Multinationals and the U.S. Technology Base

September 1994

OTA-ITE-612

NTIS order #PB95-109708

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Recommended Citation: U.S. Congress, Office of Technology Assessment, Multinationals

and the U.S. Technology Base, OTA-ITE-612 (Washington, DC: U.S. Government

Printing Office, September 1994).

For Sale by the U.S. Governmnt Printing Office

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M

While

Foreword

ultinational firms are critical to ensuring the health of the U.S. technology base. The most technologically sophisticated and economically significant sectors of the U.S. economy are now characterized by high levels of international production, foreign direct investment, trade among affiliated

companies, and complex forms of international financial and technological collaboration.

it is not wrong to speak of the global research and technology base of multinational firms, it can be

misleading. Extensive data suggest that technology is deeply rooted in national (or in the case of Europe, regional) concentrations or bases, with partial and company-specific interconnections. The implication of this

finding for public policy is that the U.S. national technology base must be well-maintained on a continuous

basis. Moreover, in order for the United States to retain its technology leadership in a broad range of industries,

it must address the increasingly important role of multinational enterprises in innovation and in the development of the nation’s science and technology base.

Governments understand that the health of the national technology base is related not just to R&D spending,

but also to the strategic investment behavior of companies, especially multinationals. Such investment increasingly crosses national borders. Between 1980 and 1992, global foreign direct investment grew by over a

factor of four to reach $2.0 trillion (in nominal dollars). This surge of investment transformed the world economy. Rather than substituting locally produced goods and services for imports, however, investment has augmented and created trade, often through international transfers of merchandise within networks of affiliated

firms.

Despite a dramatic increase in international business activities of all kinds, most multinationals remain

firmly rooted in the national technical, financial, and corporate cultures of their home countries, World economic integration is occurring at uneven rates, both in relation to the core technology operations of companies

and with respect to overall trade and investment relations among nations.

For the foreseeable future, it is unlikely that differences in national patterns of technology development,

direct investment, long-term finance, and corporate governance will converge. These differences may be the

source of increasing friction in the more complex economic relationships evolving among the United States

and its major trading and investing partners.

This is the second and final report of OTA’s assessment of Multinational Firms and the U.S. Technology

Base. The first report, Multinationals and the National Interest: Playing by Different Rules, was published in

September 1993. This assessment was requested by the Senate Committee on Commerce, Science, and Transportation and the Senate Committee on Banking, Housing, and Urban Affairs. Over the course of this assessment, OTA worked closely with many MNEs based in the United States, Europe, and Japan. The information

they provided was invaluable to the conduct of this study. OTA also appreciates the assistance provided by its

contractors and the advisory panel, as well as by the many reviewers whose comments helped to ensure the

accuracy of this report.

ROGER C. HERDMAN

Director

. . .

Ill
Lawrence M. Friedman

Chairman

Marion Rice Kirkwood

Professor of Law

Stanford Law School

Jay Chai

Chairman and CEO

Itochu International, Inc.

Alfred Chandler

Straus Professor of Business

History, Emeritus

Harvard Business School

Lance Compa

Administrative Officer

Washington-Baltimore

Newspaper Guild

Stanley J. Fidelman’

Senior Vice President,

Engineering, Safety and the

Environment

Merck and Co., Inc.

R. Scott Fosler

President

National Academy of Public

Administration

William Greider

National Editor

Rolling Stone

Richard W. Heimlich

Corporate Vice President for

International Strategy

Motorola, Inc.

Robert J. Hermann

Vice President, Science and

Technology

United Technology Corp.

Theodore J. Lowi

John L. Senior Professor of

American Institutions

Cornell University

David A. Markle

Vice President, Advanced

Technology

Ultratech Stepper, Inc.

Oscar B. Marx, Ill

Vice President Automotive

Components Group

Ford Motor Company**

William D. Mulholland

Bank of Montreal

James F. Rill

Partner

Collier, Shannon, Rill and Scott

Richard B. Samuels

Ford International Professor

Director of MIT Japan Program

Massachusetts Institute of

Technology

Peter Schavoir

IBM Corp. (Retired)

Steven Schlossstein

President

SBS Associates, Inc.

Harley Shaiken

Professor, Department of

Communications

University of California,

San Diego

Raymond Vernon

Clarence Dillon Professor of

International Affairs, Emeritus

John F. Kennedy School of

Government

Andrew W. Wyckoff

Head of the Economic Analysis

Section

Directorate for Science,

Technology and Industry

Organisation for Economic

Co-operation and Development

* Deceased.

* *Mr. Marx recently retired from Ford and has taken a position as President and CEO of Electro-Wire Products.

Note: OTA appreciates and is grateful for the valuable assistance and thoughtful critiques provided by the advisory panel members.

The panel does not. however, necessarily approve, disapprove, or endorse this report. OTA assumes full responsibility for the report

and [he accuracy of its contents.

iv
Project Staff

Peter D. Blair, Assistant Director, OTA

Industry, Commerce & International Security Division

Audrey B. Buyrn, Program Director

Industry, Technology, and Employment Program

William W. Keller, Project Director

Paul N. Doremus

Kenneth E. Freeman

PRINCIPAL CONTRACTORS

Louis W. Pauly

Simon Reich

CONTRACTORS

David J. Eichberg

Yoshiko Koala

Takashi Mashiko

Elizabeth Sheley

Gregory S. Tsarnas

ADMINISTRATIVE STAFF

Diane D. Jackson

Louise Staley

v
contents

Part 1: Summary, Findings, and

Policy Options 1

Executive Summary 1

1 Globalization in Perspective 5

Finding 1: Multinationals Develop Core Technology

at Home 6

Finding 2: Trade Follows Investment in the 1990s 13

Finding 3: Corporate Governance and Finance Diverge

Across the Triad 19

2 U.S. Technology Policy in International

Economic Perspective 23

The Policy Context 23

Policy Issues and Options 30

Part H: National Technology Innovation and

Multinational Firms 45

Findings 46

3 The U.S. Technology Base in Comparative

Perspective 49

National Innovation Systems: Structural

Differences 50

National Innovation Systems: Performance

Patterns 59

Conclusions 72

4 Multinationals and the Location

of Innovation 75

The Location of Research and Development 76

Technology Trade 90

International Technical Alliances 96

Conclusions 99

Part Ill: Trade and Investment in the Triad 101

Findings 102

5 Trends in Foreign Direct Investment 105

Global Trends in Inward and Outward Investment 106

vii
Explaining Recent Shifts in Global FDI 112

Mergers and Acquisitions, Strategic Alliances, and

Joint Ventures 115

The Dynamic Character of FDI in the United

States 118

Investment Balances across the Triad 122

6 Multinational Firms and International

Trade 129

The Trade and Investment Nexus 130

Forms of FDI-Contributions to the U.S. Technology

Base 150

Part IV: Corporate Foundations of National

Technology Systems 155

Findings 156

7 Corporate Governance and National

Technology Systems 159

Corporate Governance in the United States 160

Corporate Governance in Japan 163

Corporate Governance in Germany 169

Conclusions 173

8 Corporate Finance and National

Technology Systems 179

Financial Market Structure in the United States 180

Financial Market Structure in Japan 183

Financial Market Structure in Germany 185

Conclusions 187

APPENDIXES

A Glossary 1 9 3

B Summary of the First Multinationals

Report (September 1993) 196

C Competition Policy Across the Triad 199

D Data Note 203

Index 205

. . . Vlll
Part I: Summary,

Findings,

and

Policy Options

EXECUTIVE SUMMARY

M

ultinational enterprises (MNEs) are business organizations that underpin much of the U.S. economy and the

international system of trade and investment. They are

increasingly global in their origins, sourcing, communications, production, and outlook. The foreign affiliates of

MNEs control a substantial portion of the world economy, perhaps as much as one-quarter of all economic activity in their host

countries. Intrafirm trade (IFT) may account for as much as 40

percent of all U.S. merchandise trade. ]

Even though MNEs exert an increasingly profound influence

on technology development in the United States, the U.S. government currently does not have the institutions or the capability to

monitor and analyze foreign direct investment (FDI) on a global

basis, or to evaluate fully the investments by foreign-based companies in the United States. Clearly, a comprehensive understanding of the operations of MNEs is necessary to facilitate their

benefits to the U.S. technology base, as well as to inform future I I L

U.S. economic policies, both foreign and domestic. 17? Klh’-”tl

At the level of the firm, successful companies know that product design must follow consumer preference, and both vary from

market to market around the world. These firms recognize that local markets require a local presence, which has led to wider distribution of the assets of many MNEs. But local presence, even

manufacturing, does not often translate into local technology de-

‘ I IT If ckfintxl as lntematifmal trade among affiliated c[~mpanies-that is, cr(~ss-b{~rder trade txtwxm firms w Ith]n the same MNE gxmp {~f companies, See glossa~ (appen- I1

dIx A) for terms and acronyms used In thlf rep)rt.
2 I Multinationals and the U.S. Technology Base

velopment, which has remained—with a few important exceptions—stubbornly resistant to the

globalization phenomenon.

Finding 1: Multinationals Develop Core

Technology at Home

Unlike other principal activities of MNEs, research and technology development tends to be

concentrated in the country of national origin.

U.S.-based MNEs, for example, conduct less

than 13 percent of their manufacturing R&D

abroad (see figure 1-1 in chapter 1). Although

no comparable data exists for European and

Japanese MNEs, the available evidence suggests that they conduct similar if not smaller

percentages of their R&D overseas than do

U.S. firms. R&D conducted by foreign affiliates continues to increase, especially in such

sectors as chemicals, pharmaceuticals, and

electronics; however, it tends to be focused on

product design and customization.

Foreign affiliates account for a small but

rapidly rising share of all business R&D

spending in the United States. That share increased from 9.4 percent ($4.5 billion) in 1982

to 16.4 percent ($10.7 billion) in 1992.2 Much

of this growth, however, resulted from unusually heavy foreign acquisitions of U.S. firms in

the late 1980s. Among our major trading partners, Japanese affiliates in the United States exhibit by far the lowest level of R&D intensity,

which is the ratio of R&D spending to sales (see

figure 1-4).

In sharp contrast to other advanced industrial

nations, the United States typically exports

five times more technology than it imports.

Most of this trade is conducted within MNEs

(see figures 1-2 and 1-3). Japanese firms,

however, acquire considerably more

■

B

■

■

technology from unaffiliated U.S. firms than

do their European counterparts. In 1992, for

example, 43 percent of all U.S. technology

sales to Japan were conducted between unaffiliated firms, compared to 11 percent for Europe.3

Japanese firms spend more on technology

development as a percentage of GDP than

do their U.S. or European counterparts. Between 1981 and 1993 industry-financed R&D

expenditures in Japan grew at an average rate of

8.0 percent. The average growth rate for U.S.

firms was 3.9 percent. That number for the

United Kingdom, Germany, and France was

1.6, 3.9, and 4.6 percent respectively.

Finding 2: Trade Follows Investment in

the 1990s

Affiliates of foreign-based MNEs account for a

substantial portion of U.S. merchandise trade

and the greatest share of the U.S. merchandise

trade deficit. In 1991, for example, the trade

deficit of foreign affiliates in the United

States was larger than the total U.S. trade

deficit (see figure 1-5). Across the United

States, Europe, and Japan, affiliates of foreignbased MNEs have a greater propensity to import than do domestic firms. In the absence of

foreign affiliates, however, it is possible that

the U.S. trade deficit would be even greater

than it is.

Over the past decade, the U.S.-European direct investment relationship has been relatively symmetrical in scale and composition.

Japanese investment in the United States, however, exceeds U.S. investment in Japan by a

factor of three to one (see figures 1-8 through

1 -11). Moreover, it is far more concentrated in

wholesale operations (and less concentrated in

manufacturing) than is European or American

2 Unless otherwise specified, all figures in this report are expressed in 1987 constant dollars. For addit](mal inf(mnation (m data used in this

report, see appendix D.

3 This report uses *’Europe” to refer to the European Union, its associate members, and the European Free Trade Association. Consistent

with most international trade and investment data, the term does not include the countries of Eastern Europe. The report uses “European Union’”

or “EU” when the data or analysis pertains only to the countries of the European Union.
Part 1 Summary, Findings, and Policy Options 13

FDI. As global FDI expanded dramatically

in the 1980s and 1990s, U.S. direct investment in Japan failed to keep pace with the

overall trend (see figure 1 -6).

■ International trade among affiliated firms tends

to reflect the balance of investment between the

United States and its respective trading partners. Between 1983 and 1992, intrafirm

trade (IFT) between the United States and

Europe was roughly equivalent, accounting

for 43 percent of all U.S.-European merchandise trade. Of that IFT, 43 percent was conducted by U.S.-based MNEs and 57 percent by

European-based MNEs (see figure 1-7).

● Intrafirm trade between the United States

and Japan is far less balanced than U.S.-European IFT. Over the past decade, IFT accounted for 71 percent of all U.S.-Japan

merchandise trade. Of that, fully 92 percent

was conducted by Japanese MNEs and only 8

percent by U.S.-based MNEs (see figure 1-1 2).

These figures indicate that the majority of

U.S. trade with Japan takes place within

and is dominated by affiliated networks of

Japanese firms.

I Finding 3: Corporate Governance and

Finance Diverge Across the Triad

■ Despite the current blurring of national economic boundaries, the competitive strength

of individual MNEs continues to be shaped

by circumstances prevailing in their home

countries. Critically important distinctions

persist in the ways corporations govern themselves and raise long-term capital across the

United States, Germany, and Japan.

■ American capital markets are the largest,

most decentralized, open, and transparent

in the world. Japanese and German capital

markets are changing somewhat, but they are

likely to remain relatively concentrated and

opaque.

■ The ability to raise capital at competitive terms

and to deploy it effectively is crucial to both the

long-term success of particular MNEs and to

the development of critical technologies for individual nations. Long-term capital remains

more patient in Germany and Japan than in

the United States. Foreign firms enjoy full access to U.S. capital markets; however, firms

based outside Japan and Germany are less able

to benefit from the strengths inherent in those

capital markets.

m Distinctive cross-shareholding and corporate banking relationships shape the business strategies and development trajectories

of Japanese and many European MNEs.

These institutional arrangements can provide

stable foundations for the commercial adaptation, incremental improvement, and optimal

diffusion of new technologies.

● For the foreseeable future, it is likely that differences in national systems of corporate

governance and corporate financing will be

a source of increasing friction in the complex

economic relationships evolving among the

United States and several of its major trading

and investing partners.

I Policy Issues

Taken together, the findings presented above suggest that the United States has a clear interest in

the success of U.S.-based firms, both at home and

abroad, in proportion to the commitment that such

firms make to the U.S. technology base. To the extent that foreign-based companies also contribute

to U.S. technology development, the United

States has a direct interest in their success as well.

More technology innovation and development in

the United States can lead to more jobs for Americans. Furthermore, the higher-skill, higher-wage

jobs of the future are likely to reside in technology-intensive industries.

U.S. policy might pursue three basic strategic

responses to the international asymmetries in

global trade, investment, and finance identified by

this assessment. It could:

1. Seek to expand existing multilateral trade

agreements to encompass obstacles to foreign

direct investment, restrictive business practices, and other barriers to comparable market

access.
4 I Multinationals and the U.S. Technology Base

2. Create a two-tiered policy regime, one that

grants national treatment when comparable

market access exists, and another that places

conditions on national treatment in response to

enduring formal or informal market barriers.

3. Augment a broad multilateral strategy with domestic measures designed to (a) improve U.S.

technological capabilities and (b) reform U.S.

trade and investment policies to meet the demands of increasingly global commerce.

The specific policy options identified by this

assessment are divided into three broad areas:

technology development, foreign direct investment, and the ways in which MNEs govern and finance their operations. They range, for example,

from creating a uniform national benefits test for

participation in U.S. technology programs to harmonizing diverse national financial regimes.

Policy issues and options are discussed in detail in

chapter 2 of this report.
Globalization

● I

m

Perspective 1

any analysts and business executives talk about the

globalization of commerce and technology as if it were

an accomplished fact. And from the perspective of some

companies, it may indeed appear to be so. Many multinational enterprises (MNEs) now deploy multiregional or even

global marketing strategies. Some sell more abroad than they do

at home. More and more MNEs source a significant share of their

parts through international channels, and many have located major production facilities in foreign countries. A growing number

of firms from different nations enter into strategic alliances to

pool financial and technological resources, and to gain access to

foreign markets. Foreign affiliates loom ever larger in host country economies, and are important to international trade as well.

Successful companies know that product design must follow

consumer preference, and both vary from market to market

around the world. These firms recognize that local markets require a local presence, which has led to wider distribution of the

assets of many MNEs. But local presence, even manufacturing,

does not often translate into local technology development,

which has remained—with a few important exceptions—stubbornly resistant to the globalization phenomenon. Clearly, the

realities of doing business at the level of the firm tell only part of

the globalization story.

Multinational firms have developed their foreign operations at

very different rates and in varying degrees. This is evident in both

historical and functional terms. After WWII U.S. firms were the

first to venture abroad in large numbers, followed a decade later

by their European counterparts. Japanese and other East Asian

companies are, by comparison, relative newcomers to multinational commerce.
6 I Multinationals and the U.S. Technology Base

In addition, multinational firms can take many

different forms and are highly flexible business

organizations. In the first report of this assessment, OTA identified six principal types of MNEs

(see box 1-1 ).l Because of these characteristics,

multinationals are sensitive both to market factors

and government influence.

Throughout this report, the term MNE is used

in a generic sense, that is, the word “enterprise”

does not imply that companies have grown beyond the formal and legal structures of the national jurisdictions in which they are incorporated. In

addition, this report does not deal directly with labor and wage questions related to the investments

or disinvestments of multinationals from one

country to another. OTA has addressed these issues in its report on U.S. trade with Mexico.*

FINDING 1: MULTINATIONALS DEVELOP

CORE TECHNOLOGY AT HOME3

World economic integration is occurring at uneven rates, both in relation to the core technology

operations of MNEs and with respect to overall investment and trade relations among nations. Unlike other principal activities of multinational

firms, research and technology development

tends to stay at home; it remains largely centralized, even in the most internationalized industries.

One implication of this finding is that the United

1 U.S. Congress, Office of Technology Assessment, Multinationals and the National Interest: Playin~ by Diferenr Rules, OTA-ITE-569

(Washington, DC: U.S. Government Printing Office, September 1993). The report is summarized in appendix B.

2 U.S. Congress, Office of Technology Assessment, U. S.- Mexico Trade: Pulling Together or Pulling Apart?, OTA-lTE-545 (Washington,

DC: U.S. Government Printing OffIce, October 1992), passim.

3 This tinding is based on the analysis in Part II.
Chapter 1 Globalization in Perspective I 7

States has a clear interest in the success of U. S.-

based firms, both at home and abroad, in proportion to the commitment that these firms make to

the U.S. technology base. More technology innovation and development in the United States

can translate into jobs for Americans, and it is in

the technology-intensive industrial sectors where

the higher-skill, higher-wage jobs of the future are

likely to reside. To the extent that foreign-based

companies contribute to U.S. technology development, the United States has a direct interest in

their success as well.

Overseas research and technology development by foreign affiliates has increased significantly in the past decade, and in some sectors,

such as chemicals, pharmaceuticals, and electronics, contributes substantially to the local technology base. It is, however, still concentrated in

product design and customization, and pales in

comparison to the home-base R&D activities of

MNEs. As chapter 3 of this report shows, even

though U.S.-based firms trade more technology

with their foreign affiliates than do Japanese or

European companies, R&D conducted by foreign

affiliates of U.S.-based firms is still quite limited

compared to technology development at home.

In the critical area of manufacturing technology,

4 for example, U.S.-based MNEs have consistently conducted most of their research and

technology development in the United States. As

figure 1-1 shows, in the decade 1982-91, total

manufacturing R&D of U.S.-based MNEs increased by 43.2 percent. In 1991, the last year for

which these figures are available, R&D conducted

by majority-owned foreign affiliates of U.S.

MNEs reached only 12.7 percent of the total, up

from 8.7 percent in 1982.5 In addition, the

1982 1989 1991

m Manufacturing R&D by foreign affiliates of U.S. MNEs

D Manufacturing R&D by U.S. MNE parents

SOURCE: OTA based on data in U S Department of Commerce Bureau of Economic Analysis Survey of Current Business 73(7) 44, table

5, July 1993 (hereafter cited as BEA SCB)

manufacturing R&D intensity of U.S.-based parent groups—that is, R&D expenditures as a percentage of total sales—is substantially higher than

that of their foreign subsidiaries. In 1991, for example, it was 2.1 percent for U.S. parents,

compared to 0.8 percent for their majority-owned

foreign affiliates.6

R&D spending in the United States by affiliates

of foreign-based MNEs has accounted for a small

but rapidly rising share of all U.S. R&D. Between

1982 and 1992, total business R&D spending in

the United States grew by 38 percent in real terms,

from $48.6 to $67.0 bill ion.’ During the same pe4 For ~ ~{)nlprchen~lvc ~~~e~sn}en[ of U,S. ~)anu fac[ur]ng te~hno]ogy,” see U.S. c[ma~ess, ofijce f)f Technology ASScSsmmt. ~~f~J~~~,f? ~’~~l~,?.~

IlcHer: Compefing In A4anujticfur/n<q, OTA-lTE-443 (Washington, DC: U.S. Government Printing Office, Fcbruq 1990).

5 A majority-owned foreign affiliate is a subsidiary company of which the foreign parent c(m]pany owns more than 50 percent.

G U.S. Department of Conlmerce, Bureau of Economic Analysis, Sur\’ey of Current Business (Washington DC: Jul} 1993 ), table 5, p. 44 and

table 7, p, 46.

7 In constant 1987 dollars. Nati(mal Science Board, S(lence and Engineerin<q /ndicaror.~-/99.?, (Washingttm, DC U.S. Government Printing office, 1993), NSB 93-1, appendix table 4-4, p. 333.
8 I Multinationals and the U.S. Technology Base

riod, R&D expenditures by foreign affiliates in the

United States grew by 138 percent, from $4.5 to

$10.7 billion.8 Much of this $6.2 billion increase,

however, resulted from unusually heavy foreign

acquisitions of U.S. firms in the late 1980s, as opposed to higher spending levels by existing foreign-owned companies in the United States.9

Because much of the surge of FDI in the late 1980s

was concentrated in high-technology industries,

the manufacturing R&D intensity of foreign affiliates in the United States approaches that of the national average, 2.5 and 2.8, respectively. 10

Multinationals account for a large share of all

U.S. technology trade: on average, 79 percent of

exports and 67 percent of imports between 1986

and 1992. Moreover, 97 percent of all technology

exported by MNEs flows from U.S. parents to

their affiliates overseas, and 91 percent of all

technology imported by MNEs flows from overseas parents to their U.S. subsidiaries (see figures

1-2 and 1-311). These figures indicate that, in the

U.S. case, the majority of international technology trade is contained within multinational networks of affiliated companies. Foreign affiliates

may contribute to the technology base of host nations in selected sectors, but across the Triad they

are still a small part of it. 12 This finding was confirmed in numerous interviews conducted by OTA

in Europe, Japan, and the United States.

In addition, distinct patterns of technology investment are associated with firms of different nations. Since 1989, Japanese spending on business

R&D has exceeded that of the United States and

Europe as a percentage of gross domestic product.

Over the past decade, Japanese firms increased

their R&D spending by an average of 8.0 percent

each year, as compared to 3.9 percent for the

United States and 1.6,3.9, and 4.6 percent respectively for the United Kingdom, Germany, and

France. Firms across the Triad decreased their

R&D spending in response to the recession of the

early 1990s. 13

These patterns, however, do not hold for the affiliates of foreign-based firms in the United

States. European affiliates tend to spend more on

R&D in the United States and exhibit higher levels of R&D spending as a percentage of their sales

than do their Japanese counterparts. As figure 1-4

shows, R&D intensity for German affiliates is

very high, probably reflecting the concentration of

German investments in R&D-intensive industries

such as chemicals and pharmaceuticals. At the

other end of the spectrum, the very low R&D in-

* In cxmstant 1987 dollars. Data from U.S. Department of Commerce, BEA, Surt)ey oj”Currenr Business (Washington, DC: May 1993), table

1, p. 89; and U.S. Department of Commerce, BEA, Foreign Direct Intesfrnenf in fhe United States: Pre/iminury /992 Es[imafes (Washington,

DC: forthc(m]ing, 1994); table H-3A.

‘) U.S. Department of Commerce, BEA, Foreign Direct ln~’esfmenl in the United Stales: An Update (Washington, DC: U.S. Dept. of C(m~-

mcrce, June 1993), p. 70.

10 ]bl~., p. 72, Across the a~vance~ in~ustrla] nations, the R&D in[ensity of f(weign affiliates tends U) be much k)wer than the average for all

manufacturing industries in the host c(mntry. one of the few excepti(ms is the United States, where the average R&D intensity of foreign

manufacturing affiliates is driven up by the concentration of foreign investment in industries with high R&D intensity, such as phamlaceuticals,

chemicals, and mechanical engineering. Ftm a ctmlpanson of tbe R&D intensity of foreign affdiatcs in all sectors, see fig. 1-4. For an expanded

discussi(m of R&D cxmductcd by foreign affiliates in the United States, see ch. 4.

I I ~ese ~jgurcs are based on [h~ technology” balance of payrn~nts in~icator, which measures international transactions in royaltks and

license fees. This indicauw only approximates technology transfer for three reasons. First, the available U.S. data for royalties and license fees

c(m]bincs transacti(ms of all fomls of intellectual property, including industrial process technology, copyrights, trademarks, franchises, and

rights to broadcast live events. Second, it is difficult to measure intellectual property traded between affiliated firms, since the value of affiliated

transactlims is nt~t always determined (m the open market. Tb ird, technology also can be transfemed through a variety of channels that are not

captured by this or any i)ther reliable measure.

I ~ Throughout” [his reP)~, the t~nll ‘“Triad” is used to denote the United Stales, Japan and the advanced industrial economies of Europe.

I \ see figure ~-I ~ and acconlpany ing text in ch. ~.
Chapter 1 Globalization in Perspective I 9

~ 10

m-1 /

“1

6

4

2

0m

1986 1987 1988 1989 1990 1991 1992

_ All MNE technology exports

~ Exports from U.S. MNEs

4

to their foretgn affiliates

Total technology exports

SOURCE OTA based on data m BEA SCB 73(9) 122 table 7, September 1993

16j

1 4 ]

I

1986 1987 1988 1989 1990 1991 1992

_ All MNE technology Imports

n Imports by affiliates In the U.S.

from their foreign parents

+ Total technology Imports

SOURCE OTA based on data n BEA SCi3 73(9) 122, table 7 September 1993
10 I Multinationals and the U.S. Technology Base

1.8

1.6

1.4

1.2

El

g

E 0.8

0.6

0 . 4

0.2 “

o1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

Ezl

n

D

+

German affiliates

French affiliates

U.K. affiliates

Japanese affihates

All affiliates

European affiliates

NOTES: R&D intensity measures total affiliate R&D expenditures as a percent of total sales, 1992 data are preliminary

SOURCE: OTA, based on data in U.S. Department of Commerce, Bureau of Economic Analysis, Foreign Direct invesfment in the United States Operations of U.S. Affiliates of Foreign Companies revised 1983-1991 estimates and preliminary 1992 estimates, (Washington, DC U S Government Printing Office, 1986-1994), tables E-4 and H-3B from 1992, tables A-6 and H-2 from 1987-1991, and tables 8 and H-6 from 1980-1986 (hereafter cited

as BEA, FDIUS)

tensity of Japanese affiliates may reflect their propensity to invest less in manufacturing and more

in wholesale trade (compare figures 1-8 and

1 -10).14

Multinational firms are critical to ensuring the

health of the U.S. technology base. The most technologically sophisticated and economically significant sectors of the U.S. economy are now

characterized by high degrees of international production, foreign direct investment, trade among

affiliated companies, and complex forms of international financial and technological collaboration. Many of these sectors, such as

semiconductors, electronics, chemicals, pharmaceuticals, aerospace, telecommunications, and autos, are also marked by increasingly high R&D

costs. The location and character of innovative activity by MNEs significantly shapes the basic

structure of competition and competitive advantage in these and related sectors.

While it is not wrong to speak of the global research and technology base of MNEs, it is certainly misleading. The data presented above and in

Part II of this report suggest that technology is

deeply rooted in national (or in the case of Europe,

regional) concentrations or bases, with partial and

company-specific interconnections. Although

many fundamental technological innovations are

pursued in several countries at the same time, or

may be licensed from one region to another, it is

not uncommon for a nation or even a firm to hold a

leadership position or even control an important

technology. Moreover, the cost of retrieving innovation leadership may be prohibitive once it is

lost. The implication for public policy is that the

national technology base must be well-main-

] ~ See the sec[lon on R&D by foreign affiliates in the United States in part 11, ch. 4.
Chapter 1 Globalization in Perspective I 11

tained on a continuous basis. In this view, U.S.

technology programs, such as the Partnership for a

New Generation of Vehicles (PNGV) and the Advanced Technology Program (ATP), may be necessary to ensure that critical capabilities continue

to reside in the U.S. technology base.

Some analysts take a different view. They argue

that programs like the ATP and PNGV are subsidies to U.S.-based firms, subsidies that put government managers in position to pick winners and

losers. They are further concerned that, if successful, such programs might cause foreign governments to increase their support of R&D, leading to

a cycle of increasing government involvement in

technology innovation, a process that they believe

will ultimately make American firms less competitive than they might otherwise have been.

Advocates of this perspective assert that some

technology programs discriminate against the

U.S. affiliates of foreign-based MNEs, and that

they might undermine U.S. negotiators who seek

to convince other countries to open their markets

to U.S. exports and direct investment (see box

1-2). On the other hand, there is no reason that

U.S. technology programs cannot be conducted so

that they are consistent with the principle of national treatment and the GAIT Treaty of December 1993.15 (This issue is discussed in the section

on Policy Issues and Options in chapter 2.)

While it is possible to conceive of a more cohesive and global technology base in the future, its

development would require far more international

economic integration and more extensive political

cooperation. At a minimum, substantial reduction

in or removal of the asymmetries in national patterns of direct investment, trade, finance, and corporate governance would be a prerequisite. 16 In

the absence of rapid convergence in these areas, it

is likely that nations will continue working to enhance the national technology assets on which industrial competitiveness rests. In the United

States, such steps include the proliferation of government-industry cooperative technology development programs such as the ATP, the PNGV, the

Technology Reinvestment Project, the Department of Energy cooperative R&D agreements

(CRADAS), and the Manufacturing Extension

Partnerships, among others. (These developments

are discussed in chapter 2 in the section on Policy

Issues and Options.)

U.S. government support for technology development has favored participation by U.S.-based

companies over the affiliates of foreign-based

firms. Some U.S. technology programs exclude

foreign companies, such as the PNGV, which is a

partnership between Ford, Chrysler, General Motors, and the U.S. government. 17 More often, the

principle of conditional national treatment (CNT)

has been applied in legislative language that permits participation by U.S. affiliates of foreign

firms only on the condition that their countries of

origin extend reciprocal access for U.S. MNEs. 18

In Europe, CNT has taken the form of requiring

firms to establish local R&D operations. This has,

in effect, largely limited participation in EU programs to European-based companies and a few

foreign firms with R&D operations in Europe.

15 Under the new terns es[ab]lshed by tie GAn Agreement on Subsidies and C{mntmvailing Measures nqy}tiated during ~h~ LJmguay

Round, government research subsidies are permitted for up to 75 percent of the cc~sts of industrial research (defined as new kn(wledgc for

developing new or substantially improved products, processes, (w services), and up to 50 percent of the costs of prccmnpctltive devch~pmcnt

activity (defined as applied research up the point of a first, noncommercial prot(@pe).

I b These differences are described in detail in the first re~wt of this assessment, Afu/1/natform/$ and (}IC Nafwna/ /nlerf’$f, op. cit.. f(N)tn(~l~ 1.

] 7 me ~lte House, office of the ~ess Secretav, “A New Partnership for Cars of the Future, Ensuring L’. S. L>adcrship, E~pan~ing Ec(~-

m)mic Opportunity, Preserving Jobs, Protecting the Environment,” Sept. 29, 1993, p. 1.

18 such Provisl(}ns are included in tie us. Federal Technology” Transfer Act of ] 9~~, Onlnibus Trade and ~t)mpctitlf Cnt?ss ~c[ of 1988.

Technology Preeminence Act of 1991 (Advanced Technology Program), and others.
12 I Multinationals and the U.S. Technology Base
Chapter 1 Globalization in Perspective I 13

(CNT is discussed at the end of the first policy section in chapter 2.)

FINDING 2: TRADE FOLLOWS

INVESTMENT IN THE 1990s19

Governments understand that the health of the national technology base is related not just to R&D

spending, but also to the strategic investment behavior of companies, especially MNEs. Such investment increasingly crosses national borders.

Since 1980, the world stock of foreign direct investment (FDI) has grown by over a factor of four,

accelerating dramatically after the Plaza Accord .

in 1985.20 By 1992, the global stock of foreign direct investment reached approximately $2.0 trillion. 21 This surge of investment transformed the

world economy and assisted exports in many sectors. Rather than substituting locally produced

goods and services for imports, investment augmented and created trade, often through international transfers of merchandise within networks of

foreign affiliates and their parent groups, i.e., intrafirm trade (IFT). The flow of FDI to the United

States decreased significantly in the 1990s, but the

existing stock of foreign investment continues to

grow.

U.S. affiliates of foreign-based companies account for a substantial portion of U.S. merchandise trade and the greatest share of the U.S.

merchandise trade deficit (see figure 1-5).22 In

1982, the total merchandise trade deficit was

$30.2 billion; of that, U.S.-based firms accounted

for $6.1 billion, compared to $24.1 billion for

U.S. affiliates of foreign-based MNEs. In 1986,

both U.S.-based firms and foreign affiliates in the

United States ran substantial deficits, $73.0 and

$83.2 billion respectively. Since that time, the

trade balance of U.S.-based firms improved

steadily to reach a surplus of $11.9 billion in 1991

and a deficit of $6.1 billion in 1992. The trade deficit of foreign affiliates in the United States, however, remained substantial, at $72.1 and $70.7

billion in 1991 and 1992 respectively.23

This pattern does not mean that foreign affiliates are themselves responsible for the U.S. merchandise trade deficit. That deficit is affected by a

range of factors, including exchange rates, variations in national growth and productivity rates,

and different rates of domestic savings and investment. Moreover, a portion of what foreign affiliates import is used for the production of goods that

might otherwise have been produced entirely

19 ‘rhIs finding is based (m the analysis in Part 111.

‘“ The Plaza Accord refers to an agreement reached at the Plaza Hotel in New York in 1985, in which the finance ministers of the major

industrial nations agreed I(J c(wrdinate a devaluation of the dollar against other major currencies.

21 United Nations, World Iniestmcnl Report 1993: Translational Corporations and lnte,grated[n~ernational Prodticrion (NY: United Nati(ms, 1993), p.1.

‘z Part of the discussion and several of the figures in this chapter concentrate on merchandise trade as a relevant measure of multinational

actlvi[y. Merchandise trade covers manufactured goods, wholesale trade, agricultural products, and raw materials. It does not include services, a

fast-growing sector of intemati(mal trade where the United States ran a trade surplus of S61 billion in 1992. OTA is currently conducting a

separate assessment of the service sector in the U.S. economy. See also U.S. Congress, Office of Technology Assessment, Trade in Ser\’ices.”

Exports and Fore~8n Re\’enues, OTA-ITE-3 16 (Washington, DC: U.S. Government Printing Office, September 1986), and U.S. Congress, Office of Technology Assessment, Internaf/onal Competition in Ser\sices: Banking, Building, So@are, Know-How, OTA-lTE-328 (Washingt(m,

DC: U.S. G(wemment Printing Office, luly 1987). Other measures, such as the current account and the capital account, provide a more comprehensive picture of intemati(mal flows of g(x)ds, services, and capital, but they are less directly tied to the health of the U.S. technology base and

MNE actiw[y, the principal subJects of this assessment.

‘3 These trade 4ata are expressed in constant 1987 dollars, based on data provided in Department of Commerce, BEA, Sur}’ey ojCurren/

Buslnes$. (Wmhingt(m, DC: Oct(&r 1993), p. 53, table 1.
14 I Multinationals and the U.S. Technology Base

-1 20“

-140-

-160 I I I I I I I I I

198 2 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

+

-+-

U.S. and foreign firms

All foreign firms in the U.S.

U.S. firms

100 1 \

u

f ’ I

NOTE: 1992 data are preliminary

SOURCE: Adapted from BEA, SCB 73(10) 54, table 1, October 1993, BEA, SCB 73(3) 90-91, table 2, March 1993, BEA, SC/3 74(3) 68-69, table 2,

March 1994, BEA FD/US, table G-3 (1982-1986), and table G-1 (1987-1992)

abroad. Nevertheless, the data indicate that foreign affiliates have afar stronger propensity to import than do U.S. businesses. 24 Further analysis

indicates that much of the trade by affiliates is

conducted as intrafirm trade within their own

MNE networks, and that most intrafirm trade

flows from parent groups to their overseas

affiliates.

As international trade and investment expanded throughout the 1970s and 1980s, intrafirm

trade increased in tandem, but it did not do so

evenly across the Triad. International trade among

affiliated firms has tended to reflect the balance of

investment between the United States and its respective trading partners (see figure 1-6). Where

investment is relatively well-balanced, as in the

U.S.-Europe case, IFT has tended to follow suit.

U.S.-based MNEs have transferred roughly the

same amount of merchandise to their European affiliates as European-based MNEs have to their affiliates in the United States. Similarly, although

the volume is much smaller, affiliates in Europe

and in the United States transfer about the same

amount of merchandise to their foreign-based parents (see figure 1 -7). U.S.-European intrafirm

trade has been relatively symmetrical over the past

decade, even as it has grown as a percentage of all

trade. Between 1983 and 1992, IFT accounted for

an average of 43 percent of U.S.-Europe merchandise trade.25 Of that IFT, 43 percent was con24 Since 1988, the ratio of imports toexports for foreign affiliates in the United States has been about double that of U.S. businesses. In 1991,

affiliates’ imports exceeded their exports by 80 percent. See Ibid., p. 54.

2s Department of Commerce, BEA, U.S. Diret’llnt’es/menrAbroud (Washington, DC: 1983-1991 issues); Department of Commerce, BEA,

Foreign Direct /n\esfment in fhe United States (Washington, DC: 1983-1991 issues); Department of Commerce, BEA, Surtey ojCurren/Busirwss, (Washington, DC: June 1993), table 2, p. 78.
Chapter 1 Globalization in Perspective I 15

dln

200

In

100

n

r 1 rl

u

1984 1935 1986 1987 1988 1989 1990 1991 1992 1993

m Japan in U.S.

_ U.S. m Japan

D Europe In the U.S.

~ U.S. in Europe

SOURCE OTA, based on data n BEA, SCB 73(7) 65-6797-100, July 1993, 71 (8) 51-54,86-88, August 1991 69(8) 52-53,67-69 August 1989 and

77(8) 63-65 90, August 1987 and U S Department of Commerce News, “ press release, June 28, 1994, tables 2 and 3 (hereafter cited as USDOC

press release)

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

El

In

c1

Merchandise flows from U.S. afflhates in

Europe to their parents In the U.S.

Merchandise flows from U.S. parents to

their affiliates in Europe

Merchandise flows from European affiliates

in the U.S. to their parents In Europe

Merchandise flows from European parents

to their affiliates in the U.S.

NOTE: 1992 data are preliminary

SOURCE: OTA based on data in BEA FDIUS table G-4(1983-1986) and table G-2 (1987-1992), U S Department of Commerce, Bureau of Economic

Analysis U.S. Direct Investment Abroad Operations of U S Parent Companies and their Foreign Affiliates revised 1983-1991 estimates (Washington

DC U S Government Printing Office 1986-1994) tables 50 in 1983-1988 and Ill H 1 m 1989-1991 (hereafter cited as BEA USDIA) BEA, SCB 73(6):

78 table 2 June 1993
16 I Multinationals and the U.S. Technology Base

ducted by U.S.-based MNEs and 57 percent by

European-based MNEs

In the 1980s, the U.S.-European investment

relationship was also relatively well balanced in

scale and composition, and in recent years has stabilized at nearly equal levels for total investment.

As figures 1-8 and 1-9 indicate, the largest share of

investment has been in manufacturing, both for

Europe in the United States and for the United

States in Europe. Moreover, in both cases,

manufacturing and wholesale trade together account for about half of all direct investment.

With respect to the U.S.-Japan relationship,

however, broad differences persist in the scale and

composition of Japanese investment in the United

States as compared to U.S. direct investment in Japan. Japanese investment in the United States exceeds U.S. investment in Japan by a factor of 3.1

to 1 and it is far more concentrated in wholesale

operations (and less concentrated in manufacturing) than is direct investment between the United

States and Europe (see figures 1-8 through 1-1 1).

As U.S. FDI grew in the 1980s, U.S. direct investment in Japan remained disproportionately small

(see figure 1-6).

Compared to Europe, U.S. intrafirm trade with

Japan displays anomalies. First, it comprises a

much larger part, 71 percent on average between

1983-1992, of all U.S.-Japan merchandise

trade.26 Second, over the same period Japanese

MNEs and their affiliates conducted an average of

92 percent of all U.S.-Japan intrafirm trade

(compare figures 1-12 and 1-7). This asymmetry

is even more pronounced than that associated with

the bilateral U.S.-Japan imbalances in direct investment and merchandise trade, Taken together,

these two statistics indicate that most U.S. trade

with Japan takes place within and is dominated by

affiliated networks of Japanese MNEs.

In this context, the U.S. trade deficit with Japan

is linked with the bilateral imbalance in direct investment. As figure 1-13 shows, on average the

U.S. intrafirm trade balance with Japan closely

tracks the total MNE trade balance and, in most

years, the overall merchandise trade balance. In

part, the large-scale U.S. trade deficit with Japan

in the 1980s can be explained by the high dollaryen exchange rate, a decline in the growth rate of

U.S. productivity, and higher Japanese rates of

savings and investment. But its persistence into

the 1990s, especially in light of the Plaza Accord

and the prominent role of U.S.-Japan IFT, suggests that the relatively low level of direct investment in Japan is important. It is unlikely that the

U.S. merchandise trade deficit with Japan will be

corrected in the absence of substantial investment

by U.S.-based firms in Japan.

Some analysts argue that Japanese investment

in the United States looks very different from European investment because Japanese affiliates are

relative newcomers to the American business

community. They believe that, over time, the volume of Japanese intrafirm trade will diminish, reflecting an increase in the local sourcing of

Japanese affiliates, as predicted by the FDI life

cycle theory.

27 The data on this point are mixed.

For example, Japanese auto transplants—which

produce cars in the United States—report that

their percentage of locally sourced parts has increased significantly in recent years (see figure

6-13 in chapter 6). On the other hand, a U.S. Customs Service audit of the Honda Corp. in 1990

concluded that the domestic content was considerably less than the company reported.28 A further

complicating factor is that 43 percent of all U.S.

suppliers to the three largest automobile transplant producers (Toyota, Honda, and Nissan) are

26 Ibid.

27 The life cycle theory of FDl is discussed in ch.6.

28 U.S. C(mgress, OTA, Mu/finafiortal and the Nationa/ /ntere.sl, op. cit., footnote 1, pp. 96-97.
Chapter 1 Globalization in Perspective I 17

(n I

I

100

50

0

l!! ,.,.,., ,., B,.,.,,, ,.,.,.,

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

Petroleum and other industries

Services

Real estate

Insurance

Banking

Wholesale trade

Manufacturing

NOTE BEA statistics on FDI Include data on serwces only since 1987

SOURCE OTA, based on data InBEASCf373(7) 65-67, July 1993, 71 (8) 51-54, August 1991, 69(8) 52-53, August 1989, and 77(8) 90, August 1987,

USDOC press release, June 28, 1994, table 3

3CKI

100

50

0

l!! ,.,,,., //, , ,.,.,., ,.,,,,,

m

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

Petroleum and other Industries

Services

Finance

Banking

Wholesale trade

Manufacturing

—

NOTE BEA slaftshcs on FDI poslllon tnclude ftgures for servces only since 1987

SOURCE OTA, based on data [n BEA, SCB 73(7) 97-100, July 1993, 71 (8) 86-88, August 1991, 69(8) 67-69, August 1989, and 77(8) 63-65, August

1987, USDOC press release, June 28, 1994, table 2
18 I Multinationals and the U.S. Technology Base

90

80

70

U-J

~ 60

u

: 50

K

; 40

30

20

10

0

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

~Petmleurn and other industries

_ Services

co Realestate

~~ Finance

cl Banking

~ Wholesale trade

= Manufa~turlng

NOTE BEA statlsllcs on FDI tnclude data on services only since 1987

SOURCE OTA based on data wBEA,SCf373(7) 65-67 J!Jly 1993,71 (8) 51-54, August 1991, 69(8) 52-53, August 1989, and 77(8) 90, August 1987,

USDOC press release, June 28, 1994, table 3

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

~ Petroleum and other industries

- Services

~ Finance

c] Banking

~ Wholesale trade

m Manufacturing

NOTE BEA statistics on FDI posltlon lnc!ude figures for services only since 1987

SOURCE OTA, based on data In BEA SCB 73(7) 97-100 July 1993, 71 (8) 86-88, August 1991, 69(8) 67-69 August 1989, and 77(8) 63-65, August

1987 USDOC press release June 28, 1994 table 2
Chapter 1 Globalization in Perspective l 19

—

m

g

— —

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

D

In

n

Merchandise flows from U.S. affihates in

Japan to their parents In the U.S.

Merchandise flows from U.S. parents to

their affihates m Japan

Merchandise flows from Japanese affiliates

in the U.S. to their parents In Japan

Merchandise flows from Japanese parents

to their affiliates in the U.S.

NOTE: 1992 data are preliminary

SOURCE: OTA based on data in BEA, FDIUS, tables G-4 (1983-1986), and G-2 (1987-1992), BEA USDIA tables 50 (1983-1988) and Ill H 1

(1989-1992) BEA, SCB 73(6) 78, table 2 June 1993

themselves affiliates of Japanese-based MNEs

(see figure 1-14).

FINDING 3: CORPORATE GOVERNANCE

AND FINANCE DIVERGE ACROSS

THE TRIAD29

The strategic behavior of individual MNEs continues to be shaped by systems of corporate governance and long-term corporate financing that

prevail in their home countries. Sometimes these

systems provide firms with distinct advantages.

Such advantages influence the investment decisions of MNEs, especially in long-term investments in plant, equipment, research, and

technology development. Such decisions, in turn,

are often the wellsprings of future technological

innovation.

Both Japan and Germany, for example, employ

systems of corporate governance and corporate finance that can create advantages for their firms in

ways not entirely consistent with the principle of

comparable market access. In both countries, nontransparent systems of corporate governance permit business behavior that would be questionable

in the United States. Cartel-1ike arrangements legitimated by such systems, for example, are not

uncommon. Such arrangements can undercut

equality of competitive opportunity, especially

for foreign firms.

In both Germany and Japan, cross-shareholding arrangements among companies and banks are

more extensive than in the United States, and are

particularly pronounced in Japan’s major industrial groups (see table 1- 1). This can discourage

direct investment by foreign-based firms and influence their market access, although it should be

noted that Germany is far more receptive to foreign investment than is Japan. Such arrange-

~9 This finding ]s based {m the analysls in Part IV
20 I Multinationals and the U.S. Technology Base

Total MNE trade balance

IFT trade balance

Total bilateral merchandise

trade balance

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

NOTE: 1992 data are preliminary

SOURCE: OTA, based on data in BEA, FDIUS, tables G-4 (1983-1986) and G-2 (1987-1992), BEA, USDIA, tables 50 (1983-1988) and Ill H 1

(1989-1992), BEA, SCB 72(6) 88-90 table 2, June 1992, BEA, SCB 73(3) 90-91, table 2, March 1993, BEA, SCB 74(3) 68-69, table 2, March 1994

ments, together with the underdevelopment of

markets for takeovers, have often discouraged foreign MNEs from entering Japan (and to a lesser

extent, Germany) by way of acquisition.

In both countries, systems that provide longterm financing for home-based MNEs, which

often include a prominent role for banks, enable

those firms to take a broad view of their markets.

This ability can put them in a better position than

their U.S.-based competitors to concentrate on

building market share and developing new

technologies, rather than on short-term profitability. Especially with regard to Japan, such factors

appear to be implicated in enduring competitiveness problems in parts of the U.S. technology

base. They help to explain, for example, the collapse of domestic production by U.S.-based

MNEs in the consumer electronics industry.

Even though U.S. capital markets are the largest, most decentralized, open, and transparent in

the world, long-term capital is relatively more patient in Germany and Japan. Although the financial markets of the United States support novel

technology ventures, in recent years they have

often been less supportive of long-term investments in state-of-the-art manufacturing facilities

required to sustain competitive advantage. Since

the development and exploitation of next-generation technologies often depends on the existence

of such facilities, this kind of shortsightedness can

have enduring consequences for the national

technology base.

Major Japanese and German MNEs remain

firmly rooted in their home markets, despite recent, often painful restructuring. For many years,

the stability of those roots bolstered their competitive position internationally. This was especially

evident in such industrial sectors as consumer

electronics, machine tools, advanced transportation systems, and parts of the chemicals industry.

Today, Japan appears to be paying a price for the

financial bubble and inflated real estate prices of

the 1980s, while the costs of reunification are registering heavily on the German economy. In both
European and

other afflhates

6Y0

npanles

49?40

Other North

American affiliates

2%0

NOTE: Number of firms given in brackets, total number = 472

SOURCE: OTA, based on data in The ELM Guide to U.S. Automotive

Sourcing (East Lansing, Ml ELM International Inc., 1992), and The ELM

Guide to Japanese Affiliated Suppliers in North America, 4th ed. (East

Lansing Ml ELM International Inc., 1993 )

cases, however, the singular national structures of

corporate governance and finance that propelled

the growth of their corporations in critical

technology sectors are now helping those corporations adjust to new competitive realities. Those

structures are themselves adjusting, but they are

not being abandoned.

Chapter 1 Globalization in Perspective I 21

Key distinctions are likely to persist in the ways

corporations govern themselves and raise longterm capital across the United States, Germany,

and Japan. Expectations concerning their ultimate

convergence should be kept modest. National patterns are embedded in deep social and political

traditions, and they are being reinforced more than

they are being eroded by turbulence in the global

economy. For the foreseeable future, it is not unlikely that differences in national structures of corporate governance and long-term corporate

financing will be the source of increasing friction

in the more complex economic relationships

evolving between the United States and its major

trading and investing partners.

Trading,

Financial Manufacturing,

Institutions or Other

Mitsui 231 2 0 8

Mitsubishi 19.8 3 3 4

Sumitomo 2 4 2 3 0 6

Fuyo 23.6 172

NOTE: Data represents average percentage of stock held by group

members or affiliated companiees Data IS for fiscal year 1992 ended

March 31, 1993, and IS drawn from a survey conducted by Toyo Keizai

of 2,131 firms listed on Japanese stock exchanges

SOURCE: Kigyo Keiretsu Soran (Tokyo Toyo Keizai Shinposha, 1994)

pp. 44-50.
U.S. Technology

Policy in

International

Economic

Perspective 2

T

he first report of this assessment, Mulitnationals and the

National Interest: Playing by Different Rules, identified

broad asymmetries in the policy regimes of the major

trading nations+ specially market access, foreign direct

investment, financial, and industrial policies related to the activities of multinationals. ] These asymmetries, it suggested, might

have adverse consequences for the health of the U.S. technology

base. The report discussed a range of informal barriers to international trade and investment, particularly in Japan but also in Europe, that have inhibited the full realization of an open,

comprehensive multilateral trade regime that is transparent and

mutually advantageous to trading partners. OTA thus raised the

concern that widely divergent policy systems and business practices among states in the Triad might disrupt trade and investment

relations among the major economic powers.

THE POLICY CONTEXT

In the past year, significant progress was made at multilateral, regional, and bilateral levels in negotiating formal trade agreements. In December 1993, the Uruguay Round of multilateral

trade negotiations was concluded under the General Agreement

on Tariffs and Trade (GATT). The new GATT agreement establishes a World Trade Organization (WTO), which, if ratified by all

member states, would greatly strengthen multilateral provisions

1 U.S. Congress, Office of Technology Assessment, Multinationals and the National

Interest: Plav~ng by Diflerenf Rules, OTA-ITE-569 (Washington, DC: U.S. Government

Printing Office, September 1993). The report is summarized in appendix B.

2 3
24 I Multinationals and the U.S. Technology Base

for dispute resolution .

2 In an effort to expand regional trade, supplemental agreements on labor

and the environment were negotiated for the North

American Free Trade Agreement (NAFTA), and

Congress ratified implementing legislation for

NAFTA, which entered into force on January 1,

1994. Progress toward expanded trade and investment in the Pacific Region was also achieved in

the context of the Asian Pacific Economic Cooperation (APEC), where high-level meetings were

held and a Committee on Trade and Investment

was established.

In addition, considerable progress was made in

a variety of bilateral market access agreements, including the eliminat ion of duties affecting approximately $1 billion in U.S. trade with Canada,

dramatic reduction in tariffs on a variety of goods

with China, and elimination of discrimination by

European Union (EU) member states against foreign heavy electrical equipment. The United

States and the European Union were, however,

unable to resolve disputes over the sale of telecommunications network equipment in Europe

and, accordingly, the United States imposed sanctions against the European Union in this areas

Nevertheless, as the data presented in chapter 1

and in Part 111 indicate, the United States and Europe have achieved in the aggregate a relatively

balanced relationship with regard to investment

and trade—including intrafirm trade conducted

by [J. S.- and European-based multinational enterprises (MNEs).

I U.S.-Japan Economic Relations

In contrast to these successes, the U.S.-Japan economic relationship continued to deteriorate during the past year. The U.S. merchandise trade

deficit with Japan expanded despite a steady devaluation of the dollar against the yen, partly in response to the rapid U.S. recovery from the

recession of the early 1990s and sustained recession in Japan, which reduced import demand.

U.S.-based MNEs made limited headway in investing in Japan, despite partial correction of

overvalued land prices in Tokyo. The U.S. direct

investment deficit with Japan remained substantial, albeit somewhat reduced from the previous

year. Moreover, the Framework for a New Economic Relationship talks between the United

States and Japan collapsed in February 1994, confirming a long-standing pattern of disappointing

bilateral trade negotiations.4 Several weeks later,

the President reinstated the Super 301 provisions

of the 1988 Omnibus Trade and Competitiveness

Act by Executive Order. 5 Although the Framework negotiations resumed in May, it was still unclear whether a common understanding of the

objectives of the talks was achieved.

Japan poses a special problem not only for the

United States, but also for other nations with

chronic bilateral trade deficits with Japan,6 and

whose MNEs still face stiff resistance to entering

the Japanese market through direct investment.

But beyond these bilateral imbalances and the ris-

~ oftj~~ ,,f the ( lnlt~d St:ites Trade R~pr~S~nta[l\~, I 994 ~rfltjc />O/IC~~l~Cn~/~ and 1993 Annual Rciwrf (!t’the Pwsidcnt 0/ (11C Un/tcd .~t(ites

on fhe ‘/}f~Jc Agrcementr Pro,qrmn (Wash ing[t)n, DC: U.S. Govemnwnt Printing Office, 1994), pp. 14-15 and passim.

4 In p:irt]~l]liir, the Marlwt-oriented Sect(~r-Spcc}fic (MOSS) talks of the middle 1980s and the Stm~[urid ln]pedimcnts Inltiatlvc (S11 ) of

1989 and 1990 litrg~l~ !iill~d t{) product the Intended results. SW ibid., p, 61.

s W.J. Cl int(m. Prcsi&nt, United stattx, ‘“E\ccuIive order 12891 -–ldcntlficatl~)n of Triid~ E\pimslon Pri(~ritics, ” Weekly (’on) pll{J(lon” ()/

Pre.\ldcn(ial 110( lmIttz{\ 30(9) 422-423, Miir~h 3, 1994.

6 According to the Japanese M]nlstr) t)f Flniincc, Japan’s trade surplus in 1993 was higher with [~thcr Asian c(mntries than it was with the

IInlted States. “J~p:in’S sl]rp]i]~ w lth ,4sIa on a cil~tonl~-cleare(i hasis in fiscal 1993 through March 31 julnpcd 25. I percent fr(~nl the prcvi[)us

year t[~ S55.948 hllll(m Tk siqlus w ]th the LJn]td S[;ites grew 1 I.8 percentto$51. 14 bllll~m. . . Wi[h the Eurt)pean Union, [hc surplus fell I(J

$~~,~~ bl]lion< d[~wn 2 I.8 p’rccn( t_r(~nl fiscal I W2.’” i’-he Nllkei \+2ekl>, p. 1 April 25, 1994.
Chapter 2 U.S. Technology Policy in International Economic Perspective I 25

ing trade frictions associated with them, Japan

presents a significant challenge to the post-WWII

system of international trade and investment. The

challenge is to integrate all nations, including Japan, more fully into the world system—which

means convincing them to open their economies

both to imports and to foreign direct investment,

in a way that is comparable to the openness of the

United States and the European Union. Failure to

do so will almost certainly generate economic dislocation and severe pressure on the maintenance

of a global economic order based on the principles

of free and open markets, national treatment, and

multilateralism. 7

Although underlying macroeconomic factors

drive aggregatc trade and investment balances,

their composition and character can have microeconomic roots. Chronic bilateral trade and investment deficits between advanced industrial

nations matter. In part, deficits reflect competitive

disadvantages of firms based in deficit countries;

but they can also reinforce those disadvantages.

