Big Contracts: On the Verge of (Government) Troubles - Recommendations for MNEs in operating their business in the host country (Part 5 - Final)

Revisit from the previous parts

The previous parts of this paper have discussed changes on economic coordination leading to the evolution of economic governances. The paper also discussed disputed elements when a multinational enterprise operates in a host country. The final section of this paper will provide recommendations taken by multinational enterprises in devising strategies to cope with conflicting issues between multinational enterprise interests and the host government.

Foresight Steps

We recommend multinational enterprises to adopt foresight steps suggested by Daheim and Uerz (2006) in confronting issues on relations between MNEs and the host government. MNEs should apply four steps: identifying, projecting, anticipating and shaping issues associated with MNE operations in the host country. MNE can then characterize attributes of economic, social, political and environmental issues on each of these steps.

The identification step requires MNE to recognize issues both those in the pasts and developing issues in the current contexts. As disputes between MNE and the host government arise on economic/business, political, social and environmental dimensions, these factors must be taken into account. Past issues can be used as a learning process in which similarities with present issues and recurring issues in the pasts occur either in the exact forms or in different manifestations. These issues can enrich the MNE strategic vocabularies in anticipating long term outcomes that affect MNE operations once the strategic decisions have been made. On the other hand, developing issues are important for projecting the position of the MNE relative to the current and medium term contexts.

Some of the methods used to identify issues that may potentially lead into disputes between MNE and the host government can be in the form of literature studies, surveys or gathering information from experts. MNE can setup an internal organization dedicated to conduct activities associated with the host government – MNE relations. The organization does not necessarily restrict its activities in identifying issues but also can be extended to other steps (e.g. anticipating, projecting and shaping). Hence, the organization may be split into several divisions.

Four steps in confronting issues between MNE and the host government

Some examples on issues that can be identified by MNE are provided in Box 1.

Box 1. Some examples on identifying steps

Results from the identification activities above can be employed as inputs for the projection activities. Based on the identified issues, MNE can project future outlooks that affect MNE operations. Uncertainties that may affect MNE operations can be derived by analyzing results gathered from the identification step. MNE can utilize literature reviews to analyze patterns from past histories and then combined with existing issues, MNE can project future developments based on similarities between data on past histories and identified trends/issues. Another way to project future developments is by using expert recommendations. Identified issues gathered by MNE can be forwarded to futurists to obtain sound judgements on future developments that affect MNE operations. MNE can also conduct scenario exercises to portray future developments. MNE staffs involved in strategic analyses or business developments can participate in scenario exercises. The 2 by 2 matrix highlighting 2 attributes on each element (i.e economic, social, political and environmental issues) can be applied when conducting scenario exercises.

Results from the identification activities above can be employed as inputs for the projection activities. Based on the identified issues, MNE can project future outlooks that affect MNE operations. Uncertainties that may affect MNE operations can be derived by analyzing results gathered from the identification step. MNE can utilize literature reviews to analyze patterns from past histories and then combined with existing issues, MNE can project future developments based on similarities between data on past histories and identified trends/issues. Another way to project future developments is by using expert recommendations. Identified issues gathered by MNE can be forwarded to futurists to obtain sound judgements on future developments that affect MNE operations. MNE can also conduct scenario exercises to portray future developments. MNE staffs involved in strategic analyses or business developments can participate in scenario exercises. The 2 by 2 matrix highlighting 2 attributes on each element (i.e economic, social, political and environmental issues) can be applied when conducting scenario exercises.

Anticipating issues are a creative process. Results from projection activities are crucial to develop strategies and tactics for MNE to secure its operations in the host country. Anticipation should be followed with shaping activities where interactions with key individuals and organizations become essential in maintaining the MNE business. Anticipation requires measures to be taken. MNE should devise carefully its objectives, plans and actions prior to entering into the shaping step. Literature studies on international business particularly the ones which are related with government attitudes and policies towards MNEs must be taken into account. The inputs from projection activities must be well fitted into studies and reviews conducted by experts. Anticipating plans and strategies should reflect scenario writings exercised in the previous steps. In summary, results coming from previous steps must be incorporated in the anticipating steps. Some examples on anticipating issues are provided in Box 2.

