Now we’re all looking for ways to break out of filter bubble, I guess I can feel less guilty about loving The Economist. Beautifully written, it covers places and issues other papers ignore, and every so often has a big standback piece that makes you rethink. This week’s cover story, ‘the retreat of the global company’, is a fine example. Excerpts from the 4 page briefing:
‘25 years ago, with the Soviet Union collapsing and China opening up, a sense of destiny gripped Western firms; the “end of history”, in which all countries would converge towards democracy and capitalism.
Companies became obsessed with internationalising their customers, production, capital and management, enthusiastically buying rivals, courting customers and opening factories wherever the opportunity arose. Though the trend started in the rich world, it soon caught on among large companies in developing economies, too. And it was huge: 85% of the global stock of multinational investment was created after 1990, after adjusting for inflation (see chart 1).
Such a spree could not last forever; an increasing body of evidence suggests that it has now ended. In 2016 multinationals’ cross-border investment probably fell by 10-15%. Impressive as the share of trade accounted for by cross-border supply chains is, it has stagnated since 2007 (see chart 2). The proportion of sales that Western firms make outside their home region has shrunk. Multinationals’ profits are falling and the flow of new multinational investment has been declining relative to GDP. The global firm is in retreat.
To understand why this is, consider the three parties that made the boom possible: investors; the “headquarters countries” in which global firms are domiciled; and the “host countries” that received multinational investment.
Investors saw a huge potential for economies of scale. As China, India and the Soviet Union opened up, and as Europe liberalised itself into a single market, firms could sell the same product to more people. And as the federation model was replaced by global integration, firms would be able to fine-tune the mix of inputs they got from around the world—a geographic arbitrage that would improve efficiency. From the rich world they could get management, capital, brands and technology. From the emerging world they could get cheap workers and raw materials as well as lighter rules on pollution.
These advantages led investors to think global firms would grow faster and make higher profits. That was true for a while. It is not true today. The profits of the top 700-odd multinational firms based in the rich world have dropped by 25% over the past five years. The profits of domestic firms rose by 2%.
Individual bosses will often blame one-off factors: currency moves, the collapse of Venezuela, a depression in Europe, a crackdown on graft in China, and so on. But the deeper explanation is that both the advantages of scale and those of arbitrage have worn away. Global firms have big overheads; complex supply chains tie up inventory; sprawling organisations are hard to run. Some arbitrage opportunities have been exhausted; wages have risen in China; and most firms have massaged their tax bills as low as they can go. The free flow of information means that competitors can catch up with leads in technology and know-how more easily than they used to. As a result firms with a domestic focus are winning market share.
In the “headquarters countries”, the mood changed after the financial crisis. Multinational firms started to be seen as agents of inequality. They created jobs abroad, but not at home. The profits from their hoards of intellectual property were pocketed by a wealthy shareholder elite. Political willingness to help multinationals duly lapsed.
Of all those involved in the spread of global businesses, the “host countries” that receive investment by multinationals remain the most enthusiastic. The example of China, where by 2010 30% of industrial output and 50% of exports were produced by the subsidiaries or joint-ventures of multinational firms, is still attractive.
But there are gathering clouds. China has been turning the screws on foreign firms in a push for “indigenous innovation”. Bosses say that more products have to be sourced locally and intellectual property often ends up handed over to local partners. Strategic industries, including the internet, are out of bounds to foreign investment. Many fear that China’s approach will be mimicked around the developing world, forcing multinational firms to invest more locally and create more jobs—a mirror image of the pressures placed on them at home.
The jobs and exports that can be attributed to multinationals are already a diminishing part of the story. In 2000 every billion dollars of the stock of worldwide foreign investment represented 7,000 jobs and $600m of annual exports. Today $1bn supports 3,000 jobs and $300m of exports.
The last time the multinational company was in trouble was in the aftermath of the Depression. Between 1930 and 1970 their stock of investment abroad fell by about a third relative to global GDP; it did not recover until 1991. Some firms “hopped” across tariffs by building new factories within protectionist countries. Many restructured, ceding autonomy to their foreign subsidiaries to try to give them a local character. Others decided to break themselves up.
Today multinationals need to rethink their competitive advantage again. Some of the old arguments for going global are obsolete—in part because of the more general successes of globalisation. Most multinationals do not act as internal markets for trade. Only a third of their output is now bought by affiliates in the same group. External supply chains do the rest. Multinational firms no longer have a lock on the most promising ideas about management or innovation.
Many industries that tried to globalise seem to work best when national or regional. Retailers such as Britain’s Tesco and France’s Casino have abandoned many of their foreign adventures. America’s telecoms giants, AT&T and Verizon, have put away their passports. Financial firms are focusing on their “core” markets.
It looks as if, in the future, the global business scene will have three elements. A smaller top tier of multinational firms (e.g. General Electric) will burrow deeper into the economies of their hosts, helping to assuage nationalistic concerns.
The second element will be a brittle layer of global digital and intellectual-property multinationals: technology firms, such as Google and Netflix; drugs companies; and companies that use franchising deals with local firms as a cheap way to maintain a global footprint and the market advantage that brings. The hotel industry, with its large branding firms such as Hilton and Intercontinental, is a prime example.
The final element will be perhaps the most interesting: a rising cohort of small firms (‘multinationalettes’) using e-commerce to buy and sell on a global scale.
The result will be a more fragmented and parochial kind of capitalism, and quite possibly a less efficient one—but also, perhaps, one with wider public support. And the infatuation with global companies will come to be seen as a passing episode in business history, rather than its end.’