Where comparable market access is effectively

blocked, many U.S. business leaders. for example, reluctantly conclude the odds are rigged

against them and lower their expectations accordingly. In such circumstances, some settle for a minority equity position in a joint venture company.

others feel compelled to license their technology,

even when experience teaches it may ultimately

be used to compete against them in their own or

third-country markets. Foreign-based MNEs face

few comparable restraints to investment and trade

in the United States. In the case of Japanese

MN Es, this has often translated into head-to-head

competition with U.S. companies in America

from a sanctuary base at home.

Building on the analysis of the first report of

this assessment, in the chapters that follow, OTA

present a comprehensive array of macroeconomic data, detailed trade and investment statistics,

and information based on extensive staff interviews in Japan, the European Union and the

United States. These data confirm that globalization has proceeded at different rates, both in terms

of the kinds of MNEs that have emerged (see table

1 -1), and in terms of sectors of the international

economy. In addition, industries of different nations have globalized at different times and in different ways. Taken together, the data presented in

this report characterize trade and investment relations in the Triad, and also indicate the extent to

which Japan has become an outlier in the global

economic system.

1 Comparable Market Access

In addition, this analysis moveS beyond identifying asymmetries among the policy regimes of the

United States, the European Union, and Japan. It

describes the nexus between trade and investment--demonstrating the importance of intrafirm

trade among affiliated companies, which is circumscribed when direct investment is limited.

The central issue is comparable market access,

that is, the expectation that U.S.-based MNEs will

be afforded the same access to foreign markets

that foreign MNEs enjoy in the United States.

Here it is critical to distinguish between formal

national treatment and effective national treatment. When foreign companies meet sustained resistance to their imports and investment, even

where legal and regulatory restraints have been removed, equality of competitive opportunity has

not been achieved. The test is whether actual market access is comparable, both for trade and investment. especially in industries based on

critically important technologies. ”

Several members of the advisory panel

associated with this study suggested that market
26 I Multinationals and the U.S. Technology Base

access problems are not limited to Japan, but may

also extend to a number of newly industrialized

and advanced developing countries in Asia, most

notably China, Indonesia, Malaysia, the Republic

of Korea, and Taiwan, all of which run trade surpluses with the United States and have placed

conditions on investments by U.S.-based firms.8

Similar views were expressed to OTA in industry

interviews. These observations imply that there

may be fundamental differences in the organization of capital and the conduct of business from

one region to another, compounding the difficulty

of finding multilateral solutions to a widening

array of disputes associated with international

trade and investment.9

OTA conducted very limited research on this

point, primarily because the activities of MNEs in

these countries are still very small when compared

to the advanced industrial nations. U.S. direct investment in most East Asian economies is an order of magnitude smaller than it is in Japan: in

1993, for example, it was $3.0 billion for the Republic of Korea, $3.1 billion for Taiwan, and $0.9

billion for China. In addition, U.S. direct investment in these countries exceeds their investment

in the United States by approximately 3 to 1.’O Finally, in interviews conducted by OTA, U. S.-

based MNEs reported they are generally less

concerned about restrictions on their ability to invest in other Asian countries than in Japan.

I Multilateralism Beyond Trade

Large-scale trade and investment imbalances

across the advanced industrial nations must beaddressed. The Japanese economy, for example, has

become too powerful to be ignored without detriment to U.S.-based MNEs and, ultimately, to the

U.S. technology base. Moreover, for Japanese

MNEs to continue to benefit from relatively open

trade and investment regimes in the United States

and Europe without Japan reciprocating constitutes a threat to the long-term viability of the multilateral system itself. To the extent that other

nations are unable or unwilling to extend reciprocal market access to foreign-based firms, the problem is that much more critical. The United States

has pursued a post-WWII policy wedded to the

principle of national treatment, which has been

applied in the areas of trade, investment, taxation,

and (with important exceptions) to technology

promotion funding. 11 For this reason, many analysts argue that exceptions to the principle of national treatment should be made only with great

circumspection, if at all.

From this perspective, the answer to Japanese

exceptionalism is to create the normative and legal conditions for a convergence of differing national trade and investment practices toward a

global standard, exemplified by the relative openness of the U.S. economy. There is a considerable

body of opinion that identifies institutions like the

WTO as the long-term solution to broad asymmetries in market access policies and diverging business practices among nations in the Triad. In this

view, what the Uruguay Round of GAIT negotiations has done for trade, the next round could do

for investment, i.e., establish a minimum code of

conduct that would prohibit policies that discourage foreign direct investment. As the analysis in

Part III of this report indicates, trade and investment are so interdependent in the 1990s, it is unlikely that a solution to unfair trade conditions can

8 The OTA Advisory Panel on Multinationals and the U.S. Technology Base is listed in the front of this report.

9 For a discussion ~)fhow different historical pa~erns and hst]wtk)nd structures have resulted in different kinds Of capitalism ad different

rates of economic development, see J. Zysman, “HOW Institutions Create Historically Rooted Tm@ctories of Growth,” in /ndusrrial and Corporate Change 3(1 ): forthcoming, 1994.

10 In 1993, direct investment in tie United states was $().8 bl]]ion for tie Repub]ic of Korea, $ ] .3 billion for Taiwan, and for China it was

negligible. U.S. Department of Commerce, Economics and Statistics Administration, Bureau of Economic Analysis, United Slates Depurlment

of Commerce News (Washington, DC: June 28, 1994), tables 2 and 3. All figures are on a historical cost basis at year end.

I I me ~ue5tlon ~)f e]iglbl]ity for foreign-based MNEs in U.S. technology programs k discussed in d~e next section.
Chapter 2 U.S. Technology Policy in International Economic Perspective I 27

be crafted without also addressing imbalances in

FDI among major trading nations. But as Part IV

suggests, convergence toward international

norms may be less important than recognizing the

differences between the U. S., European, and

Asian economic systems, and learning how to live

with them.

For these reasons, some observers now advocate a two-tiered foreign economic policy: one

policy for countries that practice effective national

treatment and extend a high degree of market access to foreign merchandise, services, and investment; and another policy for countries that do not.

(Presumably, developing nations could be held to

a different standard, in view of their need to develop indigenous industrial bases.) Atone tier, policy

would be geared to recognize, promote, and expand the benefits of the post-WWII open system

of international economic relations to additional

countries. At the other, it would recognize the

challenge posed to that system by nations that do

not offer comparable market access, and take steps

to limit potential damage to U.S.-based MNEs

and, more broadly, the U.S. technology base. This

approach would place conditions on national

treatment, and meet infractions of international

trade and investment treaties with specific measures designed to counter them. (Conditional national treatment is discussed in the next section.)

Other voices suggest a middle ground, that is, a

U.S. approach that continues its commitment to

multilateralism and national treatment but, at the

same time, crafts specific bilateral and domestic

policies to offset persistent imbalances in trade

and investment with some of our trading partners.

This might entail compensation at the national

level to make sure, for example, that technological

resources and competencies are retained within

the United States at levels sufficient to ensure the

long-term viability of the U.S. economy and the

technology base on which it depends. Such a

policy would require, for example, highly effective coordination and implementation of a range

of U.S. technology promotion programs. (U.S.

government support for technology development

is discussed in the section on policy issues and options below.)

Still others contend that a special policy for Japan is unnecessary and ill-advised. They point out

that Japan has removed most tariffs and other formal and legal barriers that had hitherto blocked access to the Japanese economy. The increase in the

U.S. trade deficit with Japan over the past year,

they suggest, resulted largely because the United

States economy recovered from the 1991-92 recession more quickly, thus increasing the U.S. appetite for foreign-made goods and services. They

also argue that exchange rate changes have made it

more difficult for U.S. MNEs to invest in Japan,

just at a time when land prices have been adjusted

downward and the Japanese Government has

instituted reforms to promote foreign investment

in Japan.

I Conditional National Treatment

As Parts III and IV of this report demonstrate,

there is, at best, only limited convergence toward

global norms regarding foreign direct investment,

corporate governance, and the long-term financing of MNEs. Globalization of production and information systems has not led to harmonization of

rules across nations, with the possible exception

of international trade. Countries deviate from national treatment and comparable market access

when national interests are believed to be at risk,

such as national security and areas of strategic significance for economic development and competitiveness. 12

12 “Areas in which foreign-owned” c(~mpanies are often treated differently include ownership of domestic firms, paIllClpatl(m in national

R&D and technology programmed and public pr(~urement contracts. In additi(m, Iiberalising measures may be accompanied by recipnxity

conditions under which foreign-owned companies are treated as domestic ones, only if other c(mntries do the same. Such c{mditi(ms are justified on grounds of increasing the openness of countries to foreign investment and creating a ‘level playing field’. ” R. Brainard, “Globalisa(itm

and Corporate Nationality,” S7/ Re}’iew ( 13): 179, December 1993.
28 I Multinationals and the U.S. Technology Base

Proponents of conditional national treatment

(CNT) contend that unilateral application of national treatment will not ensure the long-term

vitality of the U.S. technology base and the industrial sectors that depend on it. When many global

industries are characterized by increasing price

competition, consolidation, and short-lived technological leadership, it is difficult to sustain competitive advantage in the face of large-scale

asymmetries in market access, both for trade and

investment. As one prominent analyst has suggested, foreign firms “may actually displace or deter the entry or expansion of American companies

that might normally be expected to locate more of

their production in the United States, thereby generating better jobs, more R&D, closer linkages

with local suppliers, and more technical spill-overs.” If a foreign firm “knocks out one or more domestic competitors . . . the final result may be a

more oligopolized industry, where the remaining

firms exercise significant market power.”] 3

Another aspect of CNT focuses on the principle

of specific reciprocity. It stresses that MNEs must

have the capacity to compete equitably across national borders. In this approach, U.S. government

policies would condition the treatment of foreign

companies in the United States on whether U.S.

MNEs are treated comparably in the relevant

countries with regard to imports and inward direct

investment. Proponents of CNT point out that

while the Trade Related Investment Measures under the new GAIT treaty, as well as the guidelines

on investment issued by the Organisation for Economic Co-Operation and Development (OECD),

are first steps toward an international investment

regime, they are limited. Moreover, there are no

multilateral agreements respecting other important areas such as corporate governance, finance,

and competition policy.

In practice, this means that if foreign investors

are to have the right to invest in the U.S. economy,

then U.S.-based MNEs should also have the right

to comparable access abroad. Reforms throughout

Europe suggest that access for foreign investors to

EU markets and research projects has improved

significantly in recent years, although counter-examples still exist. The evidence, however, does

not point to the same conclusion for Japan.14

Advocates of the CNT approach believe that if

the United States continues to provide unfettered

access to foreign-based MNEs despite foreign restrictions on U.S. firms, then U.S. policy favors

foreign investors over domestic ones. In this view,

asymmetric FDI can create an uneven playing

field: foreign-based MNEs enjoy access to financing, technology, and markets that is denied to

many U.S.-based MNEs. They argue that CNT is a

highly flexible policy approach that can deploy a

large number of instruments, such as performance

requirements for investment, domestic content

and export requirements, and program requirements for participation in publicly funded

technology projects.

Congress has written the principle of CNT into

a variety of laws over the past several years, and a

large number of legislative proposals in the 103rd

Congress contained similar provisions (see box

2-1 ). The CNT approach can be applied broadly

as, for example, in the American Technology Preeminence Act, which permits participation in the

Advanced Technology Program (ATP) only when

the Secretary of Commerce finds “that the company’s participation in the program would be in the

economic interest of the United States, as evidenced by investments in the United States in research, development. . . .“ It further provides

either that:

(i) the company is a United States-owned company: or (ii) the Secretary finds that the company is incorporated in the United States and has a

parent company which is incorporated in a

country which affords to United States-owned

companies opportunities, comparable to those

afforded to any other company, to participate in

13 L. D. Tyson, ‘Why They Are Not US. Why Ametican Ownership Still Matters,” The American Prospect (4):37-49, winter 1991.

14 For ~etall~ see us. CongmSS, OTA, MU/f;~/i~~/S and fhe National Interest: PkJyin~ By Diflerenl Rules, op. cit., fo(~~~)te 1.
Chapter 2 U.S. Technology Policy in International Economic Perspective I 29

1

2

3

4

5

6

7

8

1

2

3

4

5

6

7

8.

9.

10.

any joint venture similar to those authorized un- Another bill, H.R. 820, goes beyond these reder this Act; affords to United States-owned quirements. It would amend the Stevenson-Wydcompanies local investment opportunities com- ler Technology Innovation Act of 1980 to define

parable to those afforded to any other company;

and affords adequate and effective protection

for the intellectual property rights of United

States-owned companies.

Consistent with this language, H.R. 1675, section (b), of the “Aeronautical Technology Consortium Act of 1993” defines an eligible firm as one

an eligible company as one that maintains substantial employment in the United States, agrees

to manufacture resulting products here, and agrees

to procure parts and materials from U.S. suppliers.

In addition, it contains specific reciprocity provisions, requiring that the home country must afford

U.S.-based MNEs comparable treatment to that

that “conducts a significant level of its research, found in the United States on a variety of terms.

development, engineering, design, and manufac- These include access to participation in publicly

turing activities in the United States.”16

IS American Technology” Freernimmce Act of 1991 (Public Law 102-245).

16 see us, congre~~, Houw of Repre~entatlve~, HR. ] 675, and Senate, S.419, Aer~nUufj(.~/ ~e(,~~~/~gy cwzs~rfjur?j A(’[ of f993 (Washingt(m, DC: U.S. Government Printing office, 1993).
30 I Multinationals and the U.S. Technology Base

funded technology programs and to other national

resources, the employment of transparent standards of regulation, provision of local investment

opportunities, and the protection of intellectual

property rights—all to same degree as found in the

United States. 17

Similarly, U.S. defense authorization legislation requires a participating foreign-based company to conduct a “significant level of its research,

development, engineering and manufacturing activities in the United States” and have a foreign

government that encourages the participation of

U.S. companies in government-funded R&D consortia. 

18 These kinds of policies emphasize performance standards, measures of reciprocity

based on multilateral rules and, potentially, domestic content requirements for manufacturing.

Those who favor a CNT approach would, accordingly, look critically at the R&D activities of foreign investors seeking to participate in publicly

funded projects, rather than assuming positive

spillover effects from their activities.

Some opponents of CNT legislation point out

that this approach risks unintended consequences

for American firms abroad. To the extent that

U.S.-based firms are not currently constrained by

comparable foreign regulation, CNT provisions

in U.S. law increase the risk of retaliation. As an

alternative, they suggest that ambitious new multilateral codes---covering, for example, investment, market access in key sectors, and acceptable

business practice—be negotiated by countries

willing to accept greater and measurable liberalization obligations. The codes themselves could

then be opened to other countries, who would accept those obligations, and receive attendant reciprocal benefits, when they are ready to do so.

(CNT is discussed further under the subheading,

"Eligibility Requirements” below.)

POLICY ISSUES AND OPTIONS

The discussion of policy options that follows is

the product both of the policy context addressed in

the previous section and the major findings presented in chapter 1. It proceeds from a record of

solid but limited progress in both bilateral and

multilateral trade relations, interpreted against a

backdrop of enduring asymmetries in market access, direct investment, and the way in which

MNEs of different nations are financed and governed across the Triad. Chapter 1 describes three

principal findings of this OTA assessment, which

can be summarized as follows:

● MNEs develop core technology at home.

~ Trade follows investment in the 1990s.

= Corporate governance and long-term financing

diverge across the Triad.

Taken together, these findings suggest that the

United States has a direct interest in the global

success of U.S.-based MNEs, to the extent that

such prosperity translates into more innovation

and technology development in the United States.

In this respect, all Americans stand to gain or to

lose from the achievements of U.S.-based firms,

particularly in the high-technology sectors that

promise the greatest returns and the best jobs of

the future. As suggested earlier, however, the definition of an American firm would not necessarily

have to be based on a firm’s country of origin or

ownership. The nature of the contribution that the

firm makes to the U.S. technology base and, ultimately, to the U.S. economy and standard of living, might turn out to be of greater importance.

Additional data and analysis on which these

findings are based are presented in Parts II, III, and

IV. Each of the findings suggests policy issues

and options that Congress may wish to consider.

These are presented below in separate sections.

17 See U.S. Congress, House of Repr~Sen[atiVeS, H.R. 820, Narional Con~pefi[i\’enessAc”/ of 1993 (Washington, W: U.S. Government finling Office, 1993), sec. 206, subsection 20, parts A, B, C, and D.

IS ~p~nlent ,)f ~fense Authorization” ACI (Pub]ic Law 102-484); Nati(mal Defense Authorization Act for Fiscal Year 1992 and 1993

(Public Law 102- 190); and National Defense Authorizati(m Act for Fiscal Year 1993 (Public Law 102-484).
Chapter 2 U.S. Technology Policy in International Economic Perspective I 31

I MNEs Develop Core Technology at

Home (Policy Implications)

Part II of this report analyzes the national innovation systems of the United States, Japan, and the

European Union (chapter 3). It then assesses the

contribution that MNEs make to those systems,

focusing on where technology is developed and

the extent to which it is diffused across national

borders by MNEs (chapter 4). A key finding is that

the technology innovation activities of MNEs remain highly centralized compared with their international production networks.

Government Promotion of

Indigenous Technology

OTA’s findings are consistent with efforts by the

Congress over the past several years to support

and maintain the U.S. technology base. U.S. policymakers have recently reemphasized what other

countries have long recognized: to a very large extent, the health of the economy and its competitiveness rests on the strength of the national

technology base. While this view is not new in the

United States, it seemed less important during the

quarter century following WWII, when U.S.

technology led the world and U.S. military

technology was in a class by itself.

The debate on the need for government support

of the U.S. technology base stemmed largely from

congressional concerns in the late 1980s about the

relative decline of U.S. technology leadership,

and the apparent inability of the executive branch

to coordinate technology development funding in

an efficient and effective manner. Beginning in the

military field, in 1989 and 1990, Congress mandated that the Department of Defense produce a

“Critical Technologies Plan” to identify and foster

the development of key technologies that underpin U.S. national security and economic prosperity, and specifically to ensure the long-term

superiority of U.S. weapon systems. ] 9 At that

time, the U.S. military budget associated with research and technology development amounted to

approximately $10 billion.20

Although the initial emphasis focused on coordination of Department of Defense technology

base programs, this approach was soon applied to

broader economic concerns as reflected in another

congressionally mandated review, this time a Department of Commerce study of ● ’Emerging

Technologies” in 1990. Z In 1992, Congress

created a National Critical Technologies Panel

associated with the Office of Science and Technol -

ogy Policy (OSTP). It was charged with identifying areas of technological development essential

for the long-term economic prosperity and national security of the United States. Later that year,

Congress established a National Critical Technologies Institute to support the Panel de] iterations

and to coordinate its recommended actions.

In this way, a level of agreement was achieved

not only on the need for technology promotion

and coordination of U.S. government technology

funding, but also on the technology areas in need

of support.

22 By late 1993, the critical technologies perspective had worked its way into the

White House and was endorsed by the President.23 Further, the OSTP issued a plan to begin
32 I Multinationals and the U.S. Technology Base

coordination of a large number of governmentfunded technology programs, including the

Technology Reinvestment Project, the Advanced

Technology Program, the Partnership for a New

Generation of Vehicles (PNGV), the National Flat

Panel Display Initiative, SEMATECH, Energy

Department cooperative R&D agreements (CRADAs), and the Manufacturing Extension Partnerships, among others.24

Technology Funding and Foreign

Economic Policy

Programs to promote the development of new

technologies could constitute a strategic domestic

response to long-term trade and investment deficits with some U.S. trading partners. But to do so,

the range and focus of present programs would

have to be changed in two ways. First, it would be

important to ensure that they contributed to the national interest, while still extending national treatment to foreign-based MNEs; and second, they

would have to be coordinated a good deal more efficiently than they are at present. These issues are,

of course, intertwined, and each is addressed below.

With regard to the public interest, it is appropriate to ensure that technology benefits arising from

participation in programs funded in part by government ultimately accrue to the U.S. taxpayer,

who will be asked to foot part of the bill. The connection may not be easily measured, but it should

be cast in terms of a contribution to the indigenous

American technology base. In most cases, the recipients of public technology promotion funds

will be corporations that match public funds on a

50-50 basis, bring extensive technology assets to

the table, and help define the research to be undertaken. They have a right to benefit as well. However, the question of eligibility of U.S. affiliates of

foreign-owned MNEs arises. Foreign affiliates argue that they provide jobs for hundreds of thousands of Americans and so should be eligible for

participation. Conversely, a displaced auto worker from Michigan, whose job may not be restored,

might not agree that his or her taxes should support foreign auto companies, for example, even if

those companies employ thousands of Americans

in other locations.

Eligibility Requirements

In recent years, Congress and the Administration

have experimented with a variety of approaches to

the question of eligibility. In the PNGV, participation is restricted to the Big Three U.S. auto makers, without the possibility of Japanese or

European participation. In the ATP, Congress legislated a broad array of conditions, including reciprocal access for U.S. companies to similar

programs abroad. In other programs the requirements are far less restrictive, and the question of

foreign ownership is less prominent. In short, different programs take different approaches. As a result, an ad hoc and inconsistent body of law,

executive orders, and administrative practices has

built up over time, with little consensus among

policy makers about who should be eligible for

U.S. government technology funding.

In the interests of fairness and administrative

consistency, Congress may wish to enunciate a

single set of eligibility requirements that would

apply to all U.S. technology promotion programs,

with some few exceptions, perhaps requiring a

presidential finding when national security interests are at stake. This could involve a national

benefits test, with several constituent elements.

Perhaps the most important element would be a

requirement that companies receiving U.S.

technology funds demonstrate a clear prior commitment to the U.S. technology base. Companies

that could not point to existing R&D facilities and

technology infrastructure in the United States,

sufficient at a minimum to support the project in

question, would not be eligible. It would be unnecessary to make national ownership a criterion

for inclusion or exclusion for funding. Some foreign-based MNEs might be persuaded to develop

24 Ibid.
Chapter 2 U.S. Technology Policy in International Economic Perspective I 33

more technology in the United States if they

thought they could benefit from participation in

U.S. technology promotion programs.

As OTA suggested in the first report of this assessment, the answer to the policy question of

what should constitute an American company is

tied not so much to the ownership or home base of

particular MNEs, but rather to how a firm affects

the economy and standard of living where it operates. The purpose of a benefits test would be to ensure that firms receiving public funds contributed

to the national interest. In this view, MNEs should

be considered American, and therefore eligible, if

and when they contribute in a meaningful way to

technology innovation in the United States. Even

though this approach stems from unilateral or national concerns, eligibility requirements could be

written to be both consistent with the principle of

national treatment, and legal under the terms of

the new GATT Treaty and other international

agreements.

The following criteria could form the basis of a

test to determine the eligibility of both foreignbased and U.S.-based firms for all publicly funded

R&D programs. No distinction based on national

ownership would be necessary or appropriate, but

each funding authority might employ the following conditions :25

1. A measure of R&D presence in the United

States, perhaps as a percentage of U.S. sales, of

global sales, or of the company’s overall

technology development budget;

2. A set of specific technological and financial

contributions the company would make to the

project;

3. An agreement on the part of the company to

conduct all of the R&D funded under the project (or a negotiated percentage) in the United

States;

4. A requirement that the country of origin of the

MNE applying for funds afford reciprocal access to U.S.-based firms;

5. An agreement on the part of the company to

manufacture a negotiated percentage of the final product(s) in the United States; and

6. In retum for proprietary rights, an agreement by

the company not to license the technology

abroad, but to pursue export of products resulting from the technology in lieu of licensing.

Should Congress decide to incorporate some or

all of these points into legislation applicable to

U.S. technology promotion programs, it would be

important to do so in a way that did not discriminate unfairly against any firm, foreign or domestic. The test is whether the United States would be

willing to see identical conditions applied to affiliates of U.S.-based companies by foreign governments. In addition, Congress might wish to grant

limited waiver authority with respect to point

number 1 (above) in cases where a company with

insufficient R&D presence in the United States

nevertheless proposed the development of a

technology with extraordinary or unique potential. In that case, participation by the company

could be made contingent on its agreement to develop the new technology jointly with at least one

eligible U.S. partner.

Some analysts oppose reciprocity provisions

(point 4 above), which typically require reciprocal

access for U.S. firms to technology programs in

the country of origin of the foreign-based applicant in question. While this approach is already

contained in H.R. 820 and the authorizing legislation for the ATP, among others, it may present

problems. First, technology innovation systems

of the major trading nations in the Triad are configured very differently (see chapter 3), so much

so that requiring equivalent reciprocal access may

‘f These criteria are ranked in ascemhng fmier of probable difficulty of implementation. Some analysts believe that itcm 5 w (juld he inc(mslstent with U.S. treaty thligati{ms under the NAFTA and GATT agreements. In addition, item 6 might ex~~se some U.S. patents to c(m~pulsory

Ilcensing abroad.
34 I Multinationals and the U.S. Technology Base

not be feasible in practice, or might not achieve

the intended result. In Japan, for example, comparatively little technology development is

funded directly through government programs.

Second, if the approach was extended beyond

eligibility for technology programs to include reciprocal opportunity for trade or investment

abroad, some analysts believe there would be

unintended consequences that outweigh any possible benefits. This might take the form of increased tensions in international economic

relations, leading to a variety of retaliatory actions

on the part of our trading partners. Congress nevertheless may wish to consider making participation by foreign-based MNEs contingent on

comparable access by U.S.-based MNEs to foreign technology promotion programs. This would

be only one of a range of policy instruments that

could be deployed to rectify persistent trade and

investment imbalances that built up during the

1980s and show little sign of receding in the

1990s. (These and other options are discussed below in the section on trade and investment.)

Coordination of Federal

Technology Programs

If technology programs are to function, in part, to

offset some of the trade and investment asymmetries that characterize economic relations in the

Triad, they will have to be strategically coordinated. This fundamental insight lies at the heart of

now long-standing congressional concerns referred to above as the critical technologies approach. But even after years of congressional

prodding, the Department of Defense, for example, was unable to come up with a credible longterm plan to maximize the effectiveness of its

technology base programs.26 In 1991, when Congress mandated a review of critical technologies

within the Executive Office of the President and

created the Critical Technologies Institute, it

sought to enhance the capability to coordinate

technology promotion programs into a single strategic approach.

As OTA reported in early 1994, with respect to

the $1.8 billion in federal energy and environmental technology programs, only a small portion is

directed at commercial applications. In addition,

although several agencies have mission-oriented

programs, there has been little strategic direction,

and funding agencies have seldom worked closely

together to identify critical environmental problems or common technology priorities .27 With the

exception of agriculture, federal expenditures on

both military and civilian research and technology

development have devoted scant attention to the

commercialization of new technologies.28

Over the past 18 months, there has been an intense effort to coordinate federal R&D programs,

emanating largely from a new National Science

and Technology Council (NSTC). The Council

was created by executive order to function as a

government-wide coordinating body, to create

visibility for technology policy, and to establish a

single set of goals, priorities, and criteria to shape

federal R&D programs. If successful, the NSTC

would encourage greater centralization of the

R&D funding process, and could help focus the

26 b%% [Senate Armed Services] committee is deeply disappointed in the Defense Department’s inabll ity to pr(wide a comprehensive plan

addressing the deveh~pment of technologies critical to the national defense. . . The c(mtinued inability of the Administrali(m to rati(malize the

natitmal science and technology investment program, and to prioritize technology base activities, detracts both from national security and, in a

broader sense, frtml global economic competitiveness.” United States Senate, Committee on Armed Services, “National Defense Authorization

Act for Fiscal Year 1991 ,“ rqxwt 101-884 (Washington, DC: U.S. Government Printing Office, 1990), p. 179.

‘7 United States Congress, Office of Technology Assessment, Industry, Technology, and the En~)ironn]ent: Cwnpe/iri\’e Challenges and

Bwlness Opporfunities, OTA-lTE-586 (Washington, DC: U.S. Government Printing Office, January 1994), p. 291.

‘8 See D.C. Mowery, ‘-The Challenges of international Trade to U.S. Technology Policy,” in M.C. Hams and G.E. Moore (eds. ), Linking

Trade and TeIhnolo~y Polwies (Washingt(m, DC: National Academy Press, 1992), p. 124.
Chapter U.S. Technology Policy in International Economic Perspective I 35

heretofore disparate funding priorities of a large

number of agencies on a small number of nationally oriented policies and goals.29 If, however, the

budget priorities of the Council are significantly

different from those of the historically separate

funding authorities, then the Council is likely to

encounter resistance that cannot be overcome

within the Council alone.

Moreover, this effort alone does not constitute

an effective national technology strategy. Rather,

it is an important initial step to achieve greater

cooperation among the various agencies of the

U.S. Government that undertake R&D programs.

As a creation of the executive branch, the Council

lacks a clear legislative mandate. For that reason,

any successes—whether in organization or in the

implementation of an actual R&D strategy—

achieved by this Administration could be easily

abandoned by the next. Nevertheless, Congress

may wish to pay close attention to the progress of

the NSTC, chronicling its strengths and weaknesses. If it brings a greater degree of internal coherence and purpose to U.S. technology

promotion programs, Congress may wish to consider legislation to give it greater institutional

staying power. If, on the other hand, it does not

yield results, there is much that can be learned in

terms of the kinds of efforts to undertake next.

Many analysts argue that the most successful

government-sponsored R&D occurs when the

goals are clear, such as in the Apollo projector in

the decades-long effort to design ever more sophisticated and powerful nuclear weapons at the

national laboratories. Both programs achieved

their stated objectives. These lessons suggest that

efforts by government programs to increase U.S.

competitiveness or push up national productivity

will succeed to the extent they can be tied to clearly articulated national missions. They also would

have to be embedded in a stable institutional structure, insulated from patronage and partisan forces.

This is not the first time that OTA has assessed

the need for a strategic technology policy and the

institutions required to sustain it. In 1990, OTA

analyzed options to coordinate strategic technology policy and to set up a Civilian Technology

Agency. Legislation was proposed to that end in

both the 100th and 101st Congresses.30 If Congress wishes to make technology promotion programs an instrument of economic strategy, it will

have to provide both leadership and legislative

impetus. Otherwise, the history of critical

technologies suggests that individual government

agencies are likely to direct their portion of

technology funding in ways that make sense at the

level of departmental priorities, but which do not

cumulate into a national technology strategy.

I Trade Follows Investment in the 1990s

(Policy Implications)

As Part III of this report indicates, international

trade and direct investment have become highly

interdependent over the past decade, so much so

that trade among affiliated companies now accounts for at least one-third of all U.S. merchandise trade. In our most important bilateral trade

relationships, the balance of trade is highly correlated with the balance of investment. That is,

where U.S. MNEs have been able to invest freely

abroad, there is a rough balance in both IFT and

merchandise trade; where the balance of investment has been highly skewed, there are large trade

deficits. At a minimum, these findings suggest

that U.S. foreign economic policy is too focused

on trade and should give greater weight to issues

associated with foreign direct investment. For example, steady devaluation of the dollar against

—

29 J.H. Gibbons and L.E. Parwtta, Executive office of the President, Memorandum for the Heads of Executive Departments and Agtmcles,

“FY 19% Research and Development (R&D) priorities,” May 6, 1994.

~~ For a Conlprehenslye eva]ua[lorl of [hese options, see U.S. C(mgress, Office of Techntdogy Assessment, Making Thin,~~ B~r(f’r.’ ~“~~ml~cr-

~ng In Munujacrurlng, OTA-lTE-443 (Washington, DC: U.S. Government Printing Office, February 1990), pp. 32-35 and 71-89.
36 I Multinationals and the U.S. Technology Base

major foreign currencies should increase exports

of U.S. merchandise goods. But it also reduces the

ability of U.S.-based MNEs to make investments

abroad, investments that may prove indispensable

to opening foreign markets and selling U.S. products.

U.S. Policy on Foreign Direct Investment

As currently constituted, U.S. government policy

does not recognize the strategic linkage between

trade and investment. Minimal government attention and resources are devoted to foreign direct investment. The Committee on Foreign Investment

in the United States (CFIUS) is the major government organization responsible for FDI. It is an

interdepartmental committee that reviews prospective investments on military security grounds

alone. There is no formal U.S. government review

of the effect of FDI on U.S. trade, the U.S. technology base, U.S. industry, or other economic concerns. Accordingly, U.S. policy has not moved to

increase the benefits of foreign investment for the

U.S. technology base, either in terms of inducements to encourage FDIUS in research and

technology development, or in terms of measures

to discourage less desirable forms of direct investment.

Not all forms of investment by foreign-based

MNEs are equally beneficial to the U.S. economy

and technology base. OTA research suggests a

hierarchy:

1. very beneficial investment in high-technology

industries with substantial R&D and manufacturing operations in the United States;

2. intermediate investment in assembly operations using some U.S.-made parts and components;

3. less beneficial FDI in pure assembly or screwdriver operations, with less domestic value-

-added; and

4. least beneficial FDI in wholesale distributors

for foreign-made components and finished

products.

OTA interviews with managers of MNEs and

analysis of macro-level economic data suggest

that much of the surge in FDIUS in the late 1980s

was concentrated in the last two categories. Given

the increasing magnitude and importance of FDI,

Congress may wish to reconsider U.S. policy.

Several options follow.

Sustaining Unrestricted FDIUS

The analysis contained in Part 111 of this report

(and in chapter 3 of the first report of this assessment) indicates that FDIUS offers indisputable

benefits to the U.S. economy, both in terms of

augmenting investment capital, and to a lesser extent by providing technology and jobs.31 Those

who favor this approach argue that the benefits are

so great as to outweigh any costs. In the absence of

foreign direct investment, they suggest, the same

products would be imported to meet consumer demand, with the difference that the foreign capital

and associated jobs would remain abroad. They

are also concerned that any restrictions on FDIUS

might risk adverse consequences, such as reciprocal restrictions on U.S. investment abroad or, in

the extreme, disinvestment by foreign affiliates in

the United States.

For these reasons, they advocate that the principles of national treatment and unrestricted

FDIUS be sustained, even in the absence of comparable access for U.S. direct investment abroad.

They point to ongoing efforts by foreign governments, notably Japan, to provide investment capital and temporary office space to U.S. companies

seeking to establish a local presence. And they

note that governments across Europe have made

substantial progress in liberalizing their investment regimes in recent years. In this view, it

3 I ~tie ~aPlta] ~~~ct, see EM. Graham, “Foreign Direct Invest~nt in the united states and U.S. Interests,” Science 254(39): 1740-1745,

Dec. 20, 1991.
Chapter 2 U.S. Technology Policy in International Economic Perspective I 37

would be counterproductive for the United States

to send any signal regarding FDIUS that might

reverse recent progress abroad. Instead, these

analysts would minimize the application of the

Exon-Florio provision, reducing executive discretion that they suspect may exert a chilling effect on potential foreign investors. 32 With respect

to Japan, moreover, they advocate taking no action on the assumption that Japan is already slowly opening to investment, and market forces,

particularly exchange rate fluctuations, will

eventually redress the imbalance.

Multilateral Approaches

In the long term, it may be possible to seek comparable market access for investment through regional or multilateral investment codes. The

recent conclusion of the GATT Uruguay Round

included agreements on Trade Related Investment

Measures (TRIMs). But FDI was not treated in a

comprehensive manner, and multilateral rules respecting the conduct of FDI have not been established. Similarly, the NAFTA agreement involved

extensive discussion about trade issues, but largely ignored investment. The same is true of the

1992 European economic integration initiative,

where national governments retain competency

over investment matters. The United States could

seek first a North American regional agreement

for investment, then mutual harmonization with

other regional organizations such as the European

Union.

Many observers conclude, however, that reaching multilateral agreements governing foreign direct investment will be a formidable task,

particularly if extended to developing countries.

However, at the beginning of the Uruguay Round

of GAIT talks in 1986, agreement on trade-related

aspects of intellectual property (TRIPs) was

thought to be a distant possibility at best. And yet

the TRIPs agreements were included in the GATT

treaty signed in December 1993.

Addressing the Trade/Investment Deficit

A third policy approach focuses on the linkage between the U.S. trade deficit and the lack of equality of investment opportunity abroad. In a world

where more than one-third of all trade is conducted among affiliated companies, exports and

direct investment are intrinsically related. Advocates of this position point to the logical necessity

of setting up a foreign subsidiary before conducting intrafirm trade (IFT) with it. The implication:

in order to increase exports, and the high-quality

jobs associated with them, U.S.-based MNEs will

also have to increase investments abroad. In this

view, the U.S. government should press Japan to

improve investment opportunities for U.S. companies, and to that end, support the value of the

dollar against the yen.

As the Japanese economy has demonstrated,

Japanese FDI in the United States and East Asia

has increased exports from Japan of high-quality

parts, components, and finished goods. This has

expanded employment, both in export-oriented

Japanese firms and in their overseas affiliates.

Some observers distinguish between low and high

value-added jobs. The former, they contend, will

inevitably shift to lower-wage areas due to the

downward pressure on prices associated with

overcapacity and global competition in a range of

industries. It is therefore critical that U.S. policy

reflect the strategic importance of keeping high

value-added jobs at home, even if it becomes more

difficult to retain those with low value-added.33

If the policy goal is to increase U.S. investment

abroad in order to support U.S. exports and jobs,

Congress and the executive branch might consider

32 Exon.Fl[Jri~J, a Provlslon” of the (J.S, Omnibus Trade and Competitiveness Act of 1988, amended ~ltle VI1 of the ~fense ~(~uctit)n Act

of 1950 to provide the President with the authority to investigate and determine the national security impact of proposed or pending mergers,

acquisitions, and takeovers by or with foreign persons.

33 For a Summav a~lc]e on the effect of this problem on tie Germ~ ec(m(~my see F. %otzrnan, “Rewriting the Contract for Germany’s

Vaunted Workers,”” in New York 7imes, p. F5, Feb. 13, 1994.
38 I Multinationals and the U.S. Technology Base

measures to achieve comparable investment opportunities for U.S.-based MNEs. Such an objective at first requires a designation of countries in

which barriers to investment exist, and then a plan

for the most appropriate remedy. There are several

distinct approaches among those who seek greater

market openness for U.S. direct investment

abroad, including monitoring developments in

FDIUS and using policy instruments based on

specific reciprocity (see below). Others believe

that the requisite instruments are already available, such as Section 301 and Sections 1106 of the

Omnibus Trade and Competitiveness Act.34 Proponents advocate continued executive discretion

to apply such instruments in a flexible and prudent

manner; they oppose automatic or more assertive

legislative measures. They are concerned that

U.S. bilateral investment treaties with developing

nations will be more difficult to negotiate if the

United States imposes any form of investment

strictures, even if directed only at advanced industrial nations within the OECD.

Monitoring Developments in FDIUS

Making informed policy choices and conducting

successful negotiations in the complex fields of

trade and investment require extensive data and

analytic capabilities. However, U.S. government

units broadly responsible for international trade

and investment policy lack sufficient data and

analytical capability to evaluate fully the contemporary trade and investment patterns of MNEs.

Several of the executive offices with front-line responsibilities in this area told OTA they are unable

to analyze interrelated flows of trade and investment around the world and, accordingly, cannot

use that analysis to further U.S. interests. The Office of the United States Trade Representative

(USTR), for example, employs only one full-time

economist in these critical areas.

In addition, no executive agency performs a

comprehensive analysis of FDIUS, except for purposes of military security, and none is charged

with formulating a strategy to maximize the value

of FDI to the United States. The United States

does not collect systematic data on global FDI or

global technology transfer. U.S. embassies abroad

undertake only limited activities in this area. The

Department of Commerce, Bureau of Economic

Analysis (BEA), does conduct extensive surveys

of foreign direct investment in the United States

and U.S. direct investment abroad. These were indispensable in conducting the analysis for this report. But these surveys are not designed to assess a

range of important trends in trade, investment, and

technology transfer, or to analyze the implications

of foreign direct investment in the United States.

In recent years, funding for BEA and other economic data resources within the U.S. government

has not reflected the increasingly global character

of the economy and the corresponding surge in international trade and direct investment. This has

diminished the ability of the United States to conduct analysis to support sound foreign economic

policy. If Congress wishes to put U.S. negotiators

on a more equal footing with their European and

Japanese counterparts, it could increase funding

for economic analysis and data collection, specifically related to assessing trends in global trade, direct investment, and the transfer of technology.

Congress may also wish to consider reorienting

the data collection priorities of the BEA and related offices. It would, however, be unwise to diminish or to increase significantly the funding of

existing U.S. government data resources without

first examining their mandates for relevancy to the

more global economy of the 1990s. For this reason, Congress may wish to mandate a study of

U.S. government offices that collect trade and investment-related data; it would assess their missions, methodologies, cross-agency coherence,

and the adequacy of their funding to support U.S.

negotiations and policy makers.

As trade among MNEs comes to dominate the

international economy, understanding the patterns and purposes behind global FDI becomes

34 omnibus Trade md competitiveness Act {)f 1988 (Public Law 1~-41 8).
Chapter 2 U.S. Technology Policy in International Economic Perspective I 39

more important. As noted earlier, since 1980,

world stock of FDI has increased by over a factor

of four to reach $2.0 trillion (in nominal dollars) in

1990. This has transformed economic relations

among the advanced industrial nations and has

profound implications for the developing world as

well.

Because the phenomenon of FDI is here to stay,

and will continue to influence our economic wellbeing, Congress may wish to consider creating an

Office of Foreign Direct Investment, perhaps reporting to the National Economic Council or

within the Department of Commerce. Such an office could assess trends in FDI on a global basis

and recommend U.S. policy based on trends and

forecasts. It might also recommend policies to induce favorable forms of FDI in the United States.

As an interim step, Congress might consider

commissioning a study to make recommendations concerning the scope and powers of such an

Office. This study could specifically address the

following issues: whether the Office of Foreign

Direct Investment would combine existing resources for data collection and analysis with new

ones; whether it would conduct systematic monitoring of FDIUS; the extent to which it would also

monitor U.S. direct investment abroad and investment by foreign-based MNEs in third countries

(i.e., not the United States and not the country of

origin); and whether it should be charged to adjudicate FDIUS cases, based on their contribution to

or adverse impact on the U.S. technology base and

economy.

Specific Reciprocity

Yet another approach appeals to the principle of

obtaining compliance with the terms of bilateral

or multilateral agreements though the implicit

threat of reciprocal action. Proponents believe

such a policy could be used to condition continued

national treatment on the ability of U.S.-based

MNEs to obtain comparable access abroad for

trade, investment, and/or participation in government-funded technology promotion programs. A

number of bills containing elements of specific

reciprocity have been passed or proposed in recent

Congresses. (For examples, see box 2-1 above in

the section on conditional national treatment.) If

Congress wished to take an even more aggressive

stance in this area, legislation could be written to:

1.

2.

3.

Make foreign MNEs eligible to participate in

U.S. technology promotion programs only on

the condition that U.S.-based MNEs receive reciprocal treatment abroad, on a country-bycountry basis;

Require that U.S. companies be afforded adequate and effective protection in the area of intellectual property rights abroad, and apply

sanctions in cases where they are not;

Require access to equity markets and trade

associations for U.S.-based MNEs abroad,

comparable to those available to foreign affiliates in the United States.

If bilateral and sectoral imbalances persist despite these and related policy measures, Congress

may wish to consider other options. For instance,

Congress could mandate screening of FDIUS

from an economic security perspective, or it could

condition new investments by foreign companies

in the United States on reciprocal and comparable

investment opportunities (or levels of U.S. investment) abroad for U.S.-based MNEs. However,

many analysts believe that these options would

lead to unforeseen and probably undesirable political and economic consequences.

In its strongest form, legislation could be designed to empower U.S. firms to bring claims

against nonconforming nations (or firms) before

the International Trade Commission or another

designated adjudicatory body, similar to the process now employed with antidumping suits against

foreign imports. Failure to cooperate or implement settlements could, in the extreme case, lead

to a variety of retaliatory measures, such as applying a tax or other sanctions to foreign affiliates already operating in the United States, until U.S.

firms achieved comparable investment access in

the country in question. Few analysts endorse this

approach because of its highly coercive and unilateral elements.
40 I Multinationals and the U.S. Technology Base

I Corporate Governance and Finance

Diverge Across the Triad

(Policy Implications)

As chapters 7 and 8 suggest, structural differences

in corporate governance and corporate finance are

likely to persist across the Triad. Structural convergence—the unspoken assumption behind the

traditional American approach to trade and investment frictions—is a long-run prospect at best.

Japanese and German forms of corporate governance in their purest forms are probably not suitable for the United States, even if current policy

impediments were not present. In addition, even a

cursory review of American corporate history indicates that American business is unlikely to conform to the Japanese model and adopt a broadly

shared sense of the national interest.35 Nor is

American business culture likely to adapt to a German-style system that depends upon a mutual

sense of intimacy and trust among key stakeholders, including employees. To a considerable extent, the success of such systems depends upon

social mores that sometimes render acceptable the

subordination of consumer interests, executive

salaries, and immediate shareholder returns. Similarly, the prospects for Germany or Japan moving

toward the American model are limited.

American Corporate Governance in a

Global Business Environment

The system of American corporate governance

developed mainly in reaction to the need for stable

contracting arrangements in uniquely decentralized markets, as well as in response to actual or

perceived abuses of power by corporate managers,

bankers, and shareholders.36 The consequences

are reflected not only in our system of corporate

governance, but in such policy areas as antitrust,

which differs in both overt and subtle ways from

its analog in Japan or from what Europeans call

competition policy (see appendix C).

In a world where core technological competencies often remain close to the headquarters of leading MNEs, systems of corporate governance that

encourage long-term thinking and enable the pursuit of strategies that subordinate immediate returns to long-term market position can have

vitally important national implications. In fields

where American corporations have ceded markets

to competitors based in other nations, for example

in parts of the electronics sector, the task of building the critical mass required to regain a place at

the frontier of innovation will be daunting.

Such observations are part of the background

now, as national debates continue over the organization of American business, the time-horizons

and salaries of American executives, and the international competitiveness of the U.S. technology base. Many of the inadequacies identified and

agreed upon may imply domestic adjustments.37

Given historical patterns, however, it would be

surprising if internal changes in the American system happened quickly or predictably.

Responding to Different Systems of

Corporate Governance

Our basic system of corporate governance must itself be competitive. But to the extent that enduring

differences in corporate governance systems and

competition policy effectively subsidize foreign

MNEs or protect them from competition in their

home markets, American trade and investment

policies may need to be reconfigured to enable

compensatory responses. Because objective judgments are required in this regard, and because uni -

35 (}n the Japanese case see R.J. Samue]s, ‘aRlch Nation, Strong Army”: National Security and the Technological Transformation of.lapan

(Itham, NY. Cornell University Press, 1994).

36 See M. R(K, “A po]ltlcal neow Of Anlerican Cowwate Finance,” Columbia LanJournal 91 ( I ): 10-67, Jan. 1991. Also see O.E. Willlam-

~(m, 7’he L“conornic Institutions oj’C’apltalism: F“irms, Markets, Relational Contracting (New York, NY: Free Press, 1985); and W. Adams, 7’he

S[ruc(urc ofAmerican lndu.$try (London, UK: Macmillan, 1982).

37 me C{)nlw.titlyeness Pollcy Council, ~rea(e~ by congress in 1988, has commissioned a task force 10 examine paflicular aspects of tie

American system of capital allocation. A repwt is expected by early 1995.
Chapter 2 U.S. Technology Policy in International Economic Perspective I 41

lateral responses would risk disproportionate

retaliation, many analysts believe that a multilateral approach to such policy reconfiguration

would be preferable. To prepare the groundwork

for multilateral negotiations on corporate governance or competition policy arrangements that

impede comparable market access across the

Triad, Congress may wish to consider mandating

the Office of the United States Trade Representative or the Commerce Department to examine the

issue in more depth. Such an examination could

concentrate on critical technology industries. It

might look, for example, at the effects of stable

cross-shareholding arrangements and other aspects of corporate governance or competition

policy that create sanctuary markets and effective

cartels in specific industries.

Competitive advantages that may result more

from enduring national traditions than from artificial governmental manipulation may have the effect of subsidizing overly aggressive corporate

strategies. This might occur when the world market share of firms based in one country increases

rapidly in a competitive, technologically intensive sector. To reverse such a development, companies must be able to compete in the home

markets of such firms. To the extent this is precluded by unique systems of corporate governance that make it problematic to investor acquire

critical mass in those markets, those systems

could be defined as implicit trade barriers or implicit subsidies. A reasoned estimate of the value

of such practices might provide the basis for negotiating offsetting trade and investment rules. If, for

example, corporate governance structures in Japan make it too costly for foreign-based MNEs to

invest in production and distribution facilities in

Japan, but their Japanese competitors can readily

establish or acquire their own facilities abroad,

and if trade and technological innovation now

follow investment, those structures themselves

become legitimate issues for multilateral negotiation. The analytical foundations for such negotiation require much more work.

Improving Transparency

Congress may wish to consider measures to increase the transparency of the underlying governance structures of foreign corporations operating

in the United States. The Internal Revenue Service

(IRS) tries to understand the financial effects of

governance structures when foreign firms begin to

generate income in the United States. Likewise,

the Securities and Exchange Commission requires that foreign firms listing their stocks on

American exchanges meet disclosure requirements that approximate those for public companies in the United States. The right of publicly

held foreign firms to conduct operations in the

United States, for example, might be made conditional on meeting standards of financial disclosure

comparable to those of publicly held U.S. firms.

Harmonizing Divergent Accounting Rules

Accounting standards could work in a similar

fashion. Mindful of the impact on competitiveness of the interaction between traditions of corporate governance and national accounting rules,

governments and professional bodies around the

world have pursued the complex challenge of accounting rule harmonization. Aside from the substantive issues involved and the plausible

arguments used to justify specific national rules,

the harmonization agenda is complicated by the

fact that government agencies do not always establish accounting standards.

In the United States, the Financial Accounting

Standards Board established in 1973 by the American Institute of Certified Public Accountants, sets

the standards. The SEC, IRS, and other agencies

of the government certainly have critical impact

on the work of the Board, but it is most often indirect. In Germany and Japan, government offices

play the key role in standard setting. Consequently, international work on accounting harmonization has been pursued in a number of public and

private arenas, the most important being the

United Nations, the OECD, the European Com-
42 I Multinationals and the U.S. Technology Base

munity, and the (private) International Accounting Standards Committee. The SEC has been

active for many years in promoting international

harmonization.

The comparative analysis presented in Chapter

7, however, suggests that institutional differences

are not the only impediment to true harmonization. Accounting differences are rooted in idiosyncratic systems of corporate governance, which

themselves reflect diverse social and cultural priorities. OTA research in Germany and Japan bears

out the view that hidden reserves, the lack of balance sheet transparency, the treatment of R&D expenditures, and other practices that can create

competitive advantages for firms, continue to be

perceived as quite functional and even necessary-especially during periods of recession or

slow growth. Once again, such issues will come

under scrutiny as multilateral rules governing

trade and investment are reshaped in the years

ahead.

In considering the public policy environment

within which MNEs compete, a key issue centers

on our inadequate knowledge of the competitive

consequences of national accounting systems.

Both inside and outside government, policy-relevant research is still at an early stage. Congress

may want to accelerate that research by providing

the SEC with a mandate to assess the competitive

consequences of such differences. In addition, because accounting principles and corporate tax issues are closely related, Congress may wish to

link such research to ongoing work by the IRS on

the taxation of foreign and U.S.-based MNEs.

Harmonizing Financial Rules

As in the field of corporate governance, differences in underlying national financial structures

become more important when MNEs compete directly in one another’s home market. To the extent

that competitive problems occur in particular industrial sectors, Congress may again want to reconsider efforts to promote convergence in those

structures.

With convergence in mind, one option may be

to revisit the issue of expanding the powers of

American financial institutions to match the powers held by leading competitors abroad. When

Congress next reviews the Glass-Steagall provisions of the Banking Act of 1933, for example, it

might reconsider the barriers between commercial

and investment banking in the United States.

Those barriers have been allowed to erode somewhat in recent years, but they continue to have an

important impact on the structure of American financial markets. It is timely to complement traditional and enduring concerns about the safety and

soundness of those markets with consideration of

the impact of that structure on the international

competitiveness of critical technology industries.

Universal banking, whereby individual banks

combine commercial and investment banking capabilities, may not fill the financing gaps often

noted in the development and commercialization

of new technologies in the United States. Nevertheless, since many of’ our major trading partners

either have universal banking systems in place

(Germany, Switzerland, Austria) or are now moving in the direction of universal-type systems

(Canada, Britain, France, Japan, Italy), structural

differences between American financial markets

and others are likely to become more pronounced

in the years ahead. We need abetter understanding

of the effects of such differences on the international competitiveness of promising industries.

In a similar vein, Congress may wish to reconsider the issue of ownership linkages between

banks and commercial enterprises. Like the Banking Act of 1933, the Bank Holding Company Act

of 1956 might be reviewed in a global context.

Since the 1930s, concerns about the safety and

soundness of the banking system have limited the

scope for American banks, and later bank holding

companies, to take significant equity positions in

nonfinancial corporations. Constraints having a

similar effect do not exist in either Japan or Germany. This policy asymmetry matters now when

some German and Japanese MNEs are world leaders in important technology-intensive sectors. To

the extent that stable bank shareholders give them

an advantage over American-based rivals, a case

may be made for relaxing traditional legal
Chapter 2 U.S. Technology Policy in International Economic Perspective I 43

constraints. The issue requires further analysis on

a sectoral basis. (See chapter 8 of this report for

additional background.)

If adequate convergence across national financial systems in the near term is not feasible, Congress may want to develop new multilateral

approaches to competitive problems at the level of

the firm. Once again, this may depend upon bringing investment issues to the fore in trade negotiations. Enduring financial structures that either

provide long-run advantages for particular firms

or constrain fair competition do so primarily

through their effect on inward investment. New

rules aimed at comparable market access across

the Triad may be needed to counter such effects.

For example, accession to future multilateral investment and market access agreements could be

conditioned upon conformity to common standards of financial disclosure and other business

practices. Congress may wish to ensure that the

negotiation of such rules is a key objective on the

nation’s trade policy agenda.
Part II: National

Technology

Innovation and

Multinational Firms

ultinational enterprises (MNEs) are critical to the U.S.

technology base. The most technologically sophisticated and economically significant sectors of the U.S.

economy are marked by high degrees of foreign direct

investment (FDI), global production, intrafirm trade (IFT), and

complex forms of international financial and technological

collaboration. 1 These sectors, including but not limited to

semiconductors, electronics, chemicals, pharmaceuticals, telecommunications, and autos, are also marked by increasingly high

research and development (R&D) requirements. The location and

character of technology development by MNEs shapes the basic

structure of competition and competitive advantage in these and

related sectors. z

The analysis in Part 11 centers on a basic tension facing policymakers concerned with the U.S. technology base. Large firms are

an important source of national innovative capacity. However,

they are increasing y multinational, deploying strategies based on

global economic and technological calculations. MNEs can and

do move manufacturing plants, financial resources, technological

assets, and even R&D activities on a global basis in response to

international business opportunities. While policy makers are

‘ For an okcn ICW of the principal activities of MNEs, see: OTA, Muhina[ionals and

the National lntere~t: Playlng by Dlfierent Rules, OTA-lTE-569 (Washington, DC: U.S.

Gf)\emn~ent Prin[lng Office, Seplmbcr 1993).

z In a number of sectors and inqx)rtant technologies, innovation by small and medlun~-sized enterprises is very robust and extremely impmant to the U.S. technology”

base. In the aggregate, however, large firms conduct the bulk of R&D activities in private

tmterprlse. This assessment focuses exclusively (m the activities of MNEs and the unique

p{)licy c(msideratl{ms they engender.

I 45
46 I Multinationals and the U.S. Technology Base

concerned primarily with the long-term health and

regenerative capacity of the national technology

base, MNEs are concerned primarily with the

more immediate international competitiveness of

the enterprise. The central challenge facing U.S.

policy makers is to deploy national technology

policy in a way that encourages the innovative activities of MNEs and, at the same time, directs the

benefits of those activities to the U.S. economy

and technology base.

In the aggregate, the innovative activities of

MNEs remain highly centralized. Despite the

globalization of production and the international

availability of technologically intensive products,

the means to innovate and generate new technology remain relatively localized in the home markets of MNEs in the advanced industrial states. In

many respects, however, the globalization of production and commerce has expanded the international scope of technology. MNEs are conducting

more research abroad and are transferring increasing amounts of technology across national borders. In addition, reduced transportation and

communication barriers have promoted the rapid

diffusion of new technologies in the form of technologically intensive goods and services.

Nevertheless, core technology development remains rooted in the parent operations of MNEs,

which are themselves embedded in national and

often subnational innovation systems. Consequently, assessing the technology development

activities of MNEs and their significance for national competitiveness and technology policy requires understanding the structure and

performance of the national innovation systems in

which they base their global operations. To address these complex relationships, the analysis in

Part II is conducted in two stages. Chapter 3

compares the distinctive structural features of national innovation systems across the advanced industrial nations. It also analyzes the most recent

aggregate R&D and patenting data in order to

compare the basic performance of each system,

and to understand the critical role of business enterprises in those systems. Chapter 4 analyzes the

technology development activities of MNEs. It

focuses on where firms develop new technology

and the extent to which they diffuse technology

globally, as measured by overseas R&D activities,

international technology trade, and trends in international technical alliances.