Box 2. Anticipating activities

Once the anticipation activities have been formulated, MNE can start taking actions to implement these activities. The larger portion of shaping activities should be directed on interactions with stakeholders affecting MNE business operations. These include interactions with government officials, house representatives/policy makers and lobbyist group (i.e. NGO). The aim of the interaction should be targeted for obtaining prognosis while at the same time influencing these stakeholders to devise policies and actions that maintain the MNE interests. Interactions with stakeholders can also be conducted for obtaining information on the tracks/policies that will be developed by policy makers as well as those policies that will be promoted by lobbyist groups/NGOs to the policy makers. In such case, MNE will have the advantage of gaining information will further enrich inputs for the subsequent steps (i.e. projecting and anticipating steps).

The shaping step can also be done with proactive communications through various media channels. MNE can use newspapers to promote its social responsibility programs or expand its communication channels by applying electronic media for wider coverage. In addition, joining industry associations are very effective to secure the MNE operation particularly if other MNEs within the industry share similar concerns. MNE can use this channel to influence policy makers in devising policies in favour of the MNE.

References

Blomstrom, M., & Kokko, A. (1997). The Impact of Foreign Investment on Host Countries: A Review of the Empirical Evidence.

Dunning, J. (1997). Governments and the macro organization of economic activity: an historical and spatial perspective. Review of International Political Economy, 4(1), 42 - 86.

Krismantari, I. (2008, 29 March ). French Areva to invest $ 15 m for business expansion in Indonesia. Jakarta Post.

Big Contracts: On the Verge of (Government) Troubles - Elements of disputes between the host country and the MNE (Part 4)

Revisit from the previous parts

The previous parts of this paper discussed about the roles of the government in equating impacts of the MNE presence in the host country. The second part of this paper described the roles of the host government as the initiator, controller and the supervisor of the state as well as its roles as the owner of the state assets. The third part of the paper described the MNE position to the host economy and contributions given by the MNE to the host economy. Some instruments used by the MNE to preserve its presence were also delineated. In the fourth part of this paper, themes and causalities which are often disputed between the host government and the MNE will be described. To restrict the boundary of the discussion, a framework consisting of four themes: economic, social, political and environmental dimensions will be applied. We also restrict the discussion on big contracts such as those in the oil and gas concessions and those in mining operations. Although we can extend these themes with technology issues, we will leave this matter since we find that technology issues rarely lead to a dispute. Most often we find that technology issues are connected with state security issues on merger and acquisition cases.

The analysis framework on big contract issues

Economic/business issues

Economic and business issues are the most common themes contributing to the dispute between the MNE and the government. Multinational enterprises seeking for new markets beyond their home country will confront with the government interests for improving its economy. On big contracts, the government as the owner of the state tries to secure its revenues while at the same time allows local enterprises to participate on big energy contracts in order to provide them opportunities to progress, thus allowing more economic independencies in the future.

The economic/business issues cycle

Big contracts involving resource extractions are carried out to render profits both for MNE and the host country. Based on the capacity of the stored reserve and the estimated cost spent for development and production activities, the government and the MNE can project the profit return once a big contract undergoes into the production cycle. Cost estimated by both sides may have been different due to different techniques in calculating the reserve as well as different assumptions applied in estimating cost associated with development and production activities. Different interpretations, techniques and assumptions on costs spent for these activities often culminate in tensions leading to lengthy negotiation process. Some of the negotiation processes even end with contract terminations.

Once the projected financial return is on hand, the MNE uses its bargaining power to reduce development and production costs especially if the scheme is under the so called production contract scheme. The government also has its interests to speed up the development process in order to gain the return in shorter time. The government can use its role as the regulator to issue instruments favouring the MNE. Incentives, tax breaks and other fiscal instruments can be formulated to ensure the completion of the project and to guarantee the output within the projected target. The amount of incentives and tax breaks may be argued since it is the MNE interests to reduce the cost as much as possible while maintaining the projected financial return.

Economic uncertainties perhaps make large contribution to disputes between the MNE and the host government on big resource contracts. Financial crisis making either the government or the MNE halt development and production activities is not uncommon. To the MNE, investments that have been made and committed need to be returned. In contract such as the development of a power plant in which MNE is involved in development and production cycles and sells the power to the government, financial crisis often leads to the rearrangement of financial terms. On conditions in which the power price is subsidized, the government may have insufficient fund to purchase the agreeable price as a result of state deficits. The rise of energy prices can also stimulate the rearrangement of financial terms between the two parties. Both sides try to set assumptions that may disadvantage the other side.

