Global Business: Past, Present and Future 1035308037, 9781035308033

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Global Business

Global Business Past, Present and Future

Mark Casson Professor of Economics and Director of the Centre for Institutions and Economic History, University of Reading, UK

in association with Peter J. Buckley, Geoffrey Jones, Yutong Li and Teresa da Silva Lopes

Cheltenham, UK • Northampton, MA, USA

© Mark Casson 2023 Cover image: NASA on Unsplash All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Control Number: 2023941872 This book is available electronically in the Business subject collection http://dx.doi.org/10.4337/9781035308040

EE VS P

ISBN 978 1 0353 0803 3 (cased) ISBN 978 1 0353 0804 0 (eBook)

Contents List of figuresvii List of tablesviii Acknowledgementsix Introduction to Global Business1 PART I

POLICY ISSUES FOR THE FUTURE

1

International business in an age of political turbulence

2

Crises in international business: a new perspective

27

3

International rivalry and global business leadership: an historical perspective

50

4

Multinational enterprises and international cartels: the strategic implications of de-globalisation With Peter J. Buckley

PART II

8

72

THE PRESENT AGENDA: INNOVATIONS IN RESEARCH METHODS

5

The internalisation theory of the multinational enterprise: past, present and future  With Peter J. Buckley

6

The theory of international business: the role of economic models 117

7

Complexity in international business: the implications for theory 145 With Yutong Li

8

The geometry of international business

v

94

166

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PART III PRESENT CHALLENGES: INTEGRATING STRATEGY AND MANAGEMENT 9

Decision making in international business With Peter J. Buckley

187

10

Extending internalisation theory: integrating international business strategy with international management

11

Organizational innovation in the multinational enterprise: internalization theory and business history  With Geoffrey Jones and Teresa da Silva Lopes

241

12

The making of global business in long-run perspective

275

13

The role of time in international business: an historical perspective298 With Teresa da Silva Lopes

209

Index330

Figures 6.1

Interaction of production, marketing and R&D: potential inter-modular linkages involving flows of intermediate products

130

6.2

Decision tree for solution of system optimisation

133

6.3

Factors in the industry environment

139

8.1

Projection of tetrahedron: ‘side view’ 

172

8.2

Projection of cube: ‘side view’ 

173

8.3

Projection of dodecahedron: ‘side view’ 

175

8.4

Examples of patterns 

177

10.1 Schematic representation of MNE structure showing the flow of product and technology

216

10.2 Schematic representation of MNE structure showing the flow of coordinating information

224

10.3 Schematic representation of MNE structure showing the role of national subsidiaries and finance

226

10.4 Schematic representation of MNE structure with a comprehensive view of management services

229

10.5 Key groups identified in Figure 10.4

230

11.1 Proposed extension of internalization theory

253

13.1 Schematic diagram illustrating the impact of the growth of scientific knowledge and the evolution of culture and institutions on the growth of international business and the impact of this growth on population and urbanisation

304

13.2 The seven key trends and the connections between them

321

vii

Tables 2.1

Classification of crises 

32

2.2

Three key groups of human agents in a crisis

33

4.1

Summary of cartel-related activities

76

6.1

Four key characteristics of the post-1945 period: a comparison of neoclassical and IB explanations

121

6.2

Three key questions addressed by early IB theory

121

6.3

The theory of vertical integration: potential coordination failures in an intermediate product market linking upstream and downstream production activities

126

6.4

Levels of analysis

140

9.1

Types of individual decision-making most commonly used in static and dynamic theories

201

10.1 Lengths of the internal linkages shown in Figure 10.4

232

11.1 A typology of roles commonly performed by expatriate entrepreneurs in the host country

256

11.2 Five patterns of headquarters design strategy

260

12.1 Typology of physical infrastructure

282

12.2 Markets and other matching mechanisms

286

12.3 Norms, standards and their enforcement

290

12.4 Institutions for knowledge discovery

291

viii

Acknowledgements The author and publisher wish to thank the authors and the following publishers who have kindly given permission for the use of copyright material. Cambridge University Press for: Peter J Buckley and Mark Casson (2021), ‘Multinational Enterprises and International Cartels: The Strategic Implications of De-Globalisation’, Management and Organization Review, 17 (5), 968–988. Elsevier Limited via the Copyright Clearance Center for: Mark Casson (2021), ‘International Business Policy in an Age of Political Turbulence’, Journal of World Business, 56 (6). Emerald Publishing Limited for: Mark Casson (2019), ‘The Impossibility of International Business’, in Van Tulder, Robert, Alan Verbeke and Barbara Jankowska (eds.) International Business in a VUCA world: The Changing Role of States and Firms: Progress in International Business Research, 14, 31–40. Mark Casson (2020), ‘International Rivalry and Global Business Leadership: An Historical Perspective’, Multinational Business Review, 28 (4), 429–446; Mark Casson (2021), ‘Crises in International Business: A New Perspective’, in Rob van Tulder; Alain Verbeke, Lucia Piscitello and Jonas Puck (eds.) International Business in Times of Crisis: Tribute Volume to Geoffrey Jones (European International Business Association: Progress in International Business Research), 16, 33–54. John Wiley & Sons Ltd via the Copyright Clearance Center’s RightsLink service for: Peter J. Buckley and Mark Casson (2019), ‘The Internationalization Theory of the Multinational Enterprise: Past, Present and Future’, British Journal of Management, 31 (2), 239–252; Mark Casson (2022), ‘Extending Internalisation Theory: Integrating International Business Strategy with International Management’, Global Strategy Journal, 12 (4), 632–657. MacMillan Education Limited via the Copyright Clearance Center for: Mark Casson (2018), ‘The theory of International Business: The Role of Economic Models’, Management International Review, 58 (3), 363–387; Peter J. Buckley and Mark Casson (2019), ‘Decision-Making in International Business’, Journal of International Business Studies, 50 (8), 1424–1439; Mark Casson, ix

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Geoffrey Jones and Teresa da Silva Lopes (2019), ‘Organizational Innovation in the Multinational Enterprise: Internalization Theory and Business History’, Journal of International Business Studies, 50 (8), 1338–1358. Springer Nature via the Copyright Clearance Center for: Mark Casson and Li Yutong (2022), ‘Complexity in International Business: The Implications for Theory’, Journal of International Business Studies, 53, 2037–2049. Taylor and Francis Group for: Mark Casson (2020), ‘The Making of Global Business in Long-Run Perspective’, in Lopes, Teresa da Silva, Christina Lubinski and Heidi Tworek (eds.) The Routledge Companion to the Makers of Global Business, 34–54. Every effort has been made to trace all the copyright holders but if any have been inadvertently overlooked the publishers will be pleased to make the necessary arrangement at the first opportunity.

Introduction to Global Business INTERNATIONAL BUSINESS: THE BIGGER PICTURE This book summarizes my research into global business issues over past five years, carried out in collaboration with my long-standing friend Peter Buckley, my former colleague Geoffrey Jones, and my former doctoral students Yutong Li and Teresa da Silva Lopes. The basic theme of the book is the importance of studying international business and multinational enterprise as part of a bigger picture. This ‘bigger picture’ has two main dimensions: space and time.

THE SPATIAL DIMENSION The importance of the spatial dimension can be illustrated by a metaphor. In the 1960s and 1970s international business was studied mostly from the perspective of the boardroom of a large US corporation on the top floor of a skyscraper. The CEO looked about over the horizon to foreign parts, where strange languages were spoken and unfamiliar business practices prevailed. Even today, the ‘costs of doing business abroad’ and the associated ‘liability of foreignness’ are prominent themes in the international business literature. A twenty-first century perspective should focus instead on a view of Planet Earth from outer-space. From this perspective, business is conducted on the surface of a globe or sphere. Commercial activity agglomerates at strategic locations – e.g. bridging points on major rivers. These strategic locations are connected by transport and communications networks, including overland networks (roads, railways), sea-borne networks (shipping lanes) air-borne networks (flight paths) and networks above the atmosphere (satellite telecommunications). The best way of viewing international business activity is not from the top of a skyscraper but from a satellite orbiting the Earth. The ‘satellite view’ will reveal that most economic activity takes place on the surface of the globe, where 34 per cent of the surface is land, and the rest is sea. Some activity takes place below the surface, however (e.g. mining), and some above (air travel, satellite communications). The sea provides fish, and the gravitational pull of the moon provides wave power, whilst rivers and oceans provide shipping arteries. But land is the main location of housing, industrial activity, and urban amenities. Some land is at high altitude, however, 1

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and is suitable mainly for recreation, but little else, while much is desert. It is low-lying land on coastal plains with fertile soils that has the greatest economic value; this accounts for less than ten per cent of the earth’s surface, and is steadily diminishing due to coastal erosion and desertification caused by global warming. Competition to appropriate this valuable land has generated conflict in the past, and continues to do so today, and could become worse if population continues to expand. Territories are appropriated by nations who then arm themselves to defend their rights. But land may previously have been in the hands of other nations (e.g. neighbours or imperialists), who may at any time wish to reclaim it. This creates international tensions, and strengthens a popular sense of national identity, which can impede international trade and investment and the free flow of ideas. Different parts of the world have different climates, with the northern hemisphere being warm at times when the southern hemisphere is cold, and vice versa; this is due to the earth’s axis of rotation being at an angle with respect its annual orbit around the sun. The seasonality of agriculture, combined with the differing quality spoils, caused by differences in underlying types of rock, means that different crops grow at different times and in different parts of the world. Local access to minerals differs too, with countries lying on fault lines being particularly rich in important metal ores. These geographical differences create enormous potential gains from long distance trade. There is a problem in reconciling the potential gains from trade with the claims of national sovereignty. The defence of a nation cannot be guaranteed in a country that is heavily dependent on supplies imported from potentially hostile countries. History suggests that trade flourishes when one country is dominant and can maintain a world order suited to its needs. In the nineteenth century the British navy controlled the seas, and so the British Empire dominated international trade. After two World Wars the US emerged in 1945 as the new world power, but today its dominance is challenged by China and its allies such as Russia. The rapid growth of international business activity after the Second World War was driven by a US vision of national democracies with open borders, and US led-international institutions that would promote peace. International commerce would boom and the isolationism and protectionism of the inter-war years would be dispelled. This post-war era of sustained ‘globalisation’ was the heyday of the multinational enterprise, as theorised by IB scholars of the time. Ironically, had this process progressed to its logical conclusion, namely a federal world government – international business would have been effectively eliminated as there would have been no national borders. Studies of ‘international trade’ would become studies of inter-regional trade, rather like

Introduction

3

inter-state trade within the US today. Some cultural differences would have remained, of course, but overall the ‘liability of foreignness’ and the ‘costs of doing business abroad’ would have become negligible. ‘Liability of foreignness may be a feature of international business, but it is not inevitably a feature of global business.

THE TIME DIMENSION The role of time has created confusion of a different type. Until the mid-nineteenth century most firms engaged in international trading activity were partnerships between traders in different countries, often related by family or other social connections. The modern corporation, involving shareholders, professional managers and boards of directors, developed only later as a result of changes in commercial law, which in turn were stimulated by industrialization. The main exceptions were the chartered trading companies which emerged as instruments of imperialism in the seventeenth and eighteenth centuries. Failure to recognise the role of unincorporated business partnerships has led to the misleading inference that the origins of multinational enterprise lie in the nineteenth century rather than much earlier. There is much to be learned from the study of these earlier periods, but, until recently, the subject has been largely ignored by the international business profession. Technological change is a long-term phenomenon which has been a great driver of globalisation. In the 19th century it enabled the expansion of railway networks and the growth of steam navigation, in the 20th it provided the motor transport, radio, television, oil and chemical industries (to name but a few). The predominance of multinationals in high-technology industries was a notable feature of the early post-1945 period, and early economic theories of the multinational enterprise set out specifically to explain this phenomenon. The 21st century has delivered satellite communications and high-speed internet. Today many service industries, from retailing to social media to health care, embody sophisticated technology too. They too have become multinational through the development of global brands. Despite all these changes, some things do not seem to change over time. Two factors deserve particular mention: political rivalry and economic inequality. As notable above, the evolving networks of commercial links developed through globalisation have been constantly threatened by war and conflict. Many of these conflicts have been instigated and led by populist political leaders. A common claim advanced, in various forms, by political leaders is that as trade has expanded, and the impact of globalisation has spread, the economic gains have been appropriated by particular countries (e.g. ‘imperialists’) or particular groups within countries (e.g. ‘capitalists’). Populists portray

4

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themselves as fighting for the interests of the oppressed (or the interests of the ‘losers’, as the winners may describe them). In the 1950s and 1960s many developing countries gained independent from colonising countries, notably Britain and other European powers. Some Latin American countries also fought to free themselves from the ‘informal imperialism’ of the US. It is therefore somewhat ironic that in the 21st century it has often been the citizens of these same powerful countries who have been rebelling against trade and globalisation, and demanding protection from import competition and freedom from regulations imposed by international treaties. In most modern economies there have many ‘losers’, e.g. the long-term unemployed in declining industries, and relatively few winners (the super-rich business elite). In democratic countries that were previously regarded as very stable this has brought to power populist leaders with extreme opinions, whose policies have often been misguided, and have aggravated the very economic problems that they claimed to solve. International businesses scholars have, by and large, tended to side with the rich and powerful, and argue that the world as a whole has become better off as a result of globalisation, even though the benefits may have been unequally distributed. They have, however, tended to avoid public criticism of populist leaders. They have also been rather naïve in the way they have examined the issue. Firstly, they have tended to confuse different aspects of inequality and, secondly, they have ascribed economic inequality to differences in productivity, and ignored other potential drivers of inequality, such as the systematic exploitation of loopholes in the laws that govern the business system. Three kinds of inequality are important in international business, but the international business literature does not always distinguish clearly between them. The literature on international business policy has traditionally focused on inequality of incomes between nations, and the relations between rich and poor (developed and developing) countries. The literature on international business strategy has typically focused on inequalities in size and profitability between firms, and in particular on the relations between large multinationals and smaller domestic firms. Until recently, little was said about the impact on international business on the distribution of income within countries. International business scholars often championed globalisation because foreign direct investment reduced inequalities between rich and poor nations, but overlooked the fact that the offshoring of production away from headquarters countries tended to increase income inequality within the headquarters country. The failure to distinguish between different forms of inequality has led to confusion in the academic literature and has distorted political policy-making. The other issue that has been overlooked is the exploitation of legal loopholes to redistribute income from poorer people to wealthy shareholders. The practice of transfer pricing by multinational enterprises was studied

Introduction

5

intensively in the 1970s, when exports from developing countries were often systematically under-priced by multinationals so that ad valorem tariffs payments imposed on imports into developed countries could be minimised. This reduced the tariff payments paid to the developed country government, and also reduced the taxable profit of the subsidiary that was paid to the developing country government. As trade was liberalised, the tariff savings effected by transfer pricing diminished, but as many developed countries levied high tax rates on corporate income, the tax savings from mis-pricing exports from developing countries remained. Multinationals then discovered that they could save even more tax by billing foreign subsidiaries in high-tax countries for services allegedly supplied from a subsidiary based in a tax haven. In addition, foreign subsidiaries in high-tax countries could be burdened with debt that was not used to fund local investment but which was promptly loaned back at a lower rate of interest to the parent company, or another of its subsidiaries. The net result was a reduction in the multinational’s corporate tax liabilities in both developed and developing countries. These manipulations of internal transactions reduced government income from corporate taxation that was available for funding local infrastructure, alleviating poverty, which was particularly serious for the governments of developing countries. Other legal loopholes were provided by employment legislation. To avoid their responsibilities to their workers, multinationals have sometimes terminated the employment of their workers and re-engaged them as independent sub-contractors, thereby reducing job security and avoiding employers’ contributions to an occupational pension scheme. Finally, multinationals could bribe local politicians, or offer them donations to their party’s funds, in exchange for ignoring their infringements of local planning laws, their violations of environmental protection legislation, and other misdemeanours. Overall, the international business literature has generally assumed that multinationals pursue profit through improvements in product design and technology, and the global reach of their distribution systems. If firms compete against each other according to these rules, product quality will be improved, price will be driven down close to the cost of production, employees will receive a competitive wage and shareholders will receive a dividend that reflects the business risks involved. The literature has played down (though not entirely ignored) competition to avoid the law, by discovering and exploiting legal loopholes to the full. Competing on design and technology involves a race to the top, but competing to discover legal loopholes involves a race to the bottom. By undermining job rights it damages the interests of employees, and by undermining tax receipts it reduces sustainable public expenditure and damages society as a whole.

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CONCLUSION The preceding discussion suggests that the international business system, comprising multinational firms, their employees, the customers they serve, and the national governments that tax and regulate them, cannot be fully analysed by simply ‘internationalising’ a single discipline such as economics, politics or sociology. International business is best analysed through a social science perspective, in which insights from different disciplines are combined. But achieving a synthesis of this kind is a difficult task. It involves nothing less that creating a unified social science – a project advanced in the mid-twentieth century, but never fully completed. Nothing else can provide a framework in which all the different aspects of international business can be studied in a logically coherent way. This book does not claim to provide a synthesis of this kind, but it does, at least, attempt to set out some of the key analytical concepts that such a unified approach will require. A unified approach based on an inter-disciplinary synthesis will provide a better understanding of the interplay of changes over time and differences of place within the international business system. It is a long-term project, and a challenging one, but there is no realistic alternative to it.

PART I

Policy issues for the future

1. International business in an age of political turbulence 1 INTRODUCTION There have been four years of turbulence in international relations since the Brexit vote of 23 June 2016 and the Trump inauguration of 20 January 2017. During this period international business (IB) scholars have debated the economic implications of both events (Rodrik, 2018; Mudambi, 2018). The thrust of the debate has been that disaffected voters in both countries have genuine grievances, but that globalisation in general, and off-shoring in particular, are not entirely to blame; automation, the digital revolution and the rise of China have all played a significant role. Those on one side of the debate have claimed that ‘the system is broken’ and that radical change is required. Power must be confiscated from the liberal elite, who have done little to help ordinary people. Party politics is the means to power in a democracy; the ‘ends’ are so important that they justify any means of seizing power. Those on the other side of the debate, however, argue that while mistakes have certainly been made, the system of governance remains sound, and can deliver solutions in the medium term. Radical changes to the political system will only delay and impede the adoption of sensible policies. This chapter argues that IB scholars have made little impact on this debate, compared to economists, political scientists and popular journalists, because they have been unwilling, or unable, to engage with the wider issues. IB, it is argued, should not be regarded as merely a branch of business and management studies devoted to international activities, but rather as a key component of an integrated social science. The subject of study should not be narrowed down to the operations of multinational firms (MNEs) and a few related issues, but instead expanded to encompass the operations of the global business system as a whole. The activities of MNEs are a subset of the activities of the global economy. Economists have recognised this, and relate their analysis of MNEs to wider global issues. Similarly the interaction of MNEs with governments is not just a local matter, specific to individual countries, but a matter of global concern. Political scientists and researchers in development studies have long been 8

International business in an age of political turbulence

9

aware of this. It is the views of economists and political scientists which tend to be cited as expert opinion in debates involving international business issues at the United Nations and elsewhere (e.g. Stiglitz, 2017). The annual UNCTAD World Investment Report, with its emphasis on relations between developed and developing countries, continues to highlight the mediating role of foreign direct investment (FDI) in global political economy as a whole. These annual reports rely heavily on IB research, but their conclusions and policy recommendations are informed by consultations with diplomats and commentators in a wide range of countries. For too long IB scholars have cultivated an ‘inside out’ approach to IB studies, in which global issues are viewed through the lenses of the chair-persons and boards of MNEs. Economists, political scientists and scholars in other social sciences disciplines, however, have embraced an ‘outside in’ approach in which MNEs are studied from the outset within a wider global perspective, familiar to politicians and other influential policy-makers. This chapter suggests that the ‘outside in’ approach provides the best framework in which to analyse controversial issues such as the costs and benefits of Brexit and the legacy of the Trump regime. It indicates what an ‘outside in’ approach might be like. It presents a ‘big picture’ view in which the traditional focus of the IB literature is just one element of a wider perspective. The main element is an integrated social science perspective, as described below. The place of IB activity within recent political debate is used as a case study. Such debates provide a useful context in which this alternative approach can be set out. By contrast, the established view appears to be that IB studies should remain a specialised area focused on the strategies and structures of MNEs; it should not venture into wider areas in which IB scholars have limited competence. Topics in these areas should be left to specialists in other disciplines. However, IB studies has been willing to embrace debates on other potentially controversial issues such as the environmental crisis, global inequality, and corporate tax avoidance. The explanation seems to be that in these other areas there is a safe and respectable policy position that IB scholars can adopt; namely, that climate change is a real phenomenon; that inequality between the richest and the poorest countries is sustained; and that tax avoidance distorts the allocation of resources and deprives government of revenue for essential social services. The study of populism, however, has no comfortable agreed position. Between these two extreme views of the scope of IB lies an intermediate view, namely that IB studies should encompass some of these wider issues but not others. Populism is a ‘danger area’, it may be said, because opinion remains divided over the issue and is likely to remain so for some considerable time. IB scholars may have strong personal views that could contaminate their analysis, and this could import party-political bias into the discipline. Populism

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therefore makes a useful test case; if IB studies can successfully analyse the influence of populism on IB policy then it can surely embrace a wider range of other less controversial topics too. This does not mean that IB scholars need to study all forms of populism. Many populist issues have little direct bearing on IB. In the inter-war period, for example, there was a great debate over the relative merits of capitalism and socialism, but this had limited implications for IB because there was little multinational activity at the time. By contrast, the Brexit movement has directly impinged on international trade and investment between the UK and Europe and, by implication, between the UK and the rest of the world, whilst Trump’s approach to immigration and to trade relations with China has generated knock-on effects for the entire world economy. IB scholars need to embrace the analysis of populism whenever populist movements impinge on IB activity, but can analyse other aspects of populism as they wish. The remainder of this chapter is in two parts. The first part, comprising sections 2–5, presents a case study analysis of populism, designed to explore the place of populism within IB studies as a whole. Populism is defined in a precise and non-pejorative way; namely as a social or political movement that provides a simple but unproven solution to a genuine but complex economic and social problem. This definition concedes that the problem that populists addresses is real, but leaves the validity of their solution open to doubt. It questions the integrity of making a complex problem appear simple, without condemning the practice outright. Section 2 sets out five paradoxes in the study of contemporary populism. Section 3 examines the practice of populist leadership; it identifies the key strategies pursued by populists; it also examines the personal qualities that equip successful populists to perform their role. Section 4 assesses the performance of populist leaders, and identifies their most common causes of failure. Many political leaders, whether populist or not, ultimately fail, but populists often fail in a dramatic way. Section 5 summaries the results of the case study; it argues that, despite its failures, populism will continually reinvent itself so long as inequalities persist in one form or another, and underprivileged groups see populist leaders as their only hope. The second part of the chapter reflects on the implications of the case study for IB studies as a whole. Section 6 argues that policy decisions by governments, and the influence of lobbyists and populist movements on these policies, need to be endogenized within a wider IB theory. Section 7 identifies four key advantages of this approach. Section 8 reviews previous attempts at an integrated social scientific approach to global issues, and puts the challenges into historical perspective. Section 9 summarises the conclusions.

International business in an age of political turbulence

2

11

THE PERCEIVED ANOMALIES OF CONTEMPORARY POPULISM

This section sets out five main paradoxes that underlie the Trump and Brexit debates; each paradox is stated as a question, and a provisional answer is suggested. Question 2.1. Living standards today are high by historical norms, yet popular discontent in developed countries is more widespread than at any time since the 1930s. In the US, for example, the economy has been growing steadily, yet discontent has been growing too. Why? Answer. Happiness, or satisfaction with life, depends on relative rather than absolute standards of living (Frey and Stutzer, 2002). It is assessed relative to expectations, and relative to comparable social groups. Recent discontent is mainly a consequence of (1) unrealistic expectations of sustained economic growth created by post-war political leaders and (2) a sense of unfairness and injustice, reflecting the growing inequality of incomes within some major industrialised countries. Several long-term factors have depressed wage incomes in traditional industries: the impact of automation and the digital revolution, the off-shoring of production, and the impact of measures needed to combat climate change (Alvarado, Chancel, Piketty, Saez and Zucman, 2018). The legacy of the Global Banking Crisis of 2009 depressed investment too. Question 2.2. The globalisation of trade has benefitted wealthy countries specialising in technological innovation, low-income countries exporting offshore production, and everyone who consumes cheap high-technology products. Yet reversing globalisation is seen by many people as part of the solution to current problems. Why? Answer. The benefits of globalisation (e.g. cheaper products) are widespread but the costs of globalisation (e.g. loss of jobs) are concentrated in traditional manufacturing districts (McCann, 2017; Mudambi, 2018). The question asked by people in declining districts is ‘What has globalisation ever done for me?’ (Asatryan, Braun, Holger, Heinemann, Molana and Montagna, 2014). When jobs were off-shored, factories closed (Autor, Dorn, Hanson and Majlesi, 2016). They were the lifeblood of small communities. The owners walked away, and the managers left town, and so there was no money to maintain the public services. Unemployed workers waited for their old jobs to return, because they were unwilling to reduce their status by accepting menial work (Blyth, 2016, Gidron and Hall, 2017, 2020). Consumer goods may have become cheaper as a result, but the unemployed could not afford them. The shareholders benefitted, it could be alleged, partly because the costs of closure were borne by the community.

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Question 2.3. Paid employment is increasingly stressful, recruitment is highly competitive, many jobs are part-time, and tenure is insecure. The ‘jobs for life’ once held by older people are now a thing of the past. Yet much of the discontent in modern societies seems to come, not from the young, but from older people who enjoyed the privilege of a job for life (Oesch, 2008). Answer. Young people do not share the disappointed expectations of the older generation because they have never known anything better. Young people compare themselves with other young people, and few of them know anything other than insecurity. Older people, on the other hand, recall the optimism of the early post-war years, which fostered a sense of local community, which has now been lost (Blau, 1960). Question 2.4. Citizens of leading countries continue to extol the virtues of openness and toleration whilst showing increasing intolerance towards immigrants. How can these attitudes be reconciled? Answer. Low-skilled migrants tend to agglomerate in declining industrial areas with cheap high-density housing, which facilitates multiple occupancy. They may fail to assimilate due to linguistic or cultural constraints. The indigenous population perceives a threat to their traditional culture, and resents the increased labour-market competition (Ketelas, 2003). On the other hand, highly-skilled immigrants readily assimilate. The political elite socialises with a small and select group of highly-skilled immigrants, who are unrepresentative of unskilled immigrants living in poorer areas. Attitudes become polarised: the elite perceives the benefits of immigration and ordinary people perceive the costs. It is easy for the elite to tolerate problems that do not affect them, but this toleration looks like weakness and indifference to ordinary people. Question 2.5. Why did the public blame the experts? Participation in higher education is increasing globally, yet in several wealthy countries popular respect for experts and intellectuals has declined. How is this explained? Answer. The issue looks different when viewed from below. The growing population of young professionals means that there is now a much larger ‘educated elite’ whose conspicuous consumption is resented by less-well-educated people. Advancement in education is governed by a process of assessment in which the least successful fail and are progressively weeded out. When relatively few succeeded, the stigma of failure was mitigated by the fact that failure was the norm. As the success rate has increased, so has the stigma of failure. The highly-educated expert is therefore a natural target of resentment. Exercising the right to vote for a populist party is a good way in which ‘to call the experts’ bluff.’

International business in an age of political turbulence

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13

THE PRACTICE OF POPULIST LEADERSHIP

Question 3.1. How do populist leaders emerge, and why are they so divisive? Answer. A populist leader typically establishes or takes over a campaigning party that presents a simple message to a susceptible group (Moffit, 2016, 2020; Muller, 2016). There have been many studies of populist leaders; in particular, biographies of notorious politicians who wreaked havoc on their countries, e.g. Adolf Hitler, Joseph Stalin, Benito Mussolini, Pol Pot, and Mao Tse-tung. More ‘moderate’ populists include Robert Mugabe, Joseph McCarthy, Vladimir Putin, Rodrigo Duterte, Viktor Orban, Silvio Burlesconi and Benjamin Netanyahu (Kyle and Gultchin, 2018; Devinney and Hartwell, 2019). It is perhaps unfortunate, however, that so much of the biographical literature on populist leaders is written by journalists and historians who appear to lack sympathy for the causes that their subjects espoused. The politicians linked to the Brexit or Trump movements definitely qualify as moderates. They have, however, been criticised in the liberal press for mocking their political opponents, levelling unfounded accusations against foreign leaders, and suppressing scrutiny and debate of their policies on the grounds that there is an urgent need ‘to get things done’. Question 3.2. What are the basic skills of a populist leader? Answer. The key skill of the populist leader lies in recognising what has gone wrong in society, identifying a cause and providing a simple solution (Moffit, 2016, 2020). The populist identifies some critical problem which dwarfs all other problems; it has a single cause, which the populist identifies; and a single solution, which only the populist can deliver (Guiso, Herrera, Morelli and Sonno, 2017). This solution is expressed as a slogan e.g. ‘take back control’ in the UK and ‘make America great again’ in the US (UK Government, 2020; Restad, 2020). Historical knowledge is useful to a populist; it may suggest a precedent from the nation’s past. Most nations have had a ‘golden age’ in which they were powerful and progressive. By returning to the golden age, a leader may suggest, the nation can ‘get back on track’ and overtake its rivals. Classical Rome is a wonderful source of inspiration: give the public ‘bread and circuses’ and they will be loyal (Ratcliffe, 2014). The leader’s ‘facts’ may be selective, though; their gift is to make the evidence fit their interpretation, rather than the other way round. Populists can also learn from studying the careers of earlier populists: many populists appear to have been ardent students of political history.

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Question 3.3. Why would an able person want to become a populist leader? Answer. A leader may believe in their cause, and its success may bring them to power. Alternatively, they may believe only in themselves, and seek out a cause that will deliver them power. The first type of leader may well become popular, but it is the second type that is usually accused of ‘populism’, because they place their personal popularity ahead of their cause (Muller, 2016). This is reflected in the kind of legacy they like to leave: monumental public buildings, industrial mega-projects and statues of themselves. Such leaders are often concerned that their legacy may be diminished by a reversal of their policies and so they are reluctant to relinquish power (Algan, Papaioannou and Passari, 2017). Question 3.4. How can a well-connected populist leader drawn from the elite possibly appeal to a large number of under-privileged followers? Answer. The followers of a populist leader will recognise that they do not have the qualities required to lead a major campaign. They have inadequate funding, few contacts in the media, and lack the professional skills to organise a campaign. A leader needs to be smart enough to identify the core of the problem, to devise a plausible solution, and to outwit the opposition they will face. A renegade member of the establishment is ideal for this purpose. Question 3.5. Why are populist narratives often so emotionally charged? Answer. In primitive religions catastrophic events are ascribed to evil spirits that cause them to happen. In the modern industrial world, the forces that oppress the under-privileged are generated by a complex global system, but for the populist the principle remains the same: behind the complex system lies a single source of evil, such as a hostile nation (e.g. China, Russia) or a powerful institution (e.g. the European Union, the United Nations or the ‘big banks’). This hostile force may have sympathisers: an ‘enemy within’ which the populist can identify and root out. The populist’s political rivals are an obvious target. In Western democracies foreign military powers have normally been identified as ‘enemies without’, while big business, banks, trades unions, ethnic minorities and ‘experts’, have all, from to time, been identified as ‘enemies within’. In the US the present threat from China parallels a previous threat from the Soviet Union at the time of the Space Race and the Cold War; this external threat was linked, according to Senator McCarthy, to an internal threat from radical intellectuals linked to the Democratic party (Reeves, 1973). In the UK the threat to British sovereignty posed by EU regulations parallels the military threat from Germany before World War II. This military threat created an internal threat that led to the internment of German ex-patriates

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during both world wars (Bird, 1981). The threat from the EU has been linked to an internal conspiracy involving ‘remainers’ in parliament, business and the judiciary. Not every threat identified by populists has originated from a hostile foreign power, however. For example, the Gilded Age in the US witnessed populist movements based on agrarian revolts against the banking system, while inter-war Britain witnessed militant general strikes organised against the capitalist system (Dent, 2020; Rove, 2016). Question 3.6. Why do populists target their messages at the under-privileged rather than the middle classes? Answer. If the privileged have a problem they are likely to be able to sort it out for themselves, as they have the wealth and influence to do so. The under-privileged do not – they are dependent on outside support. But the under-privileged may have little training in critical thinking, and fail to recognise the extent to which their populist leader is pursuing their own agenda. Conspiracy theories may appeal to them; if they have experienced a succession of unexpected set-backs in their lives then an evil force may provide a plausible explanation. Conspiracy theories regarding the economy are nothing new (Magnusson, 1994). Mercantilist economic theory alleged that foreign countries promoted imports in order to appropriate a nation’s stock of gold. Foreign countries have often been accused of buying up the national debt of rival economic powers and dumping it later to destabilise their currency. Accusations of ‘industrial warfare’ are also common, e.g. Chinese acquisition of US technologies, and Russian cyber-attacks. In fact, some conspiracy theories have been shown to contain a significant element of truth (Casson, 2020). Question 3.7. Is populist emotion genuine or fake? Answer. The speeches made by populist leaders often contain considerable animosity towards their rivals. This can be pure expediency, but it often seems to be genuine too. Populist leaders are sometimes vain, and may turn against friends and colleagues who refuse to show them respect and to acknowledge their superior ability. Many populist leaders have gained control of political organisations by undermining, deposing, or even assassinating former colleagues. Once they have gained control they appoint a chosen group of followers who lack the ability to challenge them, thereby diluting opposition and strengthening their control. Indeed, a strong sense of personal entitlement, coupled with a grievance against their peers, may create a ‘psychological bond’ between a populist leader and their under-privileged followers. The underprivileged may also believe that their peers do not respect them. Anger can be contagious; through public displays of anger a populist can mobilise their followers to activism.

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Question 3.8. Why are populists so often accused of corruption? Answer. Some populists do not accept that they are bound by conventional morality. When in government they may attempt to by-pass normal procedures and subvert the independence of the civil service. The ‘system’, they may claim, is not designed to implement new policies but merely to delay and frustrate them. Historically, many populist leaders have behaved dishonestly, concealing mistakes, diverting public funds to friends and family, fixing ballots, imprisoning or ‘buying off’ opponents, and making deals with the army to keep them in power. Populists create confusion by accusing their accusers, and portraying themselves as victims of corruption rather than as perpetrators of it. They may attempt to intimidate their opponents, e.g. threatening them with an unruly mob. Moderates become divided over whether the mob is to be punished or appeased; with a divided opposition, the populist increases their chances of electoral success.

4

THE PRACTICAL CONSEQUENCES OF POPULIST LEADERSHIP

Question 4.1. Why do populist leaders get elected when more experienced leaders often fail? Answer. Successful populists are alert to opportunities, recognising when the time has come for them to act, by taking the leadership of a political party (Casson, 1991; Riggio and Ono, 2014). For example, the Brexit movement began as an independent party, which was then taken over by the governing party, whose leader was then deposed. Through this process the movement was transformed from an anti-immigrant campaign, arguing for tighter border controls, to a campaign to repatriate national sovereignty from the EU. Trump followed a more conventional path, competing for the presidential nomination of the leading opposition party, to which he already belonged; his campaign was strongly anti-establishment from the outset. Question 4.2. Why do populists so often fail after gaining power? Answer. Populist leaders often embrace visionary plans that may be wildly impractical. To finance their plans they need to find a ‘pot of gold’. There are two main options. The first is to run a government budget deficit. The second involves aggression: conquer new territory, appropriate foreign technologies, and so on. Both are risky, and this is usually where the leader fails. The first leads to inflation and perhaps to bankruptcy; the second leads to international conflict, potential loss of life, and perhaps military defeat.

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Question 4.3. Why are voters so loyal to failing leaders? Answer. Populist leaders can inflict enormous damage on their countries, and it is therefore remarkable how robust the core support for a populist leader often remains. Devoted supporters exhibit a ‘need to believe’ in their leaders. The leader’s movement becomes their ‘extended family’, and the sacrifices they are called to make become a moral virtue. The true believer maintains that ‘it will all come right in the end’. Question 4.4. Why is populist leadership more common in certain types of country rather than others? Answer. History suggests that in most developed countries the populist leader is the exception rather than the rule (Kuzminski, 2008). Populist leaders have been most common in developing countries. Developing countries are poor and people have more legitimate grievances, so populist programmes have greater appeal. Weak democratic traditions can make it difficult to remove a populist from office. Populist leaders often produce poor economic results (see above), and therefore perpetuate under-development. Thus under-development encourages populism, which in turn retards development. This suggests a multiple equilibrium: developed countries normally experience a virtuous circle, in which prosperity discourages populism, while developing countries experience a vicious circle, in which poverty encourages populism. This multiple equilibrium does not explain, however, why populism surfaces intermittently in developed economies. There must be a ‘tipping point’ (Gaspar, Jaramillo and Wingender, 2016). Suppose that the stability of a developed economy depends on a fair distribution of income and realistic expectations of economic growth (see section 2). Widening income inequalities, coupled with slower growth, may lead the poor to question why they are becoming poorer whilst the rich are getting richer. This provides an opening that a populist can exploit. Conversely, a spurt in economic growth in a developing country that raises the living standards of the poor and reduces income inequality may reduce the appeal of populism and promote a switch to greater realism and stronger democracy instead.

5

CAN POPULISM BE DEFEATED?

In the long run, it would seem, only honest mainstream leadership can defeat the populist challenge. There is always a supply of populist leaders waiting for their opportunity. They thrive on the anxiety and low self-esteem of under-privileged groups. Populist politicians may not fully understand the principles of economics and IB, but they ‘know their market’. They understand the psychology of the ‘left behind’. They recognise, perhaps intuitively, that

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decision-making is ‘framed’. Anxiety and shame are powerful emotions, and ordinary people may make significant material sacrifices to mitigate them (Wuthnow, 2018). There is a natural propensity for people with similar frames to associate together. They understand each other, and may develop similar interests and pursue a common cause (Siow, 2015). If they possess a variety of special skills then by combining these skills their common cause may evolve into a powerful and influential movement (see below). Successful populist leaders have a good understanding of the frames that are used by other people. They instinctively know ‘what other people want to hear’. Within their own frame of reference, the leader perceives themselves to be a ‘winner’ who understands the losers’ frames of reference, and can advance their own interests by persuading the losers that they are on their side (Guiso, Herrera, Morelli and Sonno, 2017). Populist politicians of the future will almost certainly perform no better than those of the past. Furthermore, the supply of populist politicians is difficult to constrain. In a democracy the only solution, it would seem, is to improve the supply of mainstream politicians capable of defeating them. Mainstream politicians of today, it could be suggested, need to ‘raise their game’. They must stop competing with each other by making promises that they know they cannot keep; they should compete on grounds of integrity and competence instead. These are the grounds on which populists are particularly weak. In particular, mainstream politicians need to moderate expectations of future growth, manage structural change more effectively, and address the challenges of persistent income inequality.

6

GENERAL IMPLICATIONS OF THE CASE STUDY

The case study above has provided a simple causal interpretation of an important contemporary phenomenon that has often been poorly understood. It has ‘endogenised’ a factor, namely government policy-making, that was previously regarded as exogenous in much (but not all) IB theory. Three main conclusions can be drawn for IB studies as a whole. The first is that policy-making involves a feedback loop, in which policies not only address anticipated problems of the future but seek to correct mistaken policies of the past; business must therefore always allow for the possibility that current policies may be reversed. The second is that populist governments are not necessarily pro-business; businesses that try to buy the allegiance of populist parties may find themselves let down once the party gains power.

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The third is that popular sentiment manifests itself in many ways, and not just through populist political parties. Business needs to be in touch with popular sentiment in general, irrespective of whether this is articulated by a populist party. It needs a better understanding of pressure groups, protest movements, and informal social groups. If business had invested in acquiring a better understanding of the psychology of the ‘left behind’ they could have better anticipated the impact of populist parties. Firms have studied the consumer attitudes and buying habits of the ‘left behind’ as part of their marketing strategies and their attitude to work as part of their recruitment strategies, but the business community as a whole has failed to appreciate the political implications of their findings. These three conclusions are now developed further. Policy Feed-back Loops Many areas of mainstream IB theory take the policy environment as given. When policy-makers change their policies IB scholars ask ‘What are the implications for IB?’ But in reality policy-makers themselves react to impacts from the IB system – whether on the economy, society, the climate, or other factors. It is not a case of one-way causation – from policy changes to firms’ responses – but rather a feedback loop. The feedback effect is that firms’ responses to government policies affect matters of key concern to governments, and these impacts stimulate further responses from government. Thus Brexit and Trump were political responses to changes made by firms – notable off-shoring – that were themselves responses to policies introduced by previous governments – namely trade liberalisation. This feedback loop arises because of the unintended consequences of government policies. If governments correctly anticipated the responses of firms then there would be no need for them to change their policies later in response to unintended effects. Any future changes in policy would be made only in response to new exogenous changes in the global economy that could not have been foreseen at an earlier date. Thus if the proponents of trade and investment liberalisation had not believed uncritically in ‘levelling up’, both across nations and within nations, then they could have provided a wider range of protective measures for economies that did not adjust as expected. Because these mitigating policies were not available, governments of countries that failed to adjust as expected succumbed to internal political pressure to ‘re-write the rules’, not by international consensus, but through unilateral populist policies.

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Anti-business Government IB scholars have researched government policy-making quite extensively, but mainly through the lens of business-government relations. From an IB perspective, business normally lobbies an incumbent government over some issue of specific concern to the firm, or to its industry in general. The business community may also think ahead, and lobby opposition parties that may take over government in the future. In recent years, however, business has underestimated the growing power of populism. Business leaders, it seems, have continued to assume that ‘wealth-creators’ like themselves would remain more influential with government than ‘subsidy-seekers’, such as the elderly and the unemployed. They believed that the political leaders whose campaigns they supported financially would continue to advance their business interests, and would not sacrifice those interests to gain additional popular votes. They failed to recognise that populist political leaders might choose to listen more closely to the voices of the ‘losers’ rather than the ‘winners’. To understand the challenges of modern business-government relations it is therefore important for business, and for IB researchers, to appreciate the general phenomenon of the rising power of the under-privileged as a lobby group. Pressure Groups Populism has been identified above as a political movement, but popular attitudes do not necessarily have to express themselves through political movements. They can be articulated through pressure groups, street protests and media campaigns as well. Furthermore, populism as discussed above was a movement representing under-privileged and marginalised people (or people who feel that way), but the successful and affluent may have strong opinions too. They may also choose to express their opinions either through political movements, or through the alternative channels of influence noted above. Whatever the objectives of a movement, and whoever belongs to it, there are significant advantages to members of the movement in setting up a formal organisation to pursue these objectives. Organised social and political movements deserve closer attention in IB studies, as they can impact on IB in many subtle ways. Some movements create their organisations from scratch; as the movement develops small local organisations may merge into larger national or international units in order to increase their influence. In other cases a movement may take over an existing organisation and adapt it to its purposes; a notable example is where militant activists take over a moderate political party, which then embraces a more radical agenda as a result.

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Where people’s objectives are economic, the term ‘vested interest’ is often applied to organised movements of this kind. To a certain extent, the under-privileged workers that supported Brexit and Trump can be regarded as a vested interest, and the party they voted for as their organisation, captured for them by their populist leader. However, where the objectives are mainly social – e.g. concerned with inclusiveness of gender and race – the term ‘movement’ is often used instead; similarly, where moral and religious issues are at stake, the term ‘crusade’ may be used. IB theory already engages with organised groups and vested interests, but normally only when these interests are expressed through specific types of organisation. Trades unions representing the vested interests of a firm’s workforce, for example, are addressed as an important aspect of international human resource management (IHRM). Firms themselves represent a vested interest where government regulation of their industry is concerned; many firms belong to trade associations that lobby governments on their behalf. In some cases firms may engage with the political process directly, but covertly, e.g. buying the support of politicians by promising them lucrative jobs when they retire. Lobbying is addressed in IB studies through the study of business-government relations. It is not only vested interests that are relevant to IB, however. Consumer pressure groups can exercise considerable influence over product choice and buying habits; indeed, understanding consumer pressure groups is already an important aspect of international marketing. Gender and race are important issues too, especially in large high-profile companies where women and ethnic minorities may be unrepresented at senior management and board level. Reputation as a good employer may affect not only recruitment, but the wider reputation of the firm with government and consumers too. A sophisticated MNE will seek to keep ahead of social trends in terms of the products they develop and the working practices they adopt. Less sophisticated MNEs will simply follow the trend set by the leading MNEs, while the laggards will merely adjust when forced to do so by changes in the law. Some MNEs may even find it necessary to resist emerging trends; it is important for such MNEs understand the cultural forces that they seek to oppose in order to assess whether they have any chance of success and, if so, how success is most likely to be achieved.

7

ADVANTAGES OF EMBEDDING IB WITHIN AN INTEGRATED SOCIAL SCIENCE

This case study of populism has drawn on a range of concepts from behavioural economics, leadership studies, social psychology and political history. The literature on each of these topics is somewhat divorced from the literature on

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the others, which gives the previous case study analysis a rather ‘eclectic’ feel. This is not necessarily a problem; as Dunning (1977) noted, IB theory itself can be regarded for certain purposes as an eclectic endeavour. Nevertheless the eclectic elements need a framework in which they can be integrated if they are function effectively. There is at present no established framework of this kind, However, there has been a long-standing ambition among scholars and intellectuals to develop an integrated social science. It is an ambitious project, and it is therefore no surprise that it has been a slow, and indeed unfinished, process. It is, however, very relevant to this chapter because the idea is well-suited to the development of a more general theory of IB. In the eighteenth century Enlightenment philosophers such as David Hume and Adam Smith believed that they had developed a theory of human motivation that would explain most of human history. This early form of integrated social science began to fragment in the nineteenth century as highly reductionist theories of human motivation began to proliferate, e,g. utilitarianism (Bentham), materialism (Marx) and psycho-analysis (Freud) (Blaug, 1990). In the twentieth century sociology began to emphasise the importance of class and community, and the social embeddedness of individual decision-making (e.g. Weber). It developed rapidly in the post-war period, and today provides an intellectual basis for organisational studies and human resource management (Ashley and Orenstein, 2005). Economists, by contrast, embraced the principles of utilitarianism, but gave it a distinctive subjective twist. Despite heavy criticism, their legacy persists in contemporary IB: in internalisation theory (Buckley and Casson, 1976) and, to some extent, in theories of IB strategy (Verbeke, 2009). Economic theory draws a sharp distinction between ‘ends’ and ‘means’ (Robbins, 1932). Economists tend to assume that ends are selfish and materialistic, simply on the grounds that these motives impinge strongly on competitive market behaviour. IB scholars are somewhat broader, recognising that identity and status may influence consumer choice, and that autonomy and respect may influence worker productivity. Neither economists nor IB scholars, however, have systematically examined how people feel about the society in which they live, and in particular, whether they are proud to belong to it and whether they believe that they receive the recognition that they deserve. To examine these motives, it is necessary to take a more sociological and psychological approach, drawing on the intellectual traditions mentioned above. Economists and sociologists both agree, though for different reasons, that people infer how society works from their experience of everyday life. The same situation may therefore appear very differently to different people because they experience it in different ways. Each person’s decisions are framed by their perceptions. The social psychology of decision-making is

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therefore crucial. People may well act rationally within the context of their own frame of reference, but their behaviour may appear irrational to someone using a different frame (Kahneman, 2011; Lavine, 2010; McDermott, 2004; Sears, Huddy and Levy, 2013). When framing a decision, some people will have much better information than others. The less information they have, the greater the risks they face. Risk generates anxiety, and the higher the stakes, the greater the anxiety (De Botton, 2004). When anxiety is high, emotions may control decisions; it simplifies the frame of reference by reinforcing certain factors and suppressing others. As a result, the quality of the decision, as judged by its final outcome, may be poor (Breder and Marcus, 2013). This account of decision-making resolves much of the tension that has bedevilled relations between economics, sociology and psychology and provides a promising basis for developing an integrated social science framework in which IB studies can be embedded.

8 CONCLUSION A reader of this chapter may have paused at various points to reflect ‘This may be an interesting point, but it isn’t really IB theory’. The contention of this chapter is that it ought to be IB theory. IB studies has become too narrow in scope, and too specialised in content, to impact on the public. There is a need to re-draw the boundaries of IB to encompass the full range of issues addressed in this chapter. This chapter has suggested a way of addressing this challenge. It is to advance the integration of the social sciences by reversing some of the divisions that have emerged between specific subject areas. This involves more than ‘interdisciplinarity’; it involves integrating different disciplines into a unified body of the theory with a common core of assumptions. IB studies provides an ideal context in which to realise the full potential of an integrated social science because it draws on a very wide range of different disciplines. But at the moment IB scholars tend to apply a ‘pick and mix’ approach to the social sciences, in which specific methods and techniques are selected from a menu and applied to IB. IB theory used to be much broader. In the 1970s and 1980s scholars drawn from many different social sciences were active in IB. A wide variety of different techniques were brought to bear on the subject. As an important and emerging field of interdisciplinary study, IB was a forum for the exchange of ideas between different social sciences. There were few IB textbooks, and no text-book dogma to dictate what was included in the subject and what was not. The world has recently entered a volatile period of major economic, political, social environment change. The IB profession faces a strategic choice:

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Does it focus narrowly on the impact of these changes on IB, taking the changes themselves as exogenous, i.e. as given and largely unexplained? Or does it endogenise these changes by examining their causes, and explaining the changes as part of a wider remit: namely, to study the processes of global change themselves? There are four advantages of the broader approach. First, it provides an integrated answer to key research questions by explaining both cause and the effect. Secondly, and consequentially, it allows for two-way causation, i.e. that MNEs impact on the wider environment, and the environment impacts on MNEs (Cuervo-Cazurra, Doz and Gaur, 2020). Thirdly, a broader analysis of the business environment may predict changes that might catch firms unawares; a wider view will therefore improve strategic decision-making. Finally, a wider view expands the potential audience for IB research. By explaining causes as well as consequences, it engages with a potential readership that is far wider than people who are simply interested in the impact of exogenous events on MNEs. Governments are therefore not the only players that need to make some strategic choices at this time of great uncertainty. The IB profession also needs to take strategic decisions too. A key decision concerns the scope of the subject in general, and the scope of theory in particular. The choice is essentially binary: to do nothing, and carry on as usual, or to broaden the range of theory and evidence used in order to address the causes as well as the consequences of global problems emerging in the future. There are broader lessons for the academic profession too. Economists and IB scholars must recognise that their own perception of social and economic problems has been framed by their own experiences, which are not necessarily shared by a majority of people. They need to pay more attention to the ‘ends’ of business and economic activity; they should continue to study the ‘means’, but not exclusively so. To study ends, they need to take a broader view of society. Academics are the products of a competitive educational system from which they have emerged as winners; formal education is a process of attrition, in which the stage at which a student fails determines the kind of job they get. Academics are the survivors; they are good at passing exams, and perhaps at research, but possibly not much good at anything else. It could be said that many academics never really understand the kind of people that they study. To develop realistic theories that are acceptable and useful to honest mainstream politicians, academics may need to broaden their life experiences. Within the higher education system as it stands, however, there is little incentive for them to do so.

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Guiso, L., H. Herrera, M. Morelli and T. Sonno (2017) Demand and supply of populism, EIERF Working Paper 1703 Kahneman, D. (2011) Thinking Fast and Slow, New York: Farrar, Straus and Giroux Ketalas, M. (2003) Working Class Heroes: Protecting Home, Community and Nation in a Chicago Neighbourhood, Berkeley, CA: University of California Press Kuzminski, A. (2008) Fixing the System: A History of Populism, Ancient and Modern, London: Continuum Kyle, J. and L. Gultchin (2018) Populism in Power around the World, London: Institute for Global Change Lavine, H. (2010) Political Psychology. Los Angeles, CA: Sage Magnusson, L. (1994) Mercantilism: The Shaping of an Economic Language, London: Routledge McCann, P. (2017) The UK Regional-National Economic Problem, London: Routledge McDermott, R. (2004) Political Psychology in International Relations, Ann Arbor: University of Michigan Press Moffit, B. (2016) The Global Rise of Populism: Performance, Political Style and Representation, Stanford, CA: Stanford University Press Moffit, B. (2020) Populism, Cambridge: Polity Press Mudambi, R. (2018) Knowledge-intensive intangibles, spatial transaction costs and the rise of populism, Journal of International Business Policy, 1, 44–52 Muller, J.W. (2016) What is Populism?, Philadelphia: University of Pennsylvania Press Oesch, D. (2008) Explaining workers’ support for right-wing populist parties in Western Europe: Evidence from Austria, Belgium, France, Norway and Switzerland, International Political Science Review, 29, 349–373 Ratcliffe, S. (2014) Juvenal, 2nd. ed., Oxford: Oxford University Press Reeves, T. (1973) McCarthyism, Hinsdale, IL: Dryden Press Restad, H. E. (2020) Donald Trump’s calls to “Make America great again” show that American Exceptionalism is still a powerful idea, http://​bit​.ly/​1LEdzQt Riggio, R. E. and M. Ono (2014) Leadership, Oxford: Oxford University Press Robbins, L. (1932) An Essay on the Nature and Significance of Economic Science, London: Macmillan Rodrik, D. (2018) Populism and the economics of globalisation, Journal of International Business Policy, 1, 12–33 Rove, K. (2016) The Triumph of William McKinley: Why the Election of 1896 still Matters, New York: Simon & Schuster Sears, David O., L. Huddy and J. S. Levy (eds.) (2013) Oxford Handbook of Political Psychology, Oxford: Oxford University Press Siow, A. (2015) Testing Becker’s theory of positive assortative matching, Journal of Labour Economics, 33(2), 409–441 Stiglitz, J. E. (2017) Globalisation and its Discontents Revisited: Anti-globalisation in the Era of Trump, New York: Norton UK government (2020) The Future Relationship with the EU: The UK’s Approach to Negotiations, 27 February, London: CP211 Verbeke, A. (2009) International Business Strategy, Cambridge: Cambridge University Press Welfens, P. J. J. (2020) Trump’s trade policy, BREXIT, Corona dynamics, EU crisis and declining multilateralism, International Economics and Economic Policy, 17, 563–634 Wolf, M. (2004) Why Globalization Works, New Haven: Yale University Press Wuthnow, R. (2018) The Left Behind, Princeton, NJ: Princeton University Press

2. Crises in international business: a new perspective 1 INTRODUCTION The concept of crisis has appeared with increasing frequency in the international business (IB) literature of the 21st century. Recent debate has focused mainly on events that have had a global impact, e.g. the Global Banking Crisis of 2009, the COVID crisis of 2020–1 and the long running Environmental Crisis. The literature has also considered regional crises, such as the Asian financial crisis of 1997, and national crises, such as the dissolution of the Soviet Union and the subsequent partitioning of some East European countries. There is also, however, a more traditional IB literature that is focused on narrower issues. It is not concerned with ‘big issues’ such as de-globalisation, but rather with the impacts of specific incidents on the performance of individual firms, e.g. the impact of product recalls on an MNE’s brand value and financial performance (Coombs and Laufer, 2018; Fainshmidt, Nair and Mallon, 2017). This chapter takes a broad perspective. It examines the impact of national and international crises on the global economy, and their consequent impact on MNEs as a whole. It is concerned not only with crisis management by individual firms, but crisis management by national governments, treaty organisations and international charities. It analyses the causes as well as the consequences of crises. It traces a crisis from its origins, through its emergence, to the point where it breaks out, and follows it through to examine its wider impacts. Following Casson and Lopes (2013), it discusses both the prevention of crises and the mitigation of their effects. Section 2 present a simple theory of crisis. It begins by defining key concepts. It considers what differentiates a crisis from an everyday problem. It draws a crucial distinction between a ‘critical situation’, in which there still remains some opportunity to avert a crisis, and the actual ‘state of crisis’ that later occurs. It identifies four main factors that allow a critical situation to turn into a crisis: (1) ambiguity over who is responsible for managing the critical situation; (2) lack of access to the technology (and other resources) required to address the situation; (3) failure to recruit the right sort of people to implement 27

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the measures required; and (4) failure to consult the victims and understand their needs. As a result, weak organisational structures, poor communications, lack of resources, poor selection of managers, and lack of sympathy for the vulnerable mean that there is no effective intervention to prevent a critical situation from degenerating into a state of crisis. Section 3 presents a classification of crises. It distinguishes two main types of crisis, and provides examples of each. One has its roots in natural phenomena, such as earthquakes and pandemics, while the other involves human conflicts of one kind or another. However, while natural causes may create a critical situation, it is usually human failings that convert a critical situation into a crisis. Crises caused by human conflict may be classified as political, financial or economic; for reasons of space social crises are not discussed. Crises can also occur at various levels; economic crises, for example, may affect the entire global economy, specific nations and industries, or a particular firm within an industry. These different levels of crisis are discussed as well. Section 4 discusses crises in firms. It applies the general theory set out in section 2 to the specific case of the firm. This allows the analysis of firms in crisis to be placed in a wider context. In line with the theory, it discusses both the causes of the critical situations as well as the managerial responses to them. It addresses the question ‘Is a theory of corporate crisis simply a theory of business success in reverse?’. IB scholars often ask why one firm succeeded when others did not, but they rarely address the question of why one firm failed when others did not. The concept of firm-specific advantage is widely used to explain the success of an individual firm. To explain the failure of an individual firm it would seem that a theory of firm-specific disadvantage is required. This section outlines what a theory of this kind might be like. Section 5 applies the general concept of institutional disadvantage to analyse the other forms of crisis identified in section 2. Section 6 summarises the conclusions and discusses implications for strategy, policy and future research.

2

OUTLINE OF THE THEORY

2.1

Definition of a Crisis

There is no agreed definition of a crisis. The term is often employed very loosely (Oxford Dictionary, 2021). So when does a problem become a crisis? Two factors are relevant: the problem is serious and the time available to resolve it is short. The key issue is ‘time compression’: urgent action is required to find and implement a solution within the time available (Cool, Dietrickx and Costa, 2016).

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A simple mechanism generating time compression is cumulative breakdown. Consider a system that utilises a stock of resources to generate goods and services that are consumed by a group of people. The system is managed by small team of individuals who are collectively accountable to the group. Suppose that some external factor puts the system under stress. A component of the system fails as a result, and those responsible do not immediately put it right. This increases the stress on the rest of the system. Very quickly a second component fails. The potential impact is now more serious, and the system enters a critical state. If nothing is done then a third component will almost immediately fail, and at this point the entire system will enter crisis. Internal resources may no longer be adequate to resolve the problem and external intervention may be required. 2.2

Causal Analysis of a Crisis

This discussion suggests a key distinction between a critical situation and a state of crisis. It is unfortunate that this distinction is not always used when reporting on a crisis. For example, when a manager says ‘We have a crisis on our hands’ they usually mean that a critical situation has developed that requires their urgent attention, whereas when a historian says ‘There was an economic crisis in 1929’ they are usually referring to the actual collapse of the economy at that time. In some cases the existence of a critical situation may not be recognised until after a crisis has actually occurred. A banking crisis, for example, is often dated to the collapse of a leading bank. In reality, however, the collapse will normally be the consequence of a steadily worsening financial situation which was denied by bank officials. Critical situations normally develop through a failure to manage risk factors. Effective risk management can prevent a critical situation from developing. But the risk factors may not be monitored and the hence critical symptoms may be overlooked. Complacent managers may even ignore symptoms and just ‘keep their fingers crossed’ instead. This may be summarised as: Risk factor + Complacency = ​ Critical situation

Once a critical situation develops the dangers become obvious. But response may still be slow. There may be ambiguity in control; those responsible may be waiting for others to make the first move. There may also be disagreement over the specific role of each party. Even if they agree to cooperate there may be delays in communication between them. This disrupts the collective response to a worsening situation. Because the situation is unstable, a relatively small

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change then tips the situation over into a full-blown crisis. This may be summarised as: Critical situation + Delay + Misfortune = ​ Crisis

Once a crisis has occurred, there is a short-term problem of mitigating the worst effects (e.g. disaster relief) and the long-term problem of recovery, i.e. repairing the situation where possible. Crisis + Response ​= Mitigation + Possible recovery

The aftermath of a severe crisis may be irreversible. The economic output lost in a recession, for example, is usually lost for ever. Similarly few firms recover fully from a serious crisis; a crisis can result in financial losses for the owners, loss of respect and authority by the management, and loss of goodwill from customers and workers. Crises therefore lead to permanent scarring, e.g. the loss of skilled jobs in the recent COVID crisis. There may be a ‘new normal’, but this does not mean that recovery is complete (COVID Scarring, 2021). 2.3

The People Involved in a Crisis

There are three main groups of people that are usually involved in a crisis: the trouble-makers who create the critical situation, the victims, who stand to lose most, and the trouble-shooters who are called upon to mitigate the crisis and deal with its aftermath. Sometimes the trouble-makers create a critical situation out of nothing, e.g. by failing to maintain product improvement within a firm, whereas in other cases, such as natural disasters, they may simply fail to take appropriate precautions, such as removing population settlement from vulnerable areas. These three groups of people are normally quite distinct, although in some cases they may overlap. For example, a single group of people may create a problem which they inflict upon themselves and then sort out together. There are other possibilities too: the trouble-makers may victimise themselves and then call in the trouble-shooters, the trouble-makers may respond to their victims’ needs themselves, or the victims may call in specialist trouble-shooters instead. 2.4

Engineering a Crisis for Revolutionary Ends

Can anything good come from a crisis? A potential advantage of a crisis is that it is possible to replace a defective system with a better system. The aftermath

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of a political crisis, for example, may be a wave of idealism, in which a radically new design of system is embraced. Trouble-makers may deliberately set out to undermine the system to which they belong. Far from ignoring the risk factors, they monitor risk factors carefully, seeking to aggravate a situation when risks are high. In the mid-19th century, for example, social and political revolutionary movements were particularly active in leading European economies. They set out to deliberately destabilise the system in order to replace it with a better one. However, many revolutions failed to deliver what they had promised, or performed no better, or worse, than the regimes they replaced. In the 20th century the Wall Street Crash led to widespread calls for an end to capitalism. It was claimed that the ‘rules of the game’ were fixed so that the ‘winners kept of winning’ (Knight, 1935). In the late 1960s there were plans to precipitate a crisis of capitalism through trade union militancy; the naive idealism of post-war baby boomers fuelled popular revolutionary movements in the France and the UK, and some of their criticisms of capitalist still inequality have a familiar ring today (Piketty, 2014). In other countries, such as Russia, Germany, Spain and Italy, revolutionary governments of both socialist and fascist persuasions did indeed come to power. In most cases they succeeded because the political opposition was weak and divided, and had lost popular support. There was a desire for ‘change’, even though many supporters of the revolutions do not seem to have known exactly what the changes would entail (Broadberry and O’Rourke, 2010). Historical evidence suggests that ‘silent’ revolutions, effected by incremental social change, have been more enduring and more successful than violent political revolutions (Jones, 1988). The obvious explanation is that engineering a crisis to effect reforms is costly and often ineffective. The leaders of a successful revolution may derive personal benefits from the power that they gain, but the people who were supposed to benefit often finish up as the victims of the revolution, with less personal freedom then they had before. Any crisis is costly in terms of the resources used up, the assets destroyed and the rebuilding that is required. These costs are rarely worthwhile when there are alternative ways – peaceful but slower – of achieving the same objectives.

3

CLASSIFICATION OF CRISES

This section and the next examine in detail the four main categories of crisis: natural disasters, political crises, financial crises, economic crises. Special attention is paid to the three main types of economic crisis: national crises, industry-specific crises and firm-specific crises. Table 2.1 shows how risk factors, mismanagement and misfortune interact in generating each particular

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type of crisis. Table 2.2 analyses the role of trouble-makers, victims and trouble-shooters in each type of crisis. Table 2.1 Type of crisis

Classification of crises Risk factor

Mis-

Critical

management

situation

Misfortune

Crisis

Do nothing

Threat of

Earthquake,

Loss of life,

natural disaster

flood, fire, etc.

livelihood,

Natural disasters Environ-

Location of

mental

population in

catastrophe

high-risk area

property

Political crises International

National

or regional

aggression

Do nothing

Threat of

Provocative

Barriers to

protectionism

incident

trade and FDI; war

or war

conflict

Strikes,

Provocative

Civil war,

between

demonstrations,

incident

partition;

social classes,

civil unrest

National

Tensions

conflict

Do nothing

dictatorship

cultures, races, etc. Financial crises Banking

Banks invest

Lack of due

Banks become

Public loses

Banks fail and

failure

in high-risk

diligence;

insolvent due to

confidence

depositors lose

projects

limited equity

bad investments

and rushes

their savings

to withdraw

to buffer losses

deposits Stock market

Over-optimistic

Investors

Threat of stock

Bad news

Personal

collapse

equity prices

borrow to

market crash

undermines

bankruptcy;

confidence

‘subjective

finance undiversified

wealth’ is

portfolios

destroyed

Economic crises National

Low

Failure to

Adverse

Impact of

Mass

economic

productivity

anticipate

balance of

international

unemployment,

impact of

payments,

competition

lower profits

international

rising

competition

government

depression

debt

Crises in international business

Type of crisis

Risk factor

Mis-

Critical

management

situation

33

Misfortune

Crisis

Industrial

New

Firms do not

Profits fall to

Responses are

Firms go

decline

technology

fully adapt;

a critical level;

ineffective

bankrupt and

emerges in

response is

funding debt is

rival industry

limited

a problem

Firm closure

close

Decline of the

The firm fails

Revenues

The firm

Firm closes to

market and/or

to respond

fall but costs

loses a major

avoid further

the emergence

through

remain high.

customer or

losses

of a new

innovation,

Staff morale

needs to replace

competitor

efficiency

declines. Losses

expensive

savings, etc.

are incurred

equipment

Table 2.2

Three key groups of human agents in a crisis

Type of crisis

Trouble-makers

Victims

Trouble-shooters

International or

Nation state

All nation states

Supra-national coordinator (e.g. treaty organisation)

regional political conflict National political

Oppressor, discriminator

All citizens, especially

Internal peacemaker or

conflict

or insurgent

the most vulnerable

external arbitrator

groups Natural disaster

Governments that fail to

Those that lose life,

Foreign governments,

protect their population

livelihood and property

charities, disaster relief experts

from a recognised threat Banking failure Stock market

Bankers Speculators

collapse

Depositors and

Banking regulator;

shareholders in banks

government, central bank

All citizens, and

Government

especially speculators

Economic

Low profits; weak

All citizens, but

depression

management; low

especially the

productivity workers

unemployed

Innovators of competing

Workers, managers,

technologies

shareholders, local

Industrial decline

Government, central bank

Government

communities Firm closure

Industrial decline,

Workers, managers,

Leader of local

aggravated by

shareholders, local

communities affected by

incompetent managers

communities

plant closures

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3.1

Natural Disasters

Climate change and the COVID pandemic have recently focused attention on crises driven by natural events (Mulcahy, 2004). Climate change has increased the risks of global warming, coastal erosion, flooding, desertification, loss of wildlife habitats and many other problems. COVID is the latest in a series of pandemics, which have included Spanish flu, Ebola and HIV-AIDS (Bynander and Norstedt, 2019; Boin, Lodge and Luesink. 2020). Diseases in crops and animals (e.g. Panama disease, foot-and-mouth disease) regularly create agricultural crises in specific regions (Marquhardt, 2001). While nature may be responsible for the critical situation, however, it is often human behaviour that turns a critical situation into a crisis. Common examples are commuting to work by motor car, jet travel and long-distance tourism, over-fishing, plastic waste disposal, deforestation for arable farming, 24-hour urban lighting, and coal-fired power stations. Human behaviour can also be an important part of the solution too, e.g. social distancing and compliance with rationing during the COVID crisis. Technology can also play an important role in managing critical situations and mitigating a crisis. In the context of climate change carbon capture (e.g. reforestation), alternative sources of energy (e.g. solar energy and battery power) and the construction of coastal and river defences are all examples of key technologies, whilst in the context of the COVID pandemic vaccines, drugs and respirators have all proved vital. Access to resources is also important in natural disasters; fresh water, food and medicines are usually in short supply; later it is finance for rebuilding that may be in short supply. Governments are usually expected to manage responses to natural disasters. There may be disagreement, however, as to whether national or local government should take the lead, and the extent to which international cooperation is required. Government may also face social challenges, such as how far individual liberties should be constrained in order to enforce a system of priorities. 3.2

Political Crises

International political instability can impact on both international trade and FDI. In the inter-war period military aggression posed the major threat to trade agreements between leading industrial powers; it also impeded the sharing of technology and deterred cross-investment. In the 21st century the major threat to Western countries has been the economic rise of China and, before that, the rise of the Japan, Korea and other ‘Asian Tigers’; import competition, coupled with offshoring, has undermined traditional manufacturing heartlands of the US and several Western European countries. For obvious reasons, IB

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studies has studies the impact of political risks extensively (Fitzpatrick, 1983; Boddewyn and Brewer, 1994, Bucheli, 2008). In political crises, unlike natural crises, the destruction is the result of human agency. This may be physical destruction wreaked by war or economic destruction wrought by protectionism. Like natural crises, however, political crises involve issues of technology and resources. Political crises often arise because the leader of some country believes that their country possesses a superior technological capability that can be deployed for military offensives. Their justification may be that the peaceful exploitation of this technology requires them to gain access to resources that other countries possess, and that other countries have resisted this. Such arguments are often cited in discussions of the origins of the First World War (Casson, 2020). International crises involving leading powers are particularly serious because there may be no super-power that can intervene as arbitrator or peace-maker. The rival powers could, in principle, agree on an independent peace-maker, but if they cannot agree about anything else then it is unlikely that they will be able to agree about that. Inter-governmental institutions (e.g. treaty organisations such as the United Nations) were formed largely with a peace-making role in mind, but belligerent nations can veto their resolutions if they wish (Houben, 2005). The human factor is paramount in political crises because it is typically nationalist leaders that provoke political conflict. These leaders often adopt a populist style, in which they promise to their core of committed supporters that they will restore the status and prestige that they, and their nation, once possessed. The most dangerous populists are those that believe their own propaganda, because they are less likely to be willing to compromise. Populism is usually considered to be a particular problem for autocratic and totalitarian states, although recent evidence suggests that it can afflict long-established democracies too (Hardman, 2018). Political crises can lead to economic crises, as explained below. In the present context there are fears the international conflict between the US and China may stimulate a process of de-globalisation which damages trade and foreign investment flows. There are also fears over regional and local crises too. There is a regional security crisis in Asia connected with China’s claims over Hong Kong and Taiwan and its attempt to control the South China Sea, according to some political commentators. Other commentators refer to a regional crisis between Russia and the NATO allies, focused on Russia’s relations with bordering European and Euro-Asian countries. Current national crises typically relate to civil wars; these have been endemic in certain African countries and have surfaced intermittently some South-east Asian countries, e.g. Vietnam, Korea and most recently Myanmar (Abadie and Gardiazabal, 2003). There have also been significant tensions in

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other countries, often related to issue of language and cultural identity, which have engendered separatist ‘independence’ movements, e.g. Canada, Belgium, Ireland, Spain, Australia, New Zealand and most recently, post-Brexit UK. 3.3

Financial Crises

A distinguishing feature of financial crises is that the critical situation preceding the crisis is often ‘hushed up’, or even denied outright, so that the crisis breaks unexpectedly, catching many people unaware (Calomiris and Gorton, 1991). A major reason for this is that the financial system depends on trust. There are two main types of financial crisis: a banking crisis and a stock market crisis, as explained below. 3.3.1 Banking crises The public must be able to trust the banks to maintain liquidity (i.e. carry sufficient cash to meet the daily needs of their depositors) and solvency (hold assets to a value equal to or greater than the value of their customers’ deposits). When it rumoured that a bank is insolvent its customers will rush to withdraw their deposits, creating a liquidity crisis, and forcing the bank to shut their doors. Rumour then causes contagion, so that there are runs on other banks as well. If the banks are insolvent then depositors will receive only a proportion of the funds they have deposited, or in some cases nothing at all. It is, however, open to the national government to guarantee the value of deposits up to some limit, and to charge the banks a fee for this ‘underwriting’ service (Oliver, 2007). During the Global Banking Crisis of 2008–9 many major banks were shown to be insolvent. The assets they held to back their deposits were grossly over-valued. The problem in the US lay in excessive mortgage lending to low-income households, while in Europe it lay in a wave of mergers and acquisitions, in which big banks had sought to ‘globalise’ by taking over banks in other countries (Duca, 2021; Shefrin, 2016). The legacy of the Global Banking Crisis has never been fully addressed. Government regulation of banks is much tighter than before, and ‘stress-testing’ of bank balance sheets has become routine. But interest rates have been kept low for many years, using ‘quantitative easing’ where appropriate, in order to maintain high asset values. If interest rates were to rise, asset values would fall, then bank balance sheets would again deteriorate. Because banks are now forced to hold more equity, the immediate cost would fall on the stock market. Precedents show, however, that stock market crashes can also trigger recession.

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3.3.2 Stock market crises Equity shares are held for two main reasons: dividend payments and speculative gains arising from an appreciation in the equity price. Investors may hold equity for either security or speculation. Those who seek security prefer a steady stream of dividends, while speculators prefer equities whose prices are volatile, since large price movements, if correctly anticipated, afford large capital gains. With a wide range of opinions and a wide range of assets in which to invest, it might seem that financial markets in general, and equity markets in particular, would be relatively stable. However, when equity price movements are examined with the benefit of hindsight, the influence of simplistic and misleading opinion on equity prices is indisputable. Erroneous opinions are mixed with perfectly sound opinions. Crises develop at times when misleading opinions proliferate unchecked (Allen and Gale, 2000). A consensus may develop that equity in certain types of firms is likely to appreciate in value. Such rumours are typically diffused by opinion leaders, including financial journalists and self-professed financial gurus. Some opinions leaders may be genuinely misled themselves, whilst others may be simply promoting a trend with the aim of selling out for a profit at the peak. When equity prices collapse a lot of subjective wealth is destroyed. This creation and annihilation of subjective wealth is a major problem with equity prices. When investors anticipate a boom they over-value shares, and because they feel wealthy they spend more, increasing firms’ profits and validating their expectations. When the economy reaches full employment, however, costs begin to rise and profits level off or start to fall; share prices fall, investors feel poorer, they consume less, and the economy moves into recession. This cyclical pattern in demand is further aggravated by the investment decisions of firms. No-one has ever found a satisfactory way of regulating speculation. One of the earliest crises was precipitated by speculation in tulips (Dash, 1999; Golgar, 2007). Another involved speculation in the shares of a chartered trading company (Dale, Johnson and Tang, 2005; Garber, 2001). Hyper-inflations have occurred when national currencies have lost credibility, e.g. the US in 1817 and 1825, and Germany in 1927 (Neal, 1998; Rothbard, 1962; Voth, 2003). Mortgage crises are nothing new either; a major crisis occurred in the UK in 1973-5, when house-prices fell dramatically and mortgagees faced heavy capital losses if they sold their homes (Reid, 1982). Other forms of gambling, such as betting on horse races or playing roulette, and usually regulated by setting limits on the sizes of stakes. However, prohibiting people from investing large sums of money in a single company could discourage economic growth. The usual response is to regulate accounting practices, but not all government enforce such regulations effectively.

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3.4

Economic Crises

3.4.1 National economic crises A crisis that begins as a natural political or financial crisis may develop into an economic crisis because of its disruptive effects on the economy (Odell and Weidenmier, 2002). However, not all economic crises are consequences of political problems or natural disasters; some are generated by failings in the economic system itself, as shown by historical case studies (Bernanke and James, 1991; De Bonis, Giustiniani and Gomel, 1999). The causes of economic crises have been a matter of controversy (Hayek, 1933; Keynes, 1936) The classic symptoms of economic crisis are mass unemployment and high levels of poverty (Garside, 2007). If there is a minimum wage, enforced by custom or law, then depression generally manifests itself as unemployment, whereas in the absence of a minimum wage the symptom may be low wages instead. In both cases there may be a rise in self-employment as people take supplying casual labour in various forms. Some depressions involve stagflation, where the value of money falls and savings are wiped out. Stagflation usually results from reflation going wrong, due to unforeseen bottlenecks in production. As people build inflation into their expectations, ever larger boosts to spending are required. Inflation accelerates, middle class savers become impoverished and unemployment remains high. Public discontent may fuel the rise of populist dictatorship, which boosts solidarity by marginalising minority groups and promoting conflict with neighbouring countries. 3.4.2 Industry-specific crises According to Schumpeter (1939), economic progress involves cycles of innovation and stagnation. New industries emerge in phases of optimism, when stock market confidence is high and finance is available for large high-risk investments. Investments in new forms of infrastructure (or ‘general purpose technology’) are particularly significant in this respect. But such investments may make established technologies in other industries obsolete. Obsolescence is not the only cause of industry crisis; some industries over-expand due to excessive optimism about latent demand or the advantages of scale. This precipitates an industry ‘shake-out’ in which falling prices render high-cost firms uneconomic (Klepper and Simona, 2005). Managing decline in an obsolescing industry is an important activity and raises serious issues. From a strictly business point of view, the management of decline often involves cutting losses by curtailing investment, sweating assets, cutting the labour force and putting the remaining workers on minimum wages and flexible hours. No attention is given to the secondary impact on local families and communities, Industrial plants may be abandoned and left

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to decay, together with stocks of toxic waste. On the other hand, managing decline more sympathetically, when rivals are quite ruthless, may bankrupt the firm prematurely, and reduce some of the shareholders to poverty. A similar point applies, though on a smaller scale, to the decline of an individual firm within an otherwise prosperous industry, as explained below.

