International Economics and the Growing Dominance of Multinational Corporations:

Explaining the Disconnect and Finding a New Approach for International Economics

by

Hendrik Van den Berg*

Abstract

Keywords: Culture, Neoclassical economics, Orthodoxy, Sociology, Dialectic, Marxism

* Instructor, Department of Economics, University of Massachusetts, Amherst, 217 Gordon, 218 North Pleasant St., Amherst, MA 01002, email: ; Professor Emeritus, Department of Economics, University of Nebraska, Lincoln.

I. Introduction

The models used by mainstream international economists have not kept up with the changing political, economic, and social conditions in the “globalizing” world economy. The standard model of international trade is still the Heckscher-Ohlin model, which assumes perfectly competitive markets, fixed factor endowments, profit maximizing behavior among firms and self-centered welfare maximization on the part of consumers. Models of international investment and international finance assume efficient markets, rational expectations, and full information. And, models of immigration are still based on the idea that people voluntarily move to maximize their personal well-being while the effects of immigration are analyzed in a labor market framework. The shortcomings of these approaches have been widely discussed and criticized, but to no avail in terms of how international economists go about analyzing, prescribing, and estimating the consequences of international economic activity. For example, the Heckscher-Ohlin framework is still used to estimate the gains from prospective trade agreements, immigration policy is still analyzed using the static labor market model of immigration, and open-economy macroeconomists were as blind to the possibility of a global financial crisis as were all mainstream economists in 2007. In fact, mainstream economists continue to tout free trade agreements, while they add little to the immigration debates going on in political circles throughout the world and they remain silent as governments dial back even the meager financial regulations enacted after the 2007-2009 global financial crisis.

The main reason for the inaction of international economists and the slow movement of economic thinking after major shifts in political, economic, and social circumstances is the failure of economists to understand the implications of the growing dominance of large multinational corporations in global economic activity, the political sphere, and in the formation of popular culture. This particular failure of international economists results requires a new way of thinking as well as a much broader perspective on what economists are supposed to do. I suggest a way forward: international economists should embrace Marx’s materialist dialectic.

The narrow mainstream perspective of economic activity as consisting of only exchange rather than a complete cycle of production, exchange, consumption, and indirect production, that is, Marx’s circuit of capital, will continue to hinder international economics. International trade is part of the whole circuit of capital, not an independent, isolated source of utility, and to assume that all gains from international trade are the result only of this exchange, without taking into consideration production, misses the fundamental source of human well-being. Yet, this is what mainstream international trade theory does. By focusing only on exchange, it is impossible to understand the full causes and consequences of international trade, especially now that trade is just one component of the overall activity of large corporations who produce, trade, employ labor, accumulate capital, and finance both short-term stocks and long-term investment and innovation throughout the global economy. Models of efficient markets tell us little about how large business organizations decide where to produce, what to export and import, who to employ, how much capital to accumulate, what technologies to develop, or how to maximize profits and, ultimately, how to extract surplus from their various global activities. Using mainstream terminology, international economics must become more holistic. That is, it must adopt a more dynamic, systemic, and inter-disciplinary approach. Comparative advantage is not static, and international trade involves commodities, commodities that are the result of production that requires human labor. All across the international economy there are complex systemic relationships between technology, resources, labor, production, consumption, and finance that extend beyond the simple markets international economists focus on. Furthermore, the economy is well-embedded in human society and the natural environment, which are both influenced by and causes of international economic activity. All economic activity is historical, in that economic activity takes place in within economic structures and social structures that developed over time. International economic activity takes place within structures that developed historically in many different places, in part influenced how those places were integrated into the international economic, political, and social structures. The were also shaped, in part, by the very same international economic activities they now influence.

Mainstream international trade theory’s depiction of international trade as nothing more than the exchange of products in order to exploit comparative advantage is“silly,” as the heterodox economist Michael Hudson (2018) recently suggested. We will make the case here for adopting the Marxian materialist dialectic, a “holistic” form of thought and analysis, in international economictheory, analysis, and education. This dialectic will bring out the importance of the modern multinational corporation in all international economic activity. The quest for surplus has led business firms to extend their activity across borders, and the largest firms today are those who extended themselves into the world economy most successfully at the expense of national firms. The wealthy class associated with these large firms now dominates within nations and across national boundaries, effectively becoming the contemporary ruling class. This political reality is shaping current political, economic, and social outcomes.