The evidence considered in Chapters 3 and 4

supports the following principal findings.

FINDINGS

1. Trends in both R&D spending by MNEs and

technology trade indicate that technology development generally remains rooted in distinct

national technology bases. At the same time,

MNEs are a principal mechanism behind the

globalization of technology. Higher rates of external patenting, more rapid diffusion of

technology across borders, increasing rates of

overseas R&D activity, and the growing prevalence of international technical alliances all

point in this direction. However, close analysis

of these trends indicates that the degree of internationalization is still relatively low.

2. Overseas R&D by affiliates remains quite limited when compared to both the R&D activities

of the parent group and the more extensive

internationalization of production and sourcing

(see figure 4-9 in chapter 4). MNEs typically

centralize basic research and product development in the home market. Research oriented toward customization and production process

technology moves offshore slowly, as overseas

production units become more deeply integrated into local markets. Only rarely do companies transfer or acquire basic research

functions abroad.

3. Similarly, U.S. royalties and license fee data indicate that the majority of international

technology trade takes place within MNE networks, and that technology flows principally

from MNE parents to their overseas affiliates

(see figures 4-12 and 4-13).

4. National innovation systems vary significantly

across the Triad. The institutional structure of

the Japanese and German innovation systems

favors commercially relevant innovation within industry, while the structure of the U. K.,

French, and especially U.S. innovation sys-
Part II National Technology Innovation and Multinational Firms I 47

terns gives more emphasis to defense and dualuse technologies, with weaker support for

commercial technology development.

5. Across the advanced industrial states, industry

conducts the largest percentage of national

R&D, ranging from 59.2 percent in France to

71.4 percent in Germany (see figure 3-1 in

chapter 3). However, recent trends show substantial variations across nations in the level of

R&D investment by private enterprise. Although there have been large annual variances,

between 1981 and 1992 business-financed

R&D expenditures in Japan grew at an average

rate of 8 percent. The average growth rate for

U.S. firms was 3.9 percent, while industry-financed R&D in the France, Germany, and the

United Kingdom, grew at average rates of 4.6,

3.9, and 1.6 percent, respectively (see figure

3- 13). In the context of comparatively short investment time horizons, U.S. firms are less

likely to maintain long-term R&D investments

than are many of their counterparts in Japan and

Europe.

6. The nature and degree of overseas technology

development and diffusion associated with

MNEs varies by national origin as well as by industry sector. Aggregate patterns indicate that

the magnitude and intensity of overseas R&D

is the highest both for U.S. affiliates in German y and the United Kingdom and for German

and U.K. affiliates in the United States.3 The

magnitude and intensity of overseas R&D is

the lowest both for U.S. affiliates in France and

Japan and for French and Japanese affiliates in

the United States (compare figure 4-2 with 4-7,

and figure 4-5 with 4-8).

7. Approximately half of all R&D and 81 percent

of the manufacturing R&D conducted by

foreign affiliates in the United States is concentrated in three sectors-chemicals, pharmaceuticals, and electrical and nonelectrical

machinery. German affiliates in the United

States consistently have had the highest R&D

intensity, which reflects the concentration of

German affiliates in chemicals and pharmaceuticals (typically sectors with high ratios of

R&D to sales). The comparatively low R&D

intensity of Japanese affiliates in the U.S. reflects the relatively low percentage of Japanese

foreign direct investment in the United States

(FDIUS) directed to manufacturing. In 1992,

19 percent of Japan’s FDIUS was in manufacturing industries and 34 percent in wholesale

trade, compared with 47 percent and 8 percent,

respectively, for European FDIUS.

8. Japanese firms acquire U.S. technology

through different channels than European

MNEs. Japanese firms buy an unusually large

percentage of U.S. technology from unaffiliated firms. Since arms-length transactions impart

a higher degree of control to the purchaser, Japanese firms in the aggregate retain a proportionately higher degree of control over the

technology they purchase from the United

States than do European firms. In addition, Japan accounts for over half of the U.S. trade surplus in industrial process technology (see

figure 4-15). These patterns are consistent with

the oft-noted tendency of Japanese firms to acquire overseas technology by buying it directly

rather than by initiating R&D activities in foreign markets.

~ R&D Intcnslty is the rat]{) of R&D cxpmhtures to sales, It is a standard measure f(wctm~paring the rclatii e technt~l(~glcal intensity of firms.
The U.S.

Technology

Base in

Comparative

e

Perspective 3

D

espite recent trends in the internationalization of technology, most core innovative activities of MNEs remain

centralized in distinct national innovation systems. ’ This

chapter compares the structure and performance of the

U.S. innovation system with those of other advanced industrial

nations.

The first half of the chapter examines the principal structural

features of each innovation system, which on the whole indicate

that the German and Japanese innovation systems are much more

oriented toward commercial technologies, while the French,

U. K., and especially the U.S. systems direct considerable institutional and financial resources to defense technologies. The

French, U. K., and U.S. systems are also characterized by higher

degrees of public sector R&D spending and comparatively high

levels of foreign funding of domestic R&D, while the German

and Japanese systems rely primarily on the domestic private sector for financing national R&D.

The second half of this chapter chronicles recent performance

trends across national innovation systems, focusing in particular

on the aggregate R&D activities of business enterprises. This section illustrates that the U.S. innovation system remains strong in

many respects, but its performance is undercut by comparatively

weak R&D investment rates by U.S. businesses, as well as by the

‘ The term “national innovati[m system’” refers to (he broad set of institutions that

shape the ability of national firms to develop, commercialize, and diffuse new pr(xtuct and

manufacturing process technologies. See R. Nelson (cd.), Na!iomd )nno~wlion .$ywerm: A

Conlparatli’e Anal?’sis (New York, NY: Oxford University Press, 1993); and G. Df)si, et

al., Technical Chan~e and Economic Theory (Lomhm: Pinter Publishers, 1988).

‘B

I

I 49
50 I Multinationals and the U.S. Technology Base

I I

Us . Japan Germany France U.K. EU

_Prwate and nonprof!t~ Government

~ Higher education D Business

NOTE: European Union data are averages of all EU member states

SOURCE OTA, based on data in Organisation for Economic Co-operation and Development, Economics Analysis and Statistics Division Database, Main Science and Technology Indicators, number 1, tables

17-20, May 1994 (hereafter cited as OECD, STI, (1), table number, May

1994)

large level of national R&D resources directed to

defense technologies.

NATIONAL INNOVATION SYSTEMS:

STRUCTURAL DIFFERENCES

Analysts have long noted fundamental differences

in the ways nations pursue technological development. Technology policy in the United States

often has been described as mission-oriented, in

which public resources are directed toward singular, radical innovations designed to achieve prominent national goals—as has been the case in

defense, space, and health technologies. The

United Kingdom and France also have missionoriented innovation systems, with a similar

orientation toward defense technologies. By contrast, Germany has structured its technology

policy to be more diffusion-oriented, where policy

facilitates incremental adaptation to change by encouraging the diffusion of new technology

throughout the industrial structure. Japan’s innovation system is unique among Organisation

for Economic Co-operation and Development

(OECD) nations, displaying both mission-oriented and diffusion-oriented characteristics.2

These different styles of technology policy reflect important differences in the institutional

structure of national innovation systems. The following analysis is divided into three sections,

each of which examines a principal structural

characteristic of national innovation systems:

first, which components of the system (e.g., government, business, university) perform most

R&D activities; second, which components finance national R&D activities; and third, which

technologies or sectors the system emphasizes.

H Sectoral Performance: Who

Conducts Research

Across the advanced industrial states, R&D is

conducted mostly by the business sector, although

the level varies from a low of 59.2 percent in

France to 71.4 percent in Germany (see figure

3-l). The percentage of U.S. R&D conducted by

business (71 percent) is close to that of Germany,

while business conducts slightly lower levels of

R&D in Japan and the United Kingdom (66.5 and

65.4 percent, respectively). The percentage of

R&D conducted by government ranges from a

high of 24.6 in France to a low of 9 in Japan. The

United States and Germany have fairly similar

levels of governmental R&D activity, respectively accounting for 11.4 and 13.4percent of national

R&D. In Japan, the higher education sector and

the nonprofit private sectors account for relatively

high proportions of national R&D (20.3 percent

and 4.2 percent, respectively). Higher education

2 For a discussion of the distinctions between mission-oriented and diffusion-oriented technology policies, see H. Ergas, “Does Technology

Policy Matter’?” in B.R. Guile and H. Brooks (eds. ), Technology and Global industry: Companies and Natiuns in the World Economy (Washington, DC: National Academy Press, 1987).
Chapter 3 The U.S. Technology Base in Comparative Perspective I 51

elsewhere accounts for approximately 15 percent

of national R&D, while the private nonprofit sector ranges from 3 percent in the United States to

0.5 percent in Germany.

The percentage of total R&D performed by

each sector provides a basic measure of the raw

magnitude and importance of each sector to its respective national innovation system. However,

the measure does not fully capture the importance

of each sector to the innovative capabilities of

each nation, for four reasons. First, the indicator

does not account for the quality or significance of

R&D; consequently, some sectors may appear

more or less significant than they truly are. For

instance, higher education in the United States

conducts less than 15 percent of all R&D, but the

quality and significance of R&D conducted in

U.S. universities are widely considered to be unparalled. 3 Similarly, higher education in Japan accounts for a larger percentage of national R&D

than in other advanced industrial states, but the

quality and import of Japanese university research

is regarded as comparatively weak.

Second, the indicator does not provide information on the character of R&D conducted in

each sector. For instance, over half of the governmental R&D in the United States has focused historically on defense technologies. 4 By contrast,

governmental R&D in Japan is directed almost

exclusively toward industrial technology development.

Third, the measure does not account for the

depth and breadth of linkages across sectors,

which can affect national innovative capabilities.

For instance, strong links between U.S. universities and U.S. industry are critical to the productivity of the U.S. technology base.5

Finally, each sector can affect national innovation performance not only by conducting R&D directly but also by financing national R&D efforts.

The following section confirms an important observation indicated by figure 3- l—that government plays a significant role in the innovation

systems of the United States, France, and United

Kingdom, and a comparatively weak role in Japan

and Germany.

1 Financing Patterns: Who Pays

for Research

Business and government typically fund most national R&D expenditures. However. business

plays a proportionately stronger financing role in

Japan and Germany, while government plays a

proportionately stronger role in the U. S., France,

and the United Kingdom (see figure 3-2).6 In Germany and Japan, industry finances 61.1 percent

and 68.6 percent (respectively) of all national

R&D, while government funds a comparatively

low 36.8 percent in Germany and 21.5 percent in

Japan. In the United States, the government has

consistently funded nearly half of all R&D expenditures; only France and, to a lesser extent, the

United Kingdom have similarly weighted government sectors. Industry finances approximately 50

percent of total R&D in the United States, and

slightly less in France and the United Kingdom.

There are similarly pronounced variations in the

percentage of gross R&D expenditures financed

by foreign sources, ranging from a high of 5.7 and

~ See D.C. M[w+ery, “’The Challenges of Intematiimal Trade to U.S. Technology P(~licy, “ in M.C. Harris and G.E. M{wre (eds. ), l.ln~lng

Trade and Technology Pollclcs: An International Comparison of the Poiiciev oj’lndustrialixd Natwns (Washingttm, DC Nati~mal Academy

Press, 1992); Ergas, op. cit., footnote 2; and Nelson, op. cit., footnote 1.

J For additional analysis of this point see the section on gross expenditures on research and deveh~pment In this chapter. SCC also J. AIIc, et

al., Be>ond .Yplnofl; M[litar?t ond Commercial Technologies In a Changing World (Boston, MA Harvard Business Schwd Press, 1992).

$ See Natmnal Science Btmrd, Sc~ence and Engineering lndicuror.+1 993 (Washington, DC U.S. Government Printing Of f~cc, 1993). pp.

116-127.

6 Figure 3-2 portrays direct R&D outlays by government, business. ft~reign s(~urces, and other nati(~nal sources. R&D also can ~ suPP)rted

throughindirect channels, such as government pr(mrement practices. Indirect funding mechanisms are, by nature, difficult to mcasllre.
52 I Multinationals and the U.S. Technology Base

Us . Japan Germany France U.K. EU

_ Foreign sources ~ Government

~ Other national sources n Business

NOTE: European Union data are averages of all EU member states

SOURCE OTA, based on data in OECD, ST/, (1), tables 13-16, May

1994

9.1 percent in the United Kingdom and France to a

low of 1.6 and 0.1 percent in Germany and Japan.

Patterns in the financing of business expenditures on R&D-as distinct from total national

R&D—also reflect differences in the weight of

each sector across national innovation systems.

As illustrated in figure 3-3, business finances

nearly all of its R&D in Germany and Japan (84.3

and 98.2 percent, respectively), while government

funds much of the business R&D in the United

States (30.7 percent), France (22.2 percent), and

the United Kingdom (20.6 percent). Similarly,

foreign sources finance little business R&D in

Germany and Japan (2. 1 and 0.1 percent, respectively) but have greater impact in France and the

United Kingdom (8.1 and 12.3 percent).

The comparatively large financial contribution

of the U.S. government to business R&D indicates that corporate R&D in the United States is

less financially self-sufficient than in other advanced industrial countries. In essence, this data

implies that U.S. businesses may be less able to

independently finance and pursue long-term

technology development strategies, relative to

their competitors across the advanced industrial

countries. In addition, the greater financial selfsufficiency of business R&D in Germany and Japan may indicate that corporate R&D in these two

countries is comparatively more self-contained

and difficult to access through channels other than

direct industry contacts.

Moreover, variations in funding source may

stem from differences in national attitudes toward

technology development. For instance, the U.S.

government funds nearly half of all business

R&D, but U.S. business receives little public sector assistance for technology diffusion. With the

exception of agriculture and, to a certain extent,

health, federal expenditures on both military and

civilian research and technology development

Us . Japan Germany France U.K. EU

m Foreign sources D Government

~ Other national sources ~ Business

NOTE European Union data are averages of all EU member states

SOURCE OTA, based on data in OECD, STI, (1), tables 32,35-37, May

1994
Chapter 3 The U.S. Technology Base in Comparative Perspective I 53

have “devoted virtually no attention or resources

to support. . . the adoption of new technologies.”7

In addition, the U.S. innovation system has a

pronounced orientation toward defense technologies. During the 1980s and early 1990s, the defense sector received an average of 63 percent of

all U.S. government outlays for R&D, compared

to an average of 23 percent for the European

Union (EU) and a mere 5 percent for Japan (see

figure 3-4). In the proposed fiscal year 1995 federal budget, defense-related R&D spending comprises 54 percent of federal R&D budget

authority; the budget proposes $73 billion for total

R&D (a 3 percent increase from 1994 in nominal

terms), of which $39.5 billion is directed to defense R&D (a 4 percent increase).8

Taken together, cross-national variations in the

sectoral performance and financing of domestic

R&D efforts reveal a basic structural difference

across national innovation systems. On the one

hand, the U.S. and to a lesser extent France and the

United Kingdom retain innovation systems that

reflect the institutional legacy of Cold War defense concerns. On the other hand, Germany and

especially Japan have established an institutional

structure that largely favors innovation in commercial technologies. An aggregate review of the

technologies each system emphasizes reveals

additional cross-national differences.

D Technological Emphasis: Which

Technologies are Produced

As seen in figure 3-1, national R&D across the advanced industrial states is concentrated in the

business sector. However, as figures 3-5 through

3-9 show, the sectoral composition and concentration of business R&D varies significantly.9

8 0 ,

o~

1981 82 83 84 85 86 87 88 89 90 91 92 93 94

+ Us . + Japan + EU

NOTE: European Union data are averages of all EU member states

SOURCE OTA, based on data In STI (1), table 64, May 1994

Business R&D in the United States is concentrated in four sectors: aircraft, communications

equipment, office and computing machinery, and

motor vehicles (see figure 3-5). These four sectors

accounted for 60.7 percent of all R&D expenditures by U.S. businesses in 1991. The aircraft sector consistently represents the largest percentage

of business R& D-24.3 percent in 1991. By comparison, in 1991 the communications equipment

sector accounted for 15.3 percent of all business

R&D, the office and computing machinery sector

for 11.4 percent, and motor vehicles for 9.7 percent. The sectoral distribution of U.S. business

R&D has been relatively constant over time. The

7 Mowcry, op. cit., f(~)tno(e 3, p. 124.

8 Con.grcssional Research Service, Seminar on Proposed FY1995 R&D Budget, Feb.14 1994.

9 The data in this sectmn have been obtained from the Organisation for Co-operation and Development’s Analytical Business Enterprise

R& D(ANBERD)database OECD, DST1 (STAN/ANBERD), 1993. See also OECD, flusincss En[erpri.re E.tpenditureonR&D in OECD Cauntr[es: Data at the Detolled Induso-v Letrel From 1973 to 1990 (Paris, France: OECD, 1992), pp. 39-41.
54 I Multinationals and the U.S. Technology Base

I!!!L ,..

1981

F!l- ,/,. . .

1982 1983

Ii/ .,,,.:.,,,.,.,. :.:.:,:.:.:.:,: ,:,:,:,:,:,:,:, :.:.:.:.:,:.:.: ::::::::::::::: ;;:{:;;;::;;{;:

,,, ,.,.,.,, 1984 1986 1988

R,/, ,.,,,., , \ . . ,

1989

.,.,.,.

.,.,.,.

1990

Aircraf t

~ Motor vehicles

El

S

Im

c 1

Em

1991

Communications equipment

Electrical machinery

Office and computing machinery

Nonelectrical machinery

Drugs and medicines

Chemicals

Total services

NOTES: Chemicals category excludes drugs, electrical machinery excludes communications equipment

SOURCE: OTA, based on data m Organisation for Economic Co-operation and Development, Directorate for Science, Technology, and industry, Arialytical Business Enterprise R&D Database (ANBERD), (Pam OECD, 1994) ANB/BERD table Ol (hereafter cited as OECD, DSTI, ANBERD, 1994, table

number)

only areas where R&D spending has changed notably have been in electrical machinery (which declined from 6.7 percent in 1981 to 1.4 percent in

1991 ), communication technologies (which increased from 13.2 to 15.3 percent) and office and

computing technology (from 8.5 to 11.4 percent).

By comparison, Japanese business expenditures on R&D are less concentrated than in the

United States (see figure 3-6). In 1991, the top

four sectors accounted for 49.3 percent of all business expenditures on R&D, with no single sector

dominating the list, as does the aircraft industry in

the United States. Moreover, the sectoral emphasis of Japanese business R&D is quite different. In

1991, the communications equipment sector accounted for 16.1 percent of all business R&D expenditures, while motor vehicles accounted for 13

percent, electrical machinery for 10.4 percent, and

chemicals for 9.8 percent. This sectoral distribution of R&D expenditures also has been relatively

constant over time, apart from office and computing machinery, which increased from 3.8 in 1981

to 9.6 percent in 1991, and chemicals, which decreased from 11 percent to 9.8 percent.

Business R&D in the major European nations

is concentrated at levels comparable to that in the

United States. In Germany, the top four sectors account for 60 percent of all business R&D, while in

France they account for 61.1 percent and in the

lo Since 1980 tie greatest ~te of change has been in the service sector, which grew from 4. I percent of all business R&D in 1980 to 8.8

percent by 1991. Manufacturing still accounts forover90 percent of all business R&Din the United States, and therefore remains the analytical

focus of this chapter. Some analysts have noted, however, that R&D in the service sector is underrepresented by the available data, and may

account for as much as 25 percent of R&D in the United States. See J.A. Alic, “Technology in the Service Industries,” in/ernationu/Journu/ of

Technology Managemenf9( 1 ): 1-14, 1994. The Office of Technology Assessment is cumently studying the role of the service sector in the U.S.

economy.
Chapter 3 The U.S. Technology Base in Comparative Perspective I 55

I

90

i

80

i

20

10

0

1

1.::.: ,,. :.1;::: :.:.:::.:,:.:.:. ::::.:::::::::: ;::::, i::::,;,.

_lmM_u_ H,// 1.:,:.:,,,,, :.,,:.:.:.:.:.:. .,,,,..,;::{;;.::;:;;::: . . ,,., .,..,. ,,,,,:,::,,::: .,.,

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

Aircraf t

~ Motor vehicles

~ Communications equipment

_ Electrical machinery

mOffice and computing ma~hiner-y

~ Nonelectrical machinery

n Dr.gsandmedlcines

_ Chemicals

~ Total serwces

NOTES; Chemicals category excludes drugs electrical machinery excludes communications equipment

SOURCE: OTA based on data in OECD, DSTI, ANBERD, 1994 ANB/BERD table OF

United Kingdom 60.2 percent. However, as figures 3-7, 3-8, and 3-9 illustrate, the sectoral distribution varies somewhat. The communications

sector accounts for the largest percentage of business R&D in France and the U.K. (21.8 and 19.9

percent, respectively) and the second largest in

Germany (16.8 percent). France and the U.K. also

devote considerable resources to the aircraft sector ( 18.9 and 14.4 percent), which receives a relatively small proportion in Germany (9.4 percent).

Germany and France emphasize motor vehicles

(17.7 and 11.5 percent), while the U.K. directs

only 6.8 percent of business R&D to this sector.

The pharmaceutical sector receives a large percentage of business R&D in the United Kingdom

( 14.4 percent), but a relatively small 7.6 percent in

France and 5.4 percent in Germany. Finally, the

chemical sector receives a large proportion of

business R&D in Germany (15.6 percent), but

only 9.9 percent in the U.K. and 8.9 percent in

France.

These differences in the national distribution of

business R&D expenditures correlate roughly

with the sectoral distribution of production across

the Triad. As can be seen in figure 3-10, the U.S.

share of OECD production is highest in aircraft

and lowest in electrical machinery, which corresponds to each sector’s relative share of U.S. business R&D. The same relationship holds for

Japan’s high share of OECD production in communications equipment and low share in aircraft;

Germany’s relatively high share in motor vehicles

and low share in office and computing machinery;

France’s high share of OECD production in aircraft and low share in office and computing machinery; and the United Kingdom relatively high

share of OECD production in drugs and medicines

and low share in electrical machinery.

However, there are exceptions to this pattern.

Germany’s share of OECD production is highest

in nonelectrical machinery, which receives a relatively low 9.9 percent of German business R&D

expenditures. Likewise, both the French and U.K.

share of OECD communications equipment production is low, given that this sector in both countries receives the highest proportion of business

R&D (2 1.8 and 19.8 percent, respectively). These

and other discrepancies illustrate the broader
56 I Multinationals and the U.S. Technology Base

+:+:.:+:. :,:,:,:,:,:,:,:

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

EN

D

m

Ez

u

ENI

Aircraft

Motor vehicles

Communications equipment

Electrical machinery

Office and computing machinery

Nonelectrical machinery

Drugs and medicines

Chemicals

Total services

NOTES Chemicals category excludes drugs, electrical machmery excludes commumcatlons equipment

SOURCE OTA, based on data in OECD, DSTI, ANBERD, 1994, ANB/BERD table OE

100

90

80

CJ 70

c

Z 60 al

~ 5(3

z

~ 40

0

L! 30

20

10

0

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

‘ml

c 1

m

En

c1

Exl

— .

Aircraft

Motor vehicles

Communications equipment

Electrical machinery

Office and computing machmery

Nonelectrical machinery

Drugs and medicines

Chemicals

Total services

NOTES Chem[cals category excludes drugs, electrical machmery excludes commumcatlons equ[pment

SOURCE OTA, based on data m OECD, DSTI, ANBERD, 1994, ANB/BERD table OD
Chapter 3 The U.S. Technology Base in Comparative Perspective I 57

[

: :,. .:

,..

•,~.’,~ k

;::::,,:::;:,:; ,,,.,,..,,:.,.,,,: ;.{,:

~,~,’,~

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

Aircraft

Motor vehicles

Communications equipment

Electrical machinery

Office and computing machmery

Nonelectrical machinery

Drugs and medicines

Chemicals

Total serwces

NOTES: Chemicals category excludes drugs, electrical machinery excludes communications equipment

SOURCE: OTA based on data in OECD, DSTI, ANBERD, 1994, ANB/BERD, table OH.

point that it is difficult to link R&D investment

rates directly to national, sectoral, or firm-level

production and competitiveness. Ultimately,

competitiveness at all of these levels is shaped by

numerous variables, ranging from corporate

structure and strategy to macroeconomic policy

and performance. Nevertheless, R&D investment

rates are an important indicator of long-term business strategy, and consequently the sectoral distribution of business R&D provides an important

measure of the sectoral emphasis of national innovation systems.

In sum, the marked differences in the sectoral

performance of national R&D, the financing of

national and business R&D, and the sectoral composition of business R&D reveal important structural differences in national innovation systems.

The U.S. system is deeply rooted in Cold War

political and security concerns. It is characterized

by direct governmental involvement, a high degree of national R&D resources directed to the defense sector, and relatively few R&D resources

directed to industrial technology adoption. 1 1 The

U.S. innovation system also stands out by virtue

of the high quality and large quantity of R&D performed in the higher education sector.

Although few European countries match the

degree to which the United States devotes national

R&D resources to defense, the United Kingdom

and France are similar in that they also have supported large defense-related R&D budgets and

have similar mission-oriented innovation systems. By contrast, Germany (along with Switzerland and Sweden) has devoted comparatively few

resources to defense.

I I For ~ account of the pNI.WWII origins of (he U.S. R&D system, see D.C. Mowery and N. Rosenberg, Techno/o<gJ’ and (}w pursuit ~~’

E(’onomit Gro\\/h (New York, NY: University of Cambridge Press, 1989). For a descripti(m of the contemporary implicati(ms of this system, see

Mt)wery, op. cit., f(~)tnotc 3. See also J.A. Alic, et al., Beyond .’$p~nofll” Mi/irary and Commercia/ 7&chnologies in a Changing Wor/d (Bos((m,

MA: Harvard Business School Press, 1992).
58 I Multinationals and the U.S. Technology Base

—

Chemicals Drugs

and

I

—

Non- Office Electrical Communi- Motor Aircraft

electrical and machinery cations vehicles

medicines machinery computing equipment

machinery

n Us .

m U.K.

Japa n

~ Germany

= France

_ Other OECD

avakble

NOTES: Shares are percentage of total available OECD data, “other OECD” category includes data from countries Included in STAN database only

when available for all sectors above, 1990 IS most recent year with complete data for selected countries and sectors, numbers may not total 100 due

to rounding

SOURCE: OTA, based on data from Organisation for Economic Co-operation and Development, Directorate for Science, Technology, and Industry,

Structural Analysis Industrial Database (STAN), (Paris OECD, 1994), production tables OD-OG, 0I, and OM-OP

Among the advanced industrial countries, Ja- forums do not provide the central research role

pan directs the least R&D resources to the defense that their U.S. counterparts do. Finally, Japan has

sector.l2 The commercial orientation of Japan’s great strengths in learning and adapting commerinnovation system is reflected in its institutional cial technology generated abroad. ] 3

structure. The Japanese government has a modest In their entirety, national innovation systems

role in directly funding national and business represent different institutional contexts for the

R&D, while the private sector finances and per- complex set of processes leading from technology -

forms the bulk of Japan’s most significant R&D. cal innovation to commercial competitiveness. 4

In addition, Japanese universities and other public

12 Japan,~ ~efcn~e R&D ~wndlng is concentrated in the Technical Research and Development institute (TRDI) of the Japan Defense

Agency. The TRD1 R&D budget is quite modest relative to Japan’s total R&D spending, although its programs often benefit from ctmunercial

R&D in dual-use technologies. See U.S. Congress, Office of Technology Assessment, G/obal Arms Tru[ie, OTA-ISC-460 (Wash ingt(m, DC:

U.S. Government Printing Office, 1991 ): pp. 116-120.

I ~ See R J Sanlue]s, “Rl(h Nafion, .$rrong Arn~v”: Na[iorrai Security and the Technological Tran.rforrna/ion of Japan (Ithaca, NY: comell

. .

University Press, 1994).

I A Cumently ]Itt]e is knoWn in ~ Sys[ema[lc sense a~)ul cross-national” v~ances in (he various stages ~[ween innovati(m and c(mlmercia]-

ization. OTA is currently conducting an assessment of the commercialization of new technologies in the LJnited States. In additi(m, a cross-nati(mal assessment of barriers to commercialization is being conducted by National Science Foundation in conjuncti(m with the OECD.
Chapter 3 The U.S. Technology Base in Comparative Perspective I 59

As the following section demonstrates, there are

important variations in the performance of national R&D systems. Together, the structure and performance of national innovation systems create

different contexts for the innovative activities of

MNEs.

NATIONAL INNOVATION SYSTEMS:

PERFORMANCE PATTERNS15

Gauging the relative performance and capacity of

the U.S. technology base is a complex and difficult analytical task. Most major studies conducted

in recent years conclude that the U.S. technology

base has eroded considerably. Studies by the National Critical Technologies Panel of the Office of

Science and Technology Policy, the Department

of Commerce Technology Administration, and

the Department of Defense have identified weaknesses in critical commercial, emerging, and defense technologies.

16 Broader studies by the

National Science Foundation and the Competitiveness Policy Council conclude that trends in

R&D investment and technology development

processes show disturbing weaknesses. 17 Moreover, since technology is a central determinant of

the trade performance and competitiveness of national economies, many have linked the international leveling of technological capabilities with

the weakened trade performance and competitive

posture of the U.S. economy.

This section uses these and other studies of

U.S. technology and competitiveness as a reference point for investigating performance trends

across national innovation systems. Although far

from perfect, aggregate R&D investment patterns

constitute the single best indicator of trends in the

innovative capacity of the U.S. technology base.

The analysis focuses on aggregate R&D investment by private enterprise, because it accounts for

the bulk of national technology innovation and development across the advanced industrial countries. Moreover, since competitiveness has

become increasingly linked to technological innovation, corporate R&D has assumed greater

strategic significance for nations.20

Therefore, the analysis below proceeds in three

stages. First, it examines data on business R&D

across the Triad, which indicate that U.S. businesses have reduced their R&D investment rates

to comparatively low levels. Second, it compares

data on total national R&D expenditures across

the Triad, which indicate that national R&D pat15 Most of the data in this sec[lon c(~n}~ fronl the OECD. R&D data obtained from national govemnlents are nOtOrlOUS]y difficult to ct)n~parc,

given different categorization and measurement techniques. The OECD has gone to considerable lengths to adjust the data to account for national variations in reporting, and in some cases to estimate data that national governments do not provide or do not compile.

lb National Crltlcal T~hno]ogies” panel, Report of’/he Nationa/ Criticu/ Technologies Panel (Washington, ~: U.S. Government %ntmg

Office, 1991 ); and Department of Defense, Cr\(i~al Technoiog[es Plonjijr the Committees on Armed Ser\ices Uniled Stales Con~ress (Washington, DC: Department of Defense, March 15, 1990).

I T Nationai Science Board, Conlmlttee on Indusrnal SUppOrt for R&D, The Competiri}’e Srrengrh oj’U. S. Industrial Science and Technology?’:

Srraregic /ssues (Washington, DC: National Science Foundation, 1992); Council on Competitiveness, Gaimng New’ Ground: Te(hnolog-y Prl -

oriries jtir America Future (Washington, DC. C(mncil on Competitiveness, 199 I ). See also National Science Board, op. cit. fotmrote 5.

18p, Guerrieri, “Technological” and Trade Con]petiti(m: The Changing Positions of the United States, Japan, and Germany,” and P.R. KJULZman, “Technology and Intematitmal C(mqxtiti(m A Historical Perspective, “ in MC. Hams and G.E. Moore. Linking Trade and Techno/og?

Po/icies: An /n/ernufiona/ Comparison of~he Po/lcles uf/nduswia/i~ed Nations (Washington, DC: National Academy Press, 1992). See also

T.S. Arrison, et al., Japan’s Gru}tlng 7ichno/ogical Capabl/i/y: lmp/ication.s fur the US Economy (Washington, DC. National Academy Press,

1992).

19 Al~ough the rela(lvc imP)~ance of business,gt)vemnxmt, and university research varies across countries, In IINN c(lun~ks and in most

sectors (he industrial research lab is tlw n~(~st significant Ioca[i(m of technological inmwation. See Nelson, op. cit., footnote 1. of course, the

innovative capabilities and activities of fim~s are shaped by numerous factors external to the flml, including the educational infrastructure as

well as direct and indirect f(n-rns of governmental supp(wt.

20 OECD, Economic Analysls and Statistics Divisi(m, 7’he Impacl oj’Foreign /n\esm~enr on Domes/ic Economies of OECD Coun/ries (Paris, France OECD, Nov. 12, 1993), p. 49.
60 I Multinationals and the U.S. Technology Base

2-

1I

0! I [ 1 1 1 I 1 1 r 1 I

+ Us.

+ Japan

+ France

+ German y

>

+ U.K.

+ E U

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

NOTES: Breaks in lines indicate unavailable data for Intermediate years: European Union data are averages of all EUmember states

SOURCE: OTA, based on data in OECD, STI, (1), table 25, May 1994

terns mirror business R&D trends. And third, it

assesses international trends in patenting, which

provide the best quantifiable measure of the relative output of national innovation systems.

I Business Expenditures on Research

and Development

Since World War II, private enterprise has been the

central source of commercially significant innovation in most fields. Relative to governments

and universities, businesses are well placed to

conduct and deploy R&D for a number of reasons.

First, because firms use technology directly, they

are more likely to understand where new R&D

would be most fruitful. Second, businesses can

profit from innovation because they can integrate

R&D with production and marketing. And third,

although they frequently draw on public scientific

knowledge, firms often have unique R&D capabilities that derive from practice—indeed, current

practioners are most likely to conduct and benefit

from R&D because most innovation involves incremental, cumulative improvement to existing

technologies. 21

However, firms based in different nations conduct R&D at markedly different levels. Figure

3-11 portrays total business expenditures on R&D

over the course of the 1980s and early 1990s, measured as a percentage of gross domestic product

(GDP) .22 Throughout most of the 1980s the U.S.

business sector spent more on R&D than any of its

major trading partners, averaging just under 2 percent of GDP between 1981 and 1988. However,

after peaking at 2.1 percent in 1985, U.S. business

22 Tota] business ex~nditures on R&l) should not be confused with R&D financed by business. The former category represents ail business

R&D outlays, whether they are financed by business itself, government, or other sources. Patterns in business-financed R&D are discussed

below; see figure 3-13 and accompanying text. For data on how business R&D is financed in different countries, see figure 3-3 above and accompanying text.
Chapter 3 The U. S. Technology Base in Comparative Perspective I 61

A

+/ “%&x

I

0 -

■

<, )

.5A

10-t 1 I 1 [ ) 1 1 I T

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

Us.

Japan

France

Germany

U.K.

EU

NOTES: Growth rates are based on OECD adjusted expenditures in 1985 dollars As with OTA R&D data, the OECD adjustment employed an implicit

GDP deflator breaks in Iines indicate unavailable data for Intermediate years European Union data are averages of all EU member states

SOURCE: OTA based on data in OECD, STI (1) table 23, May 1994

R&D gradually declined to 1.8 percent by 1993.

By contrast, Japan’s business R&D grew steadily

from 1981 to 1990, climbing from 1.4 percent of

GDP to a peak of 2.2 percent in 1990, having surpassed the U.S. level for the first time in 1989. After 1990, Japan’s level declined slightly, reaching

2.1 percent in 1992. In Europe, Germany has consistently maintained the highest average business

R&D rates, with a pattern closely tracking that of

the United States. France and the United Kingdom

have maintained slightly lower levels, with

France’s rate growing from 1.2 percent in 1981 to

1.4 percent in 1992, while the United Kingdom’s

has declined from 1.6 percent in 1986 to 1.3 percent by 1992.

The contrary trends in U.S. versus Japanese

business R&D since the mid- 1980s reflects opposite trends in the annual growth rate of R&D

spending during that period. As figure 3-12

shows, for much of the last decade R&D spending

by Japanese businesses grew at annual rates close

to or exceeding 10 percent, although it dropped

considerably during adverse economic periods in

1986 and the early 1990s. By contrast, U.S. business R&D growth rates dropped rapidly after

1984, remained low during the expansionary period of the late 1980s, and went negative between

1989 and 1991. In 1992, the U.S. rate increased to

2.5 percent, but then fell again to 1.5 percent in

1993. Between 1986 and 1993, U.S. business

R&D grew at an average annual rate of 0.3 percent, compared to 5.7 percent for Japan during the

same period. With the exception of the United

Kingdom, the major European economies also

had stronger growth rates in business R&D than

the United States. Between 1986 and 1993, total

business expenditures on R&D in France grew at

an average rate of 3.7 percent, compared to 2.0

percent for Germany and -0.8 percent for the

United Kingdom.

Changes in total business expenditures on

R&D do not necessarily imply changes in investment rates by businesses themselves. R&D funding by businesses can come from other sources,

including government, other national sources, or
62 I Multinationals and the U.S. Technology Base

-lo~1 1 1 1 1

* Us.

+ Japan

~ France

+ Germany

+ U.K.

+ E U

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

NOTES: Growth rates are based on OECD adjusted expenditures in 1985 dollars As with OTA R&D data, the OECD adjustment employed an implicit

GDP deflator, breaks in Iines indicate unavailable data for intermediate years, European Union data are averages of all EU member states

SOURCE: OTA, based on data in OECD, STI, (l), table 33, May 1994

foreign sources.

23 However, the changes in business R&D growth rates illustrated in figure 3-12

have been driven less by shifts in government or

other nonbusiness financing than by changes in

investment outlays by business itself.

Figure 3-13 shows trends in R&D investments

financed by business enterprises. In most cases,

business R&D expenditures declined during the

mid-1980s and early 1990s, generally consistent

with national economic trends during those periods. However, there are notable differences in

both the rate of decline and the average level over

time. Over the last decade, U.S. business stands

out for its low R&D growth rates since the late

1980s--despite favorable economic circumstances during much of that period. R&D growth

rates for U.S. business declined rapidly from 10.9

percent in 1984 to -0.6 in 1987; although the rate

returned to 3.1 percent in 1988, it continued to decline thereafter to -0.2 percent in 1992. The low

growth rates since 1987 bring down the U.S. average for the entire period to 3.9 percent.

R&D by German firms also grew at an average

rate of 3.9 percent from 1981 to 1993, although it

followed a different pattern: it expanded in the

early 1980s, remained relatively high in the

mid-1980s, and then declined after 1987. R&D

growth rates for U.K. firms have been the most

volatile, becoming negative in 1983 and again

during 1990-1991, and averaging 1.6 percent over

the entire period. Of the major European countries, French firms maintained the highest average

R&D growth rate of 4.6 percent.

By contrast, growth rates for business R&D in

Japan remained close to or over 10 percent

throughout most of the 1980s, declining in 1986

and then again in the early 1990s, reaching a negative rate for the first time in 1992. Averaged over

the entire period, business-financed R&D in Ja23 See figure 3-3 in this chapter regarding national differences in the financing of business R&D.
Chapter 3 The U.S. Technology Base in Comparative Perspective I 63

pan grew 8.0 percent, over double the rate of U.S.

firms.

Apart from U.K. firms after 1988, Japanese

business experienced the most rapid rate of decline in R&D growth rates—from 12.3 percent in

1989 to -3.3 percent in 1992. This trend reflects

the domestic recession in Japan, the most severe in

the postwar period. Further analysis of corporate

R&D in Japan, however, indicates that the recession has affected R&D growth rates in some sectors more than others, and that the slower growth

rates are likely to be temporary.

OTA interviews suggest that Japanese MNEs

have responded to recessionary pressures by cutting unnecessary business costs, reducing labor by

encouraging retirement and foregoing new hiring,

and looking for new efficiencies through reorganization. These strategies have been extended to

R&D as well as production operations. Many Japanese firms have avoided R&D budget cuts by tapering increases in spending levels and shifting

resources away from long-term basic research and

toward more immediate product development.24

Japanese firms also have focused their R&D efforts in order to conduct research more efficiently.25 Through these and other measures, Japanese

firms have retained their R&D personnel, maintained steady R&D intensity ratios, and preserved

R&D-related plant and equipment investment.26

R&D restructuring is likely to be most pronounced in Japan’s steel, machinery, electrical

machinery, and chemical industries. 27 Japan’s

computer and electronics industry has also suffered from the recession and scaled back R&D

growth rates. Fujitsu cut its 1993 R&D budget by

7.6 percent, and Hitachi by 3.8 percent, while

Sony increased its R&D spending by 2.3 percent

and NEC maintained a constant level.28 Japan’s

top ten R&D spenders show very uneven R&D

budget patterns for 1993, ranging from a low of

-7.6 percent for Fujitsu to a high of 8.1 percent for

NTT, with the average rate of increase for the top

10 being 0.13 percent.29

Despite the low aggregate R&D growth rate in

1992 and the strong downturn in important sectors, business R&D spending in Japan is expected

to grow by 2.2 percent in 1993 through March

1994.30 Moreover, survey evidence indicates that

Japanese corporations expect their R&D spending

plans to be affected only temporarily.31 In this respect, the mid- 1980s may be a precedent—in

24 See ‘“ D(mmu Klgyo m) R&D” Oyo Kalhatsu Kenkyu—fin[altcki ni Oyo Shifto,’” N{hon .Wng>w .%himbun. p.5, July 28, 1993. AccxmJing

tt) this survey. the emphasis on applied R&D was particular] y pr(m[mnced in telecommunicate (ins, precisi(m instruments, clcctr{mics, and muii -

cal suppllcs. For adchtl(mal survey data sh(wlng a shift toward “’defensive” research (e.g. R&D ft)cuscd (m existing operate scc ‘“ D(maru

Kigyo no R&D Jush] sum Kcnkyu,” ,Vlkkel .km~~w Shtmbun, August 9, 1993, p.4.

‘f ‘“Japan’s Researchers Get Back to Basics,” N~kkc~ Week/y, p. 17, Oct. 25, 1993. See also “R&D m(~ Rlsut(~ra: Tema Shltxlrl J In in Salhai -

chl,” Nihon Ke:al Shlmbun, p. 1, July 26, 1993.

26 “D(maru K].gyo no R&D. Jinin Urlagedaka Atari Kenkyuhi-Kaihatsury tku Kahuh~) Neral Ijl,” Nlhon San<~vo Shlmbun, p,5, July 29,

1993, and “D(maru Klgyo m) R&D Kanren Setsubi Toshi-Sogaku” Shit-x)rarerunaka, Kencht),” Nih(m San<q}~~ Shlmbun, p.5, July 30, 1993.

27 “Japan Researchers Get Back to Basics,” and “R&D mo Risut(~ra,” op. cit. f(x~tnotc 25.

‘s “’R&D rm) Risut(wa,” op. cit. f(Mm(~te 25.

19 Ibid.

w Based ,)n a sun, ev co~erlng 39-2 ]Cadlng Jap,~es~ companies that was conducted by the Nihon Kcizai Shlndmn Inc. :lnd th~ NI~h~I R~-

.

search lnstltute t)f Industry and Markets. See “’Japan’s Researchers Get Back to Basics,”’ op. cit., footm~tc 25. A separate sun e) of 244 firms a Is()

found (hat t(}tal corp)rate R&D budgets were up 2.2 percent fr(~m 1992 levels. See “’D(maru Kigy(~ no R&D: Kls{) Kenkyu-Chul nl IAlglrc Kelko, J(~i Kigy(~ ntha Zogaku ga (l)i,” Nihon .%ngyo Shirnbun, p.5, July 27, 1993.

~ I in ~he Nlhon Kellal Shinlbun Inc, and [he Nikkei Research lnstltute of Industry and Markets ~UWC~. only 3.4 ~’rc~nt of the r~spmd~nts

cx pcct their R&D spenchng to decline over the next five years. The majority of c(mlpanies w ant to maintain or expand (m past R&D eff(wts. but

In the present ec(m(m~ic clrcumstmces they find that very hard to do. The current trend is to focus (m a select group of research themes In order to

make more efficlcnt use {)f 1 In] itcd resources. “ “’Japan’s Researchers Get Back [() Basics,” op. cit., f(xnnt)tc 25.
64 I Multinationals and the U.S. Technology Base

1986 corporate R&D rates dropped from very

high levels to levels comparable with those of the

European Union and the United States, and then

rebounded quickly (see figure 3-1 3). Much the

same may be happening in the recent downturn.

This tendency to preserve R&D investment reflects the oft-noted Japanese penchant for the

long-term view, summed up by a Sony executive’s

comment: “If we cut research and development,

we cut our future.”32 This sentiment was echoed

by a number of Japanese executives interviewed

by OTA.

The staunch effort by Japanese corporations to

preserve their R&D budgets contrasts with consistently low R&D growth rates among U.S. firms

since 1987, despite a more favorable economic

environment during much of the period. Moreover, U.S. firms appear to have made only modest

increases in R&D expenditure plans for 1994. The

Industrial Research Institute found that only 18

percent of U.S. firms planned to increase R&D expenditures from 1993 levels, while 33 percent expected to decrease; total R&D as a percentage of

sales is expected to decrease slightly from 3.5 percent to 3.4 percent .33 This pattern may reflect continued pressure to constrain costs while

quickening product development. The efficiency

movement that first hit the factory floor in the

1980s may now be extending to the lab. U.S. corporate R&D strategists are emphasizing R&D

productivity and trying to obtain faster product

development without additional R&D outlays.34

It is difficult to forecast private-sector R&D

into to mid- 1990s. However, past trends and current survey evidence point toward sustained national differences in private sector R&D

investment. In particular, U.S. firms, compared to

their Japanese counterparts, appear less willing

and/or able to commit financial resources to R&D

over the long term.

Unfortunately, little is known about the central

reasons for the relative weakness of U.S. business

R&D spending. The most optimistic explanation

is that U.S. firms are more efficient in their R&D

efforts than are their foreign competitors. To the

extent that U.S. firms successfully offset R&D

budget cuts by increasing efficiency, the comparatively low growth rates in corporate R&D spending may be less serious than they appear.

Similarly, higher business R&D rates in Japan

could reflect corporate efforts to overcome an inefficient R&D system. However, although the

proposition is logically possible, there is no direct

evidence showing that low corporate R&D rates

in the United States are offset by greater efficiency.

A second and more common explanation for

cross-national differences in business-financed

R&D rates points to discrepancies in corporate

time horizons. By this account, U.S. firms are less

willing to conduct long-term investment strategies because they are more oriented toward shortterm return on investment than are most European

and Japanese firms. Cross-national variations in

corporate time horizons reflect different systems

of corporate governance and finance. These systems, and their particular effects on corporate investment behavior, are examined in Part IV of this

report.

Over the long term, corporate R&D investment

strategies are likely to affect national competitiveness, although the precise effect is difficult to

gauge. Linking business R&D expenditures to

economic performance is difficult due to a combination of data limitations and the rapid rate of

economic and technological change in the U.S.

32 As ~uotcd in A. PtJIIack, “Japanese, in a Painful Recessi(m, Trim Industrial Research Outlay s,” New’ York Times, p. A 1, Nov. 291993.

Accxmling to Pollack, Sony’s R&D budget is rising I percent in 1994:

33 ‘.]n~ustrla] Rese~ch Institute’s Annual R&D Trends Forecast,’” Research Technology Manugemenr 37( I ): 15-17, January-February

I 994.

34 See MR&D Scoreboard:” ]n tbe Labs, the Fight to Spend Less, Get More,’” Business Week (3325): 102-127, June 28, 1993.
Chapter 3 The U.S. Technology Base in Comparative Perspective I 65

economy.

35 In addition, possible differences in

the efficiency of national innovation systems indicate that there may not be a perfectly linear relationship between R&D rates and innovative

performance. Moreover, R&D investment is just

one of several important determinants of innovation and competitiveness. Developing and successfully commercializing new technologies

often require large investments in new plant and

equipment, new production skills, organizational

changes throughout the firm, and new marketing

strategies.

Nevertheless, R&D expenditure rates remain a

key indicator of long-term investment strategies,

and one of the most significant determinants of

long-term economic performance.36 However

imperfect the data, few would doubt that technological innovation is strongly associated with private sector R&D. Higher R&D spending alone

may be insufficient to generate new technologies,

but it is necessary.

The significance of business R&D to national

economies is further illustrated by the fact that total R&D trends+. g., the combined R&D efforts

of business, government, and academe—mirror

the business R&D trends described in this section.

As demonstrated below, total U.S. R&D expenditures, although large in absolute terms, have

weakened in comparative terms over the course of

the last decade, as has U.S. business R&D. Moreover, the commercial significance of total U.S.

R&D expenditures is undercut by the U.S. innovation system’s longstanding emphasis on defense technologies.

H Gross Expenditures on Research

and Development

In absolute terms, the United States commits far

more resources to R&D than any other nation. As

seen in figure 3-14, throughout the 1980s and early 1990s total U.S. R&D spending rose steadily

and far exceeded that of other OECD nations. On

average between 1981 and 1992, U.S. R&D

spending was 53 percent higher than the combined expenditures of European Union member

states (it was over 600 percent higher than the European Union’s single largest R&D spender, Germany), and 154 percent higher than that of

Japan. 37

In relative terms, however, aggregate R&D

spending patterns reveal more complex patterns.

The most comprehensive relative indicator of national R&D efforts measures gross national expenditures on R&D as a percentage of GDP. As

seen in figure 3-15, total R&D spending trends

across the United States, Japan, and the European

Union chart a course that is quite similar to that of

U.S. business R&D (see figure 3-11 above). Prior

to 1987, the United States consistently maintained

the highest R&D investment levels, peaking at

2.89 percent of GDP in 1985. In 1988, however,

Japan began leading the world in total R&D rates,

climbing from 2.86 percent in 1988 to 3.08 percent in 1990. As of 1992, Japan still led with gross

R&D expenditures totalling 2.68 percent of its

GDP. Throughout this period European Union

member states collectively maintained relatively

weak R&D expenditure rates, although some of

35 z GrlI1ches “Productivity, R&D, and the Data C(Jnstralnt,” The American Etwnomic Re\ie\~ 84(I): I-23, March 1994.

36 Z. Grlllches, “Pr(xluctlvity. R&D, and Basic Research at the Fiml Level in the 1970s’’American Economic Rc\’ie}~ 76( I ): 141-195, March

1986.

37 ~c nunlk.rs ~royl~e~ in figure ~-14 are sta[~d in terms of purchasing power parity (PPP). Since countries denominate R&D exPen~i -

turc~ m n~tii)nal currency units, II is difficult to compare national R&D data directly. There are two generally accepted methods for c(mlparing

R&D data. The first measures R&D as a percentage of GDP, which pr(~vidcs a rw~h relatw indicat{~r t~f nati~~nal R&D efforts. This measure is

prcscntcd in figures 3-15 and 3-17 below. The sec(md nwth(ti involves c{mverting currencies into a single unit, which allows comparis(ms of

absolute R&D spcndlng levels. The prcfmred method for converhng currencies to c(mpare R&D levels is tt) use PPPs, which acc(mnt for intcmat]~)nal dlffercnccs In the cost of buying a similar basket of g(x)ds and services. For a c(mcise statement of the util ity of PPPs f(}r comparing

nati(mal R&D data, scc Natifmal Sc]encc Board, op. cit. fo(m(w 5, pp. 98-99.
66 I Multinationals and the U.S. Technology Base

160

* Us.

140- + Japan

~ France

120-

+> Germany

1oo- + U.K.

+ E U

80-

60-

40-

20

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

NOTES: The purchasing power parity Ievels are developed by the OECD’s Economic Statistics and National Accounts Division; European Union data

are totals for all EU member states

SOURCE: OTA, based on data in OECD, STI, (1), table 2, May 1994

the larger member nations were strong on this

measure: in 1992 Germany directed 2.58 percent

of GDP to R&D, France 2.36 percent, and the

United Kingdom 2.08 percent (in 1991).

The relative decline of U.S. R&D investment

can be traced to enormous cross-national variations in total R&D growth rates during the 1980s

(see figure 3-16). In all but two years during the

1980s, Japanese annual growth rates in gross

R&D expenditures significantly outpaced those

of either the United States or the European Union.

Total U.S. R&D spending has grown at low rates

since 1986. From 1986 to 1988 it increased by

approximately 2 percent, then descended to 0.9 in

1989 and even further to negative numbers during

1990-91, rebounding modestly to 1.6 percent by

1992. Between 1986 and 1992, total U.S. R&D

expenditures grew at an average annual rate of 1.0

percent. During this time Japanese R&D expenditures increased at an average annual rate of 5.1

percent. For most of the period Japan’s gross R&D

expenditures expanded at rates exceeding 7 percent, but those rates dropped to 3.2 percent in

1991 and fell negative in 1992.

Between 1986 and 1992, total R&D expenditures in the European Union grew at an average

annual rate of 3.9 percent. During this period Germany’s total R&D spending increased at an average rate of 2.8 percent, while France’s spending

grew at 3.1 percent. The United Kingdom’s total

R&D spending declined sharply from rates of

approximately 4 percent in the mid-1980s to -5.0

percent in 1991, which brought its average annual

R&D growth rate for the period down to 1.0

percent.

Figure 3-16 also suggests that U.S. and Japanese growth rates in gross R&D spending may be

converging. In 1992, total U.S. R&D spending

grew by 1.8 percent of GDP; in 1993, U.S. R&D

expenditures tallied $161 billion, an inflation-
Chapter 3 The U.S. Technology Base in Comparative Perspective I 67

adjusted increase of 1.6 percent from 1992.38 In

Japan, total R&D spending seems likely to increase at a moderate rate. The Japanese government has increased its budget for science and

technology by 6.2 percent in 1994 (to approximately $21 billion),39 while estimates of corporate R&D spending indicate a relatively modest

growth rate of 2.2 percent in the fiscal year

through March 1994.40 Even if U.S. and Japanese

R&D expenditures grow at similar rates, the trend

over the last decade casts a long shadow. Between

1981 and 1992, the compound annual growth rate

in total U.S. R&D expenditures averaged 3.4 percent, compared to 6.7 percent for Japan.41

From the point of view of commercial competitiveness, U.S. R&D investment rates appear even

lower when defense-related R&D outlays are removed from gross R&D figures. Instead of maintaining R&D spending at levels close to those in

Japan, U.S. expenditures are more similar to those

of Europe, while Japanese expenditures are much

higher. As illustrated in figure 3-17, between 1981

and 1991 Japan’s total expenditures on civil R&D

grew from 2.3 percent of GDP to 3 percent; during

the same period, total U.S. investment in civil

R&D moved from 1.8 percent to 2.1 percent, and

the average of the European Union from 1.5 percent to 1.8 percent. Within the European Union,

France’s civil R&D expenditures increased from

1.6 percent to 2 percent, while the United Kingdom’s remained flat at 1.8 percent.42

Figure 3-17 illustrates that, from the point of

view of commercially relevant R&D, Japan ranks

Eg 1.5 “

&

n

1-

0.5-

+ Us.

+ Japan

+ EU

0[ I I I I I [ I I I I {

1981 82 83 84 85 86 87 88 89 90 91 92

NOTE: European Union data are totals for all EU member states

SOURCE: OTA, based on data in OECD, STI (l), table 5, May 1994

considerably higher than the United States and

other advanced industrial states. For the United

States, this comparison may be more relevant than

that of gross R&D expenditures because so little

of U.S. defense R&D contributes directly to the

industrial technology base. Much of the U.S. defense R&D budget is devoted to purely military

activities. Of the Pentagon’s research, development, test, and evaluation (RDT&E) budget, the

science and technology portion—arguably the

38 Natlona] Science Foundation,” Division of Science Resource Studies, “Data Brief,” no.6, Sept. ’24, 1993.

39 po]]ack (JP Cl[., f(x)mote 32. According to one budgetary analysis, the Japanese government’s commitment to R&D remains “r(d SO-

, .

id.” See J. Choy, “1993 Update on Japanese Research and Development: The Party’s Over, ’’~El Report No. 38A, Oct. 15, 1993.

W “Japan’s Researchers Get Back to Basics,” op. cit. footnote 25; and “Donaru Kigyo no R& D,” op. cit. footnote 30.

41 Calculated from OECD, Economic” Analysis and Statistics Division, Main Science and Technology Indwutors database, i 994 no. 1, table

3 (measured in constant dollars). According to the National Science Foundati(m, growth in total U.S. R&Din real terms averaged only 0.6 percent per year from 1987 to 1993, compared to the annual increase of 5.2 percent from 1980 to 1987. NSF, “Data Brief,” op. cit., footnote 38.

42 Calculated fr{)m OECD Mafn S(.len(,e ~~ Techn~/~gy lndicafor~, op. cit. footnote 41, table 6. ne OECD d~~s n@ Provide estin’ated

figures for Germany’s civil GERD. Characteristically, Germany directs comparatively few R&D resources to the defense sector.
68 I Multinationals and the U.S. Technology Base

12

10

8

6

4

2

0

-2

-4

tf!!ii. m\

+ Us.

+ Japan

~ France

+ Germany

+ U.K.

+ EU

-6 ~ [ 1 I I 1 I 1 I 1 !

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

NOTES Growth rates are based on OECD adjusted expenditures m 1985 dollars As wth OTA R&D data, the OECD adjustment employed an impllclt

GDP deflator, breaks m hnes Indicate unavadable data for mtermedate years, European Uruon data are averages of all EU member states

SOURCE OTA, based on data m OECD, ST/, (l), table 3, May 1994

3.5,

3

2.5

1

0.5

.