4

FIRM-SPECIFIC CRISES: THE ROLE OF FIRM-SPECIFIC DISADVANTAGE

Firm-specific crises are especially relevant to IB studies, and need to be examined at length. This section of the chapter is devoted to this specific purpose. 4.1

The Life Cycle of the Firm

Firms do not last for ever. Those that survive their early years may be taken over by other firms or merge with them. Even large firms can go bankrupt when their industry declines, as indicated above (Rose, 1986). Firms can also fail as a result of mistakes in management succession. Family firms are often cited in this respect; a novel by Thomas Mann (1971) gives its name to the Buddenbrooks syndrome; a family goes from ‘rags to rags’ in three generations. The first generation is entrepreneurial and founds the firm, the second generation inherits the firm and consolidates its position in the industry, while the third dissipates its inheritance, burdening the firm with debts and making it bankrupt. Large managerial firms can experience crisis too (Clementi, Cooley and Giannatale, 2010). Some survive because they are recognised as ‘national champions’ and deemed ‘too big to fail’. This principle was applied to the big banks during the Global Financial Crisis, and to the big motor manufacturers and chemical firms that were unexpectedly exposed to Asian competition in the 1970s. From a crisis management perspective, there are three main question to ask about firm failure. Who are the troublemakers? Are they internal or external to the firm? Is it the general state of the industry, or the tactics of the firm’s competitors, that are to blame? Or should management have foreseen the problems created by emerging competition, invested more heavily in modern equipment, and refreshed its brand? Should workers and their trade unions have been more flexible in accepting new working practices? Who are the victims? Are they the workers, the managers, the shareholders, or the local communities in which the firm’s operations are based? Redundant workers may find it difficult to retrain or relocate. Managers will also lose their jobs, although their generic skills and higher incomes make re-employment

40

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easier. Some of the shareholders who lose their money may be sufficiently wealthy to afford it, but others may be charities and pension funds whose dividend income provides support for other people. Finally, local communities may suffer as the prosperity of their local towns decline. Who are the trouble shooters? Should central government step in and bail out the firm with a low-cost loan? Should it place new orders on behalf of the public sector to slow the decline of the market? Should it offer financial support to the families of redundant workers, subsidise retraining, and attract new jobs to the neighbourhood? Is aid the responsibility of local government as well? Indeed should other regions contribute anything at all? The insurance principle that they should: local government income from business rates will decline in the areas affected by the closure, while local income may increase in other regions that host competing firms and newer industries. 4.2

Firm-specific Disadvantage

To explain the onset of a crisis in a single firm it is useful to stand the notion of ‘firm-specific advantage’ on its head. In conventional IB theory a successful firm possesses a firm-specific advantage that their potential competitors do not have (Buckley and Casson, 1976; Dunning and Lundan, 2008; Verbeke, 2013). This advantage normally derives from the possession of certain assets, which are typically intangible assets that are protected by secrecy or intellectual property rights. By contrast, a firm-specific disadvantage arises when some firm is excluded from access to assets that are available to other firms. The firm fails because it lacks the advantages of the kind that its competitors possess. So what are the assets that the disadvantaged firm does not possess? Conventional IB theory would suggest that the firm’s technology has becomes obsolete and its brand has been tarnished. But why does the firm not enhance its technology and refresh its brand? Management failure is the obvious explanation, i.e. failure to monitor new technological and marketing trends. Management failure may be analysed in terms of the ‘life cycle’ of the firm (Parker, 2007; Al-Taie and Cater-Street, 2020). The firm’s early growth is driven by the imagination and dedication of its founder-entrepreneur, who discovers and appropriates intangible proprietary assets. But as the founder ages, they lose their imagination and energy, and are eventually succeeded by someone with lesser ability. The firm loses its ‘first mover’ advantage. Competition from younger entrepreneurs who have subsequently entered the industry erodes the firms’ market share, and its intangible assets depreciate in value. There are therefore not one, but two aspects to firm-specific advantage, and to its opposite, namely firm-specific disadvantage. The first is the value of the

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firm’s intangible assets and the second is the entrepreneurial capability that allows the firm to acquire them and keep them up to date. This second aspect can be explored in greater detail. The key issues concern the management and finance of a growing firm. Consider the finance issue first. In the firm’s early high-growth phase additional finance will be needed, in order to scale up operations, internationalise production and sales, and deter entry by rival firms. There is a limit to the amount of investment that can be funded through fixed-interest debt, so capital may have to be raised through equity issues which dilute the owner’s control. Shareholder pressure may subsequently lead to the owner being ejected, possibly for good reason, but they may be replaced by a less competent individual who makes exaggerated promises to the shareholders. Now consider the management issue. These are often discussed, rather generally, in terms of ‘resources’ and ‘dynamic capabilities’ (Barney and Clark, 2007; Teece, 2018). To scale up and internationalise operations the entrepreneur will need to hire specialists: both technical specialists, such as engineers, and management specialists, such as marketing and human resource professionals. The entrepreneur also needs to establish a management structure through which the work of these specialists can be coordinated; this involves writing job descriptions and specifying lines of authority and communications. It is difficult for an inexperienced generalist to hire appropriate specialists, and mistakes may be made; they fail to recruit talented applicants, who join rival firms, and instead recruit unsuitable applicants who may be over-paid. Talented managers, recruited by chance, may become disillusioned, and leave to set up competing firms. Similarly, it may prove difficult to devise an appropriate management structure. Distrust of specialists may lead to over-centralisation, while misguided trust in incompetent staff may lead to excessive decentralisation instead. Once their technology is proven and their brand established, therefore, it may pay the founder, or their successors, to sell out to a larger firm, such as a conglomerate that already manages other brands in other sectors of the same industry. If they do not they may face increasing competition from subsequent entrants who offer new or improved varieties of the product. As competition intensifies, a critical stage may be reached where demand has shrunk so far that fixed costs can no longer be covered, and the firm must close. Alternatively, bank creditors, a shareholders committee or new investor may come forward to salvage some part of the business.

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Implications for IB Theory

The analysis above suggests that the advantages possessed by rival firms include not only technology and brands but also financial and management competencies, involving recruitment, organisational design and succession strategies. Conventional IB theory tends to assume, at least implicitly, that all firms possess these basic management competences. Thus any advantage is imputed to superior technology or brands, or similar monopolistic assets. By contrast, a theory of crisis, that takes failure as the norm and regards survival as exceptional, portrays basic management competences as advantages that firms in crisis typically lack. The theory of crisis therefore suggests that there are two distinct kind of advantage that firms may possess. The first comprises the familiar firm-specific advantages that are unique to individual firms, such proprietary technology and brands, while the second comprises more generic advantages that involve a range of specialist management skills. Crucially for IB theory, firms with the traditional firm-specific advantages can fail if they are seriously deficient in generic advantages. These generic management skills do not necessarily imply generic forms of behaviour, however. They have different implications for firms at different stages of the life-cycle and in different industries. A competent manager may realise that while decentralisation of management authority is appropriate in one industry it is not appropriate in another. Even within the same industry, the appropriate management strategy may vary according to the cultures of the locations in which the firm operates and the size and age of the firm. Thus the correct application of generic skills may lead to both industry-specific and firm-specific variations in the strategies favoured by the managers who possess those skills. It may therefore be difficult to disentangle from a superficial observation the relative contributions of traditional firm-specific advantages derived from proprietary assets and the efficiency gains (e.g. savings in operating costs) achieved by applying generic management advantages in specific situations.

5

INSTITUTION-SPECIFIC DISADVANTAGES

Theory suggests that firm-specific disadvantage should have an analogue in the management of the other forms of crisis discussed earlier. These disadvantages may be described as ‘institution-specific’. Because different types of crisis are managed by different types of institution, the factors governing success and failure may vary from case to case. The most important disadvantages relating to different types of crisis are summarised below.

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Natural and environmental crises. The physical geography of a country or region is a major influence on the incidence of critical situations, while its social and economic structure govern how quickly a critical situation can become a crisis. The success of local management in averting a crisis will reflect the culture of the society in which they work. Four main factors of disadvantaged institutions may be identified: a fatalistic attitude, which encourages passive toleration of a potential crisis; poverty and under-representation amongst potential victims of the crisis; technological backwardness, whereby effective solutions must be provided by external institutions; and individual selfishness, amongst both rich and poor. Selfishness amongst the rich may manifest itself in lack of concern with the fate of the poor; selfishness amongst the poor may be manifest in exploitation of fellow victims through black market dealing, hoarding scarce resources and ‘jumping the queue’ for relief. Political crises: Political crisis is a topical issue. The institutional disadvantages of vulnerable countries include totalitarianism, populist democratic leadership, lack of respect for professionals and experts, and aggressive attitudes towards foreign countries. Totalitarianism is common in countries that are geographically isolated and have limited trading links with countries other than their immediate neighbours. while democracy is more common amongst strategically-located countries that are heavily engaged in trade. However, growing inequalities in income and quality of life within democratic countries, driven by automation, digitisation, and the offshoring of unskilled work, have encouraged the growth of populism. Political instability generated by totalitarianism and populism is both a cause of critical situations and a source of institutional weakness in preventing and mitigating a crisis (Hardman, 2018). Financial crises. One of the key factors that create a critical situation for a country’s financial system is the speculative bubble, and one of the main weaknesses of governments in leading capitalist countries is their unwillingness to establish either laws or social norms that would constrain the development of these bubbles (Shiller, 2000; Wood, 1992). Greedy speculators are allowed to exploit the public’s love of gambling by starting a rumour that some asset will soon appreciate in value. Early purchasers can freely spread the rumour out of pure self-interest (since they have a vested interest in pushing up the price). Nothing is done to curb the herding instincts that encourage others to follow suit. Poor investors usually suffer most because, although their investments may be small, they account for a higher proportion of their total assets, but nothing is usually done to compensate them. Lack of intervention stems from a culture of economic individualism (Robertson, 1933). People should be encouraged to experiment with radical new ideas, it is said, and they need to make mistakes in order to learn from them. Innovative investments should not be deterred because of the possibility of failure. Financial regulation is bureaucratic; the compliance costs discour-

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age innovation and lead to economic stagnation. This view is particularly popular with democratic governments; a speculative boom is good for politicians in power, who want to ‘keep the party going’ for as long as possible, and certainly until the next election. A culture of economic individualism may therefore be described as an institutional disadvantage when managing financial crises. It tolerates, and in some cases actively promotes, gambling, speculation, herding, and greed. Furthermore, political opportunism discourages early intervention; democratic governments normally intervene, if at all, to mitigate the most serious consequences once the bubble has burst. Economic crises. Economic policy is basically about matching needs (or wants) to available resources. Critical situations develop when either there is an unexpected shortage of key resources, or the market mechanism fails. In a growing economy, for example, labour is a key resource, and a shortage of labour can therefore limit growth. Market failure, however, can have the opposite effect. If a minimum wage, set by government or trades unions, exceeds the market wage then not everyone can get a job. The Keynesian multiplier may amplify the loss of jobs, as the loss of wage income reduces consumer demand and further reduces the demand for labour (Keynes, 1936). A common feature of both these cases is that labour is not sufficiently productive. In the first case labour is not sufficiently productive to sustain the target level of growth, and in the second case it is not sufficiently productive to match the expectations of living standards held by government and workers. The two cases differ, however, in the implications for labour incomes. When labour supply limits growth there is full employment and long-term prospects are potentially good, while when labour demand limits employment there is unemployment and the long-term prospects are poor. The second case is therefore more socially divisive than the first. A key economic disadvantage for both government and society, therefore, is low labour productivity. Where low productivity leads to mass unemployment it increases economic inequality and may engender a sense of exploitation. Low productivity arises when society undervalues education, training and self-discipline. A political culture of blaming low productivity on labour exploitation may distract attention from the real cause of the problem. Industry-specific crisis. Declining sales, increasing costs and declining rates of return on assets are all symptoms of a critical situation in an industry. A decline in financial performance may, however, be regarded as purely temporary, reflecting a false assumption that external factors will quickly reverse themselves. Changes in customer preferences may be dismissed as passing fads, and new technologies ignored on the grounds that they will never work. Owners and managers may ignore external evidence due to laziness, or preoccupation with internal management issues. A key industry-specific

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disadvantage is therefore complacency: a belief shared by industry leaders that for one reason or another there is nothing to worry about. Industry leaders may believe that their trade associations are powerful and can lobby for government subsidies or protectionism as and when required. This may be correct in the short-run, but changes in political agenda may leave the firms vulnerable in the long-run. For example, the unexpected rise of foreign competition in the late 20th century posed major challenges to many traditional Western manufacturing industries.

6 CONCLUSIONS Crises attract attention. They make good news stories and boost the revenues of the media. They often cause controversy about who is to blame. Crises use up resources, increase poverty, widen social divisions and often sow distrust. On a positive note, however crises sometimes create heroes – such as ordinary citizens who ‘step up’ and do extraordinary things. Crises can also elicit compassion for their victims, and boost social solidarity. The end of a crisis is often accompanied by calls to retain the community spirit created by the crisis; indeed crises are often commemorated by monuments, memorials or special historical sites. Geologists and anthropologists have studied crises because they have changed the physical landscape and created mass extinctions of species, and thereby influenced the evolution of modern forms of life. Historians have studied crises because of their legacies, in re-drawing national boundaries, prompting mass migrations and promoting social and political revolutions. Economic theories of business cycles would not exist if were not for the periodic crises that have interrupted the growth of national economies. This chapter has analysed crises from a new theoretical perspective. It has distinguished throughout between a critical situation and the crisis that follows. The type of critical situation that develops is often highly contextualised. For this reason a classification of crises was developed. This classification reflects both the forces that create the critical situation and the magnitude of the problem. The quality of leadership and management are key determinants of whether a critical situation develops into a crisis. A management team that has failed to prevent a critical situation from developing is unlikely to have the capability to prevent or manage an ensuing crisis. This highlights an important policy implication: that when a critical situation is preventable the leadership and management need to be replaced as soon as a critical situation develops; only a new team will have the capability to avert or manage a crisis. In any critical situation it is useful to distinguish between the trouble-makers, the victims, and the trouble-shooters. Trouble-makers are more common in

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certain contexts, e.g. war, than in others, e.g. natural disasters. In IB literature governments, regulators and trade unions have all been portrayed at various times as trouble-makers. It is important to recognise, however, that when a critical situation develops there is a lot of finger-pointing in order to re-direct the blame. Trouble-shooters tend to be the heroes of any crisis, but this may be because they get to write the story themselves; they may excuse their mistakes by exaggerating the constraints they faced. It is powerful interests, and not ordinary people, who normally decide which trouble-shooters to bring in. The victims often have little voice. A trouble-shooter may do a brilliant job for the people who appointed them, whilst everyone else receives little help. IB studies has engaged with crises is a relatively modest way. It has focuses mainly on firm-specific crises. It has viewed the issue of crisis in reverse, focusing on successes rather than failures. Conventional theory is asymmetric however: the success of a firm is attributed mainly to the possession of intangible proprietary assets, while a crisis of the firm is implicitly attributed to management failures. This chapter has presented a more symmetric view, in which the advantages exploited by a successful firm are the reverse of the disadvantages possessed by a failing firm. Thus for every advantage identified by theory there is, in principle, a corresponding disadvantage; the former explains success, and the latter failure. Thus management skills may be important in acquiring proprietary assets, and so contribute to success, while management weaknesses may incur the loss of these proprietary assets, and so contribute to failure. Thus the same set of key factors that are present in success are missing in the case of failure. To achieve symmetry, ‘firm specific advantage’ should include not only the possession of unique technologies, brands and other assets, but access to the personal entrepreneurial skills that enabled these assets to be identified and appropriated in the first place. Conversely, ‘firm-specific disadvantage’ should include both the lack of key proprietary assets, such as the technologies and brands possessed by other firms, and also the lack of the management skills required to sustain and renew such assets. In addition, theory should recognise the difficulty of recruiting a suitable team of managers to exploit these assets efficiently. Firm-specific advantage should also include the skills required to select and retain managers with appropriate skills, using appropriate rewards, while firms-specific disadvantage should include the lack of such skills. One way of developing this approach would be to integrate the theory of firm-specific advantage from IB theory with theories of entrepreneurship and management capability derived from entrepreneurship theory, strategic management theory, resource-based theory and the ‘dynamic capabilities’ theory of the firm. Entrepreneurship would enable the firm to identify and

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then pre-empt an opportunity to exploit new technologies and brands, while management capability would allow the firm to recruit and motivate a team of people to organise the production and distribution of the product. Thus entrepreneurship leads to the acquisition of proprietary assets while management capability ensures that they are exploited effectively. This approach can not only provide an integrated theory of business success but also a comprehensive theory of business failure too. Reversing the analysis indicates that crisis and failure in an individual firm ensue from failing to anticipate and react to competitive threats, failing to renew technologies and brands, and failing to recruit and retain managers with appropriate skills.

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Casson, M. and T. da Silva Lopes (2013) Foreign direct investment in high-risk environments: An historical perspective, Business History, 55(3), 375–404; https.//doi​ .org/​10​.1080/​00076791​.2013​.771343 Clementi, G. L., T. Cooley and S. Di Giannatale (2010) A theory of firm decline, Review of Economic Dynamics, 13(4), 861–885 Cool, K., I. Dietrickx and L. Almeida Costa (2016) Diseconomies of time compression, in Augie, Mie and David J. Teece, Palgrave Encyclopaedia of Strategic Management, https://​doi​.org/​10​.1057​.978​-1​-349​-94848​-2​_473​-1 Coombs, T. W. and D. Laufer (2018) Global crisis management: current research and future directions, Journal of International Management, 24(3), 199–203 COVID Scarring (2021) https://​english​.elpais​.com/​society/​2021​-04​-12/​the​-enduring​ -scars​-of​-covid​-19​.html, accessed 26/05/2021 Dale, R. S., J. E.V. Johnson and L. Tang (2005) Financial markets can go mad: evidence of irrational behaviour during the South Sea Bubble, Economic History Review, 58 (2), 233–271 Dash, M. (1999) Tulipomania: The Story of the World’s Most Coveted Flower and the Extraordinary Passions it Aroused, London: Gollancz De Bonis, R., A. Giustiniani and G. Gomel (1999) Crises and bail-outs of banks and countries: Linkages, analogies and differences, World Economy, 22 (1), 55–86 Duca, J. V. (2021) Subprime mortgage crisis, 2007–10, Federal Reserve History, https://​www​.f​ederalrese​rvehistory​.org/​essays/​subprime​-mortgage​-crisis, accessed 26/05/2021 Dunning, J. H. and S. M. Lundan (2008) Multinational Enterprises and the Global Economy, 2nd ed., Cheltenham: Edward Elgar Fainshmidt, S., A. N. Mair and M. R. Mallon (2017) MNE performance during a crisis: An evolutionary perspective on the role of dynamic managerial capabilities and industry context, International Business Review, 26, 1088–1099 Fitzpatrick, M. (1983) The definition and assessment of political risk in international business: A review of the literature, Academy of Management Review, 8(2), 249–254 Garber, P. (2001) Famous First Bubbles: The Fundamentals of Early Manias, Cambridge, MA: MIT Press Garside, W.R. (2007) The Great Depression, 1929–1933, Economic Disasters of the Twentieth Century, Cheltenham: Edward Elgar, 51–82 Goldgar, A. (2007) Tulipmania: Money, Honour and Knowledge in the Dutch Golden Age, Chicago: University of Chicago Press Hardman, I. (2018) Why we get the Wrong Politicians, London: Atlantic Hayek, F. A. von (1933) Monetary Theory and the Trade Cycle, London: Jonathan Cape Houben, M. (2005) International Crisis Management: The Approach of European States, Abingdon: Routledge Johnman, L. and H. Murphy (eds.) (2005) Scott Lithgow, Oxford: Oxford University Press Jones, E. L. (1988) Growth Recurring, Oxford: Clarendon Press Jones, G. and C. Lubinski (2012) Managing political risk in international business: Beiersdorf, 1914–1990, Enterprise and Society, 13(1), 85–119 Keynes, J. M. (1936) General Theory of Employment, Interest and Money, London: Macmillan Klepper, S. and K. L. Simons (2005) Industry shakeouts and technological change, International Journal of Industrial Organization, 23(1), 23–43 Knight, F. H. (1935) The Ethics of Competition, London: Allen & Unwin

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Mann, T. (1971) Buddenbrooks: The Decline of a Family (trans. H.T. Low-Parker), Harmondsworth: Penguin Books Marquhardt, S. (2001) Green havoc: Panama disease, environmental change and labour process in the Central American banana industry, American Historical Review, 106(1), 49–81 Mulcahy, M.(2004) Weathering the storms: Hurricanes and risk in the Greater Caribbean, Business History Review, 78(4), 635–663 Neal, L. (1998) The financial crisis of 1825 and the restructuring of the British financial system, Federal Reserve Bank of St. Louis Review, May/June, 53–7 Odell, K.A. and M.D. Weidenmier (2002) Real shock, monetary aftershock: The San Francico earthquake and the panic of 1907, Working paper No. 9176, Cambridge, MA: NBER Oliver, M. J. (2007) Financial Crises, in Michael J. Oliver and Derek H. Aldcroft (ed.), Economic Disasters of the Twentieth Century, Cheltenham: Edward Elgar, 182–235 Oxford Dictionary (2021) www​ .oxford​ learnersdi​ ctionaries​ .com ‘Crisis definition’, accessed 14/05/2021 Parker, S. C. (ed.)(2007) The Life Cycle of Entrepreneurial Ventures, New York: Springer Piketty, T. (2014) Capital in the Twenty-first Century, Cambridge, MA: Belknap Press of Harvard University Press Reid, M. (1982) The Secondary Banking Crisis, 1973–5, London: Macmillan Robertson, H. M. (1933) Aspects of the Rise of Economic Individualism, Cambridge: Cambridge University Press Rose, M. (1986) The Gregs of Quarry Bank Mill, Cambridge: Cambridge University Press Rothbard, M. N. (1962) The Panic of 1819: Reactions and Policies, New York: Columbia University Press Schumpeter, J. A. (1939) Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process, New York: McGraw Hill Shefrin, H. (2016) Behavioural Risk Management, New York: Springer Shiller, R. J. (2000) Irrational Exuberance, Princeton: Princeton University Press Teece, D. J. (2018) Business models and dynamic capabilities, Long Range Planning, 51(1), 40–49, https://​doi​.org/​10​.1016/​lrp​.2017​.06​.007 Verbeke, A. (2013) International Business Strategy, 2nd ed., Cambridge: Cambridge University Press Voth, H. J. (2003) With a bang, not a whimper: Pricking Germany’s stock market bubble in 1927 and the slide into Depression, Journal of Economic History, 63 (1), 65–99 Wood, C. (1992) The Bubble Economy: The Japanese Economic Collapse, London: Sidgwick & Jackson

3. International rivalry and global business leadership: an historical perspective 1 INTRODUCTION This chapter presents an outline history of international business (IB) activity over the past eight hundred years. The focus is on international rivalry for leadership in global production and trade. The historical evidence is interpreted using modern IB theory. New insights are gained by applying a familiar theory in an unfamiliar historical context. The findings have significant policy implications; in particular they shed new light on current political and economic tensions between China and the US. IB studies tends to concentrate on foreign direct investment (FDI) rather than trade. When trade is discussed, the focus is usually on exports, which are considered as alternatives to FDI. It is almost impossible, however, to separate the history of FDI from the history of trade. FDI developed as a spin off from trade and not as a substitute for it. Imports as well as exports also play a vital role in the history of FDI. For historical reasons, therefore, the scope of this study is wider than in most other studies of FDI. The same applies to technology transfer. IB studies is mainly interested in technology transfer when it is effected through FDI. Licensing, for example, is often treated as if it were a purely hypothetical alternative to FDI. Technology transfer through industrial espionage or state-sponsored talent-hunting is not usually emphasised, except in the HRM and migration literatures (Horton, Kent and Stanton, 2017). Yet historically these are all important mechanisms of technology transfer. This study therefore takes a broad view of technology transfer too. There have been repeated calls for a more historical perspective on FDI (Hertner and Jones, 1986; Lopes, Casson and Jones, 2019). These calls have been answered, in part, by the publication of business histories of leading multinationals (MNEs) (Ferrier and Bamberg, 1982–2000). The role of economic history remains largely ignored, however. Economic history has a wider scope than business history because it describes the economic and political 50

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environment in which MNEs operate; it describes how MNEs respond to this environment, and how the environment responds to the collective impact of MNEs (Baumol, Mokyr and Landes, 2010). This chapter widens the agenda of IB studies by introducing the economic history of IB as a new stream of IB research. The chapter demonstrates the advantages of the economic history approach. It addresses ‘big picture’ issues that may get overlooked when the focus remains sharply on individual firms. It also takes a long view. Taking a long view affords new insights into theory, as it shows how theory-driven forces have operated in the past under unfamiliar conditions. It shows that popular interpretations of IB theory have been somewhat biased by applying the theory mainly to contemporary conditions. This chapter shows how theory applies to unfamiliar, but well-documented, conditions in the past. When presenting IB in historical context the scope of the study needs to be broadened in several different ways. Economic history shows that IB activities regularly interact with domestic activities, so that analysing one without the other is problematic. This study is therefore concerned with global business as a whole, treating FDI as a special case. FDI also needs to be defined in an appropriate way. It is also important to recognise that the modern corporation, with joint-stock ownership and managerial control, is a relatively recent phenomenon. Until the mid-nineteenth century most businesses were partnerships, often between family members, and were on average much smaller than they are today (Wilson, 1995). Yet many of these early businesses employed people abroad, or owned property abroad, as explained below. These foreign assets are regarded in this chapter as early forms of FDI. Early IB research had a strong Western orientation, with a strong focus on US investment in Europe. The origins of IB, however, were well before the US existed. Brazil, for example, was an important destination of Portuguese FDI in the sugar industry by the sixteenth century (Lockhart and Schwartz, 1983). IB research has since expanded geographically to provide a global coverage of countries. Economic history has always been global to some degree, and this history is therefore global too. Removing the US-European bias is not only necessary for historical purposes; it also makes it possible to present established theory in a more balanced way. The most important point to emerge from this study is that there is competition between nations and well as competition between firms. These two forms of competition interact. Nations use their leading firms as instruments of international policy. Conversely, leading firms rely on political and financial support from their home nations. It is the interplay of firm and nation state that has driven the evolution of IB over the last eight hundred years.

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2 METHODOLOGY This chapter is not structured as a conventional historical narrative. The historical evidence is presented in a conventional historical format in Casson (2019). This can usefully be read in conjunction with Dunning (1983) and Jones, G. (2002, 2005). Additional points have been derived from Casson and Casson (2013) and Lopes, Casson and Jones (2019). These books and papers cite numerous sources for the both the business history and the economic history of IB. International competition involving firms and nations has been studies by many scholars, but most notably by Jones, E. (1981) and, more recently, Bernholz and Vaubel (2004). The specific contribution to theory made in this chapter comprises the eight key propositions set out in section 3. Each proposition is derived from historical evidence, and translates historical insight into a simple theoretical point. All the propositions are compatible with standard IB theory. Some are already very familiar; in these cases history confirms the long-run validity of the theory. Other points are not so familiar. They reveal new insights regarding the interaction of firm and state. They show that the full implications of theory are best appreciated by examining how theory works under a wide variety of different historical conditions. The period of the study is as long as sources permit, and the geographical scope at any time is as wide as these sources permit. The survival of written sources is the major limitation of the study (Lewis and Moore, 1999). The study begins c.1200 and runs continuously for eight hundred years down to the present day. The geographical scope encompasses Western Europe and its colonies (i.e. North and South America, Africa and Australia). Early information on Asia and the Middle East is also available, but is more limited. Information on China is very limited owing to the loss of early records. The implications for policy are summarised in section 4 and the implications for theory development in section 5.

3

STRATEGIC ASPECTS OF FDI IN A LONG-RUN GLOBAL CONTEXT

Proposition 1. International trade stimulates FDI. From a historical perspective the origins of FDI are closely connected with the development of long-distance trade. Continuous records of organised trade in Western Europe go back to c.1250. They show that trade was organised by individual merchants, who often collaborated with other merchants, who might be family relatives, or members of the same club, association, or guild. Trade

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was often initiated by a merchant in the exporting country, but the need for return cargoes to cover transport costs encouraged exporting and importing to be linked (Dollinger, 1970). The development of regular trade on long-distance routes often benefitted from having a permanent representative in the foreign port. The representative could distribute the exports to local customers, and buy up goods from local suppliers ready for the return voyage. It was therefore useful to own a warehouse at the port for the storage of goods, namely exports from the home country awaiting local distribution and imports to the home country awaiting shipment. A permanent representative was sometimes an independent agent and sometimes an employee (Cools, Keblurek and Nolaus, 2006). The independent agent had an arm’s length relationship with the merchant, and they worked on commission or for a fixed fee. The employee, however, was internal to the mercantile enterprise and therefore represented an early form of FDI. The warehouse could be rented by the home merchant, or owned by them, or it could be rented or owned by their independent representative instead. So long as the merchant either employed their representative or owned their warehouse there was some form of FDI. If the local representative was a business partner of the home-country merchant then an international joint venture was involved. Early arrangements of this kind did not normally involve a joint stock firm, as indicated above. The closest analogues of the modern corporation were chartered trading companies, and some highly-organised urban guilds. Many arrangements involved partnerships between friends and relatives; sole traders were uncommon because of the large amount of capital, and the high degree of risk, involved. Trade also needed to be financed, and international trade required currency exchange. Merchants attending international fairs found it risky to carry large amounts of currency on their person and this created a demand for international branch banking involving the clearance of debts between different accounts held at same bank. The branch banking system organised by the Italian ‘supercompanies’, such as the Medici Bank, represented another form of trade-related FDI (Hunt, 1994). Trade and FDI were therefore complementary from an early date. They remain complementary today. Major exporters often access a foreign market through a sales subsidiary. This subsidiary may own or rent a warehouse, and employ various workers, including delivery drivers and sales staff. Sales subsidiaries may have considerable autonomy in the way they organise logistics, but little autonomy in the way in which they manage and protect the brand (UK government, 2020).

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So why are exports and FDI so often regarded as substitutes in modern IB? While IB theory recognises that trade and FDI may be complements in resource-seeking FDI, it tends to emphasise market-seeking FDI instead. The emphasis on substitution arises because the theory of market-seeking FDI focuses on the location of production rather than the location of distribution (Buckley and Casson, 1998). Location of production at home (exporting) is a direct substitute for location of production abroad (FDI). Location of distribution is not regarded as an issue in simple statements of the theory because it is assumed to be always local. But this leaves open the question of whether distribution is locally owned or not. Simple expositions of IB theory implicitly assume that it is independently owned. This can be deduced from the fact that in simple statements of the theory FDI is never associated with exporting. In practice, however, there are strong grounds for internalising distribution. Some of these reasons applied in the distant past: namely better inventory management and quality control. These reasons have been reinforced in recent times by the need to manage and protect the reputation of international brands (Lopes, 2007). Statistical evidence from company data shows that major exporters routinely establish sales subsidiaries in destination counties; however, these subsidiaries are often run from small offices, and as there is often no production plant associated with them they are omitted from any census of production (UK government, 2020). Proposition 2. The flow of FDI is mainly from a rich and powerful country to a weaker one. From a historical perspective the direction of FDI has been typically from a rich and powerful country to a poorer and less-powerful one. Modern IB theory suggests that ‘powerful’ means ownership of a superior proprietary technology, or some other intangible asset such as a strong brand (Verbeke, 2013; Casson, 2018). History suggests a somewhat broader and more tangible view of power, however. It has often meant military power (Kennedy, 1987). Consider two countries, one of which has superior military power. There are opportunities for trade; for example, one country (the ‘upstream’ country) may have significant endowments of raw materials while the other (the ‘downstream’ country) has the skills to transform the raw materials into finished product. Some of the product can be exported back to the raw-materials provider as payment for the raw materials. This is typical of colonialism, from the rise of the Spanish Empire in the sixteenth-century to the decline of the British Empire in the first half of the twentieth century (Pedler, 1974). Suppose to begin with that the downstream country has superior military power. They may threaten to attack the upstream country unless they are given favourable terms of trade. They may prefer, however, to consolidate

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their power by invading the upstream country and taking possession of the raw materials. This was a practice in the sixteenth and seventeenth centuries and was typically a two-stage process. In the first stage the upstream country was conquered and a colonial government or local ‘puppet dictator’ was put in control. The new government then reformed property ownership. Common property was ‘privatised’ and concentrated in the hands of a local elite. Ordinary people might be allowed to retain a smallholding attached to their house. In the second stage the local elite sold some of their extensive lands to foreign investors from the powerful country. Foreign investors were mainly interested in the most valuable land where key raw materials were located. These were acquired by firms headquartered in the more powerful country. Many of these firms have been described as ‘free-standing’, because all their tangible assets were located outside their home country (Wilkins and Schroter, 1998). FDI in such countries was therefore mediated by a process of colonisation in which property in the occupied country was turned into a saleable commodity before being acquired by foreign firms. History demonstrates numerous variants on this theme. In some cases the population of the occupied country was enslaved; they become servants of the local elites, or, in a worst-case scenario, were sent as forced labour to work on plantations or in mines. Slavery was prominent in the sugar trade of the West Indies and in the American cotton trade before the Civil War (Beckert, 2014; Olmstead and Rhode, 2018; Williams, 1966). In other cases the occupier imposed a meritocratic system of personal advancement in which native-born individuals deemed to be most able or most compliant were appointed to responsible jobs, and only those deemed less able were required to carry out menial work. This was characteristic of the late-nineteenth-century British administration of India (Mukhopadyay, 2018). In other cases the raw-material rich country may possess the military power. This case generates a rather different form of FDI. It may involve off-shoring the final stages of manufacturing, e.g. sewing clothing and apparel, or off-shoring low-skilled jobs in general, such as packaging and assembly. The UK off-shored penal servitude in the early nineteenth century, and waste disposal in the twentieth century. Cheap labour can be imported into the powerful country to act as factory workers, household servants or to provide basic public services. This labour may be recruited from the less accessible areas of the weaker country where employment opportunities are scarce. Examples include the US FDI in Mexico and Cuba, and UK FDI in the West Indies (Ramirez, 2006: Williams, 1966).

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Proposition 3. A rich and powerful country is normally technologically advanced. The origins of military superiority often lie in superior technology. Since the dawn of history political leaders have sought military advantages by promoting innovations in military technology. Historical examples include innovations in equipment, such as armour; fire-power, such as explosives; construction, such as fortresses and castles; and organisation, such as systems of command and control (Rogers, 2010). Political and military leaders have long recognised the importance of attracting talented inventors who could promote new technologies of this kind (Cunningham, 1897). They targeted specific groups of foreign migrants who they believed possessed valuable knowledge. They offered bounties to talented foreign migrants, and in some cases encouraged them to bring their associates (e.g. their apprentices) with them. In the fifteenth and sixteenth centuries, for example, English monarchs targeted talented metal-workers and cloth-workers in continental European countries in which there was political and religious unrest (Luu, 2005; Ormrod, McDonald and Taylor, 2018). It was also possible to send people abroad as spies. They could pose as diplomats or as wealthy foreign tourists. Espionage was so important in obtaining secret military technologies that in the seventeenth and eighteenth centuries, for example, much European diplomacy was conducted on the assumption that foreign spies were everywhere (Schaffer, 1995). Historical evidence clearly indicates that the political and military elites of leading countries did not normally take endowments of technological knowledge as given. The state of technological knowledge was something they believed that they could control (Cunningham, 1897). In modern terminology, they did not think in terms of Ricardian comparative advantage, where resource endowments are given, but rather in terms of absolute advantage, where resource endowments are created or acquired. They pursued absolute advantage derived from superior technology. Unlike modern advocates of absolute advantage, however, these elites did not see research as the main way forward. The pursuit of absolute advantage was perceived, again in modern terminology, as a ‘zero sum game’. Technology was to be stolen from rival countries. Technology as not conceived as a ‘public good’ that could profitably be shared between countries. Technology was regarded instead as a ‘private good’; it was in the heads and the hands of talented people that leaders sought to recruit. Military superiority demanded absolute advantage. Technology was to be stolen, thereby depriving the loser of the technology they once had. As talented people migrated, the weaker country would lose capability as the stronger country gained it, and the limit to this was reached only when the weaker

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country’s capability was completely wiped out. Such ‘technological warfare’ characterised relations between leading economic powers for centuries. In the Second World, for example, the military superiority of the Allied Forces relied heavily on the ingenuity of talented German emigrants to the UK and the US, and in the ensuing ‘Cold War’, Russian intelligence recruited British and US intellectuals as spies (Fialka, 1997). This emphasis on technological advantage accords well with modern IB theory. Many contemporary critics of comparative advantage theory reject its implications for the very reasons given above. They emphasise the absolute advantage of superior technology instead. Comparative advantage theory remains correct, of course, but only on the assumption that technology and resources are given, and cannot therefore be changed. Relaxing this assumption changes the policy implications in a dramatic way (Narula, 2003). There remains an important difference from modern IB theory, however. Before the late nineteenth century, there was little formal recognition of intellectual property rights (IPR), and patent rights were very expensive to acquire and police (Fitton, 1989). Inventors received social recognition, as did other original thinkers such as authors and composers, but copyright was either non-existent or difficult to enforce. The main exception concerns state monopolies awarded to private entrepreneurs. In Europe in the seventeenth and eighteenth centuries, ‘promoters’ or ‘undertakers’ purchased licenses monopolies to exploit new discoveries from the state. But these monopolies were authorised mainly to raise public revenue; promoting innovation and benefiting the public were usually secondary considerations (Yamamoto, 2018). These licenses (or ‘charters’) were very differences from the licences of today. The lack of IPR meant that international licensing of technology was not really an option until the late nineteenth century. Indeed, many business leaders regarded licensing as an unacceptable strategy right up until the 1980s, and in some cases beyond. Their reasons are related to the issues above. Licensing was very risky because the licensor could not trust the licensee. A licensee could re-sell the technology to others, or invade markets that the licensor had awarded to other people. They could use their experience to improve the technology and then register the new technology as their own. Similar risks applied to consumer brands (Lopes, 2007). Perceived risks varied between countries, e.g. Hong Kong had a very bad reputation, while the Netherlands had a much better one. Where licensing was used, it was often on a cross-party basis; each firm licensed a technology from the other, or partnered them in a patent pool, giving each licensor a sanction against their licensee. The IB literature sometimes regards licensing as a purely hypothetical option rather than a realistic one (see above), but the recent strengthening of IPR through international treaty organisations has made it is more realistic than it was before (Ryan, 1998).

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Proposition 4. Military technology may generate civilian technology as a spin-off. A technology may have multiple applications. A military technology may be defined as a technology developed for military use and refined as a result of experience in war, while a civilian technology is designed for use in peace and improved in the light of production experience and customer response. Civilian technologies can be used by a military power to strengthen, not only its own economy, but the economies of other countries that it controls. While military technology can generate civilian spin-offs, the converse also applies: civilian technologies may have important military uses. Transport and communications technologies are particularly significant in this respect. Aircraft, for example, were developed for military purposes during two world wars, but their major impact has been in civilian use: promoting international business travel, international tourism, and most recently, supporting just-in-time supply chains in high-value intermediate products. Railways illustrate the opposite case. They were developed in the early nineteenth century to carry coal and manufactured goods, and they then diversified into carrying passengers too. They were used in the American War of Independence, 1861–5, and the Franco-Prussian War of 1870, to carry munitions and troops to front-line positions. By the time of World War I, railways had transformed the logistics of war on land (Wolmar, 2009). It is sometimes difficult to determine which came first: civilian or military use. In the fifteenth and sixteenth centuries, ship-building technology and the science of navigation played a crucial role in both war and peace. Large ships designed to carry heavy guns could be adapted to carry bulk cargoes, and vice versa. They could also sail long distances, across seas rather than just along the coasts, making long-distance trade viable for a wider range of products (Gertwagen and Jeffreys, 2012). Proposition 5. A combination of military and civilian technologies facilitates the conquest of foreign territories. Shipping had a crucial impact on colonisation. The gun-power of the large ships made the conquest of territory easier, and especially the capture of major ports. Sailing up-river was more problematic because of the deep draught and the shallow water. Once the port had been captured, the ship could carry away large cargoes of plundered goods. Ships could also be used to export slaves, who were often captured by native tribes and sold to the ship-owners who were keen to satisfy growing foreign demand (Tracy, 1990). Raiding weaker countries was often a poor substitute for settling them. In the ninth and tenth century Viking raiders encountered diminishing returns

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to plundering European settlements, and decided that it was more productive to settle on the fertile agricultural instead. Raid was replaced by trade, which elicited co-operation from the local people (Hadley, 2002). While the raider’s military power may reflect their superior military technology, this technology may be linked to superior civilian technology too. Given that technology at this time was embodied in people rather than in books or plans, settling the country was a useful way of importing civilian technology and putting it to use. Advances in ship design allowed longer voyages to be made. The Venetian explorer Marco Polo, who ‘discovered’ China in 1266, travelled overland, but very soon it was possible to reach China by sea. China was strong enough to resist colonisation, but it failed to develop its international trade as a result (Larsen, 1989). Long-distance voyages of exploration funded by Spanish and Portuguese monarchs led to the colonisation of Latin America, and it was not long before the Dutch, the English and other European powers developed colonies even further away (Tracy, 1990). Proposition 6. Settlement of a conquered foreign territory stimulates infrastructure investment, which in turn encourages FDI in export-oriented production. There are four main reasons why a powerful nation may wish to extent its control of territory. Security It may wish to protect its borders by occupying neighbouring countries. This typically applies to land-locked countries, because island countries have a natural barrier along their coast. Germany after the rise of Bismark in 1871 is a case in point (Morrow, 1943). Population Pressure Productivity gains from new civilian technologies may increase living standards, reducing infant mortality and accelerating population growth. Conquering lightly populated territory permits mass emigration, and alleviates population pressure on land. UK emigration policy after the repeal of the Corn Laws in 1846 is an example (Wakefield, 1849). The native population in the conquered country may be small, and in some cases may be wiped out by low resistance to new diseases (Cook and Lovell, 1992). The two other reasons have been mentioned above.

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Access to Raw Materials These can take various forms; metal ores, such as iron, energy resources such as coal and oil, or soil and climate suitable for agriculture. To secure future supplies of minerals, it may be deemed prudent to acquire the availably stocks outright, rather than by purchase as and when required. Capture of a Market A powerful country may be concerned about the loss of export markets should new technologies or natural resources be discovered elsewhere. It can secure export demand by locking in consumers through conquest, thereby ‘locking out’ rival suppliers. Settlement creates a demand for housing, towns, transport networks, power distribution systems, and so on. It also creates demands for regional and local administration, law and order, medicine, education and sporting and cultural activities. While indigenous people may already have services of this kind, they are unlikely to meet the expectations of settlers from a more powerful, and therefore wealthier, economy. Furthermore, the settlers may wish to display their wealthy conspicuously in order to justify their status (Mosley, 1983). This encourages FDI in infrastructure and, as infrastructure improves, it may also encourage FDI in export-oriented production (e.g. New Zealand lamb and butter exports to the UK). Production for export may take place in the context of an empire or a preferential trading area (British Empire, Soviet Union). Given that the settlers are already familiar with home country preferences, exports may well be concentrated on the home country markets. The incentive to trade with the home country may be strengthened further if, as was often the case, the home country offers preferential arrangements (e.g. lower tariffs) to the settler economy (Brooke, Enders and Rogers, 2016). Domestic infrastructure investment may also facilitate the distribution of imports. If the settlers have a strong preference for home country products then this may further strengthen their ties with the home country. The home country imports consumer products from the home country and exports raw materials or agricultural products to pay for them. A strong bilateral arrangement of this kind between a home country and a settler economy has both advantages and disadvantages for both parties. The advantage is that each country can count on the other for political and military support. Although the stronger country has more to offer the weaker country in this respect, the stronger country may still benefit if it is threated by another strong country, as was the case in the UK during two World Wars.

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A disadvantage is that when a rival country emerges as competing supplier for the home country market, the settler country may find that the home country liberalises its trade arrangements in order to switch to the new supplier. This may leave the settler country in difficulties, because the trade preferences may have disguised underlying problems, such as low productivity and technological obsolescence. This threat became a reality when the UK disengaged from its Commonwealth partners in order to join the European Union (EU); it has now become a threat for the UK itself as it disengages from the EU and seeks to make trade agreements elsewhere. Proposition 7. Technology transfer from a powerful country to a weaker one risks building up the weaker country into a rival power. This is a fundamental proposition with very significant policy implications. It is not a new proposition, by any means, but it is somewhat understated in recent debates on IB policy. It has often been assumed, at least implicitly, that private enterprise and free markets are the best way to organise any economy, and that no economy that fails to fit this model can ever succeed in challenging one that does. Historical evidence does not support this view, however. In the early modern period authoritarian countries such as France, Spain and Portugal achieved significant power. It did not last, of course, but then neither did the power of later free-market economies such as the Netherlands and UK. Certain features of a leading economy may delay the onset of decline, but there is disagreement about what these features are. Work ethic, respect for authority, equality of incomes, freedom of association and freedom of thought are just a few of the qualities that have been suggested (Lall, 1998; Lynn, 1991). This chapter does not engage with this question. The proposition is simply that, whatever the characteristics of a leading country, it is always under threat. According to internalisation theory, an important motive for outward FDI is to maintain control of a technology used in overseas production. It is postulated that FDI is more secure than alternative contractual modes such as licensing. But there are risks even with FDI. Historical evidence suggests that even with patent protection and the security of FDI, loss of leadership is possible. This applies to the individual firm, and to the nation state as well. To elaborate on this point it is useful is distinguish two types of knowledge: strategic knowledge, which is knowledge of an entire production system and how it needs to be configured, and instrumental knowledge, which is more specialised technical knowledge about how one element of the system works. It is relatively easy for someone with strategic knowledge to identify individuals with appropriate instrumental knowledge, but more difficult for a person with instrumental knowledge of a single element to acquire strategic knowledge

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of the system. Strategic knowledge is key to radical innovation, particularly where international supply chains are involved. It indicates how a supply chain is to be configured and the most appropriate method of coordination (e.g. subcontracting or FDI). Strategic knowledge is very scarce, and is possessed by highly talented people, while instrumental knowledge is also scarce, but to a lesser degree. Strategic knowledge confers military and economic strength on the country, but instrumental knowledge merely equips a country to participate in supply chains designed and organised by more powerful countries. UK military power in the nineteen the century stemmed strategic technologies for steam-powered transport by rail and sea. Germany power in the early twentieth century stemmed from strategic knowledge in steel and chemicals, while US power in the mid-twentieth century stemmed from strategic knowledge of the mass production methods for durable consumer goods. US power has extended into the twenty-first century through strategic knowledge of computing and the internet (Bauer and Latzer, 2016). The change of leadership from the UK to Germany to the US illustrates the difficulty for any nation of retaining strategic leadership in a technology for very long. As a technology matures, leading countries tend to get locked in, by focusing on incremental improvements that perfect the existing technology (see e.g. David, 1985). These incremental improvements generate decreasing returns to research effort, and distract attention from new more radical opportunities that are opened up. Strong nations have several ways in which they can mitigate the risk of catch up, but none of them is particularly effective. For example, they can restrict the type of knowledge transferred abroad; this method is used to protect state secrets, but is very expensive for a private enterprise to implement. They can also learn from the countries that are learning from them, but this merely prevents them from falling behind, and does not safeguard their leadership. In the nineteenth and twentieth centuries weaker nations became very adept at catching up (Gerschenkron, 1968). As high-technology products were exported more widely, it became easier to reverse-engineer strategic technology by purchasing samples of the product. The globalisation of supply chains disseminated instrumental knowledge widely, and allowed enterprising weaker countries to synthesise this knowledge into strategic knowledge. The growth of university education made it easier for foreign students and researchers to master the scientific underpinnings of strategic knowledge. A rival country could acquire strategic knowledge by pooling the knowledge of returnees (Schmidt, Mansson and Dolles, 2014). The post-war policy consensus amongst leading Western nations, based on globalisation and world development, has promoted the notion that the diffusion of technologies from strong countries to weaker countries is a win-win

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situation. Development agencies, funded indirectly by strong countries would improve education , health and institutional quality in weaker countries (Sachs, 2008). Workers in these countries would acquire instrumental technologies that would equip them to participate in global supply chains. They were expected, however, to play only a subordinate role. Profit would be extracted by the supply chain leader, based in a strong country, that possessed a strategic technology created by their highly talented researchers. Implicit in this view was that workers in weaker ‘developing’ countries would acquire only instrumental technology. As development progressed, it was thought, developing countries would compete against each other for off-shore production, reinforcing the bargaining power of the supply chain leaders. Workers in developing countries would become marginally better off, while talented researchers and investors in the supply chain leaders would become substantially better off. In practice, however, not all weaker countries have developed as fast as expected. While some have achieved significant improvements in living standards, they are not always much better off in absolute terms because their initial standard of living was so low. Other countries have not developed much at all. This has meant that competition for off-shore production has not been so intense as would otherwise have been the case. This is a benefit to the countries that have developed, a loss to the countries that have not developed, and also a loss to the supply chain leaders who have less market power over their suppliers than they anticipated. Furthermore, there have been major losers amongst some of the strong countries, such as the US, where unemployment as risen as workers whose jobs were offshored have been unable or willing to take jobs elsewhere (Espejo, 2015). Some weaker countries set out to acquire not only instrumental technologies but strategic ones too. As early as the 1960s Hong Kong was assimilating a range of different technologies at a significant rate. In the 1970s Japan emerged as a major force, taking the lead in the automobile industry. Other ‘Asian Tigers’ emerged in the 1980s, and in the 1990s there were great hopes for the BRICs. These ‘newly industrialising’ or ‘emerging market’ economies developed state-owned multinationals that invested in leading countries with the objective of acquiring strategic technologies and mass-marketing skills (Williamson, 2013). For most of these countries the results have been mixed. Even where they gained a foothold in foreign markets, or established links with local universities, their foreign investments have not always been profitable. One country stands out as being successful, however. China has acquired strategic technologies from strong Western countries, notably the US, and has successfully challenged firms based in these countries, both in their home markets and in third-country markets too.

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Proposition 8. The path to economic power has been broadly the same for all successful countries. Post-Maoist Chinese strategy has been similar to the technology acquisition strategies of the middle ages, the ‘catch up industrialisation strategies’ of the nineteenth century, and the FDI strategies of other emerging nations in the twentieth and twenty-first centuries. Some historical attempts at winning power were successful and some were not. Some successful countries sustained their leadership for longer than others, but all eventually lost it. Those that succeeded and then sustained their leadership pursued their strategies in a sophisticated way. They were good at identifying both opportunities and threats. They identified weaknesses of established rivals that they could exploit to achieve their dominance, and also threats from potential rivals that they needed to deter in order to retain their position for as long as possible. Some historically powerful countries have enjoyed natural geographical advantages, but no single advantage seems to be crucial. Some leading countries like the UK and Japan are small islands, while Germany, China and the US are large countries that are part of even larger continents. Rivers are key in land-locked countries, but while the US is well-served by rivers, large parts of Germany are reliant on the Rhine, which borders other countries. These countries may have enjoyed advantages derived from social and institutional arrangements but, as noted above, there is no agreement what these are. China’s recent success seems to derive in large part from learning the ‘lessons of history’ and translating them into modern terms. It has mastered classic forms of state-craft, such as collecting foreign intelligence in a systematic way (Hannas and Mulvenon, 2013). It has used foreign universities as a training ground for its researchers, and encouraged them to gain employment with major foreign firms before returning home. It has secured the raw materials it needs to exploit its new manufacturing technologies from neighbouring countries and from other continents, using both long-term contracts and FDI for this purpose. It has offered cheap loans to governments in developing countries in order to finance their share of these investments. In Africa it has financed and constructed new railways to link inland mines with coastal ports. It has also proposed a ‘belt and road’ initiative to link China to Europe, the Mediterranean and the Caspian Sea (Buckley, Clegg, Cross, Liu, Voss and Zheng, 2007; Yueh, 2016). These strategies are remarkable similar to those of British governments in the Age of High Imperialism, 1870–1914. British embassies collected commercial intelligence from embassies across the world, and then circulated the reports to relevant ministers that in turn contacted leading forms to alert them of emerging business opportunities. It encouraged prospectors and speculators

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from across the world to float companies in the London capital market. Many railways, both inside and outside the British Empire, were financed in this way. They were often built by British civil engineers working with British contractors supervising local gang-masters who recruited local labour (Boughey, 2009). Many modern Chinese strategies resemble the strategies of UK imperialism. There are differences in implementation, however. Perhaps that most important is that Chinese FDI relies heavily in state finance, whereas the UK relied on private finance. Some commentators regard this as a vital weakness in the Chinese strategy, but only time will tell. It is difficult to assess the long-term financial returns from British strategy because most of the early FDI was divested to pay back the loans taken out to finance two World Wars. Similarly it is difficult to assess the financial returns to China until the extent of loan defaults becomes clear. The real question, it might be said, is why China is the only country that has succeeded in challenging Western leadership, rather than why it has managed to do it at all. Since the end of World War II Western industrial policies have implicitly assumed that Western supremacy is a given, The West has ignored the fact that leadership has moved between countries in the West, that such movement has always proved hard to resist and that there is no reason, in principle, why leadership, when it changes, has to pass to another Western country. There are other countries that can learn the true ‘lessons of history’ by studying the Chinese experience. India is a case in point. Like China, it has a large territory, a large population and good supplies of coal. Furthermore, its legacy of colonisation gives it good ports, an extensive railway system and a good awareness of English language and Western culture. It is, however, a country with many different regional cultures, some of which, it is alleged, value social status rather than business achievement (Lall, 1998). It is possible that it has been two preoccupied with managing long-standing internal conflicts to take full advantage of new external opportunities.

4

FDI AND IMPERIALISM: ITS RELEVANCE TODAY

Since the end of World War II the US has been the dominant global power. This raises the controversial question of whether the US can be viewed as a modern imperial power. US politicians deny this, but their critics disagree (Wallerstein, 2004, 2013). For historical reasons, the US perceives the UK as an imperialist, and itself as a victim of imperialism in the past. The US, it is said, decisively rejected British imperialism in 1776, and has denounced imperialism in general ever since.

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There are, however, different forms of imperialism: formal imperialism, such as British control of the West Indies, or informal imperialism, such as British influence in Argentina, are both are linked to FDI (Casson, Dark and Gulamhussen, 2009). The US may not have been a formal imperialist, but informal imperialism is a more difficult accusation to refute. From the 1920s onwards, it could be said, the US acted as an informal imperialist in different parts of the world, in pursuit of oil, tropical products, cheap labour and captive export markets. The locations include South-east Asia, Latin America and the Middle East. The US acquired not only an economic presence but a military presence too, giving it control, not only of the Atlantic, but the Gulf and the Pacific too. Indeed, it was allegations of US imperialism in post-war Europe that indirectly gave rise to modern IB theory. After World War II labour was in short supply in the US, and transatlantic transport costs were high. Europe was a cheap-labour location in which to produce US products for the European market (Vernon, 1966, 1970). The US occupied part of Germany and funded much of European reconstruction though its generous Marshall Plan. The repatriation of profit from US European subsidiaries became a political issue, however. Political radicals on both sides of the Atlantic took a critical view of profit repatriation, especially when viewed from a Marxist perspective (Rowthorn and Hymer, 1971). Modern IB theory reconciled, to some degree, opposing political views on this issue. The profit was a payment for the use of intellectual property created in the US. It was a win-win situation. The US specialised in developing civilian technology and Europe specialised in manufacturing production. So long as Europe stuck to instrumental technology, the US could monopolise the strategic technology and extract its profit accordingly. This analysis became a key component of the ‘Washington consensus’ – a global policy stance that embraced wider global issues . At the end of World War II the economic development of poorer countries also became, by default, a US responsibility, and the Washington-based World Bank was established for this purpose. From a US perspective, what worked for Europe could work for developing countries too. Indeed, war-torn Europe resembled, to some extent, a ‘re-developing’ country. Poor countries were encouraged to invest in education, health and good government, and to master instrumental technologies. This would allow them to attract off-shore FDI. Powerful countries such as the US would continue to control strategic technologies, however. This policy agenda secured domestic markets and domestic resources in weaker countries for US exports and FDI. This policy stance appears to have given the US a false sense of security. Their political leaders assumed that continued dominance was guaranteed. Since then the US has faced successive threats to its dominance in

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high-technology manufacturing from Japan, Korea, and Germany, and has survived only by ceding global market share to these rivals. There were also potential threats from the BRICS, but these have mostly failed to materialise, mainly because of internal political problems. Sooner or later one of these countries – specifically China – had to succeed. Its success cannot be questioned, but the final outcome still remains uncertain. Following disturbances in Hong Kong, some commentators predict domestic problems in China too, and a possible end to Communist Party control. Even if they are right, however, this might not be the end of the challenge from China. But even if China were to fail, there will be India, or some other country, to contend with, as noted above.

5

CONCLUSION: THE NATIONAL DIMENSION OF FDI

The nation state is important to IB because it is the defining unit, without which there would be no IB to study. Global business would still exist in a politically unified world, but IB, by definition, would not. Given the important of the nation sate, it is surprising that the nation state has not figured more prominently in IB theory. The nation state is relatively passive in most accounts of the theory; differences between states create ‘liability of foreignness’ (Zaheer, 1995) and ‘costs of doing business abroad’ (Hymer, 1976). When the nation state plays an active role in the IB arena, its impact is generally perceived as negative, e.g. protectionist policies lead to trade barriers whilst military threats lead to war. But historical evidence shows that the role of the state has been crucial is developing strategic technologies. The state can fund military R&D that has civilian spin-offs, and promote infrastructure mega-projects to encourage learning by doing. It can head-hunt talented workers from overseas. Its military power can secure access to key resources overseas. Its control of the oceans and the skies can secure international transport and communications, and contribute to cyber-security. IB theory needs to strengthen the national dimension and to pay more attention to the way that national strategy and firm strategy interact. The evidence presented above indicates the nation states of progressive countries have always taken a strong interest in international trade and FDI. For the enterprising state, military policy, foreign policy and economic policy are more closely connected than conventional IB theory suggests.

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Fitton, R.S. (1989) The Arkwrights: Spinners of Fortune, Manchester: Manchester University Press Gerschenkron, A. (1968) Continuity in History and Other Essays, Cambridge, MA: Belknap Press of Harvard University Press Gertwagen, R. and E. Jeffreys (eds.) (2012) Shipping, Trade and the Crusade in the Medieval Mediterranean: Studies in honour of John Pryor, Farnham, Surrey: Ashgate Hadley, D.M. (2002) Viking and native: Re-thinking identity in the Danelaw, Early Modern Europe, 11(1), 45–70 Hannas, W. C. and J. C. Mulvenon (2013) Chinese Industrial Espionage: Technology Acquisition and Military Modernization, New York: Routledge Hertner, P. and G. Jones (eds) Multinationals: Theory and History, Aldershot, Hants: Gower Press Horton, J., W. R. Kent and C. Stanton (2017) Digital Labour Markets and Global Talent Flows, Cambridge, MA: National Bureau for Economic Research Hunt, E. S. (1994) The Medieval Super-companies. Cambridge: Cambridge University Press. Hymer, S. H. (1976) The National Operations of International Firms, Cambridge, MA: MIT Press Jones, E. L. (2003) The European Miracle, 3rd.ed., Cambridge: Cambridge University Press Jones, G. (2002) Merchants to Multinationals, Oxford: Oxford University Press Jones, G. (2005) Multinationals and Global Capitalism: From the Nineteenth to the Twenty-first Century, Oxford: Oxford University Press Karsten, L. (2013) Globalisation and Time, Abingdon: Routledge Kennedy, P. (1987) The Rise and Fall of Great Powers. New York: Random House Lall, D. (1998) Unintended Consequences, Cambridge, MA: MIT Press Larsen, J. (1989) Silk Road, London: Heinemann Lewis, D. and K. Moore (1999) Birth of the Multinational, Copenhagen: Copenhagen Business School Press Lockhart, J. and S. B. Schwartz (1983) Early Latin America: A History of Colonial Spanish America and Brazil, Cambridge: Cambridge University Press Lopes, T. da Silva (2007) Global Brands: The Evolution of Multinationals in Alcoholic Beverages, Cambridge: Cambridge University Press Lopes, T. da Silva, M. Casson and G. Jones (2019) Organizational innovation in the multinational enterprise: Internalization theory and business history, Journal of International Business Studies, 50 (8). 1338–1358 Luu, L. (2005) Immigrants and the Industries of London, 1500–1700, Aldershot, Hants: Ashgate Lynn, R. (1991) The Secret of the Miracle Economy, London: Social Affairs Unit Morrow, I. F.D. (1943) Bismark, London: Duckworth Mosley, P. A. (1983) The Settler Economies: Studies in the Economic History of Kenya and Southern Rhodesia, 1900–1963, Cambridge: Cambridge University Press Mukhopadhyay, A. (2018) Imperial Technology and ‘Native’ Agency: A Social History of Railways in Colonial India, 1850–1920, Abingdon: Routledge Narula, R. (2003) Globalisation and Technology: Interdependence, Innovation Systems and Industrial Policy, Oxford: Polity Press Olmstead, A. L. and P. W. Roade (2018) Cotton, slavery and the new history of capitalism, Explorations in Economic History, 67, 1–17

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Ormrod, M., N. McDonald, and C. Taylor (eds.) (2018) Resident Aliens in Late Medieval England, Turnhout: Brepols Pedler, F. (1974) The Lion and the Unicorn in Africa: A History of the Origins of the United Africa Company, 1787–1931, London: Heinemann Ramirez, M. D. (2006) Is foreign direct investment beneficial for Mexico? An empirical analysis. World Development, 34(5), 802–817 Rogers, C. J. (2010) The Oxford Encyclopaedia of Medieval Warfare and Military Technology, Oxford: Oxford University Press Rowthorn, R. and S. H. Hymer (1971) International Big Business, 1957–67: A Study of Comparative Growth, Cambridge: Cambridge University Press Ryan, M. P. (1998) Knowledge Diplomacy: Global Competition and the Politics of Intellectual Property Rights, Washington, DC: Brookings Institution Sachs, G. D. (2008) Common Wealth, New York: Penguin Press Schaffer, S. (1995) The show that never ends: Perpetual motion in the early eighteenth century, British Journal of the History of Science, 28(2), 157–189 Schmidt, C., S. Mansson and H. Dolles (2014) The new face of talent management in multinational corporations, in Alvestam, C. G., H. Dolles and P. Strom, Asian Inward and Outward FDI: New Challenges in the Global Economy, Basingstoke, Hants: Palgrave Macmillan, 87–114 Schumpeter, J. A. (1934). The Theory of Economic Development. (trans. R. Opie). Cambridge, MA: Harvard University Press Tracy, J. D. (ed.) (1990) The Rise of Merchant Empires: Long-distance Trade in the Early Modern World, 1350–1750, Cambridge: Cambridge University Press UK government (2020) https://​www​.gov​.uk/​government/​statistics/​companies​-register​ -activities​-statistical​-release​-2018​-to​-2019, accessed 16/05.2020 Verbeke, A. (2013) International Business Strategy, 2nd. ed., Cambridge: Cambridge University Press Vernon, R. (1966) International investment and international trade in the product cycle, Quarterly Journal of Economics, 80(2), 190–207 Vernon, R. (1970) Sovereignty at Bay. New York: Basic Books Wakefield, E. G. (1849) A View of the Art of Colonization, London: S.W. Parker Wallerstein, I. M. (2004) World Systems Analysis: An Introduction, Durham, NC: Duke University Press Wallerstein, I. M. (2013) Does Capitalism have a Future? New York: Oxford University Press Wilkins, M. and H. Schroter (eds.) (1998) The Free-standing Company in the World Economy, 1830–1996, Oxford: Oxford University Press Williams, E. E. (1966) British Historians and the West Indies, London: Andre Deutsch Williamson, P. J. (2013). The Competitive Advantages of Emerging Market Multinationals. Cambridge: Cambridge University Press Wilson, J. F. (1995) British Business History, 1720–1994, Manchester: Manchester University Press Wolmar, C. (2009) Blood, Iron and Gold: How the Railways Transformed the World, London: Atlantic Books Yamamoto, K. (2018) Taming Capitalism before its Triumph: Public Service, Distrust and ‘Projecting’ in Early Modern England, Oxford: Oxford University Press Yueh, L. (2016) Globalisation and growth: the case of China, in Belka, M., E. Nowotny, P. Samecki and D. Ritzberger-Grunwald (eds.), Boosting European Competitiveness: The Role of the CESEE Countries, Cheltenham: Edward Elgar, 48–57

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Zaheer, S. (1995) Overcoming the liability of foreignness, Academy of Management Journal, 38(2), 341–63

4. Multinational enterprises and international cartels: the strategic implications of de-globalisation With Peter J. Buckley 1 INTRODUCTION A cartel is an association of independent businesses for the purposes of regulating trade in an industry. This chapter focuses on international cartels (ICs). It examines the relation between international cartels and multinational enterprises (MNEs). There are three important reasons for studying ICs. Firstly, they will become important in the future. (Buckley, 2020). MNEs have dominated post-war trade and investment because US hegemony has promoted foreign direct investment (FDI) and free trade. However, mass immigration and growing income inequality have created popular discontent with globalisation. The rise of Asia and the end of US hegemony may signal a more unstable international political environment. This may lead to greater protectionism in trade and technology, and increased regulation of FDI. Whatever happens, political risks are likely to increase. The coordination of international production and R&D may rely less on the conventional MNE and more on inter-firm contractual arrangements, such as cartels. It is therefore important to understand the strengths and weaknesses of cartels. They have a reputation for sustaining economic inefficiency and inequality, so it is important to know whether such allegations are well-founded. It is also important to know if they afford distinct advantages, such as improving the management of political risks (Barjot, 1994). Secondly, cartels are of immense historical significance (Fear, 2008). Their origins can be traced back to fourteenth-century guilds, and perhaps even earlier (Dollinger, 1970). In the late nineteenth and early twentieth century they played a prominent role in large-scale industry (e.g. steel and chemicals) and the development of new technologies (e.g. electric lighting) (Reich, 1992; Stocking and Watkins, 1946). In the post-war era, however, cartels became 72

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illegal in most leading market economies. They were deemed the enemy of free competition. They were accused of subsidising inefficient and declining industries. It was said that they concentrated economic power in a few hands. In the 1920s some German writers had wrongly claimed that cartels were a German invention, and so after the defeat of the Nazi state they were tainted in both economic and political terms (Piotrowski, 1933). Thirdly, cartels are poorly understood. The classic literature on cartels pre-dates the modern economic theory of monopoly and, with one or two exceptions, the modern theory of monopoly ignores cartels. There is a large literature on monopolistic and oligopolistic firms, but cartels are normally discussed as an after-thought (Caves, 1982). In contemporary competition policy, cartels are simply deemed bad. Three key issues are addressed in this chapter. Firstly, to what extent will increased international political risks encourage the substitution of ICs for MNEs? Secondly, will MNEs that belong to ICs be ‘less multinational’ (e.g. have fewer foreign subsidiaries)? Finally, are ICs more likely to emerge in certain types of industry than in others, and if so, what are the characteristics of these industries? Evidence on cartels is limited. Because of their secretive nature, much of what is known about cartels is sourced from historical business records, the testimony of ‘whistle-blowers’, and official investigations initiated in response to specific complaints (Spar, 2009). The chapter begins by defining ICs (section 2), and then examines their main activities (sections 3). These two sections provide an overview of the topic. The next four sections set out the main theories of cartel behaviour and consider their implications for IB. Section 4 examines the motives for establishing a cartel, while section 5 considers the different ways in which a cartel can be organised. Section 6 compares cartels with more informal alternatives, namely tacit collusion and price leadership, while section 7 examines four main types of cartel which are particularly relevant to IB. The next three sections examine important policy debates. Sections 8 investigates cartel instability, section 9 examines the impact of national culture on cartel solidarity, while section 10 considers the role of interlocking directorships in reinforcing the power of a cartel. Section 11 summarises the conclusions, with special reference to the role of cartels in a de-globalizing world.

2 DEFINITIONS Cartels need to be defined with care. Because ‘cartel’ can be a pejorative term, it is often used loosely, and this has caused confusion in the literature (Mirow, 1982). For the purposes of this chapter, an IC may be defined as a cartel whose member firms, considered as a group, operate in more than one country. This

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definition focuses on the location of production plants rather than the ownership of the firms. It does not require that every member of the cartel produces in more than one country, or that members are headquartered in different countries. The advantage of the definition is that if it is satisfied then a merger between the members would generate an MNE, and otherwise it would not. An international cartel may be contrasted with a domestic cartel, whose members, of whatever nationality, all produce in a single country. Note that the members of a cartel have been defined as businesses. In the post-war period the most important cartels have been inter-governmental cartels, e.g. OPEC. Important lessons can be learned from the experiences of inter-governmental cartels, as indicated below, but they are not the main focus of this chapter. Cartels are often discussed as if they were similar to syndicates, concerns, combines or trusts. This is not the case. A syndicate is usually short-lived and is organised for specific speculative purposes. The aim is often to manipulate prices so that the members can buy cheap and sell dear, e.g. cornering a commodity market, or buying and re-selling shares in a company that is in the news. The members each contribute a certain amount of capital at the beginning and withdraw a proportionate amount of capital at the end. A concern, or combine, is normally a holding company whose constituent firms are autonomous in day-to-day management and operate under independent names; their long-term strategy, however, is dictated by the concern. A trust is managed by a corporate trustee, who holds shares in various firms on behalf of others, and operates these firms to maximise their combined profits. In practice merchant banks and investment banks have often acted as trustees (Jones, 1925; Levy, 1911, 1927; Liefmann, 1932; Plummer, 1934). By comparison, a cartel is coordinated by an agreement or informal understanding between its member firms. If a cartel provides central services, such as an administrative secretariat, then members will have to pay a fee to join. Cartels may be established on the initiative of a third party who is not formally a member of the cartel. The most common example is a government-led cartel. The motivation of the government may be to promote an infant industry, to save jobs in a declining industry, to smooth out fluctuations in trade, or to eliminate foreign competition. In times of political conflict government-led cartels may also be established to gather and share strategic information obtained from, or relating to, hostile countries. Government-led cartels are normally confined to local producers, but these can include the subsidiaries of foreign-owned firms and also locally-headquartered MNEs; they therefore fall within the scope of this chapter. Cartels can also be established on an inter-governmental basis, e.g. to stabilise commodity export markets in developing countries (LeClair, 2000; Schmitz, 1981).

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A cartel may or may not be legal. Legal activities will normally be open and illegal activities secret. Legal activities may nevertheless be kept low-profile to discourage public criticism. A cartel that carries out legal activities may be used as a ‘front’ for carrying out illegal activities too (Connor, 2001). Finally, certain types of cartel are excluded from this analysis; these include purchasing cartels, e.g. the UK National Health Service, which buys in bulk for state hospitals in the UK and negotiates special prices for many medical products. It also excludes trade unions and professional bodies that negotiate wages and salaries on behalf of their members.

3

MAIN ACTIVITIES OF CARTELS

Cartels are very versatile (Mariti and Smiley, 1982). Table 4.1 identifies three main types of activity that cartels can perform: the regulation of trade, the pooling existing resources, and the provision of shared resources. Regulation includes price-fixing, quantity-fixing and capacity-fixing. Price fixing is the re-eminent cartel activity (Connor, 2005). Quantity-fixing involves setting production quotas; while price-fixing sets minimum prices, quantity-fixing sets maximum outputs. Capacity-fixing is used to reduce spare capacity and reinforce limits on production. Pooling includes revenue pools, profit pools and patent pools. A revenue pool aggregates the sales revenues of all the member firms and then divides the revenues between the firms in agreed proportions. These proportions will generally reflect historical market shares. A profit pool divides the total profits of member firms in agreed proportions. A profit pool may appear unduly generous to high-cost firms, but this is not necessarily the case if the profit shares are based on historical levels of profit. A patent pool is rather different. It allows each member to produce a full range of products using the patented technologies of other member firms; it is most attractive when protectionism constrains competition, so that each member dominates their own local market. A patent pool may be regarded as a collection of cross-licensing agreements (see below). The provision of shared resources includes drawing up and enforcing industry standards, which is particularly important in the chemical, pharmaceutical, engineering and information technology industries. It also includes joint funding of industry research facilities, technical education for employees, and the financing of stock-piles to even out fluctuations in demand and insure against disruptions to supply. It may also include political lobbying on behalf of the industry. Some of these roles are also performed by international trade associations.

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Table 4.1

Summary of cartel-related activities

Activity

Actions

Historical examples

1: Regulation of trade Price

Setting minimum prices

Shipping, pharmaceuticals

Quantity

Setting output quotas

Steel quotas

Capacity

Mandating plant closures

Closure of textile mills

Revenues

Allocating shares in total revenue

Mineral industries: diamonds,

Profits

Allocating shares in total profit

Probably exist, but very secretive

Pooling resources

Patent pools. etc.

Electric lighting, industrial

2: Pooling existing resources uranium

chemicals 3: Provision of shared resources Collaborative research

Joint funding of R&D projects

International trade associations in

Collaborative training

Joint funding of technical

Textiles, engineering and metals

high-tech industries institutes, degree programmes, etc. Standardisation

Specifying industry standards,

Railway track

technical specifications, etc. Bench-marking

Pooling information on costs etc.

International trade associations in various industries

Stock-piling facilities to buffer

Joint financing of stock-piles in

OPEC; international commodity

fluctuations

recessions

agreements for foods and minerals from developing countries

Representation of industry

Managing public relations,

International trade associations in

interests

government relations, etc.

various industries

4

MOTIVATION TO ESTABLISH A CARTEL

According to the economic theory of cartels, the objective of cartel members is to maximise profit (Casson, 1985; Marshall and Marx, 2012). Profit-maximising firms have no incentive to join a cartel unless they can make more profit inside the cartel than outside it. A necessary condition for this is that the cartel increases the total profit made by the membership as a whole. The specific form that profit motivation takes depends on the context in which the cartel operates. Cartels emerge at certain times and places and not others. What triggers a belief that an opportunity to form a cartel exists an industry? Three main sets of motives have been identified: predatory, precautionary and progressive.

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The predatory view predominates in discussions of US trusts. This literature often equates a trust with a cartel. Trusts and cartels were particularly common in the US railroads and the steel industry (Hexner, 1943, 1945). Economic analysis of cartels tends to adopt this predatory view (Epstein, 2008; Whittlesey, 1946). Members of a cartel use their monopoly power to maximise collective profit, and then distribute this collective profit amongst themselves. It is usually assumed that the pursuit of profit is purely selfish, although this not necessarily the case. Medieval merchant guilds, for example, operated as cartels; but they also funded charities, and their leading members often invested in urban infrastructure that was free to all, e.g. building and repairing the city walls (Casson and Casson, 2019). The precautionary view predominates in discussions of European cartels. The rise of Germany 1870-1914, and the aftermath of World War I, destabilised European political boundaries. Industrial heartlands bordering the River Rhine changed hands several times, and the Austro-Hungarian Empire disintegrated. Trade and technology transfer needed to be coordinated in a climate where FDI was insecure and trade could be disrupted. Cartels helped to sustain elite business networks, and provided the flexibility required to adjust the international business system to changes in the political order (Barbezat, 1989; David and Westerhuis, 2020; Matis, 1983; Nussbaum, 1986; Teichova, 1983; Wurm, 1989). The progressive view is reflected in the literature on patent pools, R&D collaboration, and trade association activities (Casson, Pearce and Singh, 1993; Jones, 1922; Luz, 2006). According to this view, cartels resemble clubs that provide ‘public goods’ that are shared amongst their members and financed from membership fees. These activities can stimulate innovation, promote best-practice, improve labour skills and thereby raise productivity within an industry. Advocates of the predatory view generally focus on the marketing activities of the cartel members, arguing that their prices are too high, while advocates of the precautionary view focus on production, arguing that excess capacity is the major problem. These two issues are closely connected, because prices affect quantities sold, which in turn affect capacity utilisation. Advocates of the progressive view take a longer-term perspective; they focus on the greater efficiency of industry-wide R&D due to the reduction of competitive replication of funded research. In practice many cartels have had multiple motivations, which evolved over time. The typical industry life-cycle begins with a small number of pioneering firms that establish early leadership in a new industry. They are typically based in advanced economies. Their success encourages new entry. The number of firms increases, but as the rate of growth of the market diminishes, so competition begins to weed out the smaller and less-efficient firms. The few remaining

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firms dominate a large and profitable oligopolistic industry. They can exploit economies of scale and use their ‘deep pockets’ to discourage further entry (see below). But then conditions change for the worse. There may be a threat of war, a recession, popular hostility, or oppressive regulation. Precautions must be taken: production is scaled back, and possibly re-located. There may also be a threat of technological obsolescence and exhaustion of natural resources. Research and exploration are required to revitalise the industry, but profits are low, so the costs must be shared. The leading firms realise that a cartel would be more profitable than competition. They become predators, buying up inefficient plants cheaply and closing them down. If the cartel can mobilise political support then its members can continue to earn monopoly profits and share them amongst themselves. Eventually obsolescence may take its toll, demand may shrink and the firms may close. In catch up countries the sequence may be different. Research comes first, followed by imitation of leading producers. Once catch up is achieved, the older producers may invite the newer producers to join their cartel, in order to neutralise potential competition. But the new producers may prefer to maintain their momentum, and overtake the old producers. In this case the newer producers take over the predatory role from the older ones and the cycle begins again.

5

INTERNAL STRUCTURE OF CARTELS

Some scholars explain the successes and failures of cartels in terms of the rise and decline of the markets they attempt to control, as described above (Levenstein, 2006). Others believe that the institutional efficiency of the cartel itself is key; this depends, amongst other things, on its internal management structure (Spar, 1994). Communications within a cartel may be centralised or de-centralised, or both. In a centralised cartel there is a single communications hub; each member is connected to other members only through this hub. In a decentralised cartel members can communicate directly with each other, and initiate debates within special-interest groups. Centralised communications suggest centralised authority (Levenstein, 1995). In practice, however, centralisation can be democratic as well as autocratic. Members can hold regular meetings where they debate in plenary sessions; they do not have to concentrate authority on the secretariat. Each member of the cartel may own their own business outright. Alternatively they may be involved in partnerships with other members of the cartel. These partnerships could involve joint ventures (e.g. research projects) or partnerships (e.g. in private banking and professional services). In practice it is often difficult to determine the boundaries between a conventional cartel, a network

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of inter-locking joint ventures, and a professional services firm coordinating the activities of a number of local professional practices (Casson and Cox, 1993; Etemad, 1995; Friedman and Kalmanoff, 1961). Theory suggests that cartels in each of the three categories listed in section 3 will tend to adopt specific organisational forms. Regulation of sales and output will tend to be centralised, and to employ a large secretariat. The same applies to revenue pools and profit pools. Patent pools, however, will tend to be more decentralised; members are fewer, and they may have technical issues that need to be resolved through discussion with other patentees. The provision of shared resources involves a wide range of issues, some of which can be settled centrally, while others require small-groups meetings; centralised and decentralised networks may therefore exist within the same cartel. Because of the secrecy that surrounds many cartels, it is difficult to find reliable evidence on these issues. The limited evidence that is available suggests that these conjectures are sound, although much of the evidence relates to domestic rather than international cartels.

6

TACIT COLLUSION AND PRICE LEADERSHIP

Tacit collusion can replicate the outcome of a cartel without direct communication between firms. The firms need to be able to observe each other’s actions, and to possess sufficient background information on the industry to interpret each other’s actions very easily (Cubbin, 1973). The main mode of collusion involves a form of ‘tit-for-tat’ behaviour. Each firm demonstrates to the others that its behaviour follows a simple rule: typically to match the lowest price set by any member firm. The threat of this action is normally sufficient to deter price cutting in the first place. Someone needs to initiate the pricing process, however. This will normally be the largest firm, or the firm with the ‘deepest pockets’. They set their price at a level they believe approximates to the monopoly price, i.e. the price that maximises industry profit. They are in a strong position to punish anyone who does not follow the rules, and can therefore act as the leader. The price leadership mechanism suggests that a cartel may not need an absolute monopoly of an industry in order to exercise market power. The rational response of a non-member firm may not be to undercut the cartel, but to shelter under its ‘price umbrella’. It cannot afford to undercut the cartel because the cartel has deeper pockets, and can force it into bankruptcy with a punitive price-cut of its own. In some industries there is a ‘fringe’ of such firms, e.g. small firms catering for minority niches or local customers. It is possible for there to be two cartels in the same industry. There would be a strong incentive for them to merge, but cultural differences could create a problem. There is some evidence that Asian cartels and European cartels in

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the same industry prefer to maintain their independence, whilst coordinating their actions by tacit collusion or secret agreement between them.

