IAR 512 (directed studies): Multinational Firms and Policy Issues in Asia-Pacific (policy studies in firms, technology and environment in Asia-Pacific) Many policy decision problems in the private and public sectors must take into account firm behaviour. By definition (e.g. their legal status) firm behaviour is primarily driven by economic incentives. This is particularly so in market economies where firms’ legal status (e.g. as tax payers) is usually based on their capacity as an on-going profitable concern. Exceptions to the above class of economic firms include firms depending on permanent government subsidies for survival. Such firms may be viewed as a government agency in disguise.

Many aspects of firm behaviour are relevant for public policy decision making in economic planning, technology / environmental management, resource consumption / waste management, and development. They include the following. (1)Economic efficiency (profit maximization, cost minimization, trade off at the margin, incentives, ) (2)The owners and stakeholders of firms, corporate governance (3)Multinational activity, international business, FDI, Technology transfer (4)Environmental management (5) Technology management (production methods, IPR protection/strategy, standard setting and first mover advantage) (6) Protection of intellectual property rights, joint research, enforcement of contracts, product liability What is the role of government policies in the above areas of firm behaviour?

(1)Economic efficiency (profit maximization, cost minimization, trade off at the margin, incentives, ) Profits are maximized, or equivalently, the cost is minimized, subject to constraints. Issues: How is the profit/cost calculated? What are the constraints? What is the product market like? Competitive, or monopolistic? Why? What are the (production) factor markets (e.g. labour, capital) like? Competitive, or non-competitive? Why? Who are the competitors? What are the government regulations like for your business? Transparent? Corruptive? What kinds of subsidies are available to firms? (E.g. R&D subsidy, wage subsidy, tax subsidy, export/import subsidy,....) What are the incentives of the workers, capital providers, government regulators,...?

Issues (continued): How is the business environment? What is the role of political interference in your business area? What are the international elements affecting firm baheviour? (Export/import markets? Exchange rates? International competition? WTO,.....) What roles are there for public policies? (2)The owners and stakeholders of firms, corporate governance Who owns firms? Usually the owners of firms are their shareholders. The founders of a firm provided the initial capital for setting up the firm. They might become the managers of the firm themselves, or hire others as the managers of the firm. The task of a hired firm manager (broadly defined, including executives) is to work to maximize firm profit for the owner of the firm. One serious incentive problem: the manager (an agent of the owner) may try to use his/her time and efforts to maximize his/her own utility, rather than maximize firm profit. (Called an agency problem. This exists under many other circumstances.)

(2)The owners and stakeholders of firms, corporate governance (continued) Agency problem does not exist if the firm founder is the sole manager of the firm (why?) In countries where firms play a significant economic role, corporate governance rules / mechanisms exist to oversee company managers’ behaviour. Corporate governance mechanisms vary from one country to another. In Anglo-American countries (e.g. the U.S., the U.K., Canada, Australia), corporate governance rules generally enforce the firm managers to behave in such a way that firm profit, or more broadly, the firm’s market value, is maximized. In other words, managers are there to serve the owners of the firm who want firm value to be maximized. (Shareholder value maximization.) Anglo-American corporate governance mechanisms are the current (de facto) world standard corporate governance rules. Emphasis on Western liberal norms, transparency, property ownership, etc. In Japan and some continental European countries (e.g. Germany, Italy, France) maximization of the welfare of the stakeholders (broadly defined) of the firm, including the owner, the workers, the creditors, and often the suppliers and customers of the firm, is emphasized in their corporate governance mechanisms. (Stakeholder welfare maximization.)

Note: market value of a firm (sometimes called firm value) and firm profit Firms’ profits are typically measured (in accounting sense) for each business reporting period (e.g. quarter, year). Precise accounting definitions (which are often difficult to implement precisely) exist for calculating firms’ profits for each reporting period for which taxes are levied by the government. (Generally, profit=revenue–cost; revenue=output unit price x quantity sold; cost=production (input) factor unit price x quantity used A firm’s market value is the price someone has to pay to buy the firm from the current owner(s) and is usually calculated as: A firm’s market value = (share price) x (the number of outstanding shares). Actually the real price the new buyer must pay is the sum of the above total equity market value and the value of the firm’s outstanding debt.

In a simplified world, the value of a share represents simply the present value of all future profits (and/or dividents) that belong to the owner of a share. This may be described as follows: suppose the firm’s profit is $y per share in every period in the future. Then [the value of a share = $ (y/r)], where r is some discount rate (or interest rate, cost of capital). Suppose r=0.1 (i.e. 10%) and y=$100. Then the above share price = $(100/0.1) = $1,000. This is equivalent to saying that the firm’s one share means owning $1,000 in a saving account at a bank at a 10% interest. In practice, both y and r are uncertain, and so are many factors which affect stock prices and discount rates. In Anglo-American countries (e.g. the U.S., the U.K., Canada, Australia), corporate governance rules generally enforce the firm managers to behave in such a way that firm profit, or more broadly, the firm’s market value, is maximized. In other words, managers are there to serve the owners of the firm who want firm value to be maximized. (Shareholder value maximization.) E.g. managers are asked to choose new investment projects that maximize their firms’ market value. Anglo-American corporate governance rules are being imported into East Asia (Japan, South Korea, China) but their implementation is facing some challenges. (To be discussed later.)

(3)Multinational activity, international business, FDI, Technology transfer (Ref: No country, developed or developing, can ignore international trade. Similarly, few firms can survive without international business content. See (slide1) Reasons: - International trade enjoys much faster growth than domestic economy - International business expands firms’ profit opportunities - International division of labour consistent with efficient production (generally consistent with the comparative advantage theory)  the driving force for free trade Concerns: - Developed nations may dictate the terms of trade, inhibiting the growth of industries of developing nations  the basis for the infant industry argument - Developed nations generally want level field for trade  want no trade restrictions Regulations - Countries, both developed and developing, may want to impose trade restrictions (e.g. tariffs, VERs, import quantity limits) - Members of the WTO promise to abide by WTO rules on trade - WTO allows for country-specific exceptions for both all developing and some developed countries

Majority of international trade is conducted by affiliated firms, i.e. the trade between the parent firm in a developed country (home country) and its affiliated companies in developed/developing countries is very commonly done. Why? Multinational firms trust its affiliated firms more than other firms; Intra-firm trade is much more profitable than otherwise (issues on transfer pricing) Multinational firms’ affiliated firms in overseas locations are called “foreign direct investment (FDI)” FDI represents firms’ overseas investment projects which involve production of goods and/or services; to be distinguished from portfolio investment in securities WTO rules do not yet apply to FDI projects But regional free trade zones / economic unions enforce their own trade rules as well as other types of rules (e.g. tariffs on imports) (e.g. NAFTA, the EU) Also bilateral free trade agreements (FTAs) An important function of FDI is technology transfer (both planned and unplanned)

Policy measures for international trade and FDI Tariffs and other types of import restrictions WTO rules Rules for free trade zones (NAFTA rules, EU rules) Export zones and tax policy for FDI projects FDI and technology transfer Ownership of FDI projects (e.g. cap on foreign ownership)

Types of ownership forms for FDI Various forms (structures) of FDI See: (FDI1)FDI1 (UNCTAD data on FDI)

Remaining topics: (4)Environmental management (5) Technology management (production methods, IPR protection/strategy, standard setting and first mover advantage) (6) Protection of intellectual property rights, joint research, enforcement of contracts, product liability What is the role of government policies in the above areas of firm behaviour?