\

(

o I ! I I I I r 1 I I

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

++- Us.

k + Japan

~ France

+ U.K.

+ E U

<

I

NOTE European Union data are totals for all EU member states

SOURCE OTA, based on data m OECD, ST/, (l), table 6, May 1994
Chapter 3 The U.S. Technology Base in Comparative Perspective I 69

area with the greatest potential for spinoff effects—totaled less than 50 percent throughout the

1980s, even though the Pentagon’s total RDT&E

budget ballooned.43 In fiscal year 1993, 29 percent of the Department of Defense RDT&E budget went to science and technology; the ratio for FY

1994 is estimated to be the same, while the portion

requested for science and technology in FY 1995

is slightly lower, at 26 percent .44 Second, there are

longstanding legal, institutional, and administrative barriers that restrict technology transfer between the defense and civil sectors. 45 Third, the

spinoff effects of military R&D that in the past

contributed to civilian technology development

(such as in semiconductors, computers, jet engines, and airframes) have declined substantially

in recent years, and in some technologies the flow

has reversed.46 Many observers believe that, in

the context of increasingly intense technological

and commercial rivalry in the contemporary international system, the historical orientation of the

U.S. R&D system toward defense technologies

may prove to be more a liability than an asset.

Ultimately, aggregate R&D investment rates

provide an important but incomplete view of

trends in the innovative capacity of the industrial

technology base. Patent data provides a limited

but crucial measure of the actual output or performance of national innovation systems. Patent

trends can be used to gauge the comparative inventiveness of national systems, the level of foreign patenting within each system, the degree of

overseas patenting

countries, and the ra

enting.

by residents of individual

io of foreign to domestic pat9 Patents

As with total R&D expenditures, national patenting rates are best measured relative to the size of

the economy. Figure 3-18 charts such a measure of

national inventiveness: the number of patent applications by residents as a proportion of the population. For most OECD countries, the level of

resident patenting activity has been stable over

time. The two exceptions are the United States and

Germany. The U.S. level increased gradually,

from 2.7 per 10,000 in 1981 to 3.5 in 1991, while

Germany’s level declined from over 5 per 10,000

to 4.1 by 1991 (a trend that may have more to do

with the increase in Germany’s population after

unification than any decline in inventive activity

per se). Japan is not represented on this graph because it is literally off the scale. In 1981 Japan

resident patent application level was 16.3 per

10,000, and it increased even further to 27.1 by

1991. Japan’s high patenting level, however, is

due largely to the peculiarities of Japan’s patent

system. Patent grants in Japan typically have a

narrow scope, which encourages multiple filings

to cover permutations of an invention that in most

OECD nations would be covered by a single patent. Japan’s “mosaic” patenting practices make it

impossible to compare Japan’s resident patenting

~1 u s congre~~, Office of TechntJl(~gy Assessn~~nt, De~&n.~e Techno/o~}l Buse: Invoducrwn and O\’er\’ie\$’, ISC-309 Washinwn, ~:

U.S. G(wemnwnt Printing office, June 1987), p. 34.

~ Calculated fronl the ~pa~nlen[ t~f Defense RDT&E budget FY 1993-FY 1995, as provided by Congressional Research kmice R&D

Budget Seminar, op. cil., f(x)tm)te 8.

4$ U,S. C{)ngress, Office of T~chno]ogy” Assessment, }Iold;ng the Edge (Washingt(m, DC: U.S. G(wemment printing office, 1989), p. 176.

46 Allc et a[., ~)p, ci[., f(x)[note 4. See also M(wery, op. Cit., f(~(~tn(~te ~, P. 125.
70 I Multinationals and the US. Technology Base

6

+ U s .

A A

o

0 -- Franc e

57/

+ Germany

m

‘+5 + U.K .

.3 4 “ )

E

* E U

3

IB m

z

: 3-

am

:

c

) n i)

z 24

wc

F

1-

0 I [ I I { I 1 1 I

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

NOTE: European Union data are totals for all EU member states

SOURCE: OTA, based on data in OECD, ST/, (l), table 77, May 1994

level with other OECD countries, although it is

possible to observe the rate of change. Between

1981 and 1991 Japan’s resident patenting level increased 66 percent, compared to a 31 percent increase in the U.S. level.47

Compared to resident patenting levels, patent

applications by nonresidents have increased significantly within most of the advanced industrial

states. In the United States, nonresident patent applications rose 91 percent between 1981 and

1991; the level rose 75 percent in France, 70 percent in Germany, 65 percent in the United King-

~ Consequently, ‘n

dom, and 57 percent in Japan.

most countries the ratio of nonresident to resident

patent applications has increased (see figure

3-19). France, the United Kingdom, and the European Union exhibit the strongest expansion in the

ratio of nonresident to resident patenting activity,

which reflects the increase in nonresident patent

applications during a period of little growth in resident applications. The lowest ratio is in Japan,

and it declined from 0.15 to 0.13, reflecting the

large growth in resident patenting compared to the

relatively smaller growth in nonresident applications. The ratio is also comparatively low for the

United States, although it increased from 0.7 in

1981 to 1.0 in 1991 (reflecting the slower rate of

increase in resident patenting compared to the

large growth in nonresident patent applications).

In sum, the different nonresident to resident patenting levels shown in figure 3-19 suggest that

there is proportionately more foreign patenting

activity taking place in France, the United Kingdom, and the smaller European Union states than

in Germany, the United States, and Japan.

The propensity of residents from each of these

nations to patent abroad has increased steadily, as

indicated in figure 3-20. Although in absolute

47 OECD, Main S(.lenle ~~ Technology Indicarurs, op. cit., foornote 41, table 77.

a Ibid., table 73.
Chapter 3 The U.S. Technology Base in Comparative Perspective I 71

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

+ Us.

+ Japan

~ France

U Germany

+ U.K.

+ E U

NOTE European Umon data are totals for all EU member states

SOURCE OTA, based on data m OECD, ST/, (l), table 75, May 1994

7’”

/

150 1/.

100

< > A

A

50

+ Us.

+- Japan

-o-- France

I

+ Germany

+ U.K.

+ E U

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

NOTE European Union data are totals for all EU member states

SOURCE OTA, based on data In OECD, ST/, (l), table 74, May 1994
72 I Multinationals and the U.S. Technology Base

6 1

+- Us.

+ Japan

-o- France

,

U Germany

+ U.K.

+ E U

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

NOTES: Foreign patent applications concern inventions already covered by internal applications, one domestic application can give rise to several

foreign applications European Union data are totals for all EU member states

SOURCE: OTA, based on data in OECD, STI, (1), table 78, May 1994

terms the United States files by far the most foreign patent applications, the rate of expansion

since 1981 has been substantial across the advanced industrial states. The United Kingdom

shows the strongest growth in external patenting,

increasing 17.5 percent per year since 1981. External patenting by U.S. citizens increased 15.6

percent, while the number increased 17.0 percent

for Japan, 10.3 percent for France, and 7.4 percent

for Germany.49

The widespread increase in external patenting

shown in figure 3-20 indicates that firms and individuals are increasingly likely to patent in foreign

markets. This trend is confirmed by the ratio of external to resident patent applications, which

49 I bid., table 74.

shows that the internationalization of patenting

activity has been increasing steadily for all but Japan (see figure 3-21 ).sO These trends suggest that

technology has been following the international

expansion of business activity. However, as chapter 4 demonstrates, the internationalization of

technology has been progressing at a much slower

rate than that of production and commerce.

CONCLUSIONS

Taken together, aggregate patenting and R&D

trends point to considerable challenges for U.S.

technology policy. First, R&D investment rates

by U.S. businesses are relatively low, particularly

WI A~aln, it is dlfficu]t t. ~onlpare Jap~’s patent trends with the rest of the OECD due W the UnUWIai character Of Jaw’s d~~rnes~lc pa~enting

system. The comparatively low ratio of foreign to domestic patenting for Japan, shown in figure 3-21, is partly due to the unusually high level of

d(mwstic patenting in Japan. As figure 3-20 illustrates, Japan’s level of external patenting has increased substantially, and in 1991 wascomparable to Gem~any’s level.
Chapter 3 The U.S. Technology Base in Comparative Perspective I 73

in comparison with Japanese firms. Second, total

U.S. R&D investment no longer leads the world

as a percentage of GDP. Moreover, the large percentage of total resources devoted to defense

technologies reduces the commercial impact of

U.S. R&D expenditures. Third, patenting data reveal trends toward the internationalization of

technology, as firms and individuals are increasingly likely to seek patents in foreign markets as

well as the domestic market. In short, U.S. industry is continuing to invest in R&D at low rates and

total U.S. R&D rates are declining in relative

terms at the very time that technology is diffusing

more rapidly and becoming increasingly internationalized.

At root, the principal mechanism behind the

internationalization of technology is the multinational enterprise. The patent trends outlined above

measure one dimension of internationalization,

but technology can also be internationalized

through other business activities, such as overseas

R&D, international sales of technology in the

form of intellectual property, and cross-national

corporate collaboration on technology development. As the following chapter demonstrates,

close analysis of these processes indicates that

MNEs have magnified the internationalization of

technology, but that—relative to their highly internationalized production capabilities—they

tend to keep their core technology development

functions in the home market. This conclusion describes a central tendency. As chapter four shows,

MNEs based in different countries and operating

in different sectors often internationalize their

core technology development functions in different ways and to different degrees.
Multinationals

and the

Location of

Innovation 4

c

hapter 4 builds on numerous recent analyses that register

concern about the comparative performance of the U.S.

innovation system and the long-term health of the domestic technology base. OTA and others have analyzed

the impact of the U.S. innovation system’s orientation toward defense technologies on the nation’s relative technological position

and international competitiveness. 1 Other analyses have focused

on the relative inability of U.S. firms to commercialize new

technologies, and the dearth of policy efforts to encourage the diffusion of new technologies along with more tacit forms of knowledge.2 Given the central role of multinational enterprises (MNEs)

in the production and diffusion of new technology—and hence in

the competitiveness of national economies—this chapter focuses

on the relationship between MNEs and national innovation

systems.

Many analysts have noted that MNEs in recent years have increased the cross-border transfer of technological knowledge and

1 See U.S. Ctmgress, OffIce of Technology” Assessment, Dej2nse Con}’crslon: Redirecl~ng R&D, OTA-lTE-552 (Washlngt(m, DC. U.S. Government Printing Office, May

1993 ); U.S. C(mgress, OffIce of Technology Assessment, Comperfng Economies: Arner--

cu. Europe. and /he Pacific R~nl, OTA-ITE- 498 (Washington, DC: U.S. Government

Printing Office, October 199 l), Nati(mal Science Board, The Con]pefili\e Strength U/ U.S.

/ndu~tr/a/ Sc~en(e and Technology: Strategic /ssues (Washington, DC: Nati(mal Science

Foundatitm, 1992).

2 See J.A. Alic, “’Technical Know Iege and Technology Diffusion: New Issues for U.S.

Government Policy,” Technology An@!ri.s and Srrafeglc Managcnlent 5(4):369.383,

1993; U.S. Congress, Office of Technology Assessment, Making Things Beffer: Con~pering in Manufacfurm~, OTA-1~-44~ (Washington, DC: U.S. G(~vemmcnt Printing Office, February 1990). OTA is c(mducting an assessment of difficulties U.S. industry has

faced in the commercia]izati(m of new technologies.

I

I 75
76 I Multinationals and the U.S. Technology Base

assets, a process referred to as the globalization of

technology. 3 However, globalization does not imply that national technology bases are becoming

more integrated and interdependent. First, most of

the core research and technology development activities of MNEs remain centralized in the home

market. Second, much of the technology sold

across borders stays within MNE networks. And

third, cross-border technical alliances and other

forms of interfirm collaboration are prominent in

a limited number of sectors, although the available data are inadequate to assess the net significance of alliances as a channel for international

technology diffusion.

OTA’s analysis shows that, although technology has become increasingly global and will likely

become more so in the future, technology development in the aggregate remains firmly rooted in

national technology bases. Moreover, MNEs

based in different countries and operating in different industrial sectors vary in their tendency to

retain core technology development capabilities

in the home market.

These conclusions follow from an analysis of

three principal mechanisms through which MNEs

can extend technology across national borders:

first, through overseas R&D activities; second,

through the direct sale of technology in the form of

intellectual property, in exchange for royalties and

license fees; and third, through cooperative R&D

agreements or alliances between firms, as well as

between firms and other R&D organizations such

as universities.4 If there are consistent national

differences in the strategic technology activities of

MNEs, then those differences should be reflected

in each of these areas.

THE LOCATION OF RESEARCH

AND DEVELOPMENT

Historically, R&D has been the last aspect of corporate activity to take on a global dimension,

since the economies of scale associated with research activities tend to favor centralization.

However, as firms establish foreign production

capabilities, they often decentralize selective elements of their R&D. In addition to supporting local production facilities, firms will move R&D

abroad for a variety of reasons:

■

m

8

m

●

■

to acquire foreign technology;

to customize products for local markets;

to stay abreast of technological developments;

to gain access to foreign R&D resources, such

as universities, public and private laboratory

facilities, and scientists and engineers;

to assist the parent company in meeting foreign

regulations and product standards; and

to gain cost efficiencies.

Consequently, as production and commerce become increasingly international, R&D should

likewise exhibit a more global character.

Analysts differ, however, on the extent and

breadth of the globalization of R&D. Some studies conclude that technology has globalized so extensively that it is becoming difficult to identify

technologies with individual firms or to distinguish one national technology base from another.5

Others note that while R&D has indeed become

3 See “Technology and Globalization, “ in Organisation for Economic Co-Operation and Development (OECD), Technology and /he Economy: The Key Relationships (Paris, France: OECD, 1992), pp. 209-236. For an extended analysis with particular reference to MNEs, see O.

Grans(rand, L. Hilkans.on, and S. S~jlander, Technolo~y Management andlnternational Business: ln(ernalionalization ofR&D and Technology

(New York, NY: John Wiley, 1992).

4 Two of these phenomenon-tie” increased frequency Of both offshore R&D and international technical alliances-are associated with the

rise of “technoglobalisrn” during the 1980s. See OECD, Economic Analysis and Statistics Division, Perjiwmance ofForeign Affiliates In OECD

Coun/ries (Paris, France: OECD, forthcoming), pre-publication copy p. 49.

S T-H. he and pp. Reid (eds.), Na[l~~/]ntereS[S In an AgeofG/oba/ Technology (Washington, DC: National Academy press, 1991 ), P. 72.
Chapter 4

more mobile, MNEs move R&D abroad far more

slowly than production, sourcing, marketing, and

other business activities. 6 Others contend that

firms are responding to global competition by

watching R&D activities closely and striving to

retain centralized control.’ Still others agree that

MNEs conduct relatively little R&D outside the

home country, but note that the strategies and policies of MNEs can affect the way R&D is owned,

organized, and located.8 Finally, OECD analyses

indicate that major MNEs may be expanding their

core R&D activities across national borders.

Some foreign acquisitions appear aimed at gaining access to technology and other R&D resources

that are already established in particular markets

(for instance, biotechnology in the United States).

In the United States, Germany, and the United

Kingdom, foreign firms “are spending substantial

sums on R&D, mainly for local markets though

increasing y for global ones, reflecting new strategies in R&D intensive industries.”9

OTA’s analysis indicates that R&D has become

more global in character, as demonstrated by the

overseas R&D activities of foreign affiliates. Nevertheless, relative to production and sourcing,

R&D across the advanced industrial states remains highly centralized in the home market operations of MNEs. The degree of centralization,

however, varies by country of origin as well as by

sector. The patterns underlying this assessment

can be seen in three areas of inquiry: the R&D activities of foreign affiliates in the United States; the

Multinationals and the Location of lnnovation I 77

R&D activities of U.S. affiliates in foreign markets; and the relationship between R&D conducted by affiliates and that conducted by MNE

parents.

I R&D by Foreign Affiliates

in the United States

R&D spending by foreign affiliates in the United

States has increased substantially, measured as a

percentage of total R&D expenditures by U.S.

businesses. In 1982 foreign affiliates accounted

for 9.4 percent ($4.5 billion) of all business R&D

spending in the United States; by 1992 that share

had risen to 16.4 percent ($10.7 billion). 10 Although relatively small in absolute terms, the rate

of increase in R&D spending by foreign affiliates

has been much more rapid than that of total U.S.

business R&D. Between 1982 and 1992, R&D expenditures by foreign affiliates in the United

States grew by 138 percent (see figure 4-1 ), while

total business R&D expenditures grew by 39

percent (from $48.6 to $67.0 billion in constant

dollars). 11

Affiliates from other advanced industrial nations increased their total R&D spending in the

United States rapidly over the course of the 1980s

and early 1990s (see figure 4-2). During that period U.K. and German affiliates consistently outspent French and Japanese affiliates. Adjusted for

inflation, U.K. affiliates in the United States spent

$1.8 billion on R&D in 1992, and German affilib J.A. Cantwell, Te<hno/oglcal Innalwtion and Mu/finarwna/ Corpora~ions (Oxford, UK: Basil Blackwell, 1989).

7 P. Pate] and K. Pavit[, “Large Fimls in the Producti(m of the World’s Technology: An Important Case of ‘N(m-GI(~balizati( m’” Journal aj’

lnlernatlona/ Business .Vudics First Quarter: 1-21, 1991.

8 J.H. Dunning, “’Multmatmnal Enterprises and the Globalization of lnnovatory Capacity,” Research Po/icy 23(1 ):67-88, Jan. 1994.

9 G, Vickery, “Global Industries and National P(~licies,” OECD Obserter 179: 1 I -14, December 199UJanuary 1993. Smaller c(mntries with

limited df~nwstlc R&D res(mrces (e.g. Sweden, Netherlands, Switzerland) tend to h~ate even more R&D abroad, often as a means of tapping

foreign technological” resources.

I (j 1n ~(}nstmt 1987 dollars. Data on R&D spending by foreign affiliates frtml U.S. Department of Commerce, FOrei/Yr Direc’1 ln~’e$tmenl ;n

[he Un[[ed.$tafes: An Update (Wash ingt(m, DC: US GPO, June 1993), table 56; and U.S. Department of Commerce, Foreign Direcf /n\’esfment

In rhe Unl~cd Stales: Pre/lminary /992 Es[~rna[e.$ (fm-thc(mling, 1994), table H-3A. Data on total U.S. business R&D are from National Science

Board, S(lence and li’ng~neer~n~ /ndi(a/ors-/993 (Washingt(m, IX U.S. GPO, 1993), NSB 93-1, appendix table 4-4, p. 333.

I I National Science Board, &,ient.e and Engineering /ndl(’alUrS--/ 993. Op cit. f(~(~~ote 1°.
78 I Multinationals and the U.S. Technology Base

1 1

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

- Wholesaletrade

~ Manufacturing

n Otherindustries

NOTE: 1992 data are preliminary.

SOURCE: OTA, based on data on U S Department of Commerce, Economics and Statistics Administration, Foreign Direct Investment in the United

States: An Update, Review and Analysls of Current Developments (Washington, DC U.S. Government Printing Off Ice, June 1993), appendix C, table

56 (hereafter cited as ESA, FDIUS), U S Department of Commerce, Bureau of Economic Analysis, Foreign Direct Investment in the United States

Operations of U.S. Affiliates of Foreign Companies, 1987 Benchmark Survey, revised 1988-1991 estimates, and preliminary 1992 estimates (Washington, DC U S Government Printing Off Ice, 1990-1994), table H-1 (hereafter cited as BEA, FDIUS)

ates spent $1.6 billion. Japanese and French affiliates have spent comparatively less on R&D over

time—$l.3 billion and $1.0 billion, respectively,

in 1992. 12

Since 1980,86 percent of the total R&D by foreign affiliates in the United States has been in

manufacturing, increasing slightly from 82 percent in 1980 to 84 percent in 1992.’3 Canadian

firms accounted for the largest share—19 percent—among foreign affiliates in the United

States during 1992 (see figure 4-3). German,

U. K., and Swiss affiliates each accounted for $1.5

billion or 16 percent, compared to $1.0 billion or

approximately 10 percent for French and Japanese

affiliates.

Between 1985 and 1992, over half of all R&D

and 81 percent of the manufacturing R&D conducted by foreign affiliates in the United States

was concentrated in three sectors: chemicals (28

percent); pharmaceuticals (23 percent); and electrical and nonelectrical machinery (29 percent

combined). 14 The most rapid rate of growth has

been in the pharmaceutical sector, where foreign

12 In C{)nstmt 1987 d(~]]ars. Dan frt~m U.S. Department of Commerce, Bureau of Economic Analysis, Survey ojCurrenr Business (Washington, DC: May 1993); table 1, p. 89; and U.S. Department of Commerce, Bureau of Economic Analysis, Foreign Direc(investment in /he Unired

States: Pre/iminaW 1992 Esrimates (Washington, DC: forthcoming, 1994); table H-3A.

t

 3 See figure 4-I.

14 (-J,s. ~p~nlen( of Commerce, BEA, Foreign Direct In\’estment in the United States: Preliminary 1992 Estimates, t~p cit. footnote 12.
Chapter 4 Multinationals and the Location of lnnovation I 79

1.8

1.6-

1.4 ‘-

~ 1.2-

~

a 1-

-u

z

~ 0.8- 0—=

G 0.6~ *

0.4-

0.2

German affiliates

French affiliates

U.K. affiliates

Japanese affiliates

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

NOTE: 1992 data are preliminary.

SOURCE: OTA based on data in BEA, FDIUS, tables 8 and H-6 (1 983-1986) and tables A-6 and H-2 (1 987-1992)

affiliates increased their R&D spending from

$596 million in 1985 to $2.8 billion in 1992 (in

constant dollars), an average increase of 26 percent per year. R&D spending by foreign affiliates

also has grown rapidly in industrial chemicals and

machinery, again with the most rapid rates of

growth taking place in the late 1980s (see figure

4-4).

The R&D spending increases shown in figure

4-2 correspond to a very active period of merger

and acquisition activity by foreign investors. The

value of foreign acquisitions in the United States

jumped from $31.5 billion in 1986 to $64.9 billion

in 1988, and remained quite high during

1988-90. 15 The correspondence between this period of high acquisition activity and the rise in

R&D spending by foreign affiliates after 1986 implies that much of the increase in affiliate R&D

was due to acquisitions of U.S. research facilities,

as opposed to the transfer of R&D activities from

the home market to existing affiliates in the

United States. 16 With only a few notable exceptions, such as NEC’s laboratory in Princeton, most

industrial laboratories run by foreign affiliates in

the United States have been established not

through new investment dedicated to R&D activities per se but rather through the merger and acquisition strategies of foreign firms.17

16 For supp)~lng analyses, See OECD, Pcrf(wm~nce of Foreign Afli/~ares, 0p. cit., f(x)tnote 4, p. 50: U.S. Depafimen[ of Commercet ‘EAJ

b’orelgn IIlrcct ln~estmenl In the Unifed Sla!es: An Update, op. cit., foi~tm)te 10, p. 70; and H. Fusf~ld, lndustr?’s Future: Changing Patterns of

Indllstrial Research (unpublished manuscript, 1994).

I T H. Fusf~ld, op. cit. fmnm~te 16.
80 I Multinationals and the U.S. Technology Base

Other foreign affiliates

12%

affiliates

Japanese affiliates 160/0

1 0%0

NOTE: Brackets show R&D expenditures in constant 1987 dollars, total

expenditures for manufacturing R&D by foreign affiliates = $95 billion

SOURCE: OTA, based on data in BEA, FDIUS, preliminary 1992 estimates, table H-4

Variations in investment strategies affect the

average R&D intensity of foreign affiliates in the

United States.18 Figure 4-5 shows that the R&D

intensity for European affiliates is above the average for all affiliates, which reflects the relatively

high percentage of European foreign direct investment in the United States (FDIUS) that is directed

to manufacturing. German affiliates in the United

States consistently have had the highest R&D intensity, which reflects the concentration of German affiliates in R&D-intensive manufacturing

industries, such as chemicals and pharmaceuticals.19 Similarly, the comparatively low R&D intensity of Japanese affiliates in the United States

reflects the relatively low percentage of Japanese

FDIUS directed to manufacturing: in 1992, 19

percent of Japan’s FDIUS was in manufacturing

and 34 percent in wholesale trade, compared with

47 percent and 8 percent, respectively, for European FDIUS.20

Table 4-1 shows cross-national variations in

the sectoral focus of manufacturing R&D by foreign affiliates in 1992. The distribution of spending reinforces the above observation that the

average R&D intensity of foreign affiliates varies

with respect to the sectoral distribution of FDIUS.

However, there are also notable cross-national differences in R&D intensity within individual sectors. As table 4-2 shows, in 1992 the average R&D

intensity for all foreign affiliates in U.S. manufacturing industries was 2.7 percent; the average for

German affiliates was 3.5 percent, while it was 2.9

for French affiliates, 2.2 for U.K. affiliates, and

1.7 percent for Japanese affiliates. Across the major industrial sectors, German affiliates typically

have the highest R&D intensity levels and Japanese affiliates the lowest, while U.K. and French

affiliates share the middle ground.

In short, the scope and intensity of R&D by foreign affiliates in the United States varies both by

country and by sector. Most of the manufacturing

R&D conducted by foreign affiliates in the United

States is concentrated in industrial chemicals,

drugs, and electrical and electronic machinery

(see figure 4-4). In these areas the R&D intensity

of foreign affiliates is two or more times the naI g R&D intensity is tie ratio of R&D expenditures to total output (sales).

19 OECD, fer~ornwnte o~Forelgn A@/la/es, t~p. cit., ftx)tnt~te 4, table 1, p. 80. For an analysis of FDIUS by country and by sector, see ch. 5 of

this report.

20 U.S. Department of Commerce, BEA, Foreign Direct Int’estmenl in the United States: Preliminary 1992 Es~/mate.s, op. cit., fix)tm)te 12.

See chapter 5 for a complete analysis (lf the composition of FDIUS.
Chapter 4 Multinationals and the Location of Innovation I 81

2.8

2.6- +

2.4-

2.2- ~

2-

P 1.8- +

m

/“7

WA.“w’-’

0.4

> ~

o I [ I I 1 1 1 { i 1 1

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

Industrial chemicals

Drugs

Nonelectrical machinery

Electric and electronic equipment

Transportation equipment

NOTE 1992 data are preliminary

SOURCE OTA based on data m ESA, FD/US, appendix C, table 56, BEA, FOULS, table H-1 (1987-1992)

1.8

1.6

1.4

1.2

ZI mp

$ 0.8

0.6

0.4

0.2

0

c??

/

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

Iz2i

o

n

German affiliates

French affiliates

U.K. affiliates

Japanese affiliates

All affiliates

European afflhates

NOTES R&D lntenslty measures total afflhate R&D expenditures as a percent of total sales 1992 data are prehmlnary

SOURCE OTA based on data n BEA, FD/US tables 8 and H-6 (1983-1986) and tables A-6 and H-2 (1 987-1992)
82 I Multinationals and the U.S. Technology Base

All countries Germany France U.K. Japan

All manufacturing

Chemicals and allied products

Industrial chemicals

Drugs

Machinery

Nonelectrical machinery

Electric and electronic equipment

Transportation equipment

9,393

5,095

1,926

2,787

2,549

894

1,656

179

1,462

871

626

n/a

379

51

328

34

1,007

239

n/a

n/a

403

168

235

26

1,492

958

86

795

141

46

94

60

981

141

53

63

612

457

156

13

SOURCE: Adapted from U S Department of Commerce, Bureau of Economic Analyses, Foreign Direct Investment in the United States Operations o/

U.S. Affiliates of Foreign Companies preliminary 1992 estimates (Washington, DC U S Government Printing Off Ice, forthcoming), table H-4

All countries Germany France U.K. Japan

All manufacturing 2,7 3.5 2.9 2.2 1.7

Chemicals and allied products 5.0 4.5 3.2 4.4 2.7

Primary and fabricated metals 0.6 8.0 n/a 69 4.0

Machinery 3.6 3.9 5,7 2.0 3.6

Other manufacturing 1.3 2.0 n/a 12 0.8

—

NOTE: R&D intensity measures total affiliate R&D expenditures as a percent of total sales, a more complete sectoral breakdown of 1992 affiliate sales

data wiII be available only after this publication has been released

SOURCE: OTA, based on data in U S Department of Commerce, Bureau of Economic Analyses, Foreign D/reef/nves[menf/nfhe Unded States: Operations of U.S. Affiliates of Foreign Companies preliminary 1992 estimates (Washington, DC U S Government Printing Office, forthcoming), tables E-4

and H-4

tional average for all industries.21 Affiliates in U.S. market for companies that have successfully

these sectors (mostly Swiss, German, U. K., and developed new technologies.22

Japanese firms) are technologically and commerc i ally powerful global competitors, and can mobi- 1 R&D by U.S. Affiliates in Foreign Markets

lize substantial R&D resources. Moreover, the Like the R&D activity of foreign affiliates in the

fact that they concentrate R&D resources in the United States, the overseas R&D by affiliates of

United States indicates the attractiveness of the

2 I In most coun~les, the R&D in[enslty of affiliates is lower or at most equal to the average R&D intensity for all manufacturing industries in

host countries. The United States is one of the few exceptions to this tendency. OECD, Per~ormance ojFw-eign Aflillates, op. cit., footnote 4,

p. 5 I .

22 Ibid.
Chapter 4 Multinationals and the Location of lnnovation I 83

2

0.5

0! 1 r !

1989 1990 1991 1992e

Industrial chemicals

Drugs

Nonelectrical machinery

Electrlc and electronic equipment

Transportation equ[pment

NOTE: 1992 data are preliminary.

SOURCE: OTA based on data in U.S. Department of Commerce, Bureau of Economic Analysis, U.S. Direct Investment Abroad Operations of U S

Parent Companies and their Foreign Affiliates revised 1989-1991 estimates and preliminary 1992 estimates (Washington DC U S Government Printing Office, 1992-1994) table III I 2-5 (hereafter cited as BEA, USDIA)

U.S. MNEs has increased rapidly over time. Be- cent for the manufacturing R&D of foreign affilitween 1982 and 1992, R&D expenditures by ma- ates in the United States. However, while R&D by

jority-owned foreign affiliates of U.S. MNEs affiliates in the United States is concentrated in

increased from $4.3 billion to $8.4 billion in real chemicals, pharmaceuticals, and machinery, the

terms. 23 Also like foreign affiliates in the United R&D by U.S. affiliates abroad is focused on maStates, the location and character of this R&D ac - chinery and transportation equipment. Of total

tivity varies by country arid by sector. overseas manufacturing R&D by U.S. affiliates

Most of the overseas R&D conducted by U.S. between 1989 and 1992,29 percent was in electriaffiliates is in manufacturing. Between 1989 and cal and nonelectrical machinery combined, 27

1992, manufacturing R&D accounted for an aver- percent in transportation equipment, 20 percent in

age of 84 percent (or $6.7 billion) of all R&D pharmaceuticals, and just 4 percent in chemicals

spending by U.S. affiliates in foreign markets .24 (see figure 4-6).25

This ratio is equivalent to the average of 86 per23 U.S. Department of Commerce, BEA, Sun)ey oj’Current Busine.$s (Washington, DC: July 1993), table 5, p.44; and U.S. Depanment of

C(mlmerce, BEA, U.S. l~lrccf/nte.$rmcnlAbr~jad: Pre/[minary 1992 Estvnules (forthcoming, 1994), table 111.13. Data adjusted t(~c{mslant 1987

dollars.

24 U.S. Department of Commerce, BEA, U.S. Direcrln\’estment Abroad, annual series (Washingt(m, DC: 1992-1 994), tables 111.13 and 111.E

3. me R&D da[a in this series goes back only to 1989. Data adjusted to constant 1987 dollars.

‘f U.S. Department of Commerce, U.S. Direcl In\’esfment Abroad: Preliminary /992 Esfmlale.$, op cit. f(M~tn(~tc 23.
84 I Multinationals and the U.S. Technology Base

* R&D in Germany

* R&D in France

~R&D in the U.K.

+ R&D in Japan

1989 1990 1991 1992e

SOURCE: OTA, based on data in BEA, USDIA, table Ill.I.3 (1989-1992)

By country, the distribution of R&D expenditures by U.S. affiliates mirrors that of foreign affiliates in the United States. In relative terms, R&D

by U.S. affiliates is concentrated in Germany and

to a lesser extent the United Kingdom, with comparatively little R&D in France and Japan (see figure 4-7). Between 1989 and 1992, U.S. affiliates

on average spent $2 billion per year in Germany

(25 percent of the total by U.S. affiliates) and $1.6

billion per year in the United Kingdom (20 percent of the total), compared with $722 million (9

percent) in France and $488 million (6 percent) in

Japan.

Like foreign affiliates in the United States, U.S.

affiliates abroad have higher R&D intensities in

the markets where they are more concentrated in

manufacturing industries (see figure 4-8). In

1992,96 percent of R&D by U.S. affiliates in Germany was in manufacturing industries; the same

ratio for the United Kingdom was 83 percent,

while it was 76 percent for France and 80 percent

for Japan. Of the $2.2 billion in manufacturing

R&D conducted by U.S. affiliates in Germany, 59

percent ($1.3 billion) was in transportation, 14

percent in machinery, and 11 percent in chemicals

and allied products. In the United Kingdom, 38

percent ($462 million) of the manufacturing total

($1.2 billion) was in chemicals and allied products, and 18 percent was in machinery. In France,

63 percent ($402 million) of the total $641 million

in manufacturing R&D was in chemicals and allied products. And in Japan, 49 percent ($213 million) of the total $437 million in manufacturing

R&D by U.S. affiliates was in chemicals and allied products, while 32 percent ($ 139 million) was

in machinery (of which 74 percent or $103 million

was in electric and electronic equipment).zc

In sum, the R&D activities of both foreign affiliates in the United States and U.S. affiliates

abroad have increased significantly in recent

years, but the scope and intensity of that activity

26 ibid. A]] amounts have been converted to constant 1987 d(~ll~.
Chapter 4 Multinationals and the Location of lnnovation I 85

2

1.8

1.6

1.4

1.2

E

gl

2

0.8

0.6

0.4

0.2

0

%-” .

1989 1990 1991 1992e

~ in Germany

~ in France

D m the U.K.

_ in Japan

* in all countries

+ in Europe

NOTES: R&D intensity measures total affiliate R&D expenditures as a percent of total sales, 1992 data are preliminary

SOURCE: OTA based on data in U S Department of Commerce, Bureau of Economic Analysis, Survey of Current Business 73(7) 53-54 table 11 1

and 112 July 1993 (hereafter cited as BEA, SCB): BEA, USDIA, table Ill I 3 (1 989-1 992)

varies by country and by sector. The magnitude

and intensity of R&D activity is the highest between the United States and Germany and the

United Kingdom, in both directions; likewise, the

magnitude and intensity of R&D activity is the

lowest between the United States and France and

Japan, also in both directions.

Although these measures of R&D activity provide useful indicators of the magnitude of R&D

conducted by MNEs in host countries, they do not

provide sufficient information to judge whether

R&D has become significantly more decentralized during recent years. For instance, the rise in

R&D by affiliates may represent acquisitions of

foreign R&D facilities more than the transfer of

research from the home market to foreign sites. In

addition, R&D spending data do not distinguish

between types of technology and types of R&D,

which makes it difficult to assess the character and

import of R&D conducted in different locations.

In short, assessing the scope and impact of R&D

by MNEs requires a more detailed comparison of

the R&D conducted by affiliates with that conducted by their parent groups in their home markets.

1 R&D Within Multinational Networks

Although the volume of overseas R&D by affiliates has increased substantially, it is still a small

fraction of the total R&D conducted by MNEs.

The domestic and overseas R&D conducted by

U.S.-based MNEs since the early 1980s illustrates

both of these points (see figure 4-9). Between

1982 and 1991 manufacturing R&D expenditures

by U.S. MNE parents increased an average of 4.8

percent per year, from $36.5 billion to $50 billion.

During the same period manufacturing R&D

spending by affiliates of U.S. MNEs grew at a

faster rate of 12.1 percent per year, rising from

$3.5 billion to $7.2 billion.27 The faster rate of

growth of R&D by affiliates indicates that R&D

27 Adjusted tc~ conslant dollars from data prf)vided in U.S. Department of Commerce, BEA, Sur\’ey ojCurrenf Busine.$s, op. cit. fmnn(~tc 23.

See also figure 4-9.
86 I Multinationals and the U.S. Technology Base

—

1982

—

1989 1991

_ Manufacturing R&D by foreign affiliates of U.S. MNEs

D Manufacturing R&D by U.S. MNE parents

SOURCE: OTA, based on data in BEA, SCB 73(7): 44, table 5, July 1993

has become more international in scope. At the

same time, however, the proportion of total MNE

R&D conducted by affiliates remains small. In

1991, the R&D conducted by majority-owned affiliates comprised 12.7 percent of the total

manufacturing R&D expenditures of U.S. MNEs,

up from 8.7 percent in 1982.28 Although no comparable data exists for European and Japanese

MNEs, the available evidence suggests that they

conduct similar if not smaller percentages of their

R&D overseas than do U.S. firms.

Like the aggregate level of R&D spending, the

R&D intensity of foreign affiliates tends to be

substantially lower than that of parent groups. For

example, the R&D intensity of U.S. MNE parent

groups in 1991 was 2.1 percent, compared with

0.8 percent for their majority-owned foreign affiliates.29 In general, across the advanced industrial

states the R&D intensity of foreign affiliates tends

to be lower than or at best equivalent to the average for all manufacturing industries in the host

country. 30 However, as with the volume of R&D

spending, the R&D intensity of foreign affiliates

has been increasing at a faster rate than that of

MNE parent groups. For example, between 1982

and 1991 the annual growth rate in the R&D intensity of majority-owned foreign affiliates of U.S.

MNEs averaged 5 percent, compared with 3 per- 31 Again, though, cent for their parent groups.

much of the growth in the R&D intensity of both

foreign affiliates in the United States and U.S. affiliates abroad can be attributed to overseas acquisitions and/or joint ventures, and consequently

does not necessarily represent a transfer of R&D

operations from the home country to foreign markets. 32

Although relatively low, the rapid increase in

both the magnitude and intensity of overseas

R&D by foreign affiliates does represent a gradual

globalization of R&D. However, it is extremely

difficult to assess the significance of this trend due

to the lack of data regarding the technological and

strategic contribution of the R&D conducted by

‘g Ibid. The pr{yxmtion of R&D by majority-owned affiliates of U.S. MNEs varies somewhat by sector. In 1991 it was highest in food and

kindred products (18 percent), chemicals and allied products (15 percent), and transportation equipment (14 percent), and lowest in electric and

electronic equipment (8 percent) and primary and fabricated metals (5 percent).

29 U.S. Department of Commerce, BEA, Sur}ey of Current Business, op. cit., f(x~mote 23, table 5, p 44, table 7, p. 46.

30 OECD, op. Cit., f(x)tn(~te 4, p. 51. One of the few exceptions to this rule is the United States, where the average R&D intensity of foreign

affiliates is driven up by the particularly high R&D intensity of foreign affiliates in pharmaceuticals, chemicals, and mechanical engineering

(respectively two, three, and four times that of all manufacturing industry in the United States).

j I u s ~p~ment of commerce, BEA, Sur]’ey of Current Business, op. cit., footnote 23. p.~.

. .

32 For data and analysis of U s MNEs see U.S. ~p~ment ofcomn~erce, BEA, Surt’ey of Current Busines.s, op. cit., f(x~tnote 23i P. 46. For

. .

an analysis of foreign afiil iates in the United States, see U.S. Department of Commerce, BEA, Foreign Direct lnt’esonen~ in the United States:

An Updafe. op. cit., f(wtnore 10, p. 70.
foreign 

Chapter 4

affiliates to the global competitiveness of

MNEs.33 Indeed, the most challenging analytical

task is to determine whether the R&D conducted

by foreign affiliates contributes to the core technological activities of the parent firms, or whether it

contributes primarily to the product and process

technology utilized by overseas production facilities.

Most studies indicate that, over time and across

countries, the most significant reason for conducting R&D in foreign markets is to customize products to accommodate local market conditions.

34 It

typically takes quite long for firms to develop

complex overseas R&D operations that support

local production facilities. For example, Philips

Electronics N.V. has maintained a U.S. research

facility at Briarcliff Manor, NY, for over two decades. The facility now accounts for approximately 15 percent of all corporate research activity, and

is an integral part of Philips laboratory network

(the company maintains four laboratories in Europe—the central lab at corporate headquarters in

Eindhoven, The Netherlands, plus smaller facilities in France, Germany, and England). While

each of the foreign facilities has its own technological capabilities and its own mix of research

programs, most basic research is conducted in

Eindhoven. The U.S. facility focuses mostly on

supporting Philips’ substantial U.S. manufactur35 OTA interviews with a number of ing facilities.

MNEs in the electronics industry indicate that it

takes at least a decade to establish an overseas research facility that can closely support affiliate

manufacturing operations.

Multinationals and the Location of lnnovation I 87

Fully integrated affiliates that conduct independent product R&D are relatively rare. For

instance, Ford Motor Company, after many years

of foreign production in Europe and elsewhere,

has just begun to reorganize its operations and become a truly global MNE.36 The company is planning to create a single operating unit, Ford

Automotive Operations, that oversees five vehicle

program centers (VPCs), each with worldwide responsibilities for the development and production

of independent product lines.37

In sum, R&D moves overseas much more

slowly than production, sourcing, and other business activities. Production facilities often can be

established quickly and moved quickly, as market

conditions change. By comparison, R&D facilities take a long time to set up and, once established, are very difficult to move. Consequently,

most MNEs centralize basic research and product

development in the home market, while research

oriented toward customization and foreign production support is gradually conducted locally as

affiliates become more deeply integrated into local markets.

The tendency for R&D to move overseas slowly, in the wake of foreign direct investment and local production, suggests an R&D life cycle that

corresponds to the FDI life cycle discussed in

chapter 6. In the initial stages of overseas production, firms tend to use product and process

technology developed in the home market. As

overseas production units become more established, local R&D activities emerge to customize

33 OECD, op. cit., footnote” 4, pp. 49-50.

~~ For exanlple, see us ~.pa~nlen[ of Conlmerce, Technology Administration, Japan Technology Program, U..s. Research Facil[tic$ ~-f

Foreign Companws, prepared by D.H. Dalton and M.G. Serapiw NTIS Pub. No. 93-134328 (Washington, DC: Jan. 1993); U.S. Department of

Cmnrnerce, Technology Adminlstratl(m and The Japan-U.S. Friendship Commissi(m, Japan-U. S. Direct R&D /n\csfment.r in the E/ecn-onlc.~

/ndu.~rr~es, prepared by M.G Serapl(~, NTIS Pub. No. 94-127974 (Washington DC: 1994); OECD, op. cit., footno[e 4.

35 On Phl]lps’ R&D opratl(~ns, see Philips Electr(mics N. V., Annua/ Report 1993 (Eindhoven, The Netherlands, 1994); philips Electr(~nlcs

N. V,, “Electronics for People, C(wp)rate Brochure (Eindh(wen, The Netherlands, 1993), p. 13; Philips Research, “Philips Research A Gateway to the Future,” Corporate Brochure (Eindhoven, The Netherlands, 1993).

36 For distinctions ~>tween “global’” and other types of MNEs, see ~)x I - I in chapter 1.

37 Kevin D(me, ‘&Tom(mow,” the W(wld,” Financial fi”mes, Apr. 22, 1994, p. IS.
88 I Multinationals and the U.S. Technology Base

products in accordance with local market conditions and, eventually, to support affiliate production operations. In advanced stages, as affiliates

become deeply integrated into local economies,

they may undertake more substantial forms of

R&D to develop products exclusively for the local

market. Few firms reach this last stage.

If this R&D cycle is the rule rather than the exception, then one would expect overseas R&D to

be more pronounced for European affiliates in the

United States than for their Japanese counterparts,

and likewise more pronounced for U.S. affiliates

in Europe than for Japanese affiliates. To some extent the evidence is consistent with this expectation. Both the magnitude and intensity of R&D

conducted by European affiliates in the United

States is substantially higher than R&D by Japanese affiliates. Similarly, recent studies of Japanese investment in Europe indicate that Japanese

affiliates conduct substantially less R&D there

than do U.S. affiliates.38

This pattern, however, could be attributed to

one or more of several different factors. First, it

could represent a life-cycle effect, such that Japanese affiliates would eventually reach R&D levels

achieved by U.S. affiliates in Europe and European affiliates in the United States. Second, it

could reflect differences in the composition of

FDI. By this account, the difference in R&D intensities between European and Japanese affiliates in the United States is due to the

comparatively large percentage of European investment in manufacturing industries, which account for far more R&D per unit of sales than other

areas of FDI.39 And third, the pattern could be due

to different national propensities to conduct R&D

overseas, as opposed to other methods of acquiring technology in foreign markets.

Moreover, the degree to which R&D is centralized or decentralized often conforms to different

technological and sectoral characteristics. For

instance, one of the reasons pharmaceutical companies conduct R&D overseas is to accommodate

different national regulatory standards and prac-

(ices. w In the consumer electronics industry,

firms often conduct R&D abroad to keep in touch

with leading-edge technological developments as

well as to adapt technologies to local standards,

such as different voltages or broadcasting systems.41 In the automotive industry, the uniform

nature of core technologies tends to encourage

centralized R&D, even though production has become highly globalized.42 In the semiconductor

industry, the high R&D component of new product costs is pressuring firms from different countries to collaborate on next-generation product

development. 43

Nevertheless, even when R&D trends are observed on a sectoral basis, there are notable variations in the degree to which MNEs based in

different countries conduct R&D in foreign markets. For instance, in the pharmaceutical industry,

U.S. firms have set up more secondary R&D facilities than MNEs based elsewhere; European

pharmaceutical firms tend to locate their second38 M, Gitte]man and E. Graham, “The performance and Structure of Japanese Affiliates in the European Community” in M. Mason ad D.

Incarnation, Does Ownership Matter? Japanese Multinationals in Europe, (Oxford, UK: Clarendon Press, forthcoming 1994), pre-publication

copy pp. 154-55.

39 see Chaptem s and fJ for a description of differences in the composition of FD1 across the Triad.

@ OECD, “Globa]isation in tie Pharmaceutical Industry,” draft manuscript dated Mar. 10, 1 ~~. p. 9.

41 DE. Wesmey, .. Cr{)ss-pacific Internationalization Of ll&DbY US and Japanese Firms,” R&D A4anqemenr23(2): 171-181, 1993; OECD,

“Globalisation of Industrial Activities: SectorCase Study of Globalisation in the Consumer Electronics Sector,’ ’draft paper dated Nov. 9, 1993,

p. 17.

42 R. Mi]]er, “G]Obal R&D Networks md Large-scale lmovations: The Case of the Automobile Industry,” Research Policy *~(~) :27-46,

May 1993. See also Pavitt and Patel, op. cit., foomote 7. As noted above, though, Ford recently embarked on a strategy that involves decentralizing some of its product R&D.

43 The chip development alliance between IBM, Seimens, and Toshiba is frequently cited in this regtid.
Chapter 4 Multinationals and the Location of lnnovation I 89

ary R&D facilities in the United States, while Japanese pharmaceutical firms have very little

exposure in foreign markets.44 In the consumer

electronics industry, Japanese firms conduct the

bulk of their R&D at home, unlike European

firms. 45 And in the automotive industry, U.S.

firms have long had independent operations in Europe that conduct advanced R&D work. By contrast, Japanese auto producers have only recently

begun to establish local technological support operations for their foreign assembly operations.%

These sectoral variations are consistent with

aggregate national patterns. The U.S. firms conduct more R&D and have higher average R&D intensities overseas than either European or

Japanese firms. European businesses, particularly

those in Germany and the United Kingdom, conduct far more R&D abroad and have much higher

average R&D intensities than Japanese affiliates.

However, these tendencies coexist with national

differences in the sectoral distribution as well as

the timing of FDI. Consequently, it is difficult to

judge the relative influence of national origins,

sectoral characteristics, or vintage effects on the

propensity of firms to decentralize their R&D operations across national borders.

Moreover, even though more R&D is being

conducted across national borders, relative to production and sourcing R&D remains highly

centralized across the advanced industrial states.

For instance, the most R&D-intensive industries---electronics, computers, and pharmaceuticals47—are largely global in terms of production,

sourcing, and marketing. Nevertheless, R&D in

each sector remains relatively centralized. For

instance, pharmaceutical firms conduct very little

research and basic clinical evaluation outside of

the home country,

48 while R&D in the computer

industry is among the most highly centralized (a

fact some analysts ascribe to domestic support

programs that favor local firms).

49 The pattern is

much the same in less R&D-intensive industries,

especially those where core product technology varies little across national markets. For example,

R&D in the auto industry remains

centralized, although design custom

often conducted locally.50

In sum, the evidence regarding the

relatively

ization is

location of

R&D leads to two principal conclusions:

1. MNEs are conducting increasing levels of

R&D in foreign markets, thereby contributing

u (lECD ~)p ~lt,, footnote 40, pp. 9, _M. In 1989, Japanese pharmaceutical firms commanded only 1.1 YC of the US nlarket, while EUrOPCan

,.

firms c(mmmded 26.7 percent of US market share. The pattern in Europe is similar: Japanese firms have a very low market presence, while US

phamlaceutical fim~s command from 18 percent (in Gemmny) to 33 percent (in the United Kingdom).

45 OECD< “G]oba]lsatl{)n of lndus[ria] Activities: !jector Case Study of Global isati(m in the Consumer Electronics Sector, ” draft paper dated

Nov. 9, ]~~, p. 17.

M “Much of their activity is in component testing, procurement and process development, but more substantial product development is

sh~w]y gathering pace—the H(mda Accord in the United States and the Nissan Primera in the United Kingdom had substantial local design

Inputs.” OECD, ‘“Gl(~balisati(m of Industrial Activities: Sector Case Study of Globalisation in the Automobile Industry,” draft paper dated June

16, 1993, p. 27.

47 Aerospace is also Consis[ent]y anlong the top four R& D.intensive sectors. It is not widely anal yzed in this report due to its unique relationship to the defense industry as well as its unusually high degree of government regulation.

~ OECD, op. cit., f(xmrote 40, p.9, table 4 p. 42.

w ~)EcD .. Globa]lza[lOn” of ]ndustrla] Activities: s~tor Case Study of Globalisation in the computer lndustyt” daft Paper ‘ated SeP. 27’

I 993, p. I I .

w pate] and Pavlt ~)p, Clt,, footnote T; Ml]ler, op. cit., f(x~tnote 42. Although the R&D intensity of the automotive” indust~ is low ‘e]ative ‘()

electr(mics, c(mlputers, and pharmaceuticals, it has been increasing over time and is well above the national average for manufacturing industnes, OECD, op. cit., fot)tm~te 46, p. 10.
90 I Multinationals and the U.S. Technology Base

to the international expansion of technology.

However, R&D across the advanced industrial

states remains fairly centralized relative to production and sourcing activities, even in global

industries.

2. Overseas R&D conducted by MNE affiliates

varies by national origin, by sector, and over

time, such that it is difficult to separate these influences analytically. On the whole, European

affiliates conduct far more R&D in the United

States than do Japanese affiliates. This variance

may reflect different national propensities to

conduct R&D overseas, although the relationship could also be explained by the distribution

and relative age of FDI.

These conclusions can be taken further by analyzing cross-national variations in other technologically significant transactions. Apart from

carrying out R&D overseas, MNEs can also extend technology across borders through direct

trade.

TECHNOLOGY TRADE

Technology can be transferred in different forms

and through various mechanisms, many of which

are very difficult to measure. The best available

quantitative measure of technology flows is the

number of royalty and license fee transactions,

representing cross-border sales and purchases of

51 Net sales over purchase s

intellectual property.

constitutes the technology trade balance, which

represents both the financial significance of

technology transactions and the volume and direction of technology flows.

Until the mid-1980s, many U.S. corporations

did not treat their intellectual property as a productive asset—in fact, few corporations even included it on their balance sheets. Throughout the

1980s, however, these companies gradually recognized and harnessed the financial power of their

intellectual property. Figure 4-10 shows that sales

of U.S. intellectual property, adjusted for inflation, have increased steadily from $8.2 billion in

1986 to $16.7 billion by 1992. Moreover,

throughout this period the technology trade balance has remained decidedly positive, rising from

a surplus of $6.7 billion in 1986 to $12,6 billion in

1992.52

Outside of the United States, few countries

have had a positive technology trade balance. In

fact, with the exception of the United Kingdom

until 1986, no other large OECD country has had a

53 Figure 4-11 shows the ratio of positive balance.

sales to purchases for the United States, Japan,

France, Germany, and the United Kingdom.

Throughout the 1980s and early 1990s the ratio

for most countries remained just under one, with

the exception of the United Kingdom during the

early 1980s. In other words, except for the United

States, the major OECD countries export roughly

s i This indicator ~)n]y approximates technology” tr~sfer per se, due to three limitations. First, the available U.S. data for royalties and license

fees includes transactions of all forms of intellectual property-+.g. it combines industrial process technology along with other forms intellectual property such as copyrights, trademarks, franchises, and rights to broadcast live events. (BEA provides data on industrial process technology

only for unaffiliated oramls-length transactions; for a discussion of these transactions see the following pages. ) Second, it is difficult to measure

intellectual property traded between affiliated fim~s, since the value of affiliated transactions is not always determined on the open market.

Although MNEs dispute the contention, many observers believe that both U.S. and foreign MNEs adjust intellectual property fees to shift costs

from their firms in low-tax regions to those in high-tax regions, thereby lowering their net tax obligations. Third, technology also can be transferred through a variety of channels that are not captured by this or any other reliable measure—for instance, technology can be transferred

through the exchange of technologically intensive goods, depending on how the purchaser utilizes those goods. Despite these limitations, analysts frequently rely on intellectual property transactions to gauge technology transfer by MNEs.

52 Since intellectual Prowny is ~intangible g(Md, the U.S. records sales and purchases of intellectual propew on the se~lces account! ‘()[

the merchandise trade account, Sales of intellectual property represent exports, while purchases of intellectual property represent imports. To

the extent that intellectual property transactions represent technology exchange, intellectual property sales are equivalent to technology exports, while intellectual property purchases are equivalent to technology imports. (See footm)te 51 regarding the accuracy of this measure. )

53 ~gmlsation for Economic” C()-()Prati()n and Development, Economics Analysis and Statistics Division Database, Main S(’ient’e and

Technology /ndicators, (1), table 82, May 1994.
Chapter 4 Multinationals and the Location of Innovation I 91

16-

14-

12-

%

~ lo75

~ 8-

.—0

L%

6-

4 -

2 ’

0

1986 1987 1988 1989 1990

L

--- 1

----i k----

1991

1

1992

n Total sales (exports)

_ Total purchases (Imports)

+ Technology trade balance

SOURCE OTA, based on data n BEA, SCEI 73(9) 122, table 2, September 1993

81

or I I I 1 1 1 1 I I

+ Us.

-4- Japan

~ France

+ Germany

+ U.K.

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

SOURCE OTA based on data m Organlsatlon for Economic Co-operahon and Development Economics Analysm and Stattstlcs Dlvlslon Database

Mam Science and Technology Indicators, table 82, May 1994
92 I Multinationals and the U.S. Technology Base

/

1986 1987 1988 1989 1990 1991 1992

_ All MNE technology exports

D Exports from U.S. MNEs

to their foreign affiliates

+ Total technology exports

SOURCE: OTA, based on data in BEA, SCB 73(9) 122, table 2, September 1993

the same amount of technology that they import.

By contrast, U.S. technology exports have consistently outweighed imports by a substantial margin. 54

The unusually high U.S. ratio of exports to imports could be interpreted in contradictory ways.

On the one hand, it indicates that the U.S. technology base is very robust, producing valuable and

highly marketable knowledge that contributes

positively to the U.S. trade balance. In this respect, the comparatively high level of technology

exports indicates a healthy and vibrant technology

base. On the other hand, it could indicate a relatively low willingness or ability of U.S. firms to

import foreign technology, which could limit the

growth of the U.S. technology base.55 Moreover,

the large surplus of technology exports over imports points to a massive flow of technology out of

the country, which also may not bode well for the

health of the technology base. Sorting out these

conflicting interpretations requires further analysis of the direction and composition of technology

trade.

As figures 4-12 and 4-13 indicate, a large percentage of U.S. technology trade is associated

with MNEs. Between 1986 and 1992, U.S. MNEs

and U.S. affiliates of foreign MNEs together sold

54 ~ls ~)bsewatlon holds Ins{)fw as intellectual pro~tiy transactions represent technology exchange per se. The val idity Of this indicator is

somewhat stronger for OECD data on technology trade than for BEA data on intellectual property transactions, due to slight measurement differences. The available BEA measure covers all intellectual property transactions, which includes patents for industrial process technology

along with copyrights, trademarks, franchises, rights to broadcast live events, and other intangible propelly rights. The OECD measure is more

tightly focused on technology trade per se, covering patents, licenses, trademarks, designs, know-how, and closely related technical services for

industrial R&D. For the purposes of this analysis, the difference in the two measurements is not significant. This chapter uses OECD data for

international comparisons of technology trade, and national data sources such as the BEA for more detailed, country-level analysis of technology trade patterns.