7

PROMINENT TYPES OF CARTEL

Four main types of IC have been of particular historical importance, and have been documented more often than others. Each type is prominent in particular industries. Price-fixing Cartel Economic theory indicates that a price-fixing cartel has an important role in an industry where one or more of the following five characteristics occur. Firstly, the price elasticity of demand is low, so that the scope for achieving monopoly profits by raising price is high. Secondly, individual products are very close substitutes for each other (so that price competition between suppliers is intense). Thirdly, demand is atomistic, i.e. there is no major buyer that can directly influence the price, and so there is no counter-vailing power. Fourthly, there are substantial economies of scale Finally, fixed costs are sunk, so that unrestricted competition will drive down price to below average cost and create losses for most, if not all, the firms (Connor, 2012). The more of these characteristics that apply, the great the potential for profitable cartelisation of the industry. Economies of scale play two roles in cartel theory. With economies of scale the marginal cost of production is lower than the average cost. Short-term competition such as a price-war will drive down price to marginal cost, and because it is less than average cost firms cannot break even; price maintenance is therefore essential for a sustainable industry equilibrium. Secondly, economies of scale mean that the optimal size of plant is very large compared to industry demand, so there will be few plants in the industry. This implies few firms, which makes a cartel easier to organise; negotiation is easier, and so is the enforcement of an agreement. Sunk costs play a similar role. Sunk costs are typically incurred when a producer purchases highly specific-durable buildings or equipment which have no alternative use. Short-run marginal cost is lower than long-run average cost, and so once again price competition cannot be sustained indefinitely. This situation is well illustrated by the shipping industry (Deakin and Seward, 1973). Consider two shipping lines, headquartered in different countries, operating a service between these two countries. A ship is a floating container and therefore exhibits significant economies of scale. Suppose that ships of both companies are in the same port at the same time, and that each ship is big enough to carry all the trade. Independent shippers turn up at the

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port and ask for the best terms from each line. Each believes that if it undercuts the other by just a small amount then it will get all the trade. It repeatedly fails to anticipate that their cut will be immediately matched by their rival. In the absence of a cartel this process will stop only when one of the lines withdraws from the trade. This happens when the price falls to the opportunity cost of the space required on the ship. If there is plenty of capacity this will be close to zero. At this price neither line can cover its costs and both will go bankrupt. If one of them is to survive they need to make an agreement. In the absence of a merger the main option is a cartel. This could take three main forms. Firstly, they could share the traffic between them. They would behave as a pure monopolist, and set their rates where marginal revenue equals marginal cost. If their marginal cost were zero then their rates would be set where marginal revenue is zero. The elasticity of demand is equal to one at this point, and so a small increase in price will produce an equi-proportional reduction in demand. Secondly, they could agree to pool their revenues or their profits. Sharing revenues will benefit the line with the lower average cost, while sharing profits will benefit the line with the higher average cost. Finally, they could dispose of one of the ships; this would reduce their combined operating costs, and generate additional revenue if the ship disposed of has salvage value. In this case they will need to share the revenues or profits from the remaining ship. Despite the abstract nature of the assumptions, this analysis fits the facts very well. Cartels known as ‘shipping conferences’ have existed from the nineteenth century onwards, and probably before. They were a feature of the international shipping industry around the turn of the twentieth century, and even more so during the inter-war trade depression. The conference system brought stability to the shipping industry. But where regulation was weak, rates could be excessive, increasing transport costs and inhibiting international trade (Wilkins, 1970, 1974). The analysis is also supported by evidence from a cross-section of manufacturing industries (Asch and Seneca, 1975). Quantity-fixing and Capacity-fixing in a Declining Industry A cartel can ‘manage’ the rationalisation of a declining industry by eliminating excess capacity in an orderly way. Competition can also rationalise an industry, by driving down prices and forcing high-cost plants to close. But plant closures can have serious social and political impacts. Mass unemployment may generate unrest, and some countries may cease to be self-sufficient in strategic products. This is characteristic for example, of the steel and heavy chemical industries, where large plants are concentrated in coastal conurbations.

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Cartels can therefore respond to political mandates to decelerate decline in key industries (LeClair, 2000). However, simply maintaining prices will encourage more production rather than less, and so output quotas are the answer. Prices are maintained high but companies are prevented from producing more than is allowed. Negotiating quotas is, of course, a difficult task, but the basic principle is clear; everyone who needs a quota should have one, however small their quota may be. There may be provision for quotas to be traded between members of the cartel. For example, a state-owned firm could sell off its production quota and use the proceeds to create new jobs for redundant workers. A suitable buyer would be a low-cost firm that could profit from the sale of additional output. Licensing a Patent to a Network of Licensees This example is taken straight from IB theory (Buckley and Casson, 1976). Consider a manufacturing firm that has developed a new branded product incorporating some advance in design or technology (or both). The market for the product is potentially global. The firm needs to establish a global network of regional production and distribution facilities. The firm lacks knowledge of local markets and believes that foreign ownership of production is risky. It therefore licenses its technology to a group of independent local firms, who produce and sell the product on its behalf. Each licensee is offered a local monopoly, and in return they pay a lump sum for access to the technology and a small charge for each unit produced. The actions of the licensees are coordinated through a licensing ‘cartel’ operated by the firm. Each licensee will typically have an incentive to export to nearby markets. Reciprocal invasions will depress local prices; if this is foreseen before contracts are made then it will undermine the value of the licences. Hence the cartel leader must enforce rigorous export restrictions. In addition, the licenses may sell unbranded varieties of the product in which they pay no fees, or even sell under their own brand names instead. A cartel plays a vital role in enforcing appropriate restrictions. Patent Pooling Suppose that a new product is produced using a combination of technologies owned by different firms headquartered in different countries (Reich, 1992). These technologies may relate to sequential stages in the production of a conventional product (e.g. chemical refining), or modular elements incorporated into a multi-component product (e.g. automobiles). When each technology is governed by a separate patent, the patents must be pooled in order to produce the product. In principle one firm could buy up patents from the others. But

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political pressure may demand that an international licensing agreement is negotiated, in which each firm licenses the others to use its technology. This is, in effect, a world-wide patent pool sponsored by a group of governments in developed countries.

8

CARTEL INSTABILITY

Reasons for Instability Some economists argue that cartels are fundamentally unstable. By inflating profits through restrictive agreements, cartels attract entry. Entry increases capacity in the industry, putting downward pressure on prices. Unless the members of the cartel cut their prices to match the entrants’ prices they will lose market share. By inflating prices cartels therefore provide a strong incentive for members to cheat by under-cutting one another. Cheating may be difficult to detect. If members cannot trust each other then there is little point in belonging to the cartel. Secrecy may be difficult to sustain. Firms that quit a cartel, for whatever reason, have less incentive to protect its secrecy. If these objections applied to every cartel then cartels would never exist for very long. In practice some cartels have survived for many years (Dick, 1996; Grossman, 2004). Theory suggests that cartels will be stable only when one or more of the following conditions apply. Firstly, there are significant barriers to entry. Secondly, opportunities for cheating can be controlled,. Thirdly, secrecy can be maintained. Fourthly, the industry is unaffected by cyclical variations, and finally, the cartel has a flexible organisation. The more of these factors apply, the more stable the cartel is likely to be. Barriers to Entry as a Stabilising Factor There are three main barriers to entry: economies of scale, excess capacity, and specific privileges. Economies of scale at the plant level require entry on a large scale. This creates an ‘indivisibility’ problem: the entrant runs a risk of pushing the industry from shortage of capacity to excess capacity in a single step. Large scale may also create a financing problem; an entrant with limited reputation may find it difficult to raise capital in order to fight their way into a cartelised industry. High sunk costs create additional risks; because an unsuccessful entrant cannot recover their cost of entry by exiting the industry later, they are less likely to be able to raise the capital to begin with. Excess capacity discourages entry because entry would aggravate an existing problem. This factor is particularly relevant during economic depressions.

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Specific privileges accrue to cartel members from which an entrant is excluded. Firstly, the cartel members may have privileged access to a patent pool which has been created through a comprehensive cross-licensing agreement. As a result, an entrant would have to ‘steal’ the patents or gain access to some alternative technology. Secondly, one of the cartel members may have exclusive access to the only known sources of some input, such as a rare mineral, and they may agree to restrict supply to members of the cartel. Finally, inter-governmental patronage may restrict membership of a cartel to established ‘national champion’ firms; this is particularly likely in ‘strategic’ industries such as defence equipment, chemicals and explosives. Control of Cheating as a Stabilising Factor Cheating can be controlled detecting cheats effectively and punishing them heavily. It is important to be able to punish an individual cheat without punishing everyone else as well. A simple way for members to cheat in a price-fixing cartel is to offer a superior quality product for the price of a normal quality product. The incentive to cheat in this way can be reduced by specifying different standards of quality and setting a separate price for each. In early steel cartels, for example, numerous grades of steel were identified, and a separate price set for each. The detection of other forms of cheating is facilitated by channelling sales transactions through a marketing board, or sales syndicate, which invoices customers on a member’s behalf. The cartel may also establish a central secretariat which is staffed by people who are employed directly by the cartel rather than by people seconded from member firms. Punishing offenders can be difficult, however. Members may be required to deposit funds in accounts from which fines can be taken. Members will consent so long as they trust the cartel administration more than they trust their fellow members. The ultimate punishment is expulsion, but this may be counter-productive if it creates an external competitor for the cartel. Credible Leadership and Competent Administration Cartels need a leader to establish an organisation that firms can join. The leader may be a person or an institution, e.g. a dominant firm, a merchant bank, or the government of some powerful country. The leader must be trusted. They must possess sufficient credibility to persuade the major producers to join, so that others will join as well. The cartel must include all the significant producers, though not necessarily the competitive fringe (see above). The evidence supports the importance of leadership (Spar, 1994, 2009). Many successful cartels were established by individual entrepreneurs who

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promoted their ideas to the managers of other firms. These entrepreneurs were typically members of a cosmopolitan social elite, and were often connected with the bank that financed the cartel (Maclean and Harvey, 2006). A large successful cartel may find it difficult to keep its existence secret. Customers of the cartel, and especially downstream firms, may become suspicious and complain to their governments, A cartel leader must therefore lobby politicians to persuade them not to intervene. Their message may be well received if politicians have more pressing problems on their hands, e.g.in a global recession.

9

NATIONAL CULTURE AND CARTELS

It has often been noted that the proliferation of domestic cartels is significantly higher in some countries than in others. Germany is often regarded as the home of modern industrial cartels, while Japan’s sogo sosha trading companies, Italian ‘business groups’ and the Sicilian Mafia have also been likened to cartels (Graham, 1995; Tilton, 1996; Yonekawa and Yoshihara, 1987). The US, on the other hand, is usually perceived as ideologically committed to competition, transparency and respect for law, all of which encourage opposition to cartels (Freyer, 1992). Nevertheless, in the ‘gilded age’ at the end of the nineteenth century, Wall Street financiers and railroad barons presided over large trusts. The populist response, however, was to condemn these trusts, and since the 1920s US anti-trust policy has consistently opposed cartels and championed the right of the ‘small businessman’ to enter any industry. UK policy has been more ambivalent. In the late nineteenth century London became the financial centre for a number of international cartels exploiting the resources of the British Empire, but after the end of World War II support for trusts waned as the Empire declined, and more attention was focused on consumer protection. In Germany and Japan cartels have been strongly represented in innovative industries. Cartels can help to avoid wasteful duplication of R&D, as noted above. They allow each firm to work continuously on the improvement of its product range, without undue concern for its rivals (Schroter, 1986). In the US and UK, however, innovation has tended to be regarded as a highly disruptive process, in which a radical innovator enters an industry and renders existing technologies obsolete. Under this scenario, cartels deter innovation by keeping innovators out. Some of these differences can be explained in purely economic terms. For example, the UK was a leading country and Germany a catch-up country before World War I, and the US was a leading country and Japan a catch-up country after World War II. But not all differences can be explained in this way; e.g. the US was also a catch-up country in the late nineteenth century

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but it followed a very different approach to Germany. Residual differences can be explained in cultural terms (Connor, 2001). In Germany and Japan, it has been suggested, senior management believes that the value of a product is intrinsic; it resides in the technology and skill embodied in its production. Their ambition is to win the respect and the trust of other firms. In the US and UK, on the other hand, managers believe that the value of a product resides in customer perception, and not in the integrity of the product itself. They strive to win the respect of customers by giving the customers what [the customers] think they want, and to out-wit competing firms in doing so. Competition for customer satisfaction is therefore key, and the attitude to other firms can be disrespectful. The consequence, it is suggested, is that in Germany and Japan firms co-operate in pursuit of technical excellence, and the consumer is rewarded with a product that is intrinsically high-quality. Its price reflects this intrinsic value. It is set by the producers because they are the experts. In the US and UK, however, the customer is the expert, because only they know what they want, whatever the ‘intrinsic quality’ may be. Other producers are ‘the enemy’, because they steal market share by flattering the customer. The conclusion, therefore, is that it is more natural to co-operate with fellow-producers in Germany and Japan than it is in the US and UK (Wurm, 1993).

10

CARTELS AND CONSPIRACY

Conspiracy theories of cartels have always been popular and deserve to be taken seriously. The principal assertion is that many cartels have, in practice, been controlled by a small and secretive ‘financial elite’, e.g. major industrialists or merchant bankers and their family dynasties. The suggestion is that at various times individuals from such elites possessed major shareholdings in several leading firms in the same industry, and held inter-locking directorships, through which they promoted solidarity within the cartel. Evidence for this is strong for the US ‘gilded age’ at the end of the nineteenth century, and for Germany and Austria in the early twentieth century (Grou, 1985; Maclean and Harvey, 2006; Kotz, 1978; Mackay, 1986; Scott, 1987). The same may be true today, but the evidence is incomplete. Holding companies controlled by elite groups certainly have substantial shareholdings in leading companies in some industries. Elite groups do not need majority ownership to exercise control; they simply need to be dominant shareholders. The more highly leveraged the firms in which they invest, the easier it is to gain control of them with a relatively modest equity stake. This concentration of power certainly applies today in the ownership of brands. Public information from company websites and private information from market research consultancies shows that in fast-moving consumer goods

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industries multiple bands are often owned by the same company, giving dominant firms national market shares of over 50 per cent in many large countries. The globalisation of brands in recent years has extended this concentration of market power to international markets too. Mineral industries have always been prone to concentration of market power because rare minerals are found in only a few locations (British Columbia, 1980). Furthermore, certain precious minerals, such as gold, silver and diamonds, derive their value almost entirely from their scarcity, which is maintained through the control of global mining output using cartel-like agreements. The De Beers cartel, for example, is infamous for having restricted the supply of diamonds for over a century in order to maintain their value, despite the discovery of new deposits, most recently in Russia (Bergenstock, Deily and Taylor, 2006). However, the extensive use of off-shore holding companies and other financial intermediaries makes it difficult to determine how far such arrangements persist today.

11 CONCLUSIONS Why Cartels Have Received Little Attention in IB Theory Although they are an ‘alternative contractual arrangement’ to the conventional MNE, cartels have not, until recently, been considered seriously as a strategic option in IB. There are three main reasons why ICs have been studied so little in IB theory. Firstly, the concept of a cartel was tainted by their behaviour in the inter-war period and was not acceptable to post-war politicians and regulators. However badly MNEs may have been regarded in the early post-war period, they were deemed preferable to cartels. Cartels are, however, usually good for their members, if not for their customers, and they therefore need to be taken seriously. Furthermore, not every type of cartel is bad; because they rely on monopoly power, they need to be regulated in the public interest, but they do not necessarily need to be banned. Secondly, cartels are complex and difficult to study. Because they are very versatile, they can take a variety of forms. There are several possible motivations and many different activities that can be performed. The motivations for cartels have varied over time. In peace-time the emphasis has been on predation, and in war-time on precaution. Technological differences mean that industries vary significantly in the suitability of cartels. There are also differences between countries, which reflect national culture and stages of development. Mature industrialised countries with a culture of individualism tend to develop predatory cartels while catch-up countries with more cooperative culture tend to develop progressive cartels. As a result, a negative view

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of cartels tends to prevail in mature individualistic countries, and this has influenced modern economic analysis of cartels. Thirdly, cartels tend to be secretive, and the more they are regulated the more secretive they become. It is widely believed that post-war competition laws put paid to cartels (see above). In practice some have obtained government endorsement (e.g. international commodity agreements) and others have ‘gone underground’. The most successful post-war cartels are almost certainly the ones that customers are unaware of and that the regulators do not know about. What is the Future for International Cartels? As the global economy and its governance changes over the next decade, cartels may well become influential once again. Three key questions were raised in the introduction. Firstly, will increased political risks encourage the substitution of ICs for MNEs? Secondly, will MNEs that belong to ICs be ‘less multinational’ than before (e.g. have fewer foreign subsidiaries)? Finally, are ICs more likely to emerge in certain types of industry than in others and, if so what are the characteristics of these industries? The preceding analysis provides answers to these questions. The answer to each of the three questions is a qualified ‘Yes’. The key difference between a cartel and an MNE lies in the ownership rather than the location of production. A cartel can coordinate two plants in different locations that are owned by different firms. An MNE coordinates two such plants by bringing them under common ownership and control. FDI is the crucial difference: an MNE requires it but a cartel does not. When there is political stability FDI may be superior to licensing, but instability can raise the costs of FDI and make licensing profitable. Political instability therefore encourages the substitution of cartels for MNEs. Political instability may increase tariffs, and war may be even more disruptive. This creates existential uncertainty, e.g. about where the political boundaries of the future will lie. The disintegration of the international political system encourages firms to ‘dis-intermediate’ the politicians and implement their own independent system of inter-corporate governance. Although firms may distrust their competitors, they may distrust the political system even more. Under such conditions an IC can provide a network of communications that allows firms to manage international supply chains and retain access to markets through partners within their cartel. Some ICs may operate within the boundaries of existing political alliances, but some may transcend them because they are unsure where future boundaries will lie. Political instability may affect some industries more than others. In high-technology defence industries, for example, governments may organise

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domestic cartels of local firms to manage capacity and supervise intermediate product flow within the industry. In other cases, such as shipping, cartels may be replaced by direct government control. ICs may be harnessed by governments to carry out industrial espionage and steal technology from other foreign-owned firms within the cartel (Casson, 2020). Overall, therefore, the incentive for a firm to de-globalise depends mainly on the increasing strength of the precautionary motive described above. It also involves a change of emphasis in the progressive motive from consumer product innovation to innovation in defence equipment and environmental technology. This suggests a reversion to the types of cartels that emerged in the inter-war period. Other people have arrived at the same conclusion, but not in the same way. The analogy with the inter-war period needs to be qualified, however. The initial conditions are not the same: the state of the international economy in 1914 was different from today. The obvious difference is that the MNE was barely recognised as a form business organisation in 1914, whereas it is almost ubiquitous today. The leading economic powers in 1914 – the UK and US – shared a common cultural heritage, unlike the US and China today. Although de-globalisation will be driven by political risks, just as it was in the inter-war period, the risks will be different from before. War in Europe and the Atlantic was the driver of change in the inter-war period. War seems less likely today, because physical conflict will probably be replaced by cyber ‘warfare’, but no one can be sure. Wider Implications for the Future of IB Research If IB studies is to retain is reputation for policy-relevance it must engage with the issue of institutional responses to globalisation, and this must include the analysis of cartels. Cartels are an industry-wide phenomenon rather than a firm-specific phenomenon. The concentration of production on a few leading firms makes industrial cooperation easier. Much IB theory remains focused on the individual firm. It analyses monopoly and competition, but pays limited attention to the oligopolistic industry structures that often generate cartels. Cartels cannot be studied without reference to wider literature on economics, politics and sociology. Economic principles explain why cartels tend to be more common in some industries than others. Political theory analyses the stability of inter-governmental relations, which is crucial for cartels. It also explains the attitudes of politicians towards cartels. Sociology explains how differences in national culture generate international differences in cartel policy. It also explains the social processes that reinforce shared economic

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interests in maintaining cartel solidarity. IB must engage more strongly with other social sciences if it is to provide a fully satisfactory analysis of cartels.

REFERENCES Asch, P. and J.J. Seneca (1975) Characteristics of collusive firms, Journal of Industrial Economics, 23, 223–237 Barbezat, D. (1989) Competition and rivalry in the international steel cartel, 1926–1932, Journal of Economic History, 49(2), 435–447 Barjot, D. (ed.) (1994) International Cartels Revisited, 1880–1980, Caen: Editions-Diffusion du Lys Bergenstock, D. J., M. E. Deily and L. W. Taylor (2006) A cartel’s response to cheating: An empirical investigation of the Der Beers diamond empire, Southern Economic Journal, 73(1), 173–189 British Columbia (1980) Report of the Commission of Inquiry into Uranium Mining, Victoria, BC: Queen’s printer Buckley, P. J. (2020). The Return of Cartels? Management and Organization Review. (forthcoming) Buckley, P. J. and M. Casson (1976). The Future of the Multinational Enterprise, London: Macmillan Casson, C. and M. Casson (2019) To dispose of wealth in works of charity: entrepreneurship and philanthropy in Medieval England, Business History Review, 93 (3), 473–502 Casson, M. (1985) Multinational monopolies and international cartels, in P. J. Buckley and M. Casson, Economic Theory of the Multinational Enterprise, London: Macmillan, 60–97 Casson, Mark (2020) International rivalry and global business leadership: an historical perspective, Multinational Business Review, 28 (4), 429–446 Casson, M., R. D. Pearce and S. Singh (1992) Global integration through the decentralisation of R&D in M. Casson (ed.) International Business and Global Integration, London: Macmillan, 163–204 Casson, M. and H. Cox (1993) International business networks: theory and history, Business and Economic History, 22 (1), 42–54 Caves, R. E. (1982) Multinational Enterprise and Economic Analysis, Cambridge: Cambridge University Press Connor, J. M. (2001) Global Price Fixing: Our Customers are the Enemy, Boston: Kluwer Connor, J. M. (2005) Price-fixing overcharges: legal and economic evidence, Research in Law and Economics 22, Oxford: Elsevier, 59–153 Connor, J. M. (2012) Price effects of international cartels in markets for primary products, in S. J. Everett and F. Jenny (eds.) Trade, Competition and the Pricing of Commodities, London: Centre for Economic Policy Research, 61–80 Cubbin, J. (1973) Apparent collusion and conjectural variation in differentiated oligopoly, International Journal of Industrial Organization, 1, 155–163 David, T. and G. Westerhuis (2020) International business networks, in da Silva Lopes, T., C. Lubinski and H. Tworek (eds.) Routledge Companion to the Makers of Global Business, Abingdon: Routledge, 249–264 Deakin, B. M. and T. Seward (1973) Shipping Conferences: A Study of their Origins, Cambridge: Cambridge University Press

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Dick, A. (1996) When are cartels stable contracts? Journal of Law and Economics, 39, 241–283 Dollinger, P. (1970) The German Hansa, London: Macmillan Epstein, R. A. (2008) Free Markets under Siege: Cartels, Politics and Social Welfare, Stanford, CA: Hoover Institution Etemad, H. (1995) International production networks and alliances, in Boyd, G. (ed.) Competitive and Cooperative Macro-management: The Challenge of Structural Interdependence, Cheltenham: Edward Elgar, 153–185 Fear, J. (2008) Cartels, in Geoffrey G. Jones and Jonathan Zeitlin (eds.) Oxford Handbook of Business History, Oxford, Oxford University Press, Chapter 12 Freyer, A. (1992) Regulating Big Business: Antitrust in Great Britain and America, 1880–1990, Cambridge: Cambridge University Press Friedman, W. G. and G. Kalmanoff (1961) Joint International Business Ventures, New York: Columbia University Press Graham, E. M. (1995) Japanese culture and the performance of Japanese firms, in Boyd, G. (ed.) Competitive and Cooperative Macro-management: The Challenge of Structural Interdependence, Cheltenham: Edward Elgar, 129–152 Grossman, P. (ed.) (2004) How Cartels endure and How they Fail: Studies of Industrial Collusion, Cheltenham: Edward Elgar Grou, P. (1985) The Financial Structure of Multinational Capitalism, Leamington Spa: Berg Hexner, E. (1943) The International Steel Cartel, Chapel Hill, NC: University of North Carolina Press Hexner, E. (1945) International Cartels, Durham, NC: University of North Carolina Press Jones, E. (1926) The Trust Problem in the United States, New York: Macmillan Jones, F. D. (1922) Trade Association Activities and the Law, New York: McGraw-Hill Kotz, D. M. (1978) Bank Control of Large Corporations in the United States, Berkeley, CA: University of California Press LeClair, M. S. (2000) International Commodity Markets and the Role of Cartels, Armonk, NY: M.E. Sharpe Levenstein, M. C. (1995) Mass production conquers the pool: Firm organisation and the nature of competition, Journal of Economic History, 55(3), 575–611 Levenstein, M. C. (2006) What determines cartel success? Journal of Economic Literature, 54, 43–95 Levy, H. (1911) Monopoly and Competition, London: Macmillan Levy, H. (1927) Monopolies Cartels and Trusts in British Industry, London: Macmillan Liefmann, R. (1932) Cartels, Concerns and Trusts, London: Methuen Luz, S. F. (2006) International Cartels and Oligopolistic Markets: An Empirical Analysis, Reading: University of Reading, Department of Economics, PhD thesis. Maclean, M. and C. Harvey (eds.) (2006) Business Elites and Corporate Governance in France and the UK, Basingstoke: Palgrave Macmillan Mariti, P. and R. H. Smiley (1982) Cooperative agreements and the organisation of industry, Journal of Industrial Economics, 31(4), 437–451 Marshall, R. C. and L. M. Marx (2012) The Economics of Collusion: Cartels and Bidding Rings, Cambridge, MA: MIT Press Matis, H. (1983) Disintegration and multi-national enterprises in Central Europe during the Post-war Years (1918–23) in Teichova, A. and P. L. Cottrell (eds.) (1983) International Business and Central Europe, 1918–1939, Leicester: Leicester University Press, 73–96

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McKay, J. (1986) The House of Rothschild (Paris) as a multinational industrial enterprise, in Teichova, Alice, Maurice Levy-Leboyer and Helga Nussbaum (eds,) Multinational Enterprise in Historical Perspective, Cambridge: Cambridge University Press, 87–102 Mirow, K. R. (1982) Webs of Power: International Cartels and the World Economy, Boston: Houghton Mifflin Nussbaum, H. (1986) International cartels and multinational enterprises, in Teichova, Alice, Levy-Leboyer, M. and H. Nussbaum (eds,) Multinational Enterprise in Historical Perspective, Cambridge: Cambridge University Press, 131–144 Piotrowski, R. (1933) Cartels and Trusts: Their Origin and Historical Development from the Economic and Legal Aspects, London: George Allen & Unwin Plummer, A. (1934) International Combines in Modern Industry, London: Pitman Reich, L.S. (1992) Lighting the path to profit: GE’s control of the electric light industry, 1892–1941, Business History Review, 66(2), 305–334 Schmitz, A. (1981) Grain Export Cartels, Cambridge, MA: Ballinger Schroter, H. (1986) A typical factor in German international market strategy: agreements between the US and German electrotechnical industries up to 1939, in Teichova, A., M. Levy-Leboyer and H. Nussbaum (eds.) Multinational Enterprise in Historical Perspective, Cambridge: Cambridge University Press, 160–170 Scott, J. (1987) Intercorporate structures in Western Europe: a comparative historical analysis, in Mizruchi, M. S. and M. Schwartz (eds.) Intercorporate Relations: The Structural Analysis of Business, Cambridge: Cambridge University Press, 233–263 Spar, D. L. (1994) The Cooperative Edge: The Internal Politics of International Cartels, Ithaca, NY: Cornell University Press Spar, D. L. (2009) National policies and domestic policies, in Alan M. Rugman (ed.) Oxford Handbook of International Business, 2nd. ed., Oxford: Oxford University Press, 205–227 Stocking, G.W. and M. W. Watkins (1946) Cartels or Competition: The Economics of International Cartels by Business and Government, New York: Twentieth Century Fund Teichova, A. (1983) The Mannesman concern in East Central Europe in the inter-war period, in Teichova, A. and P. L. Cottrell (eds.) (1983) International Business and Central Europe, 1918–1939, Leicester: Leicester University Press, 103–137 Tilton, M. (1996) Restrained Trade: Cartels in Japan’s Basic Materials Industry, Ithaca, NY: Cornell University Press Whittlesey, C. R. (1946) National Interests and International Cartels, New York: Macmillan Wilkins, M. (1970) The Making of Multinational Enterprise: American Business Abroad to 1914, Cambridge, MA: Harvard University Press Wilkins, M. (1974) The Maturing of Multinational Enterprise: American Business Abroad from 1914 to 1970, Cambridge, MA: Harvard University Press Wurm, C. A. (ed.) (1989) International Cartels and Foreign Policy: Studies on the Inter-war Period, Stuttgart: Franz Steiner Wurm, C. A. (1993) Business, Politics and International Relations: Steel, Cotton and International Cartels in British Politics, 1924–1939, Cambridge: Cambridge University Press Yonekawa, S. and H. Yoshihara (eds) (1987) Business History of General Trading Companies, Fuji Conference Vol. 13, Tokyo: University of Tokyo Press

PART II

The present agenda: innovations in research methods

5. The internalisation theory of the multinational enterprise: past, present and future With Peter J. Buckley 1 INTRODUCTION International Business (IB) is an inherently complex subject because of its global context, the importance of innovation, and the range of ownership and location factors that need to be examined. Here it is argued that IB theory can learn from economics, but that it should not emulate economics too closely because economics makes restrictive assumptions that assume away important issues in IB. We argue that better IB theory can be created by extending existing theories rather than by starting again with new kinds of theory. However, existing theories need to be formulated in a more explicit manner in order to increase their predictive power. More attention needs to be given to the role of the entrepreneur and the headquarters function. More emphasis also needs to be placed on the industry rather than the firm, so that competition and co-operation between firms can be better understood. The approach is pragmatic and constructive. It not only sets out how IB theory can be extended, but explains exactly how it can be done. This chapter thus presents an agenda for extending the internalisation theory of the multinational enterprise (MNE) in order to explain a wider range of international business phenomena. Some aspects of international business have been studied exhaustively over the past decades – e.g. the market entry decision (Buckley and Casson, 1998b; Dunning, 1977; Dunning and Lundan, 2008), the role of subsidiaries (Rugman and Verbeke, 2001) and the location of headquarters (Menz, Kunisch and Collis, 2015, Kunisch, Menz and Ambos, 2015) – but others – e.g. oligopolistic rivalry and the functions of MNE headquarters – have received relatively little attention. The theory needs to be extended to explore these neglected areas more thoroughly (Buckley, Doh and Benischke, 2017).

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The structure of this chapter is as follows. The following part examines the contribution of internalisation theory to international business. Section 3 presents some criteria for good theory. It critically examines existing IB theory and argues that much of it lacks predictive power. Section 4 examines the limitations of current theory, especially in relation to recent developments in the global economy. The fifth part suggests future theoretical developments to encompass these developments. The conclusion includes a research agenda.

2

THE CONTRIBUTION OF INTERNALISATION THEORY TO INTERNATIONAL BUSINESS

Classic internalisation theory (Coase, 1937) says that, conditional on location factors, multinational enterprises (MNEs) emerge when the benefits of internalisation exceed the costs (Williamson, 1975; McManus, 1973, 1975; Hennart, 1982; Rugman, 1981). As it stands, this is almost tautological. When a firm is found to be an MNE, it is claimed that the net benefit of internalisation is positive, and if it is not an MNE then it is claimed that the net benefit is negative. But internalisation theory contains other propositions too, and it is the synergy between all these propositions that gives the theory explanatory power (Buckley and Casson, 1976, 1985, 2009; Casson, 2014). Adding the proposition ‘proprietary knowledge incurs heavy licensing costs that can be avoided by internalisation’ enables the deduction from the theory that multinationality will be most common in knowledge-intensive industries, and the evidence will show this to be correct (Hymer, 1976). To develop the theory further, we can add ‘the benefits of internalising knowledge are particularly high when intellectual property rights (IPR) are weak’. This predicts that in knowledge-intensive industries foreign direct investment (FDI) will be most common in countries with weak IPR, and licensing most common in countries with strong IPR, and again this is (mostly) right (Casson, 2000). To refine the theory additional factors can be identified, e.g. ‘local entrepreneurial capabilities’ to further increase explanatory power (Buckley and Casson, 1998a). Internalisation theory not only explains what will happen; it explains what will not happen too. Internalisation assumes that firms maximise profit. Managers do not make irrational decisions that damage the interests of the shareholders. This implies, for example, that firms do not internalise organised commodity futures markets, except at times of panic or crisis, because it would be inefficient to do so. The assumption that drives these strong results is often questioned (Buckley, Devinney and Louviere, 2007). Are managers really rational, and do they always put shareholders’ interests first? This does not accord with empirical observation. So we can assume that they can be irrational and dishonest. Irrationality can take many forms, and so can dishonesty. So managers can

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now do almost anything. They could even act rationality, but only by accident or mistake. The theory has degenerated into a tautology. It says, in effect that ‘managers do whatever managers do’. The theory is more realistic – but is not a predictive theory any more. The theory can be rescued, but it requires some effort. Suppose we observe an irrational bias to internalisation. Perhaps managers believe they are rewarded by the size of the firm as well as profitability. Thus they have a bias to internalise because it increases firm size and boosts their salaries. shareholders will not necessarily lose. If shareholders believe that bigger firms are more attractive to institutional investors, then growth through internalisation may increase the equity price and afford the shareholders capital gains, which could exceed their temporary loss of profit. The theory can therefore remain predictive if we change the assumptions. We assume that managers maximise shareholder value rather than profit, that value depends upon size, and that size affects salaries. All of these are testable propositions. Rationality still prevails, but in a wider context than before. We have not rejected the key assumption, but rather refined it, by replacing profit with shareholder value. We have rescued the theory and avoided tautology.

3

BY WHAT STANDARDS SHOULD A SOCIAL SCIENCE OF INTERNATIONAL BUSINESS BE JUDGED?

3.1

Explicit Assumptions

The origins of internalisation theory lie in economics. In economics, assumptions are made explicit. They are combined with each other, and hypotheses are derived by logical deduction. This logical process gives the theory a transparency which other types of IB theory often lack. Transparency makes logical error easy to expose. Economic theory can derive an entire set of hypotheses from a single set of assumptions. Internalisation theory, for example, explains both horizontal and vertical integration by an MNE. The use of a common set of assumptions for different hypotheses ensures that these hypotheses are logically consistent. It is easy to criticise the assumptions of economics because they are so explicit. It is harder to criticise the assumptions of other IB theories because they are often implicit. Furthermore, many hypotheses in IB are derived from a synthesis of the literature, and embody different assumptions made by different authors. There is no guarantee that hypotheses derived in this way are mutually consistent.

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Using Mathematics to Achieve Clarity

Economic theories are often presented in a formal, even mathematical, way. This is sometimes regarded as an obstacle to understanding, but mathematics often provides clarity. The global economy is intrinsically complex, and IB studies is therefore complex too. Ownership, location, exporting, direct investment, licensing, competition and co-operation all have to be considered at the same time. Simple theories inevitably over-simplify, and distort reality as a result. As theory becomes more complex, it becomes increasingly difficult to follow a purely verbal exposition. Mathematics addresses complexity directly by replacing words with symbols and sentences with equations. This makes the logical structure clear. Using mathematical notation, a complex theory can be just as easy to understand as a simple one. Although the number of factors changes, the mathematical structure does not. Other branches of social science have developed sophisticated mathematical models, and there is no insuperable reason why IB studies cannot do the same. IB theorists have not been particularly ambitious in this respect, however. They need to be more ambitious if IB theory is to realise its full potential. 3.3

Developing a Logical Structure in Theorising

The typical structure of sophisticated social science theory is outlined below. It is illustrated with practical examples from IB. The unit of analysis is specified. A key type of actor is identified (e.g. individual, firm, nation state). The actor is usually a ‘decision-maker’ who owns and controls some resources (Buckley and Lessard, 2005). The number of actors is specified (e.g. the number of firms in an industry, the number of subsidiaries in a firm). The objectives of each actor are specified (e.g. to maximise the value of some performance measure, such as productivity, profit, market share or growth rate). Each actor has a specific set of actions they can perform (e.g. alternative activities to which they can allocate their resources). Some actors may have a wider range of opportunities than others; this is determined by their access to resources, and by other individual characteristics (e.g. reputable firms with strong brand identities have greater access to finance). The nature of the environment is described. There are two aspects of this: the physical environment and the knowledge environment. In firm-level studies the physical environment typically comprises the world and its resources, while in managerial micro-studies it may be the firm itself, or even one of its subsidiaries, or the people working in them. The knowledge environment is only implicit in many theories, and has not received the attention it deserves (Richardson, 1998). In a global context it comprises the set of all recorded evidence and the set of all concepts and theories available to analyse them.

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In IB the knowledge environment is usually discussed in the context of the individual firm, where the focus is on the set of existing technologies available to the firm, together with new technologies that it is capable of developing. The structure of the environment is specified. The physical environment may be divided into sub-units. In IB geographical sub-divisions are naturally prominent, e.g. different nation states. Different types of product are also distinguished, e.g. different industries, and also different functions, e.g. production, marketing and R&D. Relations between sub-units may be specified, e.g. distances between geographical sub-units, substitutability and complementarity between products, and inter-dependencies between functional areas. The knowledge environment is structured in many different ways, e.g. theories, documents and data in different subject areas, some of which are relevant to IB and others not. Exogenous factors which govern the environment are itemised. These are typically the key factors to which actors respond (e.g. taxes, tariffs, product demand). The values of these factors may vary across sub-units (e.g. local demand, institutional environment and local resource availability in each nation state). With M general factors and N sub-units there are MN factors altogether. Exogenous factors driving change in the knowledge environment include scientific progress and cultural trends. Allowance is made for diversity of institutions. Deeg and Jackson (2008) make the point that the view of institutions in IB general is “thin”, relying on numerical average or summary indicators rather than thick description. The diversity of institutional landscapes would, in their view, allow richer theorising. This is certainly a promising direction of international business theorising giving much more heft to the external environment as a key determinant of internationalisation, internalisation and other strategic decisions of MNEs. Behaviour. Each actor selects a particular action to perform (e.g. innovate, invest in a location). These actions are endogenous because they respond to the environmental factors (e.g. location is influenced by tariffs). Actors may also respond to the actions of others (e.g. an established firm may respond to the entry of rivals by cutting price). The response of each actor is mediated by their objectives, resources and other characteristics (e.g. a firm’s response to investment opportunities is determined by its objectives, e.g. profit, growth, its resources, e.g. its technological capabilities, and other characteristics, such as whether or not it is family-controlled). Distributed actions. Each actor may perform a different action in each sub-unit (e.g. a firm may licence in one market but undertake FDI in another). Behaviour in each sub-unit may respond only to local factors, or to factors elsewhere in the environment too (e.g. a firm may not license in one market because it fears that the licensee will export to a neighbouring market in which the firm has already invested).

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Outcomes. A set of actions, when performed in a given environment, results in a set of outcomes (e.g. prices, profits). Different outcomes are of concern to different actors (e.g. each firm’s profit is mainly of concern to its own managers and shareholders). Some outcomes are public knowledge (e.g. the published profits of rival firms) whereas other outcomes are known only to those who are affected by them (e.g. sales revenue generated by a firm’s specific products). Equilibrium. At the time an actor makes a decision they may have a definite expectation of what the outcome of that decision and its consequences will be. After the decision has been made, the outcome will be observed, and the actor can then compare the expected outcome with the actual outcome. If they are the same then the actor is said to be in equilibrium, since there is no reason why they would wish to have changed their decision, given the state of the environment and decisions made by other actors. If every actor is in equilibrium then the system is in equilibrium. Feedback and learning. If the actual outcome differs from the expected outcome, however, then the actor must decide whether this is the result of an unpredictable random fluctuation, in which case they may not want to change their decision, or the consequence of some limitation of their judgement, such as lack of information or bad theory. They may investigate the outcome further order in order to learn from their mistake (e.g. when sales are higher or lower than anticipated). The incentive to learn is greatest when a serious mistake has been made. Learning from mistakes augments the future stock of knowledge and so modifies future behaviour (e.g. if sales are unexpectedly low advertising budgets may be increased). Behaviour therefore evolves over time. Measurement. Endogenous decisions and exogenous factors are typically represented by the values of various categorical, binary, discrete, or continuous positive variables (e.g. sales and profits are continuous variables, industry is a categorical variable, and family control is a binary variable). 3.4

Current Issues in IB Theory

This discussion so far may be summarised as follows. • There is too little emphasis on the individual and too much on the firm. • There is too much emphasis on the single representative actor, operating in isolation, whether they are an individual or a firm. Conversely, there is too little emphasis on interactions between actors, such as networking between individuals or competition and co-operation between firms. • The objectives of actors are often fuzzy. Without a clear statement of actors’ objectives it is difficult to relate their behaviour to the environment. This vital link in theorising is often weak.

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• The global environment of IB activity needs to be spelled out much more clearly and systematically. More attention needs to be given to the specific factors that impact on actor’s behaviour, and how these factors can be measured accurately. • The issue of learning needs to be taken more seriously. While equilibrium models are rightly criticised for ignoring learning, nothing much has so far been learned from theories of learning because most of these theories lack predictive power.

4

WHAT ARE THE OUTSTANDING THEORETICAL PROBLEMS IN INTERNATIONAL BUSINESS?

4.1

Limitations of Existing Theory

The theory still, at least implicitly, relates to manufacturing industry. Services have become increasingly tradeable, not only because of their embodiment in physical products (products as a mobile store of future services (Casson 1990 p 2)) but also because of the movement of people (leisure services, medical care) and trade via telecommunications and the internet. The focus on a single market – most obviously in high technology products – is limiting. Internalisation of markets in semi-processed inputs, components and information requires a focus on multiple markets. The focus on a single firm (Hennart 2009) is unwarranted. This requires widening the theory to a system-wide perspective. Boundaries of firms often abut one another and thus rival multinationals compete, often in a pre-emptive internalisation strategy for key activities. Joint ownership in alliances and joint ventures may be an optimal outcome or competition, direct or through a third party thus raise complex strategic questions, understandable only at the system level. Leading from the previous point, a polarised view of contractual arrangements – contrasting pure arm’s length trade with hierarchy – is unjustifiable in the modern world economy. The theory needs to include social as well as legal aspects of contracts to encompass the complexity of quasi-integration. The theory remains unduly static when competitive advantage is taken as fixed. The evolution of the global system is continuous and does not simply move from one static equilibrium to another. In internalisation theory the behaviour of the firm is endogenous, while the environment of the firm is exogenous (Coase, 1937). The theory generates hypotheses, linking endogenous behaviour of firms to the exogenous business environment. The link depends on the profit assumption (or an equivalent), which is key (Casson, 1996, 2014). The theory manifests contingency. If a firm is knowledge-intensive it is more likely to be an MNE; if it not, it is less likely to be an MNE. Changes in

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the contingent factors change the behaviour of the firm. If IPR is strengthened over time then internalisation decreases. If the IPR regime is stronger in one country than another then licensing is more common in that country (Buckley and Casson, 2011). Contingent factors explain historical variations. Some forms of MNE, such as free-standing firms, which do not trade in their headquarters country, are not so common today as they were in the nineteenth-century (Wilkins, 1988). Conversely, horizontally-integrated market-seeking firms were not so common in the nineteenth century as they are today (Dunning, 1983).This is because global production has shifted from commodities to manufactured products. The theory is not completely static, therefore. It can address dynamic issues. It portrays behavioural change as adaptive: it explains changes in behaviour as a rational response to a changing environment. Building in contingency adds robustness to the theory. A good theory is a general theory. The theory does not have to change every time circumstances change. A general theory sets out many possible states, such as different configurations of the MNE, and shows that in different environments different configurations emerge. The theory may encompass many possibilities that appear absurd. The theorist may be criticised for even mentioning them. But if circumstances change in a radical way then ‘absurdities’ suddenly become practical possibilities. Likewise many familiar configurations may disappear. The twentieth-century MNE was very different from the nineteenth-century MNE and the twenty-first-century MNE may well be different from both. The theory must be sufficiently general to include the unthinkable as a logical possibility, so that when it occurs it can be properly understood (Casson, 2005; Casson, Dark and Gulamhussen, 2009). 4.2

Distinctive Issues Arising in IB Studies

‘If advances in IB theory were easy they would have been made already.’ There is some truth in this remark, but it is not completely correct. IB could have made more use of mathematical theory, as noted above. It could follow early IB theorists, and import ideas from economics, but instead, for the last thirty years, it has imported ideas from strategy instead (Barney, Wright and Ketchen, 2001; Cantwell, 2014; Porter, 1980; Rugman and Verbeke, 2003; Dunning, 1993). But direct emulation of economics would have been a mistake. IB has a number of distinctive features which mean that economic theories must be modified before they can be imported into IB (Robbins, 1932; Samuelson, 1947; Richardson, 1964; Casson and Wadeson, 2012). Heterogeneity of the principal actors. In many economic models, all the leading actors, such as individuals or firms, are the same (Penrose, 1959). The entire analysis is conducted in terms of a representative consumer or a repre-

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sentative firm. Pairwise relations between representative agents are then scaled up to theorise about the economy as a whole. But in IB the leading actors are heterogeneous (Buckley and Lessard, 2005). Every MNE is different, because each technology is different, the entrepreneurs are different, and key characteristics, such as headquarters location, are different too. It is these differences make IB a fascinating subject. But they also pose a challenge. Industry analysis with homogeneous firms is quite challenging, as economic theory makes clear, and industry analysis with heterogeneous firm is even more so. Nevertheless, progress is possible, as explained below (Beugelsdijk, van Ees, Garretson, 2014). Complexity of the physical environment. The global economy is an extremely complex system (Krugman, 1991; Markusen, 2002). Economic theories are still formulated mainly at the level of the nation state. This is partly a legacy of the nineteenth century; Marshallian economics developed when European nation-building was at its height, and there has been little fundamental change since then. The global economy is the province of international trade theory, migration theory, and other specialised sub-fields; it does not occupy the central place in economics that it does in IB theory. There are theoretical reasons, as well as practical reasons, for focusing on the global economy. The global economy is a closed system, whereas a national economy is an open system. The national economy trades with other nations but the global economy is largely self-contained. As such, it satisfies internal conservation laws, e.g. total imports equal total exports, and total outward investment equals total inward investment. When formulated at a global level, IB theory must satisfy these laws, and this provide a valuable check on consistency (Buckley and Hashai, 2004). Importance of the knowledge environment. The crucial role of innovation in IB means that the knowledge environment is far more important than in conventional economics, where the nature of the product usually remain fixed over time. Furthermore, knowledge is distributed over space, e.g. knowledge of all kinds tends to be clustered in specialised hubs based in major cities and regions. Customer perceptions of products are also influenced by local knowledge encoded in customs and traditions. Successful innovation requires good judgement, which must be supplied by the innovating entrepreneur. The entrepreneur’s job is to collect as much information as they can, including confidential information obtained through business and professional networks, and to interpret this information in the light of their previous experience. For this purpose they may employ simple heuristics rather than rational calculation. Theorising is difficult because an individual’s choice of heuristics depends on a range of personal and social factors that remain poorly understood (Casson, 1997).

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Granstrand (1998, p 465) explicitly links “the idiosyncrasies of technology (i.e. technical competence)” to management. “In particular, a technology-based firm tends to engage in technology diversification, thereby becoming multi-technological”. This suggests that theory can develop by analogy to product diversification as strategic decisions of MNEs, as demonstrated by Penrose (1959). An exciting extension of the theory might then be to model the implications of multi-technological firms along the lines of Buckley and Casson’s (2007) interpretation of the growth dynamics of Penrosian product diversification. Importance of learning. In many economic theories interaction is instantaneous. In Marshallian market theory, for example, prices are negotiated instantaneously so that all trade takes place at equilibrium prices. In practice, however, interactions take time. Markets adjust through inventory changes and slack in capacity, as well as through price. People learn slowly and modify their behaviour accordingly. Technologies are improved through feedback from production experience. Policies change when politicians learn from their mistakes. Learning is a complex process, however. People constantly update their memory by adding new information, but they discard information too. Learning itself may be regarded a rational process that optimises performance when information is costly: patterns are inferred from correlations, and causation is imputed (rightly or wrongly) from leads and lags. Another approach is through heuristics; these are behavioural rules, often based on intuition, which are up-dated in the light of experience. The study of entrepreneurial heuristics could be a useful starting point in developing a predictive theory of learning that is relevant to IB. 4.3

The Need to Extend the Range of Topics Addressed

Internalisation theory was developed to explain two key phenomena of the 1970s: namely the concentration of FDI in knowledge-intensive industries and the cross-flow of FDI between the US and Europe. Neither could be explained using conventional economic theory. There were anomalies that had to be addressed. The theory was designed for this specific purpose. Because it was based on a fundamental principle, however, it was readily generalised. The early focus on Western MNEs was broadened. It has been claimed, at various times, that internalisation theory cannot explain Japanese MNEs, Chinese MNEs (Buckley, Clegg, Cross, Zheng, Voss and Xin Liu 2007), and other emerging market MNEs, but it has since been shown that the theory applies to MNEs wherever they are headquartered (Ramamurti and Singh 2009; Ramamurti, 2012; Hoskisson, Wright, Filatotchev and Peng, 2013) . It is a general theory that develops contingent predictions, as explained

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above, and it is this contingency – allowing for different forms of MNE to emerge in different contexts – that gives it such flexibility (Buckley and Ghauri, 2004, Buckley, 2007, 2009(a), 2010, 2011(a), (b), 2012, Buckley and Strange, 2015). Internalisation theory covers ‘market-seeking’, ‘resource seeking’ and ‘efficiency-seeking’ MNEs (Dunning, 1958). It has been integrated into ‘new trade theory’ to explain global patterns of trade and FDI in differentiated products. It also explains patterns of intra-firm trade in intermediate products. Most recently it has been used to analyse global value chains and the ‘global factory’ (Rugman and D’Cruz, 2000, Buckley and Ghauri, 2004, Buckley, 2011b, 2012). It also explains anomalies in business history. As noted earlier, nineteenth-century MNEs used organisational forms that are unfamiliar (though not unknown) today. Internalisation theory accounts for these forms by recognising the advantages of separating legal and administrative headquarters, as noted above (Casson, 2016). The internet and the world wide web have had an enormous impact on global business, and social life in general, but little research has been published on the internet in IB journals. There have been two special issues of JIBS, which were fifteen years apart, in 2001 and 2016, and very few other papers. Most papers treat the internet and web as part of the environment of business rather than as business operations themselves. Instead of analysing innovation by internet MNEs, and exploring their internalisation strategies, these papers examine the impact of the internet on the boundaries of conventional MNEs. Verizon, for example, which is a large MNE formed by the merger of GTE and Bell Atlantic in 2000, has been mentioned only once in JIBS, and then only in a list of the top 25 regional MNEs in 2004 (Oxley and Yeung, 2001; Leamer and Stoper, 2001; Brouthers, Geisser and Rotlauf, 2016; Chen and Kamal, 2016; Rugman and Verbeke, 2004). The internet, as its name indicates, is part of a networked ICT industry. There is functional specialisation between infrastructure owners (both cable and wireless) and customer-facing service suppliers (internet service providers, ISPs) who generate traffic. There are virtual ISPs who hire capacity from other ISPs, and specialist facilities firms that host co-located servers. The system has a ‘hub and spoke’ configuration, comprising trunk lines and local feeders, with some firms combining end-on links to connect up distant cities. There is price competition between firms that control alternative routes. Cartels and mergers can stifle competition, however, when a single firm, or group of firms, owns and controls all the fastest routes. The boundaries of internet firms is recognised as a crucial issue by the UN-based International Telecommunications Union, the Internet Society and other non-profit associations, yet there is very little analysis of it within IB. It

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seems to be assumed, at least implicitly, that such analysis is the province of ICT specialists alone. There is more IB research on the use of the web for marketing, but even here the internalisation strategies of search engine proprietors, social network sites, mail-box providers and internet service providers have not been fully investigated. It could be argued that the complexity of ICT networks is a deterrent to research, and that the firms involved are secretive. But major insights can be gained by using simple metaphors. The railway system is often described as the ‘Victorian internet’, while the web is likened to a virtual market place. These metaphors work extremely well. The railway system, like the internet, was a network that speeded up communication; it combined infrastructure with traffic generation, and integration (i.e. common ownership) between the two. Likewise conventional urban markets involve private retailers supervised by local councils and government officials just as the web resembles a global market place with private web sites overseen by non-profit international associations.

5

EXTENDING INTERNALISATION THEORY: HOW IMPROVEMENTS CAN BE EFFECTED

5.1

Three Key Steps; the Entrepreneur, Headquarters Functions and Industry Level Analysis

The first step should be to clarify the role of the entrepreneur. This will rehabilitate the individual actor in IB, and counter the corporatist approach that now dominates so much of the literature. The second step should be to examine in depth the headquarters functions of the firm. An entrepreneur can, in principle, be supported by a management team distributed over different locations. Headquarters has too long been regarded as a unitary activity with a fixed location. Evidence shows that different headquarters functions can be devolved, and possibly co-located with local production and marketing functions too. Despite recent progress in this field, more theorising needs to be done. The third step is to generalise classic internalisation theory from the firm level to the industry level. There is too much emphasis on a single firm studied in isolation, and too little emphasis on competition and co-operation between firms in an industry. While economists have analysed competition in detail, IB theorists have not. Early progress in IB oligopoly theory has not been followed up (Rowthorn and Hymer, 1971; Knickerbocker, 1973; Graham, 1978). While co-operation has been analysed at the dyadic level, there has been only limited analysis at the industry level.

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The Role of the Entrepreneur

Entrepreneurs have been defined as individuals who specialise in taking judgement decisions. A judgemental decision is one in which people cannot agree on what is the right decision (Knight, 1921; Kirzner, 1973). People cannot agree because they either possess different information, or interpret the same information in a different way, or a combination of the two. Entrepreneurs believe that they have an information advantage over others, and they exploit this advantage to identify new opportunities. It gives them the confidence to invest in new ventures that others would avoid. If they are correct in their beliefs they make a profit and if they are wrong then they make a loss. Entrepreneurship was discussed as long ago as the eighteenth century, when the entrepreneur was described as an employer of labour (Casson, 1982). Directing employees is a special case of exercising judgement. The worker, it is assumed, does not know what consumers want; the entrepreneur believes they do know, but they lack the skill to produce it themselves. The entrepreneur therefore hires the worker, paying them what they could earn in their best alternative job (their reservation wage). The entrepreneur guarantees this wage to insure the worker against their own misjudgement. The wage is paid in advance of the sale of the product, so this investment is at risk. The entrepreneur accepts this risk because they are confident. They believe that they can charge more for the product than it costs to produce, and so they will make a profit. The worker signs a contract in which they forego their ‘natural right’ to the product of their labour, and accept the direction of the employer over what they produce and how they produce it. Entrepreneurs establish firms. A firm is a useful legal device for an entrepreneur, as it separates their business interests from their personal interests. A firm can provide limited liability and tax privileges. The entrepreneur intermediates between worker and customer. The firm acts as the nexus of the contracts. The entrepreneur appropriates a profit through the firm from the margin between the wage and the price. As a legal entity the firm can outlive the entrepreneur. For the business to survive and grow in a volatile environment, the entrepreneur’s successors must adapt the business, responding creatively to new opportunities and threats. They too must be entrepreneurs. Entrepreneurs not only create firms; they create markets as well. In economic theory the numbers of firms and markets are often taken as fixed, but in practice they change continually. Product innovation creates new markets, as new firms spring up to capitalise on the success of the innovator. Firms and markets are not exogenous therefore; they are the endogenous outcome of entrepreneurial activity. The entrepreneur is particularly important in IB theory because they take important decisions about the organisation of the MNE. Writing in the 1930s,

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Schumpeter (1934) identified organisational innovation as one of five main types of innovation. Schumpeter cited cartels as an example, but international cartels have been relatively unimportant post-1945. The MNE itself is an organisational innovation, but the MNE built on earlier organisational innovations, such as the ‘modern corporation’ of the 1920s, as described by Chandler (1962), which raised bureaucratic management techniques to new heights of sophistication. This involved reporting systems, accounting systems, and the mechanisation of the office through type-writers, duplicators and calculating machines, which in turn stimulated further innovations, such as the M-form multi-divisional firm, based on internal transfer pricing. It also created two contrasting management styles, the low-trust style based on explicit contracts, formal monitoring and high-powered pecuniary rewards, and the high-trust style based on implicit contracts, informal mentoring, lifetime employment and status-based rewards. By 1945 there was a repertoire of management models that firms could adopt, and entrepreneurs could choose between them. The choice of organisational culture is an important entrepreneurial decision. It influences the costs of coordination in both internal and external markets. Relatively little is known about the costs and benefits of different cultures, except that they seem to vary considerably between industries. Knowledge-intensive industries often claim to possess a high-trust culture, but the sincerity of this claim is debatable. More research is definitely required. 5.3

The Headquarters Function

A large MNE has a legal headquarters, from which taxes are paid. It has shareholders who underwrite financially the strategic decisions of the entrepreneur, and therefore needs a financial headquarters. The firm also needs to control its subsidiaries and negotiate with its subcontractors, franchisees and licensees. For legal reasons the firm needs to be incorporated in a politically stable country with efficient and impartial legal institutions,; for financial reasons it needs representation in a major stock market where new shares can be issued and existing shares traded; and to coordinate its global activities it needs an operational headquarters at a communications hub (Bei and Fageda, 2008; Buckley, 2011b). In principle these different headquarters activities could be located in different places: the legal headquarters in a low-tax country, the financial headquarters close to a major stock market and the operational headquarters at centre of transport and communications networks. There is also the question of where the entrepreneur themselves would like to live. There are obvious advantages to co-location, and so locations that meet all four criteria – low-tax good-lifestyle well-connected financial centres – will attract co-located operations. A distributed headquarters may be useful,

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however, for specific purposes; thus a French-owned firm operating mainly in the British Empire might select Paris as its financial headquarters but London as its legal headquarters in order to gain political influence with the British state. The headquarters of a firm can therefore be distributed over different locations, and the locations chosen may reflect both the strategic requirements of the firm and the preferences of the entrepreneur. 5.4

From Firm-level Analysis to Industry-level Analysis

Firm-level analysis and industry-level analysis are often conflated in IB. The concept of ownership advantage or monopolistic advantage is sometimes invoked to suggest that an MNE has no competitor, so that firm and market are the same. This not usually the case, however. Most MNE face one or more competitors, and together they form the industry. Industry level analysis thus involves interactions between multiple firms. These interactions may be competitive or co-operative, or both. They may involve many firms or few firms. Conventional economics emphasises perfect competition, which involves a large number of small firms. The theory was developed at the turn of the twentieth century, when small business was still dominant in industrialised economies (Backhouse, 1994). The theory merits careful study. It assumes that all firms produce the same homogeneous product. Because firms are small, each firm does not react to other firms individually, but to all other firms in the aggregate. The other firms all serve the same group of customers, and so competition between them determines a competitive price. If the individual firm entered this market its market share would be so small that it would not affect the price. The prevailing price is therefore the price that the firm would get if it entered the market. All interaction between firms can therefore be regarded as an interaction between each firm and the market price – a single statistic that is publicly known. The rise of big business challenged this theory and led to the development of oligopoly theory. In oligopoly there are fewer firms in the industry, and the entry and exit of any firm can change the price. Each firm responds to each other firm individually. There is a problem, however: how can each firm know how the other will respond to them when they respond to it? There is no easy answer to this. There is a simple way of analysing the issue, however. This is to postulate a simple but unrealistic process that may mimic the outcome of a real and much messier process. Oligopolistic strategy is, in practice, the responsibility of the entrepreneur. It is normally analysed using the theory of non-co-operative games. If a given entrepreneur knew the decisions already taken by all the other entrepreneurs then, given their knowledge of their own situation, the entrepreneur could choose their best response. For example, if they knew that everyone else

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planned to innovate they might anticipate that the market would be saturated and decide not to innovate themselves. On the other hand, if they knew that no-one else planned to innovate then they might decide to innovate because they could obtain a monopoly. In general they could calculate their best response to any combination of strategies by the others. Suppose now that information about their responses was available to everyone else, so that everyone knew everyone else’s responses to everyone else’s moves. Two main possibilities now emerge (Fudenberg and Tirole, 1991). Everyone could determine which sets of moves would leave everyone (including themselves) making their best response. These sets of moves would be common knowledge. Each set of would represent an equilibrium, because no entrepreneur would have any reason to regret their move. Suppose that there was a single such set of moves. This set could then become a ‘focal point’; each entrepreneur would conjecture that the others will make their equilibrium moves, and so it would pay them to make their own equilibrium move as well. If there were several such sets of moves then there would be several focal points, however. If everyone benefited most from the same equilibrium than that could become the focal point, but otherwise conjectures could be incompatible. It can therefore be predicted that a unique equilibrium will generate a unique outcome, but multiple equilibria will normally not. The other possibility is that the moves are made in sequence. This gives an advantage to early movers, because they can predict the responses of subsequent movers, and optimise their own move accordingly. The sequential approach always generates a unique equilibrium. But the question of who determines the sequence remains unresolved. One solution is to say that the most entrepreneurial person moves first, the second-most entrepreneurial moves second, and so on. But to have predictive power, each person’s entrepreneurial ability must be determined from independent information and not just inferred from the sequence of moves. Oligopoly theory is well suited to the analysis of innovation (Sanna-Randaccio and Veugelers, 2007; Petit and Sanna-Randaccio, 2000; Petit, Sanna-Randaccio and Sestini, 2012). Each potential MNE is controlled by an entrepreneur who has discovered some new product or process and is deciding whether to commit to its exploitation. For each entrepreneur the profitability of innovation will depend on whether their rivals decide to innovate as well. The outcome can be predicted using the equilibrium concepts set out above. Oligopoly theory can also be used to analyse co-operation (Buckley and Casson, 1988, Axelrod, 1984). In this case entrepreneurs benefit when other entrepreneurs innovate too. Co-operation can be achieved either by conjecture or contract. Co-operation by conjecture is similar to competition in that each entrepreneur has to anticipate how the others will behave. Under competition, innovation strategy tends to follow the principle ‘I will if you won’t, and

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I won’t if you will. I will go first, if I can, to discourage you from following’. But under co-operation by conjecture, entrepreneurs tend to follow the principle ‘I will if you will; I won’t if you won’t. I will go first, if I can, to encourage you to follow’. Co-operation by contract, on the other hand, involves all the entrepreneurs ‘sitting around the table’ (either actually or metaphorically) and negotiating a single multi-lateral agreement. It can be analysed using the theory of co-operative games. Equilibrium requires that each party profit at least as much as they would from making no deal, or from negotiating a credible alternative deal of some kind, possibly with a sub-set of partners. In practice the entrepreneurs may form rival alliances which then compete against each other. The division of profit between rival alliances will be determined by impersonal competitive forces, as in the pure competitive theory, whilst the division of the profit within each alliance will be determined by contractual negotiations between the parties involved.

6

CONCLUSION AND RESEARCH AGENDA

IB research has always focused on the firm (Hennart, 2009). Looking inside the firm reveals headquarters and subsidiaries. But headquarters is not unitary; it is a collection of functions, which can be separated. The key function is that of the entrepreneur, who until recently was almost entirely missing from IB theory. The entrepreneur is a real person, unlike the firm, which is a legal fiction. The firm, of course, has a management team, but this team is selected mainly by the entrepreneur. Looking outside the firm reveals the environment. But the board room windows give a very parochial view. The key question is not how the board sees the environment but what the environment is actually like. The global environment is both large and complex, and is best observed with detachment by taking a ‘bird’s eye’ view. The inside and the outside of the firm are connected. The entrepreneur scans the environment for opportunities. Only when an opportunity has been discovered will the founder establish the firm. The firm is an instrument of value creation and appropriation and its organisation structure is designed by the entrepreneur with this in mind. Internalisation is only one of many issues that the entrepreneur must consider. Once they have invested in the firm (and persuaded others to do so too) competitive threats become a major issue. The entrepreneur cannot afford to view these threats as a vague attempt by hostile forces to undermine his ‘ownership advantage’. The entrepreneur needs to identify specific potential entrants, and consider whether they can deter them, or mitigate the impact if they enter. In other words, the successful entrepreneur needs a ‘bird’s eye’ view, and not a ‘boardroom view’, and this is the view provided by oligopoly theory.

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The boardroom view must be understood for what it is: a myopic version of the bird’s eye view. The bird’s eye view is complex and sophisticated. It is rendered intelligible, not through over-simplification, but through clarification. Metaphors can be useful in discerning the structure of a system, but the underlying logical structure is often best revealed with the aid of some simple mathematics. What goes in inside the firm is indeed related to what goes on outside, but to understand the connections fully it is necessary to develop a rigorous theory of the global system as a whole. This is what many of the founders of IB theory set out to do. Progress has been made – but not far enough. Completing this mission is a worthwhile agenda for future IB theory. The practical implications of expanding IB theory in the directions suggested focus managerial and entrepreneurial attention onto the external environment, particularly its risk profile, onto issues of delegation of authority from Headquarters and onto competitive strategies. Entrepreneurial and managerial judgement about the expansion of the boundaries of the firm – including alliances and takeovers, together with the risk and uncertainty faced in such expansions (or contractions) are areas in which theory can aid strategic decisions. The implications for firm structure are embedded in the role of Headquarters, their location and the division of managerial labour across the firm. Competitive strategies both with the industry and along value chains are practical outcomes of theory development, together with the links between competition, cooperation and innovation. Future theorising can also be a practical guide to strategy. Internalisation is not simply about ‘make or buy’. Internalisation decisions can also be strategic weapons pre-empting or excluding competitors. A terse version of the research agenda that emerges from this analysis is the exploration of managerial behaviour in the internalisation theory context. This connects the sub-themes of this chapter including the role of entrepreneurship over time as the firm emerges from the start-up stage to maturity, where internal entrepreneurs drive innovation, both in technology and in marketing and managerial practice (Casson, 1990, 2000). The HQ function has, with the exception of its location, been under-researched and its roles need to be deconstructed and examined. This would include complementarities between functions, externalisation of HQ functions and the locus of entrepreneurial decision making as the firm develops, recombines its activities and mutates into a network (Foss, 1977, Collis, Young and Gould, 2007, Martin and Eisenhardt, 2010). The role of internalisation as a strategic weapon is also a fruitful area for future research, taking internalisation beyond the ‘make or buy’ decision to a comprehension of the role of replacing markets in order to pre-empt competitors. The inclusion of competition as a central focus of internalisation theory requires some theoretical realignment to the ‘industry’ or ‘strategic group’ level (Porter, 1980, Harrigan, 1985).

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The resulting research agenda is dynamic, management-focused and allows meaningful engagement with cognate studies on entrepreneurship, business history and strategic management. In this way, internalisation theory becomes a central concept in a true social science of business strategy.

REFERENCES Axelrod, R. (1984) The Evolution of Co-operation, New York: Basic Books Backhouse, R. (1994) New Perspectives in Economic Methodology, Routledge: London Barney, J., M. Wright, and D. J. Ketchen, Jnr. (2001) The resource-based view of the firm: Ten years after 1991, Journal of Management, 27, 625–641 Bei, G., and X. Fageda, (2008) Getting there fast: Globalisation, intercontinental flights and the location of headquarters, Journal of Economic Geography, 8 (4), 471–495 Beugelsdijk, S. B., H. van Ees, and H. Garretson (eds) (2014). Firms in the International Economy: Firm Heterogeneity meets International Business, Munich: CESifo Seminar series Brouthers, K.D., K. D. Geisser and F. Rothlauf (2016) Explaining the internationalization of ibusiness firms’, Journal of International Business Studies, 47(5), 563–576 Buckley, P. J. (2007) The strategy of multinational enterprises in the light of the rise of China’, Scandinavian Journal of Management, 23(2), 107–126 Buckley, P. J. (2009) The impact of the global factory on economic development, Journal of World Business, 44 (2), 131–143 Buckley, P. J. (2010) The role of headquarters in the global factory, in Andersson, U. and U. Holm (eds.), Managing the Contemporary Multinational, Cheltenham, Edward Elgar, 60–84 Buckley, P. J. (2011a) Globalization and the Global Factory, Cheltenham: Edward Elgar Buckley P. J. (2011b) International integration and coordination in the global factory, Management International Review, 51, 2, pp. 269–283 Buckley, P. J. (2012) The multinational enterprise as a global factory, in Verbeke, A. and H. Merchant (eds.), Handbook of Research on International Strategic Management, Cheltenham: Edward Elgar, 77–92 Buckley, P. J. and M. Casson (1976) The Future of the Multinational Enterprise. London: Macmillan [25th Anniversary edition], 2001 Buckley, P. J. and M. Casson (1985) Economic Theory of the Multinational Enterprise, London: Macmillan. Buckley, P. J. and M. Casson (1988) A theory of cooperation in international business, in Contractor, F. J. and P. Lorange (eds.), Cooperative Strategies in International Business, Lexington MA: Lexington Books, D. C. Heath & Co. Buckley, P. J. and M. Casson (1998a) Models of the multinational enterprise, Journal of International Business Studies, 29 (1), 21–44 Buckley, P. J. and M. Casson (1998b) Analysing foreign market entry strategies: Extending the internalization approach’, Journal of International Business Studies, 2 (3), 539–561 Buckley, P. J. and M. Casson (2007). Edith Penrose’s Theory of the Growth of the Firm and the strategic management of multinational enterprises’, Management International Review, 47 (2), 151–173

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Buckley, P. J. and M. Casson (2009) The internalization theory of the multinational enterprise: A review of the progress of a research agenda after 30 years, Journal of International Business Studies, 40, 1563–1580 Buckley, P. J., and M. Casson (2011) Marketing and the multinational, Journal of the Academy of Marketing Science, 39 (2), 492–508 Buckley, P. J., L. J. Clegg, A. Cross, P. Zheng, H. Voss and X. Liu (2007) The determinants of Chinese outward foreign direct investment, Journal of International Business Studies, 38 (4), 499–518 Buckley, P. J., T. M. Devinney, and J. J. Louviere (2007) Do managers behave the way theory suggests? A choice-theoretic examination of foreign direct investment location decision making, Journal of International Business Studies, 38 (7), 1069–1094 Buckley, P. J., J. Doh, and M. Benischke (2017) Towards a renaissance in international business research? Big questions, grand challenges and the future of IB scholarship, Journal of International Business, 48 (9), 1045–1064 Buckley, P. J., and P. N. Ghauri (2004) Globalisation, economic geography and the strategy of multinational enterprises, Journal of International Business Studies, 35 (2), 81–98 Buckley P. J., and N. Hashai (2004) A global system view of firm boundaries, Journal of International Business Studies, 35(1), 33–45 Buckley P. J. and D. R. Lessard (2005) Regaining the edge for international business research, Journal of International Business Studies, 36, 595–599 Buckley, P. J. and R. Strange (2015) The governance of the global factory: Location and control of world economic activity, Academy of Management Perspectives, 29 (2), 237–249 Cantwell, J. A. (2014) Revisiting international business theory: A capabilities-based theory of the MNE’, Journal of International Business Studies, 45, 1–7 Casson, M. (1996) The nature of the firm reconsidered: Information synthesis and entrepreneurial organization, Management International Review, 36 (1), 55–94 Casson, M. (1997) Information and Organization, Oxford: Oxford University Press Casson, M. (1982) The Entrepreneur: An Economic Theory, New ed. 2003. Cheltenham: Edward Elgar Casson, M. (1990) Enterprise and Competitiveness, Oxford: Clarendon Press Casson, M. (2000) Economics of International Business: A New Research Agenda, Cheltenham: Edward Elgar Casson, M. (2005) Visions of international business, in P. J. Buckley (ed.), What is International Business? Basingstoke: Palgrave Macmillan Casson, M. (2014) The economic theory of the firm as a foundation for international business theory, Multinational Business Review, 22 (3), 205–226 Casson, M. (2014) Coase and international business: the origin and development of internalisation theory, Managerial and Decision Economics, 36 (1), 55–66 Casson, M. (2016) The Theory of International Business: Economic Models and Methods, London: Palgrave Macmillan Casson, M., K. R. Dark and M. A. Gulamhussen (2009) Extending internalisation theory: From the multinational enterprise to the knowledge-based empire, International Business Review, 18, 236–256 Casson, M. and N. S. Wadeson (2012). The economic theory of international business: A supply chain perspective, Multinational Business Review, 20(2), 114–134 Chandler, A. D. (1962) Strategy and Structure: Chapters in the History of the American Industrial Enterprise, Cambridge Mass: MIT Press

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Chen, W. and F. Kamal (2016) The impact of information and communications technology adoption on multinational firm boundary decisions, Journal of International Business Studies, 47 (5), 563–576 Coase, R. H. (1937) The nature of the firm, Economica (New Series), 4, 387–405 Collis, D., D. Young and M. Gould, (2007) The size, structure and performance of corporate headquarters, Strategic Management Journal, 28 (4), 383–405 Deeg, R. and G. Jackson (2008) Comparing capitalisms: Understanding institutional diversity and its implications for international business, Journal of International Business Studies, 39 (4), 540–561 Dunning, J. H. (1958) American Investment in British Manufacturing Industry, London: Allen & Unwin. Dunning, J. H. (1977) Trade, location of economic activity and multinational enterprise: A search for an eclectic approach’, in Ohlin, B., P. O. Hesselborn and P. M. Wijkman (eds.), The International Allocation of Economic Activity, London: Macmillan, 395–418 Dunning, J. H. (1983) Changes in the level and structure of international production: The last one hundred years, in M. Casson, (ed.), The Growth of International Business, London: Allen & Unwin, 84–139 Dunning, J. H. (1993) Internationalising Porter’s Diamond, Management International Review, 33 (2), 7–15 Dunning, J. H., and S. M. Lundan (2008) Multinational Enterprises and the Global Economy, 2nd. edition, Cheltenham: Edward Elgar. Foss, N. J. (1977) On the rationales of corporate headquarters, Industrial and Corporate Change, 6 (2), 313–338 Fudenberg, D. and J. Tirole (1991) Game Theory, Cambridge: MIT Press Graham, E. M. (1978) Transnational investment by multinational firms: A rivalistic phenomenon, Journal of Post-Keynesian Economics, 1, 82–99 Granstrand, O. (1998) Towards a theory of the technology-based firm, Research Policy, 27 (5), 465–489 Harrigan, K. R. (1985) An application of clustering for strategic group analysis, Strategic Management Journal, 6 (1), 55–73 Hennart, J-F. (1982) A Theory of Multinational Enterprise, Ann Arbor: University of Michigan Press Hennart, J-F. (2009) Down with MNE-centric theories! Market entry and expansion as the bundling of MNE and local assets, Journal of International Business Studies, 40 (9), 1432–1454 Hoskisson, R. E., M. Wright, I. Filatotchev and M. W. Peng (2013) Emerging multinationals from mid-range economies: The influence of institutions and factor markets, Journal of Management Studies, 5 (7), 1295–1321 Hymer, S. H. (1976) The National Operations of International Firms, [MIT PhD dissertation, 1960] Cambridge, MA: MIT Press Kirzner, I. M. (1973) Competition and Entrepreneurship, Chicago: University of Chicago Press Knickerbocker, F. T. (1973) Oligopolistic Reaction and Multinational Enterprise, Cambridge MA: Harvard University Press Knight, F. H. (1921) Risk Uncertainty and Profit, Boston: Houghton Mifflin Krugman, P. R. (1991) Geography and Trade, Cambridge, MA: MIT Press Kunisch, S., M. Menz, and B. Ambos (2015) Changes at corporate headquarters: Review integration and future research, International Journal of Management Reviews, 17 (3), 356–381

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Leamer, E. E. and M. Storper (2001) The economic geography of the internet age, Journal of International Business Studies, 32 (4), 641–665 Markusen, J. R. (2002) Multinational Firms and the Theory of International Trade, Cambridge, MA: MIT Press Martin, J. A., and K. M. Eisenhardt (2010) Rewiring: Cross Business-Unit Collaborations and Performance in Multi-business Organizations, Academy of Management Journal, 53 (2), 265–301 Menz, M., S. Kunisch and D. Collis (2015) The corporate headquarters in the contemporary corporation, Academy of Management Annals, 9 (1), 633–714 McManus. J. C. (1973) The theory of the international firm, in G. Paquet (ed.), The Multinational Firm and the Nation State, Toronto: Collier Macmillan, 66–93, reprinted in Casson, M. (ed.), Multinational Corporations, Aldershot: Edward Elgar, 1990, 32–59 McManus, J. C. (1975) The cost of alternative economic organizations, Canadian Journal of Economics, 8, 334–350 Oxley, J. E. and B. Yeung (2001) E-commerce readiness: institutional, environmental and international competitiveness, Journal of International Business Studies, 32 (4), 705–723 Penrose, E. T. (1959) Theory of the Growth of the Firm. Oxford: Blackwell Petit, M. L., and F. Sanna-Randaccio (2000) Endogenous R&D and foreign direct investment in international oligopolies, International Journal of Industrial Organization, 18, 339–367 Petit, M. L., F. Sanna-Randaccio, and R. Sestini (2012) R&D and foreign direct investment with asymmetric spill-overs, Economics of Innovation and New Technology, 21(2), 125–150 Porter, M. E. (1980) Competitive Advantage, New York: Free Press Ramamurti, R. (2012) What is really different about emerging market multinationals?, Global Strategy Journal, 2 (1), 41–47 Ramamurti, R. and J. Singh (eds.) (2009) Emerging Multinationals in Emerging Markets. Cambridge: Cambridge University Press Richardson, G. B. (1964) Economic Theory, London: Hutchison (reprinted Routledge, 2003) Richardson, G. B. (1998). The Economics of Imperfect Knowledge: Collected Papers, Cheltenham: Edward Elgar Robbins, L. (1932) An Essay on the Nature and Significance of Economic Science, London: Macmillan Rowthorn, R., and S. H. Hymer (1971) International Big Business, Cambridge: Cambridge University Press Rugman, A. M. (1981) Inside the Multinationals: The Economics of Internal Markets, London: Croom Helm Rugman, A. M. and J. R. D’Cruz (2000) Multinationals as Flagship Firms: Regional Business Networks. Oxford: Oxford University Press Rugman, A. M. and A. Verbeke (2001) Subsidiary–advantages in multinational enterprises, Strategic Management Journal, 22 (3), 237–250 Rugman, A. M. and A. Verbeke (2003) Extending the theory of the multinational enterprises: Internalization theory and strategic management perspectives, Journal of International Business Studies, 34 (2), 125–137 Rugman, A. M. and A. Verbeke (2004) A perspective on regional and global strategies of multinational enterprises, Journal of International Business Studies, 35 (1), 3–18

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Samuelson, P. A. (1947) Foundations of Economic Analysis, Cambridge, MA: Harvard University Press Sanna-Randaccio, F. and R. Veugelers (2007) Multinational knowledge spill-overs with decentralised R&D: A game-theoretic approach, Journal of International Business Studies, 38, 47–63 Schumpeter, J. A. (1934) Theory of Economic Development (trans R. Opie), Cambridge, MA: Harvard University Press Wilkins, M. (1988) The free-standing company, 1870–1914: An important type of British foreign direct investment, Economic History Review, 41 (2), 259–282 Williamson, O. E. (1975) Markets and Hierarchies: Analysis and Anti-trust Implications, New York: Free Press

6. The theory of international business: the role of economic models 1 INTRODUCTION This chapter reviews the scope for economic modelling in international business (IB) theory. Economic modelling was commonplace in the 1970s, became unusual in the 1990s, and was controversial by 2000. There are eminent IB scholars today who deny the usefulness of formal economic models in IB. This is odd. Economic theory addresses existential issues in IB. Why do firms become multinational? Why are some firms multinational and others not? Why did the number and the size of multinationals (MNEs) increase in the 1950s? Why did ‘new forms’ of MNE emerge in the 1980s and 1990s? Economic theory provides a set of general principles that addresses these issues. MNEs are clearly economic in terms of the functions they perform, e.g. production, investment and trade. They employ labour, borrow capital and have shareholders who bear business risks. They are not purely economic, of course. Their managers and workers socialise amongst themselves. They are multi-cultural organisations, but they are not the only organisations of this type. The United Nations, the European Union and other inter-governmental organisations are multi-cultural too. No-one argues that political organisations should be analysed without reference to politics, so why should MNEs be analysed without reference to economics? MNEs may well be multicultural, but that is not their defining characteristic. Economic analysis has been crowded out of leading IB journals by studies of cross-cultural organisation. These studies examine issues that are not specific to MNEs; they do not explain why MNEs exist, which markets they serve and where they produce. They typically ignore the fact that MNEs are profit-driven, subject to competitive pressures, and must be efficient in order to survive. Two main factors explain the shift away from economics: economic theory is perceived as highly technical and of little practical relevance, while business strategy is seen as offering a more relevant non-technical substitute. 117

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Critics of economics claim that economic theory has become a mere collection of mathematical models whose assumptions are patently absurd. Mathematics is employed, it is said, not for its practical utility, but to create a pseudo-scientific image and to confer spurious authority. Excessive reliance on mathematics, the critics claim, renders economic theory unintelligible to students and irrelevant to practising managers. Distaste for economics in general, and mathematics in particular, has led to low citations of economic papers. Some journal editors avoid publishing economics papers because impact factors, and hence rankings, may be lowered; this in turn discourages economic research in IB. The ‘other side of the coin’ is the rise of business strategy. It is widely believed that the most important aspects of economic theory have been incorporated into theories of business strategy. There is an element of truth in this. Porter’s (1980) seminal work on Competitive Strategy took the basic principles of industrial organisation theory and presented them, not from the standpoint of government regulation, but from a boardroom perspective. There is a problem, however. Porter over-simplified the economic theory of industrial organisation. He dropped the industry perspective, which was fundamental to the theory, and replaced it with the firm perspective. But he failed to alert his readers to what he had done. He coined new terms, such as ‘value chain’, for existing concepts, such multi-stage production and (more controversially) substituted ‘competitive advantage’ for monopoly power. By inventing new jargon, and failing to acknowledge some of his sources, Porter cut off his readers from the intellectual tradition on which he himself relied. In the 1980s a new generation of scholars, teaching strategy in business schools, began to theorise using Porter’s concepts, unaware that his over-simplified framework was inadequate for rigorous theory development. The most obvious symptom of the failure of the strategy literature is the confusion that now prevails on theoretical issues. Over-simplification has destroyed much of the legacy of earlier theory. If IB theory is to progress, future developments need to be based on more secure foundations than strategy. It is necessary to go ‘back to basics’. This involves stripping away the superfluous concepts that have proliferated in IB theory over the past twenty years. The first step in theory development must be to recover the fundamental principles on which IB theory was originally based. This chapter sets out these principles and outlines a research agenda that builds upon them.