Observations from most cases suggest that disputes on the economic and business issues are relatively moderate unless financial tumbles occur. However, as often seen in countries having abundant resources with political instabilities and changes, the strenuous dispute often stems from political dimensions.

Political issues

While the rationales on business and economic issues leading to the dispute between MNE and the host government are based on economic objectives, the dispute coming from political issues is rather complicated since the causalities behind them can be either hidden or directly identified. Unlike disputes on the other issues, disputes stemmed from political dimensions may often permeate into economic/business, environmental, social and even technological dimension.

It is noted that changes on political system create the most arduous disputes between the MNE and the government. The political system changes often bring new attitudes from the government in viewing the role of MNE to the state economy. New political structure often carries new ideology, hence restructure the way a state conducts its economic activities. Mainly in developing countries, new political system often leads to the restructuring of the economic and business institutions. The government as the controller, regulator and supervisor as well as the entity that represent the state assets will maximize these roles to recuperate the loss they believe coming from the previous economic regimes.

Political issues that affect MNE operation

Changes on the government and public representatives (e.g. parliament, house of representative) are somewhere between modest and moderate as long as they will not change the political system of the country. New government often promotes new ideas, develops new policies and establishes new institutions which may affect MNE operations in the long run. The establishment of the business competition supervisory agency in Indonesia can be taken as an example in which its presence gives effects to business practices in the telecommunication industry.

Changes on public representatives may also give impacts to the MNE operation. On the state system where the parliament is responsible for developing and formalizing bills and laws, rotations on parliament personnel may bring new dimensions to the business practices affecting the MNE operation. MNE must identify the majority composition in the parliament particularly when the parliamentary election is near. Changes on the parliament majority may lead to changes on laws and bills addressing business practices. It is often found that changes on the parliament as a result of the election bring disadvantage to the MNE particularly if the newly elected majority was the opposition of the old parliament regime.

The third factor that may lead to the dispute between MNE and the host government interests is the shift attitudes from public, government or the parliament. It is the factor that emanates from various dimensions. Pressures from international institutions or other countries may significantly change the host government attitude on MNE. On some occasions, diplomatic tensions may also suppress the MNE operation. Nationalization programs are promoted not because the host government intends to regain the benefit enjoyed by the MNE, but sometimes due to sentiment reactions to the country where the MNE comes from. On the local concern, sentiment reactions to the MNE emanate from local industries as they cannot compete with the MNEs. For some big energy contracts where MNE builds an exclusive complex for their operations in a remote region, social concerns are elevated to address social inequalities between people living in the MNE compound and their surroundings.

Social issues

Social and environmental issues commonly occur at local levels but these do not mean that the issues will elevate at the national level. On social issues, big contracts often create issues emanating from social discrepancies between MNE and local residents. When big contracts are orchestrated on undeveloped areas, a multinational enterprise often builds a complex for people working for the contract during the construction, development and production cycles. On the construction and development program, construction concretes and heavy machineries often introduce new perceptions for local residents. On these stages, local residents may find their areas are about to be invaded by a new world. Local residents are about to find that their social living will be distracted by the world of concretes and projects that create two different worlds. Their norms and cultures may be obstructed by new comer cultures. Consequently, rejections on the contract start to emerge during these phases.

Social issues on big contracts

When the contract progresses into production cycles, a multinational enterprise has settled its operations. The complex built for the contract is isolated from its surrounding. People living inside the complex are often equipped with facilities and luxuries unavailable in the local areas. Often, they do not assimilate with local residents because their activities are fully absorbed for the success of the project. Even for daily needs, such as foods, the complex has made an arrangement to cater the people in the complex with a designated catering service. These practices are not expected by local residents where they are used to interact to each other for daily needs. Often, these facilities stimulate envy attitudes to local residents. To make it worst, the isolated complex is well guarded creating a different space, different cultures and different worlds between activities inside the complex and activities outside the complex. Sometimes, the central government assists the multinational enterprise in securing the compound by sending troops to strengthen the security arsenal. Thus, instead of the conflict between the host government and the multinational enterprise, big contracts on remote areas create conflicts between the local government and the multinational enterprise.

