oflPAs in OECD Countries

Country

Year of Establishment

Employees 1994

Budget 1994b (Million US$)

Australia Austria Canada Denmark Finland France Germany Italy The Netherlands New Zealand Norway Sweden Switzerland United Kingdom

1979 1961

5.0 3.5

_a

1980

8.0 6.0 6.5 -

1977 1980 1990

2.5 1.0 0.6 0.5 -

1987

30.0

21.3

1990 1971 1988 1977

5.0

8.3

1975C 1982 1973

17.0 3.5 4.0 9.0

0.2 1.1

5.5

1.2 1.0

12.0

-

Notes: ~ signifies that the information was not available. b The budget figures are not necessarily directly comparable. Apparently, some respondents have included salary expenses in the budget figures whereas others have not. c The Swedish office was reorganized in 1991, but was originally established in 1975. a

it is clear that they no longer have any activities directly aimed at imports from developing countries. In fact, import promotion activities seem in general to have been canceled, at least temporarily. As an example, an official of the Hungarian Chamber of Commerce pointed out to us: "In the current transition period we have no choice but to suspend our activities as Import Promotion Office..." Table 10.1 gives information for all import promotion offices in the OECD countries except Japan where import promotion is the responsibility of JETRO; the Japanese External Trade Organization. An Import Promotion Department was established within JETRO in 1990 and according to JETRO (1994) as much as 75% of the total budget—or about US$70 million annually—is now devoted to import promotion. The major share of this effort is not, however, spent on increasing imports from developing countries. We have not been able to estimate the share of JETRO's import promotion efforts directed towards developing countries and Japan has therefore not been included in Table 10.1. With the exception of the Austrian office, which is part of the Department for Foreign Trade within the Federal Economic

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Chamber, the first IPA established was the one in the Netherlands (1971). The Austrian office underlined in their response to us that they could not be compared with an import promotion office like the one in the Netherlands. The establishment of the IPA in Austria in 1961 may hence not be the start-up year for import promotion from developing countries. The establishment of import promotion offices seems to be a phenomenon related to the 1970s, when six of the offices in Table 10.1 were started. The 1980s witnessed the opening of five more offices, while two offices (in France and Italy) were founded in 1990. As already pointed out, the Import Promotion Department in JETRO (Japan) was also established in 1990. It is reasonable to assume that the increased awareness of the problems faced by developing nations in the 1970s—and the need to increase exports expressed by UNCTAD III in 1972—have been a driving force behind the wave of establishments that took place. With a few exceptions, the IPAs are small units as indicated by the number of employees and annual budget. The average number of employees is 8.8 and the median size is 5.75 employees.7 As for the annual budget, the mean is US$4.2 million and the median US$1.1 million based upon the available figures reported in Table 10.1. The size distribution is markedly skewed, as a few offices are much larger than the others. As can be seen in Table 10.1, the largest IPA by far is the one in Germany—PROTRADE. The offices in the Netherlands and in the U.K. are also substantially larger than average. German ministries as well as the European Union finance the German import promotion office. An interesting aspect of PROTRADE is that its objective is not restricted to promoting imports to Germany alone, but rather to promote imports into the EU in general. A similar arrangement applies to the import promotion office in the Netherlands—CPI—which (while financed exclusively by the Dutch Ministry for Development Cooperation) also assists exporters from developing countries in entering other Western European markets in addition to the domestic market. VI.

SUPPORT ACTIVITIES

As indicated in Table 10.2, the objectives of the various import promotion agencies vary in terms of the focus and scope of the activities undertaken by the offices. For some IPAs the field of operation is rather narrow, either geographically (such as the IPAs in Australia and New Zealand) or because the support is explicitly aimed at exporters in developing countries (for example Canada and the Netherlands). Other IPAs—in particular those in Austria, France,

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Geir Gripsrud and Gabriel R.G. Benito TABLE 10.2

Statement of Goals oflPAs in OECD Countries

Country

Stated Goal

Australia3

"To assist the development of business activity in the Forum Island Countries, promote and facilitate investment in and exports from these countries"

Austria13

"Promote business relations with developing countries"

Canadab

"To promote exports of developing countries and Central/Eastern Europe"

Denmark b

"To assist companies in developing countries in their export endeavors"

Finland b

"To promote direct imports of manufactured products from developing countries to the Finnish market (and to increase the export awareness in LDCs in general)"

France*

"To develop market access and trade relations with the LDCs and in the long-term to implement, within the framework of bilateral and multilateral development projects, integrated programs capable of generating a lasting trade flow"

Germanyb

"To support trade relations between developing countries, Eastern European countries and industrialized states"

Italyb

"To supply assistance to exporters from developing countries, to assist Italian companies in the research of raw materials strategic for our industry, to disseminate information and to assist Italian companies involved in countertrade"

The Netherlandsa

"To assist developing countries in strengthening their export capabilities towards West European and in particular Netherlands markets"

New Zealandb

"To encourage South Pacific exports to New Zealand, and to encourage investment and tourism in the Pacific Islands"

Norway2

"To contribute to make competitive products from developing countries available in the Norwegian market"

Swedenb

"To promote a favorable business environment and sustainable enterprise in developing countries and Eastern Europe"

Switzerland6

"Promote the imports into Switzerland of goods and services from developing countries"

United Kingdom

Not available.

Notes: a

Stated in official material.

b

Stated in questionnaire.

Norway, and Sweden—state their objectives in more general terms, which suggests that these offices may be involved in a wider range of activities. It is also interesting to note that in some countries, e.g. Germany and the Netherlands, the activities undertaken by the IPAs are not limited to the home market.

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As previously argued, the support activities of the import promotion offices may be grouped according to the main target groups: (1) exporters in developing countries, (2) importers and (3) consumers. In some cases, it may be difficult to distinguish between activities aimed at helping exporters and activities primarily directed towards importers. In the questionnaire the respondents were asked to name the three most important services offered to exporters and importers, respectively. The question was open-ended, which of course makes classification and comparisons somewhat difficult. Still, the most important service offered to exporters seemed to be efforts to establish contacts with importers. General information about the market where the office is located was also frequently mentioned. Furthermore, several offices indicated that business visits undertaken by exporters were supported, and sometimes even arranged by the offices. Some noteworthy, but more rarely mentioned, activities aimed at exporters included assistance in market development for new products (the Swiss IPA), and trade-fair subsidies (the German IPA). Regarding support activities directed at importers, providing information about potential suppliers and undertaking general market research were generally perceived to be the most important. Organizing trade missions is another activity that was mentioned by many of the IPAs. In contrast, the marketing support and import guarantee schemes offered by the Norwegian import promotion office (Gripsrud and Benito 1995), were not mentioned by any of the other offices. Finally, the respondents were asked to state whether the institution supported activities aimed at the final consumers. As it turned out, only a minority of the offices (Finland, Germany, New Zealand, Norway, and Sweden) undertook such activities, usually on a project basis only. Typically, specific product groups were selected and the IPA sponsored brochures and other advertising material aimed at consumers in order to stimulate demand. In the questionnaire, the IPAs were also asked to estimate how the total resources available to the office were distributed among activities directed at the three target groups discussed above. The results are given in Table 10.3. Unfortunately, complete estimates were only available from nine of the IPAs in OECD countries. In addition, the Dutch and Austrian offices indicated in their replies that no activities were directed towards final consumers, but did not distinguish between efforts aimed at exporters and efforts aimed at importers. The picture emerging from Table 10.3 is that the majority of IPAs give priority to the exporters. The average percentage of resources

210

Ce/'r Gripsrud and Gabriel R. G. Benito TABLE 10.3 Distribution of the Support Activities oflPAs in OECD Countries Percentage of total resources spent on activities aimed at: Exporters in developing countries Country

Australia Austria Canada Denmark Finland France Germany Italy The Netherlands New Zealand Norway Sweden Switzerland United Kingdom Note:

a

Importers

Consumers

(I)

(C)

_

_

10 40 30 -

0 0 0 5 -

80

15

5

50

50

0

(E) _a

100 (E + I) 90 60 65 -

100 (E + I)

0

85

10

5

35 45

55

10 3

85

52 15

-

-

0 -

— signifies that the information was not available.

directed at exporters is 66%. On average, less resources are allocated to activities aimed at importers (31%), while the efforts made at stimulating demand from consumers are negligible in most countries. Still, a few IPAs are spending most of the resources available on influencing the behavior of importers. This policy is most clearly pursued by the Norwegian and Swedish offices, but the IPAs in Italy and Denmark also spent a considerable share of their total resources on activities directed at importers. Only five of the ten offices from which we have information were engaged in any activities aimed at consumers. The office in Norway seems to be the one that allocated the largest share (10%) to such efforts. An additional dimension of the support activities is to what extent the scope of the support is restricted to imports from specific developing countries. In the questionnaire, we asked whether priority was given to specific developing countries. Only three of the ten responding offices stated clearly that this was not the case (Austria, Germany, and Italy). The most explicit restriction applies to the office in New Zealand (South Pacific Trade Office), which was set up to represent the 13 countries of the South Pacific Forum. The

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remaining replies indicate that priority is often given to LDCs and middle-income countries. Furthermore, the import promotion office in a country often selects the developing countries receiving the major share of the developing aid from that country for the programs they initiate. Some services, such as providing general information and assistance, are nevertheless usually not restricted to countries that otherwise receive special attention. VII. SUMMARY AND DISCUSSION