2

BACK TO BASICS: THE ROLE OF THEORY

A good way to begin is with the question ‘Why is theory so important, and what distinguishes a good theory from a bad one?’. A good theory affords

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a unified explanation of a range of different phenomena concerning a given topic. Theory provides economy of thought. It summarises a mass of detail by postulating a simple set of relationships that fits all (or most) of the facts. Good theory is logically consistent. It deduces multiple hypotheses from the same set of core assumptions. Good theory usually involves contingency: it explains not only what is normal, but why different outcomes emerge under different circumstances. Under conditions A the outcome X is observed, and under conditions B outcome Y is observed instead. It may be said that A causes X, and B causes Y, especially if X and Y appear after A and B. In economic theory outcomes are typically rational responses to causal factors, i.e. X is the best response to A and Y the best response to B. Economic theory is highly contingent. Because resources are scarce, trade-offs are common, and so economic behaviour adapts as resources change. Unlike strategy, which often purports to identify the ‘one best way’ of doing things, economics shows that adaptation is usually the best strategy. It is often said that a good theory is a simple theory (Morgan, 2012). But there is a trade-off. A simple theory is often unrealistic. IB is an inherently complex subject. It involves the interplay of location and ownership within a global system of production. Everything is connected to everything else in the global economy and a good theory will recognise this. Good theory clarifies the nature of these interdependencies; it does not just assume them away. Good theory is more realistic than simple theory; it reflects the genuine complexity of the system and clarifies the nature of the inter-dependencies that hold it together. Good theory is not only about simplicity, but about clarity of thinking too. While interdependency and contingency increase the complexity of economic theory, they enhance realism and therefore explanatory power. It is better to have a single contingent theory that explains a range of phenomena with clarity than a portfolio of simple theories that each explain a different phenomenon. It is easier to understand a general theory based on a single set of assumptions than a collection of special theories based on different assumptions that cannot be reconciled with each other. This chapter therefore focuses on general theories rather than specific theories of specific phenomena.

3

ORIGINS OF MODERN IB THEORY

3.1

The Failure of Neoclassical Theory

IB theory did not emerge simply because someone thought that it would be a good idea. It emerged because orthodox theory failed. It could not account for the rise of MNEs in the post-1945 period. In particular, it could not explain the dramatic growth in the number and size of MNEs, why they were mainly

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headquartered in the US and why they mainly invested Europe. Furthermore, it could not explain why their investments were concentrated in technology– intensive and marketing–intensive industries. Mainstream ‘neoclassical’ economists regarded foreign direct investment (FDI) simply as a form of international capital flow (McDougall, 1960, Kemp, 1971). Capital was assumed to be homogeneous, and no distinction was drawn between direct investment (giving control of resources through a majority equity stake) and indirect or portfolio investment (involving minority equity stakes and bonds). Neoclassical theory predicted that • at any given time there would be a net flow of investment from low-profit countries to high-profit countries; • this flow would be transitory; it would cease once international capital stocks had adjusted so that profits rates were equalised across countries; • since capital was homogeneous, flows would be the same irrespective of industries; and • there would be no ‘cross-hauling’; i.e. capital would only flow in one direction at the same time. This conflicted with just about everything that was known about FDI at the time (Dunning, 1958): • it flowed from a high-profit country, the US, to low-profit countries in Europe; • it was persistent and growing; • it was industry-specific; and • it flowed in both directions at once. The abject failure of neoclassical theory is summarised in Table 6.1. The key facts are shown in the left-hand column. The neoclassical predictions are shown in the middle column, and the predictions of modern IB theory in the right-hand column. IB theory provided a simple, direct and intuitively satisfying explanation for everything that neoclassical theory failed to explain. 3.2

Three Key Questions

The basic outline of IB theory was established over the period 1960–76. Three key questions were identified, as shown in the left-hand column of Table 6.2. The answers given are shown in the middle column and the type of theory from which the answers were derived appears in the right-hand column.

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Four key characteristics of the post-1945 period: a comparison of neoclassical and IB explanations

Evidence

Neoclassical prediction

IB theory explanation

Direction of net flow: Investment flows mainly from US to UK

Investment flows from low-profit countries to high-profit countries

US firms make high [monopoly] profits from proprietary technology. Most UK competitors do not possess such technology

‘Cross-hauling’: There is also some UK investment in the US— often in the same industries

Cross-investment is inefficient perfect international capital markets make and impossible

UK high-technology firms can invest in the US for the same reasons that US firms invest in the UK. It is efficient to share technologies wherever they are developed.

Industrial bias. Flows are concentrated in specific industries

Flows affects all industries equally, unless there are industry-specific government barriers

Direct (majority equity) investment is different to indirect (portfolio) because it confers control. Control is required mainly to protect knowledge transfer, which is highest in technology– and marketing-intensive industries.

Time profile. Gross investment flows increase steadily

Investment flows are intermittent. They are once-for all stock adjustments.

The flow of direct investment increases as technological innovation and brand innovation increase.

Table 6.2

Three key questions addressed by early IB theory

Question

Answer

Relevant economic theory

Why did US firms locate production in the UK?

‘Location advantage’: jump tariff barriers, eliminate transport costs, cheaper labour

Classical theories of location and trade (Ricardian comparative advantage); economic geography (the interplay of transport costs and economics of scale)

How could they compete against UK firms with better local knowledge?

‘Ownership advantage’: they had a compensating advantage which could be transferred internationally: proprietary knowledge

Monopoly and oligopoly theory

Why did they not sell (license) theory advantage to UK firms?

‘Internalisation advantage’: avoiding costs of arm’s length contracts due, e.g., to weak intellectual property rights (IPR)

Institutions (coordination/ transaction costs) and knowledge (public good)

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1. Location of production. Why would US firms produce in Europe rather than the US? Answer: The post-war ‘dollar shortage’ made US labour expensive relative to European labour, while high-tariffs encouraged European production in order to ‘jump the European tariff wall’. 2. Ownership of production. Politicians were mystified by how US firms achieved higher productivity than European firms when employing European workers. Surely they must have suffered from lack of local knowledge? Explanation: US firms possessed a countervailing advantage in superior technology, labour management and/or marketing methods, which compensated for their lack of specific local knowledge. 3. Internalisation advantage. Why not have the best of both worlds, by combining the general knowledge of the US firm with the local knowledge of a European firm using a license agreement in which a European firm produced the US product for the European market using US technology? Answer: There must be some obstacle to licensing which makes it more efficient to internalise the transfer of knowledge from the US to Europe within the US firm. The first two question concerning location and ownership were addressed by the Hymer-Kindleberger (HK) theory (Hymer, 1976; Kindleberger, 1969). This theory appealed to trade theory for its explanation of location, and to monopoly theory for its explanation of the firm’s advantage. The final question concerning licensing was addressed using internalisation theory, as explained below. Two approaches: eclectic theory and internalisation theory There were two different responses to this early success of IB theory. 1. A special theory of IB was all that was required, and that had already been developed. It explained the special facts that neoclassical theory could not explain. The HK theory was perfectly sound, and internalisation was just an ‘add-on’. Adding internalisation created the ‘eclectic theory’ (Dunning, 1977). The key facts could be explained terms of three advantages, corresponding to the three questions listed in the table; location, ownership and internalisation. It was stated, rather rashly, that these advantages together were necessary and sufficient for FDI. 2. The second response was that, since neoclassical economics claimed to be a general theory, but could not explain IB, it must be fundamentally flawed, and therefore needed to be replaced. A new general theory was required to restore the credibility of economics. It would be a general theory of the firm in space; the MNE would emerge quite naturally under

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specific conditions, so IB would figure as a special case (Buckley and Casson, 1976). Advocates of the first approach regarded the second approach as extravagant, and much of its content superfluous. Advocates of the second approach claimed that they could achieve much more than simply explaining some specific facts: their approach provided a general framework within which many different types of firm, and many different forms of firm behaviour, could be understood. By embedding specific explanations within a wider framework, greater analytical clarity would be achieved. This second approach led to classic internalisation theory.

4

CLASSIC INTERNALISATION THEORY

4.1

The Multi-plant Firm

Neoclassical theory confused two fundamental concepts: the plant and the firm. Internalisation theory, on the other hand, drew a key distinction between them. A plant was a physical facility; it could be a factory, R&D laboratory, warehouse, office or shop. The firm, by contrast, was an institution. It owned the product produced in its facilities. The firm was a legal instrument through which shareholders combined their capitals to produce an output that was sold for profit. The firm was a fictional person, recognised in law, that acted as a nexus of contracts between workers, shareholders, suppliers and customers. It added value by intermediating between them. Neoclassical economics implicitly assumed that firms were single plant firms, and therefore operated in a single country. This reflected reality at the end of the nineteenth century, at the time when the theory was developed. But even then multi-plant firms were becoming more common, although most were only multi-regional (e.g. retail chain stores). A multi-plant firm operates several plants in different locations, and if the plants are in different countries then the firm becomes an MNE. National borders are often arbitrary; e.g. drawn up to consolidate territory gained or lost through war. Internalisation theorists believed that once the economic logic of the multi-plant firm was established it would be easy to account for the MNE on the basis of the irrationality of national borders. Multi-plant firms would naturally be multinational if the ‘costs of doing business abroad’ (or the ‘liability of foreignness’ in modern terminology) were not too high.

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4.2

The Legacy of Ronald Coase

The development of internalisation theory was inspired by the work of Ronald Coase (1937), who was in turn inspired by the work of his mentor Lionel Robbins (Casson, 2014). Coase’s analysis of ‘the nature of the firm’ was embedded within a more general question of what determines the balance between ‘planning’ and ‘prices’ in the allocation of resources within a national economy. This was a topic of intense ideological debate in the 1930s. Coase noted that the state is not the only institution that undertakes planning; firms also plan. But unlike the state, which asserts its authority to plan, firms only plan by consent; the shareholders must agree to invest, the workers must agree to be employed, and the customers must agree to buy the product. Furthermore, the state must be willing to recognise firms as legal entities. Firms plan by consent, Coase argues, because markets are imperfect, and so under certain circumstances it pays to replace them with firms. The more imperfect are markets, the greater the benefits of firms. But planning systems are imperfect too, so the boundaries of a firm are set where the marginal benefit of planning (i.e. internalisation) is equal to the marginal benefit of using prices (i.e. arm’s length contracts). 4.3

Modular Systems

Internalisation theorists applied this idea to inter-plant coordination. They took a modular view of production. Production may involve a set of different activities, each carried out in a different plant. Modularisation may be vertical, with upstream production feeding into downstream production, or horizontal, where different plants perform the same activity at different locations. Vertical modularisation takes two main forms. The first involves a flow of semi-processed product through a multi-stage production system and the second involves a flow of knowledge between R&D and production. The first flow typically involves raw materials and components, while knowledge flow may involve only documents. Knowledge is a public good; it can be shared by different plants. It is usually more economic for two plants to share the same knowledge rather than to independently generate the same knowledge for themselves. 1. Where different plants in different locations share the same knowledge vertical modularisation involving R&D is linked to horizontal modularisation involving production. 2. Where the knowledge is shared by different plants at different stages of production two types of vertical modularisation are involved: one

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involves the flow of knowledge to the plants and the other involves the flow of semi-processed product between the plants. Each form of modularisation has its own coordination requirements. Multi-plant firms arise when the internalisation of coordination brings different plants under common ownership and control. Internalisation theory embraces all forms of modularisation. Some writers, however, emphasise vertical modularisation involving knowledge to the exclusion of everything else; this over-simplifies the theory and weakens its explanatory power. 4.4

Specific Applications of Coase: Theories of Vertical and Horizontal Integration

The strength of Coase’s work is its high level of generality. It has two main weaknesses, however. 1. Lack of practical applications. Coase’s main example of internalisation involves intra-plant coordination involving teams; the productivity of each team member depends on the productivity of others, and so the employer directs each worker while they perform their tasks (see also Alchian and Demsetz, 1972). There is no analysis of inter-plant coordination, as discussed above. There is certainly no discussion of the internalisation of knowledge; indeed, Coase specifically claims that knowledge cannot be appropriated, and that attempts by firms to uphold intellectual property are futile. 2. Vagueness about the nature of market costs. Coase refers mainly to the costs of ‘discovering prices’. Today it is recognised that markets incur several different types of cost: • Search costs: identifying potential trading partners and making contact with them; • Specification costs: specifying product characteristics; • Negotiation costs: bargaining over price and other terms of contract; • Administrative costs: coordinating time and place of delivery; and • Enforcement costs: Deterring default on product quality or payment with the threat of prosecution or reprisal. Coase emphasises search costs, while today most emphasis is placed on enforcement costs. 4.5

Vertical Integration in Production

For practical insights into internalisation it is necessary to consult the literature on vertical and horizontal integration.

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The theory of vertical integration focuses on intermediate product flow between upstream and downstream plants. ‘Integrated’ plants have a common owner and so internalise the intermediate product market between them. Table 6.3 summarises key literature, some of which pre-dates Coase. Table 6.3

The theory of vertical integration: potential coordination failures in an intermediate product market linking upstream and downstream production activities

Authors

Problem to which internalisation may be the answer

Various

Duplication of inventory due to distrust between managers of different plants

Arrow

Missing contingent forward contracts in intermediate product markets inhibit inter-temporal coordination

Warren-Boulton and others

Economies of scale within multi-stage production generate monopoly/ monopsony power which distorts intermediate product prices and hence factor-proportions at earlier and/or later stages of production

Williamson Mark I

Recurrent high-frequency contracts for intermediate product are costly to negotiate and enforce.

Casson

Quality control is difficult for a downstream buyer when the intermediate product is an ‘experience’ rather than ‘inspection’ good.

Williamson Mark II/ Klein

High sunk costs and bilateral lock-in within multi-stage production create

Crawford and Alchian

‘small-numbers’ bargaining problems between ‘opportunistic’ upstream and downstream plants

A popular explanation for vertical integration in manufacturing was the potential to rationalise inventory; a point later refined by Arrow (1975), who identified missing contingent forward markets as a motive for internalisation. Another explanation emphasised that monopoly at any stage of production distorts relative prices at adjacent stages unless the distortion is removed by internalisation (Warren-Boulton, 1978). Williamson (1975; 1985) offered two explanations for vertical integration; firstly that it reduces the costs of repeated contracting, and secondly (following Klein, Crawford and Alchian, 1978) that it mitigated bargaining problems when upstream and downstream plants were locked into each other (e.g. by co-location or technological complementarity). IB theory added yet another factor: improved quality control; quality control is easier when the downstream firm owns its own source of supply (Casson, 1987). Today vertical integration plays a prominent role in analysing resource-seeking MNEs that integrate backwards into overseas mining or agriculture.

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127

Horizontal Integration in Production

Horizontal integration occurs where two or more plants at the same stage of production are owned by the same firm; it is key to the standard analysis of the market-seeking MNE. Early literature associated horizontal integration with monopoly power If a customer typically visits two different stores in two different towns and buys from the cheapest, and a chain store then takes over the independents or drives them out of business, the customer’s choice is limited and competition is suppressed. Monopoly power drives up the price and rewards the chain store with monopoly profit. The arm’s length equivalent of horizontal integration is the cartel (Casson, 1985). A cartel is an agreement between firms to maintain prices above their competitive level. International cartels in basic commodities were common in the inter-war period (e.g. in oil, chemicals and metals). Cartel agreements are difficult to enforce, however, because covert price-cutting is easy. Enforcement is particularly difficult when cartels are opposed by governments, because they cannot then be enforced by law. Government support was forthcoming in the inter-war period because, with over-capacity in basic industries, international competition damaged the profits of ‘national champion’ firms, but post-war US hegemony led to cartels becoming illegal. 4.7

Vertical and Horizontal Integration Applied to Knowledge

The introduction of proprietary knowledge was a key innovation of modern IB theory. (Hymer, 1976; Buckley and Casson, 1976). Knowledge encompasses technology, brands, and other kinds of specialised know-how. In neoclassical theory knowledge was usually assumed to be a free good, equally accessible to all at zero cost. In IB theory knowledge is a public good (see above), but it is not a free good. In neoclassical theory the stock of knowledge was usually taken as given. Little attention was paid to the incentive to produce it. In IB theory, however, knowledge production plays a central role. The focus is on privately-funded R&D undertaken by firms. R&D incurs large sunk costs which must be recovered from subsequent profits. Monopoly power is the key to profit. Imitation creates competition, undermining profits and so deterring R&D. Patents and other intellectual property rights (IPR) are crucial in appropriating profit, but IPR can be costly to enforce. Secrecy is an alternative to patenting when IPR is weak. Secrecy favours internalisation because of the ‘buyer uncertainty’ problem (Vaitsos, 1974, Casson, 1979). A potential licensee may be unsure about the quality of the secrets they are offered; they could be unreliable or they could be things that

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they already know. This a variant of the quality assurance problem encountered in ordinary commodity markets (see above). Where different licensees are used in different countries, protecting monopoly profits requires a licensee’s cartel. If the final product is cheap to transport then licensees can easily invade each other territories, dissipating monopoly profits though competition (Casson, 1985). The greater the problems of organising a licensee’s cartel, the greater are the advantages of internalising all production. The same knowledge may also be used at different stages of production. If two adjacent stages of production draw upon the same source of R&D then internalisation of knowledge at each stage leads automatically to vertical integration in production. This applies whether or not the vertical integration has an international dimension. This point was overlooked in early statements of Williamson’s (1975) influential theory of vertical integration. A great deal of ingenuity has gone into contriving explanations of domestic vertical integration in terms of opportunism and hostage-taking when a simple explanation based on shared use of the same proprietary knowledge would have been more convincing. 4.8

Origins of Classic Internalisation Theory: Summary

Classic internalisation theory is a reconstruction of neoclassical theory which rejects several key assumptions of the theory. Two of the rejected assumptions are fundamental: • Markets work perfectly • Knowledge is free to all Two others were implicit assumptions that slipped in unchallenged: • Each firm owns just a single plant • FDI involves a flow of homogeneous capital These assumptions were replaced by alternatives that are more relevant and realistic. Simply dropping objectionable assumptions and not replacing them would weaken the explanatory power of the theory. The new assumptions are: • Markets are costly; these costs depend on product characteristics and other observable factors. • Knowledge is often proprietary. • The multi-plant firm represents the general type of firm and the single-plant firm of neoclassical theory is just a special case where the number of plants is one.

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• FDI involves a flow of heterogeneous knowledge. Direct investment confers control of this knowledge. In classic internalisation theory: • Individuals are rational, though not perfectly informed. They seek out opportunities for mutual benefit whenever possible. Where competition is intense the outcome of negotiations approximates to a perfect market outcome but in other cases it does not. Monopoly outcomes are common and, when there is reliance on privately-funded R&D, they may even be desirable. • While the single plant firms may be the statistical norm, out-numbering other types of plant, the multi-plant firm represents the general case. The MNE is an important special case of the multi-plant firm. • Knowledge is more important than capital. Knowledge is fundamentally heterogeneous, unlike financial capital, such as bonds, which are relatively homogeneous. This means that every firm exploiting proprietary knowledge is different from every other firm that does the same and needs to be treated as such. Some assumptions of neoclassical theory are retained by classical internalisation theory. The most important of these is profit-maximisation. Contrary to popular opinion, profit-maximisation does not imply selfishness. When shareholders finance a firm they share a common purpose to make as much profit as possible subject to the law. Their social and ethical concerns are reflected in the way they choose to spend their share of the profits, and the way they vote on government policies to regulate firms. People with a conscience (e.g. virtuous pensioners) can rightfully own shares in profit-maximising firms that follow laws designed to protect the public interest. In a competitive economy firms that fail to maximise profit are unlikely to survive and so any noble aims they profess that are at variance with profit will not be realised.

5

THE SYSTEMS VIEW

5.1

Linkages between Production, Marketing and R&D

The analysis of vertical and horizontal integration involving R&D and production is illustrated schematically in Figure 6.1 (see Buckley and Casson, 1998a, 1998b). An R&D laboratory (identified by a triangle) develops knowledge that is embodied in an innovative product supplied to customers in two different countries. Local marketing and distribution is identified as a modular downstream activity, which takes wholesale product as an input from upstream production and passes it on to final consumers. Both production and marketing

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are represented by boxes; product flow is represented by black lines, and knowledge flow by grey lines. National boundaries are indicated by thin black lines; R&D can be located in either country.

Key: Box: physical activity; Triangle: generating knowledge; Circle: generating local information. Lines: Black: product; Grey: knowledge. Arrows: Direction of principal flow.

Figure 6.1

Interaction of production, marketing and R&D: potential inter-modular linkages involving flows of intermediate products

R&D and production can be located in either country. Marketing and distribution have to be located close to the market however. There are thus 2x2x2=8 location strategies (two for R&D location, two for production for country 1 and two for production for country 2). Under certain circumstances the number of options can be reduced. If cross-hauling the product is inefficient, for example, only three production options need to be considered: producing locally in each country, and exporting from either country. If economies of scale are significant it may be inefficient to replicate production in both countries, and then only two production locations options would be viable. Each linkage can be internal or external, apart from the link to the final customer, which is always external. For each location configuration, knowledge flow can be internal or external, with separate decisions made for production and marketing. If both production and marketing are internalised then product flow is internalised as well. If one is internalised and the other is not then product flow is external. With production internalised, franchising occurs,

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while with marketing internalised subcontracting occurs. If neither production nor marketing is internalised then the knowledge is licensed. It may be licensed to a single firm that integrates them both, or out-sourced to different firms, one of which is a subcontractor and the other a franchisee; this resembles the ‘putting out’ system commonly encountered in the textile industry and in other multi-stage production systems. Altogether, therefore, there are five main ownership options that need to be considered for each market configuration. In principle separate decisions can be made for each market. There are thus 5x5=25 distinct ownership options for production and marketing. With 8 location options there are 8 x 25 = 200 options need to be considered altogether. 5.2

Simple Internalisation Theory as a Special Case of the Systems View

In simple expositions of internalisation theory only three configurations are considered, namely exporting, licensing and FDI. So how are 200 options reduced to three? 1. The location of R&D is fixed; this halves the options to 100. By convention R&D is located in ‘home’ country which is country 1. 2. The focus is on the ‘foreign’ market only (country 2). The ‘home’ country market (country 1) is served by internal local production. This reduces the locations of production options to two: export to country 2 from country 1 or produce in country 2. Ownership choice exists only for the foreign market; this reduces the ownership options to five, leaving 5 x 2 = 10 options altogether. 3. In the foreign market the internalisation decision for marketing is the same as that for production; this reduces the number of ownership options to three. The total number of options is thereby reduced to six. 4. If production and marketing are both out-sourced they are licensed to an integrated licensee; this reduces the number of options to four. 5. Exports from the home country to the foreign country are produced in a wholly-owned plant; this reduces the number of options to three. To appreciate the limitations of simplified versions of the theory, it is important to recognise that simplification eliminates certain issues by pre-determining the relevant decisions. 1. The first restriction assumes away the issue of R&D location. 2. The second assumes away off-shoring of production for the local market. Licensing production for the home market is also ruled out. 3. The third rules out subcontracting and franchising, leaving licensing as the only alternative to internalisation.

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4. The fourth assumes that licensing involves just a single integrated licensee that undertakes both production and marketing. 5. The fifth assumes that a foreign licensee does not produce in the home country to serve the foreign market. Because of these assumptions, simple versions of the theory are unable to analyse some important questions. In fact, these assumptions are quite unnecessary in order to solve the model. The full model is perfectly soluble; indeed, under certain conditions it can be solved in three simple stages. The conditions require that there are constant returns to scale in production and that local product markets are independent of each other. These conditions ensure that ownership and location decisions for each market depend only on the location of R&D and are independent of decisions made for other markets. The three-stage procedure is as follows. 1. Optimise internalisation decisions for each market conditional on the location of production for that market and the location of R&D. Thereby determine the minimum cost of serving each market under each location strategy given optimal internalisation decisions; this summary information is used in stage 2. 2. Optimise the location of production for each market conditional on the location of R&D. Assume that the optimal internalisation strategy is used in each market (as determined in stage 1). Thereby derive the minimum cost of serving each market conditional on R&D location, with optimal production location and internalisation decisions. Determine the profit generated by each market conditional on the location of R&D; this information is used in stage 3. Hence determine whether it is profitable to serve each market. 3. Optimise the location of R&D, given that, conditional on R&D location, each profitable market is served in an optimal way. The profitability of serving individual markets depends on consumer demand as well as on cost of supply. Profit is readily calculated when demand in each market is a linear function of price, or when there is a uniform reservation price and fixed market size. 5.3

Decision Trees

The solution described above can be illustrated using the decision tree shown in Figure 6.2. Each strategic option is represented by a vertical line. The tree has five levels. The decisions at any level are conditional on decisions made at a higher level. Decisions are represented by branching points in the tree where different roots diverge. These branch points are illustrated by solid circles.

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Each decision assumes that lower level decisions have already been optimised. To keep the tree simple, all the decisions involve binary choices; two-tiered binary decisions are equivalent to a single four-way decision, and so on. High-level decisions concern unitary activities, where a single facility occupies a single location (in this case R&D), while low-level decisions concern replicable activities, where the same activity (in this case production and marketing) may be performed at different locations. Replication is indicated by a point with a ‘plus sign’ inside a circle. These are the points at which decisions bi-furcate, with localised decisions at lower levels being independent of each other.

Figure 6.2 5.4

Decision tree for solution of system optimisation

Decentralisation of Decision-making

Decisions relating to each replicable facility depend only on decisions taken with respect to unitary facilities (R&D). Decisions related to replicable activities can therefore be decentralised to the facilities concerned. Each market has a local manager appointed by headquarters. This manager obtains quotes for wholesale product supply from alternative producers at different locations, and compares them with ‘do-it-yourself’ internal production costs at these same locations. They also solicit bids from local licensees and franchisees, and

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compare these bids with the profit that could be obtained from ‘do-it-yourself’ local marketing. The quotes are then adjusted for differential transport costs, contractual costs and other costs incurred. The optimal market-sourcing decision is then determined by maximising the profit generated by the market. Each local manager communicates their profit estimate to headquarters. This quote is conditional on R&D location, since this determines the knowledge transfer costs incurred in production. Headquarters then determines the optimal location of R&D by comparing the net profit contribution of alternative R&D locations, taking account of access to supply of local skills, the advantages of co-location with headquarters, and other relevant factors. Once R&D location has been determined, the decision is communicated to local managers and they implement local arrangements. At the appropriate stage a local manager may decide not to serve a market, or headquarters may decide not to carry out R&D; there is no incentive for the firm to undertake any activity that makes a loss. Decentralisation effects a division of labour in coordination. Different people are responsible for different stages of decision-making. Global decisions about R&D are taken at headquarters by people with global vision, who synthesise and interpret summary information supplied by local managers from across the world. Local decisions are taken by local managers who have access to local information that headquarters staff lack. Centralisation, by contrast, requires headquarters staff to process detailed information from many locations without much knowledge of the local context from which it has been supplied. Although the IB literature has discussed decentralisation at great length, the logical structure of decision-making revealed by decision-tree analysis is rarely mentioned. This logical structure depends on the nature of production and marketing, and in particular the strength of local market inter-dependencies and economies of scale. Other factors are important too. Decentralisation is most advantageous when information is highly localised and communication costs are high. Since communication costs increase with speed, this implies that decentralisation is favoured when decision-making need to be quick. This discussion demonstrates that questions of subsidiary autonomy are closely connected with the logical structure of system-wide optimisation. It suggests, more generally, that the organisational structure of the MNE can be understood as a rational response to the logical structure of internal problem-solving. 5.5

Families of Decision Trees

The systems view, as its name suggests, comprises a whole family of models of the kind discussed above. Different research questions call for different variants of the model above. Additional markets, production locations and

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contractual options can all be introduced but there is no point in adding to complexity unless the questions asked demand it. The systems view can be expanded into an entire suite of models, each useful for a different purpose. The logical properties of each model will stem from the structure of its decision tree. The decision–tree is a ‘fingerprint’ of the model, which uniquely identifies each model and highlights its important properties in symbolic form. By exploring the IB field in a systematic way it is possible, in principle, to identify a list of key questions that the system approach should address. A family of models can then be developed, tailored to the needs of specific questions. In principle there exists an encompassing model, or ‘super-model’, that includes all of these specific models as special cases. A solution of the super-model permits the solution of each specific model by to be derived from simplifying restrictions imposed on the super-model solution. The development of the super-model requires specialised modelling capabilities. It is an intellectual activity rather than a practitioner activity. To motivate the pursuit of such activity as a route to career advancement, the professional culture of IB studies may need to change.

6

THE INDUSTRY VIEW

6.1

Interactions between Firms

The systems view emphasises the interaction of decisions within a single firm. But many decisions involve interactions between firms. Firms can either compete or co-operate, or combine elements of the two. Competition may stem from direct imitation or the development of new rival technologies, while co-operation may involve mergers or joint ventures. What is really required, therefore, is a systems view of the industry. The systems view of the firm would then be embedded within this wider view. The systems view of the industry is not merely a view of the industry through the eyes of a firm within it, but rather a detached ‘bird’s eye’ view from the standpoint of the academic or policy-maker. No individual firm is of special interest from this view, unless they possess significant monopoly power. In IB studies a global industry is usually viewed as an oligopoly, comprising a small number of leading firms and a competitive fringe of smaller firms. The small firms may be recent entrants striving to gain market share, or declining firms pursuing a long-run exit strategy. It is important, however, to recognise the role of licensees, franchisees and subcontractors within this industry view. In the systems view of the firm, set out above, such firms play only a relatively passive role. They compete for contracts with knowledge-intensive firms, but they are not regarded as knowledge-intensive themselves. While they

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possess local knowledge, they have no monopoly of it, and therefore supply their knowledge on competitive terms. A comprehensive industry view must recognise that these firms may possess knowledge advantages of their own and therefor possess market power. 6.2

Mapping the Structure of an Industry

Both neoclassical theory and early Coasian theory is that they take an industry-level view rather than a firm-level view of the economy. In neoclassical theory production decisions made by other firms interact with consumer demand to determine the competitive price to which the firm responds. In Coasian theory each firm is bounded by other firms, and its boundaries are fixed through interaction with these firms. Neither neoclassical theory nor Coasian theory provides a fully satisfactory account of the industry environment, however. Neoclassical theory typically assumes that there are many small identical perfectly competitive firms. Coasian theory postulates heterogeneous firms operating in imperfect markets, but it rules out proprietary knowledge. A satisfactory account of industry structure must be based on a systems view of the firm as set out above. It would distinguish between production, marketing, R&D and headquarters. It would also take a modular view of production. It would identify the location and ownership of each facility: the production plants, distribution centres, R&D laboratories and headquarters offices. These locations would be mapped in relation to major centres of product demand. Flows of products and services would be indicated, including flows of knowledge, semi-processed products, final products, and coordinating information. Two sets of boundaries would be drawn on the map. The first would be political boundaries identifying different countries. The second would be ownership boundaries, indicating the boundaries between different firms. MNEs would exist where ownership boundaries encompassed political boundaries. Ownership boundaries would be of two main kinds. Some boundaries would intersect linkages, indicating an arm’s length contract between two firms. Boundaries that intersected flows of R&D would correspond to licensing, subcontracting and franchising arrangements in which an innovative firm supplies knowledge to an ordinary firm possessing relevant local knowledge. Boundaries that intersected flows of semi-processed product flows would correspond to vertical disintegration in multi-stage production. Other boundaries would separate firms that had no linkages at all. These firms would typically be competitors, operating rival production systems based on different variants of proprietary knowledge.

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137

A Systems View of an Industry

The challenge facing theory is then to explain why the map takes the specific form it does. There are many possible configurations, but only one reflects reality at any given time. Theory needs to possess some principle that selected the actual configuration from all the possibilities. The most significant difference between industry analysis and firm analysis in IB is the requirement in industry analysis to analyse interactions between different knowledge-intensive firms. Some interactions may be negotiated, such as mergers and joint ventures. These involve contractual arrangements that can be analysed using methods similar to those employed above. Competitive interactions, however, do not involve negotiated contracts but mainly rival investments based on conjectures about how rival firms will act and react. There are two main approaches to modelling interactions of this kind. The first regards interaction as a real-time process and industry outcomes over time, while the second regards interaction as a virtual process that results in an equilibrium outcome at a given point in time. The first approach is associated with behavioural models of industry dynamics and the second with the theory of games. Neither approach is entirely satisfactory. Industry dynamics are usually modelled by postulating simple decision rules followed by firms, and tracking their interactions over time. The results are sensitive to assumed initial conditions, and the sequence in which firms are allowed to move. Sophisticated models incorporate learning, so that decision rules are modified over time. In the long run quick learners tend to profit at the expense of slow learners leading to total dominance by the fastest learners. In practice, however, high speeds of learning are difficult to sustain. Speed of learning is a characteristic of the entrepreneur who heads the firm and takes the key decisions; it is a quality that is difficult to perpetuate through personal succession, or to fully embed in the culture of a firm. Realistic models of industry dynamics need to address the issue of entrepreneurial recruitment, retention and succession, but no model has successfully implemented this approach so far. The theory of non-co-operative games analyses strategic interactions between rivals. It assumes that interaction is a virtual process in which firms make conjectures about each other’s behaviour. There are two main variants: in the first the firms act simultaneously and in the second they act sequentially. Simultaneous decisions. Firms consider every possible scenario that could result from other firm’s behaviours and calculate correctly what their best response would be in each case. Each firm then independently identifies the set of all scenarios in which each firm, including themselves, will respond in the appropriate way given the other firm’s behaviours. This is an equilibrium

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set, in the sense that for any scenario in this set no firm will regret the decision it has made given what it observes that the other firms have done. If there is a single equilibrium scenario there is a unique outcome in which each firm behaves in a definite way. If there is no equilibrium scenario then there is no predicted outcome; if there are several equilibria then it is assumed that one of them will appear, although the logic behind this assumption is unclear. Sequential decisions. With sequential decision-making each firm acts in turn. Each firm can predict correctly how other firms will react to their decision, and to the decisions already made by other firms. This gives an advantage to the first mover, because through their decision they can influence, within limits, how following firms will react. The sequence must be specified in advance (as in behavioural models). One way of doing this is to assume that the most entrepreneurial firms act first, and the least entrepreneurial last. From a pragmatic perspective, all three approaches can be used and their predictions compared on a case-by-case basis. In then becomes possible to tinker with the best-performing theory to improve its fit with the evidence. A useful starting point for analysing industry competition would be IB theories of oligopoly that were developed in the 1970s and have been largely neglected since. For industry co-operation, theories of international joint ventures, firm co-location and agglomeration are an obvious starting point. 6.4

Factors Influencing the Boundaries of Firms in a Global Industry

Industry analysis can be used to generalise the systems view of the firm set out earlier. An industry outcome, however determined, predicts which firms will innovate and which will not; which firms will serve which national markets, where they will locate headquarters, R&D and production, whether they will license, subcontract or franchise when serving specific markets. As a bonus, the theory can also predict prices in each market, quantity sold, revenues, costs and profits. If firms innovate with perfect foresight then all firms that innovate will break even or make a profit, and all firms that do not innovate would not have made a profit if that they innovated as well. In terms of the map discussed above, the solution obtained from the industry analysis identifies all the points and all the boundaries on the map. Industry outcomes can take many different forms, giving many possible configurations of firms. Which configuration prevails at any given time depends, in general, on the state of the global economy and the state of each global industry in particular. Figure 6.3 identifies some of the major factors influencing industry outcomes. The factors are derived from the discussion in earlier sections of this chapter.

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The analysis can also be used to compare the different types of configurations that are likely to emerge in different types of global industry (Spender’s (1989) ‘industry recipes’). It can also explain the nature and direction of these changes. Changes in exogenous factors in the industry environment will induce endogenous changes in firm behaviour, thereby re-drawing the boundaries between firms as they adapt to new industry conditions. Competitive forces may stimulate entry and exit, thereby changing the population of firms as a whole. Systems theory applied to IB theory is not a theory of any particular type of MNE. ‘US’, ‘European’, Chinese’ and ‘emerging market’ MNEs simply represent different outcomes of industry interaction, conditioned by the industry environment prevailing at any given time. It is a general theory, as noted above, and it is unnecessary to develop special theories every time circumstances change.

Figure 6.3

Factors in the industry environment

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7

MULTI-LEVEL ANALYSIS

The range of topics encompassed by modern IB studies is impressive but their sheer diversity raises the question of how they are related. The usual answer is that they focus on different functional areas of the firm, and employ different methods of analysis, but are united by a focus on international issues. The theory set out above suggests another way of categorising the literature, however, namely by level of analysis. Table 6.4 identifies five levels of analysis commonly found in IB studies. Higher levels of analysis typically involve greater aggregation. The preceding analysis is embedded in the middle level levels of this analysis, which means that there is an opportunity to both raise and lower the level of analysis. The table indicates what this would mean in practice. Table 6.4

Levels of analysis

Level

Type

Description

1

Global economy

Structural change driven by basic research, shrinking distance, environmental change, etc.

2

Global industry

Inter-firm competition and co-operation

3

Firm

Boundaries of the firm; interaction of ownership and location on

4

Plant and office

Intra-plant organisation, management procedures and working

5

Personal

Recruitment, retention and motivation of staff; personal relations

production, marketing, R&D and headquarters practices with customers and suppliers

1. The highest level of analysis relates to the global economy. It concerns patterns of trade flow, FDI flow and knowledge flow between major countries. It features trading blocs and international institutions. 2. The next level disaggregates the global economy into global industries. Although certain industries predominate in IB literature – automobiles, pharmaceuticals, computers, textile, etc. – this level includes all major sectors including many different types of services. 3. Global industries comprise a large collection of firms, including MNEs, their partners (licensees, franchisees, subcontractors, etc.) their rivals, joint venture partners and so on; they also include many small firms of a purely national character. Firm-level studies typically focus on innovation strategies and headquarters-subsidiary relations. The interface between the firm level and the industry level is a key issue in IB theory, as noted above.

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4. The modular view of the firm identifies different types of activity carried out in different types of establishments – production plants, wholesale warehouses, retail outlets, R&D laboratories and so on. These specialised activities, and the establishments in which they are carried out, can be examined separately. This creates specialised sub-fields, such as international marketing and innovation management. Modularisation may extend to the sub-division of plants in multi-stage production and multi-tier supply chains; this is linked to supply chain management. Modularisation may also be applied to administrative activities. Headquarters may comprise separate legal, financial, and strategy departments. In some cases headquarters may be distributed across a network of different locations, with legal located in a tax haven, financial close to a major stock market and strategic at a global communications hub. The internal coordination of specialised establishment focused on specific functional areas creates another level of analysis. While firm-level analysis typically focuses on inter-plant coordination within a multi-plant firm, this level of analysis focuses on intra-plant coordination instead. 5. The lowest level of analysis, corresponding to the highest level of disaggregation, focuses on individual people. These are typically employees – usually managers, but sometimes workers too. The selection, training and retention of key employees are crucial to the success of the firm. Yet this level of analysis is often detached from mainstream IB research and treated separately as international human resource management. Furthermore, it is often forgotten that many key decisions in a firm are taken by entrepreneurs – people who specialise in taking judgemental decisions involve the commitment of large resources under conditions of great uncertainty. People matter not only because the strategies of a firm impact on many people – customers, suppliers and shareholders as well as employees. People matter because it is people that take the key decisions that determine strategy. The firm is an institution – a legal construct – and does not have a mind of its own. The minds that determine strategies are the minds of individual entrepreneurs, such as the founder, CEO or principal personal shareholder of the firm. A key component of the research agenda for economic modelling in IB is to extend the previous theory to other levels of analysis. Extending upwards will allow the theory to inform debates about the future of the global economy. IB scholarship is often marginalised in policy debates about global futures because its high-level theory is under-developed, and extending the system view to this level would help to resolve this problem. Extending downwards to the individual level would emphasise the role of personal characteristics in firm performance, and counter a tendency in current literature to assume

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that firms and not people are the principal actors in IB. It would also advance understanding of the role of teamwork in coordinating individual action within the firm.

8 CONCLUSION This chapter has set out an agenda for economic modelling in IB. Economic modelling provides a degree of relevance and intellectual rigour that other forms of theorising cannot match. MNEs are fundamentally economic organisations, allocating scarce resources internally in order to compete against rival firms. They are complex organisations operating in a complex environment, and formal models are therefore required to clarify the inter-dependencies within and between firms. Good models are based on a small set of explicit assumptions from which a range of distinct but related hypotheses can be derived. The logic of such models can often be expressed most easily in mathematical terms. Mathematics is a language like any other; many IB scholars have mastered multiple languages, and it would be highly advantageous if they mastered mathematics too. Standard economic models are typical based on neoclassical assumptions. IB models require that some neoclassical assumptions – perfect markets and free knowledge – are replaced by weaker assumptions – namely market imperfections and proprietary knowledge. Confusion between plants and firms must also be resolved: plants produce, firms coordinate, and the same firm can coordinate several plants. In a spatially distributed politically divided world, multi-plant coordination creates the MNE. Formal modelling must be based on secure foundations, and these foundations are provided by early IB theory. Later theory is too simplistic and wedded to a ‘boardroom view’ of the firm. Classic internalisation theory was established in the 1970s and extended in the 1990s by the ‘systems view’. Since then the pace of theoretical development has slowed, but there is now an opportunity to revive it, particularly as new economic methods, such as game theory, have become available. The systems view can be extended to the industry level, and additional levels of analysis can also be explored. By employing the same small set of assumptions at all levels of analysis, a coherent theory of IB will emerge that encompasses the many different fields covered by existing IB literature.

REFERENCES Alchian, A. A. and H. Demsetz (1972) Production, information costs and economic organization, American Economic Review, 72, 777–795

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Arrow, K. J. (1975) Vertical integration and communication. Bell Journal of Economics, 5, 73–183 Buckley, P. J. and M. Casson (1976) The Future of the Multinational Enterprise, London: Macmillan Buckley, P. J. and M. Casson (1998a) Analysing foreign market entry strategies: Extending the internalization approach, Journal of International Business Studies, 29 (3), 539–562 Buckley, P. J. and M. Casson (1998b) Models of the multinational enterprise, Journal of International Business Studies, 29 (1), 21–44 Casson, M. (1979) Alternatives to the Multinational Enterprise, London: Macmillan Casson, M. (1985) Multinational monopolies and international cartels in P.J. Buckley and M. Casson, The Economic Theory of the Multinational Enterprise, London: Macmillan, 60–76 Casson, M. (1987) Quality control and vertical integration, in Mark Casson, The Firm and the Market, Cambridge, MA: MIT Press, 84–120 Casson, M. (2014) Coase and international business: the origin and development of internalisation theory, Managerial and Decision Economics, 36 (1), 55–66 Casson, M. (2016) The Theory of International Business: Economic Models and Methods, Basingstoke: Palgrave Macmillan Casson, M. (2016) Alan Rugman’s methodology, International Business Review, 25 (3), 758–766 Casson, M., L. Porter and N.S. Wadeson (2016) Internalization theory: an unfinished agenda, International Business Review, 25 (6), 1223–1234 Casson, M. (2014) The economic theory of the firm as a foundation for international business theory, Multinational Business Review, 22 (3), 205–226 Casson, Mark, G. Jones and T. da Silva Lopes (2017) Explaining the Unconventional, Paper presented at the Academy of International Business (UK Chapter) / Dunning Centre Conference, University of Reading, April 3–5 Cheung, S.N.S. (1969) Transaction costs, risk aversion and the choice of contractual arrangements, Journal of Law and Economics, 12, 23–42 Coase, R. H.(1937) The nature of the firm, Economica (New series), 4, 387–405 Demsetz, H. (1968) The costs of contracting, Quarterly Journal of Economics, 82, 33–53 Dunning, J. H. (1958) American Investment in British Manufacturing Industry, London: Allen & Unwin Dunning, J. H. (1977) Trade, location of economic activity and the MNE: the search for an eclectic approach, in Ohlin, B., P-O. Hesselborn and P.M. Wijkman (eds.) The International Allocation of Economic Activity, London: Macmillan Hymer, S. H. (1976) The International Operations of National Firms: A Study of Direct Investment, Cambridge, MA: MIT Press [PhD dissertation, MIT, 1960] Kemp, M. C. (1971) The Pure Theory of International Trade and Investment, Englewood Cliffs, NJ: Prentice-Hall Kindleberger, C. (1969) American Business Abroad, New Haven: Yale University Press Klein, B., R.G. Crawford and A. A. Alchian (1978) Vertical integration, appropriable rents and the competitive contracting process, Journal of Law and Economics, 21, 297–326 MacDougall, G.D.A. (1960) The benefits and costs of private investment from abroad, Economic Record, 36, 13–35

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Morgan, M. S. (2012) The World in a Model: How Economists Work and Think, Cambridge: Cambridge University Press Porter, M. E. (1980) Competitive Strategy, New York: Free Press Spender, J.-C. (1989) Industry Recipes, Oxford: Blackwell Vaitsos, C. (1974) Inter-country Income Distribution and Transnational Enterprises, Oxford: Oxford University Press Warren-Boulton, F.R. (1978) Vertical Integration of Markets: Business and Labour Practices, Cambridge, Mass: Ballinger Williamson, Oliver E. (1975) Markets and Hierarchies: Analysis and Anti-trust Implications, New York: Free Press Williamson, Oliver E. (1985) The Economic Institutions of Capitalism, New York: Free Press

7. Complexity in international business: the implications for theory With Yutong Li 1 INTRODUCTION Prominent IB scholars have claimed, quite correctly, that IB is a uniquely complex field of studies (Eden and Nielsen, 2020). Aguinis and Gabriel (2021), have recently asserted, however, that such claims are exaggerated and misplaced. These claims, they suggest, have encouraged IB to become an intellectual silo cut off from other fields of management studies. This critique of Aguinis and Gabriel (2021) suggests that their criticisms are misplaced. IB is indeed a uniquely complex field of study, and it is so for good reasons. The real-world complexity of IB studies arises from the heterogeneity of the key units of analysis, namely the nation and the firm, the intricacy of the spatial networks by which they are connected, and the sustained and rapid evolution of the global business system. Furthermore the spatial networks in IB are of different kinds – knowledge transfer, product flow and management coordination – each of which has a different configuration. Despite this real-world complexity, IB studies has been rendered simple and straightforward by the power and simplicity of the theoretical principles that it employs (Buckley and Casson, 2001). IB theory has developed simple models, in which over 150 different countries, tens of thousands of firms and millions of different products are reduced to very small numbers of representative units, e.g. two rival firms, two countries and perhaps just a single product. Likewise, IB theory summarises the technical details of complex production systems using simple economic indicators such as profit-margins and unit costs. IB theory is subtle and sophisticated. It abstracts from all the detail that does not really matter for the analysis of any given issue, and pares the analysis down to highlight key relations between critical factors. Many of the principles that underlie IB theory can be applied in other disciplines too. This creates a bridge between IB and other disciplines which can be readily exploited. Aguinis and Gabriel (2021) have under-estimated the salience of this point. 145

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If IB is becoming a silo, as they suggest, it is for very different reasons. IB has striven to differentiate itself from related fields of study, e.g. strategic management and international marketing, in order to defend the autonomy of IB studies within the business school, and protect the jobs that go with it. Furthermore, IB has developed a series of silos within itself, which correspond to the different tracks that routinely dominate its annual conferences. These sub-silos encourage IB researchers to specialise in narrow topic areas, leading some scholars to lose sight of the general principles that give their subject such vitality. Although the previous authors are right to argue that IB benefits from permeable boundaries, their premises are wrong. It is not some misguided belief in the complexity of the subject that discourages links with other subjects, but rather a mind-set generated by the pressures of academic survival in the modern business school. The ability of IB theory to simplify complex problems, as highlighted above, is a major intellectual selling point (Verbeke, van Tulder, Rose and Wei, 2020). Sustained development and formalisation of this theory will maintain, and indeed enhance, the wider reputation of IB studies. Contrary to what the previous authors suggest, IB scholars do not suffer from ‘false uniqueness bias’; to promote their subject more widely, they simply need to capitalise on the strengths of IB theory, and develop its wider potential. This chapter is structured as follows. Section 2 begins by exploring the concept of ‘complexity’; different aspects are distinguished and then examined in turn. Section 3 identifies the key dimensions in IB analysis and shows that each dimension can be examined at different levels of aggregation. Section 4 illustrates how complexity is generated through classification and cross-classification applied to the various dimensions identified in section 3. Section 5 examines the networks of relationships which are such a prominent feature of IB activities. Section 6 examines the dynamics of the IB system, and the complexity that is involved in analysing process and change. Various numerical measures of complexity are introduced at each stage. Section 7 contrasts the complexity of the subject with the simplicity of the theory. This simplicity arises from the straightforward nature of the key principles on which the theory is based, and gives the theory considerable versatility. Section 8 concludes by arguing that IB studies needs to build on its strengths, and avoid excessive self-criticism.

2

ALTERNATIVE CONCEPTS OF COMPLEXITY

2.1

A Brief Review of the Literature

The concept of complexity is rarely defined, and Aguinis and Gabriel (2021) is no exception. It is generally accepted that there is no agreed definition.

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Complexity can, however, be regarded as the opposite of simplicity; this suggests that a complex system involves an intricate pattern of relationships between different objects that is difficult to understand. The literature on complexity covers a wide range of topics (Manson, 2001). The modern literature was initiated by Simon (1964); he describes a complex system as possessing many parts that interact in a non-simple way, but unfortunately he focuses mainly on hierarchies. Fortunately a number of important recent papers in IB have contributed to the analysis of complexity (e.g. Vahlne and Johanson, 2021). Five papers are particularly relevant to this counterpoint and are discussed below. Asmussen, Benito and Petersen (2009) have examined complexity in the market entry decision. They distinguish between foreseeable and observable contingencies (‘ordinary contingencies’), such as product and place, and unforeseeable or unobservable contingences (‘meta-contingencies’), such as customer reactions and competitive responses. These contingencies must be considered when making an entry decision, Successful entry, they argue, depends crucially on the managerial capability to handle meta-contingencies, e.g. the ability to learn from experience and improvise solutions to unforeseen problems such as consumer reactions and competitive responses by other firms. Hashai and Adler (2021) analyse in depth competitive response as a source of complexity. They interact competitive complexity with the complexity created by long and intricate supply chains, and show how competition between rival supply chains can be analysed in terms of the theory of games. Although a realistic model would be detailed and difficult to solve, a simple model can provide insight and intuition that will improve decision-making by managers engaged in supply chain competition. Bekes, Benito, Castellani and Murakozy (2021) develop this approach using the concept of a business ‘footprint’. Their focus, however, is on the complexity of the operations controlled by the management of the firm rather than the complexity of the environment in which the firm operates. They distinguish between the ‘extent’ and ‘boldness’ of the footprint. The extent of the footprint reflects the range and locations of the activities in which the firm is involved, whilst its boldness of the footprint reflects the level of risk that it incurs. The complexity of the firm and the complexity of the environment may be related, however. It could be said that the extent of the footprint reflects the ordinary contingencies described above, while the boldness of the footprint reflects the meta-contingencies. It is possible, though by no means certain, that complexity of the environment could stimulate not only complexity in decision-making but also complexity in the footprint of the firm. Other IB scholars have approached the issue of complexity from a psychological rather than an economic perspective. Caligiuri, de Cieri, Minbaeva,

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Verbeke and Zimmermann (2020), for example, examine the managerial complexity created by the COVID crisis. Interruptions of supplies arising from staff illness, social distancing requirements and export bans have caused managerial expectations based on a state of normality to be suddenly falsified, creating stress, anxiety and confusion. Complexity increases because of the range of different scenarios that have to be considered in every decision. This provides a new and insightful contribution to the analysis of risk and complexity summarised above. Finally, Aguinis, Rawani and Cascio (2020) examine complexity in the research process itself. They report that the mismatch between theoretical constructs and evidence on actual behaviour generates complexity for researchers attempting to reconcile theory with practice. This is particularly acute when analysing managerial responses to risk, as discussed above. 2.2

Different Types of Complexity

To position the current debate within the wider literature it is useful to make three key distinctions. The first is between the complexity of reality itself, which is enormous, and the complexity of a theory, or model, that is used to analyse reality, which is necessarily much lower. The focus of this chapter is on the complexity of theory, although the complexity of reality is considered too. The second is between complexity of structure and ‘complexity of process. Structure refers to the range and diversity of the elements in a system and the ‘tapestry’ of the connections between them. Process, on the other hand, refers to the behaviour of the system over time, as determined by the decisions of autonomous agents operating within the system as they respond to external changes. This chapter focuses on structural complexity, which is the main topic of the current debate, although issues of process are briefly discussed as well. The debate over structural complexity in the previous papers is particularly interesting because there until recently there was little discussion of this subject in the management literature as a whole. The third distinction is specific to applications in business and management studies. It is between the complexity of the environment to which managers react, or seek to control, and the complexity of the management structures they create for this purpose (Contini, 2017). Most management scholars advocate simple but versatile structures for managing complex environments, but others advocate stable complex structures that micromanage the environment instead. The focus of this chapter is on the complexity of a firm’s environment, although the discussion has implications for the complexity of management structures too.

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149

Real-world Complexity and Theory Complexity

It is useful to examine the first two distinctions more closely. As indicated above, real-world complexity refers to the complexity of the reality that is being studied, while theoretical complexity refers the complexity of the representation of the same reality afforded by a theory or model. Real-world complexity cannot be assessed directly. For example, real-world business activity is embedded in an intricate socio-economic system that cannot be observed under controlled experimental conditions. Unlike a scientific laboratory experiment, the system is not under anyone’s complete control, The only thing that is completely controlled is the choice of the theory or model that is used to interpret the behaviour of the system. An investigator of a complex real-world system therefore has two main options. One is to focus on some small subset of the real-world system that is sufficiently simple that it is easy to describe in detail. The other is to construct a theory or model of the entire system by abstracting from superfluous detail, as indicated above. What is deemed superfluous will depend on the research question. Different investigators, asking different questions, will therefore make different simplifying assumptions. These assumptions necessarily involve some element of professional judgment; they can only be assessed in retrospect, when the predictions made using alternative sets of assumptions are compared with actual outcomes. The more complex the real-world problem that needs to be studied, the more complex the corresponding theory or model is likely to be. But the more complex the theory, the more difficult it is to understand; and the more difficult it is to understand, the more difficult it is to teach. IB studies deals with real-world problems of exceptional complexity, which need to be understood by people from very different backgrounds. IB scholars have therefore invested heavily in developing theory that is both directly relevant to real-world situations yet easy to understand and teach. 2.4

Structural Complexity and Process Complexity

The contention of this chapter is that structural complexity is extremely high in IB studies because of the many different nations, firms and industries involved and the many connections between them. It can also be argued that process complexity is high as well, because of the uncertainties associated with technological innovation, political and social changes oligopolistic rivalries, etc. It must be conceded, however, that the difference between IB and other subjects is not so great in respect of process as in respect of structure. Financial markets, for example, regularly trade complex claims whose value is contingent on a range of uncertain future events (Brock

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and Hommes, 1997). For this reason the emphasis of this chapter is on structural rather than process complexity. There is an enormous management literature on process complexity (Vahlne and Johanson, 2021). It is often discussed under the rubric of ‘computational complexity’ although this term is given multiple interpretations in the literature. In a real-world context it may refer to the practical problems of decision-making under uncertainty, and in particular the difficulty of optimising some performance measure in a volatile and unpredictable environment (Aksentijevic and Gibson, 2012). In theoretical terms it may refer to the additional complexity introduced into a model by a volatile environment, multiple decision-makers, multi-period decision-making, and subjective probabilities (Chellappan, Gupta, and Venkat, 2021). In computer science theoretical process complexity is often referred to as ‘computational complexity’, and relates to the time taken by an algorithm to solve a mathematical problem. Unfortunately this term has recently been applied in various branches of management studies in a way that is inconsistent with this original use (Bossaerts and Murawski, 2017). 2.5

The Classification and Measurement of Theoretical Complexity

Aguinis and Gabriel (2021) provide a classification of complexity. This is implicitly a classification of theoretical complexity, although they do not make this explicit. They follow Eden and Nielsen (2020) in recognising three distinct dimensions of complexity: multiplicity, multiplexity and dynamism. Multiplicity and multiplexity represent different aspect of structural complexity, whereas dynamic complexity, as its name suggests, is mainly concerned with process complexity. Multiplicity corresponds, broadly speaking, to the heterogeneity of the basic elements in the structure; it can also be described as categorical complexity, i.e. the complexity created by the existence of many different types of entity, each of which belongs to a different category. Multiplexity refer mainly to network structures, which were also mentioned above; multiplexity is particularly high if the connections between the elements involve different types of flow which may go in one direction or another, or in both directions at once. Dynamism refers to change over time. Dynamism is exemplified by sequential exogenous shocks which disturb a system. When actors in the system plan ahead dynamism complicates decision-making, especially when there is uncertainty about the future, and decision-makers base their judgements on subjective probabilities. This chapter develops this approach further. It introduces metrics that can be used to assess the various dimensions of complexity (Rebout, Lone, De Marco, Cozzolino, Lemasson, and Thierry, 2021). Real-world complexity cannot be

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measured directly, as indicated above, because everything observed is based on appearance. However, an approximation to real-world complexity may be achieved by allowing the dimensions of a theoretical model to increase, to match the complexity that an ordinary observer of the system would perceive. This chapter suggests eight different measures of complexity. They are referred to as dimensionality, classification, cross-classification, assortment, connectivity, partition, volatility and persistence. The first three represent different aspects of multiplicity, the next three different aspects of multiplexity, while the last two represent different aspects of dynamism. These three aspects of complexity are examined in turn in the sections below. A practical illustration of the application of some of these measures is given in the Appendix.

3

STRUCTURAL COMPLEXITY: DIMENSIONS OF ANALYSIS

One reason why IB studies is so complex compared to other disciplines is that it embraces no less than four different dimensions of analysis: production, location, ownership and management (Vasconcelos and Ramirez, 2011). By comparison, other subjects often focus on just one or two dimensions, e.g. mainstream economics is mainly concerned with production, geography with location, finance with ownership and organisational studies with management. Production. The most familiar unit of analysis in IB is the firm. In economics the firm is the basic unit of production at the micro-level. Most economic theories of the firm, however, regard it as a ‘black box’. But IB theory opens up the black box to look inside. It identifies a network of plants, e.g. factories, warehouses, shops, research laboratories, and headquarters offices. These ‘black boxes’ can in turn be opened up; inside each may be found teams of employees, and inside each team is found the individual team member or worker. This is generally the smallest unit of analysis found in IB; it may be referred to as the pico-level. Below this level, other disciplines normally take over. The unit of analysis can also be raised; firms can be merged into industries (meso-level), and industries aggregated into production as a whole (macro-level). Location. It is the nature of IB studies that space is important. The fundamental role of space is one reason why IB studies tends to be more complex than other disciplines, many of which do not take space so seriously. The largest spatial unit of analysis in IB studies is the global economy as a whole. The initial step in the subdivision of space identifies the major continents, free trade areas, trading blocs, and major concentrations of economic power, such as the ‘Triad’ countries. Next below are individual nation states. These are the basic meso-level entities that are, by definition, the focus of IB

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theory. Nations determine the laws governing business conduct, rates of taxation and subsidy, and the tariffs or non-tariff barriers imposed on trade. Nations may be further sub-divided into provinces, countries, or, in the case of the US, individual states. Below this level are the major cities and conurbations. The process of subdivision can be continued, using, for example, the successive lines of a postal address, to distinguish the street, the premises, and even an individual room in an apartment block. The finest subdivision is effected by coordinates of longitude and latitude, which uniquely identify each point on the surface of the Earth. In conjunction with a map, these coordinates provide useful economic indicators, such as distance to any other point by a direct route; also soil fertility, climate, proximity to a river or the coast, and other useful information. Ownership. Ownership in IB generally relates to ultimate corporate ownership, as indicated by the country in which the parent firm is legally headquartered. The interaction of plant location with plant ownership generates numerous possible combinations, as described below. Internalisation by an MNE simplifies the ownership structures involved in IB because it eliminates more complex structures involving licensees, franchisees, subcontractors and joint venture partners. This is particularly important where lengthy supply chains are involved, where out-sourcing diffuses control and replaces management authority with potentially complicated negotiation (Huang, Han and Macbeth, 2020; Wiedmer, Rogers, Polyviou, Mena and Chae, 2021). Management. Within an MNE the corporate management team is normally divided between headquarters and individual subsidiaries. A hierarchical management structure can be represented by a decision tree. Each vertical line in the tree represents a line of authority, e.g. from supervisor to supervisee. The seniority of a manager is indicated by their level in the tree. At any given level of the tree, different managers will typically perform different roles, i.e. they may be responsible for different functions, different products, or different market areas. Roles may also differ between successive levels of the tree. In ‘flat’ organisations many decisions are made by committees and many strategies are implemented by teams. Most committees have chairs, however, and teams have leaders, so a hierarchical tree may still be appropriate. Each team leader may control several supervisees, and each chairperson may preside over several committee members. A person’s seniority may not reflect their level in the tree; indeed highly skilled team members near the bottom of tree may earn more than senior people higher up the tree.

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STRUCTURAL COMPLEXITY: MULTIPLICITY

4.1

Simple Classification

153

Classification refers to the number of different types of units found in each dimension of analysis. With no classification, all units are implicitly regarded as the same. This approach is often applied to firms in simple economic models of a competitive industry. Classification implies heterogeneity, the degree of which is reflected in the number of categories used. The finest classification accords each unit its own identity, and gives it a name. IB case studies exemplifies this, where leading firms in an industry are identified by name and discussed separately. Most classifications represent an intermediate case where there are several different categories and several units are allocated to each category. Production. Products can be classified in various ways. Intended use is the most common criterion, e.g. cosmetics such as hair spray and face cream. The technology used to make a product work is another, e.g., radio, electric light. Others are classified by the materials from which they are made, e.g. metalwork, while food and drink are often described by their ingredients, e.g. beef and bacon. All of these criteria are used in standard industrial classifications, some of which are defined up to an eight-digit level. Products can also be classified by stage of production, e.g. raw materials, intermediate products and final products. Location and ownership. Plant location and ownership are normally both classified by country. There are approximately 200 countries in the world, of which about 30 are significant foreign investors. Management. Management is usually classified by structure, and structures are often identified using contrasting ideal types, e.g. centralised (U-form) or decentralised (M-form); high trust (X-form) or low-trust (Y-form); formal or informal (Z-form); flexible or inflexible (e.g. project-based) and so on. In IB theory a distinction is also drawn between autonomous and dependent subsidiaries (Williamson, 1985; Ouchi, 1981). 4.2

Cross Classification

Cross-classification arises when two or more dimensions of a classification are combined. If there are M1 categories in one dimension and M2 in another then when both dimensions are employed there are M1M2 categories. As additional dimensions are added the number of categories increases at an accelerating rate. With N dimensions there are M1M2….. MN categories altogether.

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IB cross-classifications include • production with location (different types of product are produced in different locations); • ownership with location (firms headquartered in different countries own plants located in different countries); • management and location (subsidiaries in different countries adapt their management styles to local conditions); • ownership and product (firms headquartered in different countries produce different types of product); • ownership and management (firms that are owned in certain countries adopt specific styles of management); and • management and product (the production of different types of product is managed in different ways) Three-way and four-way classifications are also used, e.g. early post-war US MNEs were said to produce high-technology products in developed European countries using formal hierarchical models of management, while UK MNEs produced food and minerals in developing countries using relatively informal and personal models of management. A simple numerical example of the generation of complexity through cross-classification is set out in the appendix. 4.3 Assortment In practical applications of a classification scheme each unit in a sample or population is usually allocated to a one particular category. If the are N units, each of which has its own identity, and M categories, then there are MN different possible assortments. This applies whether the categories are generated by simple classification or by cross-classification.

5

STRUCTURAL COMPLEXITY: MULTIPLEXITY

5.1 Connectivity Consider a set of units that are all of the same type, but each has a separate identity, e.g. firms or individuals. These units may be connected. Thus the owners or managers of two separate firm in a given industry might know and trust each other. Let there be N firms in the industry; then there would be V = N(N – 1)/2 different possible connections of this type. Each connection could, in principle, exist independently of the others. There are therefore T = 2V different possible configurations of the network. Let the number of actual connections be C. Overall connectivity may be measured by C/V. The greater

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the connectivity, the greater the opportunities for co-operation in the industry. This could benefit customers through co-investment in worker education or shared infrastructure, or damage their interests through collusion over price. Let the managers be indexed i = 1.,,, N. Let manager i have ci connections to other managers, where ​Σ​ci = C. Then ci /V is a measure of the influence of manager i within the network; while ci /C measures the extent to which their power dominates that of others. Connections can also be used to analyse marketing strategies. Consider for example a set of K major customers, each of which can communicate with one or more firms. There are KN possible configurations of the network linking customers and firms. The more customers a firm can connect with, the greater its sales potential. The more firms a given customer can connect with, the greater their bargaining power. The most profitable firms will tend to be the firms that have the most connections with those customers who do not have many connections with other firms as well. A similar analysis can be applied to the influence of directors on the policies of firms they serve. Different firms may have different numbers on directors on their board. The more directors there are on the board, the smaller the influence of any given director and the greater the power of management (as the board is less likely to be able to agree on strategy); conversely, the fewer the directors, the greater the influence of each director on corporate strategy and the weaker the influence of management. The most influential directors are those that serve on the greatest number of boards that have a small number of directors. This analysis is relevant to the issues of secret trusts, which acquire substantial interests in competing firms, place nominees on their boards, and then promote collusion through their nominees. Connectivity between managers and between firms raises many important issues in IB. The topic is particularly suitable for historical research, as many connections of this type are highly confidential. 5.2 Partitions Partitions are a major source of complexity in any system. They are relevant to industrial concentration, to firm-specific advantage, and to resource-based theories of the firm, but do not often appear in IB theory. Their potential relevance to IB theory is illustrated by the example below. Consider a global population comprising N managers, each of whom works as part of a team. Each team manages a single firm within a given global industry. A team can involve any subset of managers up to size N (by convention an owner-managed firm has a management team of size one). Managers can be teamed up in many different ways, although each manager can belong to only

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one team. Some combinations of managers work well together, and others do not. The theory of partitions shows that there are B(N) possible configurations of teams, where B is the Bell number, which is related to Stirling numbers of the second kind (Merca, 2014). The Bell number describes the number of ways in which a set of N different managers can be partitioned into a set of teams. The Bell number accelerates rapidly with respect to N; thus B(4) = 15, B(5) = 52, B(6) = 203, B7) = 877, and so on. Suppose that each team develops and exploits a specific type of product, and that the profit it makes is independent of the profits made by other teams. (At this stage profit is measured gross of management salary costs, which are later subtracted to determine net profit.) A given partition of the set of managers generates a unique set of firms in the industry. The profits generated by each active firm can be summed to generate the total profit of the industry. Economic efficiency of the industry normally requires the maximisation of total industry profit, subject to the constraints on the supply of managers as described above. The owners of each firm compete to recruit their preferred combinations of managers. Competition between the firms increases management salaries up the point where some firms drop out of the bidding because their salary bill exhausts their gross profit. Eventually an equilibrium is reached in which (1) each manager receives the best offer they can expect to get, (2) all the firms that operate break even or make a profit, and (3) the remaining firms cannot operate because they cannot recruit all the managers they require without incurring a loss. In equilibrium each manager receives a salary just slightly above the salary that they would have received if they had accepted the best alternative offer. Bidding stops when equilibrium salaries have been offered and accepted by the managers. The surviving firms all break even or make a small net profit. This determines the optimal configuration of firms, the remuneration of each manager, and the profits of each active firms. The theory shows how the firm with best combination of managers makes the highest profit. The industry will normally generate a wide variety of products. Each firm will produce a different product because it will employ a team of managers with a distinctive mix of skills. . The firms with the largest teams are on average likely to make the largest profits, but this is by no means assured. A small firm with a highly individualistic entrepreneur has the potential to make a large profit too. It is possibly to proxy the size of firm by the number of mangers employed. Given this measure, it is easy to measure industrial concentration by the Gini coefficient, or the Herfindahl index, or some other statistic (Naldi and Flamini, 2016). It is possible to measure the distribution of profit across the firms in the same way too. Note, that is not appropriate to use these indices as meas-

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ures of monopoly power in the industry. By assumption each team produces a non-competitive differentiated product; each firm has a monopoly of its own specific product, but not necessarily a large share of total sales and employment in the industry.

6

PROCESS COMPLEXITY: DECISION-MAKING IN A DYNAMIC ENVIRONMENT

Classic IB theory has been criticised in the past for being too static. The theory needs to be made more ‘dynamic’, it is said (Colli, 2015; Pitelis and Verbeke, 2007). But dynamic theories are inherently more complicated that static theories, which is why many theorists do their best to avoid them. Dynamics are intimately associated with process: the more complex the process, the more difficult it becomes to analyse its dynamics. For the purposes of this chapter, therefore, it is reasonable to equate the dynamics complexity of Eden and Nielsen with process complexity, as defined above. There are many different aspects of process complexity; some are easy to measure, but some are not. Most dynamic theories involve a periodisation of time. It might be suggested that the number of periods is a convenient measure of process complexity. But there is a problem. Whilst empirical studies of dynamic phenomena are necessarily confined to finite periods of time, most dynamic theories cover a potentially infinite period; indeed many relate to continuous time. The period of time does not therefore differentiate adequately between different degrees of process complexity. Dynamic theories are often concerned with uncertainty about the future. The more volatile the environment, the greater this uncertainty, other things being equal. However, if it is easy for decision-makers to reverse their decisions, then volatility has limited impact. What happens in each period is largely determined by events in that period and not by the legacy of the past. The timeline of events is just a snapshot of a series of unconnected actions. The decision problem becomes serious when the environment is volatile but decisions cannot be easily reversed; in other words, when the environment is unpredictable from period to period but the decision-maker is locked into any decision that they make. A combination of volatility in the environment and persistence (i.e. lack of volatility) in response creates complexity for the decision-maker that is so serious that it needs to be analysed by a dynamic theory. Dynamic theories become particularly complex when structural complexity (as previously described) and process complexity (as described here) interact. Structural complexity means that there are a large number of independent decision-makers making a large number of related decisions (e.g. different firms making different market entry decisions), while process complexity

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means that each of these decisions involves a substantive long-term commitment whose outcome depends on an uncertain environment and on the decisions made by other decision-makers too. While it is more difficult to measure complexity in a dynamic theory than in a static theory, there are certain types of dynamic theory for which it is relatively easy to construct complexity measures. For example, the complexity of a dynamic theory involving strategic interactions can often be measured using the dimensions of a decision tree. Consider, for example, the evolution of a global industry. The industry begins in an oligopolistic equilibrium, which is then disturbed by an innovative potential entrant. This threatens the incumbents (who may once have been innovators themselves). If the incumbents anticipate entry by the innovator, they may move first to pre-empt it, e.g. by tying in existing customers with loyalty schemes, or buying up key resources that the entrant is likely to require. A smart entrant will therefore disguise their plans to gain an element of surprise. With first-mover advantage they may be able to anticipate how the incumbents will respond to entry, and foreclose their options by strategies of their own. For example, they may enter on a large scale rather than a small scale, driving down marginal costs, so that they are bound to win a price war; the incumbents must therefore either agree to share the market with them or quit it altogether. This sequence of moves and countermoves can be represented by a tree in which new branches develop with each successive move (Casson, 2016). In the scenario above, the incumbents have the option of moving first, the entrant moves second, the incumbents respond, and the process alternates until all the participants have committed all of their available resources. Once it has been specified who believes what about whom at each stage of the process, the decision tree can be used to predict the outcome,. In most cases the sequence of moves is crucial to the outcome. The complexity of the strategic process can be measured by the number of roots at the bottom (final stage) of the tree. Let S be the number of stages, and R the average number of branches at each stage; then complexity, C, is approximately equal to RS.

7

THE ROLE OF THEORY: RADICAL SIMPLIFICATION OF A COMPLEX REAL-WORLD SYSTEM

Several of the contributors to complexity theory in IB have been theorists, and amongst these theorists there are several who can be described as ‘modellers’ who have employed mathematical techniques (graphical or algebraic) to analyse IB issues. It is easy to see why modellers would be interested in complexity. As explained in this chapter, many theorists have been struck by

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the complexity of the IB system. Indeed, part of the attraction of IB studies lies in the challenge of radically simplifying the representation of a highly complex system in order to make it more intelligible. Critics of IB theory, on the other hand, often question the assumptions on which these models are built. Simplifying a complex system using a formal model is a distinctive research skill. Most theorists have a specific object in view – a research problem that they need to resolve – and they construct their model by eliminating all the extraneous detail that might distract from the problem. Strong assumptions are often made for this purpose; these assumptions do not represent a dismissal of extraneous factors, but rather a recognition by the modeller that these extraneous factors are so important that they require a different type of model to analyse them. IB modellers are typically interested in the IB system as a whole, rather than the individual firms – i.e. the MNEs themselves. This explains the focus of the complexity literature on the system rather than the firm. The analysis of complexity in this chapter has demonstrated the importance of the skill of the modeller in analysing the IB system as a whole. A modeller can take a general model of the system, such as one of those described above, and reduce the dimensions of the analysis so that intuition can be used to interpret the model. For example, a complex model containing H firms operating in N countries, can be reduced a simple model involving just two firms and two countries. This simple model will illustrate vividly most of the effects that could be observed within the larger and more realistic model. As explained above, there is both a structural and a process dimension to IB theory. If process can be simplified in the same way that structure was simplified in the example above then a simple dynamic model of the IB system can be developed. Various ways of simplifying the dynamics have been noted. One of the most effective – and popular – methods is to use game theory to analyse the interactions between oligopolistic MNEs in an innovative industry. Some modellers have used simultaneous decisions games, while those who are most committed to the dynamic approach use sequential games (Casson, 2016; Hashai and Adler, 2021). The skills of IB modellers, it may be suggested, are a significant asset to the IB profession. Yet the IB profession, it can be argued, has not exploited these skills as fully as it might have done. In the light of recent political turbulence, the trend to de-globalisation, and the COVID crisis, there is an increasing demand for a more dynamic approach to the IB system (Verbeke and Yuan, 2020). The dynamics would encompass the interplay of business and politics, as well as rivalry and cooperation between firms. It is hoped that the analysis of complexity presented here will promote the wider use of formal modelling, with its emphasis on the simplification of complex systems, and result in a new

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suite of models that will address the wide set of issues with which IB scholars now need to engage. A new emphasis on simple formal models will also build bridges to other disciplines as advocated by Aguinis and Gabriel (2021). The formal analysis of location factors will reinforce existing links with economic geography; the formal analysis of knowledge generation will facilitate closer integration with innovation studies; while the formal analysis of coordination through internal markets will build closer links to institutional theory and management science. New linkages can be established too. To analyse environmental change, for example, IB can extend its analysis of supply chains to include recycling, and waste management in general, e.g. the present ‘linear model’ of supply chains can be extended to embrace emerging models of the ‘circular economy’.

8

CONCLUSIONS AND IMPLICATIONS FOR FUTURE RESEARCH

This chapter has shown that complexity is itself a complex subject. The concept has never been properly defined, and the different forms of complexity have not been so clearly distinguished as they should have been. Under these circumstances it is not surprising that controversies should arise over the complexities of different subjects. This chapter has shown that the claims of Eden and Nielsen are correct: IB studies is indeed a uniquely complex subject. The logical structure of IB theory is simple and straight-forward however. The key principles can be understood from an analysis of two firms competing in a two-country world, but, if desired, the model can be scaled up to many countries, many firms, and, indeed, many different varieties of product too. Other management disciplines possess some degree of complexity too, but few, if any, can rival that of IB studies. Aguinis and Gabriel (2021) argue that IB studies is no more complex than entrepreneurship, strategy and organisation studies. But IB theory already embraces significant elements of theory from each of these fields. Not only does it synthesise theory from different fields of management studies, but it adds an international dimension too. This significantly increases the amount of cross-classification involved. IB theory recognises that every worker, every manager, every plant and every firm is located in space, and possesses unique coordinates that define its position. Workers interact within the plant, plants interact within the firm, and firms interact with each other, and with politicians and other stakeholders too. These spatial interactions create massively complex webs of communication and orchestrated movements, whose general structure theory is able to explain. The power of IB theory to engage with complexity in a manageable way is a profession-specific advantage (or PSA). The profession has become multinational; it is represented everywhere where IB-trained professionals practice

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their skills. The profession has become an integral part of the phenomena it studies. The profession needs to leverage its PSA in much the same way as an MNE would leverage an firm-specific advantage (or FSA). It should enter emerging fields of study (new ‘markets’ for professional study) and exploit its unique ability to interpret highly complex phenomena in a direct and intuitively simple way. It should move first, before other disciplines colonise IB territory instead. The only thing that may be lacking is the confidence to do this. Aguinis and Gabriel (2021) undermine this confidence by accusing the profession of false uniqueness bias. A close examination of this claim, however, does not support it. This chapter has suggested that, on the contrary, the profession should have the confidence to rise to the challenge and take advantage of new opportunities. An exciting research agenda awaits; IB scholars ‘have the tools’, so they just need to ‘get on with the job’.