At this stage, the suspicion alleged by the local resident during the construction and development cycles elevates. To local residents, the complex has created and introduced a culture that is alien to their daily practices. With isolated interactions between those living inside the complex and those living outside the complex, local residents feel that they are treated differently. Local residents feel that they are being offended not because of the activities of the contract but because the social living inside the complex is different from their norms and the people inside the complex has closed the door of interactions in which local residents are used to practice with each others.

Consequently social unrests evolve. It is not uncommon to find trespassing violations, rampant aggressions, stealing some of materials within the complex as well as vandalisms by local residents on facilities in the complex as well as to people living inside the complex. Therefore, a multinational enterprise must devise a strategy to cope with these issues to ensure their operation.

Environmental issues

Environmental issues relate in a great deal with the so called “externalities” in the economic studies. Externalities are impacts resulted from business activities carried out by the first party to the third party which does not have relationships to each other. Environmental issues are mostly found in the form of negative externalities in which the third party must bear the cost and impacts caused by activities carried out by the first party. At the local scale, externalities can be caused by air pollution emanated from MNE business operations. The act may create health problems to local residents and the cost born by the third party (local residents) is often uncovered by the first party.

Negative externalities in the form of waste pollutions can also occur when the contract involves material processing such as processing activities in the mining, petrochemical and refinery industries. Processing materials into higher added value products requires chemical materials that will be disposed once a cycle of process completes. These materials are often disposed to rivers and lands. In the short or long term, disposing toxic materials will bring ecological impacts to the surrounding areas. Toxic materials disposed to the river will bring health problems to local residents especially if the water on the river will be used for daily consumptions. Wasting or burying hazardous materials to the land can endanger the ecology of the local environment since disposed hazardous materials may contaminate the artesian water flowing under the ground and affect the habitats living within the area.

Disputes on environmental issues originate from externalities

Impacts in the long term can also originate from deforestation. Big contracts such as in the mining concessions often require land clearances where tropical forests reside. Although the clearances may not have direct impacts, ecological impacts are often detected in the incoming years. Deforestation affects climate changes and often contributes to global warming. Deforestation also reduces the soil ability to absorb the rainfall which in turn will create potential landslides not only within the contract area but also to its surroundings.

Disputes on environmental issues often start between local residents and a multinational enterprise. But as the dispute progresses and the environment impacts caused by MNE operations threaten the state environment, the host (central) government often interferes and uses its roles as the owner of the state asset to secure the state interests in preserving the national environment. While efforts offered by a multinational enterprise to substitute the cost of externalities may be worthwhile, it is often noted that the long term impacts of the MNE operation affecting the environment has only emerged in the incoming decades. Thus, the total cost born to the multinational enterprise may not equal to the impact it causes in the future.

Big Contracts: On the Verge of (Government) Troubles - Positioning multinational enterprise in the global economy (Part 3)

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 Venezuela forcing ExxonMobil to use arbitration mechanism exemplifies the case. Multinational enterprises can also seek justice through arbitration when they perceive their interests under jeopardy. Big contracts are often exposed to international arbitration settlements because of different perceptions and interests held by both the host government and a multinational enterprise. As an example, Newmont threatened to use arbitration in securing their interests in Indonesia as different perceptions over divestment processes between the company and the government occurred. The Karaha Bodas case perhaps represents one of the most elusive cases in Indonesia on the use of arbitration. The company charged the Indonesian government because its rights to develop a geothermal plant were postponed due to the Asian financial crisis. From most cases, it is noted that the stake of using arbitration is high as there is no guarantee that the process will be resolved quickly. Using arbitration to settle issues may pose some risks to the multinational enterprise. The multinational enterprise image will be exposed and the trust from other countries to grant investment rights to the MNE may lose. However, the reciprocal condition applies. The host country that persistently settles foreign investment issues through international arbitration may lose its attractiveness in luring foreign investors.

Big Contracts: On the Verge of (Government) Troubles - The state roles in the global economy (Part 2)

Revisit from the first part

The first part of this paper has identified the call for understanding the role of the state and the MNE as well as how these two entities interact in the global economy. Mainly with the tendency to impose regulations as a mechanism in maintaining the economic interests of the nation versus the flexibility to mobilize assets to more favourable options has been utilized by both sides in the search of optimum economic margins. Accordingly, in the second part of the paper, the roles of the government in equating globalization with the benefits a nation can gain from it will be discussed.