II. The Growing Economic and Social Dominance of Multinational Corporations

The growing concentration of most industries in the United States and in the World has been well-documented. According to a report for the Brookings Institute, a rather mainstream organization, by William Galston and Clara Hendrickson (2018), the Fortune 500’s revenue as a share of GDP has increased from 58 percent to 73 percent since 1980. The share of the largest 100 has risen from 33 percent to 46 percent. They conclude: “Over the last two decades, over 75 percent of U.S. industries have seen an increase in concentration, with the number of firms competing against one another in precipitous decline.” Along with the rise in concentration, corporate profits have risen sharply: Shapiro (2017) finds that corporate profits made up 7-8 percent of GDP in the mid-1980s, but is now in the 11-12 percent range.[1] The Economist finds, furthermore, that today’s firms are much more likely to remain profitable for longer periods, suggesting that persistently high profits remain unchallenged for longer periods of time.[2] Grullon, Larkin, and Michaely (2017) investigate recent mergers in the U.S. economy, and they find many different manifestations of industrial concentration, not least the lax enforcement of anti-trust laws and the near complete freedom for large firms to buy smaller rivals: …authorities are less likely to investigate a $20 billion form buying ten $1 billion firms that a similar firm buying a $10 billion firm. Gao, Ritter, and Zhu (2013) found that the main reason for the near disappearance of IPOs over the past two decades is that innovative startups are now much more likely to sell their assets directly to a larger firm than to go public.

Grullon et al. (2017) also look at the role of foreign competition in mitigating the consequences of increased concentration in the U.S., but they find that neither the presence of foreign firms nor import competition substantially changes the strong relationship between concentration measures and firm profitability.[3] International competition has often been suggested as a source of competition, but that channel does not seem to be offsetting the effects of concentration in corporate profits. Of course, when similar increases in concentration are occurring in all countries, and the firms operating in each country are the increasingly multinational firms rather than local firms, foreign firms are no longer adding much to competition levels in national economies.

Pol Antràs and Stephen Yeaple (2014) collected a wide range of data on the operations of multinational firms, and they distinguished the following general characteristics of firms that operate internationally:

  1. Most multinational business activity occurs in developed economies, and developing countries were more likely to be the destination of multinational activity than the source.
  2. The relative importance of multinationals in economic activity is higher in capital intensive and R&D intensive goods,
  3. A substantial share of two-way FDI flows is intra-industry in nature.
  4. The parents and the affiliates of multinational firms tend to be larger, more productive, more R&D intensive, and more export oriented than non-multinational firms.
  5. Within multinationals, parents are relatively specialized in R&D while affiliates are primarily engaged in selling goods in foreign markets.
  6. Cross-border mergers and acquisitions make up a large fraction of FDI and are particularly important mode of entry into developed countries.

The implications of these general findings are obvious. Multinational firms have grown in importance because they are more productive, conduct more R&D, and specialize and trade more than non-multinationals. Furthermore, multinational firms are engaged in extending the capitalist accumulation process into developing countries with new investments, but within the more developed capitalist economies, they are primarily engaged in concentrating production by acquiring competitors. Helpman (1984) showed that intrafirm trade is correlated with factor endowment differences across countries, suggesting that FDI is often used to take advantage of comparative advantages across borders. The finding that most FDI occurs between similarly-endowed developed economies suggests that, indeed, most FDI serves to concentrate ownership, which conforms with findings elsewhere that globalization has not offset concentrations within individual economies. Concentration of production occurs within and across countries, with the result that multinational firms control an increasing share of economic activity worldwide.

Pol Antràs and Stephen Yeaple (2014) find evidence suggesting that greenfield investments and M&A are not equivalent, even though the efficient markets literature suggests that they should be. More productive firms tend to engage in greenfield investments more often. Another issue is that greenfield investments add to competition while M&A investments reduce competition; this latter phenomenon seems to dominate FDI between developed economies. The prediction that wage inequality should decline, as suggested by the Stolper-Samuelson theorem, does not seem to be supported by the evidence.

Antràs and Yeaple point out that while vertical integration may be common to many large multinational firms, many multinationals that offshore production do so not by opening their own foreign production plants, but by contracting with other producers. This brings up the issue of why firms choose to internalize production across borders instead of operating at arms length with foreign suppliers, licensors, and distributors. The Singer Co. learned back in 180 that internalization, despite its investment costs, may be more profitable than licensing. Contract theory, and the imperfections of contracting, have been used by economists to predict FDI flows. The new institutional economics, with its focus on transactions costs, provided much of the impetus for this research in international economics. Rent dissipation and hold-up problems may lead to direct foreign investment, either by creating an affiliate production or distribution operation abroad or by acquiring and directly controlling a foreign operation. Also, high firm-specific economies of scale relative to plant-specific economies of scale generally favors FDI over contracting. And, ownership per se raises bargaining power, no matter what the combination of international arrangements.