REFERENCES Aguinis, H. and K.P. Gabriel (2021) International business studies: Are we really so uniquely complex? Journal of International Business Studies, doi​.org/​10​.1057/​ s41267​-021​-00462​-x Aguinis, H., R.S. Ramani, and W.F. Cascio (2020) Methodological practices in international business research: An after-action view of challenges and solution, Journal of International Business Studies, 51, 1593–1608 Aksentijevic, A., and K. Gibson (2012) Psychological complexity and the cost of information processing. Theory & Psychology, 22(5), 572–590 Asmussen, C.G., G.R.G. Benito and B. Petersen (2009) Organizing foreign market activities: From entry mode choice to configuration decisions, International Business Review, 18, 145–155 Bekes, G., G.R.G.Benito, D. Castellani and B. Murakozy (2021) Into the unknown: The extent and boldness of firm’s international footprints, Global Strategy Journal, 11(3), 468–493 Bossaerts, P. and C. Murawski (2017) Computational complexity and human decision-making, Trends in Cognitive Sciences, 21(12), 917–929 Brock, W. and C. Hommes (1997) Models of complexity in economics and finance, in Schumacher, C., B. Hanzon and C. Praagman (eds.), System Dynamics in Economic and Finance Models, New York: John Wiley & Sons, 3–41 Buckley, P. J., and M. Casson (2001) Strategic complexity in international business. In Rugman, A. M. and T. L. Brewer (eds.), Oxford Handbook of International Business, Oxford: Oxford University Press, 88–126 Caligiuri, P., H. De Cieri, D. Minbaeva, A. Verbeke and A. Zimmermann (2020) International HRM insights for navigating the COVID-19 pandemic: Implications for future research and practice, Journal of International Business Studies, 51, 691–713 Casson, M. (2016) The Theory of International Business: Economic Models and Methods. Basingstoke: Palgrave Macmillan

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Chellappan, R., A. Gupta and R. Venkat (2021) Strategic decision making: A study using computational complexity theory, Turkish Journal of Computer and Mathematics Education, 12(11), 3535–3543 Colli, A. (2015) Dynamics of International Business, Abingdon: Routledge Contini, R. (2017) Complexity and sociology, Sociology Study, 7(7), 376–387 Eden, L., and B. Nielsen (2020) Research methods in international business: The challenge of complexity, Journal of International Business Studies, 51(9), 1609–1620 Hashai, N. and N. Adler, (2021) Internalization choices under competition: A game-theoretic approach, Global Strategy Journal (11), 109–122 Huang, Y., W. Han, W. and D. Macbeth (2020) The complexity of collaboration in supply chain networks, Supply Chain Management, 25(3), 393–410 Manson, S. (2001) Simplifying complexity: a review of complexity theory, Geoforum, 32(3), 405–414 Merca, M. (2014) A chapter on the Jacobi-Stirling numbers, Integral Transforms and Special Functions, 25(3), 196–202 Naldi, M. and M. Flamini (2018) Dynamics of the Hirschmann-Herfindahl index under new market entry, Economics Papers, 37(3), 344–36 Ouchi, W. (1981) Theory Z: How American Business can meet the Japanese Challenge. Reading, Mass: Addison-Wesley Pitelis, C. and A. Verbeke (2007) Edith Penrose and the future of the multinational enterprise: New research directions, Management International Review, 47 (2), 139–149 Rebout, N., J. Lone, A. De Marco, R. Cozzolino, A. Lemasson and B. Thierry (2021) Measuring complexity in organisms and organizations, Royal Society Open Science, 8(3) Simon, H.A. (1962) The architecture of complexity, Proceedings of the American Philosophical Society, 106, 467–482 Vahlne, J. and J. Johanson (2021) Coping with complexity by making trust an important dimension in governance and coordination, International Business Review, 30(2), 101798. Vasconcelos, F. and R. Ramirez (2011) Complexity in business environments, Journal of Business Research, 64(3), 236–241 Verbeke, A., R. van Tulder, E.L. Rose and Y. Wei (eds.) (2020) The Multiple Dimensions of Institutional Complexity in International Business Research. Bingley: Emerald Verbeke, A. and W. Yuan, (2020) A few implications of the COVID-19 pandemic for international business studies research, Journal of Management Studies, 58(2), 597–601 Wiedmer, R., Z. Rogers, M. Polyviou, C. Mena, and S. Chae (2021). The dark and bright sides of complexity: a dual perspective on supply network resilience, Journal of Business Logistics, 42(2), 1–24 Williamson, O.E. 1985. The Economic Institutions of Capitalism, New York: Free Press

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APPENDIX: CASE STUDY OF THE MEASUREMENT OF STRUCTURAL COMPLEXITY IN A SIMPLE IB MODEL The complexity of IB studies and the power of IB theory may be illustrated by a simple example. Consider a world composed of N different countries, populated with H firms, all of which are potential MNEs. Each firm uses a different proprietary technology to the others, although consumers regard their final products as basically the same. It is desired to determine which firms supply which markets, what prices will prevail in each market, and what profits each firm will make. Each firm has to decide whether to serve each national market and, if so, where to locate its production for that market. Each firm serves a given market from a single location, but can serve different markets from different locations, if it wishes to do so. Whether a firm becomes an MNE depends on the choices that it makes; if it decides not to produce abroad then it does not become an MNE. It is assumed to begin with that headquarters and R&D are collocated at a fixed location. Firms with inferior technologies may not operate at all. Consider a set of tables summarising the solution of this problem. One subset of tables relates to production and trade. For each firm there is an NxN table showing how much it supplies from each production location to each market. There are H firms and therefore H such tables and, taken together, they have a total of HN2 cells. There is a smaller table with N cells recording the prices that prevail in each market, and another table with H cells reporting the profits made by each firm (firms that do not operate make a zero profit). The solution is therefore encoded in HN2 + H + N cells. This number is a measure of the ‘tabular complexity of the solution’. The solution varies according to the assumptions on which the theory is based. Suppose that there are two general principles: that firms maximise profit, and that they compete for market share in each country. Suppose, in addition, that each customer in each market demands a fixed amount of each product, and refuses to pay more for the product than some reservation price, p*. Then the amount of product demanded in each market at or below the reservation price is some amount, q. The prices and quantities demanded vary across markets according to local population, incomes and tastes. Suppose also that there are constant unit costs of production and transport, and that there are no fixed costs. Let the total cost to firm h of supplying a unit of product from a plant in location i to a market j be chij (h = 1,…, H; i, j = 1,…, N). The elements chij are measured gross of production costs, transport costs, tariffs and technology transfer costs. They number HN2 and constitute the elements of H individual NxN tables, each of which represents the cost structure faced by an individual firm.

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The other quantitative data required to specify the problem concerns the structure of the individual markets; the amount of the product demanded in each market, qj, and the maximum price that consumers will pay p*j (j = 1,.., N). The data is therefore contained in HN2 unit costs cells, a column of N market sizes and another column of N reservation prices. These comprise a total of HN2 + 2N cells. This is almost the same as the number of cells that need to be filled by the solution; indeed, if there were no reservation prices (so that each market was always served) then the two would be identical). This number represents the ‘tabular complexity of the data’. Each firm can serve any given market from any location; one option is to serve a market by local production, and the others are to import from plants in other locations. Each firm plans to serve a given market from the cheapest location, i.e. the location i*hj where its unit cost is a minimum, c*hj = mini chij. The firm with the lowest cost, c**j = minh c*hj will serve the entire jth market. They will drive out their competitors by setting price just below the unit cost of their closest competitor, which is the firm with the second lowest unit cost. There are two exceptions, however. If the lowest unit cost is above the local reservation price then no firm will serve the market at all; and if the second-lowest unit cost exceeds the reservation price then the firm will charge the reservation price because otherwise it will lose the market altogether. Let pj* be the price set in the jth market when that market is served by its least cost firm. Let qj be the size of the market, as measured by the quantity of sales. Revenue is equal to Rj = p*jqj, and cost is Cj = c**j qj. In the absence of fixed costs, the profit of the firm serving the jth market is π*j = R*j – C*j. There is no limit to the size or geographical diversification of any firm. Its decisions about whether to serve a particular market are not constrained by its decisions to serve other markets. According to this competitive outcome, some firms may be entirely domestic, serving their home market by local production; some may serve their home country only by imports; whilst others may produce in the home country for export, and perhaps for their domestic market too. Some may serve one or more foreign markets, either by exports from their home country or from a third country. By counting up the number of arithmetical operations involved in the solution process a measure of ‘computational complexity’ can be obtained; such measures are widely used to assess the efficiency of computer algorithms. The solution involves four main steps, as indicated above. The first step is to determine for each firm the least cost production location from which to serve each market, and the unit cost associated with it. This is effected by moving along the list of location-specific costs for each combination of firm and market and recording the lowest figure. This process involves HN2 operations. The second step is to compare the costs across firms for any given market; it is the least-cost firm that serves the market. This involves HN operations.

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The third step is to determine market prices by calculating the minimum of the reservation price and the lowest cost in each market. If the reservation price is the minimum then the market is not served. If the least cost is the minimum then it is necessary to compare the second least cost with the reservation price. Whichever is the minimum determines the market price. This involves reprocessing the information obtained at the first stage; the amount of reprocessing depends on the number of firms involved. Overall, therefore, the calculations involve a minimum of HN(N + 1) operations; this may be regarded as a measure of the computational complexity.

8. The geometry of international business 1 INTRODUCTION1 International business (IB) theory has been criticised for focusing on a rather narrow range of issues (Buckley and Casson, 2020). This chapter argues the case for addressing a much wider range of issues, by shifting the perspective from the international aspect of business to the global aspect. The idea is not new, of course; it is reflected in the title of leading journals such as the Global Strategy Journal and the Journal of World Business. The globalisation of the world economy during the latter part of the twentieth century and the early part of the twenty-first century reduced the importance of international barriers to trade and investment and stimulated the growth of truly global business. Whatever the legacy of Trump, Brexit and the Corona virus, it is unlikely that the overall position will completely reverse itself. Increasing concerns about sustainability also have an impact on IB (Forrester, 1973). Many of these concerns focus on Planet Earth, and the threat to its environment. It is impossible to address issues such as climate change without recognising that the surface of the earth is spherical rather than flat. The spherical nature of the planet governs tides, winds and storms, and generates different time zones and different climatic zones (temperate and tropical). It has other implications too, e.g. it makes possible polar air routes between Europe and Asia. Taking Planet Earth more seriously will have numerous benefits for IB. It will introduce greater realism into the analysis of location choice. Greater realism will, in turn, enhance its relevance to managers, and strengthen its impact on policy-making. It will also provide a fresh perspective on some familiar issues, such as market entry, and thereby rejuvenate research in certain areas of the subject. This chapter develops this theme by examining the strategic nature of plant location in a spherical world. Most IB analysis of location implicitly assumes the world is flat, because it draws upon ‘flat earth’ propositions from theories of international trade and economic geography (e.g. Fujita and Krugman, 2003). Location on the surface of Planet Earth differs profoundly from location on a flat plane. On Planet 166

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Earth every location has an ‘opposite’ number on the other side of the sphere; New Zealand, for example, is opposite the UK, and Japan is opposite Brazil. Opposites do not exist on a plane, unless the plane is arbitrarily centred on some point. Furthermore, a simple solution to the optimal location problem does not exist in a spherical world. Under ‘flat earth’ assumptions, the optimal solution is simple: each plant serves a hexagonal market area; each area abuts on six other identical areas, and together all these hexagons cover (or ‘tile’) the plane. On the surface of Planet Earth, by contrast, hexagonal tiling is impossible because of the curvature of the surface, and some other solution must be found. There is no general solution, however; the configuration of market areas for any given number of plants is specific to each case. In a brief chapter, Casson (2019) considered solutions to this problem based upon convex polyhedra with a high degree of rotational symmetry. This chapter extends that analysis by considering a wider range of possible solutions based on polyhedra with lower degrees of symmetry. This means that location problems that had no solution in the previous exercise now have a solution. The analysis is more complicated, however, because there are many more potential solutions that need to be evaluated, as demonstrated below. Section 2 sets out the assumptions usually made in the economic analysis of plant location, as reflected in models that analyse locations along a line or in a plane. Section 3 introduces the key concept of the convex polyhedron; this is the geometric structure that is projected onto the surface of an encompassing sphere to generate a configuration of plants and their market areas. Using this construct, the locational options are examined for each number of plants between one and twenty. Sections 4 and 5 discusses more complex configurations of market areas that are suitable for a larger number of plants. Section 6 addresses technical issues relating to the concept of centrality. Section 7 introduces the concept of duality and explores its relevance to the design of transport networks, while section 8 discusses inter-plant communication in a similar way. Section 9 concludes by indicating the new horizons that are opened up by a rigorous analysis of global plant location strategy.

2

THE OPTIMAL LOCATION OF PLANTS

The problem selected for examination concerns a familiar issue which many readers may believe has already been solved. It concerns the optimal location of production plants by an MNE serving a global market. Various special cases have been discussed but the general case has not. In the IB literature discussions of ‘location advantage’ or ‘country-specific advantage’ often cite the classic literature on spatial economics and the economics of location (von Thunen, 1826; Weber, 1929; Hotelling, 1929; Christaller, 1933; Losch, 1954;

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Eaton and Lipsey, 1975; Samuelson, 1983; Ota and Fujita, 1993). This literature is concerned not only with plant location and market areas, but also with the growth of cities, the spatial variation of agricultural rents and the stability of spatial competition. The literature typically assumes that transport costs from factory to customer are directly proportional to distance and to volume carried, and that customers are identical and uniformly distributed across the total market area. Each production plant incurs a fixed cost and a constant unit cost. Models focusing on a single firm typically assume that firm to be a monopolist. Various assumptions are made about demand; typically the customer has a downward-sloping demand schedule, or merely purchases a single unit for which they have a fixed reservation price. Sometimes the customers pay their own collection and delivery charges and in other cases the producer absorbs them into the price. Occasionally the producer can discriminate between customers according to where they live or how many units they buy. These assumptions seem quite strong, but they are fairly reasonable as a first approximation; furthermore, many of the results derived are quite robust, and do not vary greatly depending on which sets of assumptions are applied. The simplest models of this type analyse the location of plants along a line (e.g. a highway or other transport artery.) A typical solution is that plants are strung out along the line at equal distances from each other, with each plant serving the locations that are closest to it. It should be noted, however, that these models often assume a line of infinite length or one that is circular; this avoids having to analyse the plants at the end of the line differently from the plants in the middle, and having to pack the plants into a fixed amount of space. Assumptions of this kind are not required where spherical models are concerned. To provide greater realism, this conventional model may be extended to a flat two-dimensional plane. If there is just a single plant then the solution is very simple: the solitary plant serves a circular market area. The argument for circularity is very simple; If the area were not circular but irregular then transport costs could be reduced by switching supplies from the more distant customers on the extremity to areas nearer to the centre but just outside the boundary; as this process continued, the irregular area would become circular. When there is more than one plant, complications arise. Even if circular market areas are tightly packed, spaces will still remain between them. A close look at a wine-rack will demonstrate the problem. These spaces represent customers who receive no supplies, and they imply a loss of revenue to the firm. It is normally efficient to fill these spaces by serving each customer from the nearest plant. This transforms each circular market area into a square one; its surface is ‘tiled’ with squares.

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Square market areas, however, are not as efficient as circular ones, because along each side of a square the corner points are further away from the centre than the mid-point of the side. There are, in fact, many ways of tiling a plane with identically-shaped tiles, and so the question arises as to whether there is a tiling solution better than a square. An efficient solution must involve convex tiles, i.e. tiles where any line connecting two points on the tile lies wholly within the tile. Two simple alternatives are a triangle and a hexagon. The most efficient triangle is an equilateral triangle, and the most efficient hexagon is a regular hexagon where all the sides are of equal length and all the interior angles are equal. A hexagon is more efficient than a triangle because, compared to a triangle, the corner points along the perimeter are not much further from the centre than are the mid-points of the sides. Hexagonal tiling of a plane is a well-known solution in location theory (Christaller, 1933), but it suffers from two serious practical defects. First, the surface of the earth is not unbounded, and when boundary conditions are applied then hexagonal tiling may not work. A constellation of abutting hexagons always has an irregular boundary and so if the actual boundary is regular then fitting hexagons will leave empty spaces. A more fundamental practical problem is that the surface of the earth resembles, not a boundless plane, but the surface of a sphere. A boundless plane was a reasonable assumption in the early twentieth century when pioneering theorists were analysing the location of cities in the mid-West US, but the post-war expansion of global business means that it is no longer a reasonable assumption today. It is necessary to move from two dimensions to three.

3

GENERALISATION TO THREE DIMENSIONS

Moving to three dimensions is not only radical in conceptual terms; it also has radical implications for market areas. This is because hexagons do not tile the surface of a sphere. The optimality of hexagons applies only in two dimensions. The reason for this is simple but profound. Unlike the infinite plane, the surface of a sphere is closed. As hexagons multiply, the surface of the sphere bends them round so that they begin to meet up with each other from opposite directions, and there is no guarantee that when they meet up they will match. Indeed, they won’t. This opens up the whole question of where production plants will be most efficiently located on the surface of a sphere. The investigation of this problem does not have to begin from scratch. Spherical geometry is a branch of pure mathematics (Briggs and Edmondson, 1906; Van Brummelen, 2013). It is already known to have many applications in the natural sciences, including physics, crystallography, and bio-chemistry (Smith, 1982). Applications to geology (specifically the location of mountain ranges), were pioneered in the nineteenth century, using the octahedron and

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dodecahedron (Sengoer, 2014; Touret, 2007). More recently, pharmacists have suggested that viruses develop their survival power from the optimality of their spherical chemical structures (Chiu, Coulibaly and Metcalf, 2012). Thus IB is, in some respects, just another field of application of spherical geometry. There is a significant difference, however, between IB and these natural sciences, in that IB focuses almost exclusively the surface of the sphere whilst natural scientists tend to focus on the location of atoms or sub-atomic particles within the interior of the sphere as well; while IB is concerned with ‘tiling’ the surface of the sphere, chemistry is concerned with ‘packing’ the interior of the sphere too. Surface and interior are connected by the theory of convex polyhedra, which is another branch of pure mathematics (Aleksandrov, 2005; Zaffanella, 2018). The notable eighteenth-century Swiss mathematician Leonhard Euler made important contributions to this field, which are used in the analysis below (Bradley, 2007). For the purposes of this chapter, a convex polyhedron may be described as a many-sided object where the shape of each side is that of a regular two-dimensional polygon, and where the corners of the object all coincide with points lying on the surface of an encompassing sphere. Polyhedra may be classified by their degree of symmetry. Some polyhedra are regular, in the sense that all their faces are identical; these are the Platonic solids (see below), which were well-known to Greek mathematicians (DeHovitz, 2016). Others have different faces, but all the faces of any given type are regular, in the sense that they have sides of similar length and/or equal interior angles. For each convex polyhedron a set of market areas can be generated by projecting the flat faces of the polygon radially from the centre of the encompassing sphere onto its surface. Each set of faces will tile the entire surface of the sphere with a set of market areas. While all Platonic solids generate markets areas, not all market areas are derived from Platonic solids. This section compares and contrasts the optimal configurations of market areas for different numbers of plants, N. It evaluates a range of relatively simple structures. More sophisticated structures, derived by ‘truncation’, are discussed later. The economic assumptions generalise those of the one- and two-dimensional models referenced above. Customers are identical and are uniformly distributed over the surface of the sphere. Transport costs are proportional to distance. The objective is the minimise total distribution cost for a given quantity purchased by each customer. In the following discussion, market areas correspond to the ‘faces’ or ‘facets’ of a polyhedron, the linear boundaries of a market area are ‘edges’ of the polyhedron, and the corners where three or more market areas meet are ‘vertices’ of the polyhedron. The discussion identifies leading candidates for

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an optimal solution; mathematical proof of optimality is a formidable challenge, and is not attempted here. N = 1. With a single plant the entire surface of the earth can be served equally well from any point. Thus the market area is the sphere itself. Note that on a plane the corresponding market area would be potentially infinite, and bounded only by escalating transport costs. On the sphere the market area is finite even if transport costs are zero. There is another feature specific to the sphere which merits comment. A threshold is reached when half the global market is served. If the location of the plant is identified as a pole then the boundary of this area is the equator. With a uniform distribution of customers the equator marks the point where a marginal increase in the distance along the surface from the plant generates the greatest number of additional customers; after this point the number of additional customers declines steadily until a single final customer is served at the opposite pole. If transport costs are high relative to product price, then the equator marks a natural point at which the boundary of the market area may be set. To simplify the ensuing discussion, however, it is assumed that production is always sufficiently profitable that it pays to serve every customer. N = 2. With two plants, efficiency requires that each plant is located at the opposite pole to the other. The boundaries of the market areas lie on the equator. The location of the poles is indeterminate, however. The efficiency of opposing poles suggests that under certain conditions a global firm might deliberately choose to locate at the furthest point away from home, rather than nearby. This may explain the apparent paradox that firms headquartered in imperial countries often locate their principal foreign subsidiaries at the furthest point of empire rather than the nearest, e.g. Dutch investment in the East Indies and British investment in Australia (Stopford, 1974). This location strategy stands in direct opposition to the Uppsala view that firms internationalise incrementally rather than in a radical way (Vahlne and Johansen, 2017). The Uppsala view, however, relates to an environment where there are significant costs of ‘doing business abroad’, where there is foreign competition from indigenous firms, and experience is important in forming a global strategy. The ‘polar’ strategy, on the other hand, is appropriate where the costs of doing business abroad are negligible, the firm is a monopolist, and internationalisation strategy is determined at the outset. N = 3. Three plants can be located at equal distances apart along the equator (or any other great circle). Each of the boundaries begins and ends at the same pair of poles, where they meet at angles of 120 degrees. This creates three identically-shaped segments, resembling the segments found inside oranges and other fruits. This solution is already familiar to IB researchers because it resembles the Triad of US, Europe and Asia (Ohmae, 1985). This is the first

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of many examples where solutions derived from the optimal location problem corresponds to solutions found in nature (Benyus, 2003). N= 4. Tetrahedral projection. With four market areas the first, and simplest, of the Platonic solids is encountered. The tetrahedron is a symmetric pyramid with a triangular base; each of the three sides has the same size and shape as the base. When projected onto the surface of an encompassing sphere, the triangular pattern is replicated (see Figure 8.1). The side of the triangles are bent into curves which correspond to sections of intersecting great circles. The triangular shape of each market area limits the efficiency of the solution because the distance of the boundary from the centre is much greater at a vertex than at a mid-point of each side.

Source: Casson (2019).

Figure 8.1

Projection of tetrahedron: ‘side view’

N = 5. Pentahedral projection. A pentahedron takes two main forms. The first is a natural generalisation of the tetrahedron, being a four-sided pyramid with a square base. This square pyramid lacks some of the symmetries of the tetrahedron, which reduces its potential efficiency, but the use of a square in place of a triangle compensates to some extent by providing a base that is more circular than before. The second form is a triangular prism. The ‘prism’ refers to a block with rectangular sides and triangles top and bottom. The advantage of the prism is that it has only two triangular sides as compared to the four above; its disadvantage is that other three sides, are rectangular rather than square. The four sides of the pyramid all meet at the apex, whereas only three sides of the prism ever meet. The market areas created by the pyramid are therefore more ‘pointed’ than those of the prism, making it costly to serve customers near this point. On these grounds the prism is to be preferred.

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N = 6. Cubic projection. The projection of a cube provides a remarkably simple and robust solution (see Figure 8.2). The cube has six square sides, and when projected each of these sides acquires a curvature imparted by the sphere. The use of squares in place of triangles is a big advantage over the previous pyramid structures, as the consumers located near the vertices are now much nearer to the plant that serves them than they were before. Because the boundaries of the market areas are only modestly curved, each side can be readily divided into four areas which are also relatively square, making 24 areas altogether. This provides the cube with a ‘fractal’ property (Mandelbrot, 1982). Each subdivision has the same basic shape, but a different orientation. Further subdivision is possible, by making four new market areas out of each of the previous 24 market areas, but now the sub-divided areas differ according to which of the previous sub-divisions they were created from.

Source: Casson (2019).

Figure 8.2

Projection of cube: ‘side view’

N = 7. Heptahedral projection. There are many different forms of heptahedron, but two possibilities stand out. One is a pentagonal prism and the other a hexagonal pyramid. Because hexagons efficiently tile a plane, it might seem that the hexagonal pyramid is to be preferred. This would be a mistake however, because the apex of the pyramid is very pointed, which is undesirable for reasons given above. The pentagonal prism has the advantage that it contains two pentagons, as opposed to a single hexagon, so that two of the seven sides are approximately circular in shape (Moulton, Lu and Zaworotko, 2001). Its remaining fives sides are rectangular rather than triangular, which is beneficial too. The pentagonal faces of the prism can be identified with the North and South Poles, leaving the five rectangular sides to form a belt around the sphere.

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These could be mapped, for example, into Europe, Middle East, India, China and the US. A theme has now developed which continues for higher N, namely that solutions based on pyramids and prisms appear as alternatives on a regular basis. As the number of markets increases so the number of possible configurations increases at an increasing rate, but nevertheless, the prism and pyramid continue to dominate. The prism has an early lead, but needs to develop multiple layers of rectangles in order to retain this lead. The main exceptions to this dominance are at N = 8, 12 and 20, where Platonic solids appear. N = 8. Octahedral projection. The octahedron is a Platonic solid with eight equilateral triangular market areas. It is a double tetrahedron with two opposing pyramids sharing a common base (embedded within the solid). The boundaries of the market areas projected onto the sphere are formed from three great circles that intersect each other at right angles. The circle first is equivalent to an equator, the second to a meridian through the poles, and the third to another meridian at right angles to it. The intersections correspond to the vertices of eight triangles. Each of the equilateral triangles can be subdivided into three smaller triangles, although these are isosceles rather than equilateral and are very pointed, each having two interior angles of only 30 degrees. N = 9. Enneahedral projection. There are many ways of generating a nine-sided polyhedron, but few that create suitable market areas. A strong candidate is a triangular bi-pyramid prism, comprising isosceles triangles top and bottom, bonded by a three-sided rectangular block. The contrast with the previous case shows that incrementally changing the number of plants can radically alter the set of options that is available. While increasing the number of plants from eight to nine may improve customer service by reducing the average distance involved in distribution, the overall improvement is reduced by geometrical constraints. N = 10. Decahedral projection. A strong candidate is the five-sided bi-pyramid, whose opposing pyramids meet on a pentagonal base. Other candidates can be created by truncation, as explained the next section. N =11 Hendecahedral projection. From a large menu, a strong candidate is a truncated triangular bi-pyramid prism. The truncation of a pyramid with a triangular base by slicing off the apex generates a figure with four triangular faces and a base. Mounting the bases of two opposing truncated pyramids on a triangular block with three rectangular faces generates an 11–sided figure, comprising two triangles, three rectangles and six four-sided areas, each with a pair of parallel sides. N = 12. Dodecahedral projection. A Platonic dodecahedron is a set of twelve pentagons which generate twelve identical five-sided market areas (see Figure

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8.3). The high degree of symmetry associated with this form, together with the relative circularity of the pentagon, makes this a very attractive option.

Source: Casson (2019).

Figure 8.3

Projection of dodecahedron: ‘side view’

N = 13 – 19. From tridecahedron to enneadecahedron. As N increases further the potential configurations become more complex, but the relative performance of leading families of options remains largely unchanged. For a sphere of given size the proliferation of areas makes each area smaller, and therefore relatively flatter, so that for any individual market the discrepancy between the curvature of the boundaries and the straight sides of the underlying polyhedral face is reduced. The tetradecahedron (N = 14) requires special note. This outstanding solution involves two opposing hexagons linked by two interlocking layers of six pentagons each. This is a remarkably efficient solution, as it avoids the use of triangles or rectangles altogether. This form can be generated from a simpler form by the truncation process described below. N = 20. Icosahedral projection. The final Platonic solid is the icosahedron, which generates twenty triangular market areas. This configuration is useful when there are many plants each serving relatively small areas. But for reasons already stated the shape of the market areas is not particularly efficient. Indeed, although all the areas are triangular, there are not identical, because some are equilateral and some only isosceles. It is worth noting, however, that adjacent market areas can be combined. Combining adjacent pairs generates ten six-sided market areas, which can, if desired, be further combined to generate five eight-sided areas. These larger areas provide additional solutions for N

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= 5, 10, as discussed above, but because of their unusual shapes they are not particularly efficient. Recent bio-medical research into virus structures has transformed knowledge of the icosahedron. Caspar-Klug improved the efficiency of the icosahedron by partitioning each of the 20 triangles into 3 areas (Caspar and Klug, 1962; Venkataram Prasad and Schmid, 2012). Instead of using the centre of each triangle as the common vertex of three smaller triangles, their partitioning splits each of the three smaller triangles in half, and then combines the resultant segments into three 4-sided areas, creating 60 market areas altogether. Each market area has four vertices, one of which corresponds to a vertex of one of the original twenty triangles. Although more complex and irregular then the twenty market areas they replace, these sixty market areas are more circular and therefore potentially more efficient from a logistical point of view. While the specific model described by Casper-Klug generates exactly sixty areas, the method of analysis can be applied more generally, and is useful for analysing global production systems serving many markets.

4 TRUNCATION Intuition suggests that slicing off the corners (vertices) of a polyhedron will produce a more rounded shape, which may, in turn, lead to more ‘circular’ market areas. This process is known as truncation. Truncation is particularly useful for slicing off the corners of triangles, but it can also usefully be applied to squares. By turning each vertex into a new market area truncation naturally proliferates market areas. It is therefore particularly useful for devising efficient configurations involving many market areas. Truncation is a flexible method of generating new configurations because different shapes of market area emerge depending on how deeply cuts are made. Slicing off the corner of a triangle may produce another smaller triangle as a residue, as explained above, but if each corner of a triangle is sliced off close to the corner, the interior of the triangle will become a hexagon, which is an efficient market area, as noted above. From an economic perspective, therefore, the value of truncation depends on how deeply the cuts are made. The truncated icosahedron is particularly important. As noted above, the icosahedron itself is composed entirely of triangles, but slicing off the corners of the triangles transforms the situation. Slicing off one third of the length of each side around each vertex of a triangle creates a hexagonal residue, as indicated above. In the icosahedron five triangles meet at each vertex. If the detached portions of each of the five neighbouring triangles are merged they form a pentagon. The overall result is a ‘truncated icosahedron’ with 32 market areas, comprising 20 identical hexagons and 12 identical pentagons. All of

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these areas are relatively circular, and certainly a significant improvement on the original icosahedron. The areas of the pentagons and hexagons can be adjusted to equalise them, but there is a trade-off between equalising the areas and preserving the symmetry of each area. A well-known example of a truncated icosahedron is the soccer ball. Its surface comprises a mixture of pentagons and hexagons, as described above; indeed, the pentagons and hexagons are often given different colours, turning efficient market areas into a work of art. Inflating the ball is similar to the process of projection, as it transforms the underlying polyhedron into a perfect sphere.

5 PATTERNING Another technique, which complements truncation, is patterning. This involves drawing a pattern on the surface of each face of a polyhedron. In principle each face could be patterned differently, but if one pattern is more efficient than another on any given face then it pays to pattern all similar faces with the same pattern.

Figure 8.4

Examples of patterns

Most polyhedra that generate efficient market areas comprise faces that are equilateral triangles, squares or regular pentagons. A selection of suitable patterns for such faces is illustrated in Figure 8.4. The top row shows how an

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equilateral triangle can be resolved into four similar triangles with sides half the length of the original triangle. This process of subdivision can be repeated indefinitely; the effect of a single repetition is illustrated on the left-hand side of the figure. If the original triangle belonged to an octahedron, for example, then progressive subdivision of triangular faces would yield solutions involving 25 = 32, 27 =132, 29 = 528 etc. market areas. These market areas would not be particularly efficient, however, as a triangle is not a very ‘circular’ market area, as noted above. A triangle can also be divided into three identical quadrilateral forms, meeting at its centre of gravity, and having interior angles of 60, 90, 90 and 120 degrees (not shown). This subdivision generates more circular market areas, but cannot it be repeated. The middle row of the figure illustrates a progressive subdivision of squares; if applied to the sides of a cube, this would lead to solutions involving 6 x 4 = 24, 6 x 24 = 96, 6 x 43 = 384 etc. market areas. The bottom row illustrates the subdivision of a pentagon. This can be done using five triangles, as illustrated on the left-hand side, or by five quadrilaterals and a smaller pentagon, as illustrated on the right. The triangles are not equilateral but are isosceles, and each can be divided into four isosceles triangles. However the outcomes will be inefficient because isosceles triangles make less efficient market areas than equilateral ones. The quadrilaterals on the right-hand side cannot be conveniently subdivided, but the pentagon can be divided into isosceles tringles if required. The overall conclusion is that patterning is potentially efficient for polyhedra comprising equilateral triangles and squares but has limited application to polyhedra whose faces have five or more sides.

6

THE CENTRE OF A MARKET AREA

Once a suitable set of market areas has been determined, each local plant or distribution centre will be located at the centre of the corresponding area. This ‘centre’, however, has not yet been defined. In most cases the answer seems obvious, but it is not quite so obvious as it appears. In the case of a sphere the centre is unambiguous: by definition the surface is equidistant from the centre. The location of a plant, however, is at the centre of one of the faces of a polyhedron. This centre may be defined in four different ways: • the centre of gravity of the face, where the distances from the centre of all the customers on the face ‘balance out’; • the centre of a circumscribing circle that touches all the vertices; • the centre of an inscribed circle that touches the mid-points of each side;

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• the point of minimum distance, which has the smallest total distance to all the points on the face. If the face has an irregular shape, these different points will not coincide. Compare, for example, a tall isosceles triangle, whose sides are much longer than its base, with an equilateral triangle, where all the sides are equal. In the isosceles triangle, the centre of the circumscribing circle is higher (further from the base) than the centre of the inscribed circle, and the centre of gravity lies between them. In the equilateral triangle, however, all three coincide. The point of minimum distance is the economically efficient solution. For fully symmetric faces, such the equilateral triangle, this centre coincides with the other three. It is easy to show that under these conditions the efficient location of a plant must be at the centre of the market area. If the plant were displaced from this centre in some direction by a small amount, then it would approach one point on the boundary and move away from an opposite point an equal distance away. If the boundary remained fixed then some customers that became closer to the plant but lay outside the boundary would not be served while some customers inside the boundary that became more distant from the plant would continue to be served. For a given level of output, therefore, costs would be increased. They could be reduced by relocating the plant back towards the original centre. This incentive would disappear only when the plant had returned to its initial position.

7

DUAL POLYHEDRA

So far a market area has been identified with the face of an underlying polyhedron. The location of each plant has then been fixed at the centre of each face. An alternative approach is to locate each plant at a vertex of the polyhedron rather than in the centre of a face. This arrangement has the advantage that the vertices actually lie on the surface of the circumscribing sphere, while the faces lie beneath it. The reason for rejecting this approach above was simply that it does not directly portray market areas. Switching the focus from faces to the vertices exploits the ‘duality’ properties of convex polyhedra. Duality is a phenomenon that arises in many economic contexts, e.g. prices and quantities are duals in many resource allocation problems (Ruys an Weddepohl, 1978). Considered mathematically, duality is closely linked to convexity. The dual of a polygon is a polygon with a number of vertices equal to the original number of faces and a number of faces equal to the original number of vertices. A polygon and its dual both have the same number of edges (Aleksandrov, 2005).

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Many of the solutions discussed above are ‘self-dual’, i.e. the number of vertices is equal to the number of faces, so that transposing faces and vertices simply recreates the original shape with a slight change in orientation. Duality can be illustrated by examples. For N=2, the bi-polar market areas which meet at the equator have bi-polar duals which have poles at the centres of the market areas and a boundary down a line of longitude between them. For N=4 the Platonic tetrahedron is self-dual. It has four vertices and four faces; when each vertex becomes the centre of a face then the centre of each face becomes a vertex. By contrast, the cube is not self-dual; it has six sides but eight vertices. Turning the vertices into sides creates an octahedron. Each of the new faces is derived by taking a quarter of each of the previous faces that met at a corner and smoothing them out into a plane. The result is a another Platonic solid. In this case, therefore, the dual of one Platonic solid is another Platonic solid of a different type. For N=8, the converse applies; the dual of the octahedron is the cube. For N=12, the dual of the Platonic dodecahedron is the Platonic icosahedron (and conversely). The dodecahedron has 12 pentagonal faces, 20 three-way vertices and 30 edges, while its dual, the icosahedron, has 20 triangular faces, 12 five-way vertices and 30 edges. Because the dodecahedron has pentagonal faces it has a smoother spherical shape than the icosahedron, which has far more faces but all of them triangular. A key advantage of the dual approach is that because plants are located at vertices, the edges that connect the vertices also link adjacent plants. If several edges meet at a vertex then the plant located there becomes a transport hub. The icosahedron, for example, when considered as a dual, supports 12 plants with five-way connections to adjacent plants. By contrast, the dodecahedron, also considered as a dual, supports 20 plants, but each has only three-way connections. The dodecahedron, therefore, supported by an icosahedral dual, provides 12 pentagonal market areas, each with a centrally located plant connected to five other adjoining plants. Each of the routes that converge on a plant intersects a segment of the pentagonal boundary at right angles at its mid-point. This arrangement compares favourably with the icosahedral set of market areas supported by a dodecahedral dual, where are larger number of plans have only three connections each. The full set of edges that link the vertices where plants are located provides, on the whole, a reasonably dense transport network. Because it is so dense, however, this network may be costly to build and maintain. It is not necessary for a transport network to use all these edges, however, and so costs can be reduced by reducing the number of edges. At the other extreme is a minimal network. To connect N plants it is only necessary to have N – 1 links. Such

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links could form a linear chain, although other configurations are possible. A minimal network of this type will be relatively cheap to build and maintain. A linear network connects each plant to only two of its neighbours, and two of the plants, at either end, are connected only to one. As a result, plants that are near to each other on the surface of the sphere may be some distance from each other on the network. For example, the plants at either end of a chain may be quite close together, indeed at opposite ends of a vertex, but the distance between them on the network may be considerable, due to the meandering path of the chain as it takes in other plants en route. Consider a tetrahedron, for example, comprising a pyramid on a triangular base. It has four edges. It is self-dual, and so there are four plants located at the centres of the faces, and four linkages between them. But only three are necessary for a transport network. Three links can support either a simple chain or a three-way hub. The three-way hub is more efficient since no trip involves more than two steps. It is not cheaper to construct, but it is cheaper to operate because the distances travelled are on average shorter. If construction costs are low and distance-related operating costs are high then it will pay to build the entire network with all four links. On the other hand, if construction costs are high and operating costs are low then it will pay to connect each of the plants to a single hub instead. A more complex example concerns the cube, which has six sides and 12 edges. Its dual is an octahedron. The six vertices of the octahedron correspond to plants located at the centres of the faces of the cube. Each plant is connected to four other plants by links that cross each of the four sides of its market area. There are 12 such linkages, but only five are needed to connect all six plants together. There is a wide range of possible network configurations. As before, the selection of the appropriate configuration involves a trade-off between construction costs on the one hand and distance-related operating costs on the other. High construction costs favour a sparse network, while high operating costs favour a denser one. Network resilience may also be a factor. Resilience may require, for example, that any pair of plants is linked by at least two possible routes, so that if one route is blocked another is always available. An obvious way to achieve resilience is to join up the two ends of a link to create a circular route. This could approximate to one of the ‘great circles’ described above, but it may be more efficient for it to zig-zag across the surface in order to take in all the vertices. Such zig-zag circles are analogous to some of the routes followed by international tramp shipping in the nineteenth century (Hurd, 1922).

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GLOBAL COMMUNICATIONS

It is not only transport networks that can be analysed using the dual; communications networks can be analysed too. In the nineteenth century communication networks and transport networks were essentially the same, but in the digital age they are almost entirely separate. The cost structures associated with lines and terminals in telecommunications are completely different too. Given the prevalence of undersea cable and satellite communications, the Planet Earth perspective is well adapted to analysing the geography of global business communications. Consider again the basic model set out in section 2. If customer demands are volatile, or production is prone to disruption, then inter-plant communication is crucial. Communication may be either centralised or decentralised. If it is fully decentralised then individual plants will contact other plants when they have a problem caused by an unexpected boost in demand or a shortage of supply. They may a preference for dealing with their neighbours, but if their neighbours cannot help they may need to look further afield. The alternative is centralisation, in which headquarters play a key role. Headquarters can operate in two main ways, but both have similar implications for network structure. Headquarters may organise an internal auction market where plants can notify their excess supplies and demands; this market generates an equilibrium price at which the plants trade with each other. Alternatively, headquarters may determine quantities rather than prices, and simply instruct plants how much to produce; this requires the plants to notify headquarters in advance of local requirements (Casson, 1995). In either case the plants do not communicate directly with each other but with headquarters instead. The centralisation of decision-making therefore requires communications between plants and headquarters, but not direct communication between the plants themselves. Because of the symmetry conditions imposed on the model, any plant is as good a place as any other plant at which to locate headquarters. However, the selection of the relevant plant depends on factors, such as access to local management skills, which are outside the scope of this model.

9

CONCLUSIONS AND IMPLICATIONS FOR FUTURE RESEARCH

This chapter has set out a Planet Earth perspective on the location of international production. It presents a spherical model of Planet Earth that integrates IB into wider debates about climate change, environmental degradation and geo-political conflict.

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There is no simple solution to the optimisation of plant location on the surface of a sphere. Solutions must be derived on a case-by-case basis. Configurations of interlocking squares, pentagons and hexagons tend to be most efficient, but each specific configuration works best with specific numbers of plants. This raises the issue of whether certain numbers of plants are more common than others because the geometry of market areas favours them. It is possible, of course, to criticise the assumptions on which this analysis is based. The crucial assumption is that customers are uniformly distributed over the surface of the sphere. This assumption ignores the fact that only a small proportion of the earth’s surface is usable by international business. The oceans function as maritime highways and not as centres of residence or locations of production. Rugged mountain ranges are unsuitable for transport and residence, and their main productive use is mining. Nevertheless the assumption of uniformity provides a useful benchmark against which to assess the impact of natural geography on the location of production. The solutions presented in this chapter connect with seemingly unrelated topics such as viruses and sport. Indeed, the connection with other disciplines goes much deeper than this. The equilibrium of many social and physical systems is determined by a balance between attractive and repulsive forces. In economic systems, agents typically agglomerate when they wish to cooperate, but disperse when they seek to exploit a monopoly. In IB, for example, multinationals agglomerate in commercial centres and research hubs in order to share the use of specialist resources, but they disperse in ‘product space’ by designing differentiated products and reinforcing these differences using rival brands. In the model outlined above plants cooperate with their customers by seeking to locate as near to them as possible (attraction) whilst seeking to keep as far away as possible from rival plants (repulsion). By employing this very general approach to the issue of plant location, new analogies and metaphors are suggested for IB behaviour. While a general solution of the plant location problem may be hard to find, the process of seeking it will generate its own rewards. These will come in the form of insights and intuitions as well as in formal mathematical results. Because of the generality of attraction-repulsion problems, there is plenty of opportunity to gain insight from related disciplines and perhaps, in the future, for these disciplines to derive insights from IB. Tackling difficult problems should be part of the fun of any subject, and would be welcome in IB. There is also an empirical challenge. There are few IB-related studies of global logistical systems. Although the location of wholly-owned foreign plants is fairly well known, especially for larger companies, there is little empirical research into which particular markets are served from which particular plants. One reason for the lack of such research may be the lack of

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a theory that provides hypotheses to test. This chapter has generated several hypotheses which are, in principle, easy to test. It has also set out a methodology by which additional hypotheses can be derived. Both theorists and empiricists can therefor benefit from pursuing plant location on Planet Earth as a promising new area of research.

NOTE 1.

I am grateful to Peter Buckley, Janet Casson, Jeremy Clegg, Irina Gokh and Nigar Hashimzade for useful discussions on this topic.

REFERENCES Aleksandrov, A.D. (2005) Convex Polyhedra, Berlin: Springer Benyus, J. M. (2003) Biomimicry: Innovation inspired by Nature, New York: Harper Perennial Bradley, R. E. (2007) Leonhard Euler: Life, Work and Legacy. Amsterdam: Elsevier Briggs, W. and T.W. Edmondson (1906) Mensuration and Spherical Geometry, 3rd ed., London: University Tutorial Press Buckley, P. J. and M. Casson (2020) The internalisation theory of the multinational enterprise: Past, present and future, British Journal of Management, 31(2), 239–252 Caspar, D.L. and A. Klug (1962) Physical principles in the construction of regular viruses, Cold Springs Harbor Symposium on Quantitative Biology, 27, 1–24 Casson, M. (1995) Information and Organization, Oxford: Oxford University Press Casson, M. (2019) The impossibility of international business, in van Tulder, R., A. Verbeke, and B. Jankowska (eds.), International Business in a VUCA World: The Changing Role of States and Firms, Bingley, Yorks: Emerald, 31–40 Chiu, E, F. Coulibaly and P. Metcalf (2012) Insect virus polyhedra, Current Opinions in Structural Biology, 22(2), 234–240 Christaller, W. (1933) The Central Places of Southern Germany, Englewood Cliffs, NJ: Prentice-Hall DeHovitz, D. C. (2016) The Platonic Solids, https://​www​.whitman​.edu/​Documents/​ Academics/​Mathematics/​2016/​DeHovitz​.pdf, accessed 23/05/2019 Eaton, B C. and R.G. Lipsey (1975) The principle of minimum differentiation: some new developments in the theory of spatial competition, Review of Economic Studies, 42 (1) 27–49 Forrester, N. B. (1973) The Life Cycle of Economic Development, Cambridge, MA: Wright-Allen Fujita, M. and P. Krugman (2003) The new economic geography: Past, present and future, Papers in Regional Science, 83(1), 139–164 Hotelling, H. (1929) Stability in competition, Economic Journal, 39 (153), 41–57 Hurd, A. (1922). The Triumph of the Tramp Ship, London: Cassell Losch, A. (1954) The Economics of Location (trans. W.H. Woglom), New Haven: Yale University Press Mandelbrot, B. (1982) The Fractal Geometry of Nature, San Francisco: W. H. Freeman Moulton, B., J. Lu and M.J. Zaworotko (2001) Periodic tiling of pentagons, Journal of the American Chemical Society, 123 (37), 9224–5 Ohmae, K. (1985) Triad Power, New York: Free Press

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Ota, M. and M. Fujita (1993) Communication technologies and spatial organization of multi-unit firms in metropolitan areas, Regional Science and Urban Economics, 23 (6), 695–729 Ruys, P.H.M. and H.N.Weddepohl (1978) Economic theory and duality, in Jacob Kriens (ed.) Convex Analysis and Mathematical Economics, Berlin: Springer, 1–72 Samuelson, P. A. (1983) Thunen at two hundred. Journal of Economic Literature, 21, 1468–1488. Sengoer, A.N.C. (2014) Edward Seuss and global tectonics: An illustrated ‘short guide’, Austrian Journal of Earth Sciences, 107 (1), 6–82, zobodat​.at/​pdf/​MittGeolGes​_107​ _1​_0006​_0082​.pdf Smith, J. V. (1982) Geometrical and Structural Crystallography. New York: John Wiley Stopford, J. M. (1974) The origins of British-based manufacturing enterprises, Business History Review, 48(3), 303–335 Touret, J, (2007) Elie de Beaumont (1798–1874), De systemes de montagnes au resuax pentagonal, Travaux du Comite Francais h’Histoire de la Geologie, 3rd series, 21, annales​.org/​archives/​cofrhigeo/​elie​-touret​.html Vahlne, Jan-Erik and Jan Johanson (2017) From internationalization to evolution: The Uppsala model at 40 years, Journal of International Business Studies, 48(9), 1087–1102 van Brummelen, G. (2013) Heavenly Mathematics: The Forgotten Art of Spherical Trigonometry. Princeton, NJ: Princeton University Press Venkataram Prasad, B.V. and M.F. Schmid (2012) Virus Structural Organisation, Viral Molecular Machines, 726, 17–47 von Thunen, J.H. (1826) Von Thunen’s Isolated State (trans. C.M. Wartenberg). Oxford: Pergamon Press, 1966 Weber, A. (1929) The Theory of the Location of Industries. Chicago: Chicago University Press Zaffanella, E. (2018) On the efficiency of convex polyhedra, Electronic Notes in Theoretical Computer Science, 354, 31–44

PART III

Present challenges: integrating strategy and management

9. Decision making in international business With Peter J. Buckley 1 INTRODUCTION This chapter has three main objectives: to critically review the current state of internalisation theory; to comment on the previous papers; and to outline a research agenda based on key theoretical issues. This agenda emerges partly from our own personal reflections, and partly from our reading of the special issue papers. In the 1970s international business (IB) scholars were optimistic about the development of their field. IB scholarship attracted significant interest from other disciplines, including economics, politics, sociology, psychology, geography, history and statistics. In the past twenty years, however, the subject seems to have lost self-confidence. It now tends to follow intellectual trends in other fields rather than setting trends itself. This chapter considers the potential for reversing this situation in order to regain some of the intellectual ground that IB has surrendered. Instead of looking outwards from where IB studies is today, it look inwards on IB studies from where other disciplines are today, to see what there is that may interest them (Buckley and Casson, 2019). It concludes with some practical suggestions for developing new theory and re-engaging with these disciplines.

2

THE SCOPE OF INTERNALISATION THEORY

When internalisation theory was first developed in the 1970s, there were two main strands of IB research. One focused on the external environment of the firm, and was dominated by quantitative economic research, while the other focused on the key functional areas of management within the firm, such as marketing, procurement, accounting and finance. There was a degree of tension between these approaches. One reason for the difference was disciplinary: the external environment was largely the province of economics and politics, while internal process and structure was largely the province of 187

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sociology, psychology and business studies (Stopford and Wells, 1972). For a time, however, these differences were submerged, but they have gradually re-emerged and have now become so prominent that they need to be addressed. In the early days of IB theory one issue dominated all others: namely the post-1945 rise of the multinational enterprise (MNE). Neither the internal approach to the firm nor the external approach had the answer. The answer was to look at the nature of the firm itself (Rugman and Verbeke, 2008). It was realised that a firm was not just a single plant; it could be multi-plant, like a retail chain store, for example, whose shops shared a brand-name, or multinational, like an automobile manufacturer with factories in different countries. There were various rationales for multi-plant operation. One was that plants shared access to some intangible asset monopolised by the firm, e.g. a proprietary technology or brand (Hymer, 1976). Other rationales were possible too: e.g. buying power exercised through centralised procurement or tax-avoidance through internal ‘transfer pricing’ (Buckley ad Casson, 1976). Centralised resources could be shared in two main ways: internally, within a single firm, or externally, through a network of contracts with independent local firms. Internalisation theory asserted that the structure of the firm reflected efficient choice (Casson, 2014; Coase, 1937; Hennart, 1982). The boundaries of the firm were set at convenient points where arm’s length contracts worked reasonably well. Where contracts would not work, activities were internalised within the same firm. There was a trade-off: internalisation of activities reduced the costs of making contracts, but could require the firm to operate in risky and unfamiliar environments. Only if the savings in contractual costs outweighed these additional risks would the ‘internalisation’ of branch-plant production be profitable. Firms whose managers made efficient choices would survive and prosper, and those whose managers made inefficient choices would not. The theory identified key factors that governed efficient choices and therefore dictated observed outcomes. These factors included the strength of intellectual property rights, the political risks of foreign ownership, and the ability to hire trustworthy local managers with local knowledge. Weak intellectual property rights, low political risks and access to trustworthy local managers all favoured the MNE; by contrast, strong intellectual property rights, high political risk and a lack of trustworthy local managers all favoured licensing or franchising instead (Casson, 2016). Economic geography was important too. High tariff and non-tariff barriers, and low costs of international knowledge transfer encouraged local production in foreign markets, while economics of scale in production encouraged the centralisation of production at a single export hub. High costs of international knowledge transfer encouraged location of the hub in the home country. The more that localised production was favoured, the more likely was the MNE

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to emerge. MNEs, in other words, emerged under certain conditions but not under others. The interplay of proprietary knowledge, contractual costs and economic geography gave internalisation theory its unique capability to explain the MNE. But internalisation has never been just a theory of the MNE; it is essentially a general theory of the firm in space. It sets out the conditions under which related business activities will be brought under common ownership and control, and the conditions under which they will not. It is, therefore, not only a theory of why some firms are MNEs but also a theory about why many firms are not. Internalisation theory relates to the entire population of firms within an industry. Internalisation theory therefore has a wider scope than IB theory. It explains the relationships between technology-owners and their foreign licensees, whether or not the technology owners and the licensees are MNEs. It explains the emergence of multi-regional firms, irrespective of whether they are multinational. Multinationality is often a political accident, resulting from the enlargement or partition of a country after war; e.g. the modern US borders with Canada and Mexico are both quite arbitrary from an economic point of view. Modern IB studies focuses on international boundaries to a singular degree. Even if there were no international boundaries, there would still be global businesses, global-value chains and multi-plant firms – but apparently IB studies would not study them because no national boundaries would be involved! In other respects, however, IB studies transcends internalisation theory. IB theory claims to address any and all of the issues that arise with respect to MNEs. Some of these issues have little direct connection with internalisation theory; e.g. the adaptation of marketing strategies to domestic cultures, or the internal organisation of local procurement within a foreign subsidiary. There are other issues, however, which are connected to internalisation, but which are not directly addressed by the theory in its current state of development. For example, the theory does not explain how many MNEs will dominate a global market, or the specific countries in which they will be headquartered. Internalisation is a necessary component of such explanations, but not a sufficient one. Neither does it explain the financial structure of the firm, e.g. the debt/equity ratio, or the internal organisational structure through which resources are allocated between subsidiaries. Once again, however, it is a necessary component of any such explanation. To transform internalisation into a truly general theory of IB it is necessary to incorporate other theories within the framework. To address the issue of competition for global market share, for example, a theory of oligopolistic rivalry is required. To address the issue of debt versus equity a financial theory of risk-management is required, while to address the issue of organisational

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structure, a theory of decentralisation and delegation is required (Casson, 1995; Egelhoff, 1988, 1993). This raises the issue as to whether the theory should be extended, or whether other theories should be developed alongside it instead. As a theory is extended it necessarily becomes complex, and therefore more difficult to understand. It may also lose coherence. Different elements introduced into the theory may be based on incompatible assumptions, so that theoretical diversity leads to loss of logical consistency. The dangers of the process are illustrated by Dunning’s ‘eclectic theory’ (Cantwell, 2003). The eclectic theory bundled together the three key elements of internalisation theory into a single accessible framework. In Dunning’s terminology ‘proprietary knowledge’ became ‘ownership advantage’, contractual costs determined ‘internalisation advantage’ and economic geography governed ‘location advantage’. Dunning reviewed the literature on each of these three advantages, and then included relevant iideas from this literature in his theory. But some of this literature was based on one set of assumptions, and some on another, and some on no clearly stated assumptions at all. To accommodate this diversity, the theory evolved into the OLI ‘paradigm’. As a paradigm it gained in generality, and became a useful ‘one stop shop’ for new researchers in the field. But it was no longer a theory, because there was no longer any core set of assumptions from which all its propositions were derived (Eden, 2003). There is a danger that the same thing could happen again. An attempt to create a new theory of everything in IB could result in a new theory of nothing. It is a nice idea to make IB an ‘inclusive subject’ where any new theory is welcomed and added to the body of theoretical knowledge. But once the body of knowledge loses consistency, it also loses clarity. Internal contradictions emerge, and disputes arise as to how they should be resolved. New concepts are introduced to ‘paper over the cracks’. Concepts proliferate, but no new insights are created as a result.

3

THE VERSATILITY OF INTERNALISATION THEORY

Another problem with extending internalisation theory is that the existing theory is not always properly understood. There are some issues that need to be clarified before the theory is developed further. Internalisation theory sets out a menu of possible forms that multinationality can take. There is a basic distinction, made in the 1970s, between horizontal and vertical integration. Under horizontal integration the MNE owns different plants at the same stage of production, whereas with vertical integration it owns plants at different stages of production. According to Dunning, internal-

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isation of technology and brands typically leads to ‘market-seeking’ investments by horizontally integrated firms, while Internalisation of intermediate products, such as semi-processed commodities and manufactured components leads, respectively, to ‘resource-seeking’ and ‘efficiency-seeking’ investments by vertically integrated firms. Different forms of ownership can also be distinguished. It is well-known, for example, that ownership of technology can be shared with a joint-venture partner, and that different types of agreement can be made between the partners regarding equity shares, governance structures, and buy-out options. It is less well-known that a firm can also own product without owning the plant in which the product is produced. In a global value chain, for example, the ‘orchestrator’ firm may own the product as it progresses through successive stages of production, even though it does not necessarily own the plants in which the product is processed. This arrangement was known in the nineteenth century as a ‘putting out’ system. The orchestrator may therefore own foreign assets, in the form of inventory and work in progress, even though it does not own any foreign plants (Casson, 2016; Casson, Porter and Wadeson, 2016). A related point is that contracts can take different forms too. Parties are free to make contracts, but once they have made a contract they are constrained by its terms, and specifically by the obligations into which they have entered. The classic example concerns the employment contract, in which workers agree to be directed by their managers in return for payment of a wage. In the context of IB, licensees may be constrained in the prices they can charge for the products they sell, and in the export markets they can serve; franchisees may be constrained by the quality of service they must supply; while subcontractors may be constrained by the fact that they do not own the product they produce, as noted above (Buckley, 2009, 2011). This shows that it is not only ownership that confers control; contracts confer control as well. There are also different options regarding a firm’s headquarters and its location (Buckley, 2010). Headquarters functions such as finance, tax and operational control, though often co-located, can in fact be separated. These functions can, in principle, be located anywhere, although in practice they are likely to be located, for fairly obvious reasons, in large cities in relatively wealthy countries. Similar considerations apply to the location of R&D. With so many degrees of freedom in multinational operation, it is difficult to understand why many IB scholars still seem to believe that internalisation theory predicts that MNEs will be headquartered in developed Western countries, will carry out all their R&D in their headquarters country, will only control what they own, and will therefore never control their licensees, franchisees or subcontractors. None of this is implied by internalisation theory (Casson and Wadeson, 2018).

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Not only is there a wide range of forms that multinationality can take: there is also a wide range of factors that affect the form of multinationality that is chosen in any particular industry at a particular time. Many of the factors that determine multinationality were mentioned above; they influence both whether the firm is multinational and what specific form its multinationality takes. They range from cultural factors such as language barriers, through institutional factors, such as the strength of intellectual property rights, to purely physical factors such as international transport costs. These factors vary across countries, across industries, and over time. Diversity, not uniformity, is the hallmark of multinational operations. IB scholars have repeatedly called for new theories to explain new patterns of multinationality that they have observed. They have often failed to note that these new developments are directly driven by changes in the factors mentioned above. They are perfectly compatible with existing theory and, indeed, are often predicted by it. Internalisation theory implies that multinational organisation is highly versatile. Multinational strategies adapt to changes in the international environment, so that when this environment changes, the organisational structures and the nationalities of leading firms will change as well (Casson, 2018). Cultural changes may reduce language barriers, thereby reducing the costs of international knowledge transfer and of centralised management control. Technological changes may reduce transport and communication costs, making exporting more attractive relative to foreign investment. Changes in global business strategies are not, therefore, autonomous events prompted by changes in business thinking, but intelligent responses to technological progress, falling transport costs, faster communications, greater international labour mobility, political integration through treaty organisations, and other factors identified by theory.

4

A CULTURAL PERSPECTIVE ON INTERNATIONAL BUSINESS THEORY

The preceding remarks suggest that internalisation theory does not need to be extended because of any failure to explain emergent phenomena. The theory does what it sets out to do in a satisfactory way. But it could do more. For example, it could scale up its analysis from firm to industry, and examine oligopolistic market structures in global industries. In other words, it could do more to analyse the external environment of the firm. Extending the theory from the firm to the industry is not, in fact, so great a challenge as it sounds. The key principle of internalisation theory is essentially an economic principle, namely efficiency-seeking, and this principle also underlies the analysis of market structure. Just as the boundaries of the

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firm extend up to the margin where the benefit of further internalisation is just offset by the cost, so the number of firms in an oligopolistic global industry increases up to the point where a further entrant would just fail to break even, and so stays out because they could not make a profit. Extending the theory by drilling down to the ‘fine detail’ of organisation and control within the firm is more problematic, however. Economic principles still apply, but their impact is moderated by sociological and psychological principles too. The importance of sociological and psychological factors reflects key differences between the external environment and the internal environment of the firm. Firstly, the external environment of the firm is mainly competitive whilst the internal environment is co-operative too. In the external environment, for example, customers can readily switch between firms on the basis of price and product quality whereas within an organisation employees are usually ‘locked in’ to relationships with their colleagues. They cannot ‘substitute’ between the colleagues with whom they deal as easily as they can substitute between the products that they buy. Secondly, interactions are more personal. Internal interactions are communication-intensive, whereas external interactions are usually not. External interactions between firm and customer may involve no more than displaying a price in a self-service store and collecting a credit card payment, whereas internal interactions may involve protracted negotiations with the same group of people before an outcome is achieved. Thirdly, internal interactions tend to be multi-lateral rather than bilateral. External markets usually work through bilateral agreements, while organisations rely mainly on multilateral agreements effected by committees. Committees are required because a large amount of complex information must be synthesised in order to reach the correct decision; simple price comparisons are not sufficient for a correct decision. The outcome of committee decision-making processes is difficult to model and predict. Fourthly, becoming an employee of a firm involves a greater personal commitment than becoming a customer. Employees may relocate to take a job, and must invest in getting to know their colleagues. Once ‘locked in’ they may begin to feel exploited; on the other hand, if they feel welcome they may develop loyalty to their employer. These attitudes complicate the way that their decisions are made. Fifthly, tensions within a firm are managed and moderated by informal customs rather than formal legal processes. Because market transactions are so simple, enforcement is relatively simple to, and can be devolved to external legal institutions. Internal disputes are much more complicated; they may concern complex issues involving many people, as explained above, and can

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undermine the performance of an organisation unless they are resolved internally by consensual means. Sixth, peer comparison is crucial where rewards within an organisation are concerned. Rewards are not purely material or pecuniary. Respect from colleagues and recognition from the employer are both important. Relative pay and hierarchical status may be more important than absolute pay; they are indicators of how much a person is valued by their organisation. Finally, informal customs and the principles of peer-evaluation may different significantly between firms, and even between different parts of the same firm, e.g. between parent and subsidiary, or between one subsidiary and another. These differences are often summarised as ‘cultural differences’; they may reflect the countries in which the organisation is located, and the dominant language, religion, or professional background of the employees (Andresson, Forsgren and Holm, 2007). In IB theory there has been a tendency to regard nationality as the key determinant of corporate culture, but in practice the situation is more nuanced; in high-tech firms that recruit globally, for example, shared professional allegiance may be more important than shared nationality in supporting internal cohesion. This discussion demonstrates that any extension of internalisation theory into the micro-structure of organisations must take account of cultural issues. It is inappropriate to analyse the internal organisation of a firm by simply imposing on the subject economic ideas that have proved successful in analysing the external environment of the firm. But this raises a further issue. Is the internal structure of the firm to be analysed using completely different concepts and techniques to those that are used to analysis the external environment, or is it possible to integrate the two? Indeed, what exactly would integration mean? The simplest answer to this question is that integration would need to be a two-way process. Integration would involve applying cultural concepts to the external environment of the firm as well as the internal environment. An integrated theory would recognise that culture impacts on the diffusion of knowledge and the transfer of technology between countries. It would also recognise that it impacts on the formulation of global strategy: the cultural background of a CEO and their key advisers will frame their ‘world view’, and therefore influence their strategic decisions (Bouquet and Birkinshaw, 2011; Baer, Dirks and Nickerson, 2013). The economic domain of IB theory therefore needs to be opened up to cultural analysis. Conversely, integration would involve applying economic concepts to analyse the internal organisation of the firm. Internalisation theory has always recognised that there are alternative organisational structures. At one extreme lies the centralised firm (the Williamson U-form), in which strategic decisions are taken at headquarters and the only role of subsidiary management is to

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implement the chosen strategy. At the other extreme is the divisionalised firm (the Williamson M-form) employing incentivised managers; headquarters and subsidiaries negotiate internal transfer prices for intermediate products, and managers receive pay based partly on the performance of their division and partly on their own performance within their division, measured relative to that of their peers (Williamson, 1975; 1985). In between these two extremes lie many alternative organisational forms (Verbeke and Yuan, 2005). Each form reflects as specific culture and operates under the influence of the corresponding cultural norms.

5

DECISION-MAKING IN IB: CULTURAL AND ECONOMIC ASPECTS

Obstacles to Integrated Theory An integrated theory sounds, in principle, like a really good idea. It could ‘integrate’ the IB profession, and halt the fragmentation into specialist silos that threatens so many academic disciplines. Empirical researchers would appreciate a convenient ‘one-stop-shop’ for theory. An integrated theory could become a ‘flagship’ for a revitalised field of study, and attract interest from cognate disciplines in business, management, and social science generally, as suggested at the outset. But if it such a good idea, why has it not been developed already? The answer is that there are obstacles that need to be overcome (Felin, Foss and Ployhart, 2015). This chapter argues that the major obstacle is the proliferation of different theories of decision-making in IB. The solution to this problem may not lie in standardisation on one specific decision-making theory, but the rather the identification of a suite of decision-making theories that are suitable for different levels of analysis. Each theory would be applicable to a particular type of decision. The integrated theory would explain why each type of theory was best adapted to each specific types of decision, as explained below. Degrees of Rationality Decision-making is a fundamental component of all IB theory, and many controversies in IB ultimately stem from different views about how decisions are made. These differences are often expressed as a simple binary conflict between theories of rational action and theories of bounded rationality. This section of the chapter proposes a more nuanced view. According to this view, different views of decision-making within IB are actually complementary rather than conflicting, because each addresses the weaknesses of the other.

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Within an integrated IB theory, the strengths of one approach would compensate for the weakness of the other, providing a versatile general theory. There are many forms of bounded rationality. Indeed one of the key features of ‘bounded rationality’ is that it is defined, not by what it is, but by what it is not, namely that it is not purely rational. There are many ways in which a person can behave irrationally, and asserting that they are irrational is not a helpful way of predicting what they will do. Bounded rationality can mean anything from making a simple mistake to acting perpetually in an erratic and inconsistent way. Indeed, advocates of bounded rationality cannot even agree on what rationality means. In economic theory rationality is the ability to rank alternative outcomes in a logical and consistent way. It is sometimes equated, however, with acting on perfect information. This would imply that a person who rationally seeks out information must be irrational because of their limited information, whereas in fact they are rational because their search is conducted in a rational way. In other cases rationality is equated with pursuing self-interest. Self-interest however, is a moral choice that reflects indifference to the well-being of others. It is perfectly possible to pursue altruistic objectives is a rational way, which implies that self-interest cannot be the same thing as rationality. There are different degrees of rationality that span the entire spectrum from perfect rationality based on perfect information through to bounded rationality based on very limited information (Buckley, Deviney and Louviere, 2010). All these forms of rationality can be theorised, but some types of rationality are more difficult to theorise than others. If the nature of decision-making is itself the subject of interest, as in psychology, then it is foolish to focus on the most simple form of rationality, namely perfect rationality. But if the focus is on business decisions such as location choice then it may be useful to focus on simple rationality in order to highlight the economic factors that are involved in the decision. In other words, it is appropriate to assume different types of rationality when analysing different types of problem. It is also useful to assume different forms of rationality when examining the internal organisation of the firm and a firm’s relation to its external environment. When focusing on the firm’s environment, it is unhelpful to complicate the picture with sophisticated theories of decision-making, but when focusing on social relationships within the firm a simple theory of decision-making is a handicap. It is therefore most unfortunate that advocates of complex decision-making theories that work successfully ‘inside’ the firm denounce the use of simple decision theories ‘outside’ the firm, whilst advocates of simple theories used outside the firm deride the complex theories used inside the firm. Different theories of decision-making complement each other. Each

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is well adapted to analysing distinctive types of problem, all of which need to be addressed by IB theory. Different topics is IB theory therefore require different types of rationality in order to analyse them. The decisions of a solitary individual, such as a CEO, contemplating a complex environment, can most usefully be analysed using perfect rationality, so that the complexity of the environment is ‘centre-stage’. On the other hand, a group of managers implementing a pre-determined headquarters strategy in a foreign subsidiary should be analysed differently, so that the more constrained rationality of their social interactions is featured instead. In general, the more complex the constraints that the environment imposes on decisions, the fewer constraints should be imposed on rationality, and conversely, the simpler the constraints imposed by the environment the more constraints can usefully be imposed on rationality. There is only so much complexity that a theory can handle; the more complex the environment, the simpler the theory of decision-making needs to be. The Nature of a Decision Decision-making theories vary from the very simple to the highly complex. Simple behavioural theory postulates a one-to-one connection between a stimulus and a response; It portrays decision-making as a knee-jerk reaction which does not engage the brain. Decision-making may also be portrayed as inertial, involving the use of habitual routines (Winter, 2013). By contrast, simple rational action, almost by definition, involves the brain. Choice between alternatives is key. The ‘choice set’ specifies the number of options that need to be evaluated; the greater the number of discrete alternatives, the more complicated the decision (Simon, 1961, 1967, 1982). To compare alternatives some criterion is required. The valuation of alternative options will depend on the environment in which the decision is taken. Theory will suggest which factors are relevant to valuation; the more factors there are, the more evidence the decision-maker needs to collect, and the greater the cost of taking a decision. Simplifying a decision can save considerable cost. Simplification strategies include reducing the number of options to be considered, using a simple criterion, ignoring various factors, and only collecting the most accessible information (Cyert and March, 1963; Kostova and Roth, 2012). Economising on decision costs can be perfectly rational as a strategy, even though it may lead, on average, to a worse decision (see below). Some people may have better judgement than others, and therefore achieve, on average, better outcomes for a given cost. A person’s judgement may reflect both personality and culture. Culture influences the basic assumptions they make when simplifying a decision. Personality may influence the sources of

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information they prefer (e.g. family or friends; documents or databases) and how drastically they simplify their decision. Decisions are often made using indicators or symptoms of underlying factors that cannot be observed. Good judgement involves choosing the most appropriate indicators in each specific situation (Casson, 2003). People with superior judgment may specialise in taking decisions on behalf of others. People who lack decision-making skills may delegate business decisions to people whom they believe have better skills. This is particularly important with complex decisions. For example, one reason why shareholders in an MNE delegate strategic decisions to the CEO is because they believe the CEO has better judgement in complex business matters than they have themselves. Statics and Dynamics There is an important distinction between static and dynamic theories of decision-making. Static decision-making relates to a single period of time, while dynamic decision-making relates to a sequence of periods (Dixit and Pindyck, 1994). In dynamic theories of decision-making the number of periods may be finite or infinite. In static theories the time elapsing between successive events is so small as to be negligible. In static internalisation theory, for example, a CEO begins by observing the market they plan to enter, they then decide their mode of market entry, and finally they implement their chosen strategy; all this takes place within a single period. A key issue in dynamic theorising is whether the decision-maker is fully aware of the evolving situation in which they operate. Are they aware that what they decide in the first period may have legacy effects in subsequent periods? In particular, do they take ‘real options’ into account? Legacy effects can be direct or indirect, e.g. investing in durable assets not only generates resources for future periods ( a direct effect) , but also limits options for future investment by committing resources now that could have been used later instead (an indirect effect). Direct effects are easy to take account of in dynamic theory, but indirect effects are not. Agents who fail to take account of indirect legacy effects may be described as myopic. They may recognise that decisions taken in the past frame the options available to them in the current period, but fail to recognise that decisions taken in the current period frame the decisions they can take in the future. Decision-making by myopic individuals can be modelled as a sequence of essentially static decisions. The options available in the current period are perceived as a legacy of decisions made in previous periods, but no account is taken of future options when taking current decisions.

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Risk and Uncertainty The availability of information is another factor affecting the complexity of decision-taking. Does the decision-maker actually know that state of the environment at the time they take their decision? Lack of information generates risk and uncertainty (Hutzschenreuter, Kleindienst, Grone and Verbeke, 2014). In internalisation theory, for example, it is often assumed that the decision-maker knows the relevant characteristics of each market before they enter them, but if they have not entered them then how can they truly know the state of the market? A full account of the market entry decisions would take account of how the information required to take the market entry decision is obtained. Radical uncertainty arises when the decision-maker does not even know what it is that they are uncertain about. For example, a firm entering a foreign market may not understand that the government is corrupt because they have no previous experience of government corruption and are unaware that it is even an issue. Uncertainty is less radical when the decision-maker knows what is possible but does not know the probability attached to each possibility. In these circumstances the decision-maker may associate a subjective probability with each possibility, based on their judgement or intuition, but without any conviction that these probabilities are correct. In some cases, however, precedents for the decision may provide information from which a risk-assessment can be generated. In this case the relative frequencies of past occurrences can be used to generate the probability values associated with the various possibilities (Knight, 1921; Foss and Pederson, 2014). Searching for Information Search can also be used to address uncertainty. The decision maker pro-actively seeks out information to inform decisions (Hirshleifer, 1989; Hirshleifer and Riley, 1992). Search introduces a sequential element into the decision-making process. The decision-maker first decides whether to seek out information, and if so when to stop. Search does not eliminate uncertainty, because when a search commences the searcher does not know what they will find; but once the search has been completed the ensuing decision will be less uncertain than it was before. To inform their search decisions the decision-maker needs to know the costs of the search process, the various possibilities they might discover, and the prior probability of each. Once the search has been completed, these prior probabilities are replaced by posterior probabilities which tend to be more accurate. Some posterior probabilities may approximate to certainty, even if they do not point to a single outcome. Experience can also be used to address uncertainty. An experienced decision-maker can search through their personal memory bank to identify

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precedents for their situation. Precedents may by identified by some analogy with the present situation; they do not have to replicate it exactly (Buckley, Clegg, Chen and Voss, 2016). Analogies can, however, can be misleading, as crucial difference between superficially similar situations may be overlooked. Reliance on misleading analogies can make decision-makers over-confident about the outcomes of the decisions that they make. Dynamics of Learning Learning is extremely difficult to theorise. Despite recent advances in artificial intelligence, the subject remains poorly understood . Yet learning is core to IB theory, and especially to the internationalisation process (Forsgren and Johanson, 1992; Johanson and Vahlne, 2009). There are three main approaches to learning that are relevant to IB, and all merit further development (Kogut and Zander, 1996). The first is Bayesian learning, in which prior probabilities are revised and updated in response to new information. The principles are sound and straightforward, but implementation is complex (Neal, 1996). The second is pattern recognition, where new events are tentatively linked to other changes that occurred at about the same time. Pattern recognition is typical of computerised learning algorithms based on correlation analysis. These can be very successful where similar events routinely recur, but not so good when novel events require investigation. The third approach is behavioural. Good outcomes are attributed to good decisions which are then repeated with greater frequency, while bad events are attributed to bad decisions which are then repeated with lower frequency. The behavioural approach is the simplest of the three, but only because it is the least sophisticated. In practice, the attribution of cause to effect may be superficial and emotional, rather than careful and considered. As a result, the behavioural approach tends to understate the element of luck in any outcome, and overstate the importance of the decision; this leads to good decision-making being discredited because of bad luck and, conversely, bad decision-making being reinforced by good luck. Theories of Decision-making: A Summary The discussion is summarised in Table 9.1. Perfect information theory is so simple in comparison to others that it is used in both static and dynamic theory. The use of perfect information in static economic theory demonstrates the major insights that can be achieved by using simple assumptions to bring clarity to complex problems. Internalisation theory is just one instance of numerous cases of this kind. Despite being counter-intuitive, perfect informa-

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Table 9.1

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Types of individual decision-making most commonly used in static and dynamic theories

Method of

Static theory

Dynamic theory

Rational: Perfect information

Yes

Yes

Rational: Uncertainty

Yes

Rational: Search

Yes

decision-making

Learning: Bayesian

Yes

Learning : Artificial intelligence

Yes

Learning: Behavioural

Yes

tion is also used in dynamic theories to illustrate issues relating to investment and capital accumulation. Theories of rational decision-making under uncertainty are used to analyse business and financial risks, including the risks of business failure, while theories of rational search are used to analyse information gathering through global scanning by CEOs and their headquarters staff. Theories of learning have so far received little attention in mainstream IB theory, however. Part of the explanation is that dynamics has remained an under-developed area of IB theory. Part of the reason for that is that many IB issues are quite complicated even without their dynamics, so that adding dynamics is very challenging. Dynamics is most effective in fields of IB where the fundamentals are relatively simple.

6

BUSINESS ETHICS AND PROFIT-MAXIMISATION

Criteria for the Best Decision Having examined the process of decision-making in some depth, it is appropriate to consider other issues relating to the choice of the decision criterion. Most economic analysis of corporate decision-making assumes profit-maximisation, but many IB scholars reject this view. From a methodological perspective, two issues need to be considered. The first is whether the CEOs of firms maximise anything at all, and the second is why, if they do, they would wish to maximise profit (Scott, 1981). Most firms are set up by their founders with some sort of objective in mind, and that objective can usually be expressed in terms of something that can be maximised. What they maximise does not have to be merely the profit they derive from the business, however. It could be their personal reputation, or

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the wealth they leave behind when they die. The founder of a family business may wish to provide employment for family members; the founder of a consumer co-operative may wish to sell affordable products to customers; and the founder of a workers’ co-operative may wish to pay high wages to their employees. In all of these cases the existence of a well-defined objective means that the decision-maker is seeking to maximise the value of some target variable (Casson, 1991). Multiple Objectives A decision-maker could have multiple objectives. This complicates the analysis, but does not undermine it. There are two main possibilities. The first is that the decision-maker attempts to maximise a weighted average of two or more target variables, e.g. profit and reputation. While the existence of multiple objectives seems quite plausible, it raises the question of how the relevant weights are determined. Without knowledge of the weights that a decision-maker is using it is difficult to predict the decision they will make. The second approach is to assume that the decision-maker maximises the value of one target subject to a constraint that some other target must be met. For example, an ethical CEO might wish to maximise growth subject to the constraint that workers receive a minimum wage. Higher growth could be achieved by reducing wages and cutting prices to gain market share, but this growth is sacrificed in the interests of social justice. An important constraint on any firm is survival; it is difficult for a firm to survive if it makes sustained losses. Survival also applies to the CEO. If the firm’s equity falls into the hands of institutional investors, these investors may demand generous dividends, backed by a high rate of return. This can only be sustained through high profits, and so a profit constraint becomes key to the CEO’s survival. If the equity is held by speculators, then a share-price constraint may prevail instead. In general, any pursuit of ethical objectives will be constrained by some sort of financial performance criterion; even purely charitable organisations have to break even in the long run. Profit-maximisation, therefore, is simply the limiting case of a general requirement, namely that a minimal level of financial performance is required for any large organisation to survive. Under difficult conditions, e.g. in a highly competitive industry with excess capacity, survival may become so demanding that it dominates all other considerations, and profit-maximisation emerges as the sole objective.

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The Ethics of Profit-maximisation It is sometimes suggested that profit-maximisation is itself an ethical objective. CEOs, it is said, are stewards of shareholder’s interests and are bound to act as they desire. Many shareholders, however, may not wish to hold shares in an unethical business, which means that they desire any business in which they invest to behave in an ethical way. From this perspective, the shareholders can require the CEO to maximise profit subject to an ethical constraint, instead of maximising an ethical objective subject to a profit constraint, as above. If shareholder interests are not dominant, then management interests may become dominant instead. A CEO may seek to make their firm as large as possible in order to increase their executive power and their personal reputation. They may have ethical concerns as well. They may, for example, set a minimum wage for the benefit of their employees and their families. But even if shareholders are passive, there is still a constraint: the firm must pay interest to banks and bondholders. In this case firm growth is maximised subject to a financial constraint and a wage constraint (Penrose, 1959). However complex the motives of corporate decision-makers, therefore, there is always good reason to believe that their objectives involve the maximisation of some target variable subject to one or more constraints. The assumption of profit maximisation is a plausible way of radically simplifying the objectives of a CEO. Many alternatives have been discussed in the literature, especially the maximisation of sales revenue, revenue growth, and share price. In most of these cases a high level of profit is essential to sustain high performance. Thus while alternative objectives nuance the pursuit of profit, they do not remove the profit motive altogether.

