23 Things They Don't Tell You About Capitalism

companies are home-country nationals, there is bound to be some home-country bias in their decisions. Although free-market economists dismiss any motive other than pure self-seeking, ‘moral’ motives are real and are much more important than they lead us to believe (see Thing 5).

On top of those personal feelings of managers, a company often has real historical obligations to the country in which it has ‘grown up’. Companies, especially (although not exclusively) in the early stages of their development, are often supported with public money, directly and indirectly (see Thing 7). Many of them receive direct subsidies for particular types of activities, such as equipment investment or worker training. They sometimes even get bailed out with public money, as Toyota was in 1949, Volkswagen in 1974 and GM in 2009. Or they may get indirect subsidies in the form of tariff protection or statutory monopoly rights.

Of course, companies often fail to mention, and even actively hide, such history, but there is an unspoken understanding among the relevant parties that companies do have some moral obligations to their home countries because of these historical debts. This is why national companies are much more open to moral suasion by the government and the public than foreign companies are, when they are expected, although cannot be legally obliged, to do something for the country against their (at least short-term) interests. For example, it was reported in October 2009 that South Korea’s financial supervisory agency was finding it impossible to persuade foreign-owned banks to lend more to small and medium-sized companies, even though they, like the nationally owned banks, had already signed an MOU (memorandum of understanding) about that with the agency, when the global financial crisis broke out in the autumn of 2008.

Important though the moral and historical reasons are, by far the most important reason for home-country bias is economic – the fact that the core capabilities of a company cannot be easily taken across the border.

Usually, a company becomes transnational and sets up activities in foreign countries because it possesses some technological and/or organizational competences that the firms operating in the host countries do not possess. These competences are usually embodied in people (e.g., managers, engineers, skilled workers), organizations (e.g., internal company rules, organizational routines, ‘institutional memory’) and networks of related firms (e.g., suppliers, financiers, industrial associations or even old-boy networks that cut across company boundaries), all of which cannot be easily transported to another country.

Most machines may be moved abroad easily, but it is much more costly to move skilled workers or managers. It is even more difficult to transplant organizational routines or business networks on to another country. For example, when Japanese automobile companies started setting up subsidiaries in Southeast Asia in the 1980s, they asked their subcontractors also to set up their own subsidiaries, as they needed reliable subcontractors. Moreover, these intangible capabilities embodied in people, organizations and networks often need to have the right institutional environment (the legal system, informal rules, business culture) in order to function well. However powerful it may be, a company cannot transport its institutional surroundings to another country.

For all these reasons, the most sophisticated activities that require high levels of human and organizational competences and a conducive institutional environment tend to stay at home. Home biases do not exist simply because of emotional attachments or historical reasons. Their existence has good economic bases.

‘Prince of darkness’ changes his mind

Lord Peter Mandelson, the de factodeputy prime minister of the UK government at the time of writing (early 2010), has a bit of a reputation for his Machiavellian politics. A grandson of the highly respected Labour politician Herbert Morrison, and a TV producer by profession, Mandelson was the chief spin doctor behind the rise of the so-called New Labour under Tony Blair. His famous ability to sense and exploit shifts in political moods and accordingly organize an effective media campaign, combined with his ruthlessness, earned him the nickname ‘prince of darkness’.

After a high-profile but turbulent cabinet career, marred by two resignations due to suspected corruption scandals, Mandelson quit British politics and moved to Brussels to become European Commissioner for Trade in 2004. Building on the image of a pro-business politician, gained during his brief spell as the UK’s Secretary of State for Trade and Industry back in 1998, Mandelson established a firm reputation as one of the world’s leading advocates of free trade and investment.

So it sent out a shockwave, when Mandelson, who had made a surprise comeback to British politics and become Business Secretary in early 2009, said in an interview with the Wall Street Journalin September 2009 that, thanks to Britain’s permissive attitude towards foreign ownership, ‘UK manufacturing could be a loser’, even though he added the proviso that this was ‘over a lengthy period of time, certainly not overnight’.

Was it a typical Mandelson antic, with his instinct telling him that this was the time to play the nationalist card? Or did he finally cotton on to something that he and other British policy-makers should have realized a long time ago – that excessive foreign ownership of a national economy can be harmful?

Now, it may be argued, the fact that firms have a home-country bias does notnecessarily mean that countries should put restrictions on foreign investment. True, given the home bias, investment by a foreign company may not be in the most desirable activities, but an investment is an investment and it will still increase output and create jobs. If you put restrictions on what foreign investors can do – for example, by telling them that they cannot invest in certain ‘strategic’ industries, by forbidding them from holding a majority share or demanding that they transfer technologies – foreign investors will simply go somewhere else and you will lose the jobs and the wealth that they would have created. Especially for developing countries, which do not have many national firms that can make similar investments, rejecting foreign investment because it is foreign many people believe is frankly irrational. Even if they get only lower-grade activities such as assembly operation, they are still better off with the investment than without it.

This reasoning is correct in its own terms, but there are more issues that need to be considered before we conclude that there should be no restriction on foreign investment (here, we put aside portfolio investment, which is investment in company shares for financial gains without involvement in direct management, and focus on foreign direct investment, which is usually defined as acquisition of more than 10 per cent of a company’s shares with an intent to get involved in management).

First of all, we need to remember that a lot of foreign investment is what is known as ‘brownfield investment,’ that is, acquisition of existing firms by a foreign firm, rather than ‘greenfield investment’, which involves a foreign firm setting up new production facilities. Since the 1990s, brownfield investment has accounted for over half of total world foreign direct investment (FDI), even reaching 80 per cent in 2001, at the height of the international mergers and acquisitions (M&A) boom. This means that the majority of FDI involves taking control of existing firms, rather than the creation of new output and jobs. Of course, the new owners may inject better managerial and technological capabilities and revive an ailing company – as seen in the case of Nissan under Carlos Ghosn – but very often such an acquisition is made with a view to utilizing capabilities that already exist in the acquired company rather than creating new ones. And, more importantly, once your national firm is acquired by a foreign firm, the home bias of the acquiring company will in the long run impose a ceiling on how far it progresses in the internal pecking order of the acquiring company.

Even in the case of greenfield investment, home-country bias is a factor to consider. Yes, greenfield investment creates new productive capabilities, so it is by definition better than the alternative, that is, no investment. However, the question that policy-makers need to consider before accepting it is how it is going to affect the future trajectory of their national economy. Different activities have different potentials for technological innovation and productivity growth, and therefore what you do today influences what you will be doing in the future and what you will get out of it. As a popular saying among American industrial policy experts in the 1980s went, we cannot pretend that it does not matter whether you produce potato chips, wood chips or microchips. And the chance is that a foreign company is more likely to produce potato chips or wood chips than microchips in your country.

Given this, especially for a developing country, whose national firms are still underdeveloped, it may be better to restrict FDI at least in some industries and try to raise national firms so that they become credible alternative investors to foreign companies. This will make the country lose some investment in the short run, but it may enable it to have more higher-end activities within its borders in the long run. Or, even better, the developing country government can allow foreign investment under conditions that will help the country upgrade the capabilities of national firms faster – for example, by requiring joint ventures (which will promote the transfer of managerial techniques), demanding more active technology transfer, or mandating worker training.