Apart from short descriptive accounts of the activities of some import promotion offices (see, for example, Germain 1989), few studies have investigated the role and behavior of import promotion offices. The exploratory study presented in this chapter provides some information about the organization and scope of activities undertaken by such offices. In the mid-1990s, 25 IPAs seemed to exist, which were mainly established in the 1970s and 1980s. In general they were rather small, as the median number of employees was 5.75. According to the extended model of trade promotion suggested by Gripsrud and Benito (1995), the support activities undertaken by an IPA may be aimed at three main target groups; (1) exporters in developing countries, (2) importers, and (3) final buyers. It turns out that the majority of the IPAs can be regarded as substitutes for the EPOs in developing countries as they concentrate their efforts on assisting exporters from such countries. Considerably fewer resources are being spent on activities aimed at importers in developed countries, and efforts directed toward stimulating demand from consumers are almost non-existent. The findings of the present study are in accordance with Seringhaus and Rosson's (1990) earlier assessment that IPAs mainly offer the same types of assistance as the EPOs. Only three offices—Italy, Norway, and Sweden—spend at least as much on assistance to importers as they do on support to exporters. Activities directed at consumers are virtually non-existent in most cases. Regarding the type of barriers to trade that importers and exporters typically face—informational, motivational and operational (Seringhaus and Rosson 1990)—it appears that IPAs mainly target informational barriers. Notable exceptions include the Norwegian import guarantee scheme and the marketing development assistance provided by the Swiss IPA to exporters from developing countries. The focus on export assistance is reflected in the goal statements of some of the IPAs, but in other cases the objective is stated as trade promotion in general. Why is assistance to importers, then, more or less neglected? The implicit assumption made by the IPAs seems to

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be that market-based import barriers are not particularly important. Several studies suggest that this is probably not the case. Thorelli and Glowacka (1995) found for instance that North American industrial buyers typically use country stereotyping. Countries are commonly classified as either technologically advanced or as less advanced, and willingness to purchase is related to the perceived country-of-origin image. These findings indicate that market-based import barriers may indeed be present. In another study, Deng and Wortzel (1995) focused on the selection criteria used by North American importers regarding choice of suppliers from developing countries in Asia. As hypothesized, they found that price, product quality and delivery were rated the most important, while brand name was the least important among the criteria investigated. The authors argue that foreign buying is clearly distinguished from domestic buying. The limited weight attached to the brand name is a phenomenon typically found for imports from developing countries, even if the importance of the selection criteria vary with the nature of the business (wholesaler/retailer) as well as with the product group considered. Many importers—whether they are retailers, wholesalers or manufacturing companies—are large organizations that are sourcing globally (Egan and Mody 1992). The majority of IPAs may base their present focus on export assistance on the presumption that large-scale importers do not need any assistance. The available evidence indicates that even such large organizations may be influenced by country-of-origin perceptions and that top management commitment is instrumental in promoting international sourcing (Deng and Wortzel 1995). If a major importer switches from a supplier in a developed country to one in a developing country, the effect on exports from developing countries could be substantial. Moreover, not all importers are large organizations with considerable resources, and these smaller companies may be in even more need of assistance in finding suitable sources. Developing countries could therefore benefit significantly from various forms of import promotion even though such activities are not directly aimed at indigenous companies. The neglect of import promotion may in fact be related to how the task of the IPAs is interpreted. Instead of maximizing total exports, the IPAs may in general be more concerned with how the export from developing countries is organized. Getting many small companies engaged in exporting may be considered to be more important to the IPAs than promoting total exports from developing countries per se. Furthermore, it may be part of their mission—even if it is not made explicit—to promote finished goods

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(rather than, for example, raw materials) produced in developing countries into developed markets. Intra-company trade in raw materials and semi-finished goods is hence neglected. Such an interpretation may explain why so little effort has been made so far to influence the major importers, even though such a strategy would probably pay off in term of total imports. Given the fact that most IPAs focus on assistance to exporters, a relevant question is why this task is not left to the EPOs in the various developing countries. Presently, there seems to be an overlap in the activities performed by the two types of institutions, and the "comparative advantages" of each need to be analyzed. The activities performed by IPAs and EPOs are both aimed at reducing various types of barriers. In general, the main strength of the IPAs is likely to be importer-oriented activities, while the EPOs should be in a better position to take care of the particular needs of exporters. Still, it may be difficult for an EPO to adequately provide the market specific knowledge needed by exporters. In such cases, the IPAs may have an important role to play even in activities directed towards exporters. Future research should explore in more depth the relative merits of influencing the exporting and importing sides, respectively. The effect of trade promotion activities is a question that needs to be investigated more closely. At a micro-level, the attitudes and behavior of individual importers could be analyzed, preferably using a longitudinal design. At the macro-level, the results, if any, of the activities of import promotion offices can be investigated by looking into the composition of imports into a country. One such recent study of OECD countries concludes that the share of imports originating in developing countries was indeed positively influenced by the presence of an IPA in the importing country (Benito and Gripsrud 1999). However, even if studies suggest that IPAs may have a positive effect on promoting exports from developing to developed countries, the question remains how the resources should be allocated between EPOs and IPAs. In-depth comparative studies of the two types of institutions would therefore be particularly useful. REFERENCES Aggarwal, R. and Agmon, T. (1990) The International Success of Developing Country Firms: Role of Government-Directed Comparative Advantage, Management International Review, 30(2) :163-180. Bagozzi, R.P. (1975) Marketing as Exchange, Journal of Marketing, 39, October: 32-39. Benito, G.R.G. and Gripsrud, G. (1999) Promoting Efforts from Developing Countries: An Empirical Test of the Impact of Import Promotion Offices, International Trade Journal, 13 (2): 187-209.

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Benito, G.R.G., Solberg, C.-A. and Welch, L.S. (1993) An Exploration of the Information Behaviour of Norwegian Exporters, International Journal of Information Management, 13(4) :274-286. Bhagwati, J.N. (1990) Export-Promoting Trade Strategy: Issues and Evidence, in: Milner, C. (Ed.), Export Promotion Strategies: Theory and Evidence from Developing Countries, Harvester Wheatsheaf, New York. Bilkey, W.J. and Tesar, G. (1977) The Export Behavior of Smaller-sized Wisconsin Firms, Journal of International Business Studies, 8(1) :93-98. Cavusgil, S.T. (1984) Organizational Characteristics Associated with Export Activity, Journal of Management Studies, 21(1) :3-22. Cavusgil, S.T. and Czinkota, M.R. (Eds.) (1990) International Perspectives on Trade Promotion and Assistance, Quorum Books, Newport. Crawford, J.C. and Lumpkin, J.A. (1993) Environmental Influences on Country-ofOrigin Bias, in: Papadopoulos, N. and Heslop, L.A. (Eds.), Product-Country Images, International Business Press, Binghamton, New York. Deng, S. and Wortzel, L.H. (1995) Importer Purchase Behavior: Guidelines for Asian Exporters, Journal of Business Research, 32(1 ):41—47. Dominguez, L.V. and Sequeira, C.G. (1993) Determinants of LDC Exporters' Performance: A Cross-National Study, Journal of International Business Studies, 24(1):19-40. Egan, M.L. and Mody, A. (1992) Buyer-Seller Links in Export Development, World Development, 20(3):321-334. Elvey, L.A. (1990) Export Promotion and Assistance: A Comparative Analysis, in: Cavusgil, S.T. and Czinkota, M.R. (Eds.), International Perspectives on Trade Promotion and Assistance, Quorum Books, Newport. Germain, M. JR (1989) Canada's Import Promotion Office for Developing Countries, International Trade Forum, 25 (3): 10-13. Gray, H.P. (1995) The Modern Structure of International Economic Policies, Transnational Corporations, 4(3):49-66. Gray, H.P. (1999) Global Economic Involvement: A Synthesis of Modern International Economics, Copenhagen Business School Press, Copenhagen. Gripsrud, G. (1990) The Determinants of Export Decisions and Attitudes to a Distant Market: Norwegian Fishery Exports to Japan, Journal of International Business Studies, 21(3):469-485. Gripsrud, G. and Benito, G.R.G. (1995) Promoting Imports from Developing Countries: A Marketing Perspective, Journal of Business Research, 32(2):141-148. International Trade Center (1993) Import Promotion Offices: A Directory of Import Promotion Offices and Similar Organizations that Provide Marketing Assistance to Exporters in Developing Countries, UNCTAD/GATT, Geneva. JETRO (1994) Import Promotion Activities: 1990-1993 Progress Report, JETRO, Tokyo. Katsikeas, C.S. and Dalgic, T. (1995) Importing Problems Experienced by Distributors: The Importance of Level-of-Import Development, Journal of International Marketing, 3(2):51-57. Korhonen, H., Luostarinen, R. and Welch, L. (1996) Internationalization of SMEs: Inward-Outward Patterns and Government Policy, Management International Review, 36(4):315-329. Krueger, A.O. (1990) Perspectives on Trade and Development, Harvester Wheatsheaf, New York.

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Mclntyre, J., Narula, R. and Trevino, L. (1996) The Role of Export Processing Zones for Host Countries and Multinationals: A Mutually Beneficial Relationship? International Trade Journal, 10(4):435-466. Seringhaus, R.F.H. and Botschen, G. (1991) Cross-National Comparison of Export Promotion Services: The Views of Canadian and Austrian Companies, Journal of International Business Studies, 22:115-133. Seringhaus, R.F.H. and Rosson, P.J. (1990) Government Export Promotion: A Global Perspective, Routledge, London. Seringhaus, R.F.H. and Rosson, P.J. (1991) Export Development and Promotion: The Role of Public Organizations, Kluwer, Norwell, Massachusetts. Thorelli, H.B. and Glowacka, A.E. (1995) Willingness of American Industrial Buyers to Source Internationally, Journal of Business Research, 32(1):21-30. Wang, C.-K. and Lamb, C.W. (1983) The Impact of Selected Environmental Forces Upon Consumers' Willingness to Buy Foreign Products, Journal of the Academy of Marketing Science, 11 (2): 71 -84. Welch, L.S. and Luostarinen, R.K. (1993) Inward-Outward Connections in Internationalization, Journal of International Marketing, 1(1) :44-56. Womack, J.P., Jones, D.T. and Roos, D. (1990) The Machine that Changed the World: The Story of Lean Production, Rawson Associates, New York.

NOTES 1.

2.

3.

4.

5.

6.

