The political economy of cross-border transactions in FDI and trade in the new economy1, and its impact on the configuration of multinational enterprises’ (MNEs) decision-making structures with reference to headquarter-subsidiary mandates, has resulted in crucial changes in strategic thinking within MNEs. This carries serious consequences for the world economy in general and developing countries in particular.

The so-called ‘golden age of capitalism’, in which MNEs were made up of rigidly structured divisions locked into linkages with other parts of the same firm, has given way to a new international environment that is challenging from a policy perspective. With competitive pressures increasing relentlessly, the questions that MNEs ask are, first: where to locate productive assets and manufacturing activity in order to differentiate efficiently between locations and maximise the difference between manufacturing value-added and locational cost structures; and, secondly, how should the assets and activity be controlled (and co-ordinated)?

The locational decision concerns the relative merits of the cost and market-related advantages between different locations. The control decision concerns whether or not to own or to have an option on ownership through collaboration – for example, outsourcing, sub-contract, joint venture, strategic alliance with different firms.

Desire for flexibility

In the new economic environment, MNEs’ desire for flexibility militates against the rigid backward and forward vertical integration into input factors or into distribution that characterised the ‘golden age’. The more advantageous alternative is to sub-contract production and franchise sales, thereby distributing the associated risk profiles. The implications for developing countries are that their leaderships need to fully understand, and incorporate into their development policy and strategy, the dynamics of these two decisionsby MNEs.

The outcome of these two decisions by MNEs is manifest in the disintermediation and re-intermediation of the spatially distributed production networks and the internalisation of external markets by MNEs. With managerial utility being ever-increasingly emphasised, especially during the 1990s, divisional managers have incentives to want to have more degrees of freedom in which they can deal with economic agents external to their own firm.

The overall result of this dynamic is a complex strategic set that confronts decision-makers and managers in MNEs – and, by definition, policy-makers in developing countries who aspire to capture parts of the MNEs’ system of production and marketing.

Policy strategy

In the course of the four decades of development (notwithstanding the ‘fortune’ of the Vietnam War2, and the inflationary 1970s and early 1980s), policy-makers in south-east Asia have been arguably the best at understanding how exploitation of these dynamics can be built into economic development strategies.

In the new economy, about 80% of all e-commerce transactions is accounted for by B2B engagements over the internet and intranet. In other words, interactions between formal businesses are driving the content in, and the media of, e-commerce. This has profound implications for developing countries that wish to connect with the integrated international production and marketing services of MNEs, their networks of subsidiaries and the supply chains that link them to other firms. Among the most serious implications is that the perennial dichotomy between focusing on the global or the local in co-ordinating networks can be managed better on the worldwide web and/or the intranets of MNEs. For developing countries on the wrong side of the digital divide, the implications are enormous.

Open structure

Among the outcomes of this process of co-ordinating networks with reference to the MNEs’ operations under way in the world economy, the internal markets of MNEs tend to become more open. This leads to a loosening of the ties between divisions and their production capacities at adjacent stages of manufacturing. The effect is that MNEs become more like hubs in networks of interlocking collaborations.

The open internal markets of these networks result in more efficient signals of price and profit to which all players must competitively respond, including policy-makers in developing countries who proactively incentivise their industrial sectors. That is why the digital divide – in reality, a profound difference in capacity and use of information communications technologies (ICT) between the industrialised and the developing countries – is so crucial3. The lack of capacity and low skills debilitate the developing countries from exploiting the interstitial spaces of spatially distributed networks of the MNEs.

Such hub-centred networks retain torsional flexibility across a broad range of corporate functions, including industrial, and science and technology research and development (R&D). To a certain extent, the high-performance Asian economies (the ‘Tigers’) and the newly industrialising economies of Asia and Latin America testify to successes of diffusion of technology since the first development decade of the 1960s. Thus the range of countries able to innovate with confidence and competence has increased significantly. However, many developing countries have failed to exploit this development adequately with the result that there is not only a digital divide but also an innovation divide4.

New perspective

The new economic perspective for MNEs in managing the international operations of their FDI concentrates managerial attention on:

• the characteristics of volatility and uncertainty in markets;
• the value of options and flexibility in entry modes for FDI;
• alliances, collaborative and network forms of co-operation and competition;
• entrepreneurship within networks;
• managerial competence;
• and a corporate and organisational culture that is progressively more adaptable to the demands of change.

This set of valuable attributes that management in organisations engaged in international business must continuously develop distills into flexibility of operations. This is the ability to orchestrate the allocation, and re-allocation, of resources efficiently, smoothly and rapidly in anticipation of, and in response to, change. Implicit in this is the ability to locate (and capture) resources that may not be with the purview of the organisation smoothly and quickly in response to internal or customer demands. The greater the amplitude and frequency of change in the business environment, the greater this need for organisational and operational flexibility5. The challenge that developing countries face is that the increasing pace in liberalisation in FDI, trade, and capital and financial markets means that exogenous shocks travel through geo-economic spaces without the breaks that were once imposed by sovereign borders (each with a different set of rules and regulations) and at a pace that catches most policy-makers by surprise. Developing countries need to appreciate the examples of punctuated equilibria much more intensely if they are to emerge from the marginalisation that is confining them.

The result of the centre-periphery quality to the structure of MNEs and the fact that sources of innovation are no longer confined to MNEs’ headquarters is an increasing aversion to internal monopoly6. The underlying common factor to this dynamic is the acceptance among international managers, as they operationalise their FDI, that the boundaries of the firm are no longer well-defined and are far more virtual than real. The notion of arm’s length markets is less solid and firms merge with markets and markets merge with firms7.

