Originally published on November 16, 2017.
Multinational (MN) trade is as old as the formation of the city states. It began as unstructured trade in commodities. For example, the trading of salt was an important economic activity in Europe and North Africa, and cities such as Salzburg, owe their origins to the salt mines.
Today, MN corporations are among the world’s biggest economic institutions. A rough estimate suggests that the 100 largest MNs control nearly one-quarter of the world’s productive assets. Apple earns about 60% of its revenue overseas and its market capitalization is greater than the GDP of all but 18 countries.
MNs tend to dominate in industries where output and markets are concentrated in the hands of a relatively small number of firms due to capital requirements, patent protection or network constraints that favor oligopolies such as Facebook, Netflix and Google. The top five car manufacturers, for instance, are responsible for nearly 53 per cent of worldwide sales of motor vehicles.
Still based predominantly in Western Europe, US, and Japan, MNs’ operations span the globe. The US bell weather of MNs, GE has facilities in 130 nations employing 295,000, for example, and Cargill, the largest grain company, has operations that span 65 countries from Australia to Zimbabwe. MNCs are now a part of the global force that is integrating the world economy.
The origins of MNs lie in the colonizing and imperialist impulses from England and Holland in the 16th century. The first MN corporation was the Dutch East India Company followed by the British East India Trading Company – the only MN with its own army that colonized a nation. At the height of its rule in India, the British East India Company had a private army of about 260,000 – twice the size of the British Army.
The MNs evolved in the 1800s, with the development of financial markets, advances in industrial revolution and manufacturing processes, better warehousing techniques, and faster shipping. Later, the search for resources such as minerals, food, and oil as well as pressure to increase markets further drove MN expansion. For most of the 1900s, US, UK and Holland accounted for nearly three quarters of all cross-border trade.
After WW2, multiple trends converged to accelerate MN growth:
- Favorable post WW2 economic world order that favored trade over conflict.
- Banks in the US, Europe, and Japan began to lend vast sums of money to industrial companies, encouraging expansion and mergers.
- Technological advances in transport, IT, and communications.
- Emerging markets, burdened by debts and unemployment, began to view MNs as a path to rapidly access technology, capital, and accelerate employment. The East Asia miracle was largely based on MN trade.
As the MNs grew in size, they were sometimes directly involved in the politics of the host countries. At times, the American military itself intervened on behalf of MNs. For instance, the US invaded Guatemala to prevent the government from taking, with compensation, unused land of United Fruit Company for redistribution to peasants. Another direct intervention occurred in the 1970s, when the CIA was offered $1 million by a MN to defeat the candidacy of Salvador Allende in Chile. After copper mines in Chile were nationalized, the US government took a series of steps to topple Allende.
By early 1990’s, as China and India liberalized, and as Europe consolidated itself into a single market, the multinationals sought to be truly global by integrating their global production, capital and management. Investors began to pay a premium for MN equities given the potential for economies of scale. Global firms began to optimize the mix of inputs i.e. management expertise, financing, marketing and technology from the advanced economies; and lower labor costs and commodities from the host countries. Most of the global investment by MNs was made during this period.
The 1990’s trend has reached its limits. Multinational firms have less advantage now based upon the most promising ideas about management or technology. Some geographical arbitrage opportunities have been depleted– wages have risen in China; and the rapid flow of information means that competitors can catch up in technology and functional processes more easily.
As a result, investors do not automatically bestow premiums to the MN equities and the stocks of bell weathers such as GE have stagnated as the overall market has hit new highs.
The Brexit vote, the election of Donald Trump, the popularity of far-right European politicians raises important questions about the future of free trade. But the outlook of the multinational corporation is not in doubt. Global economic integration is not solely merchandise trade. Economic integration includes merchandise trade, services trade, cross-border investments, and data flows. By these measures, global integration will continue to thrive but some changes are likely:
- Globalization will become a matter of choice. Unlike the earlier eras where it was enforced by gunboat diplomacy by Admiral Perry in Japan and by military intervention to sell opium in China, countries now choose to globalize because of macro-economic benefits. India has a campaign called “make in India” to attract manufacturing jobs to complement IT enabled services.
- Host countries will become more demanding. Countries will push foreign firms for indigenous innovation, local component sourcing and intellectual property sharing. Strategic industries will likely remain out of bounds.
- To meet these challenges, MNs will tunnel deeper into the local economies by localizing their production, supply chains and management. Global trade used to be led by trade; It will be increasingly led by investment as multinational corporations start to double down on localizing their operations in major markets. The design and specifications of products may remain largely standardized but the actual production of goods and services will be localized.
- Technology giants will remain in an advantaged position. According to the Economist, “their foreign profits comprise 46% of the total foreign earnings of the top 50 American multinationals, up from 17% a decade ago. Where the MNs have enforceable patents, they are still at an advantage, where economies of scale are best created by spreading costs over the entire world”.
- The host countries will become less welcoming towards intangible services such as intellectual property, drug patents and finance. The MNs in these areas may use franchising deals with local firms to access the local markets.
- Technology will increasingly help small firms using e-commerce to buy and sell on a global scale. Many small firms already do this to access the global market as reflected in cross-border transactions executed by PayPal.
- As China continues to grow, it will become a major player in the MN trade. The state-controlled groups in China have already made several acquisitions of natural-resources firms to secure access to raw materials. Some of these deals were at the peak of the commodity price cycle similar to Japanese experience two decades ago when they overpaid for a Hollywood studio and the Rockefeller Center. But China will learn and bring its own brand of MNs. India and other emerging countries, as they grow, will find their place in the MN landscape.
- US Congress will likely change the tax code which would see MN firms bringing profits home while adding levies for moving production abroad.
These future trends will continue to enhance the integration and co-operation between emerging and developed markets, and contribute to the dynamism and growth of the global economy.
Read more posts by Mohan Kharbanda
Want to know Mohan Kharbanda better? Follow him on LinkedIn.