All of these conclusions by researchers examining the growth of multinational firms confirm that, indeed, industrial concentration is occurring. However, there is little discussion within the field of international economics with the deeper causes and consequences of this global concentration of production, profit, and power. Specifically, the current discourse in international economics has stranded on an unproductive path, along which a narrow set of issues are discussed within a narrow theoretical framework that ignores the changed power structure within the international sphere of economic activity. Not only are multinational corporations (MNCs) responsible for most of the world’s international trade and international investment, but they increasingly “capture” government institutions. Technically, as the overall stakes from international economic integration rise, policy makers’ political ability to close borders gives them power over MNCs and international financial corporations. On the other hand, MNCs seem to be getting the upper hand in their relationship with governments because international economic integration lets MNCs play one government against another. That is, commercial interests no longer bargain with a single national government about how they pay for protection and favoritism, but with open borders they can threaten to take their taxes, political contributions, investment projects, and jobs elsewhere if one national government’s terms are not to their liking. Of course, the superior ability to accumulate wealth also gives MNCs the economic power to shape national and international institutions in their favor. They engage in lobbying, public relations, advertising, marketing, and other exercises to solidify their political and economic power.

Modern Mercantilism?

It is important to note that even when Smith (1776 [1976]) was writing about why free trade is beneficial for human well-being, most international trade was being carried out within colonial empires, and among very unequal trading partners. So when Smith criticized mercantilism, he was effectively criticizing the business culture of his day. Unfortunately for subsequent historical analysis, Smith framed his criticism of mercantilism in a very simplistic manner, defining mercantilism as little more than the attempt by countries to accumulate gold by boosting exports and restricting imports. This interpretation of mercantilism persists in the international economics literature. More appropriate is Charles Wilson’s (1963, p. 26) definition of mercantilism as “all the devices, legislative, administrative, and regulatory, by which societies still predominantly agrarian sought to transform themselves into trading and industrial societies.”

As described by Marx and many other historians, sixteenth century Europe mercantilism solidified the political base of national monarchs at the expense of the local feudal relationships that remained from earlier feudal societies. Mercantilism is characterized not only by actively managed international trade, but also by the primitive accumulation and strengthening of property rights detailed by Marx in his Capital. When the same alliances between central governments and commercial interests were extended overseas, mercantilism becamecolonialism, the government-private conquests of overseas territory and resources.

The growth of modern MNCs, which increasingly shape government policy by using a combination of direct monetary influence and indirect threats to shift investment and employment overseas, as a new phase of mercantilism, one in which government is very much the junior partner in the power arrangement. As a result of the political clout of wealthy and footloose MNCs, the internationally integrated economic system is increasingly characterized by formal and informal institutions that raise MNC profits and reduce political and economic opposition to corporate power and profit. Voters increasingly vote for right-wing and libertarian politicians who lower taxes on capital, scale back labor laws and union power, and accept “the market” as a symbol of not only economic efficiency, but also of justice.

The fact is that markets can only function in the presence of rather sophisticated government institutions, such as a legal system that enforces property rights and contractual arrangements, a justice system that arbitrates business disputes, regulations that require information on products and firms’ financial conditions, andregulations that prevent the financial sector from stealing the savings entrusted to its care. It is this need for collective institutions in a market system plus the likelihood that the private business enterprises that arise under these institutions will gain disproportionate power to shape the institutions in their favor that has led many intellectuals since the time of the Enlightenment to argue that government should be democratic. The self-interested behavior of individuals and wealthy firms will not maximize overall human well-being unless the institutions that shape the individual behavior are designed with the public interest in mind. MNCs are using their huge financial wealth to corrupt democratic political systems and to shape institutions that give them greater freedom of operation. Large entertainment MNCs have even come to control most of the news media around the world, and MNCs increasingly use their money to influence universities and other educational institutions to manipulate people’s beliefs and society’s cultures. MNC-funded advocacy groups have even influenced appointments to the U.S. Supreme Court, which in 2010 returned the favor by ruling that corporations are effectively individuals with unlimited freedom to directly fund political campaigns.