This analysis raises the issue of accelerated dynamic market entry and exit as the strategic preference for MNEs. In the new volatility, FDI is revealed as a high-risk strategy – in the absence of location-specific compensating factors, such as a transparent and coherent business climate with both the ‘hard’ and ‘soft’ infrastructure to do business. However, developing countries would need to realise that FDI offers much better options for capturing information in comparison with other entry modes8. Although exporting and licensing confer more flexibility in anticipation of market decline, FDI confers more flexibility in anticipation of market growth.

What options are there for an even more flexible approach for MNEs? Kogut (1991) posits that international joint ventures may be the answer because they hold the value of options9. In terms of strategic superiority, on the one hand, an international joint venture in which the real option is never executed is probably inferior to a FDI that takes the form of a wholly-owned subsidiary. On the other hand, an international joint venture in which the option is exercised at the first opportunity does not last long (by definition)10.

FDI policy design

With respect to the interaction between markets that developing countries have to take into consideration when designing their FDI policies, from the MNEs’ perspective11, the cost-based competitiveness inherent in the economies of scale and rationalisation in networked global operations have to be weighed against the revenue-based competitiveness of local operations. This is due to the fact that, in the latter case, MNEs can differentiate products and services to such an extent as to extract maximum rents from their firm or ownership-specific advantages.

In much the same way, reflecting the flexibility inherent in spatially distributed production networks, the ‘hub’ and ‘spoke’ strategies that MNEs employ enable responsiveness to market decline by divesting distributional assets to local partners (exercising one of the options in joint venturing) while retaining production capacities with high appropriabilities12, the output of which can be diverted to other markets.

Globalisation represents a dynamic that is geared to different speeds depending on geography. The concern about marginalised developing countries is that their collective velocity is so retarded. They are in danger of being left behind in a world of their own that is essentially cut off from the industrialised countries and characterised by extremes of high risk, the uncertainties of the failed state and the inability to use either the language of modern business or the tools of communication in effective engagement with the rest of the world.

The electronic revolution has increased the co-ordination skills of MNEs. Thus, the intensification of the process under way – whereby the collation of data that, when given purpose, leads to information and which in turn, when given value through manipulations such as statistics, yields knowledge – is largely by-passing many developing countries. The information processing and co-ordination skills of MNEs give flexibility by improving forecasts and reducing the costs of change with respect to the location of international production. Developing countries have to begin cultivating the zeal for data and its purposeful exploitation and manipulation so that policy-makers can anticipate more accurately the moves and counter-moves of MNEs.

Difficult task

With respect to the co-ordinated networks in terms of outsourcing and related logistics, contract manufacturing (sub-contracting and original equipment manufacturing using formalities such as licensing and co-production) has been growing apace since the late 1980s and early 1990s as MNEs have sought to concentrate on upstream value-adding activities while shedding downstream routinised activities13. From the developing countries’ perspective, the issue is how to go about identifying the evolution of, and capturing the directions of change in, the sub- contracting networks of MNEs as they are configured and re-configured according to the relative differences in factor conditions and costs among countries and within regions. This difficult task is complicated by the fact that the sub-contracting networks of MNEs are also subject to intra-industry trade and FDI vectors.

Footnotes

1 The ‘new’ economy is taken as the technological revolution in information and communications and electronic commerce in the context of developments in the opening years of the new millennium.

2 The volume of resources poured into south-east Asia during the period for the ‘effort’ would need to be recalled.

3 Developing countries’ capacity is highly truncated. It is estimated that the total number of telephone lines in the 48 LDCs is less than 1% of the number of lines in North America and that Africa has about 1% of all the world’s telephone lines (and of these, South Africa has about half).

4 These reflect the asymmetries in FDI flows and technology flows.

5 This raises questions pertinent to ‘emergence’ — the study of complex adaptive human systems and businesses from the perspective of complexity science and philosophy — and coherence in strategy and operations of MNEs, of which developing countries need to be increasingly aware.

6 In the 1980s, the arguments for maintaining centralised R&D lost ground to those managers wanting to distribute these centres as services for internal (and in some cases of co-R&D joint ventures external) customers in competition with other providers (universities etc) in an attempt to diversify risk. There followed the delayering of middle management ranks.

7 According to UNCTAD (1995), 60-70% of all global trade is either within MNEs or between MNEs.

8 Anecdotal evidence from MNEs suggests that, in many cases, MNEs prefer to maintain a presence in a market even when there may be an economic argument to exit, for the advantage of being able to capture information and market intelligence.

9 The phenomenal growth in joint international business associations throughout the 1990s attests to this. In addition to mergers and acquisitions being responsible for most of FDI throughout the 1990s, according to The Economist (May 1999) between 1996 and 1998 more than 20,000 international strategic alliances (ISAs) were formed worldwide. The number of bio-technology ISAs for the leading pharmaceutical MNEs rose from 152 in the period 1988-1990 to 375 in the 1997-1998 period. The number of inter-firm technology and marketing agreements rose from 280 during 1980-1993 to 650 in 1996 alone.

10 This points to managers’ reluctance to enter international joint ventures, the instability of joint ventures (Pearce, 1997) and the pressing need for managers to enter international joint ventures.

11 See Simon London, ‘Corporations with hard and soft centres’, Financial Times, February 20, 2002, for the management levers used by global companies.

12 Due to monopolistic-oligopolistic advantages that are sourced, inter alia, from technological functions.

13 See ‘Factories for hire’, The Economist, February 12, 2000; and ‘Incredible shrinking plants’, The Economist, February 23, 2002, for a view of contract manufacturing growing at about 20% per year since the mid-to-late-1990s, with Asia and Mexico playing key roles and redefining, for example, the boundaries between automotive manufacturers and their suppliers through outsourced “flexible global manufacturing”.