7

THE SOCIAL BASIS OF DECISION-MAKING

Delegation of Decisions: Autocracy or Consultation A decision-maker can pool the experiences of other people through consultation. It may be useful to consult, not only those with experience, but also those who will be involved in the implementation of a decision. People may be consulted individually or collectively, and informally or formally. Individual consultation is often informal (e.g. a confidential chat) while collective consultation may be formal (e.g. in committee). It is also possible, however, to meet formally one-to-one (e.g. an interview) or informally as a group (e.g. at dinner). The benefit of consultation is that diverse opinions reveal the full complexity of the situation. Consultation may also win ‘buy in’, creating a consensus to

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which everyone is committed. The disadvantage is that irreconcilable opinions may be voiced, polarising participants into opposing groups. Peer-to-peer Decision-making Peer-to-peer decision-making occurs when two or more decision-makers control their own resources. The decisions of each decision-maker impact the outcome achieved by the other. In a global oligopoly, for example, CEOs have to take account of other CEO’s decisions. This applies both whether the CEOs are joint-venture partners or market-share maximising rivals, or both. The outcome of peer-to-peer decision often depends on the sequence in which people communicate with each other and the sequence in which they make their moves. In many instances neither sequence is specified in advance. This makes modelling peer-to-peer decision-making extremely complex. Expectations play a crucial role in peer-to-peer decision-making. Each peer has an expectation of how others will act in response to their own decisions. Communication can play an important role in shifting expectations. Agreement on a contract is most likely once expectation are aligned; e.g. the buyer does not believe the seller will accept less and the seller does not believe that the buyer will pay more. Alternative options also play a crucial role in aligning expectations. Consider a two-stage production process where the CEO of a downstream firm is negotiating with the CEO of an upstream firm to buy some intermediate product. The buyer will try to persuade the seller that another seller has offered them a lower price while the seller will try to persuade the buyer that another buyer has offered them a higher price. In a competitive market both buyer and seller have a wide range of options, giving credibility to these claims, and helping to drive the buyer and seller towards an equilibrium price. If neither buyer nor seller have alternative options, however, and both are aware of this, then they are locked into a ‘zero-sum’ game. In this context internalisation of the intermediate product market through merger or acquisition offers a convenient solution to protracted bargaining . In terms of internalisation theory, bilateral monopoly increases transaction costs by impeding negotiation and thereby favours vertical integration. Another major area of peer-to-peer decision-making in IB is innovation rivalry. Innovation typically involves large sunk costs that cannot be recovered if it fails. The value of an innovation depends crucially on monopoly of exploitation, because competition to exploit an innovation will drive down product price towards the marginal cost of production and innovators will fail to cover the sunk costs of R&D. Under these conditions the sequencing of decisions is crucial.

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If two firms plan to innovate competing products, and they make their moves sequentially, then first mover advantage is likely to prevail. Single firm innovation is profitable because it yields monopoly, but two-firm innovation may result in losses for both. Each firm’s decision strategy is therefore ‘I will innovate if and only if the other does not’. Under these conditions, whoever innovates first takes the whole of the market and makes a monopoly profit, because once they have innovated their rival will stay out. Sequence is everything, as the ‘first mover wins’ and the ‘winner takes all’. This is not the only scenario, however. If the second mover can imitate the first mover’s innovation, they can avoid sunk costs and get a ‘free ride’. Under these conditions, ‘After you!’ may be the dominant strategy for both players. Each wants to be second, and the other to be first. But if they both wait for each other then the opportunity may be lost. Communication may be useful in securing innovation. The firms may form a cartel in which the first-mover’s costs are reimbursed out of the profits they jointly make. If a cartel agreement is difficult to enforce; they may merge instead; in this case internalisation, once again, resolves a strategic issue in peer-to-peer communication. These are both very simple cases. With several firms, each with several options, there are many possible outcomes to evaluate. Peer-to-peer decision-making is therefore a major challenge for IB theory. But it is a major challenge for other subjects too, including economics. A theory that modelled peer-to-peer decision-making in a general context and took account of all the possibilities would be formidably complicated. It would probably be so complicated that it would be impossible to understand. A fundamental problem with decision-making theory, therefore, is that scholars themselves are boundedly rational, and can only cope with so much complexity. Simple theories are a necessity. A theory can be simple either because the environment is simple or because decision-taking is modelled in a simple way. When the environment is complex, as it is outside an organisation, the decision-making process must be simple if it is to be intelligible. If the environment is simple, however, as it is (relatively speaking) inside an organisation, then the decision-making process can be complex. Social realism may work inside the organisation, but economic rationality normally needs to prevail outside. IB is distinctive in having many different contexts in which complex peer-to-peer communication is a crucial issue. It is therefore an excellent field in which pioneer new ideas about how to simplify decision-making when analysing complex situations. Indeed, several of the papers in this special issue engage, directly or indirectly, with this fundamental issue.

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8 CONCLUSIONS IB theory achieved success in the 1970s and 1980s through the application of simple rational action models to IB issues. The market entry decisions of MNEs were derived from profit maximisation subject to the transactions costs of alternative contractual arrangements. Decision-making issues were not ignored, but were subsumed in the category of transaction costs. It later became the practice to impute transactions costs entirely to imperfect property rights, but the costs of negotiating contracts have always been an important part of the theory. Once the basic rationale of multinational business had been established, it was natural for IB to progress to the detailed consideration of organisational structure and headquarters-subsidiary relations (Westney, 1993). As indicated above, simple rational action modelling has serious limitations in this domain. In retrospect, it was perfectly natural for other concepts of rationality to be invoked to analyse these organisational issues. The mistake was to assume that both types of rationality could not co-exist together. Introducing perfect information into organisational structure assumes away key issues, but equally, introducing bounded rationality into market entry decisions is liable to complicate an already complex issue. It is not impossible to do, but it requires considerable subtlety to do it well, as explained above. Using multiple concepts of rationality with a single body of theory can cause confusion, however. It is important to have a coherent view of which form of rationality provides the most appropriate tool for analysing particular fields of IB. The discussion above suggests that rational action will always have an important role in analysing the place of multinational business within the global economy. Where oligopolistic markets are concerned, peer-to-peer modelling will be required, and so sequential structures may be needed to simplify the analysis of rivalry and partnership in innovation. Within the organisation, where social interaction is crucial to high-trust communication, decision models will be complex, reflecting the influence of cultural factors. Managing the interface between different elements of IB theory will be challenging, but with respect and goodwill within the IB community it can surely be done.

REFERENCES Andersson, U., M. Forsgren and U. Holm (2007) Balancing subsidiary influence in the federative MNC: A business network view, Journal of International Business Studies, 38(5), 802–818 Baer, M., K.T. Dirks and J.A. Nickerson (2013) Microfoundations of strategic problem formulation, Strategic Management Journal, 34(2), 197–214 Bouquet, C., and J. Birkinshaw (2011), How global strategies emerge: An attention perspective. Global Strategy Journal, 1(3–4), 243–262

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Buckley, P. J. (2009) The impact of the global factory on economic development, Journal of World Business, 44 (2), 131–143 Buckley, P. J. (2010) The role of headquarters in the global factory, in Andersson, U. and U. Holm (eds.), Managing the Contemporary Multinational – The Role of Headquarters Cheltenham, England: Edward Elgar, 60–84 Buckley, P. J. (2011) International integration and coordination in the global factory, Management International Review, 51(2), 269–283 Buckley, P. J., and M. Casson (1976). The Future of the Multinational Enterprise, London: Macmillan Buckley, P. J. and M. Casson (2019) The internationalization theory of the multinational enterprise: past, present and future, British Journal of Management, https://​ doi​.org/​10​.1111/​1467​-8551​.12344 Buckley, P. J., L. Chen, L.J. Clegg and H. Voss (2016) Experience and FDI risk-taking: A microfoundational reconceptualization, Journal of International Management, 22(2), 131–146 Buckley, P. J., T.M. Devinney, and J.J. Louviere (2007). Do managers behave the way theory suggests? A choice-theoretic examination of foreign direct investment location decision-making, Journal of International Business Studies, 38 (7), 1069–1094 Cantwell J.A. and R. Narula (eds.) (2003) International Business and the Eclectic Paradigm: Developing the OLI Framework, London: Routledge Casson, M. (1991) Economics of Business Culture: Game Theory, Transactions Costs and Economic Performance, Oxford: Oxford University Press Casson, M. (1995) Information and Organization, Oxford: Oxford University Press Casson, M. (2003) The Entrepreneur: An Economic Theory, 2nd.ed., Cheltenham, England: Edward Elgar Casson, M. (2014) Coase and international business: the origin and development of internalisation theory, Managerial and Decision Economics, 36 (1), 55–66 Casson, M. (2016) The Theory of International Business: Economic Models and Methods, Basingstoke: Palgrave Macmillan Casson, M., L. Porter, and N.S. (2016) Internalization theory: an unfinished agenda, International Business Review, 25 (6), 1223–1234 Casson, M. (2018) The theory of international business: the role of economic models, Management International Review, 58 (3), 363–387 Casson, M. and N.S. Wadeson (2018) Emerging market multinationals and internalisation theory, International Business Review, 27 (6), 1150–1160 Coase, R. H. (1937) The nature of the firm. Economica, 4 New series, 386–405 Cyert, R. M. and J.G. March (1963) A Behavioural Theory of the Firm. Englewood Cliffs, NJ: Prentice Hall Dixit, A.K. and R.S. Pindyck (1994) Investment under Uncertainty, Princeton, NJ: Princeton University Press Eden , L. (2003) A critical reflection and some conclusions on OLI, in Cantwell, J.A. and R. Narula (eds.) International Business and the Eclectic Paradigm: Developing the OLI Framework, London: Routledge, 277–297 Egelhoff, W. G. (1988) Organizing the Multinational Enterprise: An Information-processing Perspective, Cambridge, MA: Ballinger Egelhoff, W. G. (1993) Information-processing theory and the multinational corporation in Ghoshal, S. and E. Westney (eds.), Organization Theory and the Multinational Corporation, New York: St. Martin’s Press, 182–210 Felin, T., N.J. Foss and R.E. Ployhart (2015). The microfoundations movement in strategy and organization theory, Academy of Management Annals, 9(1), 575–632

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Forsgren, M. and J. Johanson (1992) Managing internationalization in business networks, in Forsgren, M. and J. Johanson (eds.), Managing Networks in International Business, Philadelphia, PA: Gordon & Breach Foss, N. J. and T. Pedersen (2014). Microfoundations in strategy research, Strategic Management Journal, 37, E22–E34, https://​doi​.org/​10​.1002/​smj​.2362 Hennart, J. F. (1982) A Theory of Multinational Enterprise. Ann Arbor: University of Michigan Press. Hirshleifer, J. (1989) Time, Uncertainty and Information, Oxford: Blackwell Hirshleifer, J. and J.G. Riley (1992) The Analytics of Uncertainty and Information, Cambridge: Cambridge University Press Hutzschenreuter, T., I. Kleindienst, F. Gröne, and A. Verbeke (2014). Corporate strategic responses to foreign entry: Insights from prospect theory, Multinational Business Review, 22(3), 294–323 Hymer, S. H. (1976). The International Operations of National Firms: A Study of Direct Foreign Investment [PhD thesis, 1960], Cambridge, MA: MIT Press Johanson, J. and J.E. Vahlne (2009) The Uppsala internationalization process model revisited: From liability of foreignness to liability of outsidership, Journal of International Business Studies, 40(9), 1411–1431 Knight, F.H. (1921) Risk Uncertainty and Profit, Boston: Houghton Mifflin Kogut, B., and U. Zander (1996) What do firms do? Coordination, identity, and learning, Organization Science, 7(5), 502–518 Kostova, T. and K. Roth (2002) Adoption of an organizational practice by subsidiaries of multinational corporations: Institutional and relational effects, Academy of Management Journal, 45(1), 215–233 Neal, R.M. (1996) Bayesian Learning for Neural Networks, New York: Springer Penrose, E. (1959) The Theory of the Growth of the Firm, Oxford: Blackwell Rugman, A. M. and A. Verbeke (2008) Internalization theory and its impact on the field of international business, in Boddewyn, J. J. (ed.), International Business Scholarship: AIB Fellows on the First 50 Years and Beyond, Bingley: Emerald Group, 155–174 Scott, W. R. (1981) Organizations: Rational, Natural, and Open Systems, Englewood Cliffs, NJ: Prentice Hall Simon, H. A. (1961) Administrative Behaviour, 2nd. ed., New York, NY: Macmillan Simon, H.A. (1967) Models of Man, New York: John Wiley Simon, H. A. (1982) Models of Bounded Rationality and Other Topics in Economics, Cambridge, MA: MIT Press Stopford, J. M., and L.T. Wells (1972). Managing the Multinational Enterprise. New York: Basic Books Verbeke, A., and W. Yuan (2005) Subsidiary autonomous activities in multinational enterprises: A transaction cost perspective, Management International Review, 45(2), 31–52 Westney, E. (1993) Institutionalization theory and the multinational corporation, in Ghoshal, S. and E. Westney (eds.), Organization Theory and the Multinational Corporation, New York: St. Martin’s Press, 53–76 Williamson, O. E. (1975) Markets and Hierarchies, New York: Simon and Schuster Williamson, O. E. (1985) The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting. New York: Free Press Winter, S. G. (2013) Habit, deliberation, and action: Strengthening the microfoundations of routines and capabilities, Academy of Management Perspectives, 27(2), 120–137

10. Extending internalisation theory: integrating international business strategy with international management 1 INTRODUCTION This chapter attempts to ‘bridge the gap’ between international business strategy (IBS) and international management (IM). Both obviously involve an international dimension. However, IBS is mainly concerned with the external environment of the multinational firm (MNE), and the analysis of global innovation, international oligopolistic rivalry and foreign market entry strategies, while IM is mainly concerned with the internal organisation of the MNE and in particular with coordination within and between key functional areas such as human resource management (HRM), finance, and information technology (IT) services. There is a methodological difference between these two areas. IBS derives many of its concepts from economics, game theory and competitive strategy, while IM relies more on sociology, organisational behaviour and psychology (Buckley and Casson, 2019). This difference seems to have widened over time, with research papers in each area citing very different strands of literature. There is obviously an overlap between these areas, however. Strategy is partly a product of organisational structure, while organisational structure will adapt to serve strategic objectives. This chapter is dedicated to exploring this overlap between the two. Internalisation theory is a key component of IBS, and so this chapter proposes to explore this overlap by applying internalisation theory to IM. These two strands are obviously linked, because the word ‘internalisation’ indicates an interest in the internal operations of firms. Indeed, managers cannot logically optimize the boundaries of a firm without comparing an externalisation strategy with the best available internalisation strategy. To identify the best internalisation strategy they need to evaluate all possible internalisation strategies, which places the problem firmly within the IM domain (Madhok, 1997, 2002). 209

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Most internalisation theorists have focused on the question of why firms internalize, and the conditions under which they do so, rather than the specific methods of internalisation that they use. However, there are a few scholars who have explored the managerial implications of internalisation theory. Buckley and Hashai (2005, 2014), for example, emphasise that the knowledge-intensity of the firm will impact on its organisational structure. Taking a somewhat different perspective, Tomassen and Benito (2009) and Benito and Tomassen (2010) have examined the implications of governance costs for the exploitation of technology in a knowledge-intensive firm. Despite these seminal contributions, however, internalisation theory offers relatively few predictions about the internal structure of the firm and the specific methods of internal coordination that are employed. By contrast, IM scholars, including some business gurus, have routinely engaged with internal coordination issues (e.g. Bartlett and Ghoshal, 1989). They are often prescriptive rather than analytic, however; they make a stark distinction between the way a firm is organized at present and the way that it needs to be organized in future. This future organisation could, in theory, be equated with the optimal structure identified by internalisation theory, but in practice it is not. Although IM scholars have recognized the potential relevance of internalisation theory, in practice they have made little use of it. A natural objection to this proposed integration is that internalisation theory is based on a theory of rational choice and that this approach is not appropriate to IM. It should be emphasised, however that internalization theory does not assume perfect information; on the contrary, it analyses rational responses to problems created by imperfect information. It does, however, emphasise that most large firms regularly review their managers’ performance, giving managers a strong incentive to act rationally in the view of their superiors. Likewise workers whose effort is closely monitored and who wish to retain their job or get promoted will seek to appear industrious so far as their supervisors are concerned. Performance measurement has its limitations, however. Internalisation theory recognises that while the internalisation of an activity can reduce incentive problems it does not eliminate them altogether. For example, a contract of employment can never fully reconcile the corporate objectives of the employer with the personal objectives of each employee. An ‘enlightened’ employer will therefore seek to understand and appreciate the personal objectives of their employees, and to accommodate them as far as possible. The optimisation of internal structure, therefore, requires more than narrow economic calculation; an appreciation of individual psychology and work-group culture is also required. Sections 2–4 summarise the application of internalisation theory to IBS, while the remainder of the chapter explores its application to IM. Section 2

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presents a brief intellectual history of internalisation theory. Section 3 examines the internal configuration of activities within the MNE. Section 4 focuses on the coordination of production, distribution and R&D in an innovative MNE. It emphasises that the internal structure of the firm is influenced not only by the location and internalisation of core activities, but also by the firm’s external market power (Dunning and Lundan, 2008). Section 5 presents the main analysis of internal structure. It distinguishes between core activities, such as those described above, and support activities. Support activities are supplied both to individual plants and to the firm as a whole; they include not only HRM, finance, and IT services, but also facilities management, local procurement, etc. This section presents a diagrammatic and tabular technique for applying internalisation theory to the internal structure of an MNE. Section 6 examines psychological issues in management from an internalisation theory perspective. It discusses how ordinary employees view the internal structure of the firm, and how this can affect their productivity. The conclusions are summarised in section 7.

2

THE CONCEPT OF INTERNALISATION

Origins Internalisation signifies the coordination of resource utilisation by planning within a single organisation rather than by negotiation in open markets between independent organisations. It can be applied at several different levels, including the factory, the firm, and the state (Robertson, 1923; Lange and Taylor, 1938; Hayek, 1945; Dobb, 1955). Ronald Coase (1937) applied the concept to the firm. He focused on the role of the firm as an employer of labour. Planning was exemplified by the direction of a team of workers by the owner of a firm. The market alternative was exemplified by self-employment; independent workers would agree to cooperate and work together as a team. Coase argued that the direction of a team by the owner of a firm would normally be more efficient than cooperation between independent workers. Investors would be willing to finance a firm, but not a group of individual workers. In a competitive market economy, therefore, firms would emerge whenever it was profitable to plan the work of a team; otherwise workers would work for themselves instead (Casson, 2014). Buckley and Casson (1976) applied similar reasoning to the MNE. The MNE, they argued, was just a special type of multi-plant firm. In effect, they took Coase’s scheme, replaced the ‘worker’ with a plant, distributed the plants in space, introduced national borders, and thereby turned the firm into an MNE. From this perspective the firm is a nexus of contracts involving workers, independent suppliers and customers.

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The Multi-plant Firm But why bring different plants under common ownership and control? If the plants are unrelated then the economic case is weak. But suppose that they are connected, because their outputs needed to be coordinated. If every plant were separately owned then the owners would need to negotiate a contract with each other (just as the workers did above). The contract would need to specify in advance what each of them would do, and if circumstances changed they would need to renegotiate it. To provide more flexibility they could negotiate long-term contingent contracts, but these would be very complex (Arrow, 1975). With insufficient flexibility they could get ‘locked in’ to irreversible commitments that they later regretted (Williamson, 1975, 1985). Negotiations could be protracted and they might be unable to agree on terms. More fundamentally, they simply might not trust each other (Casson, 1997). To ensure full compliance with the contract they would need to supervise each other closely. Merger would improve efficiency. One owner could buy the others out and, after compensating each of them in full, could appropriate some residual profit for themselves. Better still, why not set up a multi-plant firm from the start? New plants would then be added as sales increased, financed by the reinvestment of profits within the firm, which is the typical strategy of an MNE. The Division of Labour Most MNEs employ a functional division of labour within the firm (Smith, 1776). To generate goods and services a production team is required. To deliver finished product to consumers a distribution system is required. To develop new products and improve existing products R&D activity is required. Management must coordinate these functions and also coordinate within each function too. Each function is normally carried out in different plants. Some functions may comprise multiple activities, embedded within horizontal, vertical or pyramid structures. Each activity may be concentrated at a single location or replicated at multiple locations (Buckley and Strange, 2015). Each activity typically requires a team of workers with a distinctive set of skills. Different plants may be connected by flows of tangible or intangible intermediate products (e.g. semi-processed raw materials, technological know-how). The role of management is to coordinate the relations between the functional areas, and within each functional area to coordinate the activities of plants at different locations. Finally, within each plant it is management’s responsibility to coordinate the actions of individual workers. IBS typically focuses on the coordination of different functions and IM on the coordination of individual workers. In between lies the coordination of the same function at different

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locations; this is one of the key interfaces between IBS and IM that is explored in this chapter. It is not only productive activities that need to be coordinated, however, but the management of these activities too. Managers represent the interests of the shareholders; they scan the business environment, plan the allocation of resources, and give instructions to workers accordingly. Management can also be functionally specialised and spatially distributed (Dunning, 1958). Individual managers can specialise in different aspects of coordination, e.g. coordinating research and production, or coordinating production and sales. This creates a division of labour in the management of the firm. People with different aptitudes specialise in different management roles. Some management roles may benefit from co-location, and may be centrally located at headquarters. Other roles may dispersed to specific locations where key skills are available. Coordination is largely an office-based activity, and the logic of office location is somewhat different to that of plant location. For example, with good communications a regional network of plants can be coordinated from a remote centralized headquarters. This raises the interesting possibility that a firm could be multinational by virtue of the location of its offices rather than the location of its plants, and this is explored further below. Proprietary Technologies Internalisation theory highlights the possibility that the firm may possess exclusive or monopolistic rights, giving it privileged access to a technology, brand name or supply of scarce natural resources. The firm has the option of selling these rights; if it does so, it will normally employ fewer workers, because the buyers of these rights will employ workers of their own. However, the firm may still need to employ managers to oversee contractual arrangements with other firms. This will affect the managerial skills that the firm requires; for example, directing and supervising production workers demands a different set of skills to monitoring external technology licensees. Similarly, marketing the firm’s final product demands a different set of skills to monitoring independent franchisees who are responsible for local marketing and distribution of the product. This point may be developed further (Martin and Salomon, 2003, Hashai, 2009). A firm endowed with special skills in recruiting managers of a certain type may internalise activities that require such skills, and externalize activities where internal skills are missing. Likewise a firm may deliberately devise a proprietary technology to exploit the specific management skills it possesses, whilst avoiding technologies in areas where such skills are missing. This establishes a link between internalisation theory and resource-based theories of the firm (Silverman, 1999; Leiblein, 2003). A firm with a given set

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of management resources which it is costly to change may invest in proprietary technologies whose exploitation requires the production and marketing skills that its managers already possess while, conversely, a firm already endowed with a proprietary technology may set out to recruit managers who have the specific skills required to coordinate the production and marketing of these products. Where the technology and management skills can be readily matched the firm will internalize, and when they cannot it will resort to external contractual arrangements of the kind described above. Pushing this analysis back to the start-up phase of the firm suggests that a rational entrepreneur seeking an opportunity to exploit will focus on business opportunities that not only involve novel technologies, but involve specific technologies whose exploitation depends on a management team with a combination of skills which they have the ability to acquire and retain. The specific skills they are able to recruit may influence their subsequent internalisation strategy. If deficiency in recruitment forces them to externalize production and marketing activities that would be better internalized then they may make less profit than they otherwise would. Formalising the Role of Management in IBS Theory In IBS theory the concept of internalisation is used to analyse relations between firms, their customers and their workers. But workers are not the only employees; managers are employees too. Just as workers work in teams and need to be managed, so managers also work in teams and need to be managed as well. The management of managers by other managers creates a hierarchy within the firm (Williamson, 1996). Furthermore managers are accountable to shareholders. In small firms the senior manager may also be the owner, and the sole shareholder in the firm. But in a large MNE senior management is accountable to numerous external shareholders. To integrate IBS and IM perspectives, therefore, it is necessary to introduce shareholders and managers as well as customers and workers into the analysis of the firm (Hennart, 1991; Foss and Foss, 2005).

3

MODELLING THE MULTINATIONAL ENTERPRISE

Diagrammatic Analysis The remainder of this chapter focuses on the internal structure of a fully internalized firm. The analysis can be extended to a network of firms, comprising a lead firm and its licensees, subcontractors and franchisees, but that is beyond the scope of this chapter. The specific focus is on a multi-plant firm, such

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as a multi-domestic firms of the kind assumed in most expositions of basic internalisation theory. There are many ways in which plants can be connected within a multi-plant firm. One plant may supply intermediate product to another (‘vertical integration’), or both plants may depend on a third plant for access to a shared resource, in order to carry out the same activity (‘horizontal integration’). Horizontal and vertical integration may be combined, as illustrated in Figure 10.1. The figure presents a stylised picture of a typical ‘market-seeking MNE’. The firm owns and controls an R&D facility which generates a technology that is shared by two production plants. These plants supply the firm’s customers through local distribution facilities. One facility is based at home (country 1) and the other abroad (country 2). If there is an imbalance between production capacity and consumer demand in each country then intra-firm exports may take place, as illustrated by the diagonal lines in the figure. So far as location is concerned, theory suggests that upstream activities are pulled towards resources (labour, raw materials) and downstream activities towards final customers, and that R&D is pulled to university towns and research hubs. These forces are countered, to some extent, by transport costs and the costs of long-distance communication, which tend to push these activities together. Headquarters is typically pulled towards the ‘centre of gravity’ of these operations (however that is defined) (Adler and Hashai, 2009). Five interesting special cases can be identified from the figure; these are a subset of a larger set of all the possible cases that can emerge. 1. The firm supplies only the home country 1, but off-shores production to the foreign country, Production may be based in country 2 because key resources are located there; this is often described as ‘resource-seeking’ FDI. 2. The firm produces only in country 1, but owns a distribution facility in country 2. The firm exports to country 2 but also has a ‘sales subsidiary’ there. This situation is rarely discussed; it is notable because exports and FDI are complements, and not substitutes, as is often assumed in simple accounts of foreign market entry. 3. The firm produces and sells only in country 2. It undertakes no R&D, so all its other operations are conducted overseas. It is described in the literature as a ‘free standing firm’. There are plenty of historical examples; e.g. 19th century British railway companies with head offices in London that ran railways operations in Latin America (Rippy, 1959). 4. The firm subcontracts production in both countries. Subcontracting is widely discussed in the context of value chains (Buckley and Strange, 2015; Gereffi, Humphries, Sturgeon, 2005) but it is often misunderstood. The firm continues to own the technology which is used in production and

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Key: Square box: production or distribution facility; Triangle: R&D facility; Circle: representative individual decision-maker; Thick black lines: flow of product or service that is ultimately sold to customers (including intra-firm exports); Thick black dash double dot lines: flow of knowledge (shared as a ‘public good’ between production facilities); Dash-dot black line: ownership boundary of the firm. Notation: C: customer; D: distribution; P: production; R&D: R&D facility.

Figure 10.1

Schematic representation of MNE structure showing the flow of product and technology

also owns the distribution facility to which the product is supplied. The subcontractor is normally offered a fixed fee for their services (i.e. use of their labour and factory equipment) but the firm retains the ownership of the work-in-progress which embodies its technology. The firm does not sell its patent rights to the subcontractor and then buy back the product, as this would expose it to unacceptable risks. The firm continues to own a foreign sales subsidiary and so it remains an MNE. 5. Every activity, including R&D, is subcontracted to a different firm. This radical strategy creates a so-called ‘hollow’ firm’, or ‘flagship’ firm (Rugman and D’Cruz, 2000; Parmigiani and Mitchell, 2010). The firm owns the technology and the product, and the work-in-progress, but

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owns no plants and employs no labour. It only employs managers; these managers replace the markets that would otherwise link the independent firms. The role of management is often described as the ‘orchestration’. The independent firms consent to this arrangement because their rewards are fixed; they agree a rate for the job and so the commercial risks are born entirely by the hollow firm. Defining the MNE A question that arises naturally when discussing these examples is ‘Is this firm really an MNE?’. This question is particularly relevant to the free-standing firm and the hollow firm. Internalisation theory applies both inside and outside IB studies; the question is not important for internalisation theory, therefore, but nonetheless it is crucial for defining the boundaries of IBS studies. It can only be answered by reference to a definition of an MNE. An MNE is often defined as a firm that owns and controls productive activities in more than one country. But what is meant by ‘ownership’, control’ and ‘productive activity’? Ownership. Most firms do not own machinery, equipment and buildings outright; they usually rent or lease them for a short period. A firm that ‘owns’ a factory in a foreign country may simply be leasing it for a number of years. What the firm owns is the local subsidiary company. It is the ownership of the subsidiary, rather than the subsidiary’s ownership of assets, that legally makes the firm an MNE. A subsidiary is, however, likely to own outright the inventory and work-in-progress stored in its plants. Foreign ownership may therefore be construed as the ownership by a foreign subsidiary of leases on buildings and equipment, and of stocks and work in progress on the factory floor. Control. Control allows a firm to allocate resources between alternative uses without consulting other parties. A contract of employment, for example, allows a firm to allocate a worker’s time between a limited number of specific tasks. But if the firm employs a subcontractor it cannot do this; it can, however, allocate productive activities between subcontractors. Foreign control therefore includes control, not only of activities within a plant, but also of the movement of intermediate product between plants. This implies that hollow firms with international operations are indeed MNEs. They own the work in progress and control the allocation of work between their subcontractors. Productive activity. A key question is whether the management of operations is a productive activity exactly like the activities that it manages (e.g. production, distribution and R&D). Most firms not only produce goods and services that they sell, but also produce services that they use themselves. IBS focuses on core activities that contribute directly to saleable output. Consistency suggests that because management supplies an internal coordinating service

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that contributes to final output, it should be regarded as productive too. So too should internal services that support management functions, e.g. human resource management (HRM) and finance. This has important implications for both IBS and IM. In the context of free-standing firms, for example, it implies that they are indeed MNEs, because headquarters supplies internal services that are exported overseas. More fundamentally, it also implies that a firm may be an MNE simply because a foreign subsidiary supplies internal support services to its domestic activities. This scenario is considered further below.

4

THE PERFORMANCE OF FIRMS

This section addresses an important issue in IBS, namely the performance of firms (as measured, for example, by profitability). Internalisation decisions are crucial for firm performance, but a full explanation of variations in firm performance requires other factors to be taken into account. This section reviews two important factors, namely market power and economies of scale (Dunning and Lundan, 2008). Firm and Industry Because of similarities in basic technology and customer requirements, most firms in any given industry will have a similar structure of plants. This suggests that they may reveal similar patterns of internalisation too. Other factors point in the same direction. In some industries the advantages of internalisation may be so strong that the decision to internalize is obvious. In other cases, however, internalisation decisions may be quite complex (Hashai, 2009). Decisions may be so complicated that firms simply decide to ‘follow the leader’. The first explanation suggests that firms will be quick to switch internalisation strategies when circumstances change, whilst the latter suggests that they may be slow because they wait for each other to make the first move. Similarly, the first explanation suggests that internalisation decisions will normally be correct, while the second suggests that all the firms might make the wrong decision. The logic of internalisation is therefore an ‘industry logic’ rather than a ‘firm-specific logic’. This inference fits well with the concept of ‘industry recipes’, in which firms in the same industry tend to be organized along similar lines (Spender, 1989). This suggests that internalisation strategy is unlikely to be a major determinant of differences in performance between firms with the same industry. The main exception is where the decision is complex and one firm has the confidence (rightly or wrongly) to go against the trend.

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Market Power IBS theory suggests that the main factor that influences the relative performance of firms within the same industry is their market power. Market power is usually discussed under the rubric of ‘ownership advantage’ or ‘firm-specific advantage’. These two concepts are not quite the same, however. Firm-specific advantage focuses on advantages that are unique to the individual firm. Ownership advantage, by contrast, includes advantages that are not specific to the firm; Kindleberger (1969) argued, for example, that US MNEs derived an advantage from access to the New York stock exchange, where investors took an optimistic view of risk. In the context of internalisation theory it is firm-specific advantage that is most relevant (Verbeke, 2013). Internalisation can protect and reinforce monopoly power. The main argument for preferring foreign direct investment (FDI) to overseas licensing is that FDI is more effective in protecting trade secrets and intellectual property rights. Less well-known is the argument that backward integration into overseas raw material supply can enhance the exploitation of monopsony power (Casson, 1979). It has been argued that the global reach of MNEs gives them greater power in the labour market, but this is a more dubious proposition. Labour is normally recruited to local plants from local labour markets. The foreign operations of the firm are only relevant when the firm can threaten to switch production to low-wage countries if local labour bargains too aggressively over wages. Sustainable market power requires barriers to the entry of new competitors. Creating entry barriers and attacking the barriers erected by rival firms are a major focus of the IBS literature. Barriers to entry are normally discussed in the context of the product market. There are five main types: patents and trademarks, reputation, government protection, economies of scale, and network economies. The last two barriers are most important for the internal structure of the firm. Economies of Scale Economies of scale are an important barrier to entry. There is a crucial difference, however, between economies of scale at the plant level and economies of scale at the firm level. Economies of scale at the plant level encourage the concentration of production at a small number of plants. This may encourage exports and discourage FDI unless, of course, the plant is located overseas. By contrast, economies of scale at the firm level directly encourage large firms. One important scale economy has already been discussed: namely superior knowledge relating to innovative products. The same principle can also be applied to knowledge that is used, not directly to produce a marketable

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product, but to generate internal services that support production and distribution within the firm. Many internal services are highly specialized; thus in order to maintain a specialist fully employed a large demand for the service is required. It may be difficult to contract out the service because of quality assurance or confidentiality issues; conversely, it may be difficult to sell surplus services to other firms for similar reasons. To exploit these services fully, therefore, it may be necessary to increase internal demand for these services by increasing the scale of the firm. Provided internal services can be remotely supplied, service provision can be centralized within the firm, e.g. at headquarters. Remote service provision can also be decentralized, however. Routine data services, for example, can be offshored to locations where office workers can be recruited cheaply. This raises an important point: namely that a firm can not only offshore conventional production activities that generate product for sale (as noted above) but can offshore support services too. Thus to become an MNE does not have to produce or distribute for sale in a foreign country, because it can produce there for internal use instead. Network Economies and the Network MNE Network economies are a distinctive manifestation of economies of scale. There are three main types: collection networks that connect suppliers to a central plant or warehouse; distribution networks that connect a central plant or warehouse to a diffuse set of customers; and communications networks that connect customers to each other. In the first two cases a central facility is key to the value of the service, while in the third case it is merely incidental in facilitating connectivity. The first two cases have been discussed frequently in the IB literature: the collection network features in supply chain analysis, and the distribution network in marketing. The third case is mainly discussed in modern literature on digital platforms, where the central facility processes user instructions and connects up the appropriate participants (Autio, Mudambi and Yoo, 2021; Stallkamp and Schotter, 2021). In each case competition normally selects the largest network. Spreading the fixed costs of the central facility is crucial. Other things being equal, the largest network will have the lowest average costs and will therefore be able to offer the lowest prices. As consumers switch to the larger network its average costs fall further, and as they desert the smaller networks their average costs rise, and so the larger network eventually takes over the entire market. A notable feature of these networks is first mover advantage. Even if the first mover is a higher cost producer than the later networks, it may have established such a large customer base by the time the second mover enters that the

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second mover will have to price at a massive loss until its market share has overtaken the leader’s market share; the second mover therefore requires very deep pockets if it to finance its later entry. The power of the first mover is particularly great where a communications network is concerned. Increasing the size of the network not only reduces the average cost of the central facilities but also directly enhances the value of the network to the users. Competition on communications networks therefore leads directly to monopoly, rather than to oligopoly as in the other cases. Until recently communications networks were normally owned and operated on a national basis, and national monopolies were either highly regulated or fully nationalized. International communications were facilitated by cooperative agreements between national networks who shared the revenue from each call between the originating and the destination countries. The internet has changed this dramatically, however, allowing the development of global platforms that increasingly monopolize specific types of communication.

5

INTERNAL COORDINATION

The Management of the MNE IM theory developed well before the internalisation theory of the MNE. Researchers at Harvard Business School led the development of case studies of US MNEs in the early post-war period (Barlow, 1953). Shortly afterwards a series of influential texts were published for use in management education (Brooke and Remmers, 1970; Stopford and Wells, 1972). Since then the literature has mushroomed, although the basic approach has remained largely unchanged. From the outset IM was more practitioner-oriented than IBS. A common theme has always been the need for flexible organisations and continuous change, driven by charismatic leaders and implemented by empowered employees. Academic ‘gurus’ have called for transformation changes to new organisational structures (Mintzberg, 1978; Peters, 1988; Kanter, 1989; Bartlett and Ghoshal, 1989; Hamel and Prahalad, 1992; Noria and Ghoshal, 1997; Forsgren, Holm and Johanson, 2005). In the context of international business the emphasis has been on the advantages of subsidiary autonomy and internal entrepreneurship (Birkinshaw, 1997). Empirical studies, however, have not always confirmed the view that traditional management structures are inefficient, or that visionary changes always work well. Despite IM’s early lead as a field of study, however, no management equivalent of internalisation theory has emerged. The most systematic treatment of decision-making structures in the MNE remains Egelhoff (1998). The closest analogue to internalisation theory in IM is the ‘network’ approach to organi-

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sational structure (Ghauri, 1992; Hedlund, 1986; Pearce and Papanastassiou, 1996). This approach is similar in some respects to the network approach illustrated in Figure 1 above. The main difference is that Figure 1 relates to flows of intermediate products within a firm, whereas an IM network relates to authority relations and flows of information within the firm. Synthesising these two networks can, however, provide an integrated approach to the internal structure of the MNE that spans both IM and IBS. To fully implement this synthesis, a two-stage process is required. The first stage identifies all the possible configurations of internal structure that are available and the second selects the best. This generates predictions about how rational managers will adapt the internal structure of the MNE to reflect the structure of its operations. This section outlines this approach with the aid of diagrams. It demonstrates that although the number of possible internal configurations is very large, even in a small MNE, it is possible to eliminate many of the possibilities as demonstrably inefficient and reduce the final choice to a small set of candidates. It also shows that the final choice hinges on key trade-offs, such as that between a lean flat structure with a high degree of ambiguity and a tall hierarchical structure with very clear lines of authority. The optimal solution depends on the nature of the operations and the way they are connected, which in turn reflect the fundamental factors identified in IBS, e.g. technology, location and market power. There is, therefore, no ‘right answer’ to questions about internal structure that applies to every firm or industry. Intermediation: Managing Linkages within the Firm The key to this exercise is to examine how a network of information flow coordinates a network of intermediate product flow within a firm. Early writers on internalisation, cited above, employed a binary distinction between two main types of management organisation. The first was a centralized approach involving military-style command and control, which concentrated decision-making making on a small elite, and the second was a decentralized approach in which the managers of separate plants negotiate with each other over internal transfer prices (sometimes referred to as a ‘shadow prices’ or ‘accounting prices’) (Spicer and Ballew, 1983; Spicer, 1988). Both these systems create administrative difficulties (Benito and Tomassen, 2009; Tomassen, Benito and Lunnan, 2012). Centralisation involves a significant loss of detailed information through aggregation, while price negotiation in a decentralised system can be time-consuming and adversarial. The IBS literature has debated extensively the role of transfer prices, while the IM literature has focused mainly on alternative structures of authority. The links

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between these literatures have been explored by Colbert and Spicer (1995), Shelanski (2004) and others. A compromise between centralisation and decentralisation is intermediation (Casson, 1997). Applying the principle of intermediation suggests a three-tier management structure. (1) Top-level decisions are taken by a chief executive (CEO) who consults with their senior managers in order to achieve consistency across the firm. The CEO takes key decisions about investments in specific assets and other decisions that lock the firm into its long-term strategy. (2) Each senior manager oversees the linkages between a key set of related activities within a specific strategic area (e.g. technology, human resources). They collect information from the local managers of relevant plants and organize supplies of internal services from one part of the organisation to another. (3) Each local manager collects local information to optimize the performance of their own activities. Where transfer pricing is used to coordinate internal flows, the prices may be imposed by senior managers or negotiated between the managers of individual plants, with senior managers maintaining general oversight (Colbert and Spicer, 1995). In the following discussion it is assumed, for simplicity, that firms adopt transfer pricing whenever it facilitates tax avoidance; the prices are set by senior managers, and quantity decisions are taken by local managers in response to these prices. Imposing this structure on the diagrammatic analysis significantly reduces the number of potential configurations that need to be evaluated. Figure 10.2 illustrates the approach in the case of the configuration of activities presented in Figure 10.1. Each plant is managed by a local manager who is indicated by a circle placed inside a triangle or square. The linkages between plants could in principle be coordinated by direct negotiation between the managers of the plants concerned but this would be problematic, as explained above. It would mean, for example, that while the manager of plant P1 was negotiating with the managers of the distribution plants D1, D2, these managers would also be negotiating with its internal ‘rival’ P2. This problem is addressed by introducing senior managers as authority figures. The global production manager GP intermediates between the plant managers P1 and P2, while the global distribution manager GD intermediates between the distribution managers D1 and D2. In addition a home-country subsidiary manager intermediates between P1 and D1, while a foreign subsidiary manager S2 intermediates between P2 and D2. Resolving the negotiation problem in this way creates another problem, however: communication between P1 and D2, and between P2 and D1 is indirect. To address this issue, communication is mediated at board level by discussions between the global production director GP and the global distribution director GD; or alternatively between the national subsidiary managers S1, S2.

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Key: Square box: production or distribution facility; Triangle: R&D facility(ies); Circle: representative individual decision-maker. Colour of circle: dark grey: highest-ranked decision-maker H (chairperson/CEO); light-grey: second-rank decision-maker (global coordinator, chief financial officer and subsidiary managers in countries 1 and 2); white: lowest-ranked decision-maker (facilities managers). Thick black lines: flow of product or service that is ultimately sold to customers (including intra-firm exports). Thick black dash double dot lines: flow of knowledge (shared as a ‘public good’ between production facilities). Thin black continuous lines: flow of coordinating services; the direction of the arrow indicates the line of authority. Dashed black line: boundary of headquarters location (indicating co-located staff). Dash-dot black line: ownership boundary of the firm. Notation: C: customer; D: distribution; GD: global distribution coordination; GP: global production coordination; GR: global R&D strategy-making; H: global headquarters; P: production; R&D: management of R&D facilities.

Figure 10.2

Schematic representation of MNE structure showing the flow of coordinating information

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Relations between R&D and production are mediated by the global research director, GR, who engages with the global production director GP at board level. The board is presided over by the CEO, based at the headquarters, H, who controls the firm as a whole. Board members have an opportunity to pool their information at meetings of the board, but this process is mediated by the CEO. The key to the figure explains the conventions used; in particular, the thin black lines that have been introduced into the figure indicate two-way communications, and the position of their arrows indicates the direction of authority. Although the figure is complex, it is the simplest representation that illustrates all the key points. This figure, together with the two subsequent figures, represent a ‘blueprint’ of the organisation structure of an MNE. It is the least complex of all the possible figures that could be used to illustrate this structure. In practice the organisational structures of large MNEs are normally so complex that neither ordinary employees nor external auditors can fully comprehend them. These diagrams are comprehensible to the reader only because simplifying assumptions, based on the underlying theory, have been made in order to construct them. The Role of Financial Services The coordination described in Figure 10.2 relates exclusively to the core activities of production distribution and R&D. Figure 10.3 extends the analysis to consider the role of finance. The financing of the firm is instrumental in sustaining its core activities. The money raised from banks and the capital market is spent mainly on these core activities, apart from funding the operating costs of headquarters and the finance activity itself. The banks, represented by B at the top of the figure, negotiate with the finance director F, who intermediates between them and headquarters H. Once negotiations have been completed, however, the banks lend directly to H. The funds are then distributed to the two national subsidiaries, S1, S2, who in turn fund production and distribution activities in their respective countries. R&D is financed directly by H as an ‘overhead’ activity. A significant refinement of the analysis is the introduction of a third subsidiary, S3, located in a tax haven, country 3. In this country the marginal corporation tax rate is significantly lower than in countries 1 and 2. The principal object of the subsidiary is tax avoidance (Cooper and Nguyen, 2020). The subsidiary supplies notional services, such as expensive internal loans or unnecessary internal insurance, to the production and distribution operations. These services are routed through the national subsidiaries S1, S2, as indicated by the thin grey lines in the figure. Charges for these services appropriate much of the operating profit from production and distribution, thereby reducing the

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Key: Square box: production or distribution facility; Triangle: R&D facility(ies); Circle: representative individual decision-maker. Colour of circle: dark grey: highest-ranked decision-maker (chairperson/CEO); light-grey: second-rank decision-maker (global coordinator, chief financial officer and subsidiary managers in countries 1 and 2); white: lowest-ranked decision-maker (facilities managers and manager of subsidiary in country 3). Thick black lines: flow of product or service that is ultimately sold to customers (including intra-firm exports). Thick black dash double dot lines: flow of knowledge (shared as a ‘public good’ between production facilities). Thin black continuous lines: flow of coordinating services; the direction of the arrow indicates the line of authority. Thin grey lines: flow of support services (including, where appropriate, financial services) from a remote location (this includes communication between the relevant parties too). Dashed black line: boundary of headquarters location

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(indicating co-located staff). Dash-dot black line: ownership boundary of the firm. Notation: B: representative stakeholder; C: customer; D: distribution; F: finance; GD: global distribution coordination; GP: global production coordination; GR: global R&D strategy-making; H: global headquarters; P: production; R&D: management of R&D facilities; S: national subsidiary.

Figure 10.3

Schematic representation of MNE structure showing the role of national subsidiaries and finance

profits of the national subsidiaries S1 and S2. This reduces reported profits in the high-tax countries, and generates substantial profits in the low-tax country 3. These profits are consolidated with the profits from S1 and S2 in the annual group accounts prepared by the finance director F and reported to the tax authorities in the headquarters country 1. If the tax authorities in country 1 treat the profits accruing in country 3 as tax paid, even though the rate of tax is lower, then the net tax burden on the MNE is substantially reduced. Shareholders benefit, jobs are created in country 3, and no one working for the firm elsewhere loses out; the only loser is the government of country 1 and its citizens, who would have benefited from the government spending that would have been possible had the tax been paid in full. Central Services in General Coordination of product flows and financial flows are by no means the only management services that are used within a firm. Most plants normally require access to human resources (HR) services, computing services, facilities maintenance, and other specialized services. Some of these services feature more prominently in the IM literature than others. Market-facing services are general regarded as the most significant. These involve collecting information on external conditions in order to inform strategy at either local, national or international level, e.g. marketing, procurement, and management recruitment. Others simply support routine day-to-day operations, e.g. computing services and facilities-management services. All these services can, in principle, be contracted out to specialist suppliers, and this may indeed be appropriate in certain cases, e.g. where there are substantial economies of scale. There are many services, however, such as those involving confidential information, that are unsuitable for subcontracting, and for these internal supply is essential. It is possible that a firm could supply these services for itself, and sell excess supply to other firms. This would require other firms to contract out, however, and, given the earlier remarks about industry recipes, this is most unlikely. In practice, therefore, most internal services, however supplied, are never resold but are used exclusively with the firm.

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Some internal services, such as finance, are supplied mainly to the headquarters of the firm, but most are supplied to individual plants, which are normally the main employers of labour and the major users of buildings and machinery. Some internal services need to be supplied locally, but others can be supplied remotely. In the digital age, for example, data processing can be remotely supplied, but building maintenance cannot. Some internal services may exhibit economies of scale, suggesting that if they can be remotely supplied then they should be concentrated at a single location. This location could well be the headquarters, but that is not necessarily so. If communication costs are relatively high then the ‘centre of gravity’ of the plant locations may be chosen, while if relevant skills are scarce then access to specialist workers may be the paramount concern in the location of these internal services. It is not only local plants whose internal services can be off-shored; it is headquarters too. For example, there are powerful incentives to off-shore certain financial operations, as indicated above. Headquarters services could be offshored to existing plants, e.g. when the skills required by the internal services are similar to those required by the local plants. For highly confidential services, however, headquarters may prefer the services to be locally supplied. Figure 10.4 incorporates general management services into the activity structure portrayed in Figure 10.3. It focuses on HR services, which are shown near the top of the figure. HR advises the CEO at headquarters H on personnel issues (including the selection of the senior managers who serve on the board). HR is also in dialogue with the key stakeholders, including the banks that appear at the top of the figure. The figure is quite complex. Once again, the principal of intermediation is applied, but now there are so many activities to be coordinated that the number of permutations is quite large. To simplify further, additional restrictions are introduced. It is assumed that the internal services used by individual plants are supplied either from the plant itself or from the national subsidiary, and that a national subsidiary is supplied with services either locally or from headquarters. Headquarters is supplied either locally or from the offshore subsidiary S3. Where internal services are supplied locally to individual plants they are included, for simplicity. in the same category as labour and other local resources supplied to a plant for its principal production activity; these activities are represented by the boxes in the left- and right-hand margins of the figure. A simple interpretation of the figure is offered in Figure 10.5. The figure shows eight main groups of individuals who are responsible for various aspects of coordination. Each of these groups has been abstracted from the network of linkages shown in Figure 10.4. In each group the highest-ranked (most senior) individual is represented by the darkest coloured circle and the lowest-ranked (junior) individuals by white circles. The function of

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Key: Square box: Physical resource; Colour of box: white: production or distribution facility; light grey: local labour, buildings and infrastructure. Triangle: R&D facility; Circle: representative individual decision-maker. Colour of circle: dark grey: highest-ranked decision-maker (chairperson/CEO); light-grey: second-rank decision-maker (global coordinator, chief financial officer and subsidiary managers in countries 1 and 2); white: lowest-ranked decision-maker (facilities manager and manager of subsidiary in country 3). Thick black lines: flow of product or service that is ultimately sold to customers (including intra-firm exports). Thick black dash double dot lines: flow of knowledge (shared as a ‘public good’ between production facilities). Thin black continuous lines: flow of coordinating services; the direction of the arrow indicates the line of authority. Thin grey lines: flow of support services (including, where appropriate, financial services) from a remote location (including supporting communications). Dashed black line: boundary of headquarters location (indicating co-located staff). Dash-dot black line: ownership boundary of the firm. Dashed grey line: flow of local supplies of labour, building services, infrastructure services, etc. Notation: B: representative stakeholder; C: customer; D: distribution; F: finance; GD: global distribution coordination; GP: global production coordination; GR: global R&D strategy-making; H: global headquarters; HR: human resources management; LR: local resources of labour. etc. P: production; R&D:

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management of R&D facilities; S: national subsidiary (the subsidiary in country 3 serves no local market but provides off-shore services).

Figure 10.4

Schematic representation of MNE structure with a comprehensive view of management services

Note: The groups are derived from Figure 10.4. The relations between the members of each group have been simplified. Because the emphasis is on communication within the group the distinction between communications and the flow of services has been suppressed, and all communication is indicates by bi-directional lines.

Figure 10.5

Key groups identified in Figure 10.4

each group is to intermediate between specific activities carried on in specific facilities. These activities are managed by the lowest-ranked individuals. The lowest-ranked individuals do not negotiate directly with each other, except in the presence of, or under the scrutiny of, the senior individuals. The determination of individual rankings rests ultimately with the highest-ranked individual, who chairs the main board. Both the structure of authority, and the location of the senior members, indicates a relatively hierarchical structure. This hierarchical structure is the consequence of the indirect communication between production plants and their overseas distribution facilities noted earlier. It would be possible to

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introduce a direct line of communication between the two, but to maintain the authority structure it would be necessary for this to be intermediated. Either the global production director or the global distribution director could take this responsibility; however, if they shared this responsibility they would have to negotiate with each other and this would create ambiguity in control.

6

INTERNAL COORDINATION

Trade-offs There are several trade-offs involved in optimising internal structure. The most important trade-off is between directness of communication and ambiguity of control. The more ‘vertical’, ‘tall’ or ‘hierarchical’ the structure of communication, the more indirect is the communication between individual lower-ranked managers, but the more unambiguous are the lines of authority. Conversely, the more ‘horizontal’, ‘flat’ or ‘consultative’ the structure, the more direct the communication, but the more ambiguous the lines of authority. Table 10.1 shows the length of the most direct lines of communication between any given pair of managers in the structure portrayed in Figure 10.4. All the managerial roles identified in the figure are listed in the left-hand column, and the letters used to represent them appear in the column to the right. The number in each cell represents the number of links in the chain of communication between a pair of managers in given roles when they use the shortest line of communication between them. Since the number of linkages is independent of the direction of communication, it is only necessary to show the number of linkages for one direction of communication. To avoid duplication of information in the table, therefore, numbers appear only in the cells below the diagonal. The totals shown in the bottom line of the table are the total number of linkages required for a manager in a given role to communicate with managers in every other role. For each given role the total number of linkages is calculated by summing both the numbers in the corresponding row and the numbers in the corresponding column. The results reported in the table show that the highest-ranked managers, though ‘distant’ from the lowest-ranked managers, nevertheless have reasonably good access to the whole of the organisation because they can communicate downwards through the hierarchy in any direction. By contrast, a low-ranked manager has a direct, if distant, connection to a top manager, but an exceptionally long connection to another low-ranked manager, particular one who operates a different type of facility in a different country; this only matters, however, if there is real need for communication between the two. In a flatter and more consultative organisation there would be many more linkages and so the average ‘distance’ between any pair of managers would

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Table 10.1

Lengths of the internal linkages shown in Figure 10.4 H

Activity

GP

GD

GR

Headquarters

H

Global

GP

1

GD

1

2

GR

1

2

2

Finance

F

1

2

2

2

Human

HR

1

2

2

2

F

HR

S1

S2

S3

P1

P2

D1

D2

R&D

production Global distribution Global research 2

resources Subsidiary 1

S1

1

2

2

2

2

2

Subsidiary 2

S2

1

2

2

2

2

2

2

Subsidiary 3

S3

1

2

2

2

2

2

2

2

Production 1

P1

2

1

3

3

3

3

1

3

3

Production 2

P2

2

1

3

3

3

3

3

1

3

2

Distribution 1

D1

2

3

1

3

3

3

1

3

3

2

3

Distribution 2

D2

2

3

1

3

3

3

3

1

3

3

2

2

Research &

R&D

2

3

3

1

3

3

3

3

3

4

4

4

4

16

23

23

27

27

27

23

23

27

29

29

29

29

development Total

39

Notes: The number in each cell indicates the number of the linkages in the shortest chain connecting the activity in the given row to the activity in the given column (and vice versa). The table is based on Figure 11.5. It refers only to internal linkages; it excludes linkages to customers and stakeholders. The table is shown in lower-diagonal form because, if shown in full, the numbers in the cells above the diagonal would be mirror-images of those below the diagonal. The ‘totals’ shown in the bottom row are the total number of linkages by which a given activity is connected to other activities in the system. The total in each column pertains to the activity indicated in the heading of the column, Because the numbers above the diagonal have been suppressed, the number of linkages used to make a given connection must be read off, where appropriate, from the relevant row as well as from the relevant column. Comments: The system portrayed in Figures 11.4 and 11.5 is relatively centralized. With 14 activities there are (14 x 13)/2 = 91 potential linkages; this corresponds to the number of cells below the diagonal in the table. Yet there are only 17 direct linkages between any pair of activities; most linkages are indirect because they are intermediated by managers. The number of direct linkages is therefore parsimonious; this means that most linkages are indirect, and so the total number of linkages involved in connecting every activity to every other activity is very high (the total of the column totals is 342). There are few alternative routes of equal length; the main example involves connecting headquarters to production and distribution facilities either via the local subsidiary or via the global production or distribution directors respectively.

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There are several ‘roundabout’ alternatives, e.g. production in one country can be connected to distribution in a foreign country, not only via a short route involving the two subsidiary headquarters, but via a longer route involving the global production director, global distribution director, and headquarters. If connectivity were to be increased, a useful shortcut would be to connect the global production director, global distribution director and the global R&D director directly as well as via headquarters. As additional linkages are introduced into the management structure, the variation in the number of linkages relating to each activity (i.e. the variation in the column totals) reduces, because the maximum number of linkages for any activity shrinks sharply while the minimum number of linkages for any activity increases much less (if at all).

be much lower. Furthermore each manager, including the lowest-ranked managers, would be directly connected to a greater number of other managers. The difference in connectivity between lowest-ranked managers and highest-ranked managers would tend to be smaller, although the strength of this effect would depend on where exactly the additional linkages were introduced. The organisation would also be robust to disruption, because alternative linkages would be available if any linkage were disrupted; indeed, in some cases the second-best line of communication may be almost as good as the first. A taller and more hierarchical organisation has fewer linkages, and therefore greater distance between managers, especially between managers at the same level of authority. With a limited number of linkages, it is also more vulnerable to disruption. If some line of authority is cut off then the best alternative channel of communication (if one exists) may be very indirect. Thus if a single senior manager resigns or falls ill, for example, the ensuing disruption may be considerable if no-one with similar expertise is available to replace them. Personal Motivation: Economics and Psychology of Teams A useful way of summarising the preceding analysis is to say that management of an MNE can be analysed as if the MNE were a team of teams. Each team has a leader, and the leader of a low-ranked team is typically an ordinary member of a higher-ranked team. In a strict hierarchy the lower-ranked team leader belongs to just a single higher-ranked team, but in a flatter and more consultative structure they may belong to several such teams. Higher-ranked teams are responsible mainly for the allocation of resources between the lower-ranked teams. In the previous discussion the plant was the smallest unit of analysis. It was effectively a ‘black box’. Opening up the black box will reveal more demands for coordination. A plant may contain multiple work teams, and within each team there will normally be a leader who coordinates the members’ efforts. Hierarchies may therefore exist within individual plants; for example, the plant

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manager may chair a production board composed of work-group managers; thus the plant itself becomes a team of teams. A team perspective is useful because it indicates that a leader is more than just an authority. Each leader is also accountable for the performance of their team. They account to a higher authority, namely the leader of the team to which they, and other leaders of similar rank, belong. A leader is therefore responsible for the actions of people other than themselves. The leader of the firm, namely the CEO is responsible to stakeholders external to the firm. Only an ‘ordinary worker’, who takes orders but does not give them, is responsible simply for themselves. Accountability raises a serious problem for management, because the leader of a team becomes responsible for the behaviour of other members who may have objectives very different from their own. In principle a contract of employment resolves this problem because the employee (team member) agrees to follow their employer’s instructions (as given by their leader), whether or not they agree with them themselves. In practice, however, such contracts can be difficult to enforce. If the objectives of the leader and team member conflict then there is an incentive problem. The leader needs to understand the other person’s objectives in order to determine the kind of reward they seek. They can then promise this reward in return for compliance. Compliance is checked by monitoring the employee, e.g. by measuring their effort. Monitoring performance can be difficult, however. Where interdependence within the team is high, lack of effort by a single worker can nullify the efforts of all the others, i.e. the team is no stronger than its ‘weakest link’ (Marschak and Radner, 1982). If the leader can only monitor the aggregate outcome then incentives will have to be based on overall team performance, which may make them relatively weak so far as any individual is concerned. However, if the workers have ‘inside information’ they may apply personal rewards and penalties amongst themselves. Understanding other people’s objectives can also be difficult. It is often assumed that employees are concerned mainly with bonuses, pay, and promotion, but non-pecuniary factors can be important too. These include self-respect, and peer respect from within the team or beyond. Non-pecuniary incentives are potentially more powerful that pecuniary incentives because the worker essentially monitors and rewards themselves. The worker may regard their work as the fulfilment of an obligation: to society (‘pride in the job’); to their employer (reciprocity or respect for authority); or to their colleagues (‘solidarity’). The same attitudes can also be reversed, however: alienation from society, distrust of authority and contempt for colleagues can produce bad results (Casson, 1991).

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The ideal solution is to align the objectives of the employee/ordinary team member with the objectives of the employer/team leader, and then leave the team member to monitor themselves. This can be achieved in three main ways: the employee can buy into the employer’s objectives (e.g. as a partner in a co-operative firm); the employer can buy into the employee’s objectives (e.g. corporate sponsorship of good causes), or the two can be combined. Given that the leader is ultimately responsible for the performance of their team, it is for the leader to decide which, if any, of these policies is pursued. The problem with the first is that conflict may develop at the highest level between employee owners and non-employee owners, though a possible solution is to give the employees non-voting shares. The problem with the second is that there may be differences in objectives between individual employees. Leaders can address this problem in the long run by recruiting only like-minded members to their team. This has the disadvantage, however, that by restricting the recruitment base, and encouraging ‘group think’ it may reduce the diversity of knowledge and skill within the team.

7

ALTERNATIVES TO THE MNE

In practice, there are many varieties of firm in an IBS system. An important role of internalisation theory is to analyse how the structure of the firm adapts to the job that the firm needs to do. For most MNEs this job is to recognise and exploit external opportunities (e.g. technological innovation, product differentiation), and to anticipate and neutralize external threats (e.g. deter imitation, accommodate changes in consumer preferences). The firm must adapt its internal structure, as and when required, in order to facilitate effective response. It is widely recognised that firms require ‘dynamic capabilities’ to adjust to changing circumstances (Teece, 2009), but only internalisation theory explains in detail the precise adjustments required to achieve specific types of change. There are many coordination possibilities in the IBS system. Joint ventures networks, international cartels and international investment trusts are all potential alternatives to the MNE. Networks of international joint ventures are already common in many high-technology industries (pharmaceuticals, motor vehicles, etc.). International cartels were prominent in the inter-war period, when both trade barriers and political risks were high, and these conditions may return in response to political moves towards de-globalisation. International investment trusts are created when investors acquire large stakes (usually in the names of holding companies) in a range of firms, with each stake sufficient to acquire a right of nomination to the board of directors. They then coordinate the actions of their representative directors to orchestrate the actions of the firms, and thereby achieve outcomes that would often be illegal if implemented through a merger or a cartel.

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Firms can also restructure their product or technology portfolios to their mutual advantage through simple trades. For example, an exchange of patents can allow independent firms to reinforce their individual monopolies of technologies in a particular sector of the economy. Diversified pharmaceutical firms, for example, can exchange their patents so that each acquires a monopoly of technologies in a particular field of medicine. Similarly, diversified fast-moving consumer goods firms can exchange brands in order to acquire a monopoly of leading brands in specific sectors, such as ice cream, detergents, and snack foods. The analytical techniques developed in this chapter can also be applied to these alternative organisational forms. The management structures used to implement these ‘alternatives to the MNE’ have been studied relatively little, and offer an exciting agenda for future IBS research.

8 CONCLUSIONS This chapter has examined the potential for integrating theories of IBS and IM. This is a broad and ambitious agenda and this chapter has examined only selected aspects of the topic. It has introduced diagrammatic techniques for analysing the linkages between activities within an MNE. The diagrams examine how these activities can be coordinated through intermediaries. The intermediaries are managers who collect information from individual plants, supervise negotiations between plant managers, and if necessary impose decisions. These managers also need to coordinate their own decisions. This is the responsibility of senior managers (e.g. board members), who oversee negotiations between these managers and manage relations with external stakeholders. Managers rely on wide range of specialized support services which are supplied by teams led by other managers. Some of these teams may be co-located with the plants they serve, while others may be located at a distance and supply their services remotely. Some of these services may be supplied from locations where the firm would not normally produce, e.g. tax havens. The location of support services may therefore influence the multinationality of the firm. The analysis can be extended further by opening up some of the ‘black boxes’, such as plants and service centres, and thereby disaggregating to a lower level. In principle there is no reason why the analysis cannot drill right down to examine coordination between the individual members of work groups within a production plant. It is, in fact, at this level that many of the ethical concerns relating to modern MNEs are most intense. The analysis above has drawn extensively on techniques of network analysis. Neither IM nor IBS has exploited the full potential of these techniques. IBS has used networks to analyse the flow of product or diffusion of knowledge,

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while IM has used them mainly to examine management structures and hierarchies of control. This chapter has integrated the two, and has shown that they are more powerful together than they are apart. This integrated approach is an ideal framework with which to analyse the role of support services within the MNE. In many business schools each support service is studied in a different department, or perhaps by a different group of scholars. Each group argues, quite correctly, that the services they study are crucial to the performance of the firm. This fragmented approach does not, however, address the issue of how these support services interact with each other, and how location decisions relating to support services influence the multinationality of the firm. Bridging the gap between IM and IBS may also serve to bridge other ‘gaps’ within IBS studies as a whole. This analysis sheds light on other long-standing issues in IBS theory too. Different types of industry will have different configurations of plants and will therefore develop distinctive management structures of their own. In general, manufacturing firms will differ from service firms, high-technology firms will differ from low-technology firms, and firms that integrate back into primary industries will differ from firms that do not. In particular, some firms may develop distinctive advantages in the coordination of internal activities. They may grow large because they are able to internalize more activities than less-advantaged firms which find it necessary to out-source activities that they lack the skills to manage. The analysis also resonates with earlier work in internalisation theory which has, to some extent, been overlooked in recent literature – the early contributions by Williamson and Hennart in particular (cited above). The diagrammatic analysis can be used to clarify some of the subtle philosophical points they make about internal and external markets and the internal governance mechanisms of the firm. In general, a deeper understanding of internal coordination will almost certainly bring to light additional firm-specific advantages based on specific management skills that are pertinent to specific types of industry. It will also enrich understanding of the nature and significance of internalisation, which could lead to significant further developments of the theory.

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11. Organizational innovation in the multinational enterprise: internalization theory and business history With Geoffrey Jones and Teresa da Silva Lopes 1 INTRODUCTION Recently there have been multiple assertions that ‘history matters’ in IB, although overcoming the methodological roadblocks to making it matter remains a work in progress (Jones and Khanna, 2006; Buckley 2009; Jones and Pitelis, 2015; Verbeke and Kano, 2015). This chapteroffers a concrete example of the value of bridging the gap between IB theory and history which speaks directly to recent calls for addressing big questions and employing multidisciplinary perspectives (Buckley, Doh and Benischke, 2017). It presents compelling new evidence about how entrepreneurs and firms with multinational activity faced by market imperfections in the nineteenth century changed the design of their headquarters roles and their organizational structures rather than changing their entry modes. This phenomenon is well-known in contemporary global business, and has erroneously been used to criticize internalization theory. The contribution of this chapter is to show that there is absolutely nothing new about this strategy. It is well-established that the multinational enterprise (MNE) as an organizational form has been around since the nineteenth century (Wilkins, 1970, 1974; Jones, 2005). Historical research on MNEs is often informed by the classic internalization theory proposed by Buckley and Casson (1976) to explain the emergence of the modern, internationally operating firm (for example Wilkins, 1998a, b; Jones, 2000, 2005a; Lopes, 2007, 2010, Verbeke and Kano, 2015, among others). One interesting element that arises, when looking at MNE historical trajectories, is the diversity of organizational forms employed across time. The past does not present us with what could be interpreted as a simplified version of today’s modern corporation. Instead the past reveals organizational forms 241

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that were (and are) novel, often complex, and uncommon. To use a biological analogy, it is not a single exotic animal that historians discover, but rather an entire zoo (Wilkins, 1988, 1998a, b; Jones, 1986; Dunning, 1993; Rugman and Verbeke, 1992; and Birkinshaw et al 2006). For the most part, the diversity of these firms has not been addressed explicitly by internationalization theory. Revisiting this past provides an important opportunity for the usefulness of theory to be tested in “new settings.” Historical research shows that the modern MNE emerged from a wide array of distinctly uncommon – and what appeared to be innovative – organizational forms. Three main types can be discerned. The first type is international enterprises which emerged without a domestic base, with companies either registered in the home country but with no local operations, or with local operations but no sales, or even without any home operations or sales. These included free-standing companies, a term seldom heard in the IB literature but which can be regarded as born-global companies ‘avant la lettre’, and companies created in host countries by expatriate entrepreneurs (Wilkins, 1988; Jones, 2000; Lopes, 1997; Jones and Pitelis, 2015; Verbeke et al, 2014; Lopes et al 2017). The second type evolved out of collaborative arrangements, and were characterized by the absence of hierarchical relations between operations in different markets, and often had little or no equity stake in foreign operations. This type has been described in the historical research on international cartels, some early forms of joint ventures, and so-called “cloaked” firms in Europe the interwar decades (Fear 2008; Brown 1994; Kobrak and Hansen, 2004; Kobrak and Wustenhagen, 2006; Jones and Lubinski, 2012). The third type was a network of independent firms linked by equity and non-equity connections. These were akin to today’s diversified business groups, but historically often originated from international trading companies. In these cases, enterprises tended to have a domestic base, even if only in services (Carlos and Nicholas, 1988; Jones, 2000; Jones and Khanna, 2006). Interestingly, this organizational diversity has returned in the recent past. This chapter has three main objectives: • To explain the rationale for the unconventional and innovative organizational forms adopted by some firms, as indicated by historical evidence. • To extend internalization theory by taking into account the role of the entrepreneur in sourcing local knowledge in the host country, and in choosing the location of headquarters activities. • To examine the efficiency of the evolutionary paths pursued by firms, both in terms of who performed the entrepreneurial roles and how headquarter roles were distributed.

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The chapter is organized in five parts. Section 2 provides an overview of the fundamentals of classic internalization theory, highlighting its implicit assumptions. It also explains how our empirical evidence might encourage an extension of mainstream theory, by adding two new dimensions: the role of the entrepreneur in sourcing local knowledge, and the design of the headquarters. Two main types of entrepreneurs are identified as providing knowledge: the innovative entrepreneur (from the MNE home country) and the local entrepreneur in the host country. The three main functions of headquarters that are central to its organizational design include the legal, financial, and strategic roles. Section 3 examines how entrepreneurs, and in particular expatriate entrepreneurs, impact on internalization decisions by MNEs. This section also discusses the nature of the opportunities they exploit and the modes of operation they employ in host countries. Section 4 provides historical evidence on how and why headquarters functions have been geographically distributed. It identifies the importance of political risk management and the seeking of efficiencies associated with access to resources and more favourable legal and fiscal environments as major motivations. Section 5 concludes the chapter, and highlights how inductive historical research can help refine and extend current theories.

2

EXTENDING INTERNALIZATION THEORY

Theoretical Background Classic internalization theory, first developed by Buckley and Casson (1976), and extended by Rugman (1981, 2005), Hennart (1982, 1991, 1993), Rugman and Verbeke (1992, 2003, 2004, 2008), Buckley and Casson (2009), Verbeke (2009), and Casson, Porter and Wadeson (2016), amongst others, analyses the boundaries of firms in terms of market imperfections. Internalization occurs when the benefits of using hierarchy are equal or lower to the costs of using the market. The theory was originally developed as a general analysis of the boundaries of firms. However, the impetus for its development was the need to explain the post-1945 growth of market–seeking U.S. MNEs in knowledge–intensive manufacturing industries in Europe. This was undertaken by large U.S. corporations with multidivisional (M-form) organizational structures. The M-Form type of organization which developed from the 1920s, allowed firms to pursue strategies of diversification with a view to achieve efficiencies (Chandler, 1962; Chandler et al, 1997). As has been noted as far back as Casson (1986), the fact that the classic internalization theory originated in particular historical

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circumstances created certain assumptions, and hindered application to understanding how international firms operated in different political and economic contexts. Internalisation theory developed as an explanation of ‘conventional’ MNEs of the kind described above rather than as a theory of all MNEs. As a result, every time an ‘unconventional MNE’ was discovered, there was a call for a new theory. This has been the case with both emerging market MNEs and born-global firms (Wells, 1983; Verbeke and Kano, 2015; Oviatt and McDougall 1996). Internalisation theory, as originally articulated, focused very sharply on issues of ownership and control, with higher risk being associated with organizational forms that involve higher control. It was assumed that other theories would be developed to address other key managerial issues. For example, the operations of host country licensees, franchisees and subcontractors would be explained by theories of small-firm behaviour, while the location of headquarters would be explained by organisational theory. These theoretical developments did not occur however, and so an obvious response is to extend the scope of internalisation theory to address these issues. Rugman (1981) acknowledged the importance of entrepreneurial choices in the face of uncertainty and the impact of institutional variables, especially in the realm of distance among countries and regions. Verbeke and Rugman (1992, 2003) recognized a variety of strategic and managerial issues involved in internalization, focusing in particular on the management of the innovation processes. This is achieved by infusing a ‘dynamic capabilities’ perspective, with an emphasis on generating, exploiting and rejuvenating firm-specific advantages and matching this with country specific advantages of host countries (Verbeke and Kano, 2012). This links internalisation issues to host country entrepreneurs and the sourcing of knowledge and the design and location of headquarters. Historical evidence (summarised below) suggests that these can affect internalisation decisions. Local entrepreneurs can play an active role in explaining internalization decisions and in the sourcing of local knowledge. In addition, the host country licensees, subcontractors, franchisees and sales agents, all of whom can act as entrepreneurs, are not always local, and subcontractors and sales agents can be as entrepreneurial as licensees and franchisees. In a similar vein, the classic internalization theory does not discuss the design of the headquarters. The theory expresses great confidence in the ability of the ‘modern corporation’, as described by Chandler, to internationalize without fundamentally changing its organisation or its operating methods (Chandler, 1962, 1977, 1990, 1991; Williamson, 1981a; Chandler, et al, 1987). International diversification is supposed to respect the same organizing principles as domestic product diversification. In particular, internalization theory understates the importance of risk management, including political, social,

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business, financial, and natural risks (Casson and Lopes, 2013). While IB theory recognises these risks, they assume only a marginal role in the internalization theory, and at most they affect the mode of entry into a particular market (Hill et al, 1990; Afarwal et al, 1992; Buckley and Casson, 2009). Here we show that firms historically engaged in multinational activity do not automatically choose the entry mode that minimizes risk and maximizes control for the expected return. Instead, the number of internalization options becomes much wider, even within a single entry mode, when the impact of alternative designs of headquarters in the realm of internalization decisions is acknowledged, as well as the role of the entrepreneur in sourcing local knowledge. In classic internalization theory, the legal, financial and strategic activities of the headquarters are all assumed to be located in the same place. The headquarters can readily manage operations from a distance, and efficiently control subsidiaries that may be operating in a more hostile environment overseas. Strategic knowledge is assumed to be generated in the headquarters, and local (and often also strategic) knowledge is supplied by the subsidiary. Communication with foreign subsidiaries is considered to be fast and to be easily effected, either remotely or face-to-face. Distance is a critical concept that affects the transferability, recombination, and exploitation of firm specific advantages across borders. If any dimension of distance increases, so do the costs of doing business abroad, as well as the challenges of effectively deploying firm specific advantages in a host environment. Distance creates new bounded rationality challenges for managers who must understand drastically different host environments, as well as bounded rationality problems (Verbeke and Greidanus, 2009). Historical Evidence Some of the key assumptions from internalization theory have to be relaxed when interpreting historical evidence on early MNEs. When internalization theory is stripped down to core principles, it becomes clear that the unconventional and apparently innovative organizational forms of early MNEs were an efficient response to the organisational problems of their time. Business history research provides a somewhat unique and complex picture compared to the IB literature dealing with the contemporary MNE, in particular, with regards to the role of the entrepreneur and the sourcing of local knowledge, and also the role of the headquarters. Some international business history research focuses on global firms, while other research focuses on firms that operated in just a few markets. Some firms such as Ford, Singer, Siemens, J & P Coats, Lever Brothers and Nestlé, as well as a multitude of trading companies and business groups, were present in multiple countries from early in their life (Wilkins, 1977, 1988, 2009, 2011, 2015; Jones, 1988, 2005, 2014;

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Jones and Schröter, 1993; Godley, 2006; Kim 1995; Kininmonth 2007; Lopes and Casson, 2007; Lopes, 2010). Other firms, however, invested in just a few foreign countries, and many in just a single one. The individual host country therefore occupies an important place in historical research. Many studies, for example, examine in detail the impact of MNEs (either positive or negative) on the long-run economic development of host countries (Jones, 1987; Bostock and Jones, 1994; Jones and Bostock, 1996; Jones, 2013; Jones and Lluch, 2015; Barbero, 2015; Lluch and Barbero, 2014; Beatty, 2009; Piquet, 2004). Business historians are interested not only in foreign direct investment (FDI) but in the transfer of technology and culture (Beatty, 2003), and for this reason they have been concerned just as much about arm’s length contractual arrangements such as licensing, franchising and subcontracting as about conventional FDI. Their research emphasises the important role of entrepreneurs, not only as managers of local subsidiaries, but as independent proprietors or as agents for foreign firms. The focus on host countries also means that business historians have been interested in local capabilities (Mason, 1992). Local entrepreneurship has long been seen as key to local economic development (Schumpeter, 1934; Knight, 1921; Kizner, 1973). Local entrepreneurs are very visible in historical business records. Limited liability joint stock companies were rare in the early and middle nineteenth century. The business partnership was still important, while the modern corporation was virtually unknown outside the railway industry. The role of the individual entrepreneur was therefore much more evident than it is today (Payne, 1974; Cottrell, 1979;Wilkins, 1988; 2009). Entrepreneurship There is considerable evidence concerning entrepreneurs operating in foreign markets and developing early forms of MNE. It is possible to identify different types of entrepreneurs in terms of their involvement in multinational activity and also their career trajectories and background. The foreign firm would typically be founded by an innovative entrepreneur from the headquarters’ country, while the business partner in the host economy would be a local entrepreneur. The innovative entrepreneur typically supplied knowledge regarding technology and product design as described by Schumpeter (1934), whilst the local entrepreneur contributed local knowledge, including insider knowledge obtained through personal networks, analogous to the Kirznerian entrepreneur (Kirzner, 1973, 1997). Early firms with multinational activity combined these two types of knowledge to serve their foreign markets through knowledge transfer between headquarters and subsidiaries. Their function was similar to what can be observed in the modern MNE, but the context was different, and this led to different organizational forms.