55 see ME Mogee, “Inward Intemati(~na] Licensing by U.S.-Based Firms: Trends and ln~plications,”” 7’he Journal oj’Techno/ogy 7kansjkr

16(2): 14-19, Spring 1991.
Chapter 4 Multinationals and the Location of Innovation I 93

20

18

16

14

(/)

g 12

u

: 10

:8

=

6

4

2

1986 1987 1988 1989 1990 1991 1992

_ All MNE technology imports

D Imports by affiliates in the U.S.

from their foreign parents

+ Total technology Imports

SOURCE: OTA, based on data in BEA, SCB 73(9) 122 table 2, September 1993

79 percent of all technology exports and bought

67 percent of all technology imports. However,

the figures also show that U.S. MNEs sell virtually all of the MNE technology exports (see figure

4-12), while U.S. affiliates of foreign MNEs purchase most of the MNE technology imports (figure 4-13). Between 1986 and 1992, 97 percent of

all MNE technology exports was sold by U.S.

MNEs to their foreign affiliates, while 3 percent

was sold by affiliates in the United States to their

foreign parents. The obverse pattern holds for imports: 9 percent of all MNE technology imports

was purchased by U.S. MNEs from their foreign

affiliates, while U.S. affiliates purchased 91 percent of all technology imports from their foreign

parents. 56 In short, technology trade not only is

dominated by MNEs, but also flows from parent

firms to their foreign affiliates.57

The rapid increase in both technology exports

and imports can be linked to FDI trends during the

same period. Between 1986 and 1992, technology

exports from U.S. MNEs to their foreign affiliates

increased at an average annual rate of 27 percent,

which corresponds to the growth in U.S. direct investment abroad during this period. Similarly,

during the same period imports by U.S. affiliates

from their foreign parents increased at an annual

rate of 45 percent, corresponding to the rapid increase in FDI in the United States during the late

1980s.58

S6 u s ~pannlent ~)fconlmerce, BEA, Surk,e}, ~fcurrcnf Business (Washington, DC: September 1993), tabie 2 P. 122; see also tables 4.1-

. .

4.4, pp. i 29-132.

57 Again, ~15 ~onclu510n” ho]& only K) the ex(en[ that intellectual prOpeI_ty transactions represent techn~)bv ‘rod e .

$8 For tren& in FDI in the U.S. see chap(ers 5 and 6. For data and supporting analysis of the relationship between ml and technology” tmde

flows, See U.S. Department of Commerce, Suney oj’Currenf Business, op. cit. footnote 56, table 4.4 p. 132; and U.S. Department of Commerce,

BEA, “U.S. Intemati(mal Sales and Purchases of Private Services,” Sur}’ey oj’Currem Business (Washingttm, DC: 1992); p.85.
94 I Multinationals and the U.S. Technology Base

Altogether, the aggregate technology trade data

from the mid-1980s to the early 1990s indicate

that technology increasingly flows across national

borders, but tends to stay within MNE networks.59 Moreover, the data imply that technology typically is developed in the home market

operations of MNEs and gradually extends abroad

in the wake of foreign direct investment.60 From

this perspective, one could conclude that technology development remains relatively centralized in

the home market operations of MNEs.

However, there are noticeable differences in the

propensity of firms based in different nations to

trade technology within or outside of MNE networks. Unaffiliated or arms-length technology

trade takes place among firms that have no economic relationship other than through the market.

Since unaffiliated technology transactions take

place through market-based bargaining, they reflect the market value of technology more accurately than trade among firms within MNE

networks. Moreover, unaffiliated transactions imply less control by the originator and more control

by the purchaser. Consequently, cross-national

differences in technology acquisition strategies

should be reflected in the propensity of firms

based in different countries to purchase technology from unaffiliated sources.

The data on unaffiliated technology trade show

that Japanese firms buy an unusually large percentage of U.S. technology through arms-length

transactions. In 1992, 43 percent of all U.S.

technology sales to Japan were purchased through

arms-length transactions. By contrast, 11 percent

of all U.S. technology sales to Europe were purchased through arms-length channels, while the

percentages of arms-length purchases by firms in

the larger European countries were lower than the

European average—10 percent for the United

Kingdom, 8 percent for France, and 9 percent for

Germany. 61 Consequently since unaffiliated

transactions impart a higher degree of control to

the purchaser, Japanese firms retain greater control over the technology they purchase from the

United States than do European firms.

Most of the unaffiliated U.S. technology exports are of industrial process technology. Between 1987 and 1992, industrial process

technology accounted for 62 percent of unaffiliated U.S. technology exports. This subset of

technology trade is particularly critical to commercial competitiveness, given the direct impact

of industrial process technology on productivity

and production costs. Consequently, trends in the

unaffiliated sale of industrial process technology

provide an important indicator of the near-term

competitive strategies of MNEs across the advanced industrial states.

As with total technology trade, unaffiliated

U.S. exports of industrial process technology

have consistently outweighed U.S. imports, resulting in an average annual surplus of $2.0 billion

between 1987 and 1992. Japan is the largest consumer of unaffiliated U.S. industrial process

technology—in 1992, U.S. exports to Japan accounted for 50 percent ($1.1 billion in real terms)

of all industrial process technology exports,

compared with 5 percent for Germany, 4 percent

for the United Kingdom, and 23 percent for Europe as a whole (see figure 4-14). This pattern has

been consistent; since 1987, Japan has accounted

59 1n 1992,42.5 ~rcent of all U.S. technology” imports were by U.S. aftlliates of European firms, while 12 percent were by U.S. affiliates of

Japanese fimls. Likewise, 49 percent of all U.S. technology exports were received by U.S. affiliates in Europe, while 9.4 percent were received

by U.S. affiliates in Japan. U.S. Department of Commerce, BEA, Sur\>ey oj’Curren/ Business, op cit. footrmte 56, p. 121, and table 4.4 p. 132.

a Data on technology” trade between Japan and Euro~ c(mld provide confirming evidence of this observation. unfortunately this data is

not readily available.

61 ]nlP)filng ~a[(ems by us. affiliates of foreign firms are more mixed. In 1992, 64 percent of total ~J.s. technology” lrn~)fls from EuK)pe

were from European MNEsto their U.S. affiliates, although there were large variations among the large European countries—80 percent from

the United Kingd(ml, 63 percent from Germany, and just 38 percent from France. Of all 1992 U.S. technology imports from Japan, 79 percent

were purchased by the U.S. affil iatcs of Japanese MNEs. U.S. Department t)f C{~mmerce, BEA, op. cit., f(mrme 56.
Chapter 4 Multinationals and the Location of Innovation I 95

2.5

0.54

o—

~ Japan

~ U.K.

~ France

_ Germany

+ Total for all countries

+ Total for all Europe

1987 1988 1989 1990 1991 1992

SOURCE: OTA based on data in BEA, SCB 72(9) 95-99, September 1992, and 73(9) 129-132, September 1993

for an average of 46 percent of all unaffiliated exports of industrial process technology, compared

with 4 percent for Germany, 4 percent for the

United Kingdom, and 26 percent for all of Europe.

The large percentage of unaffiliated industrial

process technology purchased by Japanese firms

is further reflected in the regional distribution of

the U.S. balance in unaffiliated industrial process

technology trade. As shown in figure 4-15, the

consistent U.S. surplus in unaffiliated industrial

process technology exchange is driven largely by

trade with Japan. Between 1987 and 1992, the average annual surplus with Japan accounted for 57

percent of the total U.S. surplus in arms-length

trading of industrial process technology. During

this period Japan ran average annual deficits with

the United States of $789 million, compared with

$71 million for all of Europe combined. The only

countries with which the United States has had a

trade deficit in unaffiliated industrial process

knowledge have been the United Kingdom and

Germany, averaging $-15 million and $-40 million per year respectively between 1987 and 1992.

In sum, U.S. royalties and 1icense fee data illustrate two important patterns in the international

exchange of technology. First, most of the crossborder exchange of technology takes place within

MNE networks—in particular, most of the

technology flows from parents to their affiliates.62

This pattern implies that, although technology

m may follow production overseas, the development

of new technology remains centralized in the

home market operations of MNEs. Second, there

are notable differences in the propensity of firms

based in different nations to acquire technology

through unaffiliated channels. In particular, Japanese firms purchase far more U.S. technology

through arms-length transactions than do European firms-in fact, the total U.S. surplus in the

unaffiliated trade of industrial process knowledge

is due largely to surpluses with Japan, while the

‘z Again, this c{mclusitm is based (m the US technology” balance of payments data, which is the (rely available data of this type
96 I Multinationals and the U.S. Technology Base

1.6

1.4

1.2

g

1

(u=

~ 0.8

z

UI

~ 0.6

.—

:

0.4

0.2

0

-0.2

—

1 1

1987 1988

/ .!3 I

~ Japan A

- U.K.

——

1 1 I 1

1989 1990 1991 1992

D France

D Germany

--A--- Total for all countries

+ Total for all Europe

SOURCE: OTA, based on data in BEA, SCB 72(9) 95-99, September 1992, and 73(9) 129-132, September 1993

United States has been a net importer of U.K. and

German industrial process knowledge. This finding suggests that MNEs based in Japan have very

different technology acquisition strategies than

their European and U.S. counterparts.63

Although both the R&D and technology trade

data indicate that technology development remains relatively centralized, technology can be

globalized through other mechanisms such as international strategic alliances and related forms of

intercorporite cooperation designed to spread investments costs and gain access to a wider range

of technologies. The abundance of interfirm alliances and joint ventures in R&D and product development, along with the growing density of

translational networks linking firms with each

other as well as with public and private-sector research institutes, significantly complicates any

assessment of how MNEs do and do not contribute to technology development in host countries.

INTERNATIONAL TECHNICAL ALLIANCES64

MNEs and

technology

domestic firms can cooperate on

development through a variety of

63 Hl~[{)rlca]]y, Japan has acquired foreign [echnology” more through direct purchases than has been the case for either the United States or

Europe; see OECD, op. cit., footnote 4. The relatively high percentage-of arms-length technology purchases by Japanese firms from U.S. intellectual property t~wners is c(msistent with Richard Samuels characterization of the technology acquisition strategies of Japanese firms. See R.J.

Samucls, “Rich Na!ion. Sfron~ Army”: Na[iona/ Security and Ihe Techno/ogica/ Transjtirmafion ofjapan (Ithaca, NY: Cornell University

Press, I 994).

64 Lltt]e enough is known a~)ut international techno]ogica]” collaboration among firms that ana]ysts frequently use different terms to describe the phemmwmm. There are important distinctions in the I iterature between short-term tactical alliances and relatively longer term strategic alliances, There are also important distinctions bet ween alliances used to develop and/or diffuse technology and those used to gain market

access and pursue other non-technological goals. For simplicity, this chapter uses a single term-international technical alliances-to describe

any interfiml collaboration (equity or non equity) that includes arrangements for joint research and/or technology transfer. For a more general

dlscussi(m of international strategic alliances, see OTA, Mu//inalionu/s and the Nationu/ Interest: P/aying by Diflerenr Ru/es, OTA-lTE-569

(Washingt(m, DC’: U.S. G(wemment Printing Office, September 1993), ch. 5. See also box 8-1 in chapter 8 t)f this report.
Chapter 4

mechanisms. In the 1970s, the most common

form of international technology collaboration

was through joint ventures and research corporations, where firms share equity ownership (and

corresponding profits and losses) in a separate and

distinct corporate entity. By the late 1980s, joint

equity col1aboration was eclipsed by nonequity alliances, in which firms forego formal equity linkages and directly organize joint R&D activities to

reduce the cost and risk of pursuing related innovations. 65 Through these mechanisms, international technical alliances have grown from just 86

during 1973-76 to 988 during 1985-88.66

The most recent data indicate that international

technical alliances are most common in hightechnology industries, and are more extensive in

some sectors than others (figure 4-16). Technical

alliances are particularly prevalent in information

technologies, where technology changes rapidly

and firms must maintain knowledge of and access

to numerous complex technologies simultaneously (as in multimedia, for example). Alliances are

also quite common in biotechnology, where research is often conducted in the context of collaborative agreements between U.S. dedicated

biotechnology companies and large pharmaceutical MNEs.67 Figure 4-15 also indicates that alliance activity across sectors is most common

between U.S. and European firms, although there

have been a relatively large number of alliances

between U.S. and Japanese firms in the automotive sector.

Multinationals and the Location of Innovation I 97

Contemporary economic and technological

conditions provide a variety of incentives for

firms to engage in international technical alliances. Firms pursue technical alliances for three

primary reasons:

To improve their ability to conduct research,

given the complexity and interdisciplinary

character of new technologies, the difficulty of

monitoring evolving scientific disciplines and

new technologies, the need to retain access to

scientific and technological knowledge, and

the need to reduce the costs and risks of pursuing R&D.

To expand their ability to produce new technologies, given shorter innovation to commercialization periods, more rapid product life cycles,

and the frequent need to capture competitors’

tacit knowledge in order to equilibrate production costs and prevent technological leapfrogging.

To pursue market access and search for new

business opportunities, given the increasing

importance of foreign markets to competitiveness, as well as the need to maintain smooth

and broadly dispersed pipelines from innovation to market.68

It appears that cooperative research does not

substitute for but rather complements firms’ internal research activities. 69 Some studies tentatively

~~ in ~crj ~crlcrdl IcnI)s, ,olnt ~entures are ~lore Conlnl(m am(mg firms seeking to imprwe their Img-tcrnl market ~)sl[lw while techlcal

all lances arc rmwe c(mml{m when fimls arc pursuing more immediate technological achievements. See J. Hagedoom, “Understanding the Rationale of Strategic Technology” Pwtncrmg Intertwganizati( mal Modes of Cooperation and Sectoral Differences,” Srra/egic Manqemenr Journa/ I 4 ( I 993) 37 I.

66 National Science B(}ard, op. ~lt,, f(M)[note 10, p. 123. The data cited in this source is drawn from the Maastricht Economic” R=arCh lnS(itutes’ MERIT CAT] dalahasc The CATI database c(wcrs (rely intertiml agreements that involve technology transferor joint research, and is

used (() dcvch~p the numbers cltcd ahlvc and in ligure 4-16. Although this is the best and most up-to-date aggregate database im international

twhnlca] allianws, It is IImited due to intrinsic difficulties in gathering complete and reliable data in this area. T’he data, therefore, should be

~ Imvcd as a useful but lnctm~pletc indicator.

67 M1~E~ arc ~[[ractc~ 10 [he ~cs~~~~h ~apabl]l[lcs of U,S. d~~icafed biotechnology companies, which me in ~rn attracted to the financial

capabilities of pham~accu(ical MNEs.

~~ Scc Hag~&)orn, op. CII.. f(Hm)tc 65, p. 371.

w ~atlonal ~clcnce Board, op. ~it., footnote 10, P. 122.
98 I Multinationals and the U.S. Technology Base

Automotive

Chemicals

New materials

Biotechnology

Information

Total

v

i

o 100 200 300 400 500 600

Number of alliances

D U.S.-Europe

~ U.S.-Japan

_ Europe-Japan

SOURCE: Adapted from National Science Board, Science and Engineering /nd/caters—1993 (Washington, DC U S Government Printing Office,

1993), p 123, p 383, table 4-42

conclude that technology transfer invariably accompanies interfirm alliances, and that close management of diffusion is critical to the success of

the alliance for each partner.70 Other studies have

concluded that technical alliances tend to be limited and are frequently unsuccessful .71

However, systematic and reliable information

on international technical alliances is sparse. OTA

interviews and other anecdotal information sug -

gest that technical alliance activity has grown significantly in recent years, but the impact of the

trend is difficult to assess. Given the increasing

R&D content of new products and the escalating

cost of developing new products, many high-tech

firms are likely to focus their R&D efforts and

technology strategy on core competencies, relying on networks of alliances to learn about and

adapt to new technologies in related areas. A number of firms interviewed by OTA indicated that

they needed to keep abreast of technological developments globally, given the broad dispersion

of leading-edge technological capabilities in their

industries. An executive at one prominent MNE in

the electronics industry told OTA that, although

the company has resisted alliance activity to date,

it is bound to pursue future alliances due to the increasing complexity and costs associated with

R&D in that industry.

Pending further data and analysis of this relatively new phenomena, OTA can only conclude

70 see D c Mowew, *. Intemationa] co]]a~)ratlve Venmres and U.S. Firms’ Technology Strategies,” in Granstrand, H&anson, and Sj~}l~d-

. .

er, Technology Management and International Business (New York: John Wiley, 1992): 224-229.

7 I The literature is rife with debates over the determinants of success in international a]]lances. !?Wme malntaln thal SUCCeSS 1S more Common”

in alliances that involve technologically comparable firms; for example, see M.E. Poner and M.B. Fuller, “Coalitions and Global Strategy,” in

M.E. Porter (cd.), Competition in G/obu//ndusrries (Boston, MA: Harvard Business Sch(x)l Press, 1986). Others argue that successful alliances

are more likely between firms that have different, complementary technological assets; for example, see Mowery, op. cit., footnote 70. The

literature generally does agree that there is insufficient data on international technical alliances to develop reliable interpretati(ms.
Chapter 4 Multinationals and the Location of lnnovation I 99

tentatively that international technical alliances

are indeed more common and more strategically

significant for an important array of high-technology firms. Yet their net effect on national technology development and international technology

diffusion is unclear and difficult to measure.

CONCLUSIONS

Taken together, the evidence linking MNEs and

the globalization of technology remains somewhat mixed. On the one hand, some data point to

the increased globalization of technology via the

business activities of MNEs. Higher rates of external patenting, more rapid diffusion of technology

across borders, increasing rates of overseas R&D

activity, and in some respects the increasing prevalence and greater strategic significance of international technical alliances all point in this

direction, with MNEs at the heart of the process.

However, closer inspection of these trends indicates that the degree of globalization is limited,

and the propensity of MNEs to extend core technological functions across borders varies across

the advanced industrial states.

First, overseas R&D by affiliates remains quite

limited when compared to both the R&D activities of the parent group and the more extensive

globalization of production and sourcing. The

R&D that does move overseas tends to be

associated with product customization and local

production processes. Only rarely do companies

transfer basic research functions to foreign markets.72 In short, inside the corporation-where the

bulk of commercially significant innovation takes

place—R&D appears to remain relatively centralized. This finding is reinforced by the data on

technology trade, which show that most intellectual property flows from parent firms to their

foreign affiliates.

Second, data on exports and imports of intellectual property indicate that most of the international flows of technology occur within MNE

networks. This tendency does vary by national

origin. Japanese firms have a much stronger propensity toward arms-length technology trade,

which is consistent with the oft-noted historical

tendency for Japanese firms to acquire overseas

technology by buying it directly rather than by initiating R&D activities in foreign markets.

Third, the role of international technical alliances appears to be somewhat limited, although

the data are insufficient to draw any solid conclusions in this area.

These conclusions should be qualified in light

of the difficulties of measuring technological innovation and diffusion. The available measures of

R&D are biased toward the research side of the innovation equation, and may miss commercially

significant forms of technology development and

diffusion. Some analysts have argued that important elements of national technological capabilities lie in tacit forms of knowledge—that is, forms

of technical knowledge that can be extremely important to successful commercialization and production but that are embodied in both people and

organizations in ways that are difficult to measure

and evaluate.73 In addition, new technology can

be transferred across borders in the form of goods

themselves, which can be reverse engineered to

reveal (and perhaps reconstruct) particular technological innovations. Therefore, it is possible

that MNEs, with their ability to transfer people,

organizational assets, and goods across borders, in

effect may diffuse technology far more extensively through their overseas production facilities than

can be captured by the measures used in this

chapter.

Nevertheless, the measures reviewed here are

sufficient to conclude that the core research and

development activities of MNEs remain relatively

centralized in the home market. If MNEs were extensively and systematically developing and dif-

‘

~ (he exceptitm to this tendency is biotechnology, where a number of European and Japanese MNEs have close basic research c{mlacts and

arrangements with small U.S. biotechnology” fim~s.

73 A]ic, op cit. footnt~te” 2-
100 I Multinationals and the U.S. Technology Base

fusing technology abroad, it would register in the implies that the globalization of technology is less

overseas R&D data as well as the technology trade an autonomous force that is shaping and integratdata. To date, the evidence reveals that MNEs are ing national economies and more a multifaceted

indeed moving more technology across national process that centers on networks of firms with

borders, but that the extent of this process is quite strong roots in distinct national innovation

limited in comparison to the global production systems.

and sourcing activities of MNEs. This conclusion
Part III: Trade

and Investment

in the Triad

c

hapters 5 and 6 analyze the changing nature of global trade

and investment, focusing not only on international trends

but also on national variations in the behavior of MNEs.

These chapters seek to describe the dynamics of trade and

investment, unravel the relationship between the two, and assess

the implications of contemporary patterns for the U.S. trade balance and—more importantly-the health and relative position of

the U.S. technology base.

Since the mid 1980s, the volume, direction, and character of

trade and investment across the advanced industrial states has

changed substantially. The privatization of assets and the liberalization of investment barriers have stimulated foreign direct investment (FDI), which grew dramatically over the past decade.

By 1992, the global stock of FDI reached approximately $2.0 trillion (in nominal terms). This surge of investment transformed the

world economy. Rather than substituting locally produced goods

and services for imports, investment also augmented and created

trade, often through international trade among foreign affiliates

and their parent groups—i.e., intrafirm trade.

Not only has FDI among the advanced industrial states increased substantially, but also a growing portion of global trade

and investment now extends beyond the confines of the OECD

nations. The world’s largest MNEs increasingly trade with and invest in emerging markets, especially those in East Asia and China. Investment in Latin America runs a distant second, while

investment in Eastern Europe remains relatively small.

At the same time, the traditional focus of FDI on integrated

manufacturing facilities has been augmented by forms of direct

investment that promote intrafirm trade. As a result, FDI and

trade have become less antithetical and more complementary. I 101
102 I Multinationals and the U.S. Technology Base

This change, along with changes in the size,

source, and composition of FDI across the developed world, has had a major impact on the global

diffusion of production processes, the sourcing of

high value-added manufacturing parts and components, and on international trade. ]

Together, chapters 5 and 6 generate a series of

findings which suggest that there is little convergence in the behavior of MNEs based in different

regions.

FINDINGS

1. The nature of foreign direct investment has

changed fundamentally. Historically, many

MNEs used FDI to shift manufacturing facilities abroad, reducing the export of products accordingly. In the 1990s, MNEs are likely to

invest in manufacturing, wholesale trade, and

service facilities in order to export domestic

products for foreign assembly and retail sales

through the mechanism of intrafirm trade

(IFT). Macro-economic and firm-level data

suggest that IFT is particularly prominent within Japanese MNEs and, to a lesser extent, German MNEs (see figures 6-11 and 6-12 in

chapter 6).

2. The United States remains an attractive location for foreign direct investment, although the

flow of FDI fell from a record high of $69 billion in 1989 to $3.4 billion in 1992. In OTA interviews, some foreign investors complained

of weak profits in the United States, which they

characterized as a mature market (see figure 5-7

in chapter 5). At the same time, they recognize

the need to sustain a local presence in the U.S.

market because of its size, the access to

technology that it provides, and the need to be

near major customers.

3. In the last decade, the flow of FDI has increased

substantially to non-OECD regions, particularly East Asia and, to a lesser degree, Latin

America and Eastern Europe. East Asia, for example, more than doubled its share of global investment stock from 6.2 to 13.6 percent during

the 1980s, a period when global investment

stock grew dramatically. Labor costs, currency

fluctuations, pressures for customization, regional trade agreements, and market access

considerations are factors often cited in explaining the spread of FDI.

4. Although the NAFTA and GATT were successfully concluded in 1993, and are likely to assist

MNEs in increasing market access and efficiency, no comparable mechanisms are in place to

govern international direct investment.2 The

lack of enforceable multilateral investment

agreements continues to limit the ability of

U.S.-based MNEs to make profitable investments abroad and to obtain foreign technology

that would enrich the U.S. technology base.

This problem is most pronounced in the U.S.

investment relationship with Japan.

5. Access to investment opportunities remains a

significant problem for many European and

U.S. firms seeking to do business in Japan, despite recent efforts to increase inward direct investment by the Japanese government and

some elements of Japanese business. Because

they believe that unilateral efforts to invest in

Japan are likely to fail, many foreign firms enter into joint venture agreements with Japanese

partners. This strategy often results in a minority investment position that limits the ability of

the U.S. firm to grow or to use the joint venture

as a conduit for trade. The inability of most foreign firms to compete in the Japanese market as

independent entities provides Japanese firms

with a significant advantage in Japan.

6. Over the past decade, the U.S.-European investment relationship has been reasonably well

balanced in scale and composition, and in recent years has stabilized at nearly equal levels

‘ See OECD, Directorate for Science, Technology and Industry, G/oba/isurion oj”ltius/rial Ac.fit~iries: Background Synthesis Report (Paris,

France: OECD, Nov. 26, 1993), p.10.

2 The TRIMs agreement under GATT is only embryonic for this purpose.
(see figures 5-10 and 5-11 in chapter 5). With

respect to the U.S.-Japan relationship, however, broad differences persist in the scale and

composition of U.S. direct investment in Japan

as compared to Japanese investment in the

United States, Japanese direct investment in

the United States exceeds U.S. investment in

Japan by a factor of 3.1:1. In addition, it is far

more concentrated in wholesale operations

(and less concentrated in manufacturing) than

is European or U.S. direct investment (see figures 5-14 and 5-15). As the stock of U.S. inward and outward direct investment expanded

in the 1980s, U.S. investment in Japan failed to

keep pace with the overall trend (figure 5-9).

7. As a result of the increase in FDI and the prominence of intrafirm trade, investment is increasingly associated with trade in the 1990s. A

comparison of the merchandise, affiliate, and

IFT trade balances between the United States

and Europe on one hand, and the United States

and Japan on the other, yields very different results. The relative convergence of these three

measures in the Japanese case (figure 6-4) and

their divergence in the European case (figure

6-3) are closely associated with the bilateral

balance of foreign direct investment in both

cases.

8. Affiliates of foreign-based MNEs account for a

substantial portion of the U.S. merchandise

Part Ill Trade and Investment in the Triad I 103

trade deficit (see figure 6-1 ). Intrafirm trade is a

major factor. In 1980, foreign affiliates in the

United States imported $36 billion more from

their parents than they exported to them. By

1990, the IFT trade deficit had more than

doubled to reach $88 billion dollars. In 1992,

IFT totaled $331 billion or about 38 percent of

all U.S. merchandise trade.

9. The character of U.S. intrafirm trade with Europe differs markedly with the character of U.S.

IFT with Japan. Over the past decade, IFT has

accounted for 71 percent of all merchandise

trade between the United States and Japan as

opposed to only 43 percent of all U.S.-European trade (see figures 6-5 and 6-6). Over the

same period, Japanese MNEs have dominated

intrafirm trade with the United States, accounting for 92 percent of bilateral IFT while European MNEs account for 57 percent of

U.S.-European IFT (see figures 6-9 and 6-1 O).

These figures indicate that the U.S.-Japanese

trading relationship is heavily weighted toward

Japanese MNEs, and that the U.S. relationship

with Europe is more evenly diversified across

corporate structures and national ownership.

The U.S. and European economies are, accordingly, far more integrated than are the U.S. and

Japanese economies.
Trends in

Foreign

Direct

Investment 5

T

hrough foreign direct investment (FDI), individuals or

corporations obtain partial or total ownership of firms located in another country. 1 FDI can take many forms and

can be directed at diverse sectors of the economy. At the

level of the firm, it often means the establishment or acquisition

of a foreign affiliated company. With foreign ownership comes

the assumption of foreign interest and influence over the operations of the enterprise in question. Ul

entiates a multinational enterprise

oriented firm.

Since the 1980s, the global pattern

timately, FDI is what differfrom a local or nationally

of foreign direct investment

has changed significantly. The following sections describe and

analyze changes in the global distribution of FDI, in foreign direct

investment in the United States (FDIUS), and in the composition

and volume of FDI across the United States, Europe, and Japan.

1 Foreign direct investment, according t{) the lntemational Monetary Fund, “refers to

investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor, the investor’s purpose being to have an effective voice

in the management of the enterprise.’” IMF definititm cited in D. Julius, G/obal Companies

and Publ\c Pollc): The Grubtin~ Chollenge of Foreign Direct Int’estment (London, UK:

Royal Institute of lntemati(mal Affairs, 1990), p. 15. Foreign direct investment in the

United States has a specific legal meaning. It is defined by the International Investment

and Trade m Services Act as [he ownership by a foreign person or corporation of 10 percent or more of the voting equity of a firm Ioeated in the United States. See U.S. Congress,

Office of Technology Assessment, Multlnationuls and the Natwnal Interest: Playing by

Dif12renr Ru/e.$, OTA-lTE-569 (Washington, DC: U.S. Government Printing Office, September 1993), p. 47. FD1 is distinct from portfolio investment, which is passive in nature.

n m-i

I 105
106 I Multinationals and the U.S. Technology Base

GLOBAL TRENDS IN INWARD AND

OUTWARD INVESTMENT

Since 1980 the world stock of inward direct investment has increased dramatically, from $491

billion to nearly $2.0 trillion by 1992.2 With the

exception of the United States, the distribution of

inward direct investment across the major advanced industrial states has been relatively stable

during this time: Europe accounted for about 37

percent in the early 1980s and early 1990s, and Japan for less than 1 percent in both periods, while

the U.S. percentage grew from 16.4 to 22 percent.3

The rate of growth in inward direct investment

in the United States, however, was not as large as

foreign investment in East Asia, which more than

doubled, rising from 6.2 to 13.6 percent. As a result, that region now attracts a larger share of

world inward investment than traditionally large

recipients of foreign investment such as the

United Kingdom. OTA interviews with senior

executives of numerous Japanese, European, and

U.S. MNEs suggest that both the absolute and relative amounts of foreign investment in East Asia

will grow significantly during the next decade.

However, although many business leaders forecast major investment in the region, to date the

U.S. investment position is relatively small: in

1993, the U.S. direct investment position in China

was $877 million; in Thailand it was $2.9 billion,

$3.0 billion in the Republic of Korea, $3.1 billion

in Taiwan, and $10.5 billion in Hong Kong.4

Over the past decade, inward investment flows

to the major industrialized economies have fluctuated less than outward flows, with the exception of

the rapid decline in inward investment to the

United States after 1989 (see figures 5-1 and 5-2).

Outward U.S. investment increased steadily

throughout most of the 1980s and early 1990s, although it declined substantially in 1988 and 1990.

Investment flows for Germany and Japan have

been quite different than those for the United

States. For both countries, outward investment increased rapidly throughout most of the period, but

then declined substantially after 1988 for Germany and after 1990 for Japan. In terms of inward investment, both Japan and Germany consistently

have remained comparatively low. The contrast

between inward and outward investment was particularly strong for Japan in the late 1980s, when

its outward flows were 4 to 5 times greater than its

inward flows. Figure 5-3 charts Japan’s inward

and outward direct investment flows with the U.S.

and Europe from 1986 to 1992.5

Japan and Germany are exceptions among the

advanced industrial economies in that, during the

1980s, they became relatively more permeated by

trade than by investment. OECD data indicate

2 U.S. Department of Commerce, lntemational Trade Administration, /nternaliona/ Direct In}’estment: G/oba/ Trends and [he U.S. Role,

1988 edition (Washingt(m, DC: U.S. Government Printing Office), table 2 p. 90; and United Nations, Wor/d/n\’estmenr Report /993: Trunsna -

/iona/ Corporations ati In[egruted lnterwtio~i Production (NY: United Nations, 1993), table I. I p. 14. Inward investment refers to the flows

of foreign direct investment into a given country. Outward investment refers to the flows of direct investment abroad from a given country. In

principle, world inflows and outflows should balance. In practice, however, they often do not (as is the case with other balance-of-payments

items). Reasons for the discrepancy between total inflows and outflows of investment include cross-national differences in acc(mnting for unremitted branch profits, capital gains and losses, reinvested earnings, real estate and construction investment, and the transactions of offshore

enterprises.

~ organisation for ~onomlc” C().()pemti()n and Developnlent (OECD), Directorate for Science, Technology, and Industry, Globulkution @

lndustria/ Actit’ities: Bacigrowui Synfhesis Report (Paris, France: OECD, 1993), p. 54, table 9.

4 U.S. Department of Commerce, Economics and Statistics Administration, Bureau of Economic Analysis, United Sfates Departmen[ of

Commerce News (Washington, DC: June 28, 1994), table 2. All figures are on a historical cost basis at year end.

5 Ministry of Finance of Japan, 2!?isei Kin’})u Tokei Geppo NW 452, Ekcember 1989, No. 476, December 1991, and No. 500, December

1993. Ministry of Finance data on inward investment is slightly higher than that provided by the OECD, which shows negative flows during

some years in the 1980s; see figure 5- I ahwe and OECD, International Direct In\qestment Policies and ‘Trends in the 1980s (Paris, France:

OECD, 1992), table 3.
Chapter 5 Trends in Foreign Direct Investment I 107

60

50

10

0

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

Us.

Japan

France

Germany

U.K.

NOTE Reinvested earnings are not Included In some national data The source IS one of a series with wmllar appendix data tables on OECD investment flows

SOURCE Orgamsahon for Economic Co-operation and Development OECD Rewews of Fo[e/gn Direct kweshnenf /re/and 1.994 (Pars OECD

1994), p 68, table 1 (hereatter cited as OECD, Reviews of FDI)

45-

40-

35-

30-

25-

20-

15”

>

101

5

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

Us.

Japan

France

Germany

U.K.

NOTE Reinvested earnings are not Included m some nattonal data The source IS one of a series with slmllar appendix data tables on OECD investment flows

SOURCE OECD, Rewews of rW, p 70 table 3
108 I Multinationals and the U.S. Technology Base

35

30

25

e

; 20

z

(n

o

1986 1987 1988 1989 1990 1991 1992

--- to the U.S.

+ to Europe

~ from the U.S.

+ from Europe

SOURCE: OTA, based on data from Ministry of Finance of Japan, Zaisei Kinyu Tokei Geppo vol. 452 (December 1989) 26-29, vol. 476 (December

1991) 30-35, and vol. 500 (December 1993) 28-30, 78-79

that, among the major industrialized countries, proportion of inward investment increased greatly

only Japan and Germany became more penetrated or was already high, and those that remained low

by imports than by FDI during the 1980s.6 Both of or declined further. Table 5-1, for example, shows

these countries emphasized trade rather than FDI changes in manufacturing employment by foreign

reform in the 1980s, and both began from a start- affiliates in the major industrialized countries. Being point where barriers to investment exceeded tween 1980 and 1990, manufacturing employbarriers to trade. For instance, Japan—starting ment by foreign affiliates expanded from 1.1 to

from a highly protected base—liberalized its trade 2.2 million in the United States and from 677 to

barriers and, to a lesser degree, its barriers to in- 775 thousand in the United Kingdom; by contrast,

vestment. 7it fell from 779 to 617 thousand in Germany and

Other indicators are consistent with this dis- from 178 to 145 thousand in Japan.

tinction between those OECD countries whose

b Aus&ia and Canati am he On]y other countries with a similar trend during the 1980s, although both are already far more penetrated by FDl

than are Germany or Japan. OECD, Economic Analysis and Statistics Division, Directorate for Science, Technology and Industry, Performance

ofForeign Aj)Viaies in OECD Countries (Paris, France: OECD, forthcoming), pp. 25,27, diagram 6. See figure 5-1 above for inward FD1 flows

of Japan and Germany.

7 ]n Japan, govemmenta] effom t. improve the conditions for inward FDI often have been weakened by the bureaucracy. For exan~Ple) a

recent Keidanren report criticized the OffIce of Trade and investment Ombudsman (OTC), which handles foreign companies’ and importers’

complaints about impediments to inward FDI) because their filing claims take too long. In addition, bureaucratic barriers often provide needless

constraints-for instance, tiling rules require the claimant to provide a comparison between Japanese and foreign regulations as well as a concrete improvement plan. See “Unsatisfied with the Capability of Handling Complaints: Keidanren Submits a Request for Improvements to

OTO,” Nihon Keizai Shimbun, Oct. 1 I, 1993, p. ~.
Chapter 5 Trends in Foreign Direct Investment I 109

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110 I Multinationals and the U.S. Technology Base

70, I

10

0

kiiil ::::::;:::::::::::

m

!7

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

_Africa and Middle East

~ Oceania

U Asia

m Europe

~ Canada and Latin America

m Us.

SOURCE: OTA, based on data from Ministry of Finance of Japan, Zaisei Kinyu Tokei Geppo vol. 452 26-29, vol. 476.30-35, and vol. 500 28-30

In absolute terms, U.S. affiliates in Japan

employed fewer people in 1990 than their European counterparts. However, between 1980 and

1990 their portion of all manufacturing employment by foreign affiliates in Japan steadily increased, partly because U.S. affiliates shed jobs at

a slower rate than did European affiliates. 8

Among all foreign affiliates in Japan, employment was reduced most dramatically in chemicals, the largest sector of employment for foreign

investors, and in the auto industry, which experienced the greatest sectoral decline in employment

by foreign investors in Japan. 9 Employment by

U.S. affiliates in Japan fell in both of these sectors.

The decrease in employment by foreign affiliates

in Japan’s automotive sector contrasts with the

growth in employment by foreign affiliates in the

U.S. automobile industry, which expanded from a

nominal level to 53,000 in the same decade.

Although they started from a higher base, job

losses among foreign investors in Germany were

much larger than in Japan, with the loss of

162,000 manufacturing jobs. These losses were

spread among a variety of sectors, with the heaviest in basic metals (53,000), chemicals (36,000)

and electrical machinery and equipment

(57,000)-all areas of traditional German industrial strength.

In terms of outward investment, the volume of

FDI accelerated sharply after the 1985 Plaza Accord, which resulted in the appreciation of the yen.

Japan’s outward investment in the 1980s was almost the obverse of its inward investment. While

Japan was the largest outward investor during this

period, it received the smallest amount of inward

investment. Japanese outward investment was

distributed widely, with about half of the flow going to the United States, and smaller portions des8 See “Japan: Employment of Foreign Subsidiaries by Origin Country or Area, “ in OECD op. cit., footnote 6, Table 7, p. 38

9 Employment fell t{) less than three thousand. Ibid., p.38.
Chapter 5 Trends in Foreign Direct Investment I 111

90

80

70

60

: w“

o

: 40“

30

20

10

0

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

~ United Kingdom

_ Netherlands

m Germany

~ France

~ Japan

D u~

NOTE: Reinvested earnings are not Included in some national data The source IS one of a series with similar appendix data fables

SOURCE Adapted from OECD, Reviews of FDI, p. 70 table 3

tined for Europe, Asia, and Oceana (see figure

5-4).

In 1992, the United States resumed its former

position as the country with the largest flow of

outward direct investment. Figure 5-5 shows the

largest six direct investors’ shares of total OECD

outward investment from 1981 to 1992. Since the

late 1980s, the share of OECD outward investment increased for the United States, France, Germany, and the Netherlands, while it decreased for

Japan and the United Kingdom.

Figure 5-6 shows the share of OECD inward investment flows for the same six countries. For

nearly the entire period, the United States, United

Kingdom, and France received over 50 percent of

the total OECD direct investment flows. However, the U.S. share has declined dramatically

since its peak in 1984. The share of inward investment has increased for the United Kingdom,

France, and the Netherlands, while it has fluctuated at a comparative] y low level for Germany and

Japan.

While the recession slowed global foreign investment during the early 1990s, U.S. MNEs sustained their regional distribution of investment.

As of 1993, Europe accounted for 49.1 percent of

all U.S. direct investment abroad (USDIA), Latin

America 18.6 percent, Canada 12.8 percent, and

Japan 5.7 percent.

10 The proportions for USDIA

in manufacturing differed little, at 48.5 percent for

Europe, 14.8 percent for Latin America, 17.1 percent for Canada, and 6.8 percent for Japan. 11

However, the destination of this investment is increasingly to Asia (excluding Japan). In 1993,

Asia and the Pacific, minus Japan, accounted for

I ~ U.S . ~pa~nlen[ of Commerce, Economics and Statistics Administration, Bureau of Economic Analysis, Umfed slatcs DcPa~fmf’nt ()-f

Commerce News (Washington, DC: June 28, 1994), table 2. All figures are on a historical cost basis at year end.

1‘ Ibid.
112 I Multinationals and the U.S. Technology Base

90,

60

E/o

~

2 40

30

20

10

0

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

1!

1:::::::::: .:::::::

1992

~ United Kingdom

_ Netherlands

m Germany

D France

~ Japan

= u~

NOTE: Reinvested earnings are not Included in some national data The source IS one of a series with similar appendix data tables

SOURCE Adapted from OECD, Reviews of FDI, p. 68, table 1

$60.9 billion or 11.1 percent of all USDIA, and

$22.2 billion or 11.1 percent of all USDIA in

manufacturing. 1 2

EXPLAINING RECENT SHIFTS IN

GLOBAL FDI

The majority of Japanese and EU outward investment between 1985 and 1989 went to the United

States, which received more than 50 percent of all

OECD investment. In the early 1990s, however,

FDIUS slowed considerably due to the change in

the value of the yen, the European need to finance

Eastern European reconstruction, and a global recession. A number of European countries, especially Belgium, Portugal, Spain, Sweden, and the

United Kingdom, had higher FDI growth rates

than the United States in the early 1990s. East

Asia also had a higher rate. ’3

It could be that the United States is experiencing a cyclical decline in FDIUS. After a period of

phenomenal growth, recessionary trends in the

U.S. economy--combined with capital scarcity

abroad--could have led foreign investors to limit

or even reduce their investments in the United

States. Different economies might operate on different recessionary and investment cycles. If this

is the case, renewed economic growth should produce a return to vibrant growth rates in FDIUS.

Alternatively, the United States may be experiencing the effects of a structural change in the

character of global FDI. The pressures of globalization may be forcing lasting shifts in the global

distribution of FDI, since the imperatives of reducing labor costs and market customization require increased investment outside of the Triad.

OTA interviews revealed a new emphasis on Asia

12 Ibid. To~l USDIA in tie Asia ~d pacific region in 1993 was $92.3 billion. Japan accounted for 34 percent, Australia for 20.0, Hong Kong

for 11.3, and Singapore for 9.5 percent. Together, these four cmmtries accounted for 74.9 percent of all IJSDIA to the regi(m.

I 3 OECD, op. cit., fm)mme 3, p. I 9.
Chapter 5 Trends in Foreign Direct Investment I 113

and Latin America as destinations for FDI by

many of the world’s leading corporations. This

trend is corroborated by the figures on USDIA

cited above, which continued to grow despite the

U.S. recession of the early 1990s, as U.S. investors sought higher returns abroad. Investors based

outside the United States are behaving in a similar

fashion. For example, in 1988,67 percent of new

Japanese direct investment went to the United

States, but by 1992 that figure had fallen to 42 percent, as Japanese investors increasingly focused

on Asian investments. 14

A combination of economic and political pressures have encouraged MNEs from Germany, Japan, and the United States to pursue investment

strategies that increasingly emphasize regions peripheral to the OECD. Investment is moving toward East Asia, Eastern Europe, and Latin

America. There are several reasons for this shift:

1.

2.

3. . 

Changes in the rate of return on investment.

The United States has become an increasingly

mature market for foreign investors. When

measured in terms of rate of return on investment, during the late 1980s the United States

became less attractive for both existing and

prospective foreign investors (see figure 5-7).

Regional economic trends. In Europe, the

trade-expansion promise of the EU 1992 Initiative prompted increased direct investment in

Europe during the late 1980s and early 1990s.

In Asia, rapid national growth rates and increasing market liberalization also attracted

FDI.

Wage costs at home. Growing labor costs have

induced MNEs to move more production offshore, including the manufacture of high value-

-added components. Doing so requires firms to

seek locations with a relatively well-educated

but lower-cost work force. This process is especially difficult for Japan and Germany, which

now have the highest labor costs in the world.

Japanese employers repeatedly told OTA that

6

{

\

1- + U.S. affiliates abroad

* All businesses in the U.S.

o -

-1

---- Foreign affiliates in the U.S.

1 1

L

1986 1987 1988 1989 1990 1991

NOTE: Rate of return on USDIA and FDIUS based on market value Rate

of return for all U S businesses based on a weighted average of stock

earnings and corporate bond yields

SOURCE U S Department of Commerce, Bureau of Economic AnalySIS, Survey of Current Business 72(8) 79, table 1, August 1992 (hereafter cited as BEA, SCB)

they were hesitant to reduce their labor force,

despite the fact that only a small percentage of

workers benefit from Japan’s lifetime employment system. Although German employers are

more willing to cut their labor force, they expressed both hesitancy to do so and an awareness that the comprehensive German welfare

state system could not support higher unemployment at the present level of benefits.

Executives in both countries expressed concern

about the social effects of investing abroad, but

noted that increased competition has heightened the pressure to reduce wages and benefits,

which in turn has made regional investment

more attractive. For example, Japanese managI ~ See a~lcle by customs Bureau Staff, Japanese Ministry of Finance, “Changes in Japan’s Trade Structure and Foreign Direct Investments,” translated and reprinted in FBIS-EAS-94-02 I -A, Feb. 1, 1994, p. 6.
114 I Multinationals and the

ers in the consumer

U.S. Technology Base

electronics industry

4.

pointed to strong competitive pressures to

move production facilities offshore, much as

U.S. manufacturers did in the 1970s and early

1980s.

The need for customization. While mature

OECD markets have experienced a sustained

recession, there have been high growth rates

and a strong demand for capital in East Asia

and China, and to a much lesser extent in Eastern Europe and Latin America. The increased

complexity of these markets, coupled with different standards and regulatory regimes in

Asia, Europe, and North America, have created

distinct regional markets.

Local rules, combined with increasingly diverse consumer demands in both intermediate

and finished products, have promoted customization and local production. Executives

across three continents repeatedly told OTA

that “you have to be there, design there, and

produce there to sell there.” This is especially

important for industries such as pharmaceuticals and information technology, where speed

to market is a crucial aspect of competitiveness

and proximity to consumers is often vital in order to meet their specific needs. 15 Indeed, most

of the R&D conducted by foreign affiliates focuses on customizing products to meet local

market conditions. 16

At the same time, however, the regionalization of markets can lead to informal barriers.

For example, representatives of one French

electronics firm noted that varying regional

standards required them to construct their products differently in some Asian markets. They

felt that this problem created an informal market barrier and weakened their competiveness.

They also expressed concern that the widespread adoption of Japanese standards throughout Asia could effectively exclude them from

that regional market.

5.

6.

The gradual diffusion of technological capa -

bilities. Cutting-edge technological capabilities tend to remain concentrated in the major

industrialized countries, while process technologies that serve the needs of most manufacturing industries have spread more widely.

Nevertheless, there are now substantial software development facilities in Pakistan and India, and fabrication plants for sophisticated

semiconductor components throughout Southeast Asia. Once the infrastructure for high

technology development exists, it can become

a magnet for additional investment.

Seeking political stability abroad. Many corporate officials suggested in interviews that

they were encouraged to invest in order to promote political stability in neighboring areas.

For instance, one executive stated that some

German firms had come under ● ’moral and

political pressure from their government” to invest in Eastern Europe and Russia. While official figures issued by the Ministry for Export

and Investment show that the amount of German investment in Eastern Europe has been relatively small and contracting, several German

executives suggested that these figures did not

reveal the full extent of the commitment of German MNEs in Eastern Europe because so many

investors were either asked to pay only a nominal price for existing facilities or those facilities

were given to them.

This focus on political stability was much

less evident in the case of Japanese and U.S.

firms. However, some Japanese business leaders expressed concern that their foreign investments might lead to accusations of predatory

behavior and, perhaps, generate a backlash

against them. And some in the U.S. have argued that U.S. investment in Mexico should be

encouraged partly because it could help reduce

illegal immigration.

Is see OEcD, op. cit., footnote 3, p. 28.

16 see chapter 4 for a discussion of R&D within nlLIltlnatiOnal fi~s.
Chapter 5 Trends in Foreign Direct Investment I 115

In addition to directing new investment to nonOECD countries, MNEs based in the Triad have

begun to emphasize strategic alliances and joint

ventures rather than rely on traditional investments.

MERGERS AND ACQUISITIONS,

STRATEGIC ALLlANCES, AND

JOINT VENTURES

After a sustained rise throughout the 1980s, the

global trend toward increasing international

mergers and acquisitions (M&As) fell in 1990 and

1991. In 1989, the global flow of M&A investment was $130.6 billion; in 1990 the flow fell to

$117.8 billion before more than halving in 1991 to

$51.9 billion. The greatest percentage decline was

in North America, where the dollar value of

M&As for 1991 fell to just over one-third of the

amount for 1990. For the first time in many years,

the value of M&As in the European Union exceeded those in North America (by $10 billion in

1990 and $21 billion in 1991).17 In 1990, both the

United Kingdom and France spent more on crossborder acquisitions than did the United States as

they sought to expand from being national players

to being European or global players through a

strategy of foreign investment.

In the early 1990s, strategic alliances and joint

ventures became relatively more popular than

M&As as an investment strategy among MNEs.

There appear to be four primary reasons for this

change:

1. Global recession. Much of the downturn in demand for M&As was prompted by a global recession that reduced the financial abilities of

firms to invest directly. The recession instead

encouraged participation in strategic alliances

and joint ventures, which are less expensive in

terms of immediate capital requirements and

allow for greater flexibility, although perhaps

at a cost to corporate autonomy. Thus while international M&As fell by 37 percent in 1991,

the number of joint-ventures fell by only 20

percent.

18 As one report suggested, “acquisition is increasingly seen as only necessary

when it relates to a core part of the business and

it is essential to have outright control. Outright

acquisition is very expensive and there are situations in which companies no longer see it as

viable. ” 19

2. Prohibitions against M&As. Financial pressures may not be the only reason to favor joint ventures. In interviews with OTA, U.S. and

European investors repeatedly stressed that

joint ventures were preferred because takeovers may be precluded through national laws

and practices. 20 Investors associated this problem most closely with Japan and Germany, two

countries where the dominant form of corporate governance differs from the United States

and the United Kingdom. Other studies corroborate this view. For instance, one analysis of

M&As in Europe states that “many contested

takeovers do not take place for the simple rea17 see CommlSslon” of the European communities, pan{)ra~ ojEc Industry /993 (Luxemhmrg ~ffic~ for official ~bllcatlons of the

European Comunitles, 1993) p. 49.

‘ 8 Ibid., p. 51.

19 KpMG rep)~ Cl[ed in Ibid.,p.51. An example of how the lack of finance has influenced global strategy and cnc(mraged strategic alliances

is discussed in the case of alliances between Japanese semiconductor firms and European partners. See Y. Ktmura, “Japanese Direc[ Investment

in the European Semlconductm Industry,” in M. Mason and D. Encamatimr (eds. ), Does Ow’nershlp Maffer? Japanese Mu/fina~iona/.\ In Europe, (Oxford, UK: Clarend(m Press, forthcmnmg 1994), pp. ~ 14-S 15 (pre-publicati(m copy).

20 Stephen Thmlsen suggests, in relati(m to foreign direct investment regulations, that “non-EC firms face national restricti(ms within the

Community even though the EC has no community-wide restricti(ms on the establishment of f(weign companim thr(mgh grcenfield investment

or acqulsiti(m. T() suggest that the absence of restrictive C(mlmunity policies ,nahes the EC rmm ()~>n than the U.S.A. IS clearly far-fetched.

Each and every Member State in the C(mmlunity has potentially rm~re restrictive polic]es toward inkes[(ws than d(ws the U.S.A. under the Ex(mFlorio amendment.”’ S. Thm]sen, “Cwnment,” in Mas(m and Encamati(m (eds. ), op. cit., fo(~tnt~te 19, p. 203.
116 I Multinationals and the U.S. Technology Base

son that nobody really believes that they can

happen”; for example, the unsuccessful hostile

bid by Italy’s Pirelli for Germany’s Continental

tire company in 1991 may have “confirmed the

view that German companies are impregnable

for as long as they have the support of the big

German banks.”21

A 1990 report identifies two types of barriers

to takeovers of public companies in the European Union. The first is “structural’’--e.g. impediments that arise from the ownership

structure and the cultural characteristics of individual markets. For example:

In Italy . . . only eight out of over 200 listed

companies have issued more than 50 percent

of their shares to the public. That means that

they remain tightly controlled by small cabals of like-minded industrialists and financiers who are not minded to give up

control .22

The study found structural barriers in the major

European economies to be strongest in France,

Germany, Italy, and Switzerland.

The second impediment to acquisitions

identified by the report was a series of technical

barriers that inhibit or prevent the transfer of

control by contested takeover. For example, in

Germany, Switzerland, and the Netherlands,

companies often restrict the voting rights of ordinary shareholders and instead concentrate

voting power in the hands of shareholder

groups that are friendly to management.

Among EU members, the United Kingdom has

relatively weak structural and technical barriers. As a result, management in the United

Kingdom is much more likely to be responsive

to shareholders’ short-term interests. In addition, the value and number of cross border acquisitions in the United Kingdom often exceed

those found in the rest of the European Union.23

With respect to Japan, OTA was told repeatedly that unsolicited acquisitions of Japanese

firms by foreign MNEs were virtually impossible due to numerous formal and informal barriers. These investment and market access

restrictions discouraged foreign acquisitions

even in sectors where domestic Japanese firms

are weaker than their international competitors

and where the rules of competition appear most

liberalized, such as in pharmaceuticals.

3. Market access. The liberalization of European

trade law and the lack of legal restrictions to investment have reduced the problem of market

access in all but a few exceptional cases within

the European Union. For example, the initial

problems experienced by Japanese financial

institutions in trying to gain access to the European market through joint ventures or direct investment seem to have been overcome in the

1990s, with two notable exceptions. The first is

in Germany, where the universal banking system allows banks to take the initiative in adopting protective measures against foreign

intrusion. The second is in France, where national regulation constrains market entry.24

OTA interviews with banking officials in both

countries corroborate this claim, as company

officials suggested that formal and informal

barriers have been effective in constraining

market entry.

In the case of Japan, corporate officials in

North America and Europe reported that establishing a joint venture is the preferred method

of gaining access to Japanese markets. Most

21 Commls.sion” of tie European Communities, op. Cit., fOOtl’10te 17, p. 51.

22 Smdy by C(x)mrs and Lybr~d, as cited in ibid., p. 51. This image of Italy is consistent with broader data On inward ml f10w5, which

remain small and relatively volatile. while the stock of investment grew in the late 1980s and early 1990s, the flow was uneven, peaking in 1988

and 1990 and dropping substantially in subsequent years. For further discussion and data on FIX flows in and out of Italy, see ibid., p.61, table

14.

23 Ibid., pp. 5 I -52.

’24 See G. Hawawini and M. Schi]l, “me Japanese Financial Presence in the European Financial Services sector,” in Mason and Encamation

(eds.), op. cit., f(mmme 19, pp. 243-247. See also chapter 8 in this report.
Chapter Trends in Foreign Direct Investment I 117

companies interviewed by OTA considered

other strategies, such as establishing whollyowned subsidiaries, to be too difficult. Company officials across the United States and Europe

repeatedly stressed that public and private sector limitations effectively deterred investment

in Japan. These managers cited problems with

the distribution system, access to local suppliers, reduced probability for public procurement, and the exceptionally high initial costs of

starting up a business in Japan. Several senior

executives of European firms stated that they

instituted joint-venture agreements with Japanese firms in Japan because they believed it

was the only means of securing business from

Japanese transplants in North America. Officials of a German auto supplier, for example,

claimed that they swapped technology for market access to the Japanese market—which they

defined as both firms in Japan and Japanese

companies located in North America. A joint

venture was necessary to enter a keiretsu, they

suggested, wherever it was located. If these

claims are true, and do not represent isolated

cases, then some Japanese MNEs may be extending restrictive practices common in Japan

to other countries.

Most joint ventures between Japanese and

foreign firms in Japan result in the Japanese

firm being the majority partner. This has major

repercussions on trade patterns, because it can

preclude foreign firms from using their Japanese-based subs i diaries as a conduit for trade .25

Unlike Japanese affiliates in the United States,

which often are either wholly-owned or majority-owned subsidiaries of the Japanese parents,

U.S.-based subsidiaries in Japan often face regulatory and informal limits to market penetration. In addition, minority partners are often

precluded from advantageous transfer pricing

practices, which limits their ability to control

foreign exchange risks and tax liabilities.26

4. Increased cost of technology. Many firms reported that the soaring costs of developing the

next stage of technology in their particular

field, coupled with enhanced competitive pressures to innovate, have forced them to pursue

strategic alliances and joint ventures.

For example, even the wealthiest of companies are often unable or unwilling to invest

alone in billion dollar fabrication plants for the

production of next-generation DRAM chips.

The profitability of commodity semiconductor

products has declined, and as product and process technology advance many MNEs have

turned to cooperative development and production strategies. The location of research and

production facilities is increasingly determined

by technological resources rather than market

considerations or broader national interests.

Even Japanese firms now tend to favor alliances with foreign enterprises in North America and Europe, rather than foreign direct

investment .27

The results of these tendencies have significant implications for the U.S. technology base.

For example, the next generation of computer

technology will rely on flat panel displays. But

IBM’s decision to locate co-production of flat

panel displays with Toshiba in Japan was determined, according to company officials, by the

lack of suitable technological infrastructure to

support such a plant in the United States, where

2s This issue IS ctmlprehensively addressed in D. Encamation, Ri\)als Beyond Trade: America Versus .lapan in Globa/ Comperifion (Ithaca,

NY. Cornell University Press, 1992).

