Revisit from the previous parts
The previous parts of this paper highlight issues on big contracts invested in a host country as experienced by multi national enterprises. Cases spanning from oil, gas and coal concessions are always connected to government terms and conditions as big contracts contribute significantly to the state revenue while at the same time pose risks on environmental as well as resource depletion issues originating from loose exploitation practices.
Big contracts are inseparable from changes on economic activities. Firms were used to operate their end to end production alone. Resources are extracted and processed on a single location. Firms also managed to sell their processed resources to buyers on the market without intermediaries. Nowadays with surging demands on energy products, big contracts are more specialized on resource extractions, resource developments, resource processing and resource distributions.
Changes on economic activities emanating from the division of labour have created separations on business activities among those involved in the extraction of raw materials, those supplying the production inputs, those processing the raw materials into higher value products and those distributing and selling the end products to the customer. As the economy of a geographical area progresses, surging demand forces firms to find additional sources to secure supplies. Resource depletion becomes a reason to expand beyond home territories. Competition has also driven firms to seek for new markets, new competitive sources and competitive labour rates as well as advance technologies to stay in the business.
Concurrently, finding new competitive sources beyond the home country has benefited both multinational enterprises and the host country. To the multi national enterprises, new markets provide a new space to maintain the business. New resources and new markets also put a multinational enterprise in a better position in the industry vis a vis to its competitors. To give a perspective, on big energy projects, the discovery of oil reserve on the host economy often raises the stock value of the multinational enterprise. Investors owning the multinational enterprise shares give credit to the MNE efforts by holding their shares. Consequently, the credit given by the shareholders creates confidence to other investors in buying the MNE shares rather than to choose on the competitor’s shares. On the other side, to the host country, foreign investment flows secure the host country economic growth while at the same time upgrade the investment status of the host country. We often see rating upgrades on a host country from institutions such as Standard & Poor when foreign investments flock into this country. However, as discussed in the previous parts of this paper, the host country must be aware that exposing access to international markets should be accompanied by providing benefits to all economic actors as well as to the society. Consequently, identifying, devising and deploying suitable policies to the favour of the state interests are essential to the sustainability of the state economy.
While we have seen the roles of the government in balancing the impacts of foreign investments, in the third part of this paper, we will see rationales of the MNE expansion at the global scale. The paper also discusses the positive roles of the MNE in the state economy and the way MNE uses various channels to preserve its global operations.
The rationales of MNE’s expansion
Perhaps there are no firms that are established for searching no profits. Firm is set deliberately as an effort to attain economic objectives held by actors through institutionalizing the division of labour. By setting up a firm, a line of business is defined, economic objectives are set, profits are sought and economic activities aiming to get profits are institutionalized and operated.
Market seeking activities is the underlying activities of a firm to attain its economic objectives. A firm seeks potential markets through assessing the demand it can provide as well as the supply it can manage to source. To do so, firms incorporate different activities based on the division of labour to produce goods or provide services in a single location. Once the demand and supply reaches equilibrium, a firm can extend its coverage in attaining its objectives by providing goods or services on different places.
Market is potentially created when new demand exists. Potential market can be viewed as an opportunity for firms to gain wealth and to sustain their operations. Firms which are able to meet new demands look for supplies to start producing goods or services. Consequently, other firms are created to supply demands of the firms which produce end products. As a result of market expansion, suppliers must expand to potential markets where buyers exist. We can see the example on the Indonesian power development projects. The plan of the Indonesian state power company to provide 10,000 MW power by 2009 resulted in power plant development projects which require electrical devices to be installed for distribution and transmission systems. The demands on electrical components were seen by Areva, a French based company, as an opportunity to expand their business operation. Accordingly, the company invested over $ 15 million in the country for fulfilling the demands on electrical devices (Krismantari, 2008).
Market seeking activities can also occur when competition intensifies. Firms doing the same business look for similar markets and confront each other to meet the demand. When the ratio of the profit per number of good to the production cost per number of good start to decline, the total industry outputs show insufficient margins to cover business operations and to gain the expected profits. Firms must find a way to repel competition either through offering cost advantages, simplifying production process, innovating or expanding to new markets.
Competition may force firms to produce competitive outputs through applying cost advantage strategy. Exploiting new locations which provide input sources that are competitive enough to reduce costs is often sought by a firm to stay in the business. New territories possessing abundant resources are explored and firms interested in seeking new resources can enter the host economy through direct investments or joint ventures. Firms involved in resource seeking activities commonly invest outside their home economies to gain cost advantages. Firms may also involve in resource seeking activities beyond their home economies due to scarce resources in their home country. Despite the two rationales, the wisdom of economic principles in gaining the maximum outputs through minimizing the input costs remains as the tenet of a firm in seeking resources beyond its home country.