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The innovative entrepreneur would register the firm in the headquarters country, issue shares, and create a board of directors to represent the shareholders. A reputable non-executive chairman, typically drawn from the social elite, would be appointed. The entrepreneur would be a major shareholder and often act as managing director, overseeing the internationalisation process. On retirement he would endeavour to appoint his own successor who would carry on the entrepreneurial role (Jones, 2000; Garcia-Ruiz and Toninelli, 2010; Becker, Knudsen and Swedberg, 2011). The local entrepreneurs could act in various capacities. They could own and control their own firm: a subcontractor would undertake local production while a franchisee would undertake local marketing. If both production and marketing were undertaken by the same local entrepreneur then the entrepreneur became, in effect, a licensee: they bought the right to produce and sell the product for a term of years at their own risk, subject to various restrictions on market area and pricing policy. As a subcontractor, a local firm could either add value to a product supplied to it by the foreign firm (‘labour only subcontracting’), or supply a product it had produced entirely by itself (though perhaps using a foreign design). Franchisees typically owned the product that they sold, and therefore bore significant market risk; on the other hand, a sales agent would be rewarded with a fee. A franchisee would normally be tied in to purchasing from a specific foreign firm, although he might be allowed to handle non-competing franchises too. Agents might also be allowed to handle non-competing products (Becker, 1998; Jones, 2000; Lubinski and Jones, 2012; Colpan and Jones 2015). A local entrepreneur could act as the manager of a foreign subsidiary instead. In this role, he would exercise powers devolved from headquarters, and use his own judgement to implement the headquarters’ strategy. In the nineteenth century communication was sufficiently slow, and risks sufficiently great, that local managers needed considerable autonomy to deal with unexpected threats or crises. The local manager would receive a salary, but could be rewarded with bonuses or increments if he performed particularly well. Nevertheless, many successful managers chose to leave their foreign employer once they had learned enough to set up a business on their own, becoming either independent partners of their previous employer, or in some cases rivals to this employer. Local entrepreneurs were not restricted to serve only the local market: they could export too, either to the source country, or to a third country, or to both. Exports to the source country were typically internal to the firm; the foreign subsidiary acted as an ‘offshore’ producer for the parent. Exports to a third country could also be internal, being consigned to another subsidiary of the same parent, as with trading firms; more commonly, though, exports would be supplied to independent foreign customers. In the nineteenth century, there-

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fore, host-country entrepreneurs enjoyed considerable autonomy, whether as independent owners or as salaried employees (Becker, 1998; Jones, 2000). Migration The nineteenth century and early twentieth century was a time of extensive international migration, especially from Europe to North America (Chiswick and Hatton, 2003). Migration is widely recognised as a selective process in which the young, healthy and most entrepreneurial from different social backgrounds are most likely to move (Hatton, 1998; Hatton and Williamson, 2002). Migration affected the supply of both innovative entrepreneurs from a home country and local entrepreneurs in host countries. The latter is the focus here. Migration is not necessarily a one-off process. Migrants may be itinerant, moving on to another country later, and perhaps eventually returning to their home country. Migrants intending to return may decide not to change their nationality, preferring to operate as aliens in the country where they work. Alien merchants are documented extensively in historical accounts (Jones, 2002; Chapman, 2003; McCabe, Harflaftis and Minoglou, 2005; Casson and Casson, 2013). Dual nationality was another option. In colonies and dependencies, citizens of the colonial power often occupied a privileged position even though they were not native to the country. In India prior to independence, for example, Indian institutions often distinguished between British citizens, Europeans and other ‘whites’, Anglo-Indians of ‘mixed race’, and locals, with the natives being further classified according to religion, caste and ethnicity, such as Parsee or Marwari (Tomlinson, 1989). In many colonies the resident expatriate was a familiar figure, a citizen of a foreign country but a permanent resident of the host country. While some expatriates settled permanently, often marrying locally, others were only temporary resident expatriates, as they returned home eventually (Lopes et al, 2017). The resident expatriates were well-suited to function as local entrepreneurs. They were familiar with the culture of their home country, and often had relatives there. They were also familiar with the host country, especially if they had in-laws there. They were ‘boundary spanners’, belonging to networks both at home and abroad. Some had a professional background and were affiliated with international associations too (e.g. consulting engineers). Another interesting group included the host-country locals from wealthy families who had been educated in the source country and returned to work at home. As alumni of elite educational institutions, they were ‘trusted’ (i.e., viewed as reliable) to manage foreign operations. Like resident expatriates, they did not only support foreign firms to operate locally, but also to help local firms obtain finance from the source country. Contacts with the source country in the financial sphere were particularly useful if they decided to set up their

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own local businesses financed from abroad (Oonk, 2007; Jones, 2013; David and Westerhuis, 2014). Finally, it is necessary to consider the temporary resident expatriate, who came from the source country specifically to be a local entrepreneur for a limited time. For the independent businessman, this implied a ‘get rich quick’ mentality, while for the manager of a foreign subsidiary it might involve a career move, designed to gain promotion. Young managers could be seconded for a short time from headquarters, and replaced by another secondee when they returned home. The relative benefits of locally-educated locals, foreign-educated locals, resident expatriates and secondees, it can be argued, depended mainly on the relative importance of the general knowledge possessed by the foreign headquarters and the local knowledge required for successful host-country operations. If local knowledge was the paramount requirement, then a locally-educated local entrepreneur who was totally embedded in the local community would be the right person for the job. At the other extreme, if up-to date familiarity with headquarters thinking was paramount, then the secondee was preferable. Although a steady stream of ‘novice’ secondees could prove disruptive, their up-to-date knowledge of headquarters thinking might outweigh this concern. Positioned closer to the middle of this spectrum of capabilities are the foreign-educated locals and the resident and temporary resident expatriates. Foreign-educated locals were more prominent in government and universities than in business, and so it is expatriates that are the focus in this chapter. Expatriates were a compromise solution, combining an appreciation of headquarters culture and local culture (Jones and Wadhwani, 2007; Cassis and Minoglou, 2005; Godley, 2001). Design of Headquarters Historical patterns in the design of headquarters by entrepreneurs can also be discerned. Business historians have been arguing for a while that the source country occupies a rather peculiar case in the business history literature because the location of the headquarters is sometimes unclear (Wilkins, 1988; Corley, 1994; Casson, 1994; Hennart, 1994, 1997; Wilkins, 1998a, b; Jones, 2000). Three main roles can be discerned. The first is that a headquarters represents the registered address of the firm for legal and tax purposes. This address governs where corporate taxes are paid, and therefore what rates of tax apply. In the nineteenth century, however, there were no significant corporate taxes, and as a result, off-shore tax havens were not the issue they would later become. As the location of the legal headquarters decides the judicial system used for the settlement of commercial disputes, this was very relevant to ‘trader’ MNEs making contracts with foreign

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businesses (Jones, 2000). The legal headquarters also gave the firm a right to call upon the home country government for protection of its overseas interests. When operating in a risky or politically unstable overseas environment, it was useful to have a major world power on the MNE’s side: imperial capitals therefore attracted legal headquarters (Wilkins, 1999; Cassis, 2010). Risk and political instability was important in other ways as well. When nations are at war, the legal headquarters may be moved to a safe haven, allowing the business to continue, even when the other headquarters functions are ‘located’ in an occupied country. If political instability is widespread, and even neutral countries are under threat, then multiple headquarters may be used: different holding companies of different nationalities are established, ready to be activated if and when required. Although legal headquarters may, in a physical assets sense, represent little more than ‘brass name plates’, deposit boxes, or empty rooms, they can be highly significant as risk management tools (Wubs, 2008). They can also be used for criminal purposes: for example, to disguise money transfers by drug traders and arms dealers (Austin, Dávila, and Jones, 2017). The second role of headquarters is that it represents the place where strategic decisions are taken by an innovative entrepreneur, and where the firm’s board of directors convenes. In this context, ‘strategic’ means two things. First, that major investment decisions are being taken under uncertainty. These decisions are often irreversible, and resources, once committed to a project, cannot be easily recovered. A mining venture, for example, involves irreversible, fixed commitments to boring tunnels and building heavy transport infrastructure. If the project fails, a hole in the ground may be all that is left. On the other hand, the decision to build a new distribution centre may involve much less risk, because the warehouse and vehicles are versatile (or mobile) assets and can be easily sold off in the second-hand market if the project fails. Strategic also means that interactions with other players are involved. These may be competitors, alliance partners, or the firm’s own subsidiaries. The headquarters needs to monitor these players, predict their behaviour and plan responses to it, and where appropriate, negotiate with them. A headquarters that performs a strategic role requires access to highly skilled managers, supported by a range of specialised professionals. It may also benefit from being located close to the headquarters of its major partners and rivals, as well as its own subsidiaries, in order to have access to the best possible information (Marshall, 1920; Porter, 1998; Zeitlin 2008). Large-scale investments require finance, and this identifies the third role of headquarters. Three different forms of finance are normally involved: equity (the riskiest), long-term fixed interest debt (the second riskiest) and short-term lending secured on versatile collateral assets (the most secure form of debt from the lender’s point of view). Procuring finance requires access to wealthy

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individuals and large financial institutions (notably banks). A stock exchange is required to provide liquidity to long-term investors. Financial backers making significant investments require regular face-to-face briefings. Thus the financial headquarters needs to be based in a major financial centre. There are a limited number of such centres from which to choose, which explains why so many large enterprises have financial headquarters in the same few locations (Wilkins, 1999; Cassis, 2010). These three headquarters roles – legal, strategic and financial – are the most crucial. But it is worth noting another, namely the location of major research laboratories or other core management functions. While the research laboratory did not become a significant factor until the end of the nineteenth century, with the commercialisation of electricity, it is mentioned here for the sake of completeness. It has been suggested that the central laboratory needs to be co-located in the same country (even if not in the same site) as the headquarters, although with which type of headquarters is unclear (Kumar, 1996). It seems unlikely to be the legal headquarters, although co-location could be relevant if patents and other intellectual property are under threat. Co-location with shareholders also seems unlikely, because ordinary shareholders are unlikely to understand what is going inside in the laboratory, and it could undermine commercial secrecy if they did. The obvious candidate for co-location is the strategic headquarters, to allow the strategy of the firm to be aligned with new technologies and products emerging from the laboratory. Evidence suggests, however, that the strongest pull to attract laboratory locations comes from knowledge hubs, where pools of specialist researchers reside and university facilities are available to support research Kristensen and Zeitlin, 2004; Christensen, 2006). Focusing on the three main roles identified above, the question is whether these roles should all be co-located in a unitary headquarters. Classic expositions of internalization theory implicitly assume that they should (Buckley and Casson, 1976; Dunning, 1981). The assumption is made by default, however, in the sense that the question is not really asked. Business history, on the other hand, clearly shows that it needs to be asked. Distributed headquarters, where different roles are carried out in different countries were very common in the nineteenth century and early twentieth century. There are two main reasons why headquarters roles could be distributed. One is specialisation of location according to comparative advantage, and the other is the management of risk. Comparative advantage implies that different headquarters roles require different sorts of inputs, and that different inputs are cheapest at different locations. Headquarters roles also require skilled professional workers and a sound institutional environment, whereby input costs are less important.

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Favourable access to legal skills could detach the legal headquarters from the others, and access to banking and financial institutions could do the same for financial headquarters (Wilkins, 1988). Strategic decision taking could be detached in order to facilitate or accelerate flows of information and goods, in particular when communications were not fast. Risk management has been a very common cause of separation of headquarters roles. Co-location of headquarters’ roles because of risk management, tends to be associated with cases of unfavourable tax regimes, war, expropriation, discrimination, and excessive or lack of regulation (Rugman, 1976; Morck and Yeung, 1991; Boddewyn and Brewer, 1994; Jensen, 2008). In the first case, it will be located in a tax haven, and in the other cases in a politically stable, well-regulated country. Since countries often become tax havens to compensate for other disadvantages (they are often small countries), a tax haven is unlikely to attract other roles. Hence, firms that relocate their legal headquarters for tax reasons, will usually have this legal headquarters separated from the strategic and financial headquarters – these other roles will not follow the legal headquarters to the same location (Hennart, 2010). There are good grounds for co-locating the strategic and financial roles. Strategists will find it useful to sound out financiers on the prospects of funding major new investments. Bankers, entrepreneurs and wealthy investors constitute a social elite that will tend to have shared tastes, based around cultural and social activities, and value international logistics connectivity. They will therefore prefer to reside in the same sorts cosmopolitan locations. The main reason for pulling them apart is that the strategists may need to co-locate with operations, and operations may be based in an ‘industrial heartland’ elsewhere (Wilkins, 1988). Finally, it should be noted that headquarters’ roles can sometimes be replicated in different locations. A focus on risk management would suggest that in times of war, the legal headquarters could be replicated among several locations. If there are two belligerent countries, and a neutral country, which might also be invaded, then it could pay a vulnerable MNE to have headquarters in each, so that irrespective of whom won the war, the firm would command headquarters in the ‘winning’ country, whether or not the neutral country were invaded (Wubs, 2008). Financial headquarters can also be replicated, but for different reasons. If two large firms merge to create an even larger firm, the new firm may acquire two large pools of shareholders in different financial centres. To keep the loyalty of both groups, it may decide to retain a presence in both countries by maintaining a headquarters office there (Wilson, 1954, 1968; Jones, 2005b; Jonker and van Zanden, 2007). Note that while different legal locations are normally alternatives to each other, different financial headquarters may be complements instead. In certain circumstances, however, legal headquarters could be complementary too, e.g., if the MNE has foreign

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investments in two different empires, or spheres of political influence, it might maximise its political leverage by headquartering different holding companies in each imperial capital (Jones, 1981, 2005). Proposed Extension IB theory has dealt with these topics separately. On the one hand, it has discussed the role of the entrepreneur in the sourcing of knowledge and the accessing of complementary assets (Richardson 1972; Rugman, 1981; Teece, 1986; Lopes and Casson, 2007, 2013; Verbeke et al, 2014; Verbeke and Kano, 2015). On the other hand, it has studied the design and functions of the headquarters (Hedlund, 1986, 1994; Bartlett and Ghoshal, 1989; Sölvell et al, 1991; Young and Goold, 1999; Sölvell and Zander, 1995; Foss, 1997; Collis et al, 2007; Andersson and Holm, 2010; Hilleman and Verbeke, 2014; Kinisch et al, 2015; Coeurderoy and Verbeke, 2016; Meyer and Benito, 2016). The historical evidence presented here challenges us to assess whether analysis of entrepreneurial roles and headquarters role distribution can be combined with internalization theory to explain unconventional or innovative organizational forms of MNEs. Figure 11.1 illustrates such an approach.

Figure 11.1

Proposed extension of internalization theory

There are three dimensions, each one represented in a separate axis. On the first dimension, the innovative entrepreneur chooses the location and internalization strategy of the corporation, which ranges from markets to hierarchies, and includes other hybrid modes such as subcontracting, franchising, and licensing. The second dimension relates to the type of entrepreneur chosen for sourcing of local knowledge in the host country. It can be a local entrepreneur, an

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expatriate entrepreneur or a secondee sent from the home country. The type of expatriate can range from alien migrant, dual-nationality entrepreneur; permanent resident expatriate, or temporary resident expatriate, among other options. On the third dimension, the innovative entrepreneur chooses the design of the headquarters, which can range from co-locating all the headquarters functions (legal, financial and strategic) in one country, to distributing these across distinct markets. Other options exist in between the two extremes, for example with the legal and financial functions concentrated in one country, and only the strategic function distributed, and so on. The historical evidence collected to develop this proposed extension of internalization theory, is provided below in sections 3 and 4. It is possible to find patterns and interdependencies between internalization strategies, the innovative organizational forms chosen by firms, and the geographical distribution of headquarters roles. Firms that rely on expatriate entrepreneurs tend to have both the advantages of knowledge transfer and sourcing of local knowledge, with the inherent limitations associated with bounded rationality (Williamson, 1975; 1981a, 1981b, 1996). Firms operating in distant and less developed markets, looking to funding their activities tend to create headquarters with financial detachment so that they can access more advanced and efficient capital markets. Firms striving to survive in markets characterized by high risks, tend to choose legal detachment. These risks can be varied, such as legal (e.g. taxation), political (e.g. war) or economic and business (e.g. lack of protection of intellectual property rights). Strategic detachment of headquarters tends to occur when it is not possible to manage operations from the legal headquarters because of difficulty of communications, and the time to take strategic decisions is very short. It is possible to identify ‘clusters’ of behaviour by MNEs, whereby particular types of MNE adopt particular strategies with regard to their decisions to internalize, their choice of entrepreneurs to manage their business in the host country, and design of their headquarters. Co-located MNEs are more likely to internationalize and create subsidiaries in foreign markets, either by sending secondees, or hiring local managers. Firms operating in high-risk environments are more likely to detach the legal headquarters. Firms investing in developing countries with need to take decisions and adapt their strategies and operations to local environments are more likely to detach their strategic activities and use expatriate entrepreneurs to manage their businesses.

3

THE ENTREPRENEUR IN THE HOST COUNTRY: HISTORICAL EVIDENCE

Expatriate entrepreneurs are well-equipped by life experience to manage effectively in culturally diverse settings, and to network internationally (Lopes et al,

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2017). In the nineteenth century many entrepreneurs were attracted to high-risk environments, such as the American frontier, gold rushes, and diamond rushes. Their lifestyle often involved significant mobility between employments as well as between countries (McCraw, 1995; Casson and Casson, 2013). Some expatriates such as Andrew Carnegie who immigrated from Scotland to the US in 1848, did not have any technical training (Livesay, 1975; Chandler, 1977). Others, were educated, with a professional background by the time they started their new businesses in foreign countries. Hans Wilsdorf, the creator of the famous (and eventually Swiss) watch Rolex, was born in Germany and moved to Geneva after loosing his parents and finishing high school. First he worked for a pearl trading company, and then for a watch exporter Cuno Korten. When he was 22, Wilsdorf moved to London first to work for a watch making company; and set up his own watch making business in 1908. During World War I he moved his business to Switzerland due to watime tax increases in Britain in levied on luxury imports. In 1920 he acquired Aegler, his wristwatch movements supplier in Switzerland, and moved the headquarters of the firm to Bienne (Jones and Atzgerger, 2013; Jones and Pitelis, 2015). All the previous experience gave Wilsdorf the technical skills to manage more risky projects and the social confidence and networks to raise funds to finance them. Notwithstanding this, in countries with large expatriate communities they could be cliquish; trust between expatriates was often mediated by peer-group monitoring through membership of ‘the club’. In some countries, in particular colonies or developing countries, the membership of elite clubs provided entrepreneurs with the possibility to network informally and also discuss business. But it was also common for entrepreneurs to create linkages between each other through interlocking directorships in their respective organizations (Ridings, 1985; Cage, 1985; Landes et al, 2010; David and Westerhuis, 2014; Cassis and Tedesca, 2017). As highlighted in Figure 11.1 above, host country expatriates could engage in international operations in three main ways. First, they could act as subsidiary managers. Such managers were often recruited from extended families, networks of friends, or through the wider expatriate community in the host country (Wilkins, 1988; Jones, 1985, 2000, 2005; Kininmonth, 2007). Second, they could operate as subcontractors, franchisees, licensees or agents. In some cases they acted as local representatives of trading companies, which were conspicuous in exports of commodities. In other cases they handled the sale of patented machinery or branded consumer products. They were not always reliable partners, however. They could copy and improve technologies used under licence, imitate or counterfeit franchised brands, and infringe agreements by exporting outside their designated market areas. While they were often selected as business partners because they were believed to be more

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‘trustworthy’ than fully local people, this advantage was relative rather than absolute (Wilkins, 1988). Third, expatriates could set up their firms, either by going solo or in partnership with others. In some cases they would travel back to their home country to raise finance before returning to the host country to invest in the business. Quite large businesses could be established in this way, including mines, ranches, commercial forests and even the railways that conveyed commodity exports to the nearest port. Expatriates also contributed to building urban infrastructure, including roads, utilities, and large-scale housing developments. Many of the larger companies established in this way were ‘free standing’; they were legally headquartered in, and financed from, the expatriate’s home country, as described in section 4. Strategy was often devolved to the host country, especially before circa 1890. They typically followed a pattern where legal and financial headquarters were in the entrepreneur’s home country and strategic headquarters in the host country (Hennart, 1986; Wilkins, 1988; Wilkins, 1998a, b; Cassis, 1992; Jones, 1993, 2000; Lopes and Simões, 2017). Table 11.1 identifies four different types of activities that commonly appear carried out by expatriate entrepreneurs in IB history. Each type of activity combines specific economic functions associated with different market opportunities. The types of activities are indicated in the columns and the opportunities identified by the expatriate entrepreneur in the rows. Each type of activity is discussed in turn. The crosses identify the cases where evidence was found, i.e. market opportunities that led expatriate entrepreneurs to be involved in specific types of activities in foreign markets. Table 11.1

Opportunity Local market

A typology of roles commonly performed by expatriate entrepreneurs in the host country Import/export

Subcontractor/associate

Franchisee of

Licensee of

merchant

producer for foreign firm

foreign firm

foreign firm

x

x

x

recognition for local production or import Local production

x

x

x

x

x

site recognition for local consumption or export Local adaptation of foreign technology Local adaptation of foreign brand

x

x

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Opportunity

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Import/export

Subcontractor/associate

Franchisee of

Licensee of

merchant

producer for foreign firm

foreign firm

foreign firm

x

x

x

x

x

x

Access to foreign risk capital Access to local risk

x

capital

The activity of the import/export merchant (column 1) is associated with the identification by the entrepreneur of local market opportunities for local production, for import, for local consumption or for export, and is often associated with access to local risk capital. An example is Joseph Nathan, a Londoner who settled in Wellington, New Zealand in 1857 and established the firm Joseph Nathan & Co. He began by importing groceries, ironmongery, from Great Britain. The fact that New Zealand was part of the British Empire facilitated the trade of goods between the two markets, with almost no barriers to entry. In the 1890s, with the development of both refrigerated ships and New Zealand farmers’ selling cooperatives, he began exporting frozen meat and butter to Britain. His business prospered, and by the 1930s the company, which had by them expanded into dried milk, detected an unexploited opportunity in nutritional foods, this marking the beginning of diversification into pharmaceuticals with the production of vitamins. This company developed into Glaxo, a major manufacturer of pharmaceuticals, which subsequently, in 2000, merged with Smith Kline Beecham to form one of the largest pharmaceutical companies in the world – MNE GSK (Davenport-Hines, 1986: 139; Davenport-Hines and Slinn, 1992: 68). An illustration of the case of associate producer (column 2) is the firm Sandeman & Co. set up in Porto, Portugal in 1814 by George Sandeman. George Sandeman was a partner of a British firm Sandeman Gooden & Foster, set up in 1790 dedicated to the import and export of wines, as well as British linens, cotton goods and other manufactured products. The business sold port wines, among other alcoholic beverages, the firm had exclusive rights to the distribution and sale for the port wine Campion, Offley and Hesketh & Co, Warre & Co., and also Thomas da Rocha Pinto in the British market, based in Portugal. Even though intermediation commissions were good, Sandeman considered that the considerable margins obtained by wine producers were very attractive. That knowledge, and also the development of new networks with farmers and other wine producers over the years, and also the increase in demand for port in the UK as the result of the Napoleonic Wars which stop imports from France, created opportunities for new port businesses to develop. In 1814 George Sandeman decided to set up his own port wine firm in Porto, independent of his London partners. The company was registered in Portugal and was completely independent from the UK business. This led to a sharp

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decline in business for the port firms Sandeman used to act as an agent for in the UK. To develop the business George Sandeman sent his nephew George Glas Sandeman to manage the newly established firm. From then onwards the British firm Sandeman, Gooden & Foster (SGF) essentially purchased, blended, aged and sold port wine which was supplied by Sandeman & Co. While acting at the main distribution channel in the UK, SGF was also central in the financing the Portuguese firm through loans (Halley, 1990; Duguid and Lopes, 1999; Lopes, 2007). A notable example of franchising (column 3) is the sewing machine company Singer, usually considered to be the first firm to use such mode of entry in different markets. In the US, Singer used a network of licensed engineers across the country, who would carry stocks of the most common components and repair the machines locally. The engineers were all self employed and paid directly by the customer, but could call themselves ‘official licensed repairers’. The engineers would buy component stock from Singer and also pay Singer a small percentage of the invoice price as a fee for being allowed to operate as authorized repairers. The business developed to the point where repair engineers also sold replacement machines. In foreign markets, Singer used franchising to enter markets that were not considered to be strategic. For instance, in 1872, Singer established a contract with Bassett & Company to develop secondary markets. Bassett handled Singer machines in Chile and Peru and appointed sub-agents in other South American countries. The contract required it to maintain ‘suitable stores’ in Valparaiso and Lima ‘ for the exclusive exhibition and sale’ of singer sewing machines, ‘to appoint and maintain agencies’ throughout Chile and Peru, to maintain an inventory adequate to serve the trade, to extend the usual terms of create and to set retail prices approved by the Singer company. Bassett had, however, to rely on its own resources to finance the marketing effort. These franchising agreements provided a mode of entry with limited risk into these markets and simultaneously formed the learning platform for subsequent foreign direct investment from 1883, when Frederick Bourne became president of the firm and exclusive sales organizations were established in the regions where the company had already expanded (Carstensen, 1984; Davies, 2012). Licensing agreements (column 4) generally require partners with more technical expertise than merchants or franchisees because they need to absorb technology in order to produce the product that they sell. An illustration is the contract set up by the Berliner Company from the US with Trevor Williams, a British solicitor, to act as exclusive sales agent and licensee in the import of records from the US, and also to produce them. To develop this business Trevor Williams set up the Gramophone Company 1898. In 1899 the company purchased the rights from Eldridge Johnson, a New Jersey engineer who had developed a spring motor that operated recordings quietly at a uniform speed,

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to manufacture sound recordings. In 1901, Johnson agreed with the British licensee that they were guaranteed at least 50 percent of Johnson’s present and future capacity. The world’s markets were divided. The Gramophone Company was to sell in Europe, the British Empire, Russia and Japan, and Johnson everywhere else. Although the company was of British origin, with capital raised in Britain, its technology and senior management were American The rationale for the choice of licensing agreements as opposed to other modes of entry was the desire to jump tariffs, the nature of the product and the market, enabling, for example, the firm to reduce the delays in bringing out new lists of locally recorded music; and transport costs (Jones, 1985). Expatriates were not, of course, the only people managing international operations in host countries. The policy of seconding headquarters staff to manage overseas subsidiaries became common in the early twentieth-century. The British cotton thread MNE J. & P. Coats was pioneering in the industry and one of the biggest MNEs before 1914, traditionally relied on agents to sell in foreign markets. From 1889, after the appointment of a new foreign sales manager Otto Ernst Philippi, the company changed its market entry strategy in foreign markets by creating ‘The Central Agency’ which aimed to control all the sales in foreign markets, except the US where alternative arrangements were in place. J. & P. Coats organization structure in international markets became very complex, with a large number of foreign subsidiaries with various degrees of ownership. Entry in foreign markets was essentially through mergers and acquisitions. That mode of entry was the most efficient in a market characterized by increased tariffs and increased competition. The combination of these factors meant that it was more effective to produce locally than to export (Wilkins, 1989; Kim 1995; Kininmonth, 2006). Throughout the twentieth century professional management and the assignment of managers to overseas posts was to become the hallmark of US FDI. The secondment of staff to subsidiaries replaced reliance on resident expatriates. In most cases, seconding staff to foreign markets proved to be effective. They had the knowledge of how to manage the company (Wilkins and Hill, 1964/2011; Wilkins, 1970, 1974, 1989, 2004).

4

THE DESIGN OF HEADQUARTERS

This study presents historical evidence on the design of headquarters. Table 11.2 presents a typology of headquarters designs based on the level of centralization versus geographic distribution of the different headquarters functions – legal, financial and strategic. The letters (A, B, C) identify the country where the headquarters is located (A represents a first source country, typically – though not necessarily – the home country; B represents another country; and C represents a third country). There are five logical possibilities that need to

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be considered for headquarters’ design strategies. Each involves a different pattern of location. The first is conventional co-location, shown as ‘Pattern 1’, where all roles are located in the same place. The next three columns indicate different forms of separation of headquarters roles: legal detachment, where the legal headquarters is moved to country B, financial detachment, and strategic detachment. The final column indicates a fully distributed headquarters where each role is performed in a different location from the other ones. Table 11.2

Five patterns of headquarters design strategy Location strategy

Headquarters

Pattern 1

Pattern 2

Pattern 3

Pattern 4

Pattern 5

Co-location

Legal

Financial

Strategic

Distributed

detachment

detachment

detachment

role Legal

A

B

A

A

A

Financial

A

A

B

A

B

Strategic

A

A

A

B

C

Note: A, B, C denote different countries for headquarters roles.

Legal Detachment An illustration of legal detachment (Pattern 2) is the Swiss MNE Nestlé just before World War II. In response to mounting international tensions, the company decided to restructure as a precaution. This restructuring stripped the headquarters of direct management of most of its established markets. Two legal headquarters were created with the aim of securing the survival of the company’s business in the Americas should a war brake out and Switzerland either entered it or was overrun. The parent company was transformed into a holding company – Anglo-Swiss Holding Company and remained based in Switzerland, the same country as the financial headquarters. Nonetheless, a second holding company – Unilac, was created by a number of Nestlé overseas associates. Unilac’s legal headquarters were in the Republic of Panama, where Nestlé had been present for many years, and remained so until 1985. When World War II became imminent it was decided that the top senior executives of Nestle would be split. The Chairman, Edouard Mullet, the Chairman, moved to Stamford, Connecticut, and devoted himself to run the overseas side of the business including North, Central and South America, and Britain (and Britain controlled the activities in Asia, including Japan). It was becoming easier to supervise some of the distant markets from the US than from Switzerland. This move switched the firm from pattern 2 to pattern 5, where all

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the headquarters role appear disintegrated. The Vice-Chairman, Carl J. Abegg, and the Managing Director, Maurice Paternot, remained in Switzerland and dealt with the continental European markets. These moves, which divided the company’s interests into two groups, each falling into the logical sphere of influence of one or other two jointly-owned holding companies, greatly simplified that task of management under exceptional war conditions (Heer, 1966; Heer, 1991; Kurosawa, 2010; Donzé and Kurosawa, 2013). Another example of legal detachment (pattern 2 again) is the case of the German pharmaceutical company Beiersdorf. In order to limit the risk of expropriation should another war break out, in 1934 it created an international ‘ring structure’. This structure placed the subsidiary in Amsterdam in the middle of a ring of foreign affiliates. As a result of this re-organization the core company in Amsterdam (which had been until then a subsidiary of Beiersdorf in Germany) became responsible for purchasing the most important raw materials and ensuring quality control, for jointly-organizing research, advertising and general administration. This central organization was financed by an annual fee to be paid by the other ring firms. In most countries, such as Switzerland, France, and the US, Beiersdorf’s affiliates held only the trademarks and sometimes plants and equipment, whereas the actual business was done by independent partner companies. The profit was divided evenly between the Beiersdorf affiliates and the partner firms in the respective markets. The parent company in Germany received a license fee based on turnover. The contact to Beiersdorf Germany was limited to the fee and the purchase of those raw materials and products that could not be manufactured abroad. As a consequence, Beiersdorf was henceforth composed of two legally separated pillars, the German business and the foreign business (Jones and Lubinski, 2012). An example of financial detachment (pattern 3) is Jardine Matheson, which was first established in 1832, in Canton (now Guangzhou) by two British expatriate entrepreneurs, and was known for its leading role in the opium trade, as well as trading tea and cotton. This firm was established in the first place to take advantage of the opportunities created by the end of the monopoly of the British East India Company on trade between Britain and China. While the main shareholders were based in the UK where it was easier and more effective to fund new investments, and also where they recruited their staff and sold their tea, the legal headquarters and strategic headquarters were both located in China. William Jardine, a British citizen, moved to Canton, where he lived as an expatriate entrepreneur until he retired in the UK in 1837. In 1841, he was elected a Member of Parliament. James Matheson also returned to the UK in the early 1840s, and also became a Member of Parliament, among other duties that he took upon his return such as serving as chairman of the Peninsular and Oriental Steam Navigation Company. In 1842 the legal headquarters moved to

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Hong Kong, which has been ceded to Britain as a result of the First Opium War and the Treaty of Nanking. The MNE still exists today as a very diversified business group with businesses spreading from retail, to real estate, financial services, shipping and aviation, and hotels, among others. In 1984, following the agreement of the British government of Margaret Thatcher to transfer sovereignty of Hong Kong to China in 1997, the legal headquarters were moved to Bermuda, with the main shareholders remaining in Hong Kong, and the top management based in the United Kingdom. Jardine & Matheson had its business in China expropriated in 1947, so this move aimed to prevent any possible risks that might arise once Hong Kong became part of China. The move of the legal headquarters was followed by a move of the financial headquarters with the primary stock exchange moving to London in 1994. Nonetheless Singapore becoming the primary trading market. The more recent changes in the location and functions of headquarters positions the firm today as reflecting pattern 5 in Table 2: the location of the legal headquarters is different from that of the financial headquarters and both are distinct from the location of the strategic headquarters (Jones, 2000; The Economist, 2015). Another illustration of financial detachment is the Precious Metals Corporation set up in South Africa in 1949 by the American entrepreneur Charles Engelhard Jr. While the main shareholders, such as Robert Flemming & Co, a London merchant bank, were based in the US and Great Britain, the legal headquarters and top management were based in South Africa. This investment resulted from an opportunity, identified by Engelhard when travelling in South Africa, to manufacture gold products for sale in the Far East where people prefer gold to paper money (Bedingfield, 1963; Jones and Benton, 2014). The main rationale for the choice of such design of headquarters very similar to that of Jardine’s over a century earlier, related to the ability to source the investment more sophisticated capital market. Strategic detachment (pattern 4) is illustrated by the free-standing firm, a type of firm identified by Wilkins (1988) which was ‘the most typical mode of British direct investment before 1914’. Other countries, also developed free standing companies but their contribution to world trade and investment during the same period was much less significant (Corley 1994; Wilkins, 1998a, b). These firms did not grow out of the domestic operations of existing enterprises as US MNEs did for the same period. In most cases they were set up by expatriate entrepreneurs who, aimed to tap into the British capital market, and established legal headquarters in the home country, but conducted all their activities in the host countries that offered attractive opportunities. Top managers and founders tended to live in the host countries until retirement, to manage the operations of free standing companies. This type of firms gave the borrowers privileged access to capital and protected the firms by British law, while tapping into overseas opportunities. The home country

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offices normally comprised a corporate secretary and the board of directors, and little else. This type of firms was particularly important in industries such as transport infrastructure, utilities, primary-sector; and urban development (hotels, offices, housing and so on). Several efficiency arguments have been provided ranging from the internalization of capital (Hennart, 1994) as borrowers had privileged access to capital. It also provided them with the ability to internalize competitive advantages associated with the market for project management skills (Casson, 1994), as manufacturing investments did not tend to take this form. An illustration is the Anglo-Persian Oil Company, set up in the United Kingdom in 1908. The venture had originated as an endeavour to find oil in Iran on the basis of a wide-ranging concession granted to William Know D’Arcy, an Australian mining entrepreneur. The venture had been struggling, and only survived after the British government – anxious to achieve a supply of oil – persuaded an existing company, Burmah Oil, to invest equity. In 1909, following the discovery of oil, the Anglo-Persian Oil Company was founded as a free-standing company. The Legal headquarters, as well as the board of directors were in London. But all the strategic decision taking and operations were based in Iran. It remained in this structure until 1914, when the British government took a majority shareholding, and subsequently transferred expropriated German owned distribution and transport companies in Britain to Angle-Persian (Jones, 1981; Ferrier, 1982). Another example of strategic detachment was Adidas, the manufacturer of sportwear. This family firm was established in 1920 for the production of sports shoes. In 1959, the son of the owner, Horst Dassler, was sent to Landersheim in France to create an Adidas subsidiary. After the death of his father Adolf Dassler, Horst Dassler became the top manager of Adidas but chose to stay mainly in France, rather than return to Germany where the headquarters were incorporated. Managing the company from France allowed Horst Dassler to strengthen the company’s position in that market. Among other strategic initiatives, he bought Arena and Le Coq Sportif during the 1970s, which he kept off the Adidas books. Throughout his life he managed Adidas operations worldwide from France, even though its legal and financial headquarters, were in Germany. While there was a governance efficiency rationale was associated with the need for the CEO of the company to be near the market where the company was aiming to invest at the time, the main reason was to separate the strategic decision taking from the majority control and opinion by the family, a reflection of the dysfunctional nature of the Dassler family (Jones, et al. 2016; Simson and Jennings, 1992: 24–25). The case of distributed headquarters (pattern 5) is illustrated by Companhia Real dos Caminhos de Ferro Portugueses, established in Portugal in 1859. It was the result of foreign investment in Portugal by a group of investors

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from France, Spain and Portugal. French institutions had the majority of the shares and control of decision taking. Even though the bylaws envisaged that the board of directors in Portugal should be the only official top management body, in practice the ‘delegation in Paris’ had the actual role of managing the business (Silva, 2014: 720). The Paris Committee was comprised of a large number of top managers, which included a chairman of the board in Paris, one executive director, an engineering consultant, and various members of staff involved in financial and cost accounting, equity and debt management. The Paris Committee approved all new contracts, issued new bonds, established new business alliances and provided loans to other companies, hired new engineering consultants and executives, and purchased new rolling stock and material, without consulting the board in Lisbon. In contrast, the formal board in Lisbon had a smaller staff and merely operational and administrative duties. Thus, while the legal headquarters were in Portugal, the strategy was set up in France, and some of the major shareholders were in Spain. This form of governance remained in place until 1884 when, as a result of negotiations with the Portuguese government for a concession for a new line, the Portuguese parliament approved an additional clause stating that Portuguese citizens should occupy the majority of seats on the board of directors. By 1887 the bylaws review had removed all powers assigned to the Paris committee and shifted managerial control to the Board in Lisbon. This led Paris to appoint a General Inspector of operations in Lisbon to oversee operations. The off-shoring of management activities in France, with the majority shareholders in Spain and the legal headquarters in Portugal, was a way to access management skills vital to railway construction and operation not available on site in Portugal (Silva, 2014). Summary From the examples provided above it is easy to see that, on the one hand, legal headquarters tend to be detached when investments take place in high-risk markets and firms need to safeguard their survival. On the other hand, financial detachment is explained by the need for entrepreneurs to internalize capital markets. Finally strategic detachment tends to take place when it improves the efficiencies in terms of flows of goods and knowledge. Firms often tend to choose markets where they can be embedded in networks and value chains that are strategic for the activities of firms. In most cases, it is efficiency considerations that dictate the particular geographic distribution of headquarter roles. However, in some circumstances that is not the case. As discussed by Cyert and March (1963), Aharoni (1966), Boddewyn (1983), Aharoni et al (2011), and Vahlne and Johanson (2014), among others, foreign investment decisions are a complicated social process. Organizational behaviour, and personal

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preferences of entrepreneurs and other behavioral variables, such as social networks, can also be alternative rationales for internationalization.

5 CONCLUSIONS This chapter has explored how historical evidence can challenge a common misperception about internalization theory. International business history provides many rich and informative examples of firms that appear to have adopted organizational forms viewed as innovative and unconventional today, but that were quite common in earlier historical eras. Entrepreneurs, in most cases, acted quite rationally at the time that they operated, aiming to maximize efficiencies such as those associated with access to more efficient capital markets and safer institutional legal systems, and the ability to take timely decisions adapted to local environments. Entrepreneurs also aimed to minimize risks and maximize the chances of growth and survival of their business. Some of these firms with unconventional organizational forms and multinational activity evolved into modern MNEs by adapting their organizational strategies and structures to changing circumstances, while other ones did not survive or were merged or acquired. The modern MNE did not develop down a linear path from a smaller and simpler version of itself. When confronted with new or unexpected imperfections in markets, the MNE does not necessarily change the mode of entry from markets (or hybrid modes such as joint ventures) to hierarchies, or from hierarchies to markets (or to any hybrid mode). Instead, the MNE can choose to keep the same mode of entry and either change the design of its headquarters by distributing all or part of the headquarters functions (legal, financial or strategic) across different markets, or can change the type and role of the entrepreneur used to provide or source local knowledge in the host country (from a local manager, to an expatriate entrepreneur or a ‘secondee’). In some cases, the MNE changes both the design of the headquarters and the type of entrepreneur sourcing local knowledge. Nineteenth-century MNEs had to address problems of slow communications and high risk. They needed to devolve power to foreign subsidiaries or affiliated firms, which could then respond to local problems in a more timely fashion, using local knowledge. For this purpose, they needed local entrepreneurs, and expatriates were considered very suitable. The flexibility of early MNEs was achieved partly by adopting what would be called today a ‘network structure’ or ‘heterarchy’, in which headquarters confined themselves to legal or financial roles, and gave subsidiaries considerable strategic autonomy. Today, as MNEs adapt to changing circumstances, they may re-invent some of the structures observed in the past.

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It looks likely that some of these apparently innovative and unconventional, but highly flexible organizational forms may re-emerge in the twenty-first century as a response to increasing and different types of risks – legal (eg. taxation), political (eg. war, terrorism, nationalism, and populism), and economic and business risks (eg. trade protectionism and weak protection of intellectual property rights), and climatic (eg. floods and tornados). While local entrepreneurship provides flexibility in the host country, it is likely that corporate headquarters will need to become more flexible too. ‘Unbundling’ or distributing headquarters activities is already quite common. It often carries negative connotations in popular discourse, e.g., the phenomena of offshore tax havens and the concentration of financial capital in ‘global cities’. However, there is a positive side to headquarters activity unbundling. Business history analysis of these risks, and more broadly, of elements of institutional quality, are critical to explaining MNE choices of entrepreneurial roles in the host country and the distribution of headquarter roles. The proposed extension to internalization theory takes into account different imperfections in markets, but considers a variety of strategic and managerial issues. It supports Verbeke and Kano’s (2015) argument that internalization theory can be enriched through ‘the infusion of a substantial business history perspective’. However, while proposed extensions tend to focus on the management of the innovation process (Rugman et al, 2011; Verbeke, 2009; Verbeke and Kano, 2012), here we propose that internalization theory need to take into account different configurations of particular entrepreneurial roles in foreign operations, and also organizational designs and distribution of headquarters’ roles. These patterns emerge clearly from deep engagement with historical evidence.

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12. The making of global business in long-run perspective 1 INTRODUCTION Records of enterprise go back as far as Rome, Greece and Babylon (Temin, 2002). But a continuous written record linking the past to the present only begins in Western Europe c.1200. From this date the role of enterprise can be clearly discerned from documents relating to commodity trade, taxes, tariffs and subsidies, licenses, property transactions, and the formation of business partnerships and merchant guilds. This evidence requires interpretation, and theories of entrepreneurship hold the key to this. This chapter applies entrepreneurship theory to interpret the history of global business since 1200 (Casson and Casson, 2013). Global business is an inter-dependent system. Every element in the system is connected, either directly or indirectly, to every other. A change in any part of the system sends ripples that spread to every corner, however remote (Samuelson, 1947). Innovations made at one location quickly spread to other locations. Disruption at one location stimulates adaptive responses, as other locations isolate the disrupted element and work around it. The global system requires coordination, but is too complex to be coordinated by a single leader (Hayek, 1949, Klein, 2014). Where there are alternative ways of doing things, markets can select the most efficient solution; promoters of rival solutions compete and customers decide between them. Where there are no alternatives, management ensures that the correct solution is applied. Firms and markets work together. Firms manage plants which transform resources into products; markets distribute the products to consumers, supply raw materials to firms, and allocate workers to jobs. Global business has emerged as the result of many inter-dependent and inter-related business decisions. Climate and natural resources frame business decision-making. Climate and resources vary considerable between locations, so that different locations favour different types of activity. Business location is a key decision in the global economy. Other key decisions relate to investment in transport and communications infrastructure. This connects different parts of the world and make possible a spatial division of labour, in which 275

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different locations specialise in carrying out different activities. Each location exports large amounts of specialised products and imports for consumption small amounts of many products, generating significant international and inter-regional trade. Other key decisions relate to the formation of institutions, such as multinational enterprises, which coordinate international operations through networks of foreign subsidiaries. These subsidiaries are linked to each other, and to their headquarters, by internal communications and by flows of semi-processed products, carried by the transport and communication infrastructure described above. International trade and investment are in turn regulated by international treaty organisations, such as the World Trade Organisation and the United Nations. Human beings play three main roles in this global system: They supply manual work by converting food into energy and then applying their skills to artisan production and factory work. They act as entrepreneurs, developing new technologies and novel products. Each new technology adds to the stock of human knowledge and raises the base level from which the next generation of technology is developed. Each new product provides users with experience which suggests further improvements to design. They act as leaders in social, political and religious life, presiding over a range of non-profit institutions, from small charities, through the nation state, to the treaty organisations mentioned above.

The focus in this chapter on the entrepreneur. Entrepreneurs sit in the middle between managers and workers below them and political and religious leaders above them. Sometimes these roles can be combined; entrepreneurs may become political leaders, while self-employed entrepreneurs may work for themselves. These roles remain distinct, however, in terms of the functions they perform, as explained below.

2

THE NATURE OF ENTREPRENEURSHIP

Entrepreneurs as Opportunity-seekers In the business studies literature entrepreneurs are typically portrayed as opportunity seekers, taking advantage of new technologies or emerging consumer trends to innovate new products or to move from small-scale craft production to mass production (Kirzner, 1973, Casson, 1982; Shane, 2000). Identifying an opportunity requires imagination. It is necessary to visualise something that does not yet exist. It could be something revolutionary, such as a railway, or ‘iron road’, as visualised in the 1820s, or the high-street chain

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store, which emerged in the 1850s once the railway network was in place (e.g. W.H.Smith in the UK, A&P in the US). It could also be something quite mundane, such as an artisan gluten-free bakery in a provincial town today. Imagination, however, needs to be tempered by pragmatism. Not every great idea is practical. Artists and other ‘creatives’ are full of imaginative ideas, but few are commercially successful because they often lack a sensible business plan. Having imagination is a necessary but not sufficient condition for successful enterprise. The same is true for pragmatism. A combination of imagination and pragmatism is necessary. But is it also sufficient to guarantee success? Success also requires good judgement. Judgment is about processing information effectively. A successful business venture needs to fulfil a demand, otherwise there will be no revenue stream. The entrepreneur must ask ‘What is the customer problem that my product solves?’, ‘Do customers realise that they have this problem?’ and ‘Are they aware that my product exists and that it solves their problem?’ In other words, the entrepreneur must diagnose the customer’s problem in order to create the demand (Godley and Casson, 2015). Demand is not the only issue; there is also supply to consider. The cost of labour and materials can be high at start-up. Novel products often need to be introduced on a small scale and priced for a luxury market. Only when technology has matured can mass production be introduced, driving costs down through economies of scale and creating a global market. Airline travel, for example, was initially a luxury product; it was only later that budget airlines used a cheaper generation of jet aircraft, no-frills service and internet booking to create a low-price mass market. Entrepreneurs as Coordinators Entrepreneurs are also coordinators. They devise mechanisms to bring supply and demand together. Coordination is usually effected through a firm; the firms acts as a nexus of contracts through which resources are procured and output sold (Casson, 2005, Foss and Klein, 2012). Workers are hired through a contract of employment in which the worker agrees to act under the direction of a manager (within limits set by law or custom) in return for a wage. The wage is fixed independently of the price for which the product sells; thus the commercial risk of weak demand and low price is borne by the entrepreneur rather than the worker. Managers too can be hired; this creates a hierarchy in which workers report to the managers and managers report to the entrepreneur. A small firm may be wholly-owned by the entrepreneur, but larger firms have independent shareholders too. If the independent shareholders between them hold a majority of shares then they effectively control the firm, provided

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they all agree; they can remove the entrepreneur from the management of the firm if they believe that his judgement is flawed. Customers, suppliers, managers, workers and shareholders all contract with the firm. In this context the entrepreneur is simply a shareholder and possibly a top manager too. The firm is a legal institution set up to generate profit from the exploitation of the opportunity identified by the entrepreneur, and possesses certain legal privileges that facilitate the performance of this role (see below). The customer does not deal directly with the worker who produced the product; they deal with the entrepreneur and his firm instead. The entrepreneur acts as a middleman, buying labour from the worker and selling the product on to the customer, thereby appropriating profit from the margin between selling price and production cost. Advertisements, shop displays, web-sites and credit-card payment all play an important role where consumer products are concerned. The entrepreneur decides the advertising medium and the message; they specify customer service (self-service, made-to-order, immediate delivery etc.); they hire the web designer and they decide how much credit to offer. The entrepreneur, therefore, takes responsibility of the choice of product, the pricing strategy, the hiring of workers and the choice of marketing methods. If his judgement is good his product sells well and his profit is high. High profit rewards the entrepreneur for his quality of judgment, and for the risk he has taken. But the risk may not be so great as others perceive, because the entrepreneur’s superior judgment may have been based on superior information. Lack of this information may have discouraged potential competitors from producing similar products. This strengthens the entrepreneur’s monopoly power and increases his profit. The more the entrepreneur’s judgement diverges from popular opinion, therefore, the weaker is the competition that he faces, the stronger his own position, and the more profitable is the business and the greater its opportunity for growth. Competition and Cooperation Competition can never be entirely eliminated, however. Innovation does not take place in a vacuum. There may be no close substitute for a new product, but there is usually some legacy product to contend with. Railways had no close substitutes for long distance travel until cars and planes arrived, but for short-distances carts, wagons and horseback all remained an option. Railways did not compete merely against other forms of transport. They also competed against other forms of leisure. Railway excursions proved popular with the working classes, diverting expenditure from local amusements such as the public house; indeed Thomas Cook’s first railway excursion was to a temperance event (Brendon, 1991).

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Innovation may also involve cooperation. Railways teamed up with hotels to accommodate passenger needs, and with local carriers to facilitate the collection and distribution of freight. Many contemporary innovations, such as the mobile phone, combine different technologies whose patents are held by different firms. Firms can cooperate and compete at the same time. Where competitors cooperate they may set up joint ventures for the purpose. A joint venture can operates as a firm within a firm. Each partner supplies the joint venture with only a subset of its knowledge and skills, reserving the remainder for competitive use. It reserves the right to buy its partner out should the venture begin to develop competitive products that could damage its overall position. Entrepreneurs are interdependent therefore; they threaten each other as competitors but they and also support each other as collaborators and in some cases they can do both at the same time. It is, therefore, a mistake to analyse entrepreneurship in purely individualistic terms. Much of the entrepreneurship literature focuses on the individual entrepreneur, discussing their personality, social background and the business they created, often using a case study method. This myopic focus often plays down the influence of other entrepreneurs. Most entrepreneurs have rivals; successful entrepreneurs have imitators whilst unsuccessful ones may be driven out of business by more efficient competitors. More to the point, entrepreneurs have collaborators; they may be business partners, but in many cases they will be suppliers or distributors. Entrepreneurs not only compete with other entrepreneurs; the rely upon them too.

3

THE ROLE OF INFRASTRUCTURE

It is easy to exaggerate the importance of entrepreneurs. Individual entrepreneurs rarely have the scientific skills needed to create inventions of their own; their innovations typically commercialise inventions made by others (Schumpeter, 1934). They rarely have sufficient wealth to fund major innovations by themselves. They often need to rely on family and friends, banks, and sometimes speculative investors too (Gompers and Lerner, 1999). Entrepreneurs therefore need support, not just from other entrepreneurs but many other kinds of people. They need to be embedded in a supporting infrastructure. This section considers the various forms that this infrastructure takes. Some of it is social but much of it is physical. In global business social interaction over distance relies on physical infrastructure. Several examples of investment in physical infrastructure are presented in later chapters; they provide a useful counterpoint to the investments in manufacturing industries which tend to dominate classic business history literature.

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Physical infrastructure is typically large, complex and durable. It ranges from docks and harbours to power stations and electricity grids (Hausman, Wilkins and Neufeld, 2007). In the short run endowments of infrastructure can be regarded as fixed. At any given time much of the infrastructure inherited from the past will have been around for so long that it is simply taken for granted, both by business managers of the time and historians of the period. But taking a long-run view of business enterprise, as in this book, it is clear that infrastructure changes. In transport, roads gives way to canals, canals to railways, and railways back to roads with the advent of the motor car. Investment in canals, railways and road improvements was complex and risky, and involved a mixture of private enterprise and state control. The making of global business is not, therefore, just the story of how global business responded to changes in infrastructure, but of how global businesses helped to change the infrastructure too. The evolution of global business involved the continuing interplay of agricultural, manufacturing and service investments on the one hand and infrastructure investments on the other. Growing demand for manufacturing and services created demand for additional infrastructure, and investment in new infrastructure stimulated the supply of manufacturing and services. Enterprise in services and manufacturing depended on enterprise in infrastructure, and vice versa. In many advanced societies much of physical infrastructure is today owned and operated by the nation states, city councils or local public bodies. Private enterprise is rarely absent, however. State and local enterprise expanded considerably 1870–1914 and again in the period 1945–70, but in many cases this involved the nationalisation of existing private enterprises. Much of the equipment used in infrastructure systems is purchased by the operators from private producers, and construction was often in the hands of private building contractors and consulting engineers too. In some cases an operator employed labour directly but in other cases labour was employed by franchisees or subcontractors who delivered customer service on behalf of the government or local community. Franchising was an important element of the ‘privatisation’ movement that gathered momentum in the 1990s. Social infrastructure encompasses law, morals, social norms and a collective sense of identity. It plays a crucial role in fostering or inhibiting entrepreneurship (Weber, 1930). Entrepreneurs can contribute to this invisible infrastructure by setting an example of social responsibility, personal achievement, and business success. But other players are important in building social infrastructure too; political and religious leaders, for example, together with artists and intellectuals. To fully account of the making of global business, therefore, it is necessary to expand the scope of study from enterprise in manufacturing to enterprise in physical infrastructure, and from physical infrastructure to the social infra-

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structure that fosters enterprise. From social infrastructure the scope of study must be extended to encompass the political and religious leaders, and the artists and intellectuals, that fashion it. This agenda is not so far-fetched as it may seem. ‘Everything depends on everything else’ in business as elsewhere, and no more so than in global business. Business histories regularly allude to political and cultural influences on business behaviour. Links between business leaders, artists and intellectuals regularly feature in accounts of late Victorian enterprise, particularly in industries like textiles that are influenced by fashion and design. These linkages need to be viewed, however, in a wider and more strategic perspective.

4

TRANSPORT, COMMUNICATIONS AND UTILITIES

Physical infrastructure comprises a set of facilities at different locations with linkages between them. Physical infrastructure enhances connectivity and increases interdependence within the global economy as a whole. Table 12.1 distinguishes four main types: transport, communications, broadcasting, and utilities. Each is examined in turn. A distinction is drawn between one-way and two-way communications, and between utilities that distribute things and those that collect unwanted things. This gives six categories altogether. To create a mass market, transport infrastructure is required. Transport allows people to send consignments of goods to each other and to pay each other visits. Investment in transport infrastructure makes it possible to distribute product from a factory to villages, towns and cities across a wide area; it also allows a factory to draw its resource inputs from a wide area (Chandler, 1965). If mass production is to be profitable then investment in transport infrastructure must be profitable too. If it cannot be made profitable then government may have to subsidise it, or even make the investment itself. Private provision of transport infrastructure therefore avoids having to raise taxes or increase public debt. On the other hand, private monopoly may restrict public access to infrastructure, while competition between private networks may lead to wasteful duplication (Bogart, 2009). Communications infrastructure is also required. A product must be advertised in order to create a mass market. In the nineteenth century popular print media provided the ideal instrument for mass-market advertising. This is one-way communication from supplier to customer. Word-of-mouth recommendation by satisfied customers is an alternative, but is too slow a mechanism to build up the level of demand required. Shops were important too; they facilitated two-way face-to-face communication. Telephone communication had a major impact on business generally and on the growth of organised commodity markets and financial markets in particular (John, 2000, 2010; Hoag, 2006;

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Table 12.1 Type

Typology of physical infrastructure Terminal facility

Other facilities

Linkage

Vehicle/user

Footpath, track, road

Person

Two-way flows Transport with two-way traffic flows Foot

House

Road

Stables, garage, parking space

Road hub, inn, cafe

Road network

Horse, cycle, car, bus, coach, van, lorry

Sea

Dock and harbour

Transhipment port

‘Sea route’, ‘shipping channel’

Ship, boat

Canal/river navigation

Canal basin

Canal hub

Canal

Canal boat

Rail and tram

Station, depot

Rail-hub, tram interchange

Railway track

Train

Air

Airport

Air-hub

‘Flight path’

Aircraft

Remote communications with two-way message flows Post (letter)

Post-box, post office

Sorting office

Transport system

Vehicles (e.g. mail-coach, mail-train, delivery van)

Telegraph (coded message)

Telegraph office

Exchange

Overhead wires

Message signal

Telephone (speech): landline

Home or office telephone, telephone box

Exchange

Landline

Message signal

Telephone (speech): mobile

Mobile phone

Exchange

Aerial, satellite, landline

Message signal

E-mail (message), skype (see and speak)

Personal computer, mobile

Server

Aerial, satellite, landline

Message signal

One-way flows Remote communication with one-way message flows from centre to periphery: publishing and broadcasting Print media (read)

Newsagent’s shop

Print works and editorial office

Delivery of publication

Newspaper, journal, directory or other publication

Radio broadcasting (listen)

Radio receiver in house, car, etc.

Studio, transmitter

Radio waves

Signal

Television broadcasting (watch and listen)

TV set

Studio, transmitter

Radio waves

Signal

The making of global business in long-run perspective

Type

Terminal facility

Other facilities

Linkage

283

Vehicle/user

Remote communication with one-way message flows from periphery to centre: consultation systems that make use of infrastructure that is also used for other purposes Voting system

Polling station

Election officer

Collection of ballot papers

Ballot paper

Telephone auction

Personal telephone

Auctioneer

Telephone system

Bid

One-way traffic flow from centre to periphery: utilities involved in generation and distribution of essential services Water

Tap, sink, wash basin, bath

Well, lake, reservoir, pumping station

Pipelines

Flow

Gas

Cooker, heater

Gas works, gasholder

Pipelines

Flow

Electricity

Household appliances, factory equipment, trains, etc.

Power station

Wires, cables, pylons

Flow

One-way traffic flow from periphery to centre: utilities involved in the collection, aggregation and disposal of surplus material Drainage and flood control

Dams, embankments

Drains, rivers, pipelines,

Flow

Sewage

Toilets

Sewage processing works

Sewers

Flow

Rubbish

Bins

Landfill sites, recycling centres, authorised local tips

Refuse collection vehicles

Rubbish items

Note: The table is organised in the following way. First, a distinction is made between one-way and two-way traffic flow. Secondly, a distinction is made between the movement of physical traffic (e.g. transport of passengers or freight) and the transmission of messages (e.g. postal or telephone traffic). Thirdly, where one-way traffic is involved a distinction is made between traffic flowing from centre to periphery and traffic flowing in the opposite direction from periphery to centre. This generates six types of infrastructure altogether. There are other dimensions along which infrastructure can be classified but they are not so relevant to this analysis. For two-way traffic involving either transport or remote communications the ‘other facilities’ listed in the third column are intermediating facilities (e.g. hubs, exchanges) because terminal facilities handle both incoming and outgoing traffic. For one-way traffic systems the ‘other facilities’ are terminals; for broadcasting, publishing and ‘generation and distribution’ they are sources of flow, while for ‘consultation’ and ‘collection and processing’ they are destinations of flow. There are few complicating factors, however (e.g. where publications are purchased from booksellers or newsagents rather than by direct subscription the booksellers and newsagents also act as hubs). Where transport and two-way communications are concerned, customers need to be connected to the specific destinations (the places to which they want to go and the people with whom they wish to communicate). Where utilities are involved, however, customers are usually indifferent about the location of the source from which their service is supplied. Punctuality is an important consideration in transport and communications, but continuity of supply is most important where utilities are concerned.

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Muller and Tworek, 2015). The growth of retailing, especially in major centres of population, allowed potential customers to inspect samples of goods at first hand, and purchase them straight away (Porter and Livesay, 1971). Since 1945 radio and TV broadcasting have transformed one-way communication, giving it a more immediate and visual aspect, while e-mail and interactive websites have expanded the range of options for two-way communication. Utilities are also important. They distribute energy and power, and other essentials such as water. They also dispose of unwanted material, notably waste and sewage. The development of utilities was crucial in allowing industry to escape dependence on local supplies of fuel (notable coal) for power and heat, allowing it to move out of congested towns into new areas powered and lit by gas and electricity. Improvements in water management, meanwhile, led to better drainage, and brought many areas of the countryside into cultivation as marshland was turned into arable fields. Water and sewage have always been controversial areas so far as private enterprise is concerned. In medieval towns the supply of water was often regarded as a civic responsibility and as a worthy object of charity. On the other hand, the removal of sewage was often entrusted to private enterprise because there was a market for ‘night soil’ as fertiliser on neighbouring farms. Despite their enthusiasm for general enthusiasm for private enterprise, Victorian town councils generally preferred municipal enterprise as a vehicle for dealing with both water and sewage. Both transport and two-way communications are often described as ‘network industries’ (Shy, 2001). This is because the linkages they employ have a network structure. Linkages radiate from hubs and hubs are linked to other hubs, so that movement between any pair of terminals typically involves transit through several hubs. The hub and spoke structure is efficient because it minimises the overall length of the connections in the network, subject to ensuring that every trip is reasonably short and more or less straight. Utilities are broadly similar to network industries, but differ in detail. They typically involve one-way rather than two-way flows, e.g. from a gas works, a power station or a reservoir to a large number of individual factories, offices, shops and households. These systems often exhibit a more restricted type of network structure, such as a ‘root and branch structure’ for water and a ‘grid’ for electricity. It is debateable whether private enterprise is the best method for constructing complex infrastructure networks. Consider railways for example. Individual entrepreneurs may build individual linkages just to connect a specific pair of towns or cities and to cater for local traffic between them. Over time these individual linkages connect up to form a network. Through traffic then develops across the network. The value of each linkage then depends upon the amount of through traffic that it carries as well as the amount of

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local traffic. To operate the network efficiently it is therefore necessary for the private operators to agree charges for through traffic (Casson, 2009). The easiest to way to sort this out is to bring all the operators under common ownership and control. However merger would create a monopoly (as happened in the US). If mergers are prohibited in order to sustain competition (as happened in the UK) then companies may divert their traffic away from rival routes, leading to inefficient routeing and high fares. Nationalisation, on the other hand, can lead to slow and bureaucratic decision-making, leading to excessive costs (as happened in France). The way these issues are resolved can impact significantly on the performance of national economies, and thereby affect the global economy too.

5

MARKETS AS INFRASTRUCTURE

Markets can also be regarded as a form of infrastructure. Markets are centres of trade, where economic activities naturally tend to agglomerate. Markets can be regarded as a match-making device in which buyers are paired up with sellers (Gusfeld and Irving, 1989). In a perfectly competitive market, as described in classic economics texts, every buyer wants the same product and every supplier offers this same product. The only thing to negotiate is therefore the price. With perfect information no one can insist on buying at a lower price than anyone else because no one will sell to them, and conversely no one can sell at a higher price than anyone else because no one will buy from them; thus everyone must sell at the same price. The buying price and selling must be equal, for otherwise a seller could gain by cutting their price in order to profit from additional sales (Marshall, 1890). Thus a uniform equilibrium price prevails. If some suppliers offer products of superior quality however, they can earn a quality premium. Furthermore, if different buyers prefer different varieties, different varieties of equal quality may command a premium over the competitive price; while no supplier has a monopoly of overall supply, they may each have a monopoly of the specific variety they offer (Krugman, 1991). Markets are not the only match-making device. Entrepreneurs may wish to match themselves to investors who are sympathetic to their product, or with wholesalers and retailers who are willing to distribute it. Introductions can be made at match-making business events, rather similar to the way that dates can be arranged between young people. Match-making is like a market in many ways: it involves making contact, and everyone wants to be paired up with someone else. But it is unlike a market in two important ways. In a perfectly competitive market any buyer can be paired with any seller and vice versa, but match-making requires a match with the perfect partner, or at least a compatible one. Secondly, it does not involve negotiations over price; because that comes later. Match-making lets people decide who to negotiate with;

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Table 12.2

Markets and other matching mechanisms

Matching mechanism

Terminal

Central facility

Traffic over linkages

Household

Urban market place,

Transport of shoppers

shopping centre, trade

to and from market.

fair

Transport of goods to and

Markets Markets for products

from shops and stalls Markets for claims

Households and

Organised exchange

Transport of brokers to

businesses

located in a city dealing

and from the exchange.

in shares, bonds,

Telephoned instructions

insurance, commodity

to buy or sell

futures etc. Online markets for

Households and

products and claims

businesses

Internet server

Messages sent as signals

Matching mechanisms Vacancies and job-seekers

Employers and

Publishers of

Postage of application

(off-line)

employees

newspapers and other

and transport to interview

media that carry job advertisements Partner-seeking (off-line)

People seeking

Organisers of

spouses, business

‘networking’ events

partners, investors etc.

where introductions

Transport to event

are made

Note: The table highlights types of markets and matching mechanisms that are specifically relevant to the theme of this chapter. There are many other variants too.

negotiations are based on more than price comparison and deals are usually long-term. Markets work best when setting prices for standardised products; match-making works best where requirements are specific and diverse, and compatibility is the major concern. Match-making complements markets, rather than substitutes for them. Table 12.2 illustrates some of the different forms that markets and matching mechanisms can take. Although markets and matching mechanisms may be classified as social infrastructure, they rely heavily on physical infrastructure too. Local markets and match-making institutions may have little need for transport and communications infrastructure, but national and international markets certainly do. Historically the expansion of markets has been key to economic and political integration. Private investment in transport and communications has played a vital role on the growth in the international entrepot in the late middle ages, in the economic integration of the US and more recently in the emergence of the European Union (Badenoch and Fickers, 2010; Lagendijk and Schot, 2007; Matterlart, 2000; Misa and Schot, 2005). Market integration through transport

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and communications has also played an important role in the development of empires too, as explained below.

6

SOCIAL INFRASTRUCTURE

Social infrastructure is intangible and largely invisible too. It can be given visible expression, however, e.g. in art and architecture. These provide symbolic expressions of the fundamental values and beliefs embedded in a culture. There is a substantial literature on this subject which is cited much in the chapters below. But there is little literature that integrates the discussion of social and physical infrastructure. Culture A shared culture aligns expectations and improves communications. It makes it easier for entrepreneurs to understand their customers, workers, investors and suppliers and for the entrepreneur themselves to be understood well. From a global business perspective, some cultures are better than others. Cultural values do not derive from economic principles so much as religious and moral ones. These principles need to be pragmatic, however. A culture that promotes the idea that markets are evil, that profit stems from exploitation and that wealth is a reward for corruption is unlikely to encourage entrepreneurial activity. On the other hand a culture that demands that people be honest, that they negotiate in good faith, and that their profits are spent on good causes is likely to have a beneficial effect. Similarly, a culture that prescribes rigid rules and dogmatic beliefs will inhibit enterprise, while a culture that encourages flexibility and curiosity will encourage it instead. Networks of Trust Trust reduces transaction costs. For the entrepreneur it reduces the risk of workers shirking and customers defaulting on payment or making false warranty claims. It also increases investor’s confidence in the integrity of the entrepreneur. The family provides a convenient environment within which to build trust; it can be a powerful resource in funding business. Historically, marrying into a wealthy family has been an important way of raising business capital; introducing your brother or sister to a potential spouse in a wealthy family can prove successful too. Friendship networks also build trust. These can be fostered by the local neighbourhood, schooling, religion, political affiliation, and membership of special interest groups. Networks can also work negatively, though, as when people get drawn into criminal gangs. Building the right sort of network is

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therefore key for an entrepreneur. Breaking into exclusive social networks is particular useful because that is where financial support and inside information can be obtained. Reputation Reputation is also important. Reputation makes it easier for an entrepreneur to raise finance from outside the family; reputation for product quality makes it is easier to attract and retain customers, while reputation as a good employer makes it easier to attract and retain skilled workers. Reputation also works the other way round; by investigating other people’s reputations the entrepreneur can avoid extending credit to heavily-indebted customers, avoid seeking loans from banks that quickly foreclose, and avoid hiring lazy workers. The personal aspect of reputation is very important where entrepreneurs are concerned; professional accreditation is mainly relevant to the people they employ. Personal reputation, however, dies with the individual. Historically, business reputation was often inherited, with an eldest son continuing the business under the father’s name. Beginning in the nineteenth century, reputations became embodied in brands. The brand attached to the product rather than the individual; as a virtual entity it never died and could be bought and sold between businesses (Lopes and Casson, 2007). The virtual nature of the brand made it easy to steal, however. It could be counterfeited, or simply imitated in such a way as to create confusion. The obvious solution was legal enforcement of trademarks. Once brands and trademarks could be registered under international agreements, the way was open for the development of global brands. Legal innovations backed by standardised protocols and enforced through international treaties were therefore a major step in strengthening product reputation in international business. The brand is not the only kind of reputation possessed by a business, however. A diversified or ‘conglomerate’ firm may produce several different products, each with its own brand name, but still enjoy a corporate reputation under a different name, e.g. the consumer products conglomerate Unilever or the drinks conglomerate Diageo. A good business reputation may enhance the share price, thereby making it easier for the business to raise capital; it may also enhance its ability to negotiate with governments over taxes or regulations. Law Reputation does not address every problem, as the Global Banking Crisis demonstrated when several highly reputable banks failed. Some industries need to be highly regulated; banks are entrusted with people’s savings, pharmaceutical firms with people’s health, and rail and bus operators with people’s

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lives. Social norms and social sanctions alone cannot address the most critical issues: law and regulation are required. But over-regulation can discourage enterprise. The law itself requires a reputation for efficiency and impartiality. Some of the laws and regulations directly relevant to entrepreneurship are summarised in Table 12.3. Self-governing Associations A self-governing association – often referred to simply as an ‘institution’ – is a group of people who agree to conform to certain standards and to be disciplined by other members of the association if they fail to comply. A classic example is the democratic state. The firm is also an institution. It is a relatively late development. Early states were reluctant to authorise individuals to associate for fear of them plotting against them. Religious institutions were the earliest institutions authorised by Western European rulers c.600. These were largely self-governing institutions, having an elected senior officer and accountability to the Pope. Universities and colleges followed c.1200 (Catto, 1984). At that time association for businesses purposes was generally effected through partnerships, with training provided through apprenticeships. Guilds developed for social and charitable purposes, but from 1300 onwards began to play an important role in organising artisan production and trade. It was not until the 1850s, however, that the modern form of limited liability joint stock company (or corporation) emerged (other than those chartered specifically by the state). The emergence of the firm was an important step in widening the scope of entrepreneurship as it allowed larger amounts of funding to be mobilised, it facilitated delegation of management, and it allowed a business to survive automatically beyond the founder’s death.

7

APPLICATIONS TO GLOBAL BUSINESS

Global business is important because it produces useful products on a global scale. Popular fascination with multinational enterprises and their battles for global market share should not obscure the economic fundamentals: global business, like any business, transforms resources into products – it just does so on a larger scale and with wider reach. Resources are scarce, so they need to be used economically: to produce the right mix of products in the most efficient way. These products should be sold to those who value them most (although in practice this often means those who can most afford to pay). Transforming resources into products requires technology. Until quite recently, however, economists used to assume that most technologies were free; if someone understood a technology then anyone could understand it, and no one could stop anyone else from using it. Although patents had existed

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Table 12.3

Norms, standards and their enforcement

Type

Examples

Enforcement agency

Full and accurate measure

Standard pint of beer, size of loaf

Legal system, trade or

Assured standard of quality

Heathy and safe to use Performance

Legal system, trade or

under reasonable conditions conforms to

professional association

Product standards professional association

specification/ expectations Interchangeable/compatible with other products as required Standards of behaviour Towards other people:

No violence or insults; show care and

Law, morals, religion

consideration Towards other people’s

No infringement of their rights, e.g. theft,

property

fraud

Law, morals, religion

Towards society in general:

Avoid vandalism/undermining collective

Social norms supported

anti-social behaviour,

effort e.g. through laziness /damaging

through law, morals and

collective reputation e.g. inappropriate

religion

behaviour Norms promoting low-cost transactions Negotiate quickly using agreed

The only threat when negotiating a contract

Social norms within

protocol

should be to switch to a competitor

a trade or profession

Delivering products and

No deception

Law, morals, religion

No default or use of counterfeit currency

Law, morals, religion

services according to specification Pay punctually for products and services as agreed

for centuries, they were deemed expensive to obtain and difficult to enforce, Matters improved as a result of international patent agreements in the 1880s. By the 1930s international patent pools were quite common and often gave rise to international cartels. But it was not until the post-war expansion of US multinationals that the importance of proprietary technology became clear. US firms producing in Europe were demonstrably more efficient that their local rivals because of their access to proprietary technology developed in the US (and the use of superior management methods too) (Dunning, 1958). Social infrastructure has played an important role in encouraging the discovery of new knowledge and its commercial exploitation. Many of the earliest institutions in Western Europe were, in fact, knowledge-based institutions, and some of the earliest forms of international association were associations for purposes of research. For further details see the chronology in Table 12.4.

The making of global business in long-run perspective

Table 12.4

291

Institutions for knowledge discovery

Type

Dating for

Role

Western Europe Community of scholars:

600-1500

religious

Monasteries and nunneries of various orders within the catholic church. Re-discovery and translation of classical texts in history and philosophy

Community of scholars:

1200-1950

secular Royal administration and

Colleges and universities. Development of law, medicine, philosophy, theology, history; natural sciences from 1800

1200-

civil service

Development of judicial systems, financial accounting, devolved regional administration. Personal taxation from 1800

Modern university

1950-2000

Basic research funded by government. Emphasis on natural science, technology and social science. Teaching of undergraduates by active researchers

Government research centres

1800-

Applied research in defence industries, agriculture, medicine, etc.

Corporate R&D laboratories

1900-

Applied research biased to patentable technologies, consumer durables, cosmetics, etc.

Political and social

1930-

think-tanks and lobby groups Post-modern university

Identification of ideas that can be applied to government policy, political party manifestos, etc.

2000-

Mass higher education. Separation of teaching and research. External sponsorship of research

One of the major differences between global business and local business is in the type of knowledge used. It could be said, rather tritely, that global business utilises global knowledge and local business utilises local knowledge. This is partly true, but not entirely so. Global business certainly exploits global knowledge but it requires local knowledge too. This is because products have to be marketed in many different localities, and at each location local knowledge is required. Products also have to be produced somewhere, and wherever this is, some local knowledge is again required. A similar point can be made about local businesses. Local businesses certainly exploit local knowledge, but they can play a role in exploiting global knowledge too. Many local businesses handle global products, e.g. as retailers, or as subcontractors undertaking local production. A firm that controls a global technology but lacks local knowledge can, if desired, rely on local distributors to sell its products and on local subcontractors to produce them. Indeed, it could license its technology to a local firm that both produced and marketed the product.

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Global business

The major difference between a global firm and a local firm, therefore, is that a global firm typically owns a proprietary technology which it chooses to exploit itself, with minimal reliance on local partners, whereas a typical local firm does not own global knowledge, but may assist a firm that does by acting as their retailer, subcontractor or licensee. This analysis applies to both manufacturing firms and to infrastructure suppliers, but the implications are rather different in the two cases. Knowledge of local conditions is crucial in infrastructure projects. Relevant conditions vary from location to location, and country to country, so that no two infrastructure projects are the same. They may depend on the same technology, but the technology always needs to be adapted to local conditions – possibly in an imaginative way. Infrastructure investment is often undertaken as a one-off project, in contrast to continuous production which is common in manufacturing industry. The end of one project does not normally dove-tail with the start of another project in the same locality. Thus continuous flow mass-production is not an option in infrastructure-building industries. The combination of one-off projects and intense demand for local knowledge encourages the use of local partners, who may be well-established local firms. It favours a consortium approach to project management whereby the owner of the proprietary technology acts as major shareholder, lead contractor and overall coordinator but local partners also take an equity stake.

8

INVISIBLE INFRASTRUCTURE AND THE GENERATION OF GLOBAL KNOWLEDGE

The history of the evolution of global business clearly shows that at various times specific countries have dominated global business, in that many of the leading firms in the global economy were headquartered in that country. In the seventeenth century the Dutch were dominant, in the nineteenth the British and in the twentieth the US. Two millennia earlier it was the Romans. Dominance in global business is closely associated, it seems, with imperial power. There are two main ways of interpreting this. One is to say that military power, and especially naval power, leads to control of trade, and that control of trade then leads to global business dominance. The other is to say that access to advanced technology is the key. On this view an empire is simply an exercise in the exploitation of technological superiority. It is this superiority that underpins both military and commercial supremacy. since both business and warfare are knowledge-based activities (Casson, Dark and Gulamhussen, 2009). The logic of empire, according to this view, is that knowledge is a public good and can therefore be shared, and that technology in particular is based on laws of nature that work across the globe. Knowledge exploitation therefore

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has potential global reach. Transport and communications infrastructure can help to exploit this global reach. But some sort of mechanism is required to exploit superior knowledge. Empire is an eminently suitable mechanism because knowledge can also be used to exercise military power. But how is knowledge supremacy achieved? One answer is that it reflects the superior quality of social infrastructure. Anyone can, in principle access knowledge, since knowledge can in principle, be shared. The fact that one person, or indeed one country, knows something, does not prevent other people, or other countries from knowing it too; in economic jargon, knowledge is a ‘public good’ (Mueller, 1979). Superiority of institutions could explain why at certain times certain countries and their peoples have made better use of the knowledge available than have others. Empire, on this view, is just the visible manifestation of an invisible advantage, namely superior knowledge acquired, not necessarily by superior intellect, but by superior institutions that seek out and apply knowledge that is available to all. One objection to this line of reasoning is that some countries appear to have achieved intellectual leadership without becoming an imperial power. China in the fifteenth century is often cited in this respect, and the same could perhaps be said of Spain and Portugal in the sixteenth century (Jones, 1981). The answer to this question may lie in the level of investment in physical infrastructure, and the type of infrastructure built. Imperial countries are noted for their commitment to building physical infrastructure, often as an expression of their confidence and status. But some imperialists have also built infrastructure for strictly economic purposes and others have not (Winseck and Pike, 2007). For an imperial nation that has already developed a wide range of domestic commodity markets there is ample profit for entrepreneurs in developing commodity trade, e.g. the Dutch in spices. This expanding trade generates a demand for additional infrastructure, which can be paid for out of the profits of trade. Private demand encourages private enterprise in the provision of infrastructure. Private enterprise is particularly useful when government intervention would encounter obstacles to taxation, such as high administrative costs of tax collection or public ill-will. Trading nations are therefore more likely to invest in transport and communications infrastructure than non-trading ones (Innis, 1950). The negative Chinese attitude to foreign trade, possibly stemming from Confucian values, may therefore have inhibited international expansion. Chinese politicians concentrated on the defence of land borders (the Great Wall) rather than exploitation of the seaboard with the South China sea and the Indian and Pacific oceans. For a manufacturing nation access to foreign raw materials is a key consideration, e.g. cotton in the UK and oil in the US. Britain followed the Dutch in becoming a long-distance trading nation, but its trade really took off with

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the Industrial Revolution. Early British railways were promoted with international trade and travel in mind. After 1830 trunk lines were quickly built from London to Liverpool, Bristol, Southampton and Dover, and harbour improvements were also made. The Newcastle & Carlisle Railway was built as a ‘land bridge’ between the North Sea and the Baltic to the east and Ireland and the Atlantic to the west. ‘Free standing companies’ invested in port cities and harbours around the world, focusing not only on settler economies (e.g. Australia) but on anywhere where sources of raw materials could be found (e.g. Latin America, South Africa) (Wilkins and Schroter, 1998). The other side of the coin concerns the type of product exported by the imperial power. The Dutch were mainly producers of artisan products, while the British exported factory products instead. Export demand not only encouraged British domestic expansion but also promoted ‘learning by doing’ through which technological progress in manufacturing was sustained. This strategy of importing low-knowledge content products and exporting high knowledge-content products was further refined by the US. From the 1890s the US began to embody its superior knowledge, not only in products produced for export in its own country but in products produced abroad for foreign markets too (Godley, 2006). This process gained momentum in the 1950s. The US transferred its technology to foreign countries but retained control of it through foreign direct investment. This allowed it to combine its superior technology, not only with its own domestic resources, but with foreign resources too.