26P. Buckley, “C(mmlent” in Mason and Encamation (eds.), op. cit., footnote 19, pp. 229-230.

27 Article by Customs Bureau Staff, Japanese Ministry of Finance, op. cit., footnote 14, p. 6.
118 I Multinationals and the U.S. Technology Base

Total Industry Manufacturing Wholesale Trade —

Country 1985 1993 1985 1993 1985 1993 — — — —

Canada 9.3 8 9 7,7 10.0 5.3 2.6

Other Americas 9.1 4.6 8.7 3.1 5.7 3.4

Europe 65.8 60.8 76.9 73,5 47.4 40,2

France 3 6 5.7 9.6 10,2 1.5 2.7

Germany 8.0 6.6 10.1 10.7 152 10.5

Netherlands 20.1 14,7 22,4 13.7 7,4 11.1

U K 2 3 6 20,0 19,6 57.2 139 9.9

Japan 10.5 21,6 4.6 10,6 40,6 49,8

Other 5.4 4,2 2.1 2.6 1,0 3.1

Total (in billions) $1846 $445.3 $59 6 $1667 $291 $69.7

NOTE: Totals are given in current dollars, 1993 data IS preliminary, columns may not add to 100 percent due to rounding

SOURCE: OTA, based on data in U S Department of Commerce, BEA, Foreign Direct Investment in the United States

Preliminary 1992 Estimates, (Washington, DC forthcoming 1994), table 3, and BEA, SCB, August 1987, table 10, p 90

to date there is no high volume commercial producer of flat panel displays. 28 This pattern may

be self-reinforcing: despite the appreciation of

the yen against the dollar, the IBM-Toshiba

joint venture is planning to increase production

capacity only in Japan .29

Furthermore, Japanese-based MNEs frequently use joint ventures with U.S. firms to

benefit from U.S. technological capabilities.

Where Japanese-based MNEs are advanced

technologically, they tend to maintain investments at home or establish majority-owned

subsidiaries abroad. But they do invest in joint

ventures and strategic alliances where their

U.S. partner is more technologically advanced

than they are.30

THE DYNAMIC CHARACTER OF FDI

IN THE UNITED STATES

Throughout the 1980s and into the early 1990s,

the United States received more than half of all

OECD FDI flows.31 By 1993, the British were

overtaken by the Japanese as the largest investors

in the United States (see table 5-2). Japanese investment in the United States grew at an average

‘g OTA interview at IBM-Japan, Sept. 30, 1993. Note, with regard to this issue, the Department of Defense’s prop)sal to offer matching

grants t(~talling $1 bllli(m to U.S. fim~s that are prepared to develop and produce flat panel display computer screens in the United States. See

“U.S. to Aid Industry in Computer Battle With the Japanese,” New York Times, p. Al, Apr. 27, 1994.

29 See “IBM Japan, Toshiba Venture to Double its Display Capacity,” The WCIII Street Jourrud, p. B8, July 6, 1994.

30 see B Kogut and s.j. Chmg, “T~hnological” Capabi] ities and Japanese Foreign Direct ]nvestment in the United Stales,” The Re~’le~’ ~!

Economics and Sia(istics 73(3):401 -413, Aug. 1991.

31 Sec figure S. 1. For a discussion of the factors that have stimulated foreign investment in the United States, see the first rePOrt of this

assessment: U.S. C(mgress, OffIce of Technology Assessment, op. cit., f(x)tnote 1, pp. 57-62.
Chapter 5 Trends in Foreign Direct Investment I 119

1,800 70

~ Number of new estabhshments

1,600 D Number of acquisitions 60

~ Value of acquisitions

1,400 + Value of new establishments 50

1,200

?

& 1,000 40 ~—. =

z —. o

~ 800 30 ?

S 600

20

400

10

200

0 0

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

SOURCE: BEA, SCB 70(5) 23, table 1 May 1990, 71 (5) 30, table 1, May 1991, 71 (5) 133, table 1, May 1993, and 74(5) 50, table 1, May 1994

rate of 34 percent a year in the 1980s, which represents a seventeen-fold increase in Japan’s stock of

investment in the United States over the decade .32

By 1993, Japanese investors accounted for 23.6

percent of all industry investment, including nearly 50 percent of investment in wholesale trade.

Most FDIUS is comprised of acquisitions, not

new establishment (or “greenfield”) investment.

During the 1980s, acquisitions accounted for 85

percent of all FDIUS, compared to 60 percent of

FDI in the EU.33 Figure 5-8 shows the difference

in number and value of foreign acquisitions versus

new establishment investment in the United

States from 1983 to 1993.

Of all acquisitions in the United States between

1981 and 1987, those by foreign individuals accounted for 8 percent of the transactions and 14

percent of the total value. These acquisitions were

facilitated by U.S. deregulation and the emergence of new financial instruments such as junk

bonds, which often required the issuers to sell

their assets rapidly in order to meet their financial

obligations .34

Although lower than acquisitions, the value of

new establishment investment also grew steadily

during the mid to late 1980s, from $3.2 billion in

1983 to a high of $11.5 billion in 1989. Foreign

firms established new facilities in the United

States for a variety of reasons specific to individual sectors, as well as to develop a mechanism to

hedge against exchange rate variations. In some

cases, the particular location of greenfield investment within the United States may have been affected by state and local incentive packages,

although it is unlikely that these incentives af32 me [n,pact of Foreign Inve~tnlent on Domestic ECOIN)mkS of OECD Countries. (Jp. cit.t ‘( M)mote 21 pp” 87 and 91‘

~~ OECD, op. cit., f(x~tm)te 3, p. 20.

M OECD, ~)p. cit., f(xm)te 6, P. 88.
120 I Multinationals and the U.S. Technology Base

fected foreign firms’ strategic decisions to estab- combination of imports and local production. By

lish new facilities in the United States (see box comparison, foreign firms account for 9 percent of

5-1 ). The net effect of greenfield and acquisition total domestic demand in Japan-of which 6 perinvestment was to boost the share of foreign affili- cent is imports, mostly of low technology predates as a percentage of U.S. manufacturing output ucts, and 3 percent is concentrated in chemicals,

into the 10-20 percent range, a level comparable to pharmaceuticals, basic metals, and food products,

Germany. 35 most of which are manufactured locally. CompaIn 1990, about 25 percent of total U.S. domes- rable figures for Europe are much higher, largely

tic demand was met by foreign firms through a

35 OECD op. ~11 f(x)mc)te ~, p. 20. ]n tie United Kingdom and France, foreign affiliates account fOr 20-30 percent of m~ufac~ring (~utPut,

.,

while in Japan foreign affiliates account for less than 10 percent.
Chapter 5 Trends in Foreign Direct Investment I 121

due to the integrating effects of the 1992 EU initiative. 36

Among foreign investors in the United States,

only the Japanese preferred establishing new

firms to acquiring existing ones. 37 For example,

table 5-3 shows that, of the 631 Japanese affiliates

operating in the United States and Europe as of

1990, 78 percent were established by greenfield

investment and 22 percent by acquisition and capital investment. Of acquisition and capital investment, 86 percent is accounted for by Japanese

chemical, iron and steel, non-ferrous metals, and

non-electrical machinery firms. These are primar-

~~ OECD, t~p. cit., f{x)tm)te 6, p. 7.

J7 Ibid., p, 88.

ily slow growth industries, and have attracted foreign firms that are seeking either to diversify or to

enhance their sectoral competitiveness by purchasing U.S. firms (as is the case for Japanese

chemical firms in the United States).3g

The United States has also attracted Japanese

investment in relatively high-growth, R&D-intensive industries such as electrical machinery.

The United States is not the only location for this

type of investment. Japanese FDI in Europe, for

example, has included significant investment in

high-wage, technologically sophisticated German

38 see H. yanlaw~i, “Ent~ patterns of Japanese Multinationals in U.S. and European Manufacturing, “ in Mas(m and Encamati(m (d.),

op. ~lt., f(N)tnote 19, pp. 98, I O I, I 08- I I O and I 18.
122 I Multinationals and the U.S. Technology Base

Japanese affiliates

in the U.S. in Europe

number percent number percent

Total number of affiliates 631 10070 336 1 00%

New Establishments 489 77.5% (loo%) 258 76 8% (100%)

Horizontal firms 430 68.2% (87.9%) 234 69,6% (90.7%)

Diversified firms 59 9.4% (12.1%) 24 7.1% (9.3%)

Acquisition and capital participation 142 22.5% (100%) 78 23,2% (100%)

Horizontal firms 105 16.6% (73.9%) 74 22,0% (94.9%)

Diversified firms 37 5.9% (26.1 %) 4 1 .2% (5.1%)

—

NOTE: Numbers may not sum to 100 percent due to roundlng. Data describe Japanese manufacturing affiliates operating in Europe and the United Stales as of 1990

SOURCE: Hideki Yamawaki, “Entry Patterns of Japanese Multinationals in U S and European Manufacturing, ” Mark

Mason and Dennis Encarnation, eds. Does Ownership Matter? Japanese Multinationals in Europet (forthcoming from

Claredon Press), p 97, table33

industries. 39 Such manufacturing investments

should not obscure, however, the tendency of Japanese FDIUS to focus on services and wholesale

trade. 40

INVESTMENT BALANCES ACROSS

THE TRIAD

The rapid growth of FDI over the last decade has

expanded the ownership and control of large industrial enterprises across national borders. By

1992, the global stock of foreign direct investment

reached approximately $2.0 trillion.41 This surge

of investment, often identified with the globalization of business, has transformed the world economy and stimulated local and international

commerce in many sectors. But it has not done so

evenly.

U.S. direct investment with Europe and Japan

tripled over the past decade to reach more than

$665 billion by 1993. As shown in figure 5-9, the

bulk of that investment, some $540 billion, was

split between U.S. FDI in Europe ($269 billion)

and European FDI in the United States ($271 billion). The remainder, approximately $128 billion,

is divided unevenly between U.S. FDI in Japan

($31 billion) and Japanese FDI in the United

States ($96 billion). Figure 5-9 shows the expansion and distribution of foreign direct investment

between the United States and its major trading

partners.

As figure 5-9 indicates, from a macro perspective U.S.-European FDI has been relatively well

balanced over time, although during 1988-89 European investment in the United States exceeded

39 H+ Yamaw&l, 4’L(~ation Decision5 of Japmese Nlulthatiom] Firms in European Manufacturing Industries” in K. Hughes, (cd.), Eu~opean Competitiveness (Cambridge, MA: Cambridge University Press, 1992).

40 Sm H. yamaw~i, “EX~M-W and Foreign Distribu[if)nal Activities: Evidence on Japanese Firms in the United States,” Re\’ieu’ ofEconomICS and Sfa~is[ics, 73(2):294-300, May 1991. See also figure 5-14 and accompanying text in this chapter.

AI united Nations, W~r/d [m’estment Report /993 0p. Cit. fOOlllOte 2, p. 1.
Chapter 5 Trends in Foreign Direct Investment I 123

600 I

200

100

0 —

r’

Ull

F1

n

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

~ Japan In U.S.

_ U.S. In Japan

~ Europe In the U.S.

~ U.S. In Europe

SOURCE: Adapted from BEA, SCB 73(7) 65-67, 97-100 July 1993, 71 (8) 51-54, 86-88, August 1991, 69(8) 52-53, 67-69, August 1989, and

67(8) 63-65,90, August 1987 “U S Department of Commerce News, ” press release June 28, 1994, tables 2 and 3 (hereafter cited as USDOC press

release)

U.S. investment in Europe by approximately $50

billion (or 12 percent of all FDI between the

United States and Europe). The U.S. investment

relationship with Japan, on the other hand, is far

less balanced. Japanese investment in the United

States now exceeds U.S. investment in Japan by a

factor of 3.1, with the imbalance totalling $65 billion in 1993 (or51 percent of all FDI between the

United States and Japan). Moreover, the Japanese

economy is roughly half the size of the U.S. or European economies, but, at $128 billion, U.S.-Japanese investment is less than one-fourth the size of

U.S.-European investment.

There are notable differences across the Triad

in the composition of investment. About half of all

FDIUS is in manufacturing and wholesale trade,

the two components of FDI that are most closely

associated with merchandise trade, while the other

half of FDI is in a mixture of services, real estate,

insurance, banking, finance, and other sectors.

However, the proportion of FDI directed to each

of these sectors varies across the Triad.

As figures 5-10 and 5-11 indicate, the composition of FDI between the United States and Europe

appears reasonably well matched. Approximate y

$100 billion is directed to manufacturing in each

direction, while much smaller but comparable

levels of FDI are directed to wholesale trade operations.

The similarity in the composition of U.S.-European FDI is reflected in U.S.-German direct investment, as demonstrated by figures 5-12 and

5-13. In each direction, manufacturing accounts

for the largest percentage of direct investment. In

wholesale trade, Germany directs a proportionately larger amount of investment to the United

States than does the United States to Germany,

while the reverse pattern holds for services.

No such similarity in composition or level exists in the U.S.-Japan investment relationship. As

can be seen by comparing figures 5-14 and 5-15,

Japanese FDI in U.S. manufacturing and wholesale trade reached $50 billion in 1992, three times

that of similar U.S. investments in Japan. In addi-
124 I Multinationals and the U.S. Technology Base

30C

250

rn

.—5

= 100

50

0

\,.,.,.,

l!!,,.,. ,.,,,\,

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

En

n

EN

c 1

EN

m

Petroleum and other industnes

Services

Real estate

Insurance

Banking

Wholesale trade

Manufacturing

NOTE BEA statistics on FDI Include data on serwces only since 1987

SOURCE BW, SCB 73(7) 65-67, July 1993,71 (8) 51-54, August 1991, 69(8) 52-53, August 1989, and67(8)90, August 1987, USDOCpress release,

June 28, 1994, table 3

300

250

20Q

150

100

50

0

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

Petroleum and other industries

Services

Finance

Banking

Wholesale trade

Manufacturing

NOTE BEA statistics on FDI posltlon Include figures for services only since 1987

SOURCE BEA, SC8 73(7) 97-100, July 1993, 71 (8) 86-88, August 1991, 69(8) 67-69, August 1989, and 67(8) 63-65, August 1987: USDOC press

release, June 28, 1994, table 2
Chapter 5 Trends in Foreign Direct Investment I 125

40

35

30

~ 25

a=

o

; 20

mc

E 15

m

10

5

0

!!!!!? ,.,.,.,

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

~ Petroleum and other industries

-Services

D Realestate

~ Insurance

DBanking

~Whoiesaletrade

=~an”fa~t”rlng

NOTE: BEA statistics on FDI include data on services only since 1987

SOURCE: BEA, SCB 73(7) 65-67, JuIy 1993,71 (8) 51-54, August 1991 69(8) 52-53, August 1989, and 67(8): 90 August 1987: USDOC press release

June 28, 1994, table 3

tion, while U.S. investment in Japan was heavily manufacturing.

45 In the United States, Europe,

weighted toward manufacturing, Japanese FDI in and elsewhere, the bulk of Japanese investment is

the United States was concentrated in wholesale in wholesaling and retailing, services, finance,

and distribution operations.42 and real estate.

As one recent study noted, of the 3,282 Japa- These differences in the composition of FDI are

nese-affiliated subsidiaries in the United States, important because, in effect, the largest portion of

less than 33 percent ( 1,054) are in manufacturing, Japanese FDI has been in U.S. distribution facilithe remainder being in non-manufacturing sec- ties, which receive imports from Japan destined

tors. 43 According to a MITI survey, there are for retail sale in the United States. The impact of

2,399 Japanese affiliates in North America, of FDI devoted to wholesale operations, and the genwhich 35.2 percent (845) are in manufacturing in- eral significance of variations in both the comdustries. 44 Similarly, of 1,785 Japanese affiliates position and scale of FDI across the Triad, are

in Europe, just under 30 percent (530) are in analyzed in chapter 6.

42 For c{wri)h)ratl(m see L.A. Davis, “U.S. F(weign Trade in Merchandise and Services by F{}reign-Owned U.S. Fim~s” in U.S. Department

of Commerce, Fore/gn ll[re~t Im’estmenr In rhe Urwed States: An Updare (Washington, DC: U.S. Government Printing OffIce, June 1993) p. 81.

43 yanlaw~l, op. C1[., f(MJtno[e 39, p. 93. These figures are taken from listings in the TOYO Keilai su~ey.

44 See M] T], “Dai ZZ kai - Wagakun i Kigyt) no Kaigai Jigyo Katsudo,’” The 22nd Sur\e,Ml\’er~cos Uuslness Activities oj’Jopanese Enterprises, July 30, 1993, p. I I, table 5.

4$ OECD, OP, cit., f~xnnote 6, P. ~ I ~
126 I Multinationals and the U.S. Technology Base

4 0

~ Petroleum andotherind.stries

_ Services

~~ Finance

C] Banking

~ Wholesale trade

= Manufacturing

!

.,,,.,., ,,, , v;:;:;

~,~,~,~,

... ,

35

R,\, \,\,\ 20

E?,,, ,

15

10

5

0

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

NOTE BEA statistics on FDI posttlon include figures for servces only since 1987

SOURCE BEA, SCEl 73(7) 97-100 July 1993, 71 (8) 86-88, August 1991, 69(8) 67-69, August 1989, and 67(8) 63-65, August 1987, USDOC press

release, June 28, 1994, table 2

100

90

80

70

(n

g60

-0

:50

c

: 40

30

20

10

o“

m

n

Em

c l

EN

m

Petroleum and other industries

Services

Real estate

Finance

Banking

Wholesale trade II Manufacturing

,.,.,., ,.,s,.,

,.,.,.,

. . .

i

,.,.,.,.

,.,,,.,.

,.,.,.,.

.,. ,

IrYd

I-d-4

&,:,...,.,.., . .

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

NOTE BEA statlst(cs on FDI Include data on serwces only since 1987

SOURCE BEA, SCB 73(7) 65-67, July 1993, 71 (8) 51-54, August 1991, 69(8) 52-53, August 1989, and67(8) 90, August 1987, USDOC press release,

June 28, 1994, table 3
Chapter 5 Trends in Foreign Direct Investment I 127

35

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

NOTE: BEA statistics on FDI position include figures for services only since 1987

~ Petroleum and other Industries

_ Serwces

~ Finance

~ Banking

~ Wholesale trade

= ~anufa~~urlng

SOURCE BEA SCi3 73(7) 97-100 July 1993 71 (8) 86-88 August 1991 69(8) 67-69 August 1989 and 67(8! 63-65 August 1987 USDOC press

release June 28 1994 table 2
Multinational

Firms and

International

Trade 6

w

hen multinational businesses first gained broad public

attention in the late 1960s, many analysts believed that

foreign direct investment (FDI) would effectively displace trade because foreign affiliates would supply local

markets not with exports but with locally produced goods. Multinational enterprises (MNEs) were expected to replicate the production process globally, producing and selling in local markets

instead of exporting from the domestic market. Historically, this

form of FDI has been most commonly associated with U.S. firms

investing abroad. Ford’s investment in integrated production

plants in Europe is a classic example of what one analyst has

called “trade-destroying” FDI. 1

However, the expectation that FDI would supplant trade has

not always been borne out. Instead of investing in fully integrated

manufacturing facilities and producing goods abroad, many

MNEs have established foreign manufacturing operations that

import a high percentage of intermediate components; others

have set up wholesaling and service facilities that import both intermediate goods and finished products. Rather than replacing

trade, these investments encourage trade—that is, they are tradecreating. To the extent that FDI promotes trade, aggregate trade

flows will tend to mirror aggregate investment flows.

1 For a discusslm of this viewf of FDI see: R. Gilpin, citing the work of Koyoshi Kojirna, in ‘Where D(NS Japan Fit In’?’, Millennium: Journal of lnrernatiunal Studies,

18( 3). 337, 1989. on F(mi’s style {~f FD1, see M. Wilkins and F.E. Hill, American Business

Abroad: F’ord on .$/t Con/] nenr.\ (Detroit, Ml Wayne State University Press, 1964).

1129
130 I Multinationals and the U.S. Technology Base

2C

c

-2C

-4C

-60

-80

100

-120

-140

-160 ,

+ U.S. and foreign firms

) * All foreign firms In the U.S.

\

+ U.S. firms

\

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

NOTE: 1992 data are preliminary

SOURCE: OTA, based on data in U S Department of Commerce, Bureau of Economic Analysis Survey of Current Business 73(1 O) 54, table 1, October 1993, 73(3) 90-91, table 2, March 1993, and 74(3) 68-69, table 2, March 1994 (hereafter cited as BEA, SCB), U S Department of Commerce,

Bureau of Economic Analysis, Foreign Direct Investment in the United States Operations of U S Affiliates of Foreign Companies revised 1983-1991

estimates and preliminary 1992 estimates, (Washington, DC U S Government Printing Off Ice, 1986-1994), table G-3 (1982-1 986) and table G-1

(1987-1 992) (hereafter cited as BEA, FDIUS)

THE TRADE AND INVESTMENT NEXUS

In the United States, foreign affiliates consistently

have imported far more than they have exported.

In 1991 their ratio of imports to exports was

1.83: 1, after having peaked at 2.98:1 in 1987.2 Except for 1984 and 1985, in each year between 1977

and 1992 the trade deficit run by foreign affiliates

has amounted to more than half of the entire U.S.

merchandise trade deficit. As U.S. businesses improved their trade performance after the post- 1985

depreciation of the dollar, foreign affiliates in the

United States accounted for an increasing share of

the total trade deficit. In 1987, the trade deficit of

all foreign affiliates in the United States was

equivalent to 53 percent of the total trade deficit;

that level rose steadily to peak at 120 percent in

1991. In 1992, foreign affiliates ran a trade deficit

of $70.7 billion in real terms, compared to a deficit

of $6.1 billion run by U.S. firms (see figure 6-1).

This pattern does not mean that foreign affiliates in the United States are wholly responsible

for the trade deficit. That deficit is affected by a

broad range of factors, including exchange rates,

variations in national growth and productivity

rates, and different rates of domestic savings and

investment. In addition, some of what foreign affiliates import is used to produce goods that might

otherwise have been produced entirely abroad.

Even if foreign affiliates were not present, much

of what they import would be brought into the

United States through other channels.

Nevertheless, the trading activity of foreign affiliates clearly represents an important component

of foreign direct investment in the United States.

2 U.S. Department of Commerce, BEA, Survey of Current Business (Washington, DC: October 1993), table 1, p. 54.
Chapter 6 Multinational Firms and International Trade I 131

30

* All Countries

-120 1 I 1 1 I r 1 1 I

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

NOTE: 1992 data are preliminary.

SOURCE: BEA, SCB 73(10) 57, table 3, October 1993, BEA, FDIUS, table G-2 (1991 -1 992)

Moreover, the trading behavior of foreign affiliates varies by national origin. Japanese affiliates

in the United States consistent y have run the largest trade deficit-$37.4 billion in 1992, equivalent to 49 percent of the total merchandise trade

deficit that year. German and U.K. affiliates also

have run deficits, although considerably smaller

at $9.6 and $4.1 billion, respectively, in 1992.

French affiliates tend to run small trade surpluses,

amounting to $3.1 billion in 1992 (see figure 6-2).

The following analysis demonstrates that variances in the trading tendencies of foreign affiliates, including variances in the trading

relationship between affiliates and their parent

firms, are closely associated with the distribution

and composition of FDI. They may also be

associated with the timing of FDI.

1 Merchandise Trade and the

Distribution of FDI

The last section of chapter five described the large

asymmetry in two-way investment flows between

the United States and Japan, compared to investment between the United States and Europe (see

figure 5-9). The difference between these two bilateral investment relationships is reflected in

merchandise trade flows. As figure 6-3 illustrates,

trade balances between the United States and Europe follow the same pattern as the bilateral investment relationship, which shifted from a

balanced position in the early 1980s into a U.S.

deficit in the mid- 1980s, and then returned to a relative balance by the early 1990s. Figure 6-4 illustrates the progression of the U.S. trade deficit with

Japan, which also reflects the bilateral investment

relationship. In 1980 investment was relatively

balanced at about $5 billion in each direction, but

since then Japanese investment in the United

States has grown to reach $96 billion by

1993-over three times that of U.S. investment in

Japan. In short, the U.S. trade balance with Europe

tends to mirror the balance in direct investment,

while the U.S. trade deficit with Japan tends to reflect the investment deficit.
132 I Multinationals and the U.S. Technology Base

20

15

10

5

1

A

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

+ Total MNE trade balance

*IFT trade balance

+Total bilateral merchandise

) trade balance

I

\

NOTE 1992 data are preliminary

SOURCE OTA, based on data from BEA, FD/US, table G-4 (1983-1986) and table G-2 (1987-1992), U S Department of Commerce, Bureau of Economic Analysls, U S Direct /nveslment Abroad Opera[Ions of U S Parent Companies and thev Foreign Afhtales revwed 1983-1991 estimates and

preliminary 1992 estimates (Washington, DC U S Government Prmtmg Office, 1986-1994), tables 50 (1983-1988) and Ill H I (1989-1992) (hereafter

cted as BEA, USD/A), BEA SCt3 72(6) 88-90, table 2, June 1992: 73(3) 90-91, table 2, March 1993, 74(3) 68-69, table 2, March 1994

-10-

t

-20-

-30- i

-40-

-50-

-60 I I I 1 I I I I

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

-+-- Total MNE trade balance

+IFT trade balance

+ Total bilateral merchandise

trade balance

NOTE 1992 data are preliminary

SOURCE OTA, based on data from BEA, FDNJ.S table G-4 (1983-1986) and table G-2 (1987-1992), BEA, [JSD/A, table 50 (1983-1 988) and table

Ill H I (1989-1992), BEA SCB 72(6) 88-90, table 2, June 1992, 73(3) 90-91 table 2, March 1993, 74(3) 68-69, table 2, March 1994
Chapter 6 Multinational Firms and International Trade I 133

75

150,

120

I

I /’

6(-

30-

0

i

w’”

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

In

+

IFT between Japanese parents

and their affiliates In the U.S.

IFT between U.S. parents and

their affiliates m Japan

Total merchandise trade

NOTE: 1992 data are preliminary.

SOURCE: OTA based on data from BEA, FDIUS, table G-3 (1983-1986) and table G-1 (1987-1 992) BEA, USDIA, table 50 (1 983-1 988) and table

Ill H I (1989- 1992) BEA SCB 73(10) 54, table 1, October 1993, 73(3) 90-91, table 2, March 1993

Figures 6-3 and 6-4 also illustrate that total

merchandise trade, total affiliated trade, and intrafirm trade (IFT) are much less closely related in

U.S.-European trade than in U.S.-Japanese trade.

Total affiliated trade measures the balance of exports and imports by both U.S.-based MNE parent

groups and foreign affiliates in the United States,

whether those goods are exchanged within or outside of the MNE network. IFT measures the balance of trade within MNE networks only.

Consequently, figures 6-3 and 6-4 indicate that,

over time, trade between the United States and Japan centers more on MNEs than is the case with

trade between the United States and Europe.

Figures 6-5 and 6-6 look more closely at the

relationship between MNEs and total merchandise trade by examining IFT, which represents

trade flows within MNE networks. Together, the

figures illustrate two important patterns. First,

IFT is much more significant in U.S.-Japanese

merchandise trade than in U.S.-European merchandise trade. On average between 1983 and

1992, IFT has accounted for 70 percent of all U. S.-

Japanese merchandise trade, compared to 43 percent of all U.S.-European merchandise trade.

Moreover, the volume of intrafirm trade between

the United States and Japan is greater than that between the United States and all of Europe. In

1992, U.S.-Japan IFT totalled $97.0 billion,

compared to $90.4 billion for U.S.-Europe IFT.

Second, the figures illustrate that IFTbetween the

United States and Japan is dominated by Japanese

MNEs, while IFT between the United States and

Europe is more evenly divided between MNEs

based in each region. Between 1983 and 1992,

Japanese MNEs on average accounted for 93 percent of all bilateral intrafirm trade with the United

States, while European MNEs accounted for 58

percent of U.S.-European IFT. In terms of volume, in 1992 Japan-based MNEs accounted for

$88.5 billion of a total $97.0 billion in IFT with

the United States, while Europe-based MNEs accounted for $49.3 billion of a total $90.4 billion in

IFT with the United States. These figures indicate
134 I Multinationals and the U.S. Technology Base

250

2oo -

~ 150-

~

z

u)

.E 1oo- =m

50-

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

?z

+

——

In between European parents

and their affiliates in the U.S.

IFT between U.S. parents and

their affiliates in Europe

Total merchandise trade

NOTE: 1992 data are preliminary.

SOURCE: OTA, based on data from BEA, FDIUS, table G-3 (1983-1986) and table G-1 (1987-1992), BEA, USDIA, table 50 (1983-1988) and table

Ill.H.I (1989-1992), BEA SCB 73(10) 54, table 1, October 1993, 73(3) 90-91, table 2, March 1993

that the U.S.-Japanese trading relationship is

heavily weighted toward Japanese MNEs, and

that the U.S. relationship with Europe is more diversified across corporate structures and national

ownership-a pattern that again reflects the distribution of FDI in each relationship.

The data considered in figures 6-3 through 6-6

illustrate a consistent correlation between bilateral investment balances and bilateral trade balances. Of course, investment flows do not

determine trade flows per se. Trade is affected by a

broad range of factors, including exchange rates,

variations in national growth rates and productivity levels, and different rates of domestic savings

and investment. Nevertheless, greater levels of

FDI can promote trade through the import and export activities of foreign affiliates, including intrafirm trade. As a result, trade balances among the

advanced industrial states often are associated

with investment balances. To the extent that this

relationship holds, the U.S. trade deficit with Japan may now be structurally linked to the U.S.-Japan imbalance in direct investment. Since

intrafirm trade accounts for the majority of trade

between the United States and Japan, it is unlikely

that bilateral trade flows will equilibrate as long as

the bilateral investment relationship remains

heavily imbalance.

1 National Variations in Intrafirm Trade

In the U.S. trade accounts, intrafirm trade consists

of all exports and imports exchanged between (1)

U.S. MNE parents and their afiliates abroad, and

(2) foreign MNEs parents and their affiliates in the

United States. Relative to total merchandise exports and imports, IFT accounts for a huger percentage of both exports and imports in U.S.-Japan

trade than in U.S.-European trade (see figures 6-7

and 6-8). From 1983 to 1992, IFT accounted for

an average of 66 percent of the merchandise exports and 73 percent of the merchandise imports in
Chapter 6 Multinational Firms and International Trade I 135

90

80

70

60

50

40

30

20

10

0

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

IFT exports

IFT Imports

Total exports

Total Imports

NOTE 1992 data are prelirmnary

SOURCE OTA, based on data from BEA FDIU.S, table G-3 (1 983-1986) and table G-1 (1987-1 992) BEA, USD/A, table 50 (1983-1988) and table

Ill H I (1 989-1 992) BEA SCf3 73(10) 54, table 1 October 1993 73(3) 90-91, table 2, March 1993

120

Ioil

80

60

40

20

0

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

—

_IFT exports

~IFT imports

+ Total exports

+ Total imports

NOTE 1992 data are preliminary

SOURCE OTA based on data from BEA, FD/US, table G-3 (1983-1986) and table G-1 (1987-1992) BEA USD/A table 50

Ill H I (1989-1992) BEA SC8 73(10) 54 table 1 October 1993 73(3) 90-91, table 2, March 1993

1983-1 988) and table
136 I Multinationals and the U.S. Technology Base

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

c1

Fzzl

c1

NOTE: 1992 data are preliminary.

Merchandise flows from U.S. affiliates in

Japan to their parents in the U.S.

Merchandise flows from U.S. parents to

their affiliates in Japan

Merchandise flows from Japanese affiliates

in the U.S. to their parents in Japan

Merchandise flows from Japanese parents

to their affiliates in the U.S.

SOURCE: OTA, based on data from BEA, FDIUS table G-4 (1983-1986) and table G-2 (1987-1992), BEA, USDIA, table 50 (1983-1988) and table

Ill H 1 (1989-1 992), BEA, SCB 73(6) 78, table 2, June 1993

U.S.-Japanese trade, compared to 39 and 46 percent respectively in U.S.-European trade.3

When bilateral IFT is disaggregate to show

the volume and direction of trade within MNE

networks, two important patterns emerge (see figures 6-9 and 6-10). First, in terms of direction,

considerably more I IT flows from parents to affiliates than vice versa. This pattern holds across the

advanced industrial nations, with ratios ranging

from a minimum of 2.4:1 for Japanese parents and

their affiliates in the United States to 3.8:1 for

U.S. parents and their affiliates in Japan.4 Second,

in terms of volume, IFT imports by Japanese affiliates in the United States far outweigh both IFT

imports by all European affiliates as well as IFT

exports by U.S. MNEs to their affiliates in Japan.

In 1992, Japanese affiliates in the United States

imported $62.2 billion from their parent firms,

while U.S. MNEs exported $6.8 billion to their affiliates in Japan. By comparison, European affiliates in the United States imported $41.9 billion

from their parent firms, while U.S. MNEs exported $32.2 billion to their affiliates in Europe.

Variations in the volume and direction of bilateral IFT are consistent with variations in the distribution of FDI. Simply put, IFT imports by

Japanese affiliates in the United States dominate

bilateral IFT flows, reflecting the fact that the vol3 IFT data fr{ml U.S. Department of Cmnmcrce, BEA surveys of Forei,gn Direct In\’estmcnt in [he Unired States and U.S. Direct ln~’estment

Abroad (Washington, DC: 1983-1991 issues, and 1992 estimates). Total merchandise trade flows frmn U.S. Department of Commerce, BEA,

Suney ofCurrent Business (Washingt(m, DC: June 1992), table 2, p. 90; and Sur\ey oj”Current l?us{rress(Washingtm-r, DC: June 1993), table 2,

p.78.

~These ratios nleasure [he ] 992 nler~handise fIOWS of parents to affiliates over those frmn affiliates to parents, in constant dollars. In the case

of U.S. parents and their aftil iates in Europe, the ratio is 2.5: I; for European parents and their affiliates in the United States, it is 3. 1: 1. Based (m

data in U.S. Department of Commerce, annual BEA surveys, op. cit. fwmmte 3.
Chapter 6 Multinational Firms and International Trade I 137

100 ~— .-

80]

60

I

i!! 40-

20

0 :

_ Merchandise flcwsfmrn U.S. affldes in

Europe to their parents In the U.S.

Merchandise flows from U.S. parents to

their affiliates In Europe

Merchandise flows from European affiliates

in the U.S. to their parents In Europe

Merchandise flows from European parents

to their affiliates In the U.S.

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992e

NOTE: 1992 data are preliminary.

SOURCE: OTA based on data from BEA FDIUS table G-4 ( 1983-1 986) and table G-2 (1987-1 992) BEA USDIA tables 50 (1983-1 988) and Ill H 1

(1989-1991 ) BEA SCB 73(6): 78 table 2 June 1993

ume of Japanese direct investment in the United

States far exceeds U.S. direct investment in Japan.

Likewise, the similarity in IFT flows between the

United States and Europe reflects the relative balance of FDI between the two regions.

In addition, variations in the proportion of IFT

to total trade may indicate that Japanese affiliates

in the United States have a stronger propensity to

trade through IFT channels than their European

counterparts. As figure 6-11 demonstrates, German

and Japanese affiliates have a stronger than average tendency to import from their parent groups,

their respective IFT imports averaging 82.6 and

80.5 percent of total imports from 1981 to 1991.

French and U.K. affiliates import noticeably less

from their parent groups, averaging 67.1 and 43.2

percent respectively over the same time period.

Since IFT trade flows primarily from parents to

affiliates, one would expect affiliates’ I IT propen -

sit y to be weaker for exports than for imports. Figure 6-12 indicates that this is indeed the case.

From 1981 to 1991, the average IFT export propensity for all foreign affiliates in the United

States was 42 percent, comparedto71 percent for

imports. The figure also shows a slightly different

cross-national pattern. As with import propensity,

France and the U.K. have the lowest export propensity; however, unlike import propensity, Germany’s export propensity also has been below

average for most of the decade, while Japan remains above average throughout, at61 percent for

the entire period.

Together, figures 6-11 and 6-12 indicate that

Japanese affiliates consistently have demonstrated a strong tendency to trade within MNE networks. 5 German affiliates have had a higher

propensity to import than to export within MNE
138 I Multinationals and the U.S. Technology Base

9 0 , ,“. 1

< + All Countries

807

_ France

70- + Germany

~

60-

50- m

40-

30

I

2 0 {

10

I

0! 1 I 1 I 1 1 1 I I

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

+ Japan

+ U.K.

1

SOURCE: BEA, SCB 73(10) 57, table 3, October 1993

networks, while French and British affiliates consistently have had a lower than average propensity. The figures also show that IFT imports have

increased as a percentage of all trade by affiliates,

from 63.5 percent in 1981 to 74.1 percent in 1991.

By contrast, IFT exports have fluctuated slightly

but increased little over the decade, from 42.0 percent of all trade in 1981 to 42.3 percent in 1991.

Some analyses suggest that the gradual rise in

IFT imports is due mostly to the increased wholesale trading activity of Japanese and Korean affiliates in the United States, primarily in the

automotive sector.6 Accordingly, variations in

IFT observed above may be due not only to the

differences in the bilateral volume of FDI but also

to the sectoral composition of foreign direct investment in the United States (FDIUS). Other

analysts maintain that the trading behavior of foreign affiliates changes over time, as they become

more deeply integrated with the local economy.

These different explanations of the relationship

between trade, IFT, and investment are analyzed

in the following section.

1 Explaining National Variations in

Intrafirm Trade

The data presented in figures 6-7 through 6-12

portray three principal variations in IFT. First, IFT

accounts for a larger percentage of both exports

and imports in U.S.-Japan trade than in U.S.-European trade. Second, IFT between the United

States and Japan is skewed toward imports by the

U.S. affiliates of Japanese firms, while IFW between the United States and Europe is more symmetrical. Moreover, because IFT is a large

percentage of U.S.-Japan trade, the volume of IFT

imports by Japanese affiliates in the United States

far outweighs that by European affiliates-$62.2

billion and $41.9 billion, respectively, in 1992.

6 Ibid.
Chapter 6 Multinational Firms and International Trade I 139

90

80-

0! I I I 1 I I 1 1 I !

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

+

&

+

All Countries

France

Germany

Japan

U.K.

SOURCE: BEA, SCB 73(10) 57, table 3, October 1993

Third, Japanese affiliates tend to import and export within MNE networks, while German affiliates have a strong IFT import propensity only and

both French and U.K. affiliates have a weaker

tendency in both directions.

As suggested above, variations in the volume

and direction of bilateral IFT conform to variations in the distribution of FDI. The similarity in

IFT between the United States and Europe reflects

a relatively equal distribution of FDI, while the

asymmetry in IFT between the United States and

Japan reflects an unequal distribution of FDI.

However, variations in the propensity of foreign

affiliates to import-and in particular to use IFT

channels-could be explained by two additional

factors: the sectoral composition of FDI, and the

relative age of FDI.

Variations in the Sectoral Composition of FDl

One of the principal determinants of the trading

behavior of foreign affiliates is the sector in which

they are located. The wholesale trade sector is

most closely associated with total trade as well as

IFT, because many wholesaling operations function primarily as distribution channels for components or finished products imported from their

parent companies. Since 1985, wholesaling affiliates in the United States have imported twice as

much as they have exported. In 1991, the ratio of

imports to exports for wholesale trade affiliates in

the United States was 2.2: 1, compared to 1.2: 1 for

affiliates in the manufacturing sector and 1.8:1 for

all industries.’ In 1991, foreign wholesaling affiliates in the United States ran a trade deficitof$51

7 U.S. Department of Commerce, BEA, op. cit. footnote 2, table 2 p.54. The foreign wholesale trade affiliates of U.S. companies follow the

same pattern; over the past decade they have imported more than triple the value of their exports.
140 I Multinationals and the U.S. Technology Base

billion, compared to $7.3 billion for manufacturing affiliates (the total trade deficit for all afiliates

that year was $72.2 billion). Over the last decade,

wholesaling operations accounted for over 70 percent of the total trade deficit run by all foreign affiliates in the United States.8

IFT comprises the majority of imports by

wholesale trade affiliates. In each year from 1985

to 1991, approximately 80 percent of all imports

by wholesale trade affiliates came from their foreign parent groups. 9 Moreover, like most wholesalers, wholesale trade affiliates simply resell the

goods they import. According to the most recent

benchmark survey by the Bureau of Economic

Analysis (BEA), more than 90 percent of the imports by wholesale trade affiliates were goods that

required no additional processing, assembly, or

manufacturing. 1 0

These characteristics of wholesale trade affiliates, combined with the sectoral composition of

FDI, partly explain the unusually prominent role

of IFT imports by Japanese affiliates in the U. S.-

Japan trading relationship (see figure 6-5). Japanese FDIUS is more concentrated in wholesale

trade than is either European FDIUS or U.S. direct

investment in either Japan or Europe (as seen in

figures 5-10 to 5-15 in chapter 5). Consequently,

U.S.-Japanese trade bears the hallmark of wholesale trade affiliates-a high import propensity,

most of which flows from parent firms in Japan to

their affiliates in the United States. 1 1 Through the

mid-1980s, wholesale trade affiliates accounted

for over 95 percent of all imports and exports by

Japanese affiliates in the United States. Although

the proportion declined somewhat since then, by

1991 they still accounted for 84 percent of all trade

by Japanese affiliates in the United States. In

1991, Japanese wholesale trade affiliates alone accounted for 42 percent ($67.7 billion) of the imports and 35 percent ($31.8 billion) of the exports

of all foreign affiliates in the United States.

Wholesale trade affiliates account for far less of

all trade by European afiliates in the United

States, as is consistent with the more balanced

composition of European FDIUS. In most cases,

wholesale trade affiliates account for less than

one-third of all exports and imports by European

affiliates in the United States. One notable exception is imports by German affiliates, 57 percent of

which were imported by wholesale trade affiliates, mostly in automobiles. ] 3

Compared to the wholesale trade sector, foreign affiliates in U.S. manufacturing industries

have a much lower import propensity and consequently have accounted for less than one-eighth of

the total trade deficit of foreign affiliates in the

United States. ’4 However, their share of the total

affiliated trade deficit has grown rapidly since the

mid-1980s, partly reflecting the rapid growth of

foreign investment in manufacturing during that

period. Between 1985 and 1990, the sales of forS Ibid. See figure 6- I for the total merchandise trade deficit of foreign affiliates in the United States since 1982.

9 Ibid., p. 54.

lo ]bid. me BEA’S last benchn~ark survey covers data for 1987. The fm-thcorning 1992 benchmark survey is scheduled 10 be released after

this report has gone to press.

I I FOr a statlstica] analysis of this relationship, see H. Yamawaki, “Expm-ts and Foreign Distributional Activities: Evidence on Japanese

Fimls in the United States,” Re}iew oj’Economics and Sra[i~rics 73(2):294-300, May 1991.

I z U.S. ~pa~ment of Comnlerce, BEA, op. cit., footnote 3, p. 56 and table 4, p. 58. Among Japanese atiliates in the United States in 1991,

wholesale trade aftlliates imported $67.7 billi(m of a total $80.6 billion, and exported $31.8 billion of a total $37.6 billion (in constant 1987

dollars).

13 Ibid., p. 58. mere is one ()~er exception to the generally moderate proponion of wholesale trade to total trade among European affiliates:

50 percent of the exports by French affiliates were shipped by wholesale trade aflliates in 1991; most were in in farm-product raw materials.

14 ibid., p. 56.
Chapter 6 Multinational Firms and International Trade I 141

All countries France

1990 —

All Industries 194

All manufacturing 16.7

Chemicals and allied products 12.1

Primary and fabricated metals 140

Non-electrical machinery 3 1 0

Electric and electronic 3 0 7

equipment

Motor vehicles and equipment 404

Wholesale trade 3 2 3

1991

196

173

13.2

14,1

3 0 4

2 8 6

45.1

3 3 9

1990 1991

12.1 107

17.3 16.2

96 95

73 69

n/a 20.3

n/a 3 7 5

n/a n/a

11,6 121

—

Germany .—

1990 1991

21,6 199

21.4 20.9

184 18.5

200 21 4

25.9 25 5

43,7 39,2

n/a n/a

3 9 9 3 9 6

Japan

United

Kingdom

1990 1991

30.2 31 7

2 8 4 2 8 0

5.1 7,2

6 6 5.9

4 8 5 4 5 3

41 4 381

49.3 5 2 8

346 38 3

1990 1991

9.6 9.2

9.4 100

11.6 13.2

7.2 73

129 9.5

113 143

n/a n/a

153 122

NOTES: Data for 1991 IS preliminary n/a denotes unavailable data, suppressed to avoid disclosure of individual companies data.

SOURCE: Adapted from U S Department of Commerce, Bureau of Economic Analysis, Survey of Current Business 73(10): 64, table 10, October 1993

eign manufacturing affiliates in the United States

grew 78 percent (from $197 to $350 billion in

constant 1987 dollars), while the sales of wholesale trade affiliates grew 24 percent (from $266

billion to $331 billion). 15

Part of the reason manufacturing affiliates

often run trade deficits is that they import intermediate goods used for production in the United

States. l6 As shown in table 6-1, the foreign content of all intermediate goods purchased by

manufacturing foreign affiliates in the United

States averaged 17.3 percent in 1991. The foreign

content among manufacturing affiliates varies

significantly by sector, ranging from 13.2 percent

in chemicals to 45.1 percent in autos. ] 7 However,

table 6-1 also shows considerable variation by

country. For all foreign manufacturing affiliates in

I 5 Ibid.

the United States, Japanese affiliates have the

highest foreign content at 28.0 percent in 1991;

German affiliates have the second highest foreign

content at 20.9 percent, while French and British

affiliates have considerably lower foreign shares

at 16.2 and 10.0 respectively. Across sectors, Japanese aftliates have the highest foreign content in

the non-electrical machinery and motor vehicles

and equipment sectors, while German affiliates

have the highest foreign shares in chemicals, electric and electronic equipment, and primary and

fabricated metals. The substantial variations in

foreign content across sectors indicate that Japanese affiliates in the United States rely more on

foreign suppliers than do European affiliates.

French and British affiliates import a relatively

low percentage of intermediate goods, while Ger16 Ano[h~r reason for [rade dcficl[s among manufacturing affiliates is that many of them also have wh(desale trade operations. Since the

BEA collects data (m an cntcrpnsc basis, the entire trade accmmt of individual affiliates is recorded under their primary business activity. Many

affiliates that arc primarily manufacturing operations also conduct secondary wholesale trade activities.

1 T Table 6.1 ~hows ,)nly selected nlanufacturing industries. In general, foreign cwrtent is highest in industries that purchase a I(J[ of m~UfaCtured intermediate g(mds. such as the machinery and transpma[ion equipment industries. Foreign c(mtent is generally the lowest in industries

that use raw materials subject to high transptmation costs, such as beverages, primary ferrous metals, and st(me, clay, and glass products. U.S.

Department of Commerce, BEA, op. CII., f(x~tno[e 2, pp. 64-65.
142 I Multinationals and the U.S. Technology Base

Intrafirm trade

as percent of

Industries total industry trade

Science-based

Pharmaceuticals 70

Computers 50-80

Semiconductors 70

Scale-intensive, high

product differentiation

Motor vehicles 50-80

Consumer electronics 30-50

Resource and labor-intensive

Nonferrous metals 30

Steel 5-1o

Clothing 5-10

SOURCE Adapted from Organisation for Economic Co-operation and

Development, Directorate for Science, Technology, and Industry, Globalization of Industrial Activities Background Synthesis Report (Paris

OECD, 1993), p 66, table 21

man affiliates import substantial percentages of

intermediate goods across several manufacturing

sectors.

The higher reliance of Japanese manufacturing

affiliates in the United States on imported intermediate goods helps to explain their high ratio of

imports to exports. In 1991, the average ratio for

all foreign manufacturing affiliates was 1 .22:1,

while the ratio for Japanese manufacturing affiliates was 2.29: 1, indicating that they imported

more than twice as much as they exported. By

comparison, German manufacturing affiliates imported only slightly more than they exported,

while French and British manufacturing affiliates

actually ran trade surpluses. 1 8

Moreover, a large portion of the imported intermediate goods shown in table 6-1 represents IFT.

Across countries, IFT is most common in both science-based industries and scale-intensive industries that have highly differentiated products

(table 6-2). Science-based industries, such as

pharmaceuticals, computers, and semiconductors, are characterized by high R&D costs, low

transport costs, and relatively high profit margins.

Consequently, foreign affiliates have a strong incentive to import intermediate goods from their

parent firm. Scale-intensive industries with highly differentiated products, such as motor vehicles

and consumer electronics, typically produce complex consumer goods that use large quantities of

manufactured parts, components, and subassemblies. In these industries, firms frequently source

components from within their MNE networks. By

contrast, IFT is usually quite low in resource and

labor-intensive industries, such as nonferrous

metals, steel, and textiles. These sectors are characterized by high transportation costs and lower

levels of manufactured intermediate goods. Consequently, IFT tends to be quite loW.

19 In essence,

the more technologically sophisticated the sector

and the individual product, and the higher the value added, the more likely intermediate goods will

be produced in the MNE’s home country and then

shipped to foreign affiliates for final assembly.

Together, the concentration of Japanese FDIUS

in wholesale trade, plus the high foreign content of

intermediate inputs used by Japanese manufacturing affiliates—particularly in high-technology

and complex, scale-intensive industries20—help

to explain why IFT is much more prominent in

U.S.-Japan trade than in U.S.-European trade.

Available evidence from Japan’s Ministry of International Trade and Industry (MITI) indicates

[g ]bido, table 4, p. 58.

IqOrgmlzatlon for Economic” c(~-(~peration and Development (OECD), Directorate for Science, Technology, ~d Industry, Globulisa(ion 0!

/nduslria/ Actii’ifies:Back~round ~ynlhesis Repwf (Paris, France: OECD, 1993 ), pp. 7,28.

20 Several studies suggest that Japanese firms focus their U.S. manufacturing investments in R&D-intensive industries. See B. Kogut and S.

J. Chang, “Technological Capabilities and Japanese Foreign Direct Investment in the United States,” The Review of Economies and Statistics

73(3):408, Aug. 1991; and T. Drake and R. Caves, “Changing Determinants of Japan’s Foreign Direct Investment in the United States,” Discussion Paper 1483 (Cambridge, MA: Harvard Institute of Economic Research, May 1990).
Chapter 6 Multinational Firms and International Trade I 143

1988 1991

IFT as IFT as

a percent a percent

Industry Exports of exports Exports of exports

All Industries

All manufacturing

Chemicals

Nonferrous metals

Machinery

Electric machinery

Transport equipment

Commerce

46,6942

28,907.8

1,454.6

328.1

2,307.5

9,550.9

9,5652

17,099.5

3 5 5

42.0

27,7

2 3 0

31,5

46,0

48.4

25,6

52,586.3

32,7826

1,512,2

259 2

1,528.5

10,705,7

13,0789

18,772,5

2 7 5

4 0 2

1 8 7

2 1 0

34.7

4 5 5

41 3

6 4

NOTES: Commerce Includes wholesale and retail trade to distributors and dealers.

SOURCE: Ministry of International Trade and Industry, Industrial Policy Bureau, International Business Affairs Division

Kaigai Toshi Tokei Soran: Dai 3-kai Kaigai Jigyo Katsudo Kihon Chosa (Tokyo MITI, 1989), tables 1-19,20,23, and 24

and Kaigai Toshi Tokei Soran: Dai 4-kal Kaigai Jigyo Katsudo Kihon Chosa (Tokyo: MITI, 1991), tables 1-22, 23, 25, 26,

and 27

that Japan’s 117 pattern with the United States is

consistent with Japan’s worldwide trade (see table

6-3), although it appears to play a larger role in Japan’s trade with North America than in Japan’s

trade with Europe (see tables 6-4 and 6-5).2

’

In short, national differences in both the tendency to trade within MNE networks and the overall import propensity of foreign affiliates are

related to differences in the sectoral composition

of FDI. Where FDI is concentrated in wholesale

trade, and where manufacturing FDI is concentrated in R&D and complex, scale-intensive industries, both the IFT propensity and the total

import propensity of foreign affiliates is likely to

be high. Japanese affiliates in the United States are

more concentrated in sectors characterized by

high IFT than are European affiliates, which helps

to explain the greater significance of IFT in U. S.-

Japan trade than in U.S.-European trade.

However, other important variations cannot be

explained by the composition of FDI. In particular, the substantial variations in foreign content

seen in table 6-1 indicate that Japanese affiliates in

the United States rely much more heavily on foreign suppliers than do most European affiliates in

the same industry. Some analysts argue that this

difference is consistent with the relative age of

FDI. The more recent the FDI, they argue, the less

likely that firms will be deeply integrated in local

economies and, consequently, they will be more

likely to source from the home market (and often

from the parent firm).

21 MITI data presented in tables 6-8 through 6-10 cannot be precisely compared (o U.S. data presented in table 6- I ((m U.S. scctt~ral data

elsewhere), since each country uses a different industrial classification system.
144 I Multinationals and the U.S. Technology Base

1986 1989

IFT as IFT as

a percent a percent

Industry Exports of exports Exports of exports

All industries

All manufacturing

Chemicals

Nonferrous metals

Machinery

Electric machinery

Transport equipment

Commerce

17,626,6

10,374,0

83.3

41.9

452.4

2,811,7

5,971.6

7,396,6

21.2

25.6

3.8

2.0

18.6

25.7

32.7

162

17,026.4

9,1900

223.9

90.7

443,2

3,126.9

4,020,9

7,509,3

52.2

63,4

48,8

29.2

67,2

65.5

64.6

34,6

NOTES: Commerce includes wholesale and retail trade to distributors and dealers.

SOURCE: Ministry of International Trade and Industry, Industrial Policy Bureau, International Business Affairs Division,

Kagai Toshi Tokei Soran: Dai 3-kai Kaigai Jigyo Katsudo Kihon Chosa (Tokyo: MITI, 1989), tables 1-19,20,23, and 24,

and Kaigai Toshi Tokei Soran: Dai 4-kai Kaigai Jigyo Katsudo Kihon Chosa (Tokyo: MITI, 1991 I, tables 1-22, 23, 25, 26,

and 27

The FDI Life Cycle Theory

In theory, the FDI life cycle is quite straightforward. 22 When MNEs establish affiliates in a foreign country, the new firms tend to import

intermediate goods, since they have more developed business relations, established standards and

certification procedures, and secure sources in the

home market. Foreign affiliates can be expected to

increase their local sourcing over time, as they become more deeply integrated into the local economy and consequently can realize the efficiencies of

local sourcing. By this explanation, Japanese affiliates in the United States have different sourcing patterns than their European counterparts

because Japanese investment in the United States

is relatively new. Over time, the theory predicts,

the volume of Japanese intrafirm trade will decrease and local content will increase as Japanese

affiliates become more deeply embedded in the

U.S. economy.

In practice, however, it is difficult to observe

the FDI life cycle. There is no standard expectation regarding the amount of time that firms need

to operate in local markets before it is reasonable

to expect high degrees of local content. In addition, data limitations make it very difficult to measure local content, particularly in industries that

produce products with large numbers of complex

manufactured parts and components. Furthermore, it can become unwieldy to define local conzz tie ~)f tie em]iest fOrmu]atlOns of the FDI ]ife cycle theory was put fmt.h by John Dunning as the “eclectic theory” of FD1; see J. H.

Dunning, “Trade, Location of Emnomic Activity and MNE: A Search for an Eclectic Approach,” in B. Ohlin, P. Hesselborn and P. Wilkman

(eds.), The lnternutionalA1/ocation oj”EconotnicActivity (London, UK: Macmillan, 1977), pp. S95-41 8. See also J. H. Dunning, Japanese Participation in British Induswy (London, UK; Dover, NH: Crm)rn Helm, 1986); J. H. Dunning, Multinational Enterprises mdthe Global Economy

(Reading, MA: Addison-Wesley, 1993); and J. Hennert, A Theory of Multinational Enterprise (Ann Arbor, MI: University of Michigan Press,

1985).
Chapter 6 Multinational Firms and International Trade I 145

1986 1989 —

IFT as IFT as

a percent a percent

Industry Exports of exports Exports of exports —

All industries

All manufacturing

Chemicals

Nonferrous metals

Machinery

Electric machinery

Transport equipment

Commerce

9,7126

5,618.2

1280

4 8 7

409.7

1,8852

1,6099

3,7482

3 6 0

4 3 4

1 4 0

124

4 4 3

5 0 6

3 3 7

24.4

12,0802

5,4030

227 9

3 7 4

357 3

2,1188

1,6916

7,0056

305

431

27.1

201

478

598

232

202

NOTES: The sources definition for commerce Includes wholesale and retail trade to distributors and dealers

SOURCE: Ministry of International Trade and Industry Industrial Policy Bureau International Business Affairs Division

Kaigai Toshi Tokei Soran: Dai 3-kai Kaigai Jigyo Katsudo Kihon Chosa (Tokyo MITI, 1989) tables 1-19 20 23, and 24

and Kaigai Toshi Tokei Soran: Dai 4-kai Kaigai Jigyo Katsudo Kihon Chosa (Tokyo: MITI, 1991), tables 1-22 23 25 26

and 27

tent in industries that include a large number of

foreign affiliates that produce intermediate goods

locally.