Before depicting the role of the government in the state economy, I will first discuss brief excerpts from Dunning (1997) paper explicating about the evolution of the government interventions on the state economy. Chiefly, changes on economic activities over time as a result of interdependencies among actors in the economic system have brought in the government engagement in the state economy to ensure the benefits of economic activities are distributed impartially both to the society and the economic actors.

Changes on economic coordination

On its early days, economic activities were modest in which the market was defined as a place where buyers and sellers met directly to exchange their needs. The transactions performed by these parties did not involve intermediaries. Economic actors were predominantly performed by individual merchants or family businesses. The production functions were confined to the use of labours, raw materials and the adoption of simple production methods. The economic actors functioned as the end to end producer carrying economic activities from extracting and processing materials to selling the end products. In this simple economic system, the price was determined by resources an economic actor(s) could access, efforts he (they) made to produce a good and his (their) demands over other goods. While competition occurred, during normal occasions, the overall transaction between buyers and sellers did not require an intervention from the government since the government intervention would create a distorted market which in turn brought more damages rather than benefits to the state economy.

As the production functions became specialized and sophisticated, coordination between economic actors became more complex. Economic actors no longer performed all production tasks which were necessary to produce goods, but left some of these tasks to other actors. To meet the surging demands, labours were specialized into a set of skills to speed up production outputs. Specializations also drove better product qualities as labours focused on less, but specific, tasks rather than performing different production routines.

Coordination among firms also stemmed from the evolving diverse specializations in providing production inputs. While prior to the specialization, firms used to source all production inputs alone, labour specialization concepts allowed firms to supply production inputs to other firms, allowing a firm to concentrate on its core businesses. This resulted in the reduction of production costs associated with material processing as well as in the increment of production rates to catch up demand. With more firms engaged in sourcing production inputs for other firms, processing technology became essential in the economic system.

Market imperfection caused by human quests in searching for efficiencies has also urged firms to expand opportunities beyond their home economies. Labour specialization as a result in questing maximum economic gains has called for market coordination where production inputs (raw materials, skills and technology), processing methods and production outputs could be independently operated by different actors. Labour specialization has also created new modes of transaction where intermediaries and distribution channels became important in connecting different economic actors. Such specialization reduced the dependencies on collocation between suppliers, producers, distributors and consumers. At the same time, interdependencies among economic actors could also lead to erratic market behaviours as demonstrated by monopoly and monopsony practices which affected the good prices. Firms were becoming tight to gain profit margins. Consequently, these resulted in two possibilities: firms searched other sources beyond their home economies and government interventions are needed to restore the economy for the benefit of all economic stakeholders in the nation.

With the quest for raising competitiveness, the economy becomes interconnected among firms and the boundary level of a state is becoming irrelevant. Market is no longer bounded to local jurisdictions but has been extended to regional and even global spheres. Firms are in their interests to find resources globally to gain their competitive advantages. They also look for new and emerging markets to maintain or improve their financial portfolios. Firms also look for new resources beyond their home economies both to gain cost advantages through competitive labour costs and improve production qualities through skilled resources. On other occasions, shortages in material supplies forces firms to look for locations offering abundant resources to ensure their production continuities. It is often noted that this quest is also accompanied with the search for lower material costs to keep the firm’s cost advantage. Parallel with these searches, technological seeking activities can opportune firms in raising production efficiencies, enhancing product qualities or even turning the landscape of the market with new innovative products. All these require new modes of coordination in the economic system not only among firms but also between firms and state authorities.

Perception of the governments on globalization

To the government, the firms’ quest to improve their competitive advantages is an opportunity to improve the state economy. Dormant endowments inherited by a country can be promoted for improving the state economy. While natural resources can be exploited and sold directly, the state has chances to lever the economy by opening access to investments that create higher added values. The measure not only drives the economy but also stimulates technology transfers leading to the improvement of human resource capabilities.

New investments sought by multi national firms also comprise of market seeking activities. Through setting up plants and production systems, multi national firms need suppliers to source their inputs. With opening up the country for foreign investments, the economy can be improved since multiplier effects resulted from the need of backward linkages will create a network of supply chains and distribution channels.