The authors thank Lawrence S. Welch, and the editor of this book, Rajneesh Narula, for their helpful comments on previous versions of this article. The financial support provided by the Ministry of Foreign Affairs in Norway is also gratefully acknowledged. Neo-classical trade theory largely disregards the roles and behaviors of microlevel actors and institutions. Gray (1999, p. 108) points out that: "The received theory of international trade neglects the role of innate barriers to international trade such as lack of delivery systems (established communications and transportation linkages), or difficulties in establishing an M&D [marketing and distribution] organization in the potential importing country." According to the ITC Directory, IPAs exist in the following countries: Australia, Austria, Belarus, Canada, Czech Republic, Denmark, Finland, France, Germany, Hungary, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Poland, Romania, the Russian Federation, Slovakia, Sweden, Switzerland, United Kingdom and Yugoslavia. The directory lists two different IPAs in Germany and two in Australia. The various agencies were asked to provide information concerning the operation of the office and the scope of its support activities and information services. One of the German offices listed in the directory from ITC stated that its mission was not to promote imports to Germany but rather to promote German exports. Therefore, the total "corrected" number of IPAs is 25. Moreover, as demonstrated by the misclassification of the German "Federal Office of Foreign Trade Information" as an IPA, the information provided by the directory is not always accurate.

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In the questionnaire, we asked for the number of employees and the annual budget in 1990 as well as in 1994. The aim was to explore whether the IPAs in general were increasing or decreasing their activity levels. Unfortunately we have few comparable figures. As for employees, six of nine offices had increased the number of employees in the period 1990-1994, one office remained at the same level, while two offices had reduced their staff. This picture remains the same when we look at the annual budgets. The most striking change concerns the German office, which increased the number of employees from 10 to 30 in the 4-year period 1990-1994 while the annual budget was more than doubled (from US$10 million to US$ 21.3 million). Hence, we conclude that even though most IPAs are rather small units, the general tendency—with a few exceptions—was to increase the activity level.

Appendix Curriculum Vitae of H. Peter Gray PRESENT POSITIONS

Professor Emeritus of Economics and Management, Rensselaer Polytechnic Institute, Troy, NY. 1991Professor Emeritus of Economics and Finance, Rutgers University, New Brunswick, NJ. 1987Adjunct Professor of International Business, Graduate School of Management, Rutgers University, Newark. 1990DEGREES

University of Cambridge, B.A., 1949; M.A., 1952. University of California, Berkeley, M.A., 1961; Ph.D., 1963. DATA Born, July 4, 1924. Married to Jean M. Gray. HONOURS AND FELLOWSHIPS

President, Eastern Economic Association, 1988-89, President-Elect 1987-88; Vice-President, 1986-87. President, International Trade and Finance Association, 1990; President-Elect, 1989. Brookings Institution, Pre-doctoral Fellowship, 1961-62; Guest Scholarships, 1965-66 and 1971-72. Ford Foundation Faculty Fellowship, 1966-67. Esme Fairbairn Senior Research Fellow, University of Reading, March-April, 1981. Guest Research Fellow, Kiel Institute of World Economics, September-October, 1987. Senior Member, Danish Summer Research Institute, Gilleleje, 1992.

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PAST EXPERIENCE Academic

Invited Lecturer, University of Ljubljana, Slovenia, December, 1995. Visiting Professor, Institute of International Economics and Management, Copenhagen Business School, Copenhagen, Denmark, September-October, 1994. Visiting Professor, Universidad Internacional de las Americas, San Jose, Costa Rica, Spring, 1993. Professor of Economics, Rutgers University, New Brunswick, 1968-87; (Douglass College, 1968-82); Associate Dean, Faculty of Professional Studies; 1983-85; Acting Director, School of Administrative Sciences, 1982-84. Professor of Economics and Management, Rensselaer Polytechnic Institute, 1988-90; Acting Chair, Department of Managerial Policy and Organization, 1988-90. Visiting Professor, Jilin University, China, May-^June, 1983. Chairman, Department of Economics, Douglass College, Rutgers University, 1968-76 and 1979-80. Professor of Economics, Wayne State University, 1962-68; Assistant Professor, 1962-64 and Associate Professor, 1965-67. Visiting Professor of Economics, Thammasat University, Bangkok, Thailand, 1966-67 (Rockefeller Foundation University Development Program). Lecturer in Economics, University of California, Davis, Spring Term, 1961. Non-academic

Economist, Division of Transnational Corporations and Investment, UNCTAD, April-July, 1995. Purchasing Manager, Dexion Ltd., 1951-53; General Manager and Secretary-Treasurer, Dexion (Canada) Ltd., Weston, Ontario, Canada, 1953-57. Pilot, Royal Air Force, 1942-47. BIBLIOGRAPHY Dissertation

Commercial Bank Profitability and the Effectiveness of Monetary Policy.

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Books

International Travel: International Trade (Lexington, Mass.: Heath Lexington, 1970); The Economics of Business Investment Abroad (London: Macmillan Press, 1972); An Aggregate Theory of International Payments Adjustment (London: Macmillan Press, 1974); A Generalized Theory of International Trade (London: Macmillan Press, 1976); International Trade, Investment and Payments (Boston: Houghton Mifflin, 1979); Free Trade or Protection? A Pragmatic Analysis (London: Macmillan Press and New York: St. Martin's Press, 1985); International Economic Problems and Policies (New York: St. Martin's Press, 1987); Global Economic Involvement: A Synthesis of Modern International Economics (Copenhagen: Copenhagen Business School Press, 1999). Monograph

International Trade, Employment and Structural Adjustment: The United States (Geneva: International Labour Office, 1986) (with Thomas Pugel and Ingo Walter): (Spanish-language edition, 1990). Books (Edited)

The Dollar Deficit: Causes and Cures (Lexington, Mass.: D.C. Heath, 1967); Capital Accumulation and Economic Development (Lexington, Mass.: D.C. Heath, 1967) (with Shanti S. Tangri); Population Growth and Economic Development (Lexington, Mass.: D.C. Heath, 1970) (with Shanti S. Tangri); The International Economics of Tourism (Special issue of The Annals of Tourism Research IX, 1982); Uncle Sam as Host (Greenwich, CT: JAI Press, 1986); Eastern Economic Journal, XIII (December, 1987), Proceedings Issue; The Modern International Environment (Greenwich, CT: JAI Press, 1989); Transnational Corporations and International Trade and Payments (London: Routledge for the UN Centre for Transnational Corporations, 1993);

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International Finance in the New World Order (London: Elsevier Science, 1995), (with Sandra C. Richard); International Trade Journal XII, Guest Editor of special issue, Spring, 1998. Chapters in Books

"Guild," Encyclopaedia Britannica, 1965 edition, Vol. X, pp. 1013-1015 (with Adam A. Pepelasis); "International Trade in Invisibles," The Dollar Deficit: Causes and Cures, op. cit., pp. 53-58; "Some Thoughts on One Aspect of the Administration's Proposal to Curb American Travel Deficits," Hearings before the House Committee on Ways and Means in Administration's Balance-ofPayments Proposals, 1968, pp. 1070-1071; "A Simple Graphical Model of the Interaction between the Rate of Population Growth, Capital Formation and Per-Capita Income," in Population Growth and Economic Development, op. cit., pp. 45-60; "Commercial Policy Implications of Environmental Controls," in Ingo Walter (Ed.), International Economic Dimensions of Environmental Management (New York: John Wiley and Sons, 1976), Ch. 7; "Intra-Industry Trade: The Effects of Different Levels of Data Aggregation," in Herbert Giersch (Ed.), On the Economics of IntraIndustry Trade (Tubingen: J.C.B. Mohr, 1979), pp. 87-110; "Structural Consequences of Changing International Trade Patterns and Possible Alternative Policies," in Irving Leveson and Jimmy W. Wheeler (Eds.), Western Economies in Transition (Boulder, Colo.: Westview Press, 1980), pp. 359-384; "International Competition: Industrial Structure and Economic Policy: Comment," in Western Economies in Transition, op. cit., pp. 297-301; "Towards a Unified Theory of International Trade, International Production and Direct Foreign Investment," in John Black and John H. Dunning (Eds.), International Capital Movements (London: Macmillan Press, 1982), pp. 58-83; "International Transportation," in Tracy Murray and Ingo Walter (Eds.), Handbook for International Business (New York: John Wiley and Sons, 1982), pp. 11.1-11.18; "International Trade in Services," in Ibid., pp. 14.1-14.22; "Balance-of-Payments Adjustments: The Bedrock of Exchange-Rate Theory," in John S. Oh (Ed.), International Financial Management: Issues, Problems and Experience (Greenwich, CT: JAI Press, 1982), pp. 3-36;

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"The Monetary View of the Balance of Payments and Exchange Rates: Comment by an Infidel," in Ibid., pp. 53-63; "The Contributions of Economics to Tourism Research and Efficiency," in The International Economics of Tourism, op. cit., pp. 105-125; reprinted in Edward M. Kelly (Ed.), Leisure Travel and Tourism (Wellesley, Mass.: Institute of Certified Travel Agents, 1987) and in Clement A. Tisdell (Ed.), The Economics of Tourism (Cheltenham: Edward Elgar Publishing, 1999); "Macroeconomic Theories of Foreign Direct Investment," in Alan M. Rugman (Ed.), New Theories of Multinational Enterprise (London: Groom Helm, 1982), pp. 172-195; "The Petrochemical Industry," in Stephen E. Guisinger and Associates, Investment Incentives and Performance Requirements (New York: Praeger Publishers, 1985), pp. 237-312 (with Ingo Walter); "Japan's Challenge to Technology Competition and its Limitations: Comment," in Thomas A. Pugel (with R.G. Hawkins) (Ed.), Fragile Interdependence: Economic Issues in U.S.-Japanese Trade and Investment (Lexington, Mass.: Lexington Books, 1986), p. 261; "Protection", in Lawrence H. Officer (Ed.), International Economics (New York: John Wiley and Sons, 1987), pp. 65-102 (with Ingo Walter); "The Role of Tourism in Economic Development," in John Millett (Ed.), The Role of Tourism in Development (Port Moresby: Papua New Guinea Institute of National Affairs, 1987), pp. 39-48; "Problem Areas in North-South Technology Transfer," in H.W. Singer, Neelamber Hatti and Rameshwar Tandon (Eds.), Technology Transfer by Multinational Firms (New Delhi: Ashish Publishing House, 1988), pp. 877-896; "Substantive Obstacles to Increased North-South Trade," in Singer, Hatti and Tandon (Eds.), New Protectionism and Restructuring (New Delhi: Ashish Publishing House, 1988), pp. 170-191; "International Trade in Services: Four Distinguishing Features," in Khosrow Fatemi (Ed.), International Trade and Finance: A North American Perspective (Boulder: Westview Press, 1988), pp. 16-30; "Population Drag and the Role of the International Sector," in Alois Wenig and Klaus F. Zimmermann (Eds.), Demographic Change and Economic Development (Berlin: Springer Verlag, 1989), pp. 116-129; "A Question of Departed Tranquility?" in The Modern International Environment, op. cit., pp. 3-14; "Services and Comparative Advantage Theory," in Herbert Giersch (Ed.), Services in World Economic Growth (Tubingen: J.C.B. Mohr, 1989), pp. 85-103;