Cost advantages can also be achieved by reducing operational costs. Specifically, firms engaged in labour intensive industries can expand their operation overseas to reduce their operational costs by using foreign labours with competitive rates. In particular when the home country labours are considered to be uncompetitive enough to the overall cost, firms start seeking new territories to move its production activities to recover their cost advantage strategy. While some would argue that a significant number of investments should be placed beforehand for catching the learning curve, the overall cost reduction in the long term is justifiable enough for a firm to expand overseas.
Differentiation on cost and to the large extent on product quality can also be achieved through using new technologies. Firms expand overseas to employ advanced technologies possessed by the host country. Firms can invest directly or venture with other companies to acquire better production systems through using new technology. By adopting new technology, a firm can produce better product qualities which are essential in differentiating its outputs to its competitors. A firm can also acquire new technology in order to speed up the production process, hence reaping the economies of scale. Acquiring new technology can significantly reduce both labour and production costs, thus increases the productivity of a firm. In some cases, innovative products require different processing technology unavailable in the home country. Firms can expand beyond their home economies to acquire technology permitting them to produce new innovative products.
All these rationales have conditioned a multinational enterprise to justify the need to expand beyond their home territories. The opportunity to seek for market, resource, skill and technological advantages is a long term perspective for the firm to stay competitive, while at the same time it intersects with the host economy interest to secure its economic growth.
MNE roles in the host economy
Although a multinational enterprise seems to be opportune enough to expand its operation beyond its home country, comparative observations suggest that the MNE investments can benefit the state economy in several ways.
The expansion of multinational enterprises brings capital flows to the state. Multinational enterprises need assets for their operations. In setting up their business, multinational enterprises need both physical and non physical capitals. Such needs are concretized by injecting financial capitals to fund MNE operations. Accordingly, the more the investment flows to the state, the more the confidence gained by the state on its investment status. Hence, not only the state can gain confidence on its monetary status but investment flows will also raise the confidence to invest in the host economy.
Another positive effect of the multinational enterprise presence in the state economy is the spillover effects. MNEs bring new skills both in management and technology during their operations. Best practice methods enable local workers to adopt new skills and learn new technology allowing them to be highly knowledgeable on the production and processing technology owned by multinational enterprises. Spillover effects will result in knowledge transfers if the labour mobility occurs. The move of employees working at multinational enterprises to local firms brings knowledge transfers which are essential in improving local firm capabilities. Multinational enterprises can also improve the quality of local products by providing feedbacks to local suppliers. In addition, MNEs can also educate customers and buyers in embracing sophisticated products (Blomstrom & Kokko, 1997). Consequently, spillover effects demonstrated by multinational enterprises lead to the improvement of product qualities and to the demand of more sophisticated products.
MNEs and the way they protect their operations
Despite the expansion rationales, multi national enterprises need to secure their operations in the host economies. Multinational enterprises invest in a large amount of money to gain profits. These investments have been committed and realized because multinational enterprises have projected the financial return in the long term. Multinational enterprises secure and commit their investments because their assessments on political, social and economical risks not only permit them to operate their business in the host economy but also secure their projected returns properly.
However, risks are unavoidable. Changes on the global economy, political transitions as well as social movements may instantaneously turn the table overnight. Large investments may not gain financial returns as projected by multinational enterprises due to unforeseen circumstances. To reduce these risks, multinational enterprises need instruments that can protect their investments in the long term. Operating in “mutual benefit agreements” with the state is one way to secure multinational enterprise interests in the host country. On a big contract, multinational enterprises share their expectations in securing their operations to the state representative and contribute some of the benefits through various means. On oil concessions, the reciprocal interests by both the government and a multinational enterprise are legalized in production sharing contract or technical assistance contract terms. Often, multinational enterprises engage in corporate social responsibility to demonstrate their good will in social development issues. On other occasion, multinational enterprises are conditioned to divest their shares to local governments or they initiate community development programs.
International market mechanism permitting asset mobilizations is another instrument used by multinational enterprises to secure their investments. In sectors involving labour intensive industries such as footwear and textile industries where physical assets are easily deployed and business operations are easily imitated by not so advanced countries, multinational enterprises can use asset mobilization instruments to move their operations to another host country. With such mobility, MNEs have the bargaining power to preserve their operations in the existing host economy by reasoning the incentive advantages offered by other countries.
International agreement is often utilized by MNE to secure their operations. Bilateral agreements between two governments often involve multinational enterprises. MNEs can use their home government roles as the owner and the protector of the state asset to secure their interests. Extension on gas contracts are often initiated from the bilateral talks between two countries followed by signing a memorandum of understanding tying the two governments in supplying and buying natural gas over a certain period of time. Prior to these talks, some of the multinational enterprises have often expressed their interests to their respective government in securing their existing operation in the host country.
The last resort often sought by multinational enterprises in securing their operations is through the use of arbitration mechanisms. In such case, multinational enterprises expect for compensation of expenses and other collateral costs spent during their operations. Multinational enterprises can litigate inconsistent regulations enacted to them. The nationalization program in