The government can also see the positive effect of globalization on the human resources. Multi national enterprise investments often bring new technology and skills unavailable in the local resources. The improvement of human resources can in turn bring benefits to local firms if labour mobility occurs. In addition, the exposure of multi national firms experienced by local resources can be utilized in gaining access to international markets.

For countries having advance technology, the opportunity to benefit from foreign investments lies on the chance to diversify the existing production systems. Local firms can discern technological changes brought by foreign investors. Diversifying into broader competencies also drives better resilience in confronting competition. Local firms can expand their competencies and capabilities which could lead into new creation of products and processing systems. Often such outcomes create a new form of industry. Thus, opening access to foreign investments for developed countries will sustain the national economy.

Despite those promising prospects in exposing the country to global markets, globalization widens the gap of market imperfections. Both the government and multi national enterprises seek for more economic margins through diffusing their economic activities in the global stage. At the same time, different interests held by both sides tend to create tensions on the economic sovereignty. While an ideal capitalist perspective suggests that a government should leave the market with its natural ‘survival of the fittest’ mechanism, in realities, the government as the owner of the state assets, through private and public channels, holds its own interests to maintain its assets intact while at the same time leverages these assets to achieve the maximum benefits for the nation.

The role of the government

The rationale of the government interventions on the state economy should be viewed from two perspectives. On the one side, the government acts as the regulator, controller and supervisor of a state. Its roles in defining and specifying the level of playing field for economic actors are aimed to provide the overall alignment on the economic system. On the other side, the government also functions as the owner of the state through its public and private channels. With this function, the government is responsible for securing its own assets for the benefit of the state.

The government role as the regulator, controller and supervisor of a state is aimed to create a harmonious system associated with economic activities. The system can be harmonious only when the institutional frameworks both in regulation, supervision as well as in coordination have been setup properly. As the initiator, the government caters the need of public and private interests by developing proper regulations. Through regulations we see bills and laws governing economic activities in the state. The government is also responsible for ensuring the implementation of such regulations by setting up institutions tasked to monitor the economic practices in the state. Accordingly, the government often needs an institution that coordinates economic policies between various institutions and actors and setups an institution that is responsible for ensuring the economic efficiency in the nation without scarifying private and public interests.

On the other side, the government functions as the guardian of public and private interests. The government must ensure that both its assets and the utilization of these assets must provide benefits to all economic actors in the state. On the public interests, the government ensures that policies associated with supply and demands and to some extend price mechanisms are feasible to protect wider interests while at the same time maintain the natural dynamic of the free market system. The government must ensure that public institutions as the government arm length associated with economic and social developments work without significant obstacles. When dealing with private institutions, the government, through policies, must ensure that private enterprises work in providing goods for the people while at the same time local capacities and capabilities are maintained and improved to enhance the national competitiveness.

While local enterprises can be seen as the government asset, it is not uncommon that in the global state, foreign investments are seen as an attractive option for a state to foster its economic growth. Not only these investments bring capital flows, but also they provide multiplier effect through knowledge transfer, fostering forward and backward linkages and providing market accesses. At the same time, as the owner of the state asset, the government is responsible for maintaining the state asset embedded in public and (local) private interests from the dominion of foreign interests.

Therefore, the government, as the state representative, plays roles in the economy through initiating and establishing overall legal frameworks and institutions where business operates. In doing so, the government uses different policies and interstate controls to govern the national interests (either conveyed by the parliament, demanded by public, internal government plans or from the business player needs) and to create the balance between interests held by local and foreign economic actors in order to achieve the objective of the state economy (often stated by achieving growth, reducing inflation, and increasing the workforce).