9 CONCLUSION This chapter has attempted to synthesise some of the insights that can be gained from later chapters in this book. It has concentrated on general themes rather than specific points in individual chapters. These themes have been woven together using the concept of entrepreneurship. Entrepreneurship has been examined in the context of the global business system, which has been viewed as an interdependent knowledge-based system in which infrastructure has a crucial role. This systems view has revealed that the making of global business represents more than just the sum of the separate contributions of individual entrepreneurs. Global business was made by the global business system which coordinated individual enterprise so that it became more than the sum of its parts. While it is quite appropriate for global business history to focus on individual entrepreneurs – their lives ambitions, successes and failures – a full understanding of the subject can only be obtained by considering the contexts in which these people operated. Part of this context is provided by other entrepreneurs. More attention needs to be given to interactions between entrepreneurs. These involve both competition and co-operation.

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Competition has been of two main kinds. Firstly, entrepreneurs competed to discover opportunities and to be the first to exploit them; in other words, they competed to identify and fill ‘gaps in the market’ which others overlooked. Secondly, entrepreneurs entered markets already created by other entrepreneurs, to offer a new variety of an existing product or an identical product at a lower price; this was conventional market competition. Business history provides overwhelming evidence that this second ‘static’ form of competition is by no means the most important form of competition, as conventional economics would suggest, and that the first more ‘dynamic’ form of competition is key. Entrepreneurs collaborated too. This collaboration was not necessarily the product of business partnerships between them; often it was collaboration coordinated impersonally by the market system. Many entrepreneurs invested, not in meeting the needs of consumers, but in meeting the needs of other entrepreneurs. For example, they responded to profit incentives by building infrastructure to meet the needs of expanding businesses in the manufacturing sector. These projects were undertaken both at home and abroad with the aim of improving international transport and communications. These entrepreneurs undertook large risky knowledge-intensive projects, often in hostile environments; their achievements often remain today, in stone and iron but they have left no household brand name by which they can be remembered. They are often more celebrated amongst engineers, or seamen, than they are amongst business historians, although fortunately many of them get a mention in this book. More generally, this chapter has highlighted the crucial role of infrastructure investment in promoting long-term economic growth. Investments in infrastructure increased global connectivity and stimulated global trade. They also fostered knowledge transfer and thereby promoted foreign direct investment and multinational enterprise. The making of global business has lasted for more than eight hundred years. Many things have changed, but throughout this period entrepreneurship and investment in infrastructure have always played a crucial role.

REFERENCES Badenoch, A. and A. Fickers (eds.), Materializing Europe. Transnational Infrastructures and the Project of Europe (2010) Bogart, D. (2009) Nationalisations and the development of transport systems : Cross-country evidence from railroad networks, 1869–1912, Journal of Economic History, 69 (1), 202–237 Brendon, P. (1991) Thomas Cook: 150 Years of Popular Tourism, London: Secker & Warburg

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Casson, C. and M. Casson (2013) The Entrepreneur in History: From Medieval Merchant to Modern Business Leader, Basingstoke: Palgrave Macmillan Casson, M. (1982) The Entrepreneur: An Economic Theory, Oxford: Martin Robertson, New ed. 2003, Edward Elgar Casson, M. (2005) Entrepreneurship and the theory of the firm, Journal of Economic Behaviour and Organization, 58, 327–348 Casson, M. (2009) The World’s First Railway System, Oxford: Oxford University Press Casson, M., Dark, K., and M. A. Gulamhussen (2009) Extending internalizaton theory: From the multinational enterprise to the knowledge-based empire, International Business Review, 18, 236–256 Casson, M. (2015) ‘Doctor, doctor …’ Entrepreneurial diagnosis and market-making, Journal of Institutional Economics, 11(3), 601–21 Catto, J. I. (1984) History of the University of Oxford, Vol.I: The Early Schools, Oxford: Oxford University Press Chandler, A. D., Jr. (1965) The Railroads: The Nation’s First Big Business, New York: Harcourt Brace Dunning, J. H. (1958) American Investment in British Manufacturing Industry, London: Allen Unwin Foss, N. J. and P. G. Klein (2012) Organizing Entrepreneurial Judgement: A New Approach to the Firm, Cambridge: Cambridge University Press Godley, A. C. (2006) Selling the sewing machine around the world: Singer’s international marketing strategies, 1850–1920, Enterprise and Society, 7(2), 266–314 Gompers, P. A. and J. Lerner (1999) The Venture Capital Cycle, Cambridge, MA: MIT Press Gusfeld, D. and R.W. Irving (1989) The Stable Marriage Problem: Structures and Algorithms, Cambridge, MA: MIT Press Hausman, W. J., P. Hertner and M. Wilkins (2008) Global Electrification: Multinational Enterprises and International Finance in the History of Light and Power, Cambridge: Cambridge University Press Hayek, F. A. von (1949) Individualism and Economic Order, London: Routledge & Kegan Paul Hoag, C. (2006), ‘The Atlantic Telegraph Cable and Capital Market Information Flows’, Journal of Economic History, 66 (2), 342–53. Innis, H. A. (1950), Empire and Communication (Oxford: Clarendon Press). John, R. R. (2000), ‘Recasting the Information Infrastructure for the Industrial Age’, in A. D. Chandler, Jr., and J. Cortada (eds.), A Nation Transformed by Information: How Information Has Shaped the United States from Colonial Times to the Present, New York: Oxford University Press, 55–105. John, R. R. (2010) Network Nation: Inventing American Telecommunications (Cambridge, MA: Belknap Press of Harvard University Press). Jones, E. L. (1981) The European Miracle, Cambridge: Cambridge University Press Lagendijk, V. and J. Schot (2007) Technocratic Internationalism in the Interwar Years: Building Europe on Motorways and Electricity Networks, Journal of Modern European History, 6, 196–216 Kirzner, I.M. (1973) Competition and Entrepreneurship, Chicago: University of Chicago Press Klein, D. B. (2014) Knowledge and Coordination: A Liberal Interpretation, New York: Oxford University Press Krugman, P. R.(1991) Geography and Trade, Cambridge, MA: MIT Press

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Lopes, T. da Silva and M. Casson (2007) Entrepreneurship and the development of global brands, Business History Review, 81 (4) 651–680 Marshall, A. (1890) Principles of Economics, Volume I, London: Macmillan Matterlart, A. (2000), Networking the World, 1794–2000, Minneapolis: University of Minnesota Press Misa, T. J. and J. Schot 2005) Inventing Europe: Technology and the hidden integration of Europe, History and Technology 21(1), 1–22 Mueller, D. C. (1979) Public Choice, Cambridge: Cambridge University Press Müller, S. M., and H. Tworek (2015), The telegraph and the bank: On the interdependence of global communications and capitalism, 1866–1914’, Journal of Global History, 10 (2), 259–283 Porter, G. and H. C. Livesay (1971) Merchants and Manufacturers: Studies in the Changing Structure of Nineteenth-century Marketing, Baltimore, MD: Johns Hopkins University Press Schumpeter, J. A. (1934) The Theory of Economic Development (trans. Redvers Opie), Cambridge, MA: Harvard University Press Shane, S. (2003) A General Theory of Entrepreneurship: The Individual-Opportunity Nexus, Cheltenham: Edward Elgar Shy, O. (2001) The Economics of Network Industries, Cambridge: Cambridge University Press Temin, P. (2002) Price behaviour in ancient Babylon, Explorations in Economic History, 39(1), 46–60 Wilkins, M. and H. G. Schroter (eds.) (1998) The Free-standing Company in the World Economy, Oxford: Oxford University Press Winseck, D. R., and R. M. Pike (2007), Communication and Empire: Media, Markets, and Globalization, 1860–1930, Durham: Duke University Press

13. The role of time in international business: an historical perspective With Teresa da Silva Lopes 1

INTRODUCTION: THE IMPORTANCE OF TIME

The chapter examines the evolution of the multinational enterprise (MNE) and its organisational structure in the very long run. It lays the foundation for a more dynamic theory of international business (IB). It identifies causal factors in the environment that have driven change, and shows how the interactions between them have transformed the typical MNE from a modest family-based enterprise to the modern corporation of today. It engages with a gap in existing literature which tends to focus on static theories, where the concept of time is absent. To achieve this objective, it is necessary to extend the traditional domain of IB research, in particular internalisation theory (Buckley and Casson, 1976; Verbeke, 2013), by developing more dynamic theories. IB needs to address explicitly the long-run forces that change the environment of global business. For this purpose, a greater appreciation of the significance of time is required. This chapter therefore presents a novel perspective on IB in which time plays a central role. This temporal perspective reveals how deeply the evolution of IB is embedded in long-term social, economic and technological change. The natural way to study long-run change over time is through history. History provides a chronology of events, based mainly on written records, that is organised by date and time. It identifies key events, provides biographies of the politicians and business leaders connected with them, and examines the geographies of the places where these events occurred. It provides an evidence base by which ‘big questions’ can be addressed (Finlay, 1985). The relevance of history to IB studies has been convincingly demonstrated by Buckley (2016), Jones and Khanna (2006) and Morck and Yeung (2007). Historical evidence needs to be interpreted, however. It requires imagination and critical judgement to reconstruct the distant past (Scranton and Fridenson, 2013). Historians normally use an inductive approach, in which reflection on the evidence suggests a theoretical explanation. We use causal analysis based 298

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on a model which involves a set of assumptions. The resulting theory is usually contingent on both time and locality. Economists, on the other hand, normally use a deductive approach, in which the theory is deduced from a parsimonious set of assumptions. The resulting theory comprises one or more hypotheses; these hypotheses are claimed to have universal validity, and to apply across time and over space (Hicks, 1969). IB has attempted to follow a middle road, and this has caused some confusion. Early historians of IB viewed the theory of the MNE as a theory of foreign direct investment (FDI) by large US corporations in the early post-war period (Chandler, 1994; Vernon, 1970). Previous foreign investments in colonial enterprises, it was thought, required a different type of theory (Burroughs and Stockwell, 1998). Some IB scholars subsequently suggested that that yet another theory was required to explain later investments by emerging market MNEs (Williamson, 2013). Economists, on the other hand, have always understood the theory of the MNE to be a special type of economic theory which, though different from neoclassical theory, still possesses universal validity. They define an MNE simply as a multi-plant business that spans an international border. In practical terms it must, at the very least, involve a partnership between two or more people based in different countries who actively collaborate in a long-term venture. The people involved could be employees of the same company or simply relatives engaged in a mercantile family business. From this perspective, post-war US FDI, colonial investments and emerging market MNEs are just special cases of the same theory (Casson, 2018). IB theory has focused mainly on the individual firm, and has usually taken the environment of the firm as given (Buckley and Casson, 2019). The passage of time, however, affects not only individual firms, but the entire global economy. To fully engage with time, therefore, IB theory needs to become more general, moving from an exclusive focus on the firm to a broader focus that encompasses the evolution of the global economy as a whole. This ambitious approach needs a structure. The aim of this chapter is to set out a structure that extends IB theory beyond the firm and focuses instead the global economy as a whole, and to fill in key details from historical sources. This structure is presented using a schematic model which extends the scope of IB theory from the individual firm to the global economy, and from short-term analysis of the growth of individual firms to long-term analysis of the growth of the global market economy as a whole. The basic proposition is that the development of MNEs is influenced, not only by local factors relevant to specific industries, but by general features of the business environment as a whole. Some aspects of this environment change over time and others do not. For example, culture, institutions and scientific knowledge evolve over time but, with certain qualifications, the physical

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geography of the Earth does not. Changes in the business environment have influenced the growth of the entire global economy, and not just growth of MNEs. A full understanding of the growth of MNEs must therefore relate their growth to wider trends in the global economy. This chapter demonstrates that a full appreciation of the significance of time is crucial in contextualising the MNE within this wider perspective. The chapter highlights the ‘five Cs’ of historical perspective: causality, change, complexity, context and contingency. It emphasises that a causal analysis of long-term change in a complex system – namely the global economy – requires historical context, which in turn demonstrates the role of contingency in the evolution of the IB system (Perchard et al., 2017). Placing IB studies in a temporal context provides politicians and business leaders with a ‘bigger picture’ that relates the present to the past. Business leaders are often too preoccupied with novelty to pay attention to the past, and politicians’ views of history are often distorted by their ideology. A theory of IB that is firmly grounded in historical scholarship will enhance their quality of judgement, leading to wiser decisions and better results. The remainder of the chapter is structured as follows. Section 2 discusses methodological issues. Section 3 sets out the relevant theory. It presents a schematic model that extends conventional IB theory by embedding internalisation theory in a wider and explicitly temporal perspective. This model identifies two main factors driving the evolution of global business, referred to, in short, as ‘culture and institutions’ and ‘scientific knowledge’. The impact of these drivers has been framed by geographical fundamentals that, until recently, have changed little over time. Sections 4–6 summarise the historical evidence on these factors. Section 7 applies the theory set out in section 3 to the evidence presented in sections 4–6. It identifies seven significant long-run trends created by the interaction between business activities and the global environment. These are: (1) the commercialisation of art and science; (2) a transition from learning-by-doing to learning from experiment and theory; (3) improvements in transport and communications that have speeded up production and decision-making; (4) the differentiation of products by design and novelty, and their promotion through mass advertising; (5) the evolution of new management structures and organisational designs; (6) the adoption of new ways of working, such as distributed teamwork; and (7) the emergence of new and diverse forms of IB activity. Section 8 examines the relationship between these trends, and considers their overall impact on economic growth and prosperity. Section 9 revisits the methodological issues raised in section 2, and section 10 concludes with implications for future research.

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METHODOLOGICAL ISSUES

Several methodological issues need to be addressed. These issues are related to time rather than to history, although the two are closely linked (Latour, 1993). Some of them can be resolved at the outset. Others can only be resolved through investigation, and the answers to them are therefore postponed until later. Questions to be Answered at the Outset 1. ‘What is the nature of time: is it a social construct or a physical reality?’ Ever since Einstein, the notion of absolute time has been questioned. According to Einstein, time is real but also relative. Time also has subjective aspects. Industrialisation raised awareness of time (for example, clocking on at the factory) and faster travel led to the standardisation of time over space (Karsten, 2013; Tann, 1973). Perceptions of time affect memories, and so can influence the interpretation of past events (Bucheli and Wadhwani, 2014). This chapter uses the calendar concept of time. It relies on documentary evidence, all of which is dated using the Julian and Gregorian calendars, initialised at the putative date of the birth of Christ (Nothaft, 2018). Some documents refer only to regnal years, which are converted into calendar years using royal records. Time is now measured with greater precision than before, but this does not affect the dating of historical records, which refer to the day of the week rather than the time of day (Whitrow, 1988). 2. ‘How long is the long run?’ According to the economist Alfred Marshall (1890), the long run is long enough for new firms to enter an industry in response to an increase in demand. In innovation studies the long run may be a century or more (Baumol et al., 2010). From an historical perspective the long run is very long indeed, and is limited only by the availability of records. Western Europe has the best business records, and these go back almost continuously to the early thirteenth century. IB activity is recorded quite soon after these records began. Medieval town guilds established companies of merchant venturers trading with foreign countries in the fourteenth century. Other companies were formed on royal initiative, for example, William de la Pole established a trading company in Kingston-on-Hull, England, in 1339 which employed agents in the Low Countries to sell exported wool (Fryde, 1988). The early thirteenth century is therefore a useful time at which to commence a study. While it is possible to push the date back even further, to early civilisations in the Middle East, China, Greece, Rome and Byzantium (Lewis and Moore,

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1999), business records are only spasmodic, and no continuous narrative is available (Temin, 2002, 2013). 3. ‘Are there long run trends, and if so how are they related?’ The proposed period of study spans over 800 years, from 1200 to 2020, and is long enough to reveal significant trends. However, trends can sometimes be masked by superimposed cycles. Economists such as Kondratieff (1984) and Schumpeter (1939) postulated ‘long waves’ of 50–60 years, interspersed by shorter cycles, such as trade cycles of 10–15 years duration. However, a period of 800 years is long enough to filter out the influence of such cycles. There may also be structural breaks (Lopes et al., 2019b). Many historians have asserted a break circa 1500, marking a transition from the medieval to the early modern period. This break may be linked to the Reformation, which reduced the influence of the church over business activity (Weber, 1930). This structural break is recognised in the analysis below. Questions to be Answered Later 1. ‘Is change progressive?’ The main reason to affirm progress is that knowledge accumulates. The more sophisticated technology becomes, the higher is labour productivity (OECD, 1998). There are qualifications, however. New knowledge may be monopolised rather than shared, so that its value to society is reduced. It may fail to be transmitted from one generation to another if social institutions break down. The natural resources required to utilise new knowledge may become exhausted. Finally, knowledge may be deployed exclusively in negative-sum games, such as conflict and war (Harrison, 1998). 2. ‘Is there an “arrow of time” that points in one direction only?’ In neoclassical economics the arrow of time almost invariably points towards a long-run equilibrium (Marshall, 1890; Samuelson, 1947). In statistical thermodynamics, on the other hand, systems move towards a state of maximum entropy (Swendsen, 2017). These two ideas seem diametrically opposed; a market equilibrium represents an efficient and orderly arrangement, whereas maximum entropy involves chaos, randomness and disorder. Can these ideas be reconciled, and if so, how? 3. ‘Is change evolutionary or revolutionary?’ Historians have identified a series of ‘revolutions’ through which advances in knowledge are said to have progressed. In a European context, these include the Urban Revolution of the thirteenth century, the Age of Discovery in the fourteenth and fifteenth centuries, the Astronomical Revolution of the sixteenth century, the Agricultural Revolution of the early eighteenth century, the Industrial Revolution of the late eighteenth century, the

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Railway Revolution of the nineteenth century, the Chemical and Electrical Revolutions of the twentieth century and the Digital Revolution of the twenty-first century (Casson and Casson, 2016). Most, though not all, of these revolutions have been associated with commercial innovations of one form or another. An opposing view is that the stock of knowledge evolved spontaneously and incrementally through learning-by-doing, and was spread through social emulation rather than commercialisation (Nelson and Winter, 1982). The question arises as to whether these apparently conflicting views are compatible. 4. ‘Does history repeat itself?’ This is a key issue for policy-makers. If history repeats itself then it is possible to ‘learn from the past’, whereas if it does not then the past is simply a ‘foreign country’ which there is no need to visit. Three main answers have been proposed. The first asserts that every situation is unique, so that ‘we never step into the same river twice’ (Wheelwright, 1959). The opposite view is that history can, and does, repeat itself (Sprigge, 1999). For example, some lessons are never learned, or are lost in transmission from one generation to another, so that each generation is doomed to repeat the errors of the past. The third view represents a compromise, namely that history repeats itself but never exactly (Trompf, 1979). In this case, judgements can be based on historical precedents, but only with care. The ‘devil is in the detail’, and the detail changes over time. The evidence reviewed below clearly identifies the most plausible approach where IB is concerned.

3 THEORY This section summarises the analytical framework used in the chapter. It presents a simple causal model, which is illustrated schematically in Figure 13.1. The model is designed specifically so that its validity can be assessed using available historical evidence. This model extends conventional IB theory by embedding internalisation theory (Buckley and Casson, 1976; Verbeke, 2013) in a wider and explicitly temporal perspective. This perspective identifies key forces of change – in particular ‘culture and institutions’ and ‘scientific knowledge’ – and the inertia that these forces have overcome. ‘Culture and institutions’ (illustrated by the box at the top of the Figure 13.1) frame economic activity in the global economy. Differences in culture and institutions make some countries more entrepreneurial than others. In medieval times, for example, the forces of market competition were moderated by social and religious constraints which have since dissolved as a result of cultural change. By medieval standards modern business opportunities are limitless in scope and in the potential earnings accruing to those who exploit

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them. A full understanding of modern IB requires a detailed analysis of why these changes occurred and when and where they began.

Note: The figure imposes a strict pattern of causation, in which each factor impacts on another without being impacted by that factor itself. In practice many impacts are two-way, creating feedback loops. These are omitted to simplify the diagram. The investigation of feedback is a subject for future research.

Figure 13.1

Schematic diagram illustrating the impact of the growth of scientific knowledge and the evolution of culture and institutions on the growth of international business and the impact of this growth on population and urbanisation

Culture and institutions both influence the stock of scientific knowledge (illustrated in Figure 13.1). The stock of knowledge determines the potential for scientific research, while culture determines the social recognition it commands. Institutions provide information that informs innovation decisions, and also define the property rights that govern the appropriation of profit (Hertner and Jones, 1986; Lopes et al., 2019a). Thus culture and institutions, together with the stock of scientific knowledge, determine the rate of innovation (see the box in the centre of Figure 13.1). The commercialisation of research requires two key decisions: where to locate production and how to control it. These are represented in Figure 13.1 by ‘location’ and ‘organisation’ respectively. Both location decisions and organisation decisions are constrained by the physical environment. Location is influenced by access to natural resources, river valleys and coastal ports, while organisation in influenced by distance and the delays in communication it entails.

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When combined, ‘innovation’, ‘location’ and ‘organisation’ determine the IB system, as indicated by the box with dashed sides in Figure 13.1. The IB system transforms the physical geography of the system, shown on the left-hand side of Figure 13.1, which is fixed into the economic geography of the system, which varies over time. Economic geography reflects patterns in the location of business activities, for example, agglomeration or decentralisation, and patterns in the ownership of these activities, for example, the spatial distribution of the headquarters and the tax jurisdictions in which shareholders reside. The directions of the arrows indicate a broad direction of causality running from left to right and, to some extent, from top to bottom. In practice, of course, the economic system is more complicated than this, because there are several feedback loops that have been omitted from the figure. As noted later, providing a more nuanced view of the system is an agenda for future research. The next two sections present evidence on each on the two main drivers mentioned above: ‘culture and institutions’ and ‘scientific knowledge’. For expository reasons, a simple periodisation is used, but no particular significance attaches to the dates concerned.

4

THEMATIC REVIEW OF HISTORICAL EVIDENCE: CULTURE AND INSTITUTIONS

This section reviews the evidence on changes in culture and institutions that can be detected at the level of the national state. It does not discuss regional or local variations in culture. It is concerned specifically with changes that impacted on business activity. To structure the exposition it identifies three main periods of approximately equal length. No particular significance attaches to these periods, as to do so would prejudge the interpretation of the evidence. It may be noted, however, that the two transitions dates approximate to the Reformation and the early phase of the Industrial Revolution. A distinction is also made between domestic institutions and international relations. This reflects the nature of the source material, which is specialised along these lines, and it simplifies the referencing to perpetuate this distinction here. It is inevitable that in a survey of this kind generalisations are made and that nuances concerning specific individual industries and localities are ignored; we merely follow existing precedents in global economic history (Allen, 2011; Roy and Riello, 2018). Medieval, 1200–1500: Domestic Institutions It is often suggested that the modern world emerged as the result of superior institutional arrangements (North, 1990), but this superiority may be exagger-

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ated. Medieval institutions were quite sophisticated. The medieval period witnessed great progress in civil laws and constitutions (Hudson, 2012). England is often identified as a pioneer of modern democracy. From the signing of Magna Carta in 1215 the king of England regularly summoned his earls and barons from the counties and representatives from the towns to parliaments in order to approve his spending and taxation plans (Holt, 1969). Property rights were formalised, the judicial system increased in scope and credibility, county and urban government was reformed, and a reputable currency was established. By 1500, medieval institutions already looked reasonably modern (Bean, 1968). Medieval merchants were clearly motivated by profit; most were self-employed, or partners in an enterprise that employed other people, so profit was their basic source of income (Carus-Wilson, 1954). The difference from today was in the way they spent this income. Much of it was spent on charitable activity, as indicated below. Large-scale organisation was conspicuous. The most obvious example is the papacy based in Rome. The Pope, as the head of Christendom, had the allegiance of all Christian monarchs. Through abbeys and churches, he held substantial property in almost every European country. These abbeys attracted donations of property from local aristocrats and successful merchants, offering prayers and commemoration in return (Knowles, 1948–59). Donated land was usually farmed, and much of the produce sold, while donated housing could be rented out. The papacy taxed this income, but only at modest rates; each local abbot or priest therefore had an incentive to boost donations, as much of the income would be retained at the local level (Braudel, 1992). The German Hansa is another example of large-scale organisation: it was an alliance of merchant guilds in leading ports around the Baltic Sea. Each guild could hold property (for example, a warehouse) in ports controlled by other towns. Since guilds were corporate entities (although loosely organised) these properties represented an early form of branch-plant FDI. Similarly, Italian banks operated international branches staffed by family members and loyal employees (Dollinger, 1970; Hunt, 1994). Medieval, 1200–1500: International Relations International relations between medieval states were relatively poor. Many states were governed by ‘warlords’, whose principal role was to lead their army into battle. Even in England, where civil society was strong, the propensity of kings to involve their subjects in wars was a major cause of concern. Peace between nations was often sealed by through inter-marriage between royal dynasties. But family members could often fall out over the inheritance of land (Seward, 1996).

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The Popes, as heads of the church in Rome, had some success in settling international disputes because, until the Reformation, most kings recognised their spiritual authority. Unfortunately, however, some Popes encouraged kings to unite in common cause by going on Crusade. Many aristocrats were killed in the Middle Eastern campaigns, while others returned penniless, having mortgaged their land to pay their travel expenses (Rist, 2009). From Medieval to Modern, 1500–1800: Domestic Institutions The Reformation in continental Europe and the Dissolution of the Monasteries in England strengthened the power of secular political leaders by reducing the power of the Pope. Political leaders became more ambitious. They created standing armies, and procured uniforms and munitions on a considerable scale. State procurement provided opportunities for mass production, which were exploited by entrepreneurs, such as Jack o’Newbury, who established large ‘proto-industrial’ factories to supply bulk orders (Delony, 1626). There was a division of labour within his factory, but little mechanisation. Other entrepreneurs developed a more conventional putting out system based in local communities where different households specialised in different stages of production. Navies also developed, with armed sea-going ships and a permanent core of seamen. This encouraged the formation of large international trading companies by reducing risks at sea. In some countries, notably England and the Netherlands, private joint-stock companies purchased a state charter conferring a monopoly of trade on certain routes; in other countries, such as Spain and Portugal, the government retained more direct control. In England the king usually took shares in such companies, which encouraged other wealthy people to invest as well. The king derived a triple benefit: he obtained a fee for the charter, a share of the profits, and avoided raising taxes to fund the navy. The expansion of international trade through chartered companies extended the division of labour overseas (Scott, 1912). Colonies were also established about the same time. Religious dissenters left England for America where, after enduring many setbacks, they established profitable cotton plantations. Later other emigrants settled in the West Indies to produce sugar and rum. Meanwhile, on the West Coast of Africa, a trade in slaves as developed, sustained by English merchants who sold guns to local tribal leaders, which fostered tribal wars and maintained the supply of slaves (Davies, 1957). Atlantic ports such as Bristol and Liverpool grew rich on this ‘triangular trade’, which shipped Africa slaves across the Atlantic on the ‘middle passage’. When the slave trade was later outlawed, indentured labour from India was shipped to the West Indies instead.

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The Glorious Revolution of 1689 signalled an important change in English financial policy, involving the establishment of the Bank of England and the creation of a National Debt (Cox, 2012). In terms of practical politics, however, little changed. The king remained as the figurehead of the state. Many members of parliament were in business, and the king became the unofficial leader of the property-owning business class. Few people had the vote. It was not until the Great Reform Act of 1832, and the elimination of ‘rotten boroughs’, that members of parliament had to seriously consider the wishes of their electorate (Brock, 1973). From Medieval to Modern, 1500–1800: International Relations In continental Europe, by contrast, many of the potential economic benefits of technological progress were dissipated in political rivalry and warfare. Political dominance in Europe shifted from Spain and Portugal in the sixteenth century to France in the eighteenth century. In terms of natural science and artistic culture, continental Europe was more advanced than England, partly because it received more patronage from the state. Taxes were high, however, and political freedoms more limited, so business activity did not flourish to the same extent. Persecutions of religious minorities prompted the emigration of artisans to England (Davies, 1996; Merriman, 2019). Modern, 1800–2000: Domestic Institutions The partnership was the dominant form of business organisation until the mid-nineteenth century, when joint-stock organisation rapidly developed in response to reforms in company law. This facilitated the emergence of big business as it is known today. It provided for the separation of ownership and control. A new social class emerged, comprising salaried managers (Berle and Means, 1932). It also created a class of absentee shareholders; some shareholders were risk-averse, for example, pensioners, while others were risk-lovers, for example, financial speculators. Joint-stock organisation facilitated the pooling of personal investments and so encouraged the exploitation of economies of scale. It was used to finance major infrastructure projects, such as railways and canals, and was later applied more widely to manufacturing. The combination of joint-stock organisation and improved infrastructure encouraged the development of multi-plant manufacturing, branch banking and chain-store retailing (Chandler, 1962). Big business presented formidable organisational problems, and investors turned initially to the armed forces and the civil service for suitable administrative models. Early railway managers, for example, were often termed ‘officers’ and given ‘regimental’ uniforms (Gourvish, 1972). Hierarchical

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structures proved too inflexible in certain industries, however, and ‘flatter’ organisational structures were developed instead. These included the creation of semi-autonomous product divisions (the ‘M-form’) and semi-autonomous local subsidiaries in MNEs (Williamson, 1970). Electricity transformed the office in the late nineteenth century, along with mechanical innovations such as the typewriter (see below). Government, the armed forces, the postal service, libraries and hospitals all developed sophisticated information management systems based on indexed filing systems, and large US firms remodelled their office procedures along these lines (Yates, 1989). The US also led in the application of scientific management to the shop floor. Mass-production (Fordism), work study (Taylorism) and quality control (Deming) were vital in producing value-for-money high-technology branded products. Modern, 1800–2000: International Relations Republicanism and absolutism were features of many European governments in the nineteenth and twentieth centuries (Taylor, 1936). They experimented with various forms of communism, socialism and fascism. Most European states were aggressors at one time or another, and international politics was often dominated by alliances formed to strengthen warring parties (Ranum, 1975). Aggression between European states was fuelled by imperial ambitions, for example, to control resources in Africa and South-east Asia – a process that ended in two world wars. In the aftermath of the First World War, leading economies like Germany, Italy and Spain were for a time totalitarian states. Economic dislocation in Europe boosted the rise of London as a financial centre. After the Second World War there was a political imperative to improve international relations in war-torn Europe and South-east Asia. The United Nations and the World Bank were established, both headquartered in the US. The European Economic Community (EEC) and the Association of Southeast Asian Nations (ASEAN) trading blocs were established, and others followed (Kreuger, 1990). Tariffs were typically higher on final products than on intermediate products, providing ‘effective protection’ to downstream production and encouraging import-substituting FDI (Greenaway and Milner, 2003). The US was the dominant economic power. It was highly successful in adapting military technologies to civilian use, and sought access to global markets for its high-technology products. It took an inclusive approach, promoting global free trade through the ‘Washington Consensus’ (though Russia and China remained aloof).

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5

THEMATIC REVIEW OF HISTORICAL EVIDENCE: SCIENTIFIC KNOWLEDGE

This section examines knowledge accumulation, with a focus on science and technology. The most helpful general sources are van Bavel (2016) for the medieval period and Freeman and Louçã (2001) for the Industrial Revolution, while Mokyr (2003) is a useful reference work. A ‘long view’, using aggregate data, is presented by Maddison (2001) and van Zanden (2009). Medieval Period, 1200–1500 Medieval agricultural productivity was low; it took a lot of land to feed each person, and Malthusian pressure kept population low. Production relied on natural sources of energy, sunlight, wind and waterfall, complemented by animal power and labour power. Energy was captured by windmills, watermills, sails and other devices, but a steady supply of energy could not be guaranteed (Kander et al., 2017). The flow of water could be controlled using dams and leets, but this was of little use in times of flood or drought. Tools were made from wood and iron, and materials were derived mainly from animals: wool from sheep, and skin and hides from cattle, together with animal bones (for carving tools and ornaments) and animal grease (for wax, candles and lubricants) (Oakley, 1975). Potters fired clay in kilns and smiths smelted ore in furnaces and forged ironwork. Their main fuels were wood and charcoal, but wood was scarce because forests were also used to provide timber for the construction of buildings and ships (Sawyer, 1979). Nevertheless, important innovations were made in the medieval period. Medieval artisans built magnificent cathedrals, huge castles and impressive bridges. They made fine jewellery and wove artistic tapestries. Master masons and engineers (designers of bridges, docks and harbours) were the super-stars of their day. They accumulated knowledge through experience, based on ‘trial and error’. As a result, towns prospered, and their markets grew; product standards were regulated, weights and measures were standardised, and special courts were established to resolve commercial disputes (Casson et al., 2020). However, technology remained essentially tacit; it resided in people’s heads. Knowledge was passed on through guild-based apprenticeship systems (Clark et al., 2000). The ‘mysteries’ of architecture, construction engineering and shipbuilding were carefully guarded, and shared amongst the artisan elites of particular towns (notably in Germany and Italy). Knowledge moved between countries when people moved. Nations seeking to catch up with the leaders ‘purchased’ new technologies by paying bonuses to skilled foreign immigrants, not unlike the football transfer market of today

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(Cunningham, 1897; Ormrod et al., 2018). Technology transfer in the textile industries enabled advanced countries to develop an export trade in sectors where they had previously imported all their luxury goods. Foreign trade could also be a useful source of knowledge. Intelligence on new technologies could be gained through social networks established in foreign ports. There was extensive trade across the Mediterranean, the Baltic and the North Sea. By 1500 ocean-going ships had navigated passages to newly discovered continents, which provided novel foodstuffs and raw materials (Braudel, 1992). Inland transport and communication was slow. The horse-back rider was the fastest messenger over land. Rivers were the main highways of inland commerce, and considerable investment was made in bridges, embankments and, later, cuts and navigations. Even in Anglo-Saxon times, English kings recognised bridge building and repair as one of the three ‘necessities’ of the kingdom (Harrison, 2007). Overall, technological change was slow by modern standards, but significant nevertheless. From Medieval to Modern, 1500–1800: Controlled Combustion There were several steps in the switch from medieval to modern, and each step had several stages (Landes, 1969). A key step involved ‘controlled combustion’. The first stage was to raise the temperature of fires whilst keeping them under control. This was effected by using bigger and better furnaces and kilns, and experimenting with alternative sources of fuel. Coal replaced charcoal and firewood, once large deposits of high-quality coal has been discovered through geological survey and deeper mining (Hatcher, 1993). The second stage of controlled combustion was the commercial development of steam power. Early steam engines were inefficient, but James Watt dramatically improved their thermal efficiency (Allen, 2009; Wrigley, 2016). In partnership with the Birmingham entrepreneur Matthew Boulton, he exported his patented inventions, in return for licence fees proportional to the fuel savings achieved by the customer. Stationary steam power could be supplied continuously using multiple boilers. Large boilers were also more efficient because loss of heat was proportionately lower. Thus, steam-powered factories provided major economies of scale and factories became much bigger as a result; they quickly replaced water-powered factories in areas close to coalfields (Tann, 1973, 1981). A high-pressure boiler pioneered by Richard Trevithick proved suitable for railway locomotion and marine power, but was unsuccessful on roads. Steam hammers improved the production of wrought iron, while belt-driven lathes improved the precision with which machinery was made. Iron machinery was

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built to very tight tolerances and was used to produce other iron machines which were just as precise (Smiles, 1874). Modern, 1800–2000: Electricity Electricity exemplifies the role of ‘table-top experiments’ and mathematical theory in the development of technology. In the 1830s Michael Faraday discovered that rotating a copper wire in a magnetic field induced a current which could be directed by wire to a remote device, such as an electric motor or a light bulb (Meyer, 1971). Electricity transmitted power at the speed of light. It powered telegraphs and telephones, and later radio, TV and satellite broadband. It accelerated communications, and made modern forms of organisation possible (see above). Electricity has proved more versatile than steam; it can be generated from steam, wind, water, sunlight, and even nuclear power; it can be stored in batteries, and distributed widely through a grid. Electricity distributed power into the factory, office and the home, and into rural areas too. Homes acquired a variety of gadgets, from radios and TVs to washing machines and vacuum cleaners. When equipped with computers and the internet, the home became an office too (Scott, 2013). Modern, 1800–2000: Chemistry Basic chemistry has been understood since pre-historic times. Cooked meals and herbal medicines were both early applications of chemical principles. From the mid-nineteenth century chemistry advanced quickly through large-scale research and development (R&D) programmes carried out in a systematic way (Aftalion, 1991). Acids and alkalis were produced from raw materials such as chalk and salt, creating artificial fertilisers that boosted agricultural productivity. The active ingredients of herbal recipes were identified and synthetic substitutes produced. This enabled the mass production of medicines, and inspired the development of rayon, nylon and other new fibres. Applying synthetic dyes to synthetic fibres generated a wide range of bright and easy-to-wear fashion products. At the interface of fashion and medicine, new cosmetics were developed, enabling consumers, however old, to look ‘forever young’ (Jones, 2010).

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THE IMPACT OF PLACE AND GEOGRAPHY ON INTERNATIONAL BUSINESS

Seventy-one per cent of the surface of the Earth is covered by sea. Apart from fishing the main economic role of the sea has been the transport of freight and (until recently) passengers. The ‘trade winds’ have historically influenced on

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the direction of voyages; they blow clockwise across the North Atlantic and North Pacific, and anti-clockwise in the Southern hemisphere. A high proportion of world population inhabits the continental shelf: coastal land that is well irrigated by rivers and suitable for both agriculture and industry. Because the Earth’s axis of rotation is angled, the movement of the earth around the sun generates seasonal variation in the climate, encouraging the sourcing of agricultural products from different parts of the world at different times of year. Minerals tend to outcrop along major geological faults, and deposits of some minerals are concentrated in a small number of locations. This natural spatial monopoly has stimulated international rivalry to control such deposits, for example, the European race for Africa in the late nineteenth century. The strategic importance of scarce minerals can increase dramatically when new technologies require them (for example, copper wire for electricity). Finally, rock formations have been important in providing access to spring water and supporting human settlement. These physical features represent the legacy of millions of years in the making of the planet, and have been fundamental constraints on all economic activities. From the medieval period, however, the need for waste disposal became an additional constraint, which became acute as living standards rose and population increased. Urban sewage systems were pioneered to mitigate pestilence and disease. Traditional materials such as wool and cloth were recyclable but many modern synthetic materials are not. The switch from animal power to steam power in the eighteenth century discharged increasing amounts of carbon into the atmosphere, and these increased to unsustainable levels in the twentieth century. At this point physical geography ceased to be exogenous to human activity. The legacy of human activity itself began to influence the climate, with particularly serious implications for tropical agriculture and populations on low-lying land. The density of population has increased dramatically in modern times. As agricultural productivity increased through improved farming practices, so diets improved, life expectancy increased and the population grew.

7

SEVEN MAIN TRENDS

At the beginning of the chapter it was asked ‘How long is the long run?’ and ‘Are there long-run trends?’ Using the period 1200–2020 it is possible to derive, from the narrative above, seven endogenous trends. These trends have been generated by the systems described in Figure 13.1. A large number of possible trends are identified in the historical literature, but not all are long-term trends, some are poorly documented. The trends itemised below

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have been identified as well-documented long-term trends that have potential relevance to IB. Commercialisation of Art and Science One of the changes attributed to the Reformation is the commercialisation of production. A wider range of products were bought and sold in open markets. Prior to the Reformation the church was dominant in commissioning art, and so art was mostly religious. After the Reformation civic leaders in big towns began to commission portraits of themselves, and artists began to produce pictures speculatively for public exhibition and sale. Successful artists charged premium prices for their work. Similarly, from religious pageants there developed a secular theatre with celebrity actors and playwrights (Vermeylen, 2003). This process reflected the decline of the ‘sacred’ and the weakening of traditional sources of authority. Personal status was increasingly determined, not by birth or education, but by worldly success. The commercialisation of art preceded the commercialisation of science, but once the commercialisation of science took off the effects were dramatic. A key incentive to commercial R&D was the extension of the scope of the patent system towards the end of the nineteenth century. Brands and trademarks also received dedicated legal protection at this time (Lopes and Duguid, 2012). A new type of commercially driven laboratory-based science emerged, committed to product development. A division of labour emerged between the pure scientist, who typically worked in a university research laboratory, the applied scientist, who worked in a corporate R&D laboratory, and the production engineer, who monitored processes on site. The largest share of profit from successful innovation went to their employers, namely the shareholders of the innovative firm. From Learning-by-Doing to Learning from Experiment and Theory In medieval times most scientific progress was made by learning on the job. Cathedral architects did not work from models; they built cathedrals and learned their lessons when towers collapsed. As late as 1800 steam locomotives were developed by running full-size locomotives and sorting out their problems. On the other hand, some early improvements in textile machinery were made by experiments using scale models. By the late nineteenth century the industrial laboratory was well established in the electrical industry. Electricity was the first major industry where theory, in the form of Maxwell’s field equations, dictated laboratory model-building. Even the pharmaceutical

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industry was based for many years on the study of natural medicines, and only took off as a result of scientific discoveries in chemistry, and later in genetics. The transition from experience to experiment and on to theory may be regarded as a natural consequence of the accumulation of knowledge. Activity generates experience, and reflection on bad outcomes prompts experiments with alternatives; comparing experimental results then reveals patterns indicative of theory. These changes are reflected in business culture. Medieval training through long apprenticeships involved the transmission of traditional technology from one generation to another. Business education today is designed for flexibility since a ‘job for life’ is regarded as a thing of the past. Entrepreneurship is highly regarded because it provides jobs for the future. Continuous change has a social cost, however; because people live longer, they witness more change, and older people may feel out of touch and ‘left behind’. Improved Transport and Communications: ‘Shrinking Distance’ in Transport, Travel and Communication Transport infrastructure has developed at an accelerating rate, and much of it exhibits a network structure connecting major hubs. Land-based systems are based on road and rail, while sea- and air-based systems depend mainly on terminals (ports, airports). It is not only the speed and volume of traffic that has increased: the spatial density of networks has increased too. With cheaper passenger transport, nineteenth-century consumers preferred the greater variety and more competitive prices offered by the bigger towns, and many medieval market towns became no longer viable. The number of towns decreased and surviving towns became much larger (Beresford, 1967). As larger towns expanded, their suburbs grew, and this process continued relentlessly down to the present. The largest centres catered for the very richest people, but employed some of the poorest people in service roles. Within these cities inequality of income distribution was exceptionally high. Today, ‘world cities’, such as London, New York and Tokyo, act as political, administrative and financial centres, coordinating activities in different continents and time zones (Hall, 1984). The growth of urban centres has been supported by migration. Migration fuelled the growth of medieval towns, and has become even more significant since then. In poorer countries it has often been the better off and the most enterprising people who migrate. This selective nature of migration benefited host locations – most notably in the nineteenth-century US.

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Marketing Novel Products that are Differentiated by Design In medieval society there was little profit to be had in supplying consumer goods to ordinary working people. They earned a subsistence income and had little disposable income to spare. Most products were either natural, for example, foods and spices, or directly fashioned from natural products using relatively simple tools, for example, textiles from wool and furniture from wood. The Industrial Revolution facilitated the design and innovation of novel mass-produced products, and this required a change in marketing practices. Distribution was no longer focused on the local ‘corner shop’, but on retail chains and urban department stores. Technological advances in printing (posters and brochures), and in radio and television (advertising) were important in promoting new products. The advent of commercial television in the mid-twentieth century amplified the power of advertising. Social mobility was increasing, and ‘conspicuous consumption’ was no longer a prerogative of the very rich. Marketing methods became increasingly manipulative, and market regulation, which had been so successful in the medieval period, failed to address the new challenges. The addictive properties of certain heavily advertised products (for example, cigarettes, gambling and high-sugar fast food) were ignored; a continuous flow of novel products (for example, cosmetics and household gadgets) emerged to addressed growing anxieties about social status (Packard, 1957). The Emergence of Large-scale Organisation for Profit Large-scale medieval organisations typically served some collective purpose. An army fought an enemy; a civil state maintained law and order, hospitals served the poor and sick, and the church served God. Organisation for profit was morally problematic. Business partnerships worked reasonably well for small numbers of people, especially when they were mediated by family or guild connections. International business was quite common, especially in luxury consumer goods, textiles and banking, but the size of individual business units was, by modern standards, small. Large-scale organisation for profit was not attempted until modern times. A fundamental problem is that if the aim of an organisation is merely profit-making then everyone will want a share. Large-scale industrial conflict over the appropriation of profit arose with the establishment of the factory system (Ward, 1970). In the early nineteenth century the UK witnessed machine-breaking and riots in industrial towns; subsequently the spread of Marxism and non-conformist religious movements stimulated the growth of the trades union movement. The extension of joint-stock ownership to small

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and medium-size businesses in the mid-nineteenth century proved to be a landmark in the development of the modern firm. But as the class war between managers and workers subsided with legal recognition of union rights, a new war emerged between the salaried managers of joint-stock firms and their dividend-earning shareholders (Berle and Means, 1932). Managers were accused of awarding themselves over-generous pay and perks. The solution was closer monitoring and performance-related pay. This did not fully resolve the problem, however, because performance itself is difficult to measure. In the 1980s small owner-managed high-tech firms emerged, supported by venture-capital finance, in a further attempt to address the management incentive problem. Large profit-making organisations may exploit monopoly power, raising prices and using ‘deep pockets’ to deter competitive entry. The US introduced federal anti-trust measures at the turn of the twentieth century, and other countries followed later (Freyer, 2006). The regulation of big business has subsequently developed into a game, whereby regulators intervene and big business takes evasive action. Shareholders have the power to impose ethical constraints on the businesses in which they invest, but are reluctant to do so. In some cases ethical constraints can increase profit by strengthening brand value, but in other cases market share may be lost to more ruthless rivals. In the latter case regulations may be necessary to impose a ‘level playing field’ in ethical values. Political parties have lined up along a binary divide between pro-regulation parties, calling for stronger government, and anti-regulation pro-business parties calling for weaker government instead. New Ways of Working: From Manual Labourer to Social Networker Manual work was the basis of production until the Industrial Revolution. The agricultural worker tilled the land, whilst the skilled artisan made jewellery, metal-work, leather goods, and so on. In the late-eighteenth century factory-work emerged, transforming many workers from artisan ‘makers’ to mere ‘minders’ of machines. While agriculture involved varied, seasonal work carried on outside in daylight hours, factory work was repetitive, and carried on inside in noisy cramped conditions. In the twentieth century automation liberated many workers from the factory, and this facilitated a growth in service employment. There was an expansion of manual work in retailing, catering, hospitals, and so on, and an increase in office work too (Noble, 2011). The internet now provides instant access to information, whilst 4G mobile phones mean that no one ever needs to be out of touch. Messages arrive almost continuously and many demand an instant response. The inability to control incoming calls, coupled with demands for immediate responses, creates stress.

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A hierarchy of time management has emerged in which high-status people demand instant responses whilst low-status people have to wait. The Expansion of International Business and an Increasing Diversity of Organisational Forms From a broad historical perspective the growth of the MNE is just another trend, although a very important one. There is no definite historical inventory of MNEs, but the weight of surviving evidence suggests that MNEs have grown steadily in number and in size (sales, employment) over time, with a notable acceleration since the end of the Second World War (Dunning, 1958, 1983). As new industries have developed, often as a consequence of scientific discovery or exploration, so the range of industries in which they operate has increased too (Dunning and Lundan, 2008). As transport and communications have improved, MNE operations have also expanded into an increasing number of territories (Jones, 2010). The geographical scope of individual MNEs has increased, particularly in consumer goods, where many firms now serve a global market (Verbeke, 2013). MNEs, however, usually specialise in particular technologies and products; although they may produce different varieties of the same product, they do not normally produce completely different types of product; the main exceptions are MNEs operating in the wholesale and retail trades (Jones, 1998). The fundamental drivers of MNE growth are similar to the drivers of the other trends. Entrepreneurial culture encouraged the recognition of business opportunities, and advances in maritime technology widened the scope. Scientific research became easier and transport and communication costs became lower. These drivers are similar to those identified by other authors using other approaches (Aharoni, 2014; Dunning, 2000). IB activity has taken many different forms at different times (Cools et al., 2006; Gras and Larson, 1939). When international trade ‘took off’ in the thirteenth century, a merchant would usually accompany their goods on ship and negotiate directly with buyers at the foreign port. By the fourteenth century many employed a permanent representative (for example, a younger member of the family) in foreign ports, and held the ship’s captain accountable for the security of their cargo. By the fifteenth century most international merchants were members of a local town guild. The guild would be affiliated with local guilds in foreign ports, and might own warehouses there; this represents an early form of FDI. Examples of such investments survive, such as the Hanseatic warehouse at King’s Lynn on the east coast of England. By the sixteenth century leading merchant guilds occupied walled areas within port cities. The Hanseatic steelyard (stadhof) in London, for example,

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included a hall, chapel, counting house, weighing scales and residential quarters. In the seventeenth century guilds were largely superseded by chartered joint-stock trading companies, as national rivalries in international trade intensified. Mercantilist writers encouraged governments to promote exports and discourage imports from rival countries (Heckscher, 1935). Capitalising on early voyages of discovery, chartered companies from rival countries – notably England and the Netherlands – established fortified trading posts in distant countries, and used naval power to disrupt each other’s trade. These chartered companies were early examples of vertically integrated MNEs. They exercised monopoly power – but through the charters they held rather than the technologies they used. Technology was embedded in the design of their ships and navigation instruments, and the improvements that they made to ports; it was not their ownership of technology that was significant, but their ability to recognise its commercial potential. In the late eighteenth century the chartered companies began to decline. Adam Smith (1776) argued convincingly that they abused their monopoly power. Trade became competitive and the business partnership became the dominant form of organisation. In the nineteenth century colonial settlement expanded, and many settlers were given lands that had previously been occupied by native peoples. Foreign investment moved inland from the ports, setting up mines and plantations, and building urban infrastructure – for example, roads, trams and cultural facilities – for settlers’ use (Dunning, 1983). Much of this investment was channelled through ‘free-standing companies’, headquartered in European financial centres but devoted solely to owning and operating railways, mines, and so on, in colonies or independent developing countries (Wilkins, 1989). Many foreign investments were very risky, and fear of competition encouraged firms to collude. The led to the organisation of trusts and cartels, especially in industries involving high sunk costs, such as railways, mining, steel and heavy engineering (Hexner, 1946). After the First World War political tensions remained high in Europe and US businesses turned to Latin America, where British war debts encouraged British investors to sell out to US firms. In Europe the redrawing of national borders and the disintegration of the Austro-Hungarian empire transformed many multi-plant firms, almost overnight, into MNEs (Teichova and Cottrell, 1983). Trade liberalisation, stronger intellectual property rights and international migration of talent gradually transformed IB after the Second World War. For example, as intellectual property rights have strengthened firms have become more willing to locate R&D remote from their headquarters (Athreye et al., 2016; Viale and Etkowitz, 2010). Many MNEs have therefore opted to

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offshore R&D to foreign research hubs, as well as offshoring upstream production to cheap-labour or resource-rich countries. In the early post-war period the MNE was often portrayed as a high-technology market-seeking firm headquartered in a developed country, which internalised overseas production because it could not trust a foreign licensee. In reality, earlier forms of FDI did not disappear. Backward integration into agriculture and minerals remains a feature of many MNEs today. Indeed, traditional backward integration was ‘re-invented’ by emerging market MNEs investing in Africa, for example, Japan in the 1970s and China in the 2000s. ‘Trader’ MNEs are still common, particular in Asian economies (Hertner and Jones, 1986). Therefore, contrary to Chandler (1962), the modern corporate organisation did not supersede traditional organisation through its absolute superiority; modern corporate organisation may well be appropriate for the production and distribution of high-technology branded consumer products, but it is not necessarily appropriate for other products, where more traditional forms of organisation may continue to perform better. The resilience of the modern MNE stems not from its adoption of a single superior organisational form, but its ability to adopt any one of a diverse set of forms as its circumstances dictate. Even today, in an age of ‘digital start-ups’ and ‘born globals’, the form of IB continues to evolve (Loane, 2005).

8

OVERALL IMPACT OF THE TRENDS

These seven trends combine to generate a final trend which summarises their overall impact on the global economy. The advance of science and its application to production has, in the long term, raised productivity and permitted average living standards to increase. Not everyone, however, has had the opportunity to participate in high-productivity production because they have lacked the skills and qualifications required. They have been forced into low-productivity self-employment or to dependency on the charity or the state. As a result, higher average incomes have been accompanied by greater social and economic inequality. This first became apparent in leading economies of the nineteenth century – notably Victorian Britain. A major objective of post-war European states was to alleviate this problem, but the legacy has been mixed: Scandinavian economies have performed on average better than other countries, including the UK. The growth–inequality trade-off is well-documented, and has been known for some time (Alvaredo et al., 2020; Fisher, 1935). It has become a source of major political conflict in some leading democracies. The challenge is aggravated by climate change (see above). This raises two related policy issues. The first is whether the response to climate change will create new jobs for

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unskilled workers, or merely better-paid jobs for a new generation of skilled workers. The second is whether adjustment requires a rethink of consumer attitudes to product selection and business attitudes to profit. These questions cannot be answered here. It is reasonable to suppose, however, that significant changes of some description may be required.

Figure 13.2 The seven key trends and the connections between them The position is summarised schematically in Figure 13.2. The seven main trends are listed clockwise around the figure. They are all interdependent to some degree, but the arrows in the figure illustrate the general direction of

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causality. The sequence ends with the growth–inequality trade-off described above. The future may not be the same as the past but the past may hold the answer to the problems of the future. If correct, it is another important reason for putting IB into historical perspective. There is a clear tension between the culture of increasing commercialisation, where the sequence begins, and the challenge of growth, inequality and climate change, where the sequence ends. The loop shown in Figure 13.2 cannot be closed at the top. More commercialisation does not appear to be answer. Some form of cultural change is required. The implications of this are considered in section 10.

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METHODOLOGICAL ISSUES REVISITED

This section addresses the four unanswered methodological issues raised in section 2. 1 ‘Is change progressive?’ Change is progressive in technological terms, but not necessarily in social terms. It all depends on how technology is used. Harnessing technology to use renewable resources is progressive, but using it to develop solutions to personal problems that have been exaggerated by advertising is not. 2 ‘Is there an arrow of time?’ The application of technology involves two main forces: the progressive accumulation of knowledge, and the progressive depletion of non-renewable resources. The first attains an equilibrium when the stock of knowledge stabilises; convergence on this equilibrium will be reflected in diminishing returns to new discoveries. In equilibrium resources would be directed entirely into maintaining the existing stock of knowledge through educating the next generation. This equilibrium has so far never been attained (Meadows and Meadows, 1973). The second force attains equilibrium when natural resources have been exhausted, and population is limited to what renewable resources will permit. Convergence on this equilibrium is problematic, however. Increasing competition for resources between people from different cultures may cause a breakdown in international relations, the harnessing of technology to global warfare, and mutual destruction. Balancing these two forces is population growth. Growing population increases the number of brains available to do research, but it also increases the number of mouths to feed, and so accelerates resource depletion. This leads to the policy dilemma described above. If the arrow of time continues on its present trajectory, civilisation may come to an end. This would be the end of ‘calendar time’, but not ‘geological’ or ‘astronomical’ time.

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3 ‘Is change evolutionary or revolutionary?’ Popular histories often portray technological progress as revolutionary, but detailed analysis suggests a more nuanced view. It would be more appropriate to say that change is evolutionary but proceeds at a varying rate, and that when it accelerates sharply a revolution is said to occur. Evidence suggests that the trajectories of different technologies are interdependent and that production technologies can only advance once various conditions have been met; it is only once the final condition has been satisfied that the ‘great leap forward’ can occur (Schumpeter, 1934). ‘Does history repeat itself?’ 4 History seems to repeat itself, but never exactly. In the nineteenth century, for example, British and Portuguese firms integrated backwards into mining and agriculture in Africa, and built railways to link mines to ports. They later withdrew, mainly as a result of decolonisation after the Second World War. In the twenty-first century, Chinese firms began building railways in Africa. The motivations were similar, but the details were different, because it was China that now played the ‘imperialist’ role.

10

CONCLUSIONS AND IMPLICATIONS FOR FUTURE RESEARCH

This chapter has extended the domain of IB research, and in particular internalisation theory, in order to make theory more dynamic. It has examined the long-run forces of change that have driven the development of the MNE. It has reviewed historical evidence, from 1200 to 2020, and identified seven long-term trends that have governed the evolution of IB. A critical appreciation of the concept of time has played a vital role in this task. Three important questions concerning the nature of time were addressed at the outset (section 2) and four other questions were answered above (section 9). The chapter has demonstrated that a thorough understanding of the concept of time is crucial in interpreting historical evidence on IB. The chapter has shown how long-run forces of change can be incorporated into IB theory. An important theme has been the historical importance of the accumulation of knowledge, and a growing emphasis on its practical application. Another theme is the emergence of an increasingly secular view of society taken by shareholders, managers and consumers; this has been associated with a growing belief in the efficacy of self-interest, and a view that law and not society should regulate commerce. These two drivers of change have been conditioned by geographical fundamentals, which have exerted a major influence on the location of IB activities. They have provided both opportunities and constraints: opportunities to

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discover new sources of minerals and to open up new routes for trade and migration, and constraints imposed by soil, climate and seasonal variations in weather. The role of geography is changing, however. The generation of atmospheric pollution and waste by industry and consumers is affecting the climate; coastal regions, where much economic activity is concentrated, face inundation, while inland plains are becoming deserts (Stern, 2007). Environmental problems have impacted towns since the medieval period, where pollution was mitigated through zoning industries and improving the water supply. Managing the global climate will be more problematic: it requires allocating more land to forests (for carbon capture), and to solar panels (for green energy), and dramatically improving the recycling of waste. While this will provide new profit opportunities, and new jobs, it is likely to increases costs of production and raise prices too. For the first time since 1200, innovation and lifestyle change may involve stagnating, or even falling, standards of living. Contemporary consumer-oriented culture may no longer be viable, but what will replace it is unclear. Further development of these themes provides a sound basis for future research. The historical evidence on IB can be augmented by drilling down to a greater level of detail, for example, there is a relative scarcity of studies of IB activity prior to 1850 (when much of it was carried out by private partnerships rather than joint-stock companies) and on high-technology infrastructure industries such as transport and telecommunications. Two-way causation needs to be analysed more thoroughly. This chapter has focused on the impact of scientific progress and institutional changes on IB. It has noted that IB, in turn, impacts science and institutions, for example, by globalising markets and stimulating R&D (Verbeke, 2013). Future research needs to integrate these two perspectives. It needs to combine a conventional account of how MNEs have changed the modern world with an explanation of how the MNE itself emerged from changes that began much earlier in the late medieval and early modern world. Interdependencies between the seven trends need to be investigated in further detail too. It has been suggested that some trends must be reversed if others are to continue. This proposition links the historical perspective to recent debates on business ethics and sustainability in IB, and this interface also needs to be explored. Attention has been drawn to the increasing diversity of organisation forms that are found as IB evolves. More research should be done to identify additional organisation forms, including traditional forms that were little used in earlier times when communication was very slow, and new forms that may

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emerge if and when communications become even faster in the future. This chapter provides conceptual foundations on which such research can be based.

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Index capture of a market, and powerful nations extending control of territory 60–61 cartels 127, 128, 205 see also international cartels (ICs) and multinational enterprises (MNEs) Caspar, D.L. 176 centralisation 222–3 CEOs, and decision-making 194, 198, 202–3, 204, 223, 225 change evolutionary or revolutionary 302–3, 323 progressivity of 302, 322 chartered companies 319 cheating (cartels) 84 chemistry 312 China historically not an imperial power 293, 294 increasing power of 35, 64, 65, 67 cities 315 classification 153–4 climate change 34, 313, 320–21, 324 co-location of headquarters 251, 252, 254, 260 Coase, Ronald and Coasian theory 124, 125, 136, 211 collusion 79–80 colonisation and colonialism 4, 54–5, 58–61, 307, 319 combine (holding company) 74 committees 193 communication(s) within cartels 78 global 182 infrastructure 281, 282–4, 287 networks 182, 220, 221 and organisational structure 223–5, 230–33

absolute advantage 56–7 access to raw materials, nations 54–5, 60, 294 accountability 234 Adidas 263 Adler, N. 147 advertising 316 Aguinis, H. 145–6, 148, 150, 161 Anglo-Persian Oil Company 263 'arrow of time' 302, 322 art, commercialisation of 314 'Asian Tigers' 63 Asmussen, C.G. 147 associate producers 257–8 backward integration 320 banking crises 36 historical development of 53 barriers to entry 83–4, 219–21 Bassett & Company 258 behaviour 98, 290 of firms 100–101 behavioural approach to learning 200 Beiersdorf 261 Bekes, G. 147 boundaries 136, 138–9, 189 bounded rationality 196 brands 86–7, 288 Brexit leaders 13 movement 16 and 'threat' of EU 14–15 business strategy, theories of 118 see also international business strategy (IBS), integrating with international management (IM) Caligiuri, P. 147–8

330

Index

Companhia Real dos Caminhos de Ferro Portugueses 263–4 comparative advantage 57 competition 108, 278, 279, 285, 295 complexity 145–6 alternative concepts of 146–51 case study of measurement of structural complexity in simple IB model 163–5 conclusion and implications for future research 160–61 and decision-making 205 of physical environment 102 process 157–8 role of theory (simplification) 158–60 structural 151–7 'computational complexity' 150 concern (holding company) 74 connectivity 154–5 conspiracy theories 15, 86–7 consultation 203–4 contracts 100, 191, 212 control 217 'controlled combustion' 311–12 convex polyhedra see geometry (plant location) cooperation 86, 109–10, 279, 295 coordination 124–6, 141 see also international business strategy (IBS), integrating with international management (IM) coordinators, entrepreneurs as 277–8 corruption 16 costs 125 COVID pandemic 34, 148 crises 27–8 classification of 31–9 conclusion 45–7 definition of 28–9 firm-specific 39–42 institution-specific disadvantages 42–5 key groups of human agents in 33 theory 28–31 critical situations 29–30, 32–3, 34, 45–6 cross-classification 153–4 cube and cubic projection 173, 181

331

cultural and economic aspects of decision-making 195–201 culture and cultural perspective 192–5, 287, 303–4, 305–9 cartels and national culture 85–6 organisational culture 107 customers 277, 278 cycles 302 Dassler, Horst 263 decahedral projection 174 decentralisation 133–4, 222–3 decision-making 22–3, 206 CEOs 194, 198, 202–3, 204, 223, 225 committees 193 criteria for best decision 201–2 cultural and economic aspects 195–201 decentralisation of 133–4 ethics of profit-maximisation 203 multiple objectives 202 organisation decisions 304–5 sequential 138 simultaneous 137–8 social basis of 203–5 strategic decisions 250 decision trees 132–3, 134–5, 152, 158 decline, management of 38–9 deglobalisation 89 demand 277 depressions 38 developed and developing countries, and populist leadership 17 directors 155 disputes, internal 193–4 distance 245 distributed headquarters 107–8, 251–2, 260, 263–4 dividends 37 division of labour 212–13 dodecahedron and dodecahedral projection 174–5, 180 dual polyhedra 179–81 Dunning, John H. 190–91 dynamic theories 157–8, 298 of decision-making 198, 200–201 industry dynamics 137

332

Global business

see also time in international business (IB), role of (historical perspective) dynamics of learning 200 dynamism 150 Earth, geography of 1–2, 166–7, 312–13 'eclectic theory' 190 economic and cultural aspects of decision-making 195–201 economic crises 32–3, 38–9, 44 economic geography 188–9 economic history 50–51 economic individualism 43–4 economic theory/models 22, 96, 101–2, 103, 117–18 classic internalisation theory 122–9 conclusion 142 industry view 135–9 multi-level analysis 140–42 origins of modern IB theory 119–23 role of theory 118–19 systems view 129–35 economies of scale 80, 83, 219–20 economists 299 education 12 efficient choices 188 electricity, and development of technology 312 empire 293 employees 193–4, 210, 234–5, 277 employment changes in nature of work 317–18 insecurity 12 England 1200–1500 306 1500–1800 307–8 enneahedral projection 174 entrepreneurs and entrepreneurship 106–12 entrepreneurs and entrepreneurship, historical perspective 246–8, 275–6, 294–5 entrepreneurs in host country 254–9 global business 289–92 invisible infrastructure and generation of global knowledge 292–4 markets 285–7 nature of entrepreneurship 276–9

role of infrastructure 279–81 social infrastructure 287–9, 290 transport, communications and utilities 281–5 equilibrium, actors in 99 equity shares 37 espionage 56 ethics 202, 203 European Union (EU), and Brexit 14–15 excess capacity 83 exogenous factors 98 expatriates 248, 249, 254–9, 260, 261, 262, 263 experiments 314–15 experts, declining respect for 12 exports 5, 54, 247, 294 family firms 39 feedback 99 feedback loop, policy-making 19 finance 41, 250–51 financial crises 32, 36–7, 43–4 financial detachment/headquarters 107–8, 251, 252, 254, 259–60, 261–2 financial services 225–7 financiers 252 firm-level analysis 108–10, 140 firm-specific advantage 219 firm-specific disadvantage and crises 39–42, 46–7 firms behaviour of 100–101 concept of internalisation applied to 211 development of modern 316–17 emergence of 289 and entrepreneurs 106 family 39 interactions between 135–6, 137–8 modular view of 141 multi-plant 123, 124–5, 188, 212, 214–15 performance of 218–21 planning 124 first mover advantage 220–21 footprint 147 foreign direct investment (FDI), historical perspective 50–51 conclusion 67

Index

333

flow, mainly from rich and powerful to poor and less powerful countries 54–5 imperialism 65–7 infrastructure investment and encouragement of FDI in export-oriented production 59–61 international trade and stimulation of FDI 52–4 methodology 52 neoclassical theory 120, 121 path to economic power 64–5 post-1945 period, key characteristics 121 technology transfer, risk of building up weaker country into a rival power 61–3 franchisees and franchising 247, 258, 280

heptahedral projection 173–4 hexagons 169 historical perspective on international business (IB) see entrepreneurs and entrepreneurship, historical perspective; foreign direct investment (FDI), historical perspective; organisational innovation in the multinational enterprise (MNE), historical perspective; time in international business (IB), role of (historical perspective) history and historical evidence 298 economic history 50–51 history repeating itself 303, 323 horizontal integration 127–8, 129–31, 190–91 Hymer-Kindleberger (HK) theory 122

Gabriel, K.P. 145–6, 150, 161 game theory 108–9, 137–8, 159 geography of Earth 1–2, 166–7, 312–13 geometry (plant location) 166–7 centre of a market area 178–9 conclusion and implications for future research 182–4 dual polyhedra 179–81 generalisation to three dimensions 169–76 global communications 182 optimal location 167–9 patterning 177–8 truncation 176–7 Germany, cartels and national culture 85–6 Global Banking Crisis (2008–9) 36 global business, nature of 289–92 globalisation 3–4, 11 government, and populism 20 government-led cartels 74 Gramophone Company 258–9 guilds 306, 318–19

icosahedron and icosahedral projection 175–6, 180 truncated icosahedron 176–7 ICT industry, networked 104–5 imagination 276–7 immigrants, intolerance towards 12 imperialism and imperial power 64–7, 292–4 incentives 234 India 65 Industrial Revolution 294, 316, 317 industries declining, quantity-fixing and capacity-fixing 81–2 life cycle of 77–8 minerals 87 network 284–5 shipping 80–81 industry dynamics 137 industry-level and firm-level analysis 108–10 'industry logic' of internalisation 218 industry-specific crises 38–9, 44–5 industry view 135–9 inequality 4–5, 11, 320 information availability of 199 perfect 196, 200–201, 285 searching for 199–200 infrastructure 60, 279–81, 295, 315

Hashai, N. 147 headquarters 107–8, 111, 141, 182, 191, 228, 244, 245, 249–53, 259–65, 265–6 hendecahedral projection 174

334

Global business

invisible, and generation of global knowledge 292–4 and knowledge discovery 291 markets as 285–7 physical 281–5 projects 292 social 287–9, 290 innovation 102, 107, 109, 204–5, 279 see also organisational innovation in the multinational enterprise (MNE), historical perspective institution-specific disadvantages 42–5 institutions 98, 289, 291, 293, 303–4, 305–9 instrumental knowledge 61–2 instrumental technologies 63, 66 integrated social science perspective and social science of international business (IB) 6, 9, 21–4, 89–90, 96–100 integrated theory (internal and external environment) 194–5 integrating international business strategy (IBS) with international management (IM) see international business strategy (IBS), integrating with international management (IM) intellectual property rights (IPR) 57, 95, 127–8 interactions between firms 135–6, 137–8 internal and external 193 intermediation 222–5, 228 internalisation theory 94–5, 110–12 classic 122–9, 243–5 contribution to IB 95–6 cultural perspective 192–5 extending 105–10 outstanding theoretical problems in IB 100–105 scope of 187–90 social science of IB, standards to be judged by 96–100 and systems view 131–2 versatility of 190–92

see also international business strategy (IBS), integrating with international management (IM); organisational innovation in the multinational enterprise (MNE), historical perspective international business (IB) theory compared with internalisation theory 189 current issues 99–100 new concepts and theories 190 outstanding problems 100–105 see also complexity; economic theory/models; integrated social science perspective and social science of international business (IB); time in international business (IB), role of (historical perspective) international business strategy (IBS), integrating with international management (IM) 209–11 alternatives to the MNE 235–6 concept of internalisation 211–14 conclusion 236–7 internal structure 221–33 modelling the MNE 214–18 performance of firms 218–21 personal motivation (economics and psychology of teams) 233–5 international cartels (ICs) and multinational enterprises (MNEs) 72–3 conspiracy 86–7 definitions 73–5 future of cartels 88–9 implications for future research 89–90 instability 83–5 internal structure of cartels 78–9 lack of attention to cartels in IB theory 87–8 main activities of cartels 75–6 motivation to establish a cartel 76–8 national culture 85–6 tacit collusion and price leadership 79–80 types of cartel 80–83

Index

international management (IM) see international business strategy (IBS), integrating with international management (IM) international relations 1200–1500 306–7 1500–1800 308 1800–2000 309 international trade 2–3, 52–4, 311, 318 internet 104–5 invisible infrastructure 292–4 J. & P. Coats 259 Japan, cartels and national culture 85–6 Jardine Matheson 261–2 Johnson, Eldridge 258–9 joint ventures 279 judgement 197–8, 277, 278 Klug, A. 176 knowledge discovery, institutions for 291 environment 97–8, 102 flow, in modular systems 124–5 generation of global 292–4 global and local 291–2 and industry view 135–6 instrumental 61–2 internalising 95 new 302 scientific 304, 310–12 strategic 61–2 and systems view 129–31 vertical and horizontal integration applied to 127–8 knowledge-intensity 210 labour market, power in 219 law 289, 290 leaders of teams 234, 235 leadership of cartels 84–5 populist 3–4, 13–18, 35 learning 99, 100, 103, 137, 200, 314–15 legacy effects 198 legal headquarters/detachment 107–8, 249–50, 251, 252–3, 254, 256, 260–62 legal loopholes, exploitation of 4–5

335

levels of analysis 140–42 licensing 57, 82, 122, 127–8, 131–2, 258–9 life cycle of firms 39–40 life cycle of industries 77–8 living standards 11, 63, 324 lobbying 20, 21 local businesses 291–2 location 151–2, 153, 154, 215, 304–5 see also geometry (plant location) long run see time in international business (IB), role of (historical perspective) management 41, 42, 152 capability 46–7 classification 153, 154 coordination 213 of critical situations and crises 45 of decline 38–9 failure 40 role in IBS theory 214 skills 213–14 techniques and models 107 see also international business strategy (IBS), integrating with international management (IM) managers 317 connections 154–5 partitions 155–7 rationality of 95–6 manufacturing 292 manufacturing nations 294 market areas see geometry (plant location) market costs 125 market entry 147, 158 barriers to 83–4, 219–21 market power 219 marketing 316 connections 155 linkages with production and R&D (systems view) 129–35 markets 285–7 matching mechanisms 285–7 mathematics 97, 118 migration 248–9, 315 military power 293 military superiority 56–7

336

Global business

military technology 58–9 minerals and mineral industries 87, 313 modular systems 124–5 modular view of firm 141 monopoly communications networks 221 power 219, 319 motivation 233–5 movements 20–21, 31 multi-level analysis 140–42 multi-plant firms 123, 124–5, 188, 212, 214–15 multinational enterprises (MNEs) defining 217–18 and IB studies 8–9 nature of 117 see also internalisation theory; international business strategy (IBS), integrating with international management (IM); international cartels (ICs) and multinational enterprises (MNEs); organisational innovation in the multinational enterprise (MNE), historical perspective; time in international business (IB), role of (historical perspective) multinationality 190–92 multiplexity 150, 154–7 multiplicity 150, 153–4 Nathan, Joseph 257 nation state 67 natural disasters and crises 32, 34, 43 neoclassical theory 119–20, 121, 123, 127, 129, 136 Nestlé 260–61 network approach to organisational structure 221–2 network economies 220–21 network industries 284–5 network resilience 181 networks communications 182, 220, 221 of trust 287–8 norms 290

objectives 234–5 octahedron and octahedral projection 174, 181 off-shoring 55, 220 OLI 'paradigm' 190 oligopoly theory 108–10 opportunity-seekers, entrepreneurs as 276–7 organisation decisions 304–5 organisational culture 107 organisational forms alternatives 235–6 diversity of 318–20, 324–5 see also organisational innovation in the multinational enterprise (MNE), historical perspective organisational innovation 107 organisational innovation in the multinational enterprise (MNE), historical perspective 241–3 conclusion 265–6 design of headquarters 249–53, 259–65 entrepreneurs in the host country 254–9 entrepreneurship 246–8 historical evidence 245–6 migration 248–9 proposed extension of internalisation theory 253–4 theoretical background 243–5 organisational structure 194–5, 221–33, 308–9 outcomes 99 output quotas 82 ownership 152, 153, 154, 191, 217, 219 papacy, 1200–1500; 306, 307 partitions 155–7 patents 82–3, 84, 290–91 pattern recognition 200 patterning 177–8 peer comparison 194 peer-to-peer decision-making 204–5 pentagons and pentagonal market areas 177, 178 pentahedral projection 172 people 141 perfect competition 108, 285 perfect information 196, 200–201, 285

Index

performance monitoring 234 performance of firms 218–21 physical infrastructure 280, 281–5, 287, 293–4 Planet Earth 1–2, 166–7, 312–13 planning 124 plant location see geometry (plant location) policy-making feedback loop 19 political crises 32, 34–6, 43 political instability 88–9, 250 political rivalry 3–4 political turbulence 8–10 see also populism; populist leadership polyhedra see geometry (plant location) pooling (cartels) 75, 76, 79, 82–3, 84 population pressure, and powerful nations extending control of territory 59 populism 9–10, 43 and business 18–21 perceived anomalies of 11–12 populist leadership 3–4, 13–16 consequences of 16–17 defeat of 17–18 and political crises 35 Porter, M.E. 118 power China 35, 64, 65, 67, 293, 294 economic, path to 64–5 imperial, and imperialism 64–7, 292–4 market 219 military 293 monopoly 219, 319 and strategic knowledge 62 United States (US) 65–7, 309 pragmatism 277 precautionary view of cartels 77, 78 Precious Metals Corporation 262 predatory view of cartels 77, 78 pressure groups 20–21 price 285 price-fixing cartels 80–81 price leadership 79 private enterprise, and infrastructure 280, 281, 284, 285 process complexity 148, 149–50, 157–8 product standards 290

337

production 151 classification 153, 154 export-oriented 60 linkages with marketing and R&D (systems view) 129–35 modular view of 124–5 vertical and horizontal integration 125–7 productive activity 217–18 productivity 44, 320 profession-specific advantage (PSA) 160–61 profit-making organisations, emergence of large-scale 316–17 profit-maximisation 129, 202–3 progressive view of cartels 77 proprietary technology 213–14, 291 provision of shared resources (cartels) 75, 76, 79 quantity-fixing and capacity-fixing, in declining industry 81–2 quotas, output 82 railways 278–9, 285, 294 rationality 95–6, 195–7, 206 R&D 127–8, 215, 314 linkages with production and marketing (systems view) 129–35 real-world complexity 148, 149, 150–51 recruitment 41 regulation 289, 290, 317 of trade (cartels) 75, 76, 79 reputation 288–9 research laboratories 251, 314 revolutionary change 302–3, 323 revolutions 31 risk 199, 244–5, 252 rivalry innovation 204–5 political 3–4 Rugman, A.M. 244 Sandeman, George 257–8 science, commercialisation of 314 sea 312–13 secondment of staff to overseas subsidiaries 249, 259

338

Global business

secrecy 127–8 security, and powerful nations extending control of territory 59 self-governing associations 289 self-interest 196 shareholders 96, 129, 203, 214, 277–8, 317 shipping industry 80–81 Singer 258 slavery 55, 307 social infrastructure 287–9, 290, 291, 293 social science of international business (IB) and integrated social science perspective 6, 9, 21–4, 89–90, 96–100 spatial dimension 1–3 speculation 37, 43–4, 74 spheres and spherical geometry see geometry (plant location) squares and square market areas 168–9, 177, 178 stagflation 38 static theories of decision-making 198, 200–201 steam power 311–12, 313 stock market crises 37 strategic decisions 250 strategic headquarters/detachment 250, 251, 252, 254, 260, 262–3 strategic knowledge 61–2 strategic technologies 62, 63, 66 structural complexity 148, 149–50 dimensions of analysis 151–2 measurement of, case study (simple IB model) 163–5 multiplexity 154–7 multiplicity 153–4 structure of an industry, mapping 136 subcontracting 215–17, 247 subsidiaries 5, 53, 54, 217, 225–7, 259 sunk costs 80, 83 supply 277 support services 220, 227–8, 229, 237 survival 202 syndicates 74 system-wide perspective 100 systems view 129–35 of industry 135–9

tax avoidance 5 tax havens 5, 252 teams 233–5 technological advantage/superiority 56–7, 293 technology 103, 290–91, 322, 323 civilian and military 58–9 historical development of 3, 310–12 instrumental 63, 66 proprietary 213–14, 291 strategic 62, 63, 66 transfer 50, 61–3 United States (US) 294 tetradecahedron 175 tetrahedron and tetrahedral projection 172, 181 time dimension 3–5 time in international business (IB), role of (historical perspective) 298–300 commercialisation of art and science 314 conclusion and implications for future research 323–5 culture and institutions 305–9 emergence of large-scale organisations for profit 316–17 expansion of IB and diversity of organisational forms 318–20 geography of Earth and human impact 312–13 learning methods 314–15 main trends, and impact of 313–22 marketing novel products 316 methodological issues 301–3, 322–3 new ways of working 317–18 scientific knowledge 310–12 theory 303–5 transport and communications 315 'too big to fail' 39 totalitarianism 43 trade, international 2–3, 52–4, 311, 318 trade unions 316–17 trading nations, and infrastructure 293–4 transfer pricing 4–5, 223 transport costs and network see geometry (plant location) transport infrastructure 281, 282, 283, 284, 285, 287, 315

Index

triangles and triangular market areas 169, 176, 177–8, 179 trouble-makers (crises) 30, 31, 33, 39, 45–6 trouble-shooters (crises) 30, 33, 40, 46 Trump, Donald and Trumpism 13, 16 truncation 176–7 trust 287–8 trusts 74, 77, 85 turbulence, political 8–10 see also populism; populist leadership uncertainty 199–200 United Kingdom (UK) cartels and national culture 85, 86 imperialism 64–5, 65–6 Industrial Revolution 294 investment flows, post-1945 period 121 United States (US) cartels and national culture 85–6

339

investment in UK and Europe 121, 122 power of 65–7, 309 superior knowledge and technology 294 Uppsala view 171 urban centres, growth of 315 utilities 283, 284–5 Verbeke, A. 244 vertical integration 125–6, 127–8, 129–31, 190–91 'vested interests' 21 victims of crises 30, 33, 39–40 Washington consensus 66 waste disposal 313 Williams, Trevor 258 Wilsdorf, Hans 255 work, changes in nature of 317–18