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"The Mechanics of International Economic Locomotion," in Khosrow Fatemi (Ed.), International Trade: Existing Problems and Prospective Solutions (New York: Taylor and Francis, 1989), pp. 24-34; "The Role of Services in the Global Structural Change," in John H. Dunning and Allan Webster (Eds.), The Changing Structure of the World Economy (London: Unwin and Hyman, 1990), pp. 67-90; "The Rapidly Evolving Global Economy," in Herbert I. Fusfeld (Ed.), Changing Global Patterns of Industrial Research and Development (Troy, NY: Center for Science and Technology Policy, Rensselaer, 1990), pp. 17-28; "The Integration of the EC Markets for Financial Services and the US Banking and Insurance Industries," in George Yannopoulos (Ed.), 1992, Europe and the United States (Manchester: Manchester University Press, 1991), pp. 128-148 (with Ingo Walter); "The Interface between the Theories of International Trade and Production," in Peter J. Buckley and Mark C. Casson (Eds.), Multinational Enterprise and International Direct Investment: Essays in Honour of John H. Dunning (Cheltenham: Edward Elgar, 1992), pp. 41-53; "Intrafirm Trade in Finished Goods and Services," in H.P. Gray (Ed.), Transnational Corporations and International Trade and Payments, op. cit., pp. 127-136; "The Importance of Intra-Firm Trade," in Mordechai E. Kreinin (Ed.), International Commercial Policy: Issues for the 1990s (London: Taylor and Francis, 1993), pp. 181-189 (with Sarianna Lundan); "Minskian Fragility in the International Financial System," in Gary Dymski and Robert Pollin (Eds.), New Perspectives in Monetary Macroeconomics: Explorations in the Tradition of Hyman P. Minksy (Ann Arbor: University of Michigan Press, 1994), pp. 143-168 (withJean M. Gray); "Labor-Force Efficiency and Adjustment Costs," in Michael Landeck (Ed.), Commercial Policy and International Trade in the 1990s (London: Macmillan Press, 1993), pp. 122-134; "The Scope of International Finance," in H. P. Gray and L. Richard (Eds.), International Finance in the New World Order (London: Pergamon Press, 1995), pp. 9-26; "The Role of Transnational Corporations in International Trade: An Overview," in John H. Dunning and Karl P. Sauvant (Eds.), Transnational Corporations and World Development (London: Routledge forUNCTAD, 1996); "International Involvement or Autarky?: A Simple Analytic Framework," in Hans W. Singer and Marjan Svetlicic (Eds.), Challenges of Globalism and Regionalism (London: Macmillan Press, 1996), pp. 250-268;

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223

"The Burdens of Global Leadership," in Khosrow Fatemi (Ed.), International Business in the 21st Century (London: Pergamon Press, 1997), pp. 17-27; "The German System of Corporate Governance—a Model which should not be Imitated: Comment," in Stanley W. Black and Mathias Moersch (Eds.), Competition and Convergence in Financial Markets: the German or the Anglo-Saxon Models (London: Elsevier Science, 1998), pp. 79-84; "International Trade and FDI: The Interface," in John H. Dunning (Ed.), Globalization, Trade and Foreign Direct Investment (London: Elsevier Science, 1998), pp. 19-27; "Open Industrialization as a Developmental Strategy: The Example of East Asia," in Khosrow Fatemi (Ed.), The New World Order: Internationalism and Multinational Corporations (London: Elsevier Science, 1999) (with Carlo Altomonte and Richard Bolwijn); Organization of World Heritage Cities, "Long-Term Investment Strategies of the Tourism Industry," Proceedings of the 4th International Symposium of World Heritage Cities (Quebec City, 1998), pp. 108-110; "The Implications of Globalization for Foreign Direct Investment in New Jersey," in John H. Dunning (Ed.), New Jersey in a Globalizing Economy (Newark: GIBER Occasional Studies in International Business No. 4, 1999), pp. 1-52 (with Lorna H. Wallace); "Macroflnancial Stability Policy: An Overview for a Globalized World," in Irene Finel-Honigman (Ed.), European Union Banking Issues: Historical and Contemporary Perspectives (Greenwich CT: JAI Press, 1999), pp. 3-18; "The Case for a Global System of Regional Blocs," in Khosrow Fatemi (Ed.), Western Hemispheric Economies in the 21st Century (Laredo, TX: Texas A&M International University, 1999); "The Monetary Theory of the Balance of Payments: A Retrospective Analysis," in Augustine C. Arize, Theologos Homer Bonitsis, loannis N. Kallianiotis, Krishna M. Kasibhatla and John Malindretos (Eds.), Keynesian and Monetary Approaches to Managing Disequilibrium in Balance of Payments Accounts (Westport, Conn.: Greenwood Press, 2000), pp. 98-110; "Towards a Theory of Regional Policy," in John H. Dunning (Ed.), Regions, Globalization and the Knowledge Based Economy (New York: OUP, 2000) (withJohn H. Dunning) (in press); "Increasing the Contribution of FDI and Foreign Portfolio Investment to Sustainable Development. Recent Domestic and International Policy Measures," in Juergen Hoist (Ed.), Finance for Sustainable Development: Testing New Policy Approaches (New York: United Nations, 2000) (with John R. Dilyard).

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Articles1 and Notes (refereed)

"Compensatory Cyclical Bank Asset Adjustments: Comment," Journal of FinanceXVII (December, 1962), 646-650; "The Effects on Monetary Policy of Rising Costs in Commercial Banks," Journal of Finance XVIII (March, 1963), 29-48; "Bank Regulation, Bank Profitability and Federal Reserve Membership," National Banking Review (December, 1963), 207-220; "Some Evidence of Two Implications of Higher Interest Rates on Time Deposits," Journal of Finance XIX (March, 1964), 163-175; "The Marginal Cost of Hot Money," Journal of Political Economy (April, 1964), 189-192; "Time Deposits and Bank Profitability: Reply," Journal of Finance XX (March, 1965), 86-88; "Factor Proportions in International Trade with Non-Competitive Imports Redefined," Weltwirtschaftliches Archiv 95 (Heft 1, 1965), 155-163; "Imperfect Markets and the Effectiveness of Devaluation," Kyklos (Fasc. 3, 1965), 512-530: reprinted in Helga Luckenbach (Ed.), Theorie des Aussenwirtschaftspolitik (Berlin-Heidelberg: Springer Verlag, 1979), pp. 107-126; "The Demand for International Travel in the United States and Canada," International Economic Review (January, 1966), 83-92: reprinted in R.W. Mclntosh (Ed.), International Travel and Tourism (East Lansing, Michigan: 1969); "United States Foreign Investment and the Dollar Exchange Rate," Economia Internazionale XIX (August, 1966), 496-502; "International Short-term Capital Movements: Comment," American Economic Review YM\\ (June, 1967), 548-551; "The Balance-of-Payments Costs of Foreign Travel Expenditures," Southern Economic Journal XXXIV (July, 1967), 17-26; "The Balance-of-Payments Contributions of Multinational Corporations," The Journal of'Business 40 (July, 1967), 339-343 (with Gail E. Makinen); "Drawings on an Old Envelope: The Relationship between the Short-run and Long-run Average Cost Curves," The American Economic Review LVII (December, 1967), 1226-1229 (with Paul B. Trescott); "Tourism as an Export Industry in Southeast Asia: A Long-Run Prognostication," The Philippine EconomicJournalVl (1967), 155-169; "Depreciation or Incomes Policy," The Manchester School (March, 1968), pp. 49-61; 1.

Articles and notes not subjected to peer review are marked with an asterisk.