The difficulties of measuring local content can

be seen in the U.S. automotive sector, which has

attracted a great deal of Japanese investment since

the mid- 1980s.23 As these affiliates have increased U.S. production capacity, they have also

increased the volume of purchases from domestic

parts suppliers. Data provided by the Toyota Motor Corporation, for example, indicate that Toyota

will have increased its U.S. sourcing for local production from $800 million in 1988 to a projected

$3.8 billion in 1994, as its U.S. production will

have grown from 164,500 to 600,000 vehicles

(see figure 6-13). These figures indicate that Toyota’s U.S. sourcing has increased at a somewhat

faster rate than its U.S. production, as would be

expected by the life-cycle theory of FDI. According to Toyota, the local content rate for its U.S.

production currently ranges from a high of 75 percent for the Camry to a low of 60 percent for the

Hilux truck, based on EPA CAFE measurement

standards .24

Some analysts note that Toyota’s local content

rates are relatively high given the difficulties new

firms face in establishing local sources for parts

and components. Switching from traditional to

new suppliers can be costly and time-consuming.

It requires new standards and certification procedures, creates uncertainties regarding the reliability and quality of supplies, often introduces new

price differentials, and can damage existing relations with traditional suppliers. Over time these

challenges may be overcome, but when affiliates

23 .A[ present, the three largest foreign affiliates producing aut[~rnoblles in the United States arc Htmda, Nissan, and T(~y(Jta. Mazda, Mitsubishi, and Subarwlsuzu also have assembly facilities in the Umted States. BMW and Daimler-Benz are currently establishing U.S. plan[s, and

should begin production in the near future.

24 Toyota Motor Corporation, press reiease, June 14, 1994, p, 13.
146 I Multinationals and the U.S. Technology Base

- o -

1988 1989 1990 1991 1992 1994

projected

Percent change in U. S.-sourced parts

used in U.S. production since 1988

Percent change in number of vehicles

produced in the U.S. since 1988

NOTE: Data points show total percentage change from a 1988 baseline of $08 billion in U.S.-sourced parts and 164,500 vehicles produced in the

United Slates For 1994, Toyota projects $38 billion in U.S.-sourced parts and 600,000 vehicles, representing a 350 and 265 percent Increase, respectively since 1988

SOURCE: OTA, based on data in Toyota Motor Corp., “This iS Toyota U S A 1993, ” Corporate Brochure, 1993

are relatively new the disadvantages of local

sourcing tend to outweigh the advantages, such as

reduced foreign exchange risk, lower transportation costs, and greater operational flexibility.

Other analysts note that the significance of particular local content levels partly depends on the

reference point. For instance, Toyota’s domestic

content is higher than average for all foreign affiliates in the U.S. automotive sector (55 percent in

1991 ), but it is lower than the average for all

manufacturing affiliates (83 percent in 1991).

More importantly, local content estimates vary

greatly, mostly due to difficulties in determining

the national origin of complex components—

many of which contain parts made in different

countries. For instance, while Toyota and Honda

claim domestic content levels of approximately

70 percent, the BEA estimates that Japanese affiliates in the automotive sector on average purchase

about 50 percent of their inputs from domestic

suppliers. 25 Although the apparent discrepancy in

these figures could be due to very low local content levels by other Japanese affiliates, conflicting

firm-level estimates suggest that part of the problem is due to different measurement techniques.

For instance, a U.S. Customs Service audit of the

Honda Corporation in 1990 concluded that its domestic content was considerably less than the

company claimed.26

‘s In 1990, the local ctm[tmt for all Japanese aut(mmtive affiliates was 50.7 percent, in 1991 it was 47.2 percent. See Table 6-1.

‘c Local cxmttmt estimates frequently diverge due to different techniques for classifying complex components that include both domestic

and foreign value-added. Different depreciation allowances can also affect the results. For a discussion of the different estimates of Honda’s

h~al c(mtent, see U.S. Congress, Office of Techrmlogy Assessment, Multinationals and the National Interest: Playing by Diflerent Rules, OTA -

ITE-569 (Washington, DC: U.S. Government Printing Office, September 1993), pp. 96-97. The enterprise-level data needed to completely assess tbe local c(mtent rates of individual firms is not publically available due to disclosure restrictions.
Chapter 6 Multinational Firms and International Trade I 147

A further complicating factor is that 43 percent

of all U.S. suppliers to the three major Japanese

automobile transplant assemblers—Toyota, Honda, and Nissan—are themselves affiliates of Japanese-based MNEs (figure 6-14), Moreover, 53

percent of those suppliers have an equity link with

one or more of these three Japanese transplant assemblers in the United States.27 In light of these

facts, some analysts have noted that the Japanese

transplant assemblers may be purchasing a large

percent of their local parts and components from

affiliates of Japanese supplier firms, often ones

within the same keiretsu.

28 Indeed, the timing of

direct investments in the United States by Japanese automotive suppliers suggests that there are

close links between the transplant assemblers and

their traditional supplier base. As figure 6-15

shows, most of the Japanese-affiliated suppliers in

the United States were established between 1986

and 1992, in the wake of major investments by the

three largest Japanese automotive assemblers—

Honda began production in Ohio in 1982; Nissan

began truck production in 1983 and automobile

production in 1985 in Tennessee; and Toyota began automobile production in 1988 in Kentucky

(after having established the NUMMI joint venture with GM).

In the context of these interfirm linkages, domestic content becomes increasingly difficult to

measure and interpret. From one point of view, it

is preferable that Japanese transplant assemblers

source from firms located in the United States—

regardless of national origin—rather than importing those goods. From another perspective,

keiretsu relations are widely regarded as restricEuropean and

other affiliates

60/0

71es

Other North

American affiliates

2“/0

NOTE: Number of firms given in chart, total number -472

SOURCE: OTA, based on The ELM Guide to U S Automotive Sourcing

(East Lansing, Ml ELM International Inc., 1992), and The ELM Guide to

Japanese Affiliated Suppliers m North America 4th ed. (East Lansing,

Ml ELM International Inc., 1993)

tive in Japan; if transferred to the United States or

Europe, there is concern that they might convey

unfair competitive advantages to Japanese automotive assemblers and suppliers. 29 Although the

former point is certainly true, there is also evidence to support the latter. Several managers in

the U.S. and European automotive industries told

OTA that the primary sourcing decisions of Ja27 OTA Auto Supplier Database, based on infmrnation from ELM International Inc., The ELM Guide to U.S. Aulonwti\eSourc[rrg (East

Lansing, Ml: ELM lntemational Inc., 1992) and ELM Intema[iona] Inc., The b’[.M Chide loJapane.~~ Aflillared Suppllers In North Amer[co, 4th

ed. (East Lansing, Ml: ELM International Inc., 1993).

28 For example, see C. Howes, Transplant.r and /he U.S. Automobile lrrdust~ (Washingt(m, DC: Ee(mtm~lc P[dicy Institute, 1993)

‘9 There is little doubt that keire(su relati(mships constitute an impediment I() c(~mpetiti(m in the Japanese autonl{}tl~ e industry. Acccmllng to

Jmm Yabe of Japan Fair Trade Cwnrnission, ‘*It makes eeom)mic sense for autt~-makers (o organize their distributtws Into Lelretsu. For example, it contributes to maintaining after-sales service and to raising sales efficiency. On the other hand, it prevents the entry of foreign cars into the

market, and is thus seen as a problem.. . .Business practices, however, restrict the freedornofdealers to handle other manufacturers cars, including fOreign cars. ” See J. Yabe, “FreedOm of Distributors Restricted: Problems including Rebates for Reaching Goals,” Nihon Keiuu Shindmn.

p.14, 1 I OetOber 1993.
148 I Multinationals and the U.S. Technology Base

pre-1950

a European and other

~ North American

_ Japanese

-

1950-59 1960-69 1970-79 1980-84 1985 1986 1987 1988 1989 1990 1991 1992

SOURCE: OTA, based on The ELM Guide to U S Automotive Sourcing and The ELM Guide to Japanese Affiliated Suppliers in North America

pan’s U.S. transplant assemblers are made in Japan, and that outside firms face considerable

difficulties breaking into Japanese supplier networks. When asked to confirm this, a representative of Toyota Motor Corporation told OTA that

all sourcing and engineering decisions for U.S.

production require the approval of the parent company. Many U.S. and European suppliers have

pursued business with the Japanese transplant assemblers by establishing joint ventures with Japanese companies and opening technical facilities in

Japan. They have done this because they believe

that it will lead to business with the Japanese

transplant assemblers in the United States.

Although sourcing relationships are very difficult to trace, some studies suggest that keiretsu-related sourcing patterns are not exclusive to

Japanese affiliates in the U.S. automotive industry. For example, one recent study indicates that

keiretsu linkages are common among Japanese affiliates in the European automotive and semiconductor sectors. 30 However, the great variety and

complexity of manufactured inputs in modem industry, combined with the proprietary nature of

the information, make systematic and comprehensive studies of international sourcing patterns difficult if not impossible.

Combined, the relatively recent presence of

Japanese FDI, the complexity and uncertain origin of manufactured inputs, and the complex patterns of national affiliation among producers and

their suppliers all make local content estimates inherently problematic. Consequently, the FDI life

cycle theory is difficult to confirm by analyzing

the sourcing behavior of foreign affiliates.

Indicators that focus on the output of affiliates

also provide important but inconclusive evidence.

For instance, the FDI life cycle theory predicts

that foreign affiliates will shift over time from

purely domestic to more internationally diversified sales. In the case of Japanese manufacturing

JO M. Mason and D. Enc~ation (eds.), Does Ownership Matter? Japanese Mullinarionals in Europe (Oxford, UK: Clarendon press, ff)rthcoming 1994), pre-publication copy, pp. 147, 156, and 314.
Chapter 6 Multinational Firms and International Trade I 149

affiliates in North America, exports have increased as a percentage of all sales since the late

1980s, yet they were the highest in 1983 at 12.8

percent and actually decreased from then until

1988, when they hit a low of 6.2 percent (see figure 6- 16).

Although individual MNEs may conform to a

FDI life-cycle pattern, aggregate data on the

sourcing and sales behavior of Japanese affiliates

in the United States and Europe do not provide

conclusive evidence. Japanese affiliates in the

United States clearly import more of their production inputs than do their European counterparts

(see table 6-1 ). It remains to be seen whether this

pattern will change over time. Japanese affiliates

may also begin to export a larger percentage of

their sales as they become more embedded in foreign markets and become more fully integrated

and independent production facilities. To date,

however, there is insufficient evidence to determine whether Japanese affiliates will indeed become more deep] y rooted in the U.S. economy and

exhibit production and trade tendencies similar to

most European affiliates.

31 Akio Morita may be

correct in observing that Japanese MNEs have

institutional characteristics that encourage them

to behave differently than their European and

U.S.-based counterparts.32

In sum, the bilateral distribution of FDI clearly

affects the relative symmetry of bilateral trade

flows. This is most evident in the U.S.-Japan economic relationship, where significant asymmetries in investment have contributed to an

imbalance trading relationship marked by consistent Japanese trade surpluses, most of which

can be associated with flows of merchandise from

14

12

10

E 8

al u

bCL6

4

2

0

1983 1986 1987 1988

m Exports

:

1989 1990

[

1991

SOURCE: Adapted from Ministry of International Trade and Industry lndustrial POIiCY Bureau, International Business Affairs Division Dai 18/19

kai Wagakuni Kigyo no Kaigai Jigyo Katsudo (Tokyo: Okura-sho lnasatsuyoku, 1991), p 18, table 11, and Dai 22 kai Wagakuni Kigyo no Kaigai

Jigyo Katsudo ((Tokyo: Okura-sho Inasatsuyoku, 1993), p 22, table

2-16

Japanese MNE parents to their affiliates in the

United States.

The composition of investment also has a significant effect on trading patterns. An important

factor is whether FDI is concentrated in manufacturing or wholesale trade. The concentration of

Japanese FDIUS on wholesale trade shows up

clearly in the aggregate trade data of Japanese affiliates in the United States. Since the mid- 1980s,

Japanese affiliates consistently have accounted

\ I ~lS ~r{KeSS “lay ~ ta~lng P]ace within individua] Japanese firms that have been in the U.S. economy fOr some time. For instance! Honda—wh)ch h>gan U.S. production in 1983—recently announced plans to expand its North American car and engine manufacturing facilities,

use the increased capacity to h)ost exports from (he region from 43,000 to 150,000 units by the end of the decade, and generally accord the

regitm greater Indcpcndcnce within H(mda’s global business. J. Griffiths, “Honda to spend $3 10m on bolstering US plants,” Ffnancia/ Times,

p, 1, July 201994.

32 See A. Mtmta, “Nih(m-gata Keici ga abunai’, Bungei Shirrju, pp.94-103, February 1992.
150 I Multinationals and the U.S. Technology Base

for 40 percent of the exports and 50 percent of the

imports of all foreign affiliates in the United

States. All but a small share of their trade has been

by wholesale trade affiliates.33

Much of the merchandise trade of affiliates is

IFT, especially on the import side. Wholesale

trade affiliates have particularly strong tendencies

toward I IT, reflecting their role as distributors for

their parent’s products. Although at lower levels

than in wholesale trade, affiliates in manufacturing industries also have high import tendencies,

largely due to IFT imports of parts, components,

and subassemblies. The considerable differences

in IFT tendencies across firms may partly be explained by the relative age of FDI, although there

is insufficient data to determine if most affiliates

routinely increase local sourcing and diversify

trading over time. Evidence to date indicates that

foreign affiliates integrate with local economies to

different degrees and through different channels,

only some of which can be explained by the relative age of FDI.

In addition to their immediate effect on trade

flows, cross-national differences in the distribution and composition of FDI have important implications for the U.S. technology base. As the

above analysis indicates, FDI can be concentrated

in different sectors and deployed to very different

effects. Consequently, different forms of FDI can

and do have different implications for the U.S.

technology base.

FORMS OF FDI-CONTRIBUTIONS TO

THE U.S. TECHNOLOGY BASE

FDI can take many forms, some of which are more

likely to result in technology development in the

United States. Five basic types of FDI are listed

below, in ascending order of their contribution to

the U.S. technology base:

1. distribution facilities for imported products;

2. final assembly facilities for imported components;

3. manufacturing facilities that use a mix of imported and locally manufactured components;

4. integrated design, engineering, and manufacturing facilities that provide customized products for the local market; and

5. fully integrated research and production facilities that are a strategic component of a firm’s

global R&D, sourcing, and manufacturing operations.

By this ranking, FDI that is concentrated in

wholesale trade makes a relatively limited contribution to the U.S. technology base, since

wholesale trade affiliates are principally distribution or final assembly facilities for imported

goods. Manufacturing FDI contributes substantially more, although the level of contribution varies with the degree of local content. In general, the

higher the local content, the greater the demand

for high value-added components produced by

domestic suppliers, and the greater the liklihood

that advanced manufacturing process technology

will be transferred to or developed in the United

States. Manufacturing FDI that includes an R&D

element provides a strong contribution to the U.S.

technology base because it creates avenues both

for importing and developing technology. It may

also employ and train U.S. scientific and technological personnel. Facilities that only include design and customization research can also provide

important contributions to the U.S. technology

base, although not as extensively as fully integrated manufacturing facilities that include independent product and process-oriented research.

Consequently, national variations in the composition of FDIUS are associated with differences

in the contribution that foreign affiliates make to

the U.S. technology base. The data are consistent

with this expectation. German affiliates in the aggregate have the highest R&D intensity of all foreign afiliates in the United States, which reflects

both the concentration of German FDIUS in

R&D-intensive industrial sectors such as chemi-
Chapter 6 Multinational Firms and International Trade I 151

cals and pharmaceuticals, and the willingness of

German-based MNEs to develop or purchase

technology assets in the United States. U.K. and

French affiliates have nearly average R&D intensities, which reflects the dispersion of each country’s investment across a range of industries with

different R&D requirements. Japanese affiliates

have a very low R&D intensity, which reflects

both the high percentage of Japanese FDIUS in the

wholesale trade sector, and the reluctance of Japanese-based MNEs to conduct technology development abroad.34

As discussed in chapter 4, R&D by foreign affiliates in the United States is relatively small but

is growing rapidly. It can play a large role in individual sectors. European affiliates, for example,

exhibit very high R&D intensities and contribute

substantially to technology development in the

U.S. pharmaceutical and chemical sectors. However, in the aggregate, most R&D conducted overseas by foreign affiliates is devoted to product

customization for local markets or, at best, to the

support of local production facilities. Fully integrated affiliates that conduct independent product

R&D are relatively rare, in part because overseas

R&D facilities are comparatively difficult to establish. In many industries, foreign plants can be

constructed quickly or moved on the basis of

changes in factor costs. R&D facilities, by contrast, take a long time to set up and are difficult to

move.

35

Apart from conducting R&D overseas, MNEs

can transfer process and product technology

abroad through FDI and local production. Indeed,

technological leadership often stimulates FDI.

Technological advantages and ancillary capabilities such as marketing know-how frequently outweigh the disadvantages of operating in

unfamiliar markets, and can encourage firms to

pursue market advantages on a global basis.36

In addition, MNEs can also use FDI as a means

of keeping abreast of technological developments

in foreign markets. In a globalizing economy,

where markets are liberalizing, technology is diffusing, and customization is increasingly important, firms must constantly upgrade and expand

their technological capabilities. Doing so often requires access to technological developments on a

global basis, wherever they emerge. Some analysts believe that there is no systematic evidence

that foreign firms use merger and acquisition strategies to obtain U.S.-developed technology. Others suggest that MNEs often enter into joint

ventures and other foreign investment arrangements to establish a listening post for overseas

technological developments.37

Among the major industrialized economies,

Japanese’ firms are most widely known for using

FDI as a means of acquiring foreign technology.

For example, U.S. investments by Japanese-based

MNEs in R&D-intensive, high-technology industries are frequently motivated by a desire to gain

34 See table 4-2 and figure 4-5 in chapter 4.

3S see chapter 4 for a discussion of R&D within MNE networks.

36 For exanlp]e, Jap~ese FDI in ce~aln ~gmen[s Of the semiconductor industry has been ascribed to leadership in MOS memory and biPoIar logic technologies. See Y. Kimura, “Japanese Direct Investment in the European Semiconductor Industry, “ in Mason and Incarnation (eds. ),

op. cit., footnote 29, p.300.

37 A Depaflment of Conlmerce study Conc]uded that foreign investors were not disproportionately interested in targeting high technology

acquisitions in the United States. See S.0. McGuire and D. Dalton, “Influence of Foreign Direct Investment on the Development and Transfer of

U.S. Technology,” in U.S. Department of Commerce, Economics and Statistics Administration, Foreign Direcl Int’esrment in [he United Stales:

An Update ( Washington, DC: June 1993), p.62. At the same time, MNEs frequently point to foreign technological capabilities as an important

motive for FD1. For instance, in a survey conducted by Japan’s Science and Technology Agency, Japanese MNEs cited the search for new

technologies as the second most important motive for investing in Europe and the United States (the first being to meet local market needs). See

OECD, Economic Analysis and Statistics Division, Directorate for Science, Technology and Industry, Performance of Foreign Afilia/es in

OECD CounmIe.Y (Paris, France: OECD, forthcoming), diagram 19p. 53. This motive was mentioned frequently in OTA interviews with MNEs

in Europe and Japan.
152 I Multinationals and the U.S. Technology Base

Industry All countries Germany U.K. Japan

Industrial chemicals 75 9 23 7

Drugs 26 2 6 7

Engines and turbines 7 1 1 1

Other transportation 21 1 10 1

Computers and equipment 77 6 19 20

Communications equipment 31 1 12 6

Electronic components 154 6 42 48

Instruments 131 10 46 27

Computer and data processing services 72 1 19 11

Engineering and architectural services 39 3 12 5

R&D and testing services 30 5 4 12

SOURCE: Adapted from Organisation for Economic Co-operation and Development, Economic Analysis and Statistics

Division, Performance of Foreign Affiliates in OECD Countries (Paris: OECD, forthcoming), p 91, table 5 of pre-publication draft.

access to U.S. technological capabilities, often

through cooperative agreements.

38 In many occasions these agreements resulted in the acquisition

of the U.S. company by the Japanese investor. One

report on foreign investment in U.S. high technology companies found that, between 1988 and

1993, Japanese companies accounted for 57 percent of all identified cases, having acquired or invested in 438 U.S. firms. Half of these

acquisitions were in information technologies,

primarily computers, semiconductors, and electronics. U.K. firms accounted for the second largest percentage of acquisitions, at 13 percent; they

focused on computers, electronics, and advanced

materials .39

Foreign acquisitions in the United States were

particularly common in the late 1980s.40 During

this period, MNEs based in Japan and the United

Kingdom acquired or established the largest number of U.S. high-technology firms (see table

6-6).41 Despite this similarity, Japanese and British FDIUS differed in two important respects.

First, Japanese investment in the United States expanded rapidly while U.K. investment grew by

smaller increments. In just over a decade, Japanese investment overtook U.K. investment that

had taken centuries to establish. Second, U.K. investment tended to be scattered over a variety of

unrelated sectors, ranging from publishing to precision instruments. By comparison, Japanese investment was concentrated in a set of vertically

integrated sectors, primarily electrical equipment,

primary metals, and motor vehicles.42 Third, U.K.

38 See B. Kogut ~d S.J. Chang, op. cit., foo~ote 20, p. 411. See also Drake and Caves, Op. cit., fm)trmte 20; and H. Yanlawdi, “Entw

Patterns of Japanese Multinationals in U.S. and European Manufacturing, “ in Mason and Encamation (eds. ), op. cit., footnote 29, p. I I.

39 See L.M. Swncer, F~reign Acquisitions Of ().s. High Technology Companies: Database Report (Washington ~: ESI, M~ch 1994), PP.

1,2 and 5.

40 see figure 5-8 in chapter 5.

11 sm a]st) Swncer, OP. cit. foomote 38.

42 See Figure 3-4 in U.S. Congrees, OTA, OP. cit., f(x)rn~te ZS? P. 58.
Chapter 6 Multinational Firms and International Trade I 153

affiliates spend more on R&D in the United States

than do Japanese affiliates. Finally, unlike the

U.S.-U.K. trade relationship, Japanese investment in the 1980s coincided with a record bilateral

trade deficit and a particularly high merchandise

trade deficit for affiliates.

Although Japanese MNEs appear to use FDI as

a strategic channel for acquiring foreign technology more frequently than others, the need to do so is

not exclusive. MNEs throughout the advanced industrial economies increasingly require access to

foreign technological developments, particularly

in R&D-intensive and technologically complex

industries. Executives of numerous MNEs told

OTA that technological capabilities have become

much more dispersed than in the past, and that

they need to maintain a global technological horizon to remain competitive. Moreover, the high

costs of maintaining technological leadership

have been pressuring them to focus on developing

their core technological competencies, while licensing or subcontracting subsidiary technologies

to other firms.

In this context, barriers to overseas investment

may exert a significant effect on the U.S. technology base, perhaps comparable to the technological

activities of foreign affiliates in the United States.

Ironically, the automotive industry illustrates this

point from both perspectives. In recent years, Toyota, Nissan and Honda have transferred much of

their manufacturing process technology and management techniques to their United States operations. Analysts widely conclude that diffusion of

this knowledge has assisted the Big Three in improving their own performance, leading to rapid

advances by the entire industry in assembly plant

productivity and quality. However, one of the reasons that U.S. automobile manufacturers had

become relatively uncompetitive in their manufacturing process technology is that, in the past,

they experienced restrictions to investment in Japan and consequently lacked the vantage point to

see important technological developments as they

emerged.

43 In short, in highly internationalized

industries, competitiveness requires constant exposure to new process and product technologies—

wherever they develop. When FDI is restricted,

whether through formal or informal barriers, firms

can be excluded from important developments in

product and process technologies, which can lead

to considerable competitive disadvantages.

Across the United States, Europe, and Japan,

legal barriers to investment are largely an anachronism. Nevertheless, as this and the preceding

chapter illustrate, imbalances in investment flows

remain. Although firm-level investment decisions

are complex and affected by a wide range of macro- and macroeconomic factors, the aggregate distribution of investment across the Triad suggests

that informal yet effective barriers to FDI persist.

As Part IV demonstrates, part of this problem may

be attributable to informal barriers that emerge

from fundamental differences in the structure of

corporate governance and finance across the

United States, Europe, and Japan.

~~ of course the difficulties experienced by the Big Three have been due to a complex array of internal and extemaI factors. . ,
Part IV: Corporate

Foundations

of National

Technology Systems

D

espite the current blurring of national economic boundaries, the competitive strength of individual firms continues to be shaped by circumstances prevailing in their

home countries. Those circumstances can provide firms

with advantages, or they can create disadvantages. Perceptions of

such advantages or disadvantages continue to influence the

investment decisions of multinationals, especially regarding

long-term investments in plant, equipment, research, and development—the wellsprings of future technological innovation.

Chapters 7 and 8 assess two principal asymmetries across national business environments, both of which are increasingly crucial to the investment patterns of American and foreign

multinationals and hence to the health and relative position of the

U.S. technology base. 1 Specifically, the chapters concentrate on

key differences in internal corporate governance and in the corporate role of financial institutions across the Triad. The analysis focuses primarily on the United States, Japan, and Germany, due to

the relative positions of these countries across a wide range of

technologically intensive industries.2 Moreover, the industrial

structures of these three nations fundamentally influence evolving contemporary economic trends.

] On the cOncept Of “natiOnal asymmetries,” see the first re~wt t)f this assessment:

U.S. Congress, Office of Technology Assessment, Multinationals mzd lhe National lntcresf.. P/ayng By Dlf)”eren: Ru/es, OTA-ITE-569 (Washington, DC: U,S, G(N emnwnt Prin[-

ing Office, September 1993), ch. 2.

2 For a broad overview, see U.S. Ctmgress, General Acc(mnting oflicc, <’wnpc/Iriteness Issues: The Business En\ Ironmen/ in the Unlled Stater, Japan, and <jerman}, GA()/

GCD-93- 124 (Washington, DC: August 1993).

I 4P-T f-----it--’--r I

I 155
156 I Multinationals and the U.S. Technology Base

In practice, corporate governance patterns and

financial systems are often linked. They are also

connected to idiosyncratic national accounting

standards, tax policies, bankruptcy rules, competition policies, and other factors that affect the

environment within which corporate strategies are

set. Bearing these other factors in mind, the main

purpose of chapters 7 and 8 is to provide an

orientation to important policy issues that arise

from persistent national differences in the ways

multinational firms govern themselves internally

and in the enduring character of their involvement

with financial institutions.

Although the chapters highlight the strengths

and weaknesses of the traditional systems of corporate governance and long-term corporate finance in the United States, Germany, and Japan,

they do not assert the superiority of any one system. During the late 1980s, it became quite common in policy circles to find fault with corporate

America and its financial underpinnings. In the

midst of severe recession in both Japan and Germany during the early 1990s, it was just as easy to

spot the flaws in the respective approaches of

those countries. Such debates will continue.

Chapters 7 and 8, however, assess the impact of

national differences that cannot be expected to

disappear in the near term. Such differences are reflected in the technology bases of the three countries, and will likely contribute to increasing

political tensions in an era of heightened competition among multinationals.

The analysis presented in chapters 7 and 8 relies in part on extensive OTA interviews with

executives of multinational enterprises (MNEs)

and banks in the United States, Europe, and Japan.

Business executives as well as policymakers

readily convey the importance of corporate governance and financial systems to the business activities of MNEs and consequently to the economic

strategies of nations. However, the subjects of corporate governance and finance are less amenable

to aggregate, quantitative analysis than are the

other areas covered by this assessment. Compared

to R&D and FDI, there is little quantitative data

available on the effects of differences in either corporate governance patterns or financial market

structures per se, and there are few comparative

empirical analyses in the open literature. Accordingly, the analysis presented here is necessarily

more descriptive and less data-intensive than that

contained in Parts II and III of this report.

FINDINGS

1.

2.

3.

4.

Critically important distinctions persist in the

ways corporations govern themselves and

raise long-term capital across the United

States, Germany, and Japan. Expectations

concerning the ultimate convergence of these

systems should be kept modest. National patterns are embedded in deep social and cultural

traditions, and they can be reinforced more

than eroded by turbulence in the global

economy.

In particular, distinctive systems of institutional cross-shareholding and corporate banking should continue underpinning Japanese

MNEs and a widening array of European

MNEs. Arguably, those systems can, in certain circumstances, slow down processes of

technological innovation. They can also,

however, provide stable financial foundations

that help facilitate the commercial adaptation,

incremental improvement, and optimal diffusion of new technologies

For the foreseeable future, it is likely that differences in national systems of corporate governance and corporate financing will be the

source of increasing friction in the complex

economic relationships evolving among the

United States and several of its major trading

and investing partners.

The ability to raise capital on competitive

terms and to deploy it effectively is crucial

both to the long-term success of particular

MNEs and to the development of critical

technologies for individual countries. Global

financial integration continues apace, however, especially with regard to short-term
Part IV Corporate Foundations of National Technology SystemsI 157

capital.3 In partial response, many MNEs are

redeploying corporate assets to take advantage of new financial opportunities and to

hedge against heightened financial uncertainties. But long-term investment patterns continue to differ significantly across countries

and sectors.

5. American capital markets are the largest, most

decentralized, open, and transparent in the

world. Japanese and German capital markets

are changing, but they remain relatively concentrated and opaque. The providers of longterm capital, in particular, remain more

patient in Germany and Japan than in the

United States. Firms based outside the United

States are able to enjoy full access to U.S. capital markets. Firms based outside Japan and

Germany, on the other hand, are less able to

benefit from the strengths inherent in those

capital markets.

6. National asymmetries in corporate governance and corporate financing have important

consequences for industry. Many other factors, of course, contribute to industrial success or failure. But solid financial foundations

are critical. The fact that a number of premier

American firms exited from the important and

rapidly growing consumer electronics sector

during the 1980s, for example, has been ascribed to myriad factors. But it is no coincidence that the Japanese and European MNEs

that took their places were able to rely on more

stable governance and financing structures.

7. Compared with Germany and Japan, the financial markets of the United States are more

supportive of novel technological development. They therefore remain a source of considerable national strength. In the recent past,

however, they have been less supportive of

the kinds of medium- and long-term investment required to commercialize new

products, such as building advanced manufacturing facilities that anticipate demand.

Since the development of next-generation

technologies often is associated with such facilities, this kind of short-term focus, even if

a cyclical phenomenon, can have negative

consequences for the national technology

base.

8. Japanese and German patterns of corporate

governance and corporate financing are often

depicted as comparatively rigid and ill-

-adapted to the initial development of novel

technologies. They can, however, be quite effective at marshaling the long-term financial

resources needed to build advanced manufacturing facilities. Historically, they have encouraged the relative concentration of such

facilities within national markets.

9. National financial asymmetries can skew

competition among MNEs, especially if outright corporate failure is precluded or discouraged in some countries. Waiting for structural

convergence provides an excuse to avoid reflecting on problems in the U.S. technology

base. To be sure, in the mid-1990s that base

looks relatively stronger in a number of sectors than it did a decade earlier. Moreover,

many vulnerabilities, which came to the fore

in the 1980s, reflect internal factors that have

little to do with MNEs. Low national savings

rates and problems in the U.S. educational

system, for example, are frequently cited. The

strategic investment behavior of MNEs, however, deserves to be assessed in this connection. MNEs make many of the long-term

investment decisions that create new technologies, and they can determine where full development takes place. In this respect,

however, all MNEs do not act alike.

10. Japanese and German systems of corporate

governance and long-term corporate financing are adjusting somewhat as national and

global market conditions change. Pessimistic

forecasts concerning the technological futures of these systems are overdrawn. Each

system remains quite capable of once again

effectively raising considerable financial and

3 OTA, ,k!ltlfln{ltfon[ll~ find the ,National lnteres~, op. cit., f(u)tn(~te 1, ch. 6.
158 I Multinationals and the U.S. Technology Base

managerial resources and focusing them on

the development and commercialization of

leading-edge technologies. The American

counterparts to those structures, to be sure,

have their strengths. But it is premature to

conclude they have proven their superiority,

especially when it comes to providing solid financial and social foundations for future technological development within the United

States.

11. Japanese and German corporate governance

and financing structures promote the creation

of organized corporate networks. Such alliances, often centered on banks, provide financial stability and facilitate long-term

planning. Although economic turbulence in

the Japanese and German economies has reduced the level of intercorporate alliance activity, OTA interviews indicate that the core

alliance structures of major MNEs are not

breaking down. In the face of deep domestic

and regional recessions, the value of these alliances to many Japanese and German MNEs

has been reinforced. Without them, retooling

and continuing investment in new technologies would pose greater challenges. The process of adjusting to a new competitive

environment might also be more rapid and violent. In the view of a number of senior executives of Japanese and German MNEs, such a

course would risk severe instability in the social bases within which their firms are and

will remain embedded.
Corporate

Governance and

National

Technology

Systems 7

P

olicymakers and academic analysts have paid increasing

attention to the ways in which different systems of internal corporate governance affect the long-term planning

and investment decisions of corporations. 1 The issue is of

direct relevance to this assessment, for these decisions constitute

the fundamental building blocks for national technology systems.

Since a strong technology base is crucial to national prosperity,

such decisions have consequences that go far beyond the immediate interests of individual corporations.

The term “corporate governance” refers broadly to the rules

and norms that guide the internal relationships among the various

stakeholders in a business enterprise. These stakeholders typically include owners, directors, managers, creditors, suppliers. employees, and customers. The emphasis here is on the central

relationships between the managers of a corporation and the owners of voting shares, whose interests are intermediated by boards

of directors. Those relationships center on rights and obligations

that are either specified in law or legitimated by long-standing

custom and practice.

Since MNEs span a number of legal jurisdictions, their governance is more complicated than that of local firms. The core governance structures of almost all MNEs nevertheless are associated

with prevailing norms in the jurisdiction within which their head

1 For analy tlcal perspwtl~ftx, sw (). W’ill]amstm, “’CfJrpJratc Finance and Ctwptmt[e

Gt\\emance,” 7’he .)oI/rrm/ {~1 Finance 43(3):567-591, Jul] 1988, and M.J. R(w, ‘“S(mw

Differences m C(wpmitc Structure in Gcmumy, Japan, and the Untted States,” with respmses by J.M. Rarnseycr and R. R(mlam), Ya/c lm}i Jourmil 102(8) 1927-2037, June

1993. Also sw “’C’(mp~rate Gt)\emancc Watching the Boss.’” 7’/1(’ E(”OWI?I1 it 330(7$$8 )“

SS3-SS5, Jan, 29, 1994.

l——————lt——————

l—-----l------n

I

I

I 159
160 I Multinationals and the U.S. Technology Base

offices are incorporated.2 Competition among

MNEs therefore embodies the frictions that occur

when distinctive national systems of corporate

governance become ever more interlinked.3 The

following sections examine basic differences

among the systems of corporate governance prevailing in the United States, Japan, and Germany.

CORPORATE GOVERNANCE IN THE

UNITED STATES

In the United States, corporate governance, corporate investment, and the national technology base

are intimately connected. Corporate governance

for American-based MNEs, and publicly owned

American firms in general, centers on legal relationships among shareholders, directors, and

managers. Under the rubric of federalism, the

foundations for those relationships are set primarily in state law, although various national laws,

and American culture more broadly, influence that

law.4 It was once conventional to refer to the system as “shareholder capitalism.”

In reality, the voice of individual shareholders

in the United States has declined over time. With

the rise of institutional investors and the increasing turnover of shareholders during recent decades, the links of accountability between owners

and managers have weakened. A spectacular series of hostile corporate takeovers during the

1980s served not to redress the situation but to exacerbate it. The takeover movement, for example,

soon set state legislatures and corporate managers

to work building ever higher legal hurdles to stymie potential raiders. In such a context, the system

seems more accurately labeled “competitive managerial capitalism.”5

In the traditional terms of American liberalism,

corporations exist mainly to create wealth for their

owners. Owners delegate their right to oversee the

corporation to a board of directors, and directors

empower managers to run the corporation. In

theory, owners have a stake in the long-term success of the corporation. Moreover, they may replace directors, and through them managers, if

they perceive the actions of those managers to be

compromising that success. In practice today,

however, the owners of most American MNEs

tend to be institutions that trade their shares frequently. In recent years, the fastest growing institutions have been mutual funds (see figure 7-1 ).

Indeed, for the 1,000 largest corporations in the

United States, estimates of the percentage of voting shares held by mutual funds, pension funds,

and other investment vehicles run as high as twothirds.6 In addition, except in atypical cases, neither the directors nor the managers of American

MNEs are actually chosen by shareholders. Most

directors on MNE boards are outsiders chosen by,

and often beholden to, chief executive officers.

In the wake of subnational efforts to make

1980s-style hostile takeovers more difficult, the

managers of many U. S-based MNEs have, in

theory, gained a degree of operational autonomy.

Whether this is a positive or negative develop2 Ft)r relevant debate, see R.B. Reich, “Wht} 1s Us’?’ ’}{art’ard B~{.$iness Retiew’68( I ):53-64, January-February 1990; and L.D. Tyson, “They

Are Not Us: Why American Ownership Still Matters,” 71e American Prospe(”~ (4):37-49, Winter 1991.

3 on the m)ti(m of “system fricti(m,” see S. ostry, Go\’ernrnen(s and Corporations in a Shrinkin8 World: Trade and Inno\’ation Policies in

(he United S/ales, Europe and Japan (New Y~)rk: Cmmcil on Foreign Relations Press, 1990). Also see J.H. Dunning, ‘The Global Economy,

Domestic Governance, Strategies and Transnatimud Corporations: Interactions and Policy Implications,” Transna~ionn/ Corpora/ions

I (3).7-45, 1992.

~ See M. J. Roe, “A P(ditical Thtwry of American Corp)rate Finance,” Co/un]bia Lmi Journal 91(1): 10-67, January 1991.

5 A. Chandler, Sea/e and Scope (Cambridge, MA: Harvard University Press, 1990), pp. 62 I -627.

6 J.W. Lorsch and E. Maclvcr, “Cmporate Governance and Investment Time Hm-izons,” background paper prepared for M. Porter et al.,

Cupid Choices, A Report to the Ctmncil on Competitiveness and co-sponsored by the Harvard Business School, June 1992. Note that of the 50

largest publicly held American companies, only seven have a shareholder with more than a 10 percent stake. Note also tbat the scale and rapidity

of the tumtwer of shareholders has increased tremendously in recent decades. In the mid- 1960s, for example, large block trades represented

ar(wnd 3 percent of the annual volume of trading on the New York Stock Exchange. By the late 1980s, they exceeded 50 percent.
Chapter 7 Corporate Governance and National Technology Systems I 161

+ Number of mutual funds

m

m

 Taxable and nontaxable money market funds

 Bond and Income funds

A

Equity funds

&

1984 1985

4

I I

I

I I

1986 1987 1988 1989 1990 1991 1992 1993

SOURCE: Investment Company Institute, 1994 Mutual Fund Fact Book, 34th ed. (Washington, DC Investment Company Institute, 1994), pp. 98-99

ment is the subject of much debate. It should be

noted, however, that the excesses of the 1980s

have had more subtle effects. Many corporate

boards, for example, have become more assertive

in meeting their oversight responsibilities. This

has been especially obvious in cases where corporations have come under severe financial pressure,

and it has culminated in the recent ouster of the

chief executive officers of several leading American MNEs, including IBM, Westinghouse, and

Kodak, Behind this new assertiveness often lay

the discontent of large institutional shareholders.

This may be a cyclical phenomenon, or it could

signal a revival of shareholder activism. In the

course of OTA interviews for this assessment,

several directors of American MNEs praised the

heightened interest in monitoring corporate performance that has come from large institutional

shareholders like the California public-employees’ pension fund (Calpers) and various

mutual funds. They noted, however, that it remained an open question as to whether a basic

change in American corporate governance was

afoot.

The American system still stresses indicators

of short-term financial performance. Securities

analysts evaluate firms largely on the basis of

quarterly earnings reports, and their assessments

exert far more influence over managerial decisions than do shareholders. Indeed, most American shareholders have little voice in day-to-day

management, although they do have the option of

exit. And they continue to exercise that option

with much more vigor and regularity than do their

counterparts abroad. For all the talk in business

circles about the wisdom of the kind of long-term

strategy associated with such investment firms as

Berkshire Hathaway, the prospect of exiting

quickly retains its attractiveness for most investors. This is especially true for mutual fund managers whose own performance (as agents for

individual investors, not as direct owners) is measured on a rigorous comparative basis that emphasizes the short term.

Because of their reliance on open and active

stock markets to raise new capital directly, as well

as to provide indirect signals to lenders and other

stakeholders, managers of American MNEs oper-
162 I Multinationals and the U.S. Technology Base

ate from abase that encourages them to emphasize

short-term returns. With individual and institutional owners frequently changing, they actually

have little direct influence on corporate decisions.

The constant churning of the shares of large corporations does, however, get one message across:

keep earnings rising on a steady track. The message is often strongly reinforced by the tying of

personal compensation packages for senior

executives to stock market performance. Two astute observers summarize the consequences:

U.S. CEOs understand this message. When they

issue their companies’ quarterly earnings report

and meet with security analysts, they believe

they are being judged on a 90-day basis. If the

verdict is not positive, many sell orders will be

forthcoming with a commensurate decline in

share prices. In an era when many CEOs have

been seriously concerned about unfriendly takeovers, such a decline was an especially unpleasant prospect. But even in more halcyon times,

CEOs feel the pressure to keep earnings up.7

As many business and academic observers

point out, this obsession with the short run can seriously hamper the development of optimal corporate strategies, especially in sectors characterized

by short product life cycles. The pressure to keep

current earnings high and dividend payments

stable can force firms to postpone the long-term

investments and restructuring measures needed to

stay competitive .

8 Delays or cuts in expensive investments in technology, or in the new plants from

which new process technologies develop, can

have a positive effect on current financial statements. In the long run, however, imprudent delays

or cuts will have a negative impact on performance. Theoretically, this impact should be discounted in current stock prices. In practice,

information flows imperfectly, and rarely are the

motives for managerial decisions obvious. The

perception that short-term thinking by corporate

managers weakens the technology base of the

country therefore has become more widespread.

Compounding the tendency to emphasize the

short term in managerial decisionmaking are the

vagaries of the U.S. corporate proxy voting system, which can make it difficult for shareholders

to cooperate in disciplining entrenched managers.

Working in the same direction are disclosure

requirements and antitrust rules that preclude

significant cross-shareholding by unrelated corporations. For example, under rules first specified

in the 1934 Securities and Exchange Act, when an

individual or related group seeks more than 5 percent of the shares of a corporation, public disclosure of plans, financing sources, and other

information is required.9 Securities and Exchange

Commission (SEC) proxy rules can also come

into play when a group seeking a controlling position is formed. Together with various impediments that have been put in place by state laws in

the wake of the “takeover wars” of the 1980s, such

rules have made both costly and risky the assemblage of large blocks of stock or significant crossshareholdings.

Senior executives of several leading U. S.-

based MNEs told OTA that their investment planning was frequently constrained by the need to

satisfy the expectations of temporary shareholders

as expressed in current stock prices. They admitted that their R&D budgets, in particular, suffered as a result. Several executives expressed

concern that many of their foreign-based competitors faced a much less binding constraint and were

therefore better able, for example, to maintain

R&D expenditure levels over an entire economic

cycle. More specifically, they suspected that differences in corporate governance helped to explain the maintenance, or at most the marginal

7 Ibid.

8 See M.T. Jacobs, Shorr-Term America: The Causes and Cures of Our Business Myopia, (Boston, MA: Harvard Business School Press,

1991 ), chs. 2, 3.

9 F.R. Edwmds and R.A. Eisenbeis, “Fin~cia] Institutions and Corporate Investment Horizons: An International Perspective,” background

paper prepared for M. Porter et al., Capifal Choices, op. cit., ftxmmte 6.
Chapter 7 Corporate Governance and National Technology Systems I 163

trimming, of R&D spending by many Japanese

MNEs even as their earnings came under severe

pressure in the early 1990s.

CORPORATE GOVERNANCE IN JAPAN

The effort to understand how Japanese corporate

governance differs from the American system has

in itself become something of a growth industry.

The once common view that Japanese MNEs represent the visible face of Japan Inc., with the implication that government really calls the shots, is

now widely dismissed as simplistic. So too is the

more recent characterization of those firms as run

by and for a managerial elite, accountable to no

one, including government or traditionally passive shareholders. Impressions garnered in OTA

interviews in Japan with senior corporate executives, government officials, and others support a

more complex view

The managers of Japanese MNEs do play the

key role in a system of corporate governance that

has evolved over time. 10 And, indeed, the system

does free them from some of the pressures for

short-term returns that their American counterparts face. Extensive institutional cross-shareholding arrangements, for example, can explain

why real earnings might be allowed to fluctuate

widely in order to keep R&D budgets stable.

However, executives of Japanese MNEs, most of

which are embedded in keiretsu networks, are accountable for their performance to a wide array of

constituencies. Some of those constituencies may

be represented on the board of directors, but most

directors are in fact insiders.

The constituencies to which Japanese directors

and managers must and do attend include employees, the MNE’s lead bank, its other long-term

creditors, corporations with which it is affiliated

in keiretsu or other intercorporate groupings, suppliers, and important customers. These constituencies share certain basic interests in the firm

beyond simple survival. Unlike the case of their

American counterparts, however, it is impossible

to agglomerate those interests under a single financial indicator, such as return on investment.

Nevertheless, one interest has long been broadly

shared by many constituencies: the need both to

compensate for past technological weakness and

to ensure technological parity or leadership in the

future. Indeed, this theme was a common refrain

throughout a series of OTA interviews with senior

executives in Japan. The structure of corporate

governance in contemporary Japan has evolved in

light of that overriding interest.

In contrast to the legalistic, arm’s-length, and

often antagonistic relationships at the core of

American corporate governance structures, the

Japanese equivalent is a system of “networks”

built upon relationships of trust, the reciprocal exchange of information, technology, and other

benefits, and expectations of long-term endurance. Within a corporate network, managers often

compete energetically, but they also cooperate to

the extent required to maintain both the network

and their place within it. During periods of crisis,

this can entail direct support of one another’s internal organizational affairs.

For most Japanese MNEs, internal network

structures are linked to, and reinforced by, external linkages to financial institutions and other

firms. l1 These tend to be stable and are often

sealed by mutual cross-shareholdings. Individual

lo See U, Schacde, “understanding CfJ~)rate Governance in Japan: Do Classical Concepts Apply’?” Industrial and Cwpwate c~w?e

3(2): f(wthcoming, 1994.

I I See M. ti,G.G. Hamilton, and M. Suzuki, patterns of Inter-Firm Control in Japanese Business, Papers in East Asian Business and

Development, N(). 7, Institute of Governmental Affairs, University of Callfomia, Davis, 1989.
164 I Multinationals and the U.S. Technology Base

Percentage of firm’s stock held

by other group members or

Financial Institutions affiliated companies

Sakura Bank 15,98

Mitsui Trust & Banking 24.42

Mitsui Kaijo Kasai 28.90

Trading, Manufacturing, and Other

Mitsui Bussan

Mitsui Mining

Mitsui Construction

Sanki Engineering

Nippon Flour MiIIs

Toray Industries

Oji Paper

Mitsui Toatsu Chemicals

Denki Kagaku Kogyo

Mitsui Petrochemical Industries

Onoda Cement

Japan Steel Works

Mitsui Mining & Smelting

Mitsui Engineering & Shipbuilding

Mitsukoshi

Mitsui Real Estate Development

Mitsui O.S.K. Lines

Mitsui Warehouse

Toshiba

Ishikawajima Harima

Toyota Motor

20,11

37.48

41,96

20.65

26.32

16,45

1211

18,65

17.56

38.39

19,94

19.56

12.70

1816

14.39

17,64

21,60

29,95

11.41

10,72

10,30

NOTE: Data is for fiscal year 1992, ended March 31, 1993, and is drawn from a survey conducted by Toyo Keizai of 2,131

firms Iisted on Japanese stock exchanges

SOURCE: Kigyo Keiretsu Soran (Tokyo: Toyo Keizai Shinposha, 1994), pp. 44-45

shareholdings may be small, but their size is often interdependence, especially obvious in the major

not as significant as their existence, for they signi - bank-centered keiretsu (see tables 7-1 to 7-4). On

fy valued and often enduring business relation- al aggregate basis it can effectively close the marships. 12 Reciprocal equity ownership comprises a ket for corporate control, not only for new foreign

critical element in a web-like system of corporate entrants but also for potential domestic rivals.

I z F[)r Sma[]er Japanese conlPie5 mat are not part of keiretsu netwm-ks, large shareho]dings are more common and they can provide the

key mechanism for exerting influence over management. See S. D. Pmwse, “The Structure of Corporate Ownership in Japan,” The Journul of

Finance 47(3): 1121-1140, July 1992.
Chapter 7 Corporate Governance and National Technology Systems

Percentage of firm’s stock held

by other group members or

Financial Institutions affiliated companies

Mitsubishi Bank 2562

Mitsubishi Trust & Banking 17.35

Nihon Shintaku Ginko 13,59

Tokyo Marine & Fire Insurance 22.61

Trading, Manufacturing, and Other

Mitsubishi Shoji 33.22

Kirin Brewery 1920

Mitsubishi Rayon 2285

Mitsubishi Paper MiIIs 3187

Mitsubishi Kasei 22.12

Mitsubishi Gas Chemical 2468

Mitsubishi Petrochemical 32.99

Mitsubishi Jushi 57.32

Mitsubishi 011 4460

Mitsubishi Steel Manufacturing 3718

Mitsubishi Materials 2490

Mitsubishi Shindo 53.27

Mitsubishi Cable Industries 4975

Mitsubishi Kakoki 3668

Mitsubishi Electric 1647

Mitsubishi Heavy Industries 19.93

Mitsubishi Motors 56.44

Mitsubishi Estate 2646

Nippon Yusen 26.07

Mitsubishi Warehouse 42.57

Asahi Glass 28.09

Nikon 27.88

— —

NOTE: Data is for flscal year 1992, ended March 31, 1993, and is drawn from a survey conducted by Toyo Keizai of 2,1 31

firms Iisted on Japanese stock exchanges

SOURCE: Kigyo Keiretsu Soran (Tokyo: Toyo Keizai Shinposha, 1994), pp. 46-47

In the early 1990s, more than half of the out- With little fear that key shareholders will

I 165

sell,

standing shares of publicly listed Japanese corpo- managers can be conservative in their payouts.

rations were held by Japanese financial They can also compensate their main shareholders

institutions and other corporations. 13 The histori- in other ways; for example, they can give their

cally low dividend rates of most Japanese corpora- lead banks a right of first refusal when they have

(ions surely have something to do with this fact.

13 w.c Kes[er, “Gt)vemance, contracting, and Investment Time Horizons,” Working Paper 92-003, Harvard Business Schw~l, Division of

Research, 1991. See also U. Schaede, op. cit., footnote 10, table 2.
166 I Multinationals and the U.S. Technology Base

Percentage of firm’s stock held

by other group members or

Financial Institutions affiliated companies

Sumitomo Bank 1932

Sumitomo Trust & Banking 26.64

Sumitomo Marine & Fire Insurance 26.62

Trading, Manufacturing, and Other

Sumitomo Shoji

Sumitomo Coal Mining

Sumitomo Construction

Sumitomo Forestry

Sumitomo Chemical

Sumitomo Bakelite

Sumitomo Cement

Sumitomo Metal Industries

Sumitomo Metal Mining

Sumitomo Light Metal Industries

Sumitomo Electric Industries

Sumitomo Heavy Industries

Sumitomo Realty & Development

Sumitomo Warehouse

Nippon Sheet Glass

NEC

33.08

38.59

30.44

29.92

23.11

47.40

32.34

19,50

29.87

48.48

20.84

28.38

17,38

37.49

2534

27.10

NOTE: Data Is for fiscal year 1992, ended March 31,1993, and Is drawn from a survey conducted by Toyo Keizai of 2,131

firms listed on Japanese stock exchanges

SOURCE: Kigyo Keiretsu Soran (Tokyo: Toyo Keizai Shinposha, 1994), pp. 44-45.

external financing requirements, and they can direct other types of business to related companies.

Sectoral studies indicate a much wider set of

reasons for reciprocal corporate shareholding.

These include the desire to solidify a relationship

with a leading supplier of vital technology. It is

well known, for example, that Japanese automobile companies frequently push key engineering

and design functions to their supplier companies.

Cross-shareholding can seal the relationship of

technological cooperation and mutual dependence that thereby results. 14

Corporate interlocks can represent the legacy

of divisions that were spun off as independent

companies once they became strong enough.

Cross-shareholding can represent the purchase of

“insurance policies” from financial institutions.

Both types of linkage yield a degree of protection

in the event of a crisis, albeit at the possible price

of having to allow the financial institutions to intervene directly in management. In addition,

cross-shareholdings can create a kind of leverage

that helps assure performance under other types of

contractual or noncontractual business arrange14 For a defense of the system, see Y. R.mugi, “What Share Cross-Holdings Mean for Cm-porate Management,” Economic Eye

I 1(1): 17-19, spring 1990.
Chapter 7 Corporate Governance and National Technology Systems I 167

Percentage of firm’s stock held

by other group members or

Financial Institutions affiliated companies

Fuji Bank 26.28

Yasuda Trust & Banking 26.38

Yasuda Fire & Marine Insurance 18.16

Trading, Manufacturing, and Other

Marubeni

Taisei

Nissin Flour Milling

Sapporo Breweries

Nichirei

Nisshinbo Industries

Toho Rayon

Showa Denko

Kureha Chemical Industry

Nippon Oil & Fats

Tonen

Nihon Cement

NKK

Kubota

Nihon Seiko

Oki Electric Industry

Yokogawa Electric

Tokyo Tatemono

Tobu Railway

Keihin Electric Express Railway

Showa Line

Hitachi

Nissan Motor

Canon

19.05

9 0 2

941

2265

10.87

1458

4330

1957

2132

24.46

1024

1995

1348

1058

2 2 7

2187

1098

2748

6 3 8

9 5 0

3552

5 0 7

1464

10.20

NOTE: Data is for fiscal year 1992 ended March 31 1993 and IS drawn from a survey conducted by Toyo Keizai of 2,131

firms listed on Japanese stock exchanges

SOURCE: Kigyo Keiretsu Soran (Tokyo: Toyo Keizai Shinposha, 1994), pp. 48-49

ments. Therefore, it is not surprising that Japanese Under the aegis of this system of corporate govcorporate managers “tend to view their proximate ernance, Japan successfully built up its economy

task as being the preservation and enhancement of throughout the past few decades. Despite the efthese complex relationships rather than the im- fectiveness of this system, some observers have

mediate, direct pursuit of any one stakeholder’s recently argued that it is now breaking down, as

interests, such as that of exclusive equity owners.”] 5

the inevitable consequence of both corporate ma-
168 I Multinationals and the U.S. Technology Base

Mitsui Mitsubishi Sumitomo Fuyo Sanwa DKB

1980 17.62 29,26 26.74 16,26 16,78 14.12

1985 17,87 25,18 25.01 15,79 16.84 13.33

1988 17.09 26.87 24.42 15,29 16,38 12.24

1991 16.58 26.37 24.67 15,62 16.67 12.16

1992 16,58 26.33 24.65 15.62 16,72 12.19

NOTE: Cross-shareholdings are the average of the ratios of stocks in one member company owned by other companies withln the group

SOURCE: Adapted from Kigyo Keiretsu Soran (Tokyo: Toyo Keizai Shinposha, 1987, 1990, and 1993)

turity and global financial integration. Despite

some evidence of marginal changes in the system,

OTA interviews and analysis indicate caution in

the interpretation and projection of those changes.

To some extent, the weakening of equity ties

between financial intermediaries and Japanese

MNEs during the late 1980s and early 1990s reflected the unusual circumstances of Japan’s financial bubble. Although the bubble weakened

some cross-equity linkages, it actually reinforced

others—particularly those of the older, core keiretsu. The bursting of the bubble encouraged a

number of firms to repair their financial relationships, despite the fact that major banks were having severe difficulties. In this regard, the

publicized instances of firms selling off their

holdings in banks appear to be exceptions to the

rule, especially in keiretsu networks.

Senior Japanese executives quite openly explained to OTA that selling member holdings

risked retaliation. This is not to say that the system

is inflexible. Many companies have rationalized

their cross-shareholdings and reduced their volume. However, since the number of shares held is

often unrelated to the degree of inter-corporate influence, neither development necessarily implies

the unraveling of the cross-shareholding system.

16 Certainly within the major keiretsu,

changes in the cross-shareholding system over the

past decade show almost no decrease. Table 7-5 illustrates this pattern within six major keiretsu.

Within Japan’s corporate networks, managers

are frequently disciplined by their bankers or related companies for poor performance, although

the system may also effectively allow them to defer painful decisions. Obviously weak firms, however, tend to be quickly and quietly liquidated or

merged. Nissan, for example, effectively took

over the management of Fuji Heavy Industries

(manufacturers of the Subaru marque) in 1990. At

the time, Nissan owned only 4 percent of Fuji’s

shares, but the two companies collaborated intensively and shared managerial staff. The de facto

“takeover” occurred without any debt being restructured or any transfers of stock between Fuji

major shareholders. The role of financial institutions is critical in such cases, and analysts have

gone so far as to depict the direct discipline such

institutions can exercise as the functional equivalent of a U.S.-style market for corporate

takeovers. 7

At certain points in Japanese history, government played the key role in nurturing this form of

lb me ana]ysls of the issue, for examp]e, found no evidence that the influence of financial institutions diminished during the bx)ming

1980s. See F.R. Lichtenberg and G.M. Pushner, “Ownership Structure and Corporate Perfm-mance in Japan,” Working Paper No. #4@2, National Bureau of Economic Research, June 1992. On the lack of a direct relationship between ownership per se and effective influence, see

Schaede, op. cit., footnote IO.