Big Contracts: On the Verge of (Government) Troubles - Introduction (Part I)

Introduction

Recent issues on high oil prices, sub prime mortgage and natural disasters have conditioned a perception where the global economy is on the brink of recessions. Countries are no longer optimist on their economies. Not even the IMF has a positive attitude on the world fate. On its 2008 global economic outlooks, the institution highlighted the world economic growth at 4.1% compared to the last year 4.9%. In the US alone, the economy does not seem to be in the favour of business and households. With the sub prime mortgage haunting most financial institutions, the more than $150 billion stimulus package does not help alleviating the economic decline at 1.5% growth rate. To make it worse, some of the top global financial institutions have conceded their shares to sovereign investment authorities. Citigroup as the largest financial institution hopes to get another fund from the Saudis even though the company has been injected with $ 7.5 billion of cash by the Abu Dhabi Investment group. Even GIC, the Singaporean sovereign wealth fund would bail out $ 6.9 billion, an amount of 4 percent stake of the group. UBS, the Switzerland giant financial institution also needs an amount of $9.75 billion to secure its financial portfolios. Likewise, Merrill Lynch and Morgan Stanley are in dire needs of cash to recover from their non performing loan nightmares.

Yet, these issues do not halt the world in searching energy supplies. In fact, even with tighter global economies, countries are trying hard to secure their energy needs, thanks to the surging energy demand from China, India and the United States.

To give a perspective, the OPEC output reaching 29.6 million barrel per day is insufficient to meet global demands. Not even George W. Bush can persuade this cartel to raise oil outputs. In the power sector, China has raised its power generation up to 14.4% at 3.26 billion megawatt hours in 2007. The country also increased its generating capacity by 114.36 % at 713.3 gigawatts. As a result, the vast need of coal has made the country a net coal importer in January 2007. Coal shortages also forced power plant operators in the country reduce some of their capacities.

Likewise, in Indonesia, the demand to secure energy supplies has been carried out through government initiatives to increase investments on oil explorations, power plants and gas block developments. However, things seem to be unfavourable for the time being.

In the oil sector, the decline of oil productions at 910,000 bpd has created worries on the state fiscal deficit. Although the recent hike on oil price appears to relieve the state fiscal revenue, the government has to bear energy subsidies for premium fuel and kerosene. However, with major oil companies in the nation have production declines due to their aging oil wells; the government target to produce 1.034 million bpd of oil in 2008 appears to be dimmed. Even with the incentive such as tax reduction and more contracts sharing percentage given to oil companies, analysts suggest that the 2008 target is far from achievable.

In the power plant development, the ministry of energy and mineral resource has targeted to produce additional 10,000 mW power by 2009. The initiative will be secured through developing 35 coal fired power plants both in and outside Java. However, recent developments on the contract negotiations suggest that only 3 contracts were secured. When counting from the total portfolio, the government is still $ 2.78 billion short from the total $4.8 billion needed to fund the projects. Financiers’ dubious attitude on the government intention to guarantee the project was initially deemed as the major reason slowing down the negotiation progress. Now, even when they have the government guarantee, the talk over the interest rate decelerates the prospect of securing the country’s dire need of electricity. To make it worse, on its 20 February 2008 edition, the Jakarta Post dispatched the message from the state electrical power officer on the possibility of power outage due to the shortened supply of coal used to generate the Jawa Bali power interconnection.

Moving into the gas concession, different perceptions over the gas pricing have made some of the contract extensions under jeopardy. Consider this, while in January 2008, the Indonesian ministry of energy and mineral resource confirmed that the negotiation of the Natuna gas block was about to be concluded with ExxonMobil as the operator, just within a month, Pertamina, the state oil company, was denoted to take over the concession.

With such attitude, we might wonder what is happening on big energy contracts. To answer the question, I will use the state and the MNE relational framework. Chiefly, I will address the role of the state and the role of the MNE in the global economy. Subsequently, I will discuss elements leading to differences and disputes between the state and the MNE. Finally, I will provide some recommendations for the MNE in dealing with a government over big energy contracts.

Multi National Enterprise and the state: profiting from economic changes – a personal note over the Natuna gas block agreement

As the soaring oil price becomes unpredictably high throughout 2007, energy users are looking for alternatives to avoid high production and consumption costs.

The stubbornly crude oil has been hovered above $ 90 in 2007 peaking at $ 99.29 on November 2007. Now, as the year turns to 2008, it appears that this trend steadily continues.

To the oil users such trend forces them to shift their attitudes on oil usages. Industries relying on oil for their production inputs face the imminent lost on their operational costs if the trend remains persistent.

Even PLN, the Indonesian power company, has accelerated its plans to develop new generation plants using mix energy sources combining gas and coal as its inputs. This is in line with the national energy policy targeting the reduction of oil usages for power generations down to 30 % by 2025.