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225

"Assessing the Lag in Population Planning Programs: A Rule of Thumb," The Indian Journal ofEconomics XLIX (July, 1968), 13-18; "A Keynesian Framework for the International Accounts," Weltwirtschaftliches Archiv (Fall, 1969), 1-22; "On Measuring the Price Sensitivity of Invisible International Trade," Bulletin, The Oxford Institute of Economics and Statistics (August, 1971), 207-216; *"Myrdal's Asian Dilemma—A Review Article," The Journal of Asian and African Studies (July-October, 1971), 248-255; "Education and Fertility," The Indian Journal of Economics LII (October, 1971), 187-190; "Two-way Trade in Manufactures: A Theoretical Underpinning," Weltwirtschaftliches Archiv (1973), 19-39; "Senile Industry Protection: A Proposal," Southern Economic Journal XXXIX (April, 1973), 569-574; "AT&T Common as an Index Bond," Public Utilities Fortnightly (April 12, 1973), 24-27 (with Laurie Sills Greene); "International Inflation: A Diagnosis," Pakistan Economist 14 (September 7-13, 1974), 9-13; "The Internal-External Balance Trade-Off: A Graphical Analysis," Weltwirtschaftliches Archiv (1974), pp. 399-411; "A Tripartite Model of International Trade," Economia Internazionale (May, 1974), 260-279; "Towards an Economic Analysis of Tourism Policy," Social and Economic Studies (1974), 386-397; "Senile Industry Protection: Reply," Southern Economic Journal 41 (January, 1975), 538-541; "Shortcomings of Mundell's Internal-External Balance Model," Eastern Economic Journal II (April, 1975), 165-168; "The Equivalence of Tariffs and Quotas: A Further Complexity," Kyklos (Fasc. 3, 1975), 645-646; "Smuggling and Economic Welfare: A Comment," Quarterly Journal of Economics (November, 1975), 643-650 (with Ingo Walter); "Determinants of Aggregate Profit Margins: Comment," Journal of Finance (March, 1976), 163-165; "Two-way International Trade: Reply," Weltwirtschaftliches Archiv (Heftl, 1977), 182-184; "Rethinking Free Trade," The New Republic (March 19, 1977), 12-13; "East-West Trade: A Theoretical Note," A.C.E.S. Bulletin (Summer, 1977), 91-100; "The Gains from Diversification of Real Assets: An Extension," Journal of Business Research 6 (January, 1978), 81-83; *"The International Allocation of Economic Resources: A Review Article," Eastern Economic Journal TV (July/October, 1978), 167-176;

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"Needed a Webb-Pomerene Act for Research?," Challenge (November-December, 1979); "The Meaning and Measurement of Product Differentiation in International Trade," Weltwirtschaftliches Archiv 116, (Heft 2, 1980), 322-329 (withJohn P. Martin); "The New International Order: A Constructive Alternative," Foreign Trade ReviewXV (April-June, 1980), 447-470; "The Theory of International Trade among Manufacturing Nations," Weltwirtschaftliches Archiv 116 (Heft 3, 1980), 447-470; "The Multinational Bank: A Financial MNC?," Journal of Banking and Finance?) (March, 1981), 33-63, reprinted in Geoffrey Jones (ed.), International Banking (Cheltenham: Edward Elgar Publishing, 1992) and in Mervyn K. Lewis (Ed.), The Globalization of Financial Services (Cheltenham: Edward Elgar Publishing, 1998) (with Jean M. Gray); "Oil-Push Inflation: A Broader View," Banca Nazionale del Lavoro Quarterly Review (March, 1981), 49-67; "Wanderlust Tourism: Problems of Infrastructure," Annals of Tourism RtsearchWIl (No. 2, 1981), 285-290; "The Case against General Import Restrictions: Another Perspective," Bulletin of Economic Research 34 (No. 1, 1982), 71-77; "U.S. Tourism Demand in Mexico: Comment," Annals of Tourism ResearchlX (1982), 262-264; "On the Meaning and Measurement of Product Differentiation in International Trade: Reply," Weltwirtschaftliches Archiv 118 (Heft 2, 1982), 335-337 (withJohn P. Martin); "Adjustment Burdens, Potential Protectionism and the Vulnerability of Export-Led Growth," Journal of Economic Development 7 (July, 1982), 7-19; reprinted in International Economic Perspectives X, 1984; "Investment-Related Trade Distortions in Petrochemicals,"Journal of World Trade Law 17 (July/August, 1983), 283-307, (with Ingo Walter); reprinted in Gray (Ed.), TNCs and International Trade, op. cit., and in Hans Singer et al. (Eds.), Foreign Direct Investments (New Delhi: Indus Publishing Company, 1991), pp. 103-135; "A Negotiating Strategy for Trade in Services, "Journal of World Trade Law 17 (September/October, 1983), 377-388; "Protectionism and International Banking: Sectoral Efficiency, Competitive Structure and National Policy, "Journal of Banking and Finance 7 (December, 1983), 597-609 (with Ingo Walter); reprinted in International Economic Perspectives XII (1986); in Geoffrey Jones (Ed.), International Banking (Cheltenham: Edward Elgar Publishing, 1992); and in Mervyn K. Lewis (Ed.) The Globalization of Financial Services (Cheltenham: Edward Elgar Publishing, 1998);

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227

"Employment Arguments for Protection and the Vita Theory," Eastern Economic Journal X (January/March, 1984), 1-13; "Tourism Theory and Practice: A Reply to Dr. Sessa," Annals of Tourism Research 11 (May, 1984), 286-290; reprinted in Clement A. Tisdall (Ed.), The Economics of Tourism (Cheltenham: Edward Elgar Publishing, 1999); "Trade Policy in the 1980s: A Review Article," Weltwirtschaftliches Archiv 121 (Spring: 1985) pp. 142-150; "Domestic Efficiency, International Efficiency and Gains from Trade," Weltwirtschaftliches Archiv 121 (Fall, 1985), 160-170; "North-South Trade: An Impasse in Policy Formulation," European Journal of Political Economy I (No. 3, 1985), 325-341; "International Trade Warfare: Economic and Political Strategic Considerations," European Journal of Political Economy I (No. 4, 1985), 563-583 (with Roy Licklider); "Multinational Corporations and Global Welfare: An Extension of Kojima and Ozawa," Hitotsubashi Journal of Economics 26 (December, 1985), 125-134; "Protection in a Democracy," Eastern Economic Journal XII (Spring, 1986), 88-93 (with Roy Licklider); "Natural Resource Pricing: Allocative Efficiency and Protection," Weltwirtschaftliches Archiv 12,2 (Fall, 1986), 365-370; "North-South Technology Transfer: Two Neglected Problems," Journal of 'Economic Development 11 (July, 1986), 27-46; "Non-Competitive Imports and Gains from Trade," The International TradeJournall (Winter, 1986), 107-128; "The Internationalization of Global Labor Markets," Annals 492 (July, 1987), 96-108; "International Crowding-Out: Concept and Policy Implications," Eastern EconomicJournalXlll (July, 1987), 193-204; "Interest Rates and the Federal Deficit," The International Trade Journalll (Fall, 1987), 23-36 (with Peter D. Loeb); "IntraTndustry Trade: An 'Untidy Phenomenon'," Weltwirtschaftliches Archiv 124 (No. 2, 1988), 211-229; "International Payments in a Flow-of-Funds Format," Journal of Post Keynesian Economics 7 (Winter, 1988/89), 241-260 (with Jean M. Gray); "The Multi-Fibre Arrangement and the Least-Developed Countries," Industry and Development (No. 26, 1989), 89-96; "Social Science: Quasi-Science?," Eastern Economic Journal XV (October/December, 1989), 273-286; "Free Trade, Economic Integration and Nationhood," Journal of International Economic Integration^ (Spring, 1990), 1-12;

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"International Financial Statement Translation: The Problem of Real and Monetary Disturbances," International Journal of Accounting 23 (Number 2, 1990), 19-31 (with Paul J. Miranti); "A Model of Depression," Banca Nazionale del Lavoro Quarterly Review

(September, 1990), 269-288 (Correction in Ibid., December, 1990, p. 487); "Insular or Open Economies?; An Extension of McKinnon's Analysis," Open Economies Review (January, 1991), 83-89; "Can Export-Led Growth Succeed Indefinitely?," Journal of Asian Economies'} (Spring, 1991), 145-152; "Tax Burdens and the Cost of Capital," Financial Management (FM Letters), (Winter, 1991), 9-10; *"International Competitiveness: A Review Article," The International Trade Journal (Summer, 1991), 503-518; "International Competitiveness and Policy in Dynamic Industries," Banca Nazionale del Lavoro Quarterly Review (March, 1992), 59-80

(with William S. Milberg); *"Stable Social Evolution in a Global Setting," International Journal of New Ideas 1 (Summer, 1992), 51-62; ^"Dangers in the Reduction in U.S. International New Worth," The International TradeJournalVl (Summer, 1992), 427-442; "Hicksian Instability in Asset Markets and Financial Fragility," Eastern Economic Journal XVIII (Summer, 1992), 249-258; "Economic Integration and Nationhood: An Extension," Journal of Economic Integration^ (Spring, 1993), 58-67; "Globalization versus Nationhood: Is Economic Integration a Useful Compromise?," Development and International Cooperation IX (June,

1993), 35-49; "The Case for a Damage-Control Strategy in Trade Negotiations," Journal of World Traded (October, 1993), 37-47; "Japanese Multinationals and the Stability of the GATT System," The International Trade JournalVII (Winter, 1993), 635-653 (with Sarianna Lundan); "Government as a Facilitator of Altruism," The International Journal of New Ideas1} (No. 2, 1993), 163-173; "Nationhood, the GATT Ideal and a Workable International Trading System," Banca Nazionale del Lavoro Quarterly Review (No.

188, March, 1994), 99-114 (with Sarianna Lundan); "The Efficiency of Financial Intermediation and International Competitiveness," Weltwirtschaftliches Archiv 130 (December, 1994), 828-840; "The Modern Structure of International Economic Policies," Transnational Corporations 4 (December, 1995), 49-66; reprinted in

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229

Thomas Brewer (Ed.), Trade and Investment Policy (Cheltenham: Edward Elgar Publishing, 1998); "The Costs of Freer Trade," The International Trade Journal 10 (Spring, 1996), 49-62; "The Ongoing Weakening of the International Financial System," Banca Nazionale del Lavoro Quarterly Review XLIX, No. 197 (June, 1996), 165-186; "Underestimating the Costs of Overvaluation," Review of Political Economy 8 (No. 3, 1996), 291-302; "The Eclectic Paradigm: The Next Generation," Transnational Corporations 5 (August, 1996), 51-65; "Culture and Economic Performance: Policy as an Intervening Variable," Journal of Comparative Economics 20 (December, 1996), 278-291; *"Dollar Depreciation and the Price of Gasoline," International Trade JournalXll (Spring, 1998), 119-128; "Free International Economic Policy in a World of Schumpeter Goods," The International Trade JournalXll (Fall, 1998), 323-344; "The Contribution of Financial Conditions to Successful Industrialization in East Asia," Review of Pacific Basin Financial Markets and Policies 1 (No. 3, 1998), 419-435 (with T.A. Fetherston); "International Trade: The 'Glue' of Global Integration," Transnational Corporations 7 (August, 1998), 137-146; "Globalization and Economic Development," Global Economic Quarterly 1 (March, 2000), 71-95 Working Papers

"Some Thoughts on Current Global Economic Problems," Institute of National Affairs Working Paper #10, Port Moresby, Papua-New Guinea, October, 1987; "A Firm-Level Theory of International Trade in Dynamic Goods," Institute of International Economics and Management, Copenhagen, 1994, Working Paper 94/3; "New Jersey in a Globalizing Economy," Rutgers University Center for International Business Education and Research Working Paper Series, 96.003 (with Lorna H. Wallace), 1996; "Toward a Theory of Regional Economic Policy in a World of Mobile Assets," Rutgers University Center for International Business Education and Research Working Paper Series, 98.006, October, 1998; "Globalization and the Relocation of S-Good Activities," The Rutgers University Center for International Business Education and Research Working Paper Series, 98.010, November, 1998;

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"Globalization: A Discriminating Force for Economic Development," in John H. Dunning (Ed.), Globalization: A Two-Edged Sword (Newark: GIBER Occasional Studies in International Business No. 3,1999). OTHER ACTIVITIES Editing and Refereeing

Editor, Research in International Business and Finance, JAI/Ablex Press, Volumes 4 through 14. Associate Editor, Journal of Finance, 1967-70; Journal of International Business Studies, 1983-84; Resource editor, Annals of Tourism Research, 1977-82; Member of the Board of Editors, International Journal of Tourism Management, 1979-82; International Trade Journal, 1985- ; Global Economy Quarterly, 2000- . Referee for: American Economic Review, Eastern Economic Journal, Economic Development and Cultural Change, Global Finance Journal, Journal of Economic History, Journal of Financial Research, International Economic Journal, Journal of International Business Studies, Journal of International Economics, Journal of International Money and Finance, Journal of Money, Credit and Banking, International Economic Review, European Journal of Political Economy, Journal of Post Keynesian Economics, Management International Review, Review of Political Economy, Southern Economic Journal, Transnational Corporations, Weltwirtschaftliches Archiv, Western Economic Journal, World Bank Economic Review, World Development. Book Reviews

Annals of the American Academy of Political Science, Economica, Eastern Economic Journal, International Trade Journal, Journal of Comparative Economics, Journal of Economic Literature, Journal of International Business Studies, International Trade Journal, Journal of Finance, Transnational Corporations, Urban Studies, Weltwirtschaftliches Archiv. Consulting

World Bank, 1974 and 1982; International Labour Office, 1981; U.S. Office of Technology Assessment, 1985; New Jersey Department of Justice, 1987; and several private corporations.

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231

Other Activities

Member of the Executive Committee of the Eastern Economic Association, 1982-85 (Chair of the Committee to Rewrite the Bylaws, 1983-85); Member U.S.LA Seminar, "International Trade, Commercial Policy and Multinational Corporations," Andhra University, Waltair, India, 1973; U.S.I.A. Speaker: Pakistan, 1974 and 1979; Iran, 1974; Jordan, 1975; Greece, 1975; Egypt, 1979, Turkey, 1979; India, 1979 and 1981; Mexico, 1983; Federal Republic of Germany, 1984 and 1987; Malaysia, 1987; Vanuatu, 1987; Tonga, 1987; Western Samoa, 1987. Faculty member, 102nd Salzburg Seminar in American Studies, 1966. Life Member of American Finance Association and Eastern Economic Association; Member of the International Trade and Finance Association and the Royal Economic Society. Fourth Expert Group Meeting on Financial Issues of Agenda 21: Finance for Sustainable Development, Santiago, Chile, 8-10 January, 1997. Fifth Expert Group Meeting on Sustainable Development, Nairobi, Kenya, December, 1999. Research in Progress

"' Socioeconomic Infrastructure', Inward Direct Investment and Economic Development. (This piece attacks the notion that formal models can embrace economic development because formal models cannot account for the complexities of social institutions.) "Macrofmancial Efficiency and Financial Infrastructure'' applies the basic concepts of the above paper to financial instability in industrializing/developing countries. (It will be submitted in December of 2000 to a scholarly journal.) " The Macrofmancial Efficiency of Alternative Financial Systems" applies the concept of financial infrastructure to industrialized countries along the lines of my 1994 paper in Weltwirtschaftliches Archiv (see above). The essence of the paper is that recognition of the quality of financial infrastructure shows why national systems can vary in their efficiency and argues that a more concentrated system (e.g. the German "insider system") is more vulnerable to agency problems. It has just been finished. "International Trade and Economic Development: An Observation". This paper applies the concept of economic involvement to the

232

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question of the effects of more liberal trade on economic growth in developing nations. " The Exhaustion of an International Public Good', completed in first draft. "Growth and Growth Efficiency' distinguishes between growth in GNP and growth in welfare by subtracting from GNP and growth the unrecognized costs of that growth. "The Measurement of Profits in a Schumpeter Firm" to be presented at EIBA meetings, Maastricht, 2000.

Author index The location of contributors' chapters in this book are shown in italic, (n) after some page numbers refers to one or more notes cited on that page; the notes appear at the end of the chapter. Abramovitz, M. 178 (n9) Acs, Z.J. 62 (n7) Adams, 44 AgarwalJ. 57,90,91 Aggarwal, R. 201 Agmon, T. 201 Agodo, O. 121 Aharoni,Y. 39,157,160 Ahmed, A. 120,125 Altzinger, W. xi, 86-112, 91, 92,101, 108 (n!9) Andersen, P. S. 90 Audretsch, D. B. 62 (n7) Aufderheide, P. 43 Babilot, G. 42 Bagozzi, R. P. 202 Balassa, B. 137 (nil) Balough, R. 58 Barrell, R. 58, 59, 63, 90 Bartlett, C. 109 BaumJ.A. C. 157 Beer, E. 108 (n!9) Beinhocker, E. 50, 51 Bellak, C. xi, 86-112, 91, 108 (n!9), 165 Benito, G. R. G. xi, 199-216, 200, 203,209,211,213 Bergsman,J. 120 Bergsten, C. F. 91, 95 Berry, M. A. 186 (n3) BhagwatiJ. N. 199 Bilkey, W.J. 203 Birkinshaw.J. M. 109 Bishop, G. 33 (n20) Blomstrom, M. 90, 91, 104 BoddewynJ. 194 Bostock, E 169, 173

Botschen, G. 203 Bower, J. 42 Brainard, S. L. 61 Braunerhjelm, P. 99 Brenton, P. 101 Brewer, T. 120, 122 Buckley, P. 45-6, 72, 122 Cantwell, J. A. 59, 62, 90, 157, 165, 180 Casson, M. 72, 161 Caves, R. E. 57, 72, 76, 77, 79, 122 Cavusgil, S. T. 199-200, 203 Chang, S. 60, 76 Chase, C. D. 122 Chenery, H. 137 (nil) Chesnais, F. 161 Choi, S. P. 24 (n!2) Christensen, C. 42 Chudleigh, M. 45 Clark, T. 40 CleggJ. 58,71 Contractor, F. J. 120 Cooke, S. 45-6 Copeland, T. 51 Crawford, J. C. 199, 202 Cunningham, W. H. 125 Cyert, R. M. 159 Czinkota, M. R. 199-200 Dlagic, T. 203 David, P. 178 (n9) Davidson, W. 160 Deardorff, A. V. 77 Deng, S. 203, 212 Desmet, D. 43 (n2) Devine, P. J. 158-9 Dicken, P. 38 233

234

Author index

DiMauro, F. 101 Dodgson, M. 159 Dohner, R. 24 (n!2) Dominguez, L. V. 199, 201, 202 Dosi, G. 157 Drake, T. A. 76 Dumagen,J. 45-6 Dunning, J. H. xii, 38, 39, 40, 45, 57, 58, 60, 72, 86 (nl) , 109, 113, 122, 125, 135-155, 136 (nn2,3,4,5), 137 (nn7,8), 138, 160, 161, 165, 169 (n6), 171, 180 (nlO) Edgecliffe-Johnson, A. 47-8 Egan, D. 186 (n2) Egan, M. L. 199, 202, 203, 212 Eika, K. 48 Eisenbeis, R. 41 Ehrlich, P. 186 Elvey, L. A. 203 Evanoff, D. 41-2 Fatehi-Sedeh, K. 122 Fladmore-Lindquist, K. 39 Fors, G. 90, 91, 104 Fouts, P. 187 Francis, T. 43 (n2) Frantz, F. 42 Freeman, C. R. 157 Froot, K 59, 131 Gates, B. 42 Gazda, G. M. 191 Germain, M.Jr 211 Ghoshal, S. 109 Gill, G. 45-6 Ginsberg, A. 157 Glowacka, A. E. 212 Goldberg, L. 24 (n!2), 27 (n!6) Graham, E. 90, 120, 160 Gray, H. P. xiii-xv, 40-1, 70, 71, 90, 99, 109 (n20), 113 (nl), 131,135 (nl), 137 (n9), 185 (nl), 199, 202,217-232 Green, L. 42 Green, R. T. 125 Griliches, Z. 62 (n7) Gripsrud, G. xii, 199-216, 200, 203, 209,211,213