So, from the oil and gas company perspectives, maintaining oil businesses for power generations, although yields large cash in the short term, may probably lead into business declines in the long term should the oil price incline.

The geopolitical condition in the Middle East is no longer favourable for producing oils. Political instabilities and social unrests are becoming daily consumption news. As countries in the Middle East are among the largest oil reserves, geopolitical instabilities drive uncertain futures in conditioning oil supplies at their ideal rates. Not to mention tensions in Nigeria, and the indifference Hugo Chavez over nationalizing oil companies in Venezuela.

Parallel to the nightmare, OPEC, the oil producer cartel, stubbornly keeps the production rate at its current output leaving the oil supply shortened.

It is not surprising that these have conditioned major oil companies to start revamping their business portfolios. In fact, companies such as BP and Shell have started diversifying their business portfolios for quite some time. History has it said that the success of Shell in becoming a major leading energy (instead of oil and gas) company lies on its strategic efforts in energy diversifications and widening its ‘radar’ over future global issues. The recent transformation of Chevron ‘Human Energy’ confirms that the energy future is no longer confined to fossil sources.

For these reasons two options have been sought for. Companies are diversifying either by selling variant hydrocarbon sources such as gas and coal or exploring renewable energy businesses.

While transitioning into a renewable energy company is considered to be more sustainable in the long run amid environmental issues, it is noticed that developing renewable energy businesses yields lower investment to revenue ratios, at least for the time being.

Likewise, turning into coal businesses requires adjustments in the organizational structure and core competencies. Oil companies may find it difficult to compete with incumbent coal producers as they are more adept in opening up field concessions, negotiating with relevant government representatives, finding suppliers and selling the outputs. Even with overlapping opportunities such as in developing Coal Bed Methane, companies putting interests on this new method has yet to acquire new capabilities and expect incentives from the government.

Thus, given the likelihood that gas would become the energy ‘diamond’ in the near future, capitalizing resources into gas extraction and production businesses is perhaps the realistic option confronted by oil and gas companies.

It is no surprise that ExxonMobil preferred to keep overseeing the Natuna gas block through negotiating for a contract extension.

At a glance, with more shares conceded to the Indonesian government in the new contract, it appears that ExxonMobil is declining its future profits.

Unlike the previous scheme, the company will not have the luxury over gaining a larger share. Furthermore, the state owned enterprise Pertamina will also take part in the contract share leaving the ExxonMobil share smaller.

Yet, one needs to recall that the reserve in the block is considered to be the largest in the Southeast Asian region. ExxonMobil can gain benefits from the contract by dealing over a longer term.

Not to mention that Malaysia, Thailand and Vietnam have given their interests to buy the gas from this block regardless the high price charged to recover the development cost. The Jakarta Post data suggest that while the market cost of gas per one million of British thermal unit (Btu) is around $ 9, the gas produced from the Natuna D-Alpha block would cost around $ 16 per million Btu.

This sets a win – win solution both for the MNE and the state. High oil price demanding the shift to alternative energy sources creates opportunities for ExxonMobil to gain profits from gas businesses over a significant time period while to the government of Indonesia bigger shares over the block will increase the state fiscal revenue.

The effects of foreign MNEs on host economies and governments roles in maximising the MNE presence to the host country competitiveness (Part III)

5. Conclusion

This essay has discussed contributions of MNE to the host country. Parallel to the discussion, government roles in sustaining competitiveness associated with the MNE presence was discussed. A conceptual model illustrating the roles of government in balancing these effects was also presented.

It is noted that debates around MNE contributions to the host country might never cease. Regardless of the debates, pressures confronted by governments to compete economically in the global stage are intensifying. At the same time, consolidations within the MNE operation are becoming common in literature studies. These dilemmas can opportune both sides. Specifically on the government side, issues in designing competitiveness policies need to be addressed.

The discussion above underlined some of the policies imposed by developing and new industrialising countries. In the reality, each policy characterises comparative advantages of the host country. Thus, policies discussed above may not represent the ones adopted in developed countries. In addition, policies for attracting MNE investments may have different approaches from those in maximising the MNE presence to stimulate competitiveness. Furthermore, the contextual settings amongst countries may require different policy instruments. Further explorations in customising policy regimes may contribute to substantial understandings in adjusting policy transfers associated with FDIs and competitiveness.

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