Grosse, R. 24 (n!2), 38 Grubert, H. 120 Guisinger, S. 120 Hagedoorn, J. xii, 56, 156-184, 180 Hainaut, P. 90 Hamel, G. 43, 49 Hanweck, G. 24 (n!2), 27 (n!6) Hartman, D. 120 Hawkins, R. 199 (nl) Helleiner, G. 137 (nil) Helpman, E. 60 (n4) Helseley, R. W. 24 (n!2) Hennart,J-F. 72 Henry, D. 45-6 Hirsch, S. 160 Hofer, H. 86 (nl) Holland, D. 106 Hollander, A. 122 Hood, N. 107, 108 Horst, T. 91,95 Hu, A. 43 (n2) Hufbauer, G. 60 (n5) HuhleJ. L. 122 Hultman, C. 24 (n!2) Hymer, S. H. 72 HyunJ. T. 122 Israilevich, P. 41 Javalgi, R. G. 39 Johanson, I. 160 Jones, D. T. 201 Jones, G. 169,173,174 Jun,J. 120 Kane, E. 24 (n!2), 27 (n!4, 15), 31 (n!8) Katsikeas, C. S. 203 Keenan, P. 51 Korhonen, H. 203 Kim, C. S. xii, 135-155 Kim, E. C. 43-4 Kimura, Y. xii, 69-85, 76, 77 Knickerbocker, F. T. 72, 74, 157, 160 Knight, G. 39, 40, 41 Kobrin, S. J. 125 Kogut, B. 60, 76, 157, 160, 161 Kojima, K. 70-71, 73-5, 77, 78, 80-84 Roller, T. 43 (n2)

Author index

Kotabe, M. 39 Kragas, E. S. 76, 77 Krause, L. 165 Kravis, I. B. 59, 131 Krueger, A. O. 199, 202 Krugman, P. 120 Kumar, N. 121 Kwan, S. 41 Lakdawalla, D. 60 (n5) Lall, S. 58, 121 Lamb, C. W. 202 Lampe, M. 191 Lankes, H-P. 95, 99 Laporte, S. 45-6 Laraqui, S. xii, 113-134 Lee, C. H. 70 Lee, N. 158-9 Leibenstein, H. 39-40 Levi, M. D. 24 (n!2) Levich, R. 26 (n!3) Levinthal, A. D. 156,159 Levy, D. L. 186 (n2), 187 Li,J. 120 Li, K. 43 Lin,J-D. xii, 135-155 Lipsey, R. E. 59,60,90,91,104,131 Lizando, S. 120, 122, 131 Lovelock, C. 39 LumpkinJ. A. 199,202 Lundan, S. M. xii, 185-198, 188, 189, 195 Lundvall, B. A. 60 Lunn,J. 58 Luostarinen, R. 160, 203 Maddison, A. 166, 167, 170 (table) Magee, S. P. 72 Malani, A. 60 (n5) March, J. G. 156, 157, 159 Markusen, J. R. 60 (n4) Martin, C. 106 Mauborgne, R. 43-4 Mauer,J. 58 Mayrhofer, P. 107 McGee, L. R. 24 (n!2) Mclntyre, J. 201, 202 Mester, L. 41, Mody, A, 58, 59, 120, 122, 131, 199, 202, 203, 212

235

Morgan, J. P. 32 (n!9) Morrison, A. J. 109 Murray, J.Y. 39 MuttiJ. 120 Narula, R. xi, xiii-xv, 55-68, 56, 57 (table), 58, 113 (nl), 131, 136 (nn2,4,5), 137 (n7), 160, 161, 165 (nlO), 180, 156-184, 199 (nl), 201, 202 Nehrt, C. 187 (n4), 193 Nelson, R. R. 157, 163 Neudorfer, P. 89, 90, 100, 101, 109 Nevens, M. 44, 46 Nordstrom, K. A. 122 Norman, G. 137-8 Norusis, M.J. 96,98,99 Osawa, T. 70-71, 73-5, 77, 78, 80-84, 160 Overdorf, M. 42 Pain, N. 58, 59, 60 (n5), 63, 64, 90, 106 Papanastassiou, M. 121,125,131 Pastore, D. 45-6 Patel, P. 59 Patterson, P. 38, 39 Pavitt, K. 59 Pearce, R. D, 121, 125, 131 Peters, E. 108 Pfaffermayr, M. 62, 86 (nl) Porter, M. 92, 107, 186, 187, 188, 189 Portes, R. 24 (n!2), 27 (n!4), 31 (n!8) Pugel, T. A. xii, 69-85, 76, 77 Rajaratnan, D. 40 Reed, H. C. 4 (n4) Reidel, G. 43 (n2) Reistadbakk, T. 48 Rennie, M. 45 Robinson, S. 137 (nil) Rondinelli, D. A. 186 (n3) Roos, D. 201 Root, F. R. 120, 125 Rosson, P.J. 200,203,211 Rugman, A. M. 72, 187, 188, 194 Rumelt, R. 57, 158, 159 Russo, M. 187

236

Author index

Safizadeh, H. M. 122 Samiee, S. 38, 41 Sampler, J. 43 Saunders, A. 24 (n!2) Saunders, R. S. 122 Scaperlanda, A. 58 Schroter, H. G. 92 Schumpeter, J. A. 161 (nl) Sekiguchi, S. 69 Sequeira, C. G. 199, 201, 202 Seringhaus, R. F. H. 200, 203, 211 Shah, A. 120 Sharma, S. 187 Sheppard, M. 45 Siddharthan, N. S. 121 Siebert, H. 26 (n!3) Simon, H. A. 158, 159 Singh, J. V. 157 SlemrodJ. 120 Smith, Roy C. 29 (nl7) Solberg, C. A. 203 Srinivasan, K. 120,131 StankovskyJ. 89 (table) Stein, J. 59, 131 StopfordJ. 160 Strandskov, J. 160 Swedenborg, B. 59 Swoboda, A. 24 (n!2), 27 (n!4), 31 (n!8) Syrquin, M. 137 (nil) TaggertJ. 107 Taylor, P. 42 Tchen, C. 48 Teece, D.J. 157,158,159 Terrell, H. S. 24 (n!2) Tesar, G. 203 Thorelli, H. B. 212 Tolentino, P. E. E. 160 Travino, L. 201, 202 Tschoegl, A. 24 (n!2) Tsurumi, Y. 69 Turnbull, P. 160

Vahlne,J-E. 122, 160 Van der Linde, C. 187, 189 Velazquez, F. 106 Venables,A.J. 95,99 Verbeke,A. 187,188,194 Vernon, R. 72, 157, 160 Veugelers, R. 59, 60 (n5) Vogel, D. 188, 193 Vredenburg, H. 187 Wakelin, K. xii, 55-68, 60 (n5), 64, 131 Wallace, C. D. 120,131 Walter, I. xii, 1-37, I (nl), 17 (nn8, 9), 26 (n!3), 29 (n!7) Walther, C. H. 122 Wang, C-K. 202 Weiss, M. Y. 50, 90 Welch, L. 160, 199 (nl), 203 Wells, L. T. 72, 160 Wheeler, D. 58, 59, 120, 122 Whitmore, K. 122 Wiedersheim-Paul, F. 160 Winklhofer, R. 91,92,101 Winsted, K. 38, 39 Winter, S. G. 157 Wolff, E. 173,177 Wolfmayr-Schnitzer, Y. 107 Womack, J. P. 201 Wortzel, L. H. 203, 212 Wymbs, C. xii, 38-54, 39, 51 Yamawaki, H. 59 Yates, L. 43 Yip, G. 39 Yoshihara, K. 69 Yoshino, M. Y. 69 Young, S. 108 Yu, C. M. 24 (nl2), 160 Yu,J. 60 Yuengert, A. 42 Ziegler, A. R.

195

Subject index ABB 46 Advertising intensity 77 Agency Fees 5 Agglomeration effect 161,163 Agglomeration economies 22, 25 and employment 87-22 Amazon.com 48,50 Asset management 17-20, 32, 34 Asset-allocation activities 17 Asset-exploiting FBI 161,164,175 Asset-securitization 32 Asset-seeking FDI 61,164, 175 Austrian FDI in CEECs 86-111 affiliates 89 comparison of direct and indirect FDI 92-5 empirical model 101-3 future strategies 109 impact of affiliate sales on employment 104-5 impact on employment and trade 90-2 initial- and post-investment period 95 internationalisation of enterprises 92,97 Intra-firm trade (IFF) 87, 90, 99-101

Back office activities 20-4 Bank for International Settlements 6 Barnes & Nobel 48,50 Barriers to importing 203 Behavioral theory 158 Big Bang 30 Bond underwriting 7 Brokerage 8 Business-to-business (B2B) 42 Business-to-consumer (B2C) 42 Canada 189, 193 Capital labor ratio 83

CEECs Austrian FDI in 86-111 intra-firm trade 99 investor ownership 86 Central and East European Countries (see CEECs) Central Europe (see Central and East European Countries) CFCs 195 Chambers of Commerce 205-6 China 193 FDI 157 Chlorine-free paper 185, 190, 192-3 Totally Chlorine Free (TCP) 192-3 Elementally Chlorine Free (ECF) 192-3 Cisco Systems 46 Classical evolutionary theory 183 Closed mill concept 190 Commitment Fees 5 Common market 173-5 Comparative advantages 27, 34—5, 73-74 Competitive advantages 27, 39-40, 72-3, 91-2, 108, 122, 136, 156-7 Complex Adaptive Systems (CAS) 50-1 Consumer reaction 190-1 Consumers 189, 191, 209-10 Contemporaneous exports 62 Corporate Finance 10-6 Country-size 56-7 Created asset intensity 153 Created assets 136-8, 152-3 Czech Republic 100 De novo FDI 163, 165 Determinants of FDI 55-68, 131, 150 Developing countries 199-215 Differences in direct and indirect FDI 92-5, 97-8, 106, 109 Direct FDI 86-112 237

238

Subject in dex

EASDAQ 33 Eastern Europe 90, 92, 108-9, 126 Eclectic paradigm 113, 118, 122 Eco-labels 191 E-commerce 38-52 Empirical model 60-4 EMU 33,37 End-sources 2-3 End-users 2-3 Environment and consumers 189 clean air, clean water act 186, 192 evolution of thinking in 186-8 pollution haven hypothesis 188 pro-active thinking 198 reactive thinking 198 regulation 186-9, 198 strategy in paper industry 188-9 Environmental strategies 185-97 Equities 2 Equity underwriting 8 E-toys 47-8,50 EU 95, 97-8, 101-3, 106, 125-7, 130 Euro 10, 12 Eurobond 29 EuroNM 33 European Union (EU) 27, 33, 58-9 Evolutionary theory 157-8,164 Export Demand Model 67 Export Promotion Organisations (EPOs) 199,203-4,211,213 Export strategies 203 Exports 58-60, 64, 67 and FBI 64 from developing countries 199-215 FBI 25, 184 and exports 58-9, 64, 67 asset-seeking 161, 164 determinants of 55-65 efficiency-based 97-9 empirical model 60-4 government policy 137 impact on trade 91 inCEECs 86-111 in EU 55-68

in Europe 55-68 in evolutionary context 160-4 in Japan 55-68 in Korea 135-55 in Morocco 113-31 in Taiwan 135-55 inter- and intra-industry trade 137-8, 150 in U.K 55-68 inward 135-51 linked to oligopolistic competition 160 market-based 97-9 motives for 90,106-8 outward 135-51 patterns of 56-7 theories 72 FBI intensity 28, 75, 150, 153 Financial Centers booking 24 direct/indirect importance 4 factors determining competitiveness 25-6 functional 24 input/output relationship 4 types of 24 U.S structure 33-4 vertical/horizontal integration 4 Financial de-regulation 31-2 Financial over-regulation 31-2 Financial regulation 37 Financial Services kinds of 4-18 locational choices of 18, 21-4 Financial services activities high mobility/low mobility functions 21-2 centripetal/centrifugal economics of 2, 21-4 Financial Services Authority (FSA) 30-1 Financial Under-regulation 31-2 Finland 189-90, 192-4, 198 Fiscal incentives 65 Fixed effects model 162 Foreign Birect Investment (see FBI) Foreign exchange 6, 33 Forest certification schemes 192, 198

Subject index France 30, 56-7, 61, 64 French FBI in Morocco 113-31 Front office activities 22-4 GATT 201 GDP 28, 166, 168, 170, 172-77, 184 GDP pattern 56-7 Germany 30, 56-7, 64, 180, 184, 190, 192, 215 Global economy 163 Globalisation 59, 107, 189 in finance 1-34 GNP 25, 135-43, 150 in Korea 135-55 in Taiwan 135-55 Government strategies towards internationalization 203-4 Green options 190-1 Greenhouse gases 186 Greenpeace 191 Hedging 8 Herfindahl-Hirshman Index 36 Honda Canada 45 Horizontal investment 95 Human capital 70, 77-8 Hungary 100

12, 16,

I-advantages (see Internalisation advantages) IBM 21,46-7 Imbalance coefficient 166-7, 174-7 Import Promotion Agencies (IPAs) 200, 204-9, 213, 215 support activities 207-12 Indirect FDI 86-112 Information Technology (IT) 39 Initial Public Offerings (IPOs) 8, 43 Innovation offsets 187, 190 Intangible assets 72, 75-77 Interest Equalization Tax (IET) 29 Inter-industry trade 137,150 Internalisation advantages 76 Internalisation theory 72 International Lending 4—6 International Portfolio Diversification (IPD) 2

239

International Trade Center (ITC) 203-4 Internationalisation 97, 175 Internet 21, 39-40, 42, 44-8, 50-1 book-distribution 48 brokerage model 48 cost-cutting benefits 44—5, 48 international banking 48 Intra-firm trade (IFT) 90, 99-101, 112 Intra-industry trade 37, 150, 213 Investment Development Path (IDP) 135-151 Investment Management 17-18 Investor Services 17-18 Inward FDI 57, 61-3, 135-54 Ireland 21 Italy 55-7, 61, 64 Japan 30, 55-7, 61, 64, 129, 198 Japanese External Trade Organisation (JETRO) 206 Japanese FDI 69-85 Kojima-Ozawa theory 70-71, 83 Korea 70, 135-155 FDIin 135-55 GNP 135-55 locational advantages 136 ownership advantages 136 trade 135-55 trade hypothesis 138-51 TOP 138-9 Kyoto agreement 186 L-advantages (see Location advantages) Lagged co-evolution 162-3, 180 Lagged exports 60, 62, 64 Legal Fees 5 Liberalization 42, 52, 201 in Morocco 113-4, 126, 128 Loan-syndication 3-6,24 Location factors 73 Locational advantages 58, 62, 108, 112, 124-5, 131, 136 London 17 Marshallian Equilibrium 49 Marshall Plan 169

240

Subject index

Merchant Banking 12 Mergers and Acquisitions (M&A) 3, 10, 12, 24, 136 Metcalfe's Law 42-3 Middle East and North Africa Economic Conference 125 Ministry of Foreign Affairs 205 MITI 81 MNE U.S activity statistics 56-7 MNEs (see Multi-national Enterprises) Morocco EDI determinants of 112, 122-5 French EDI in 113-31 future of FBI in 128-30 GDP 129-30 impact of EU 125-7 internalization advantages 127 location advantages 123-5, 131 motives for EDI in 120-2 obstacles to EDI in 128 ownership advantages 122-4, 131 taxation system 119-20 US FBI in 113-31 Moroccanization Act 114 Multifiber Agreement 201 Multilateral Agreement on Investment (MAI) 186, 194-5 Multi-national Enterprises (MNEs) 38, 153 and environment 185-7 and government interaction 188, 194, 196 and NGO interaction 194-7 horizontally integrated 60, 67 political role 194-7 service industries 38-52 vertically integrated 60, 67 NAFTA 194 NASBAQ 33,43 National system of innovation 163 Natural asset (see also Natural resources) 152-3 Natural resources 56, 58, 152-3 Neo-classical trade theory 215 Netherlands 56-7, 61, 64 Net Regulatory Burden (NRB) 26-7 NGOs 185-6, 189

Noise traders 32 Non-routinized learning (see also exploratory learning) 159,164, 179 North Africa 119 North American Industry Classification System (NAICS) 40 Norwegian Import Promotion Office 200, 203-4 O-advantages (see Ownership advantages) OECB 63, 67,186, 195, 204, 213 OECB STAN database 68 Office of FBI 29 OLI paradigm (see eclectic paradigm) OLI variables 114 Oligopolistic competition 74-5, 79, 80 Oligopoly theory 72 Operating characteristics 158 Organisation for Economic Cooperation and Development (see OECB) Organised markets 3 Origination Fees 5 Out-sourcing 47 Outward FBI 55-68, 87, 135-54 Ownership advantages 58, 60, 62, 122, 136 of French FDI 122-3,131 ofU.SFDI 122-3,131 Parallel markets 29 Patents 61-2,68 Path-dependency 158 Pension schemes 32 Physical capital 70, 77-8, 81 Primary markets 160, 162-5, 172, 178, 180 Private Banking 17 Privatisation 10, 114 Product life cycle theory 72 Psychic distance 160 R&D expenditure 68, 76 R&D intensity 76 Rate of re turn 165

Subject index

Re-capitalization 10 Research shortage 40 Resource-based theory of strategy 187 Returns to labour, capital and land 3-4 Risk management 8 Risk-arbitrage 8 Routines 157-8, 162-3 Routinized learning (see also exploitative learning) 159, 164 Satisficing behavior 156,158-9,162, 164-5, 180 Scandinavia 192-3 Schumpetarian (S) products 137, 153 Seattle 1999 Meeting 85-6 Secondary markets 160,162-5,172, 178, 180 Sequential FBI 165 Service firms 38 business strategies 49 innovative strategies 51 Service industries 38-52 Service Producing MNEs 42 Service sectors 38, 40 Services 38 derived 40, 44-5 intra-firm 41,46-7 linking 41,45 location specific 41,45 traditional 41,47 Silicon Valley 161 Slovakia 100 Soviet Bloc 126 Specialized MNEs services 40-1 Stock levels 165-6, 168, 183 Strategic alliances 136 Strategic asset-seeking FDI 153 Strategic management 156-7 Sub-optimal levels 162, 164, 167, 170-1, 179 Sweden 56-7, 61, 64, 189, 192-4 Swiss Office for Trade Promotion 205 Switzerland 12 Taiwan FDI

135-55

241

GNP 135-55 trade 135-55 Taxation 26 TDP hypotheses 138-150 Tertiary sector 67 Total Quality Management (TQM) 186-7 Trade domain of 200-2 external barriers 200 internal barriers 200 limited resources 200-1 organisation 204-7 promotion strategies 202-3 types of barriers 203 Trade Development Path (TDP) 135-151 and IDP interaction 137-8 created assets 137 exports 137 imports 137 inter-industry trade 137,150 intra-industry trade 137,150 Trade negotiations 186 Trade replacing FDI 70 Trading up 192-3 UN Conference on Environment 186 UNCTAD 56,78-9 Underwriting 8-10 fees 5 Unit Labor Costs (ULC) 58-9, 61, 63 United Kingdom (UK) 56-7, 64 United Maghreb Arab (UMA) 126 United States (US) determinants of FDI 55-65 FDI and exports 64 FDI empirical model 60-4 GDP pattern 56-7 lagged exports 62,64 pattern of FDI 56-7 patents 61-2 unit labor cost 61,63 environment 187-9, 193, 198 United States FDI 55-68 and country size 56-7 and lagged exports 62, 64 determinants of 55-65

242

Subject index

in EC6 154-84 empirical model 60-4 exports 64 fixed effects and unrestricted model 162 GNP 59 of Europe 156-183 EEC 156-183 Europe since World War II 167-78 Germany 156-183 Korea 70 Morocco 113-31 UK 156-183 pattern of 56-7 Unrestricted model 62 US MNE activity 55-68

Value chains 38-9 Value-added activity 1-2, 5-6, 12, 18, 27, 29, 31, 34, 61, 166 Value-added chain 108 Vertical investment 95

Web 42-3 Web-based alliances 51-2 Web-centric business model 43,

51-2 Win-win argument 186-8 World Bank 128 World Trade Organisation (WTO) 185-6, 195, 201 X-inefficiency

41-2