17 Ibid, and Kester, 0p. cit., footnote 12. This theme will be taken up again in ch. 8.
Chapter 7 Corporate Governance and National Technology Systems I 169

corporate governance. In addition to encouraging

cross-shareholdings and carefully shaping the

institutions that would manage corporate finance,

it accepted cautious disclosure standards, and

sometimes sanctioned cartel-like arrangements

(especially in troubled industries) and other business practices that had the effect of restricting

market access. 18 Certainly during the past two decades, the direct impact of government has been

more subtle, but its residual influence is still important. As corporate officials repeatedly told

OTA, even during a period of political instability,

officials within the relevant ministries remain capable of dispensing “administrative guidance.”19

In short, the Japanese system of corporate governance renders the managers of Japanese MNEs

accountable to others, including a wide range of

stakeholders as well as governmental authorities.

But that same system has freed them from the need

to focus their strategies rigidly on achieving high,

direct, and near-term returns to shareholders.20

This has enabled most Japanese MNEs to pursue

the kinds of longer-term strategies required to develop and commercialize new technologies. The

system has also provided those MNEs with implicit safety nets in the event of serious managerial

mistakes or unanticipated market shocks. Among

other things, the existence of such safety nets can

explain why outright corporate bankruptcy in Japan appears to be less frequent among large firms

and less costly than in the United States. It also accounts in part for the oft-noted ability of Japanese

MNEs to downplay short-term calculations of return on investment for long periods of time while

market shares abroad are established or defended.

Finally, whether deliberately or not, the system

has worked to discourage new entrants—both foreign and domestic—to Japanese markets, especially but not exclusively when entry has been

sought by way of acquisition.

The relationships that underpin particular Japanese MNEs may shift overtime, but periods of turbulence often bring to light not the fragility but the

durability of traditional patterns. In contrast to the

American system, the Japanese system of corporate governance well deserves the label “alliance

capital ism.”21 The system has commanded respect from outsiders, not in the least because of its

apparent effects on long-term managerial thinking

and investment in key technologies. While the

system may be under unusual strain today, it is

more difficult to imagine its demise than its

adaptation to new circumstances.

CORPORATE GOVERNANCE

IN GERMANY

Despite the economic troubles it encountered in

the years following unification, German y remains

the industrial leader of Europe.

22 The European

technology base continues to be influenced more

by German industry than by that of any other European country. To be sure, French, Dutch, U. K.,

and Swiss MNEs dominate particular industrial

18 see j.A. Hafl, Rl,O/ CapltO/,Yt,Y: Interna[l<)nol conl,)cti~;~ene,~y in (he Uni[ed Slare<y, J~pan, ~nd w~.f(ern k’tiropf (Ithaca, NY Cf)mt?li

University Press, 1992), ch. 2; D.J. Encamati(m, R[\a/s Beyond Trade: American tersu.$ Japan in G/oba/ ~’ompcrr~lon (Ithaca, NY C(~mclI

University Press, I 992).

I Q See also u. Schaede, “change and Ctmtinuity in Japanese Regulation,” W(wking Paper 66, Berkeley R(wndtablc (m the Intematl(mal

Economy, University of California, March 1994.

20 C(mlpared to U.S. managers, the relative freedom of Japanese managers from immediate shareholder interests is Illustrated b) lhc fa]lcd

efforts of U.S. pension funds to influence the management decisions of several Japanese corporations at thmr 1993 ,annual mcetlngs. SCC J.

Stemgold, “Japanese Companies Rebuff Mighty U.S. Pension Funds,” The Ne\* York Times, p. D], June 30, 1993.

21 M. Gcrlach, A//lance Cap~/a//.rm: The Social Or,ganl:arron ofJapane!e Bminess (Berkeley: University of California press. 1992). SW

also Lichtenbcrg and Pushncr, op. cit., fmtm~te 15.

‘z This leadership was underlined when profits began a sharp retxmnd in early 1994 in a number of core GemIan industries. See K.L. Mlllcr

and D. Wise, ‘“Slash and Earn on the Continent,” Business WecL (3369). 45-46, May 2, 1994.
170 I Multinationals and the U.S. Technology Base

sectors. But German MNEs continue to hold the

key to the evolving integration and development

of European industry in general.

Like American and Japanese MNEs, German

MNEs are embedded in a distinctive system of

corporate governance with deep roots. The system

is distinguishable from that of France, and it differs quite markedly from that of the United Kingdom; in some ways, it is similar to that of Japan.

Although currently under some stress, the German system comprised a critical component of the

country’s initial industrialization and of its recovery and growth after World War 11.23

Germany’s corporate governance, together

with the country’s approach to regulating the

broad framework within which government, corporations, and labor unions continually negotiate

their respective adjustments to market conditions,

produces an advantage in a number of industrial

technologies.

24 Germany has been a leader, for example, in high-performance transportation systems, automotive components, inorganic

chemicals, metals processing, and machine tools.

While not known for the creation of startling new

innovations in other sectors, Germany has been a

world leader in effective technological diffusion. 25 It has excelled at refining new production

and process technologies and spreading their effects across a broad industrial base.

By the early 1990s, German industry had confronted the challenge of adapting its traditional

corporate governance system and technology base

to a much more competitive global and regional

environment.26 Productivity levels had not kept

up with world standards, and unit labor costs had

swollen in relative terms. Successful adaptation

was recognized as crucial to regaining the country’s position across the industrial sectors in which

it had long excelled. The challenge of broadening

and diversifying its technology base appeared

even more formidable, since fundamental

changes might be needed to achieve such goals.

Indeed, given the social and political difficulties

associated with such changes, pessimism concerning the technological future of German industry has been in vogue. OTA analysis, however,

supports a more balanced view. German industry

is adjusting within the constraints posed by its

traditional system of corporate governance. That

system may be reshaped, but it will not likely be

abandoned. Negotiated and incremental reform is

probable.

Managers of American MNEs often remark on

the ability of their German counterparts to operate

with a high degree of apparent independence from

shareholder pressures for immediate returns. The

common view is that this independence has been

crucial to the maintenance of stable levels of investment in the technologies at the center of leading German industries. There is an element of

truth in this, but the ability of German industrial

managers to plan with other than short-term profit-maximization goals in mind derives from the

fact that German managers have been able to convince shareholders to take a long-term view.

Moreover, German corporations typically rely on

their bank relationships for long-term lending,

and obtain a relatively small portion of the firm’s

finances through the stock market. In such a context, German managers have really not been more

autonomous than American managers. They have

13 See A. Gerschenkron, Ec~n~mic Back~ardness in Historical Perspecti\’e (Cambridge, MA: Belknap, 1%2).

24 For background, see p.J. Katzenstein, pdilics and Policy in the Federal Republic of Germany: The s~mi-.$wverei~n slate (Philadelphia,

PA: Temple University Press, 1987); A.S. Markovitz, The Po/itics of the West German Trade Unions (Cambridge, UK: Cambridge University

Press, 1986); and K. Thelen, Union of Parts: Labor Po/i/m in Posmar Germany (Ithaca, NY: Cornell (University Press, 1991).

M K. Wever and CJ$ A]]en, “me Financial Systenl and Corporate Governance in Germany: institutions and the Diffusion Of ]nnOvatlOnS,”

Journal oj’Public Policy 13(2): 183-202, April-June 1993.

lb See H. Glersch, K. paque, and H. Schieding, The Fading Mirac/e: Four Decades oj’Marke/ Economy in Germany (Cambridge, UK: Cambridge University Press, 1992).
Chapter 7 Corporate Governance and National Technology Systems I 171

Individuals from comprise

.-

Private banks 7

Other banks 2 2

Insurance companies 1 6

Trade unions 12,4

Other employee representation 36.3

Industry representation 25,8

Other shareholder representation 10,2

Government (political parties 4 5

and civil servants)

SOURCE: Federal Association of German Banks, cited in E.R. Schneider-Lenne (Deutsche Bank) The Role of German Capital Markets, the

Universal Banks Supervisory Boards and Interlocking Directorships, ”

paper prepared for National Economic Development Off Ice Policy

Seminar London, Nov. 21-22, 1991

simply been subject to different pressures, some

of which can be quite severe.

German law distinguishes between two types

of companies with limited liability: joint stock

companies, which are publicly owned and listed

(Aktiengesellschaft (AG)); and privately held, unlisted companies (Gesellschaft mit beschraenkten

Haftung (GmbH)). German MNEs come in either

form. Daimler-Benz, for example, falls in the former category, while Robert Bosch falls in the latter. Since most large German firms are joint stock

companies, however, the emphasis in this assessment is on AG firms.

Under the terms of the 1976 Co-Determination

Act, in a company with more than 2,000 employees, half of the supervisory board must comprise directors chosen by the shareholders and half

by employees; one of the labor representatives

must come from middle management or higher.

Table 7-6 breaks down the composition of the

boards in the 100 largest German enterprises. The

chairman is elected by the shareholders’ representatives, all of whom are outsiders, and has the ability to vote twice—and consequently break tie

votes. The supervisory board appoints a management board, usually of 10 persons; by law, those

managers are provided with a formal contract extending from one to five years.27

Although they have formal responsibilities for

reviewing management contracts and providing

general oversight, German supervisory boards

have often been depicted as passive organs. In

fact, the chairman in particular is usually involved

in the most important strategic and financial decisions of a company. The boards also play a critical

disciplinary role when the company gets into

trouble. Their direct intervention in management,

in such an event, serves a function akin to hostile

takeovers in the American system. To participants

and close observers, the German method of encouraging corporate restructuring when required

has the notable advantage of precluding the assetstripping, short-term planning, and social disruption characteristic of the American and British

corporate takeover battles of the 1980s.28

Beyond the prominent role given to employee

representatives, the most distinguishing characteristic of the German system is the critical role

played by banks. The leading industrial banks, especially Deutsche Bank, Dresdner Bank, and

Commerzbank, are "universal” banks. This

means they are permitted to engage in a wide

range of commercial and investment banking activities under one roof. Throughout modern German history, such powers have made them the key

providers and organizers of capital for the establishment and growth of German corporations.

27 For a description Of the ~)ard s~c~re of German joint stock companies, see U. Schaede, “The Creation of a New System Of c(~w)mte

Governance for the EC: An Integrative Model of the Anglo-American and Germanic Systems,” Graduate Schm~I of lntemational Relations and

Pacific Studies, University of California, San Diego, June 1994, pp. 9-12.

‘8 See, fm example, E.R. Schneider-Lenne (Deutsche Bank), ‘The Role of German Capital Markets, the Universal Banks’ Supervisory

Boards, and interlocking Directorships,” paper prepared for National Economic Development OffIce Policy Seminar, L)ndm, Nw. 21-22,

1991.
172 I Multinationals and the U.S. Technology Base

Without them, Germany’s industrial and technology base would look quite different than it does

today.

The role of the banks, which is discussed further in chapter 8, is reflected in Germany’s corporate governance system. Bankers hold nearly 10

percent of all nonemployee seats on the supervisory boards of the 100 largest nonfinancial companies in Germany. Moreover, in the largest

companies, the lead bank (Hausbank) often provides the chairman of the supervisory board. Given the fact that there are relatively few banks

involved at the highest level of corporate finance

in Germany, this means that many supervisory

boards in Germany are interlocked.29

Underpinning such linkages, as in the case of

Japan, are significant cross-shareholdings. It is

not uncommon for a corporation’s leading creditor to hold between 10 and 20 percent of its voting

shares. 30 Combined with cross-shareholdings involving suppliers, major customers, and other

firms, intercorporate shareholding frequently

meets or exceeds half of the voting shares in many

German firms. Even when that is not the case,

however, the practicalities of Germany’s depository voting system often enable the lead bank of a

joint stock company to control well over 50 percent of its shares. Unlike in the U.S. system,

shares are issued in bearer form, and the depository institution-most often a bank—has the right

to vote on them without specific authority from

the actual shareholders. 31

The connection between owners, managers,

and creditors is even more intimate in Germany’s

privately held companies, many of which now

have operations on a global scale. The autoparts

and equipment maker, Robert Bosch GmbH, provides an example. When the company’s founder

died 30 years ago, most of his shares were transferred to a foundation that bears his name. Among

other things, the foundation now provides the bulk

of the financial resources for a hospital located in

the town where the company is headquartered. For

dividends to flow to the hospital tax-free, however, voting rights connected with the shares were

transferred to a supervisory board comprised first

of seven and now nine members. Board members

choose their own successors, typically including

the retired chairmen of the company itself, its lead

bank, other large corporations, and associated labor unions .32

In practice, the role of the supervisory board at

Bosch is limited, and the company’s managers enjoy a high degree of operational autonomy as long

as the overall performance of the firm is satisfactory.33 In practice, its managers have more than

met that standard. As the company has grown, the

shareholding structure, in particular, has enabled

it to maintain stable and relatively low dividend

payouts to the Bosch Foundation, while simultaneously building up substantial internal reserves.

Those reserves, in turn, have allowed the company to invest continuously in the technological

foundations upon which its high reputation and

market advantages rest.

Beyond the legal features of Germany’s shareholding system, commentators frequently note

‘{) Ft~r detailed analysis, see R. Ziegler, D. Bender, and H. B ichlcr, “Industry and Banking in the German Corporate” Network,” Nerw’orks oj’

~’w-porafc P(mer. F.N. Std.mnan M al. (eds. ) (Cambridge, UK: Polity, 1985).

~~) under [he Ienlls of ncW ]Cgls]a[lon, public ~onlpmies arc required to disclose the identities of shareholders owning stakes of more than 5

pcrmnt. ‘“Gcmum CtJr~mite Goverancc Stirring Things ~Jp,” The E“twwvnisr 329(7842)72-73, Dec. 18, 1993.

~ I F{)rlller]} au[{)rlla[ic and of indet:nltc duration, legal rcfomls nt)w require (he right of proxy voting to be reviewed by the true shareholders

(m a regular IXISIS, and the banks must now S(JI ic it voting instructi(ms. In practice, the banks retain a high degree of c(mtr(d. For additional discuss!(m t)f Gm-miny”s dcpmit~)ry voting systcm, see ch. 8.

‘z For U.S. tax purp)scs, the IRS c(msders the nine txwd members to be [he ultimate holding company. OTA interview, Germany, Nov. II,

1993.

~~ ~e SUw.m i sow boards of p~vate]y held firms functi(m very differently than those of joint stock companies. Board members of GnlbH

tim~s can sell their shares (rely in round lots, and must receive permissmn fr(m} the t)wncr or the kx)ard to do so.
Chapter 7 Corporate Governance and National Technology Systems I 173

that the center of gravity in its corporate governance structure is in the reciprocal and enduring

relationships that exist between the few individuals representing the various groups most involved

in the life of a corporation. These relationships

rest on a deep sense of mutual trust, which is reinforced by continual interaction. That trust tends to

be backed up, however, by the certainty of severe,

if informal, sanctions in the event of breaches. Although similar in nature to the ties that bind keiretsu and other intercorporate alliances in Japan, the

relationships in Germany appear to be more

broadly based, overlapping, and inclusive.

With the banker frequently playing a crucial

coordinating role in the most prominent German

MNEs, the system balances the interests of corporate stakeholders. To be sure, there are critics,

some quite vocal, who would like to shift the balance toward noncorporate shareholders, as in the

American system. Few objective observers, however, are predicting their imminent success. OTA

interviews with the managers of important German MNEs support such a conclusion.

Although it is now conventional to depict Germany’s recession and painful economic restructuring in the early 1990s as exposing cracks in its

system of corporate governance, the causal arrows

in such an argument probably should be reversed.

The apparent efforts of some German companies

(most notably Daimler Benz) to diversify their

over-concentrated shareholder bases by issuing

shares in the United States should not be misunderstood. Such tactical moves do not necessarily

presage the dismantling of board interlocks or extensive corporate cross-shareholdings. As one

senior executive from a leading German MNE

told OTA, “The core of the German company remains in its financial structure and the associated

mentality of its most senior managers. ” The priority is to finance new acquisitions and diversification plans out of retained earnings and hidden

reserves, thus avoiding the dilution of control that

can occur when significant amounts of capital

need to be raised externally. Having to raise external capital is widely seen as a sign of weakness.

This view may be wrong, but it will likely take

considerable time before it is revised.

German executives interviewed by OTA, in

fact, suggested that Germany’s current economic

difficulties are reinforcing the traditional system

of corporate governance rather than breaking it

apart. Senior officials from one of Germany’s

leading universal banks, for example, were forthright in explaining that a number of clients, which

had sought to loosen their ties with the bank during the booming 1980s, had abruptly reversed

course in the 1990s. Accordingly, they expected

the system to be deepened by the difficult restructuring process most German corporations must go

through in the years ahead. Significantly, no corporate managers interviewed by OTA demurred

from that opinion. At most, they expected a few

large German MNEs to diversify their capital

bases by bringing in new minority shareholders.

Most saw Daimler Benz’s recent foray into American capital markets in this light. Indeed, the consensus among the leaders of German banks and

MN Es, if expressed frankly, would be that the loss

of control to the capital markets, typically

associated with American and British MN Es. was

to be avoided at all costs.

Such a goal, of course, complicates the task of

reshaping and reinvigorating Germany’s industrial and technology base. In particular, the risk is

that it will stunt the development of broad domestic capital markets and thus prevent small and medium-sized German companies from raising the

financing that might support new technological

innovation. On the other hand, assuming that large

German companies regain their competitive edge

(by, for example, scaling back their real wage

costs and markedly increasing productivity), preserving the core of the traditional system of corporate governance could once again provide German

MNEs with stabilizing financial advantages in the

global marketplace. Assisting in this regard will

be other aspects of the German industrial system.

including its accounting rules (see box 7-1 ).

CONCLUSIONS

American, German, and Japanese MNEs differ in

the relative priorities they assign to the maximization of shareholder value, the satisfaction of cus-
174 I Multinationals and the U.S. Technology Base
Chapter 7 Corporate Governance and National Technology Systems I 175

tomer needs, and the stabilization of American corporations on short-term financial

employer-employee relations. Unique patterns of performance. This is not necessarily a bad thing,

corporate ownership and control, and associated unless those corporations are engaged in global

differences in relations between owners and man- competition with rivals capable of longer-term

thinking.34 agers, appear crucial (see table 7-7). German and Japanese MNEs have

The dispersion and mobility of shareholders in demonstrated just such a capability in the past.

the United States seem to fixate the managers of

M For ]Cga] ana]ysi~ and debate, see J.C. Coffee, “Liquidity Versus Ctmtrt}l: The Institutitmal investor as C(mp)rate M(mit(~r,’” Co/umbia

f.a)~ Journa/ 91 (6) 1276-1368, 1991.
176 I Multinationals and the U.S. Technology Base

United States Japan Germany

Banks 0.3 25,2 8.9

Insurance companies 5.2 17.3 10.6

Pension funds 24.8 0.9 —

Investment companies 9.5 3.6 —

Nonfinancial businesses — 25.1 39.2

Households 53.5 23.1 16.8

Government — 0.6 6.8

Foreign 6.7 4.2 17,7

SOURCE Central banks and stock exchange data, 1991, adapted from WC. Kester, “lndustrial Groups as Systems of

Corporate Governance, ” Oxford Review of Economic POIiCY, 8(3) 33, table 4, autumn 1993

The concentration of corporate ownership in

Germany and Japan helps explain their longerterm, customer- or employee-focused strategies.

As two analysts recently put it:

In contrast to the United States’ primary focus

on shareholder value, these other countries’ corporations are seen as durable national assets that

serve a broad base of constituents. Quality products, market share, and employment are just as

legitimate as goals as return on shareholder investment. While some U.S. top managers and

directors prefer this perspective themselves,

they are swimming against the dominant national tide.35

Such differences are reflected not only in the investment decisions of particular firms, but also in

the nature of the national technology bases those

firms have created and exploited on global

markets.

Throughout the post-war period and in various

high-technology sectors such as electronics,

transportation systems, and others using advanced manufacturing techniques, Japanese

MNEs became noted for pursuing aggressive

strategies keyed on market share, not return on investment. Corporate governance structures, accounting conventions, and public policies at home

contributed to their ability to design and implement such strategies. Those structures fostered

balanced relationships and an enduring sense of

trust, especially among employees, managers,

and institutional owners. They facilitated the sharing of information across allied firms. Most importantly, they rendered the providers of base

capital patient, while simultaneously attempting

to limit the scope for managerial abuse. Periodic

scandals indicate that the latter attempt can fail.

Japanese consumers, moreover, continue to bear

significant opportunity costs associated with this

patient capital system. Meanwhile, Japan’s massive trade surplus and international investment

imbalance indicate the external consequences of

such a system.

The Japanese system of corporate governance

spreads large volumes of minority equity claims

among lenders, customers, suppliers, and affiliates. Despite some recent flux, OTA interviews indicate that rather than changing in a fundamental

way, the current corporate restructuring is an attempt to come to grips with unforeseen consequences: the creation of surplus capacity in sectors

where growth has turned down dramatically, ill-

-advised diversification (especially into U.S. and

35 Lomch ~d Maclver, 0p. cit., f(xm)te 6.
Chapter 7 Corporate Governance and National Technology Systems I 177

Japanese commercial real estate), poor management of cash reserves built up during the 1980s,

and associated financial scandals.

The managers of Japanese MNEs are aware that

charting their way through the current difficulties

and recapturing technological advantages may

well depend upon maintaining the essential structure of their equity bases, the confidence of their

lead banks, and the loyalty of long-term employees, suppliers, and affiliated companies. The

possibility of retaliation for breaches in network

solidarity is not abstract. Bankers and MNE managers both maintained in interviews that all firms

in industrial groups understood well the fact that

companies contemplating appreciable sales of

shares in related banks or companies would elicit

immediate retaliation. Although marginal adjustment in some corporate ownership structures is

occurring, it typically reflects mutual negotiation

between the firms involved. The sense of responsibility for collectively managing the process of

national economic restructuring within tight traditional constraints remains palpable.

Parallels exist in Germany. The overarching

system of corporate governance has in the past

provided German MNEs with the financial stability necessary to build and exploit technological

advantages in key industrial sectors. Together

with a unique accounting system, it reinforced

long-term relationships between stakeholders and

enabled substantial reserves to be built up. Those

reserves, and the knowledge that owners and creditors will not abandon firms at the first sign of

trouble, encouraged managers to pursue longterm strategies. Cross-shareholding is a critical

part of the traditional German system, but it is less

extensive than its analog in Japan. Long-term

bank relationships, combined with the depository

voting system, provide an alternate source of stability. In addition, interlocking supervisory

boards in Germany play a much more important

role both in disciplining managers and encouraging long-term thinking.

The consequences of the German system can be

seen in a number of sectors, but perhaps most obviously in the chemical and automotive sectors.

Hoechst's purchase of Celanese, the steady expansion of BASF in the United States, the simultaneous building of major new plants by BMW in

Bavaria and South Carolina and by Mercedes

Benz in Alabama and Baden-Wuerttemberg--all

require a highly developed ability to endure shortrun perturbations in tough markets. Traditional

corporate governance structures and accounting

rules have helped foster just such an ability in the

past. There is little reason to assume that they will

not do so again in the future. Similar structures underpin high-profile MNEs based in Germany’s

EU partners, and nowhere is this clearer than in the

U.S. consumer electronics market. The story of

the abandonment of that market by once-dominant domestic firms is a long and involved one.

Respected analysts, however, have emphasized

strategic mistakes made by American corporate

managers and the extremely high costs that would

now have to be absorbed to regain their original

positions.36 But underlying governance structures

enabled two non-Japanese firms based outside the

United States to calculate their strategic options in

a different light, and therefore to stay in a market

whose top tier is now dominated by a few Japanese firms (as shown in figure 7-2).

There is a connection between the survival of

Thomson Consumer Electronics and Philips Electronics in the U.S. consumer electronics market

and the nature of their respective shareholder

bases. Although privatization plans for its parent

company have been looming for several years,

Thomson is in reality owned by the government of

France. Common shares in Philips are more widely held; the company relies on no one lead bank

36 ~e A Chand]er, “Chemica]s and E]~c[r(Jnics: Winning and Lt~sing in Post-War American Industry,” pre-publication nlanuscript, Huvard Business Sch(x)l, November 1993. The author notes that the domestic market for consumer electr(mics grew at a c(mlp(mnd rate t~f 15.2

percent between 1976 and 1986, but the share produced dmnestlcaliy plummeted from nearly 100 percent in 1950 to about 5 percent in the late

1980s. After 1986, the consumer electronics operations of all but one major U.S. firm, Zenith, had been acquired by foreign MINEs.
178 I Multinationals and the U.S. Technology Base

40 ) 36.6

35-

30-

v 25-

=m

: 20-

W

g 15-

=

10-

5“

o

26.6

1

Matsushita Toshiba

25.2

. 23.8 23

12.6 12.5

9.7

[ 7.1

5 4.6

3 ~

1 1,

Hltachl Philips Sony Thomson Mitsubishi Sharp Samsung Goldstar Pioneer Nokia

NOTE: Electronics sales are revenues earned by each company from sales of electronic products and services

SOURCE “The Electronics Business International 100, ”Electronic Business 18(12) 84-85, December 1992

and its shareholders include foreign investors.

However, a controlling block of voting rights,

connected to special preference shares, remains

vested in a foundation (Stichting Preference Aandelen Philips). That foundation, in turn, is controlled by a small board comprised of members of

Philips’ supervisory board and descendants of the

founding family.

37 Combined with advantages

generated by strong cash-flow from other operations, Philips did not face the takeover threats that

helped shape the thinking of American rivals in

the 1980s. To be sure, neither company is assured

of future success. Especially in the United States,

the market remains difficult, basic research has

come under severe pressure, and long-run profitability is far from certain. The point, however, is

that the dominant surviving players in a key

technology sector are all embedded in corporate

governance systems that differ markedly from the

system characterizing most publicly owned corporations in the United States.

The three systems of corporate governance

compared in this chapter each have their own

strengths and weaknesses. It is important to emphasize, however, that they are all deeply rooted in

distinctive national histories. The scope for drawing useful lessons from one system and applying

them directly to another is therefore severely limited. Moreover, despite the expanding cross-jurisdictional operations of MNEs and the resulting

insertion of particular forms of corporate governance into alien environments, convergence appears to be a long-run prospect at best. The

challenge is to find new ways to balance across the

Triad the benefits that result from the activities of

MNEs without allowing their intensifying competition to compromise core values reflected in

traditions of corporate governance. Frictions

created by the deepening interaction of diverse

systems of corporate governance must be managed. They cannot be assumed away.

37 ~c 1993 Annual Rcpofi of phi lips Electronics N.V, makes clear (on pages 62 and 63) that one of the purposes Of the ftmndati(ln is to

prevtmt unwanted overtures frmn other cmpmations. In this regard, the report states: “’Shmdd a situation arise in which the acquisition of a

cxmtrolling influence in Philips Electronics N.V. by a third party appears imminent, the Foundation may resolve to exercise [the right to acquire]

as many preference shares as there are common shares in Philips Electronics N. V.”
Corporate

Finance and

National

Technology

Systems 8

As the previous chapter noted, the corporate roles assigned

to banks and other financial institutions constitute one of

the starkest differences between American-style capitalism and other systems. Chapter 6 of the first report in this

assessment provided an orientation to the changing international

financial environment within which MNEs operate. ] This chapter

examines continuing differences among national financial structures and explores their impact on the investment strategies of

MNEs and thereby on national technology bases. Once again, the

focus is on the United States, Japan, and Germany, but not to draw

lessons from one case for application to another. The point, rather,

is that national differences are likely to persist and need to be taken into account by governments seeking stable expansion of international trade and investment across the Triad. Despite the fact

that MNEs now have a wider array of financial options open to

them, the nature of their respective strategies continues to be profoundly influenced by financial structures prevailing in their

home countries.

In the United States, banks provide MNEs mainly with secondary financing, cash management, and other finance-related services. The trend has been for corporations to reduce their reliance

on commercial bank financing, and to fund their long-term requirements from internal retained earnings or directly from bond

and stock markets.

1 U.S. Congress, OffIce of Technology Assessment, Mullinufiouds and lhe Naf/ona/

Interes/: P/ayin,g by Difierenr Rules, OTA-ITE-569 (Washingt(m, DC: U.S. Government

Printing Office, Septemher I 993).

I 179
180 I Multinationals and the U.S. Technology Base

A. Bank deposits as a percentage of

corporate financial assets - Us. 18.8

D Germany 43.8

n Japan

I

46.51

21.5

51.1

77.8

17.8

57.7

78.9

1 1 1 1

100 8 0 6 0 40 20 0

Percent

1990

1985

1980

B. Bank loans as a percentage of

comorate financial Iiablllties

25.4

61.3

58.8

29.2

60.9

67.4

I 163.1

67.4

0 20 40 60 80 100

Percent

SOURCE: International Monetary Fund, International Capital Markets Developments, Prospects, and Policy Issues (Washington, DC International

Monetary Fund, 1992), p 3

In Japan and Germany, conversely, banks have

long played critical coordinating and steering

roles in the ongoing process of national industrial

and corporate development. Before the bubble

burst in Japan, commentators frequently noted

that the centrality of banks was breaking down and

Japanese MNEs were becoming more independent. Today, the trend is not so clear. In Germany,

on the other hand, banks have never ceased to play

their central roles. Figure 8-1 illustrates these national differences.

Both OTA interviews and an expanding scholarly literature suggest that the roles assigned to

banks, as well as the basic structure of national

capital markets, affect the competitiveness of both

MNEs and the technology bases of the countries

in which they are based. Corporate performance in

particular industrial sectors where the core

technology is in a stable stage of development appears to be most affected by cross-national differences in financial structure. During the 1980s in

the United States, for example, it was in such sectors that the most aggressive and destructive takeover struggles occurred.2 Indeed, the experience

of such excesses challenged the conventional

American view that the structure and operation of

its decentralized capital markets were optimal for

building solid industries and for diffusing new

technologies. This issue is developed further in

this chapter after the U.S. system of corporate financing is compared with its analogs in Germany

and Japan.

FINANCIAL MARKET STRUCTURE

IN THE UNITED STATES

Financial markets in the United States are the

world’s largest and most dynamic—and most

2A. Chandler, “Cmnpetitive Perfmrnanceof U.S. Industrial Enterprises: A Histm-ical Perspective” in Business Hi.~/ory Re\’ie\\, spring 1994

(fm-thcoming). Relevant comparative histm-ical analysis is also included in J. Zysman, Gm’ermnems, Markem, and Gro~th: Finumia/ Systems

and fhe Po/itics of/ndus~ria/ Change (Ithaca, NY: Cornell University Press, 1983).
Chapter 8 Corporate Finance and National Technology Systems I 181

idiosyncratic. Both the timing and relative isolation of American industrialization created conditions that permitted a high degree of political

intervention and experimentation. By the middle

of the 20th century, the interplay of democratic

politics and rapid industrial expansion created a

complex and decentralized system of corporate financing. It also created the world’s largest pool of

venture capital. Not coincidentally, the United

States became the world’s leader in creating new

technologies.

In the nineteenth century, the United States did

have a system of corporate financing not unlike

those existing in Germany and Japan. Banks could

perform both commercial and investment banking

functions. They were also allowed to hold equity

positions in nonfinancial enterprises. In the wake

of a series of financial scandals and crises culminating in the Great Depression, however, new

rules were imposed at both federal and state levels

of government. Various institutional interests

gradually coalesced around those rules.

The first restrictions on the ability of commercial banks to own shares directly in industrial enterprises emerged between 1863 and 1892.

Through the vehicle of investment banks, such activities persisted, however, until 1933 when the

Glass-Steagall provisions of the Banking Act effectively banned linkages between commercial

and investment banks. Bank holding companies

came under similar constraints in 1956. In 1970,

the so-called “Douglas” amendments to the Bank

Holding Company Act ensured that, even indirectly, banks could not own more than 5 percent of

the shares of nonbanking companies. They were

also precluded from seeking to control such companies in other ways, for example, through crossshareholding arrangements. Reinforcing such

restrictions has been the evolution of bankruptcy

law within the United States; creditors to a bankrupt firm can find their claims subordinated if the

courts interpret them also to have a controlling equity stake.

The functional segmentation of the American

banking industry and the restriction of bank-corporate alliances evolved along a parallel track to

the geographic limitation on bank branching. An

ambiguous division of regulatory responsibility

for banking between federal and state authorities

goes back to the nation’s founding. Explicit limitations on interstate branching were codified in

various state laws, the federal McFadden Act of

1927, the Banking Act of 1933, and the Bank

Holding Company Act of 1956. With the emergence of regional banking pacts in recent years

and various federal regulatory and legislative developments, rigid rules on branching gradually

eroded. Their effect on money-center banks, however, would long be felt.3 Somewhat more slowly,

the functional segmentation of the industry also

came under pressure.

The financial-industrial combinations that existed in the United States during the late 19th century, complete with interlocking boards and

cross-shareholding, were effectively demolished

by the 20th century. The institutional financial arrangements still characteristic of Japanese and

German industry have long been considered

anathema. 4 Despite prohibitions on formal linkages, however, “relationship banking” characterized American corporate finance at least until the

J A “regitmal banking pact” is an agreement among individual states, usually contiguous, that allows banks chartered by one another to

expand across state lines. “Moneyr-center banks” refer to the large commercial banks, usually federally chartered, based in New York, Chicago,

Los Angeles, and other regional financial centers.

4 F R ~war~5 and R.A, Eisenbeis, “Financial institutions and Corporate Investment Hw-izons: An International perspective,” background

paper prepared for M. Porter et al., Capi[al Choices, A Report to the Council on the Competitiveness and co-sponsored by the Harvard Business

School,” June, 1992. As Edwards and Eisenbeis put it, “II was the legacy of the 1870-1911 period, however, that cemented concerns with the evils

of “bigness. ” The creati(m of a decentralized Federal Reserve System in 1913 was in deference to fears about the concentration of banking

pm cr. [n additt(m, the passage t~f the Bank Holding Company Act of 1956 was rooted in the failure of the Supreme Court to break up the TransAmerwa Corp)ra[itm and prevent its attempt to rmmopolize banking in the western part of the c(mntry; and it was a fear of so-called “congeneric” or ‘“near zalbatsu” banking c(mlpanies that resulted in the restrictions contained in [the Ilmglas] amendments of 1970.”
182 I

late

Multinationals and the U.S. Technology Base

1970s. Practical business relationships between commercial and investment banks and their

leading corporate clients were much looser than in

Germany or Japan. In the United States, for example, it was much easier for a corporate client to

switch lead banks. Nevertheless, most corporations relied on one main lender and one main underwriter. Especially during difficult periods,

most corporations could count on their lead banks

for patience, special loans, and other strategically

useful services. In addition, as they expanded

abroad, U.S.-based MNEs could often rely on the

support of the international networks of their lead

banks.

During the period after World War II, when

many of America’s top corporations were transforming themselves into MNEs, this form of relationship banking provided a stable financial base.

Even this looser form of bank-corporate alliance,

however, has been undermined in recent years.

Successful corporations built up substantial retained earnings and came to rely less and less on

banks for financing. This natural trend was reinforced by technological and regulatory developments, which led to the creation of an array of new

debt instruments and new competitors for the

banks. In addition, heightened price competition

eroded bank profit margins on traditional forms of

corporate financing. Over time, the banking industry lost a large portion of its aggregate U.S.

market share to nonbank financial institutions,

such as pension funds and mutual funds.5

The responses of banks to the heightened competition were skewed by the legal restrictions

noted above. Within their confines, however,

many banks sought new and often riskier clients to

take the place of prime corporate borrowers. Many

also expanded their overseas operations, as well as

their trading and money market activities.

Through such avenues, as well as through various

regu

poac

atory loopholes, commercial banks began

ing the corporate clients of investment

banks. Investment banks returned the favor.

All of this activity helped establish the financial conditions in the United States for the spectacular rash of corporate takeovers that occurred in

the 1980s. Many formerly staid corporate banks,

driven by fierce competitive pressures, even

helped hostile buyers acquire their own clients. In

so doing, some richly deserved the label “predator” that came to be associated with them in the

popular media. By the beginning of the 1990s, few

could doubt that the era of relationship banking in

the United States was over.

The same could not be said for other countries,

however, as is suggested by the retreat of many

U.S. banks from foreign markets in the early

1990s. Although markets like Germany’s and Japan’s were, in a legal and regulatory sense, more

open than they had ever been, an increasing number of U.S. banks retreated or scaled back their direct foreign operations because they could not

earn enough to justify their expenses. In the competition for high-profile corporate business, they

often found themselves up against formidable indigenous banks. Not only could those banks

match their pricing, but they also had long-standing linkages with the leading corporations in their

markets, linkages often formalized through reciprocal shareholding. As a former senior Treasury

official put it, such bonds no longer existed “in the

commoditized U.S. market where price is virtually all that matters.”6

The decline of banks as sources of long-run financial stability for American corporations has

not been matched by the rise of other sorts of institutions that could play a role equivalent to that

played by lead banks in Germany and Japan.

American insurance companies are often pre5 For data on the sectmal distribution of assets and liabilities overtime, see U.S. Board of Governors of the Federal Reserve System, Flow of

Funds Accounts, 1946-1993: Annual Total Flows and Year-end Assets and Liabilities (Washington, DC: Federal Reserve System, 1994).

b M. Jacobs, ShOr(-Term Ameri<.a: The Causes aticures of Our Business Myopia (Boston, MA: Harvard Business Sch(n)l hess, 1991 ), p.

153. See also S. Strange, Casino Capifa/ism (Oxford, England: Basil Blackwell, 1986).
Chapter 8 Corporate Finance and National Technology Systems I 183

Former Zaibatsu New Bank-Centered New Manufacturer-Centered

Mitsubishi Dai Ichi Kangyo Nippon Steel

Mitsui Sanwa Hitachi

Sumitomo Tokai Nissan

Fuyo Industrial Bank of Japan Toyota

Matsushita

Toshiba-lHl

Tokyu

Seibu

SOURCE Adapted from W.C. Kester, "Industrial Groups as Systems of Corporate Governance,” Oxford Review of Economic Policy, 8(3) 29, table 1, autumn 1992

vented by state laws from owning controlling

shares of stock in corporations. Mutual funds are

discouraged by federal regulations and by the national tax code from concentrating their assets in

individual firms; portfolio diversification is central to the investment management business. Similarly, pension funds, now the largest owners of

corporate stocks in America, are subject to formal

fiduciary obligations that require them to shift out

of investments if certain return on investment criteria are not met. Liability laws, governmental

regulation, and the mandates given by most plan

sponsors encourage portfolio diversification. For

better or for worse—and after the 1980s many corporate managers considered it much better-most

American MNEs must obtain long-term financing

from decentralized capital markets.

If room still remains for debate on specific

causal connections and the costs and benefits of

reform, a growing number of analysts have noted

a correlation between the current structure of U.S.

financial markets, the short time horizons of

American corporate managers, and specific problems in the national technology base. Those markets are good at harnessing risk capital for the

initial development of new technologies. They are

less good, however, at assisting in the diffusion of

innovations throughout the national technology

base and ensuring that the benefits of new innovations are commercialized and fully exploited

within the national market. The situation is much

different in Japan and Germany.

FINANCIAL MARKET STRUCTURE

IN JAPAN

Japan developed its corporate financing system

during the Meiji Restoration in the 19th century.

Until World War II, its main-bank system looked

like Germany ’s. The principal corporate alliances,

the zaibatsu, coalesced around several large

banks. Although the zaibatsu were formally dissolved after World War II, the core role of the

banks was retained in the keiretsu system of corporate alliances that emerged in the post war period. As new bank-centered keiretsu and so-called

“production keiretsu” (centered around large

manufacturing enterprises) evolved during the

same period, networks of afflliated corporate contractors and subcontractors also tended to cluster

their financial relationships around a few banks

and trading companies (see table 8-1 ).7

The big change after World War II, however,

was the imposition of a U.S.-style separation of financial functions on the market for corporate finance. In effect, the new Article 65 of Japan

Securities and Exchange Law imposed a GlassSteagall-type barrier between commercial bank7 M. Gerlach, A//lance Cupifa/ism: The Social Organi:a(ion oj~apanese Bminess (Berkeley, CA: University of California Press, 1992).
184 I Multinationals and the U.S. Technology Base

ing and investment banking. Following adoption

of the law, the city banks were restricted mainly to

short-term lending and deposit-taking functions.

Long-term credit banks did what their name implies and funded themselves mainly through the

issuance of bank debentures. Securities companies took on the functions of securities’ underwriting and ancillary services. One difference between

U.S. and Japanese practices, however, centered on

the role of bank equity stakes in nonfinancial companies. Currently the ownership limit is 5 percent

for both Japanese banks and U.S. bank holding

companies. However, in the context of Japan’s

cross-shareholding system, a 5 percent share is

sufficient to reinforce long-term business relationships, preclude hostile takeover bids, and legitimize direct intervention in the event of

emergencies. By contrast, financial equity stakes

held by U.S. bank holding companies are very restricted and prevent the banks from exerting influence over management.

Banks played the key corporate financing role

during Japan’s rapid recovery and growth in the

1950s and 1960s. Contemporary Japanese MNEs

benefited in the past from the banks’ ability to harness and channel scarce national financial resources. Even into the 1970s, banks continued to

provide Japanese corporate borrowers with over

60 percent of their external requirements. Securities markets, meanwhile, remained underdeveloped, providing only 7 percent of the country’s

financing in 1973, a number that would grow only

marginally until the mid- 1980s.8

Japan’s 13 city banks originally concentrated

on their corporate lending role, but the market for

retail deposits was decentralized. Government

used the banking system, as well as an intricate set

of public institutions engaged in deposit-taking

and policy-based lending, to steer household savings to industry. Banking functions developed under the tight constraints of direct governmental

regulation and indirect guidance.9 In such a context, and given the absence or strict regulation of

alternative funding mechanisms, the main-bank

system proved critical to the success and rapid

global expansion of Japanese MNEs.

The Japanese system provided the financial

spark that, through those MNEs, energized the national technology base. As in the case of Germany,

the banks played a variety of other roles, not least

of which was the provision of fall-back resources.

Indeed, it is still common for a corporation’s lead

bank to dispatch special teams to manage and restructure troubled firms.

In the late 1970s, aspects of the system began to

change. The technological and market pressures

that promoted a financial deregulatory agenda

elsewhere were also at work in Japan. In addition,

the leading Japanese MNEs had reached maturity.

The corporate bond market began to expand as

long-standing interest rate regulation and residual

foreign exchange controls were relaxed. As Japanese MNEs built up their own internal reserves,

corporate borrowing fell sharply. The banks, in

turn, began diversifying their operations abroad.

At the same time, banks and other Japanese financial institutions started a long and tendencious

process of encroaching onto one another’s traditional market segments.

Foreign political pressure reinforced a trend toward deregulation and liberalization. By the end

of the 1980s, Japan’s financial economy was

booming and Japanese financial institutions dominated global markets. It was not uncommon to

hear both market participants and observers speculate about the end of the main-bank system and

Japan’s inevitable convergence toward global

norms.

8 L. Pauly, Opening Financial Markels: Banking Poli/ics on the Pacific Rim (Ithaca, NY: Cornell University Press, 1988), p. 13.

‘J SW K. Kate), T. Shibata et al., f’O/iC.y-Based Finance: The Experience oj’Postw’ar Japan (Tokyo, JA: The Japan Development Bank, January 1993); also see World Bank, The East Asian Miracle: Economic Growth and Public Policy (Washington, DC: World Bank, 1993); and R.

Wade, Governing fhe Marker (Princeton, NJ: Princeton University Press, 1990).
Chapter 8 Corporate Finance and National Technology Systems I 185

A very different story was still unfolding when

OTA interviews for this study took place in Japan

late in 1993. The deregulation and financial euphoria that dramatically pushed up Japanese stock

and real estate prices had long since passed. A

deep recession followed a tight credit squeeze.

Leading Japanese MNEs and their bankers suddenly found themselves overextended. The city

banks, down to 11 from 13 after mergers in 1989

and 1990, now supplied a smaller percentage of

the financing needs of large corporations; nevertheless, their role as lenders of last resort and

work-out specialists was once again becoming apparent. It was an inauspicious time for a struggling

corporation to be caught without a solid relationship to a main bank. Many corporate executives

expect the current economic problems facing corporate Japan to be resolved in the traditional way,

by concerted efforts within industrial groups to restructure themselves with the active assistance of

their bank creditors. Indeed, some expressed relief

that the wild ride of the 1980s was over.

In one respect, however, the deregulatory

legacy of the past decade appeared likely to endure. By the early 1990s, Article 65 of Japan’s Securities and Exchange Law was becoming moot.

With the limited but growing role of the banks in

underwriting corporate stocks and bonds, some

aspects of German-style universal banking appeared to be coming quickly.

FINANCIAL MARKET STRUCTURE

IN GERMANY

On December 17, 1993, the entire senior management of Metallgesellschaft, Germany‘s fourteenth

largest industrial conglomerate, was abruptly dismissed by the firm’s supervisory board. 10 The dismissal followed reports of massive trading losses

in the firm New York office. The chairman of the

supervisory board, a senior executive from

Deutsche Bank, which along with Dresdner Bank

was the company’s leading lender and shareholder, publicly criticized the managers for inadequately supervising the New York operation. At

the same time, he announced the appointment of a

new senior management group charged with turning the company around. It later transpired that

losses extended far beyond those of the New York

office, and a massive global restructuring of the

company ensued.

Reports in the financial press interpreted these

events as indicative of the erosion of the traditional German system of corporate management, particularly the role of supervisory boards and banks

as shareholders. It is more plausible, however, to

reach the opposite conclusion. Crisis makes visible the fundamental principle of German corporate law: Ultimate authority over German

corporations remains vested in supervisory

boards. And at the core of the supervisory boards

of most prominent German MNEs remain the

banks.

Supervisory boards typically become more assertive and intrusive when troubles arise. At such

times, banks play a crucial coordinating role: they

are often lenders, partial owners, strategic advisers, and providers of emergency services, including debt work-outs and assistance in preventing

hostile takeovers. Although the scale and timing

of Metallgesellschaft’s problems led to new scrutiny of the German system, that scrutiny looked

unlikely to bring about its dismantling. If anything, the functions of the supervisory board will

be underlined and board activism promoted. In

this context, the role of banks maybe clarified and

streamlined, but it will not likely be diminished.

The Economics Minister of Germany implied as

much when he publicly urged Metallgesellschaft’s banks to assist the company to the extent

necessary. German banks have done so in many

other such cases before, and the result has been a

significant bolstering of their various roles in the

direction of corporate affairs.

lo ‘.~e Revolution” at Metallgesellschaft,” 7’he Economist 329(7843):90, Dec. 25-Jan. 7, 1994; and “SmfJking,” The Economist

330(7844):66, Jan. 8-14, 1994.
186 I Multinationals and the U.S. Technology Base

The prominence of banks in the German system

should not be misunderstood. In many ways, it

represents the legacy of Germany’s rapid but relatively late industrial development. In the absence

of broad and deep capital markets, the banks performed a crucial function in organizing the financial resources required for that development.

During the past two decades, the direct financing

role of the largest corporate banks declined somewhat as corporations accumulated the internal reserves required to fund future investments. In

cases where the ownership role of banks has increased in recent years, financial crisis has usually

been the cause. Because it agreed to convert some

of its prior loans to equity when Daimler-Benz

was having difficulties, for example, Deutsche

Bank wound up owning more of the firm than it

probably wanted. For that reason alone, the bank

had an incentive to become intimately involved in

Daimler’s efforts to diversify both its corporate

assets and its shareholder base.

Among German MNEs, however, the continuing influence of the banks comes mainly from

their universal character and from the nature of the

proxy voting system. In a universal banking system, banks are empowered to lend funds directly

to firms as well as to underwrite their stock and

bond issues. In the German case, they can perform

these functions for firms in which they themselves

have an ownership interest. In addition, the German depository voting systems allows the banks

to act as agents for individual shareholders. An individual, for example, usually signs over voting

rights to a bank, which serves as custodian for the

shares. When votes are to be taken, the bank now

tells the shareholder how it intends to vote. Unless

the shareholder specifically disagrees-a rarity—

the bank controls those shares as well as any

shares it holds in its own name. 11

Germany had recovered successfully from the

war by the 1960s and its corporations ostensibly

began to reduce their direct reliance on banks.

During the next two decades, it is estimated that

the banks owned between 5 and 7.5 percent of corporate stock.12 Under the proxy system, however,

they controlled about 60 percent. But that interest

was concentrated, and most of it reflected the

position of the banks in the leading corporations

of the country. The German Monopolies Commission reported in the late 1980s that in only three of

the largest German companies did banks or insurance companies directly control a majority of voting shares. At the same time, the Big Three banks

held significant minority interests in 13 of the

largest 100 firms. The picture changes, however,

if the proxy voting system is taken into account. A

recent study estimates that through the proxy system banks controlled 34 of the largest German

firms in 1975 and 39 in 1988.13

The German financial system comprises a large

variety of banks and other credit institutions.

Commercial banks, of which there are approximately 340, account for about one-quarter of total

business financing activity. Of that amount, the

Big Three--Deutsche, Dresdner, and Commerz—account for approximately one-third, and

most of that activity is highly concentrated on

German MNEs. In relative terms, those banks

play a much more active role in the financial life of

German corporations than do their counterparts in

the United States. The German system was reshaped after World War II, and it continues to

change. What has never taken root at the highest

levels of German corporate finance, however, is a

broad and deep de-concentration effort similar to

that which decisively transformed the American

system by the 1930s.

I I See U. Schaede, “me Creation of a New System of Cw-pw-ate Governance for the EC: An Integrative Model of the Anglo-Ameticm id

Germanic Systems, ’’Graduate School of lntemational Relations and Pacific Studies, University of California, San Diego, June 1994, pp. 12-16.

12 U.S. Congress, General Accounting office, Competitiveness Issues: The Business Environment in the United states, Japan, and Germany, GAOK3GD-93- 124 (Washington, DC: August 1993), p. 112.

‘3 Ibid., p. 113.
Chapter 8 Corporate Finance and National Technology Systems I 187

German financial markets are more open to foreign participation now than they have ever been,

although the role of foreign banks among German

MNEs remains modest. Foreign banks have

helped stimulate financial innovation, but the

leading German banks have proved quite capable

of keeping up with them. At the same time,

through their active involvement in global capital

markets, the biggest German banks also bring to

their corporate clients full access to innovative financial techniques and new pools of capital.

During the 1980s and early 1990s, it began to

look like this role might change as banks and corporations diversified their operations in the context of the evolution of a single European banking

market. 14 Since the unification of Germany, however, the situation has become more complicated.

German bankers believe that the substantial economic and political turbulence of the 1990s is reinforcing the links between leading MNEs and

their main banks. The difficulties foreign banks

have in building substantial corporate financing

operations in Germany is symptomatic of the new

reality. The market is now more open, but traditional bank-industry relationships are not under

threat. No participants or observers told OTA that

they expect this to change fundamentally even after the German economy fully recovers.

Neither the universal banking system nor the

main-bank system is under imminent threat. The

Metallgesellschaft case and others are certainly

causing some public soul-searching, and anxiety

concerning Germany technological future is frequently linked to the financial foundations and

conservatism of German corporations. In light of

Germany’s industrial history as well as the

constraints posed by circumstances now prevailing in European and world markets, however, it

seems more than reasonable to expect those

foundations to be reinforced even as they are incrementally adjusted. This will not preclude successful German MNEs from attempting to

constrain the influence of their main banks during

good times, for example, by building tactical relationships with other banks. But neither this nor the

global strategies of the big German banks imply

that the German system of corporate financing is

moving toward the U.S. capital markets model.

CONCLUSIONS

The segmentation and decentralization of the

American financial system, as well as the breakdown of relationship banking, can make life difficult for American industries in international

competition. On the other hand, they force U.S.

firms to be more agile, and they discourage reliance on potentially collusive strategies. Especially during the past few years, the American

system inhibits investors inclined toward building

large equity stakes. It also constrains institutional

cross-shareholding. Competition between American MNEs and MNEs based in financial systems

that do the opposite can therefore be skewed.

Moreover, to the extent that unstable capital

foundations discourage long-term corporate investment within the United States, the national

technology base can be harmed.

The traditional American distrust of financial

concentration, combined with the dynamic effects

of various regulatory and technological changes,

created an environment conducive to the hyperactive market for corporate takeovers in the 1980s.

Although some firms undoubtedly needed the

shake-up and rationalization that ensued, others

were severely damaged. In addition, there would

appear to be few benefits for the American economy as a whole from the excessive managerial autonomy that sometimes followed as various states

competed to provide corporations with new forms

t J ~e ~trategles ~)f the blg Ge~an banks were in fact recast more broadly. In the context of the effort tt~ create a single Eur(J~an banking

market, for example, the banks have been active pqxments of the development of Finanzplatz Deutschland as a potential rival to capital market

centers in London and elsewhere. Cross-border alliances have also begun, the most prominent including Dresdner Bank’s purchase of a minority stake In Banque Natitmale de Paris, and Credit Lyonnais” purchase of Bank fur Gemeinw irtschaft.
188 I Multinationals and the U.S. Technology Base

Merger and International

Acquisition Competitive

Activity Capability

High technology

Chemicals

Pharmaceuticals

Computers

Electronics

Aerospace

Stable Technology

Oil

Rubber

Machinery

Motor vehicles

Metals

Low Technology

Food, drink, tobacco

Textiles

Paper

Medium

Low/medium

Low

Low

Low

Medium

High

High

Medium

High

High

High

Medium

High

High

High

Mixed

High

High

Low

Low

Low

Low

Little foreign

challenge

Low

Little foreign

challenge

NOTE: OTA obtained this chart from Alfred Chandler, who developed it

in preparation for his forthcoming article “Competitiveness of U.S. Industrial Enterprises: A Historical Perspective,” Business History Review, Spring 1994 (forthcoming)

of protection from future takeovers. In one of the

most egregious and well-known cases, for example, the State of Pennsylvania passed a law in 1990

that absolved the directors of firms incorporated

in that state from their primary fiduciary obligation to shareholders and in several other respects

made takeovers much more difficult and costly. 5

Unstable corporate financial foundations exposed many American businesses in the 1980s to

unwanted and frequently damaging takeovers.

Merger and acquisition activity was highest in

sectors where core technologies were in relatively

stable stages of development (see table 8-2); many

firms in these sectors were substantially weakened or dissolved in the wake of these takeovers. 16

Takeovers also appear to have hurt some sectors

where process technologies were rapidly changing. For instance, severe damage occurred among

financially weak producers of rubber products,

nonelectrical machinery and machine tools, metals, and transportation equipment. In addition, a

dearth of patient capital was clearly associated

with instability in significant parts of the U.S.

electronics sector. In one other high-technology

sector, inorganic chemicals, the high level of

merger and acquisition activity of the

1980s—much of it initiated by foreign MNEs—

appears to correspond to differences in underlying

financial structures, especially between German

and American firms.

OTA interviews in Europe and Japan underscored the importance of reliable corporate financiers to the strategic planning process of a wide

range of MNEs. This is one reason behind the current spread of the universal banking model within

the European Community. Certainly the future of

that model is not compromised by the steady

growth of stock and bond markets in Europe. In

fact, the two trends—the spread of universal banking and the growth of nonbank capital markets—

seem to go together.1 8 The large corporate banks

of Germany, for example, may be expected to

dominate Finanzplatz Deutschland. A similar

process is under way in Japan, although a deep

conflict of institutional interests between the city

16 A Chmd]er ~)p, ~it., f(x)tnote ~; a]so We us. Deptinlent of ci)mrnerce, FOreI(qrI Direct lrr})es[merr[ in I}le Unifed sweS: An Upda(e

(Washingt(m DC: U.S. Government Printing Office, June 1993), ch, 6.

17 A. Chandler, op. cit., ft){~tn{~te 2.

I g See J B. G()()dnlan and L.W. pau]y, “me obsolescence” of Capital C(mtrt)ls’? Ec(m(mlic Management in an Age of Global Markets,” World

Polifics 46( I ):50-82, October 1993.
Chapter 8 Corporate Finance and National Technology Systems I 189

banks, long-term credit banks, and securities companies complicates the move to universal banking. In fact, a look at Japan, Germany, Canada, the

United Kingdom, France, and other leading industrial economies, shows a clear move toward

universal-type banking structures. Only in the

United States is the trajectory unclear.

Corporate networks that center themselves on

concentrated banks are provided with financial

stability. This does facilitate long-term investment decisionmaking. There is little evidence that

such financial structures are being held responsible for the severe financial pressures that have

arisen for German and Japanese MNEs during the

past few years. Indeed, OTA analysis suggests the

opposite. In the face of deep domestic and regional recessions, negative developments in exchange

rates, and problems in key export markets, many

German and Japanese MNEs have recently been

reminded of the wisdom of having long ago purchased the insurance policy of stable banking relationships.

To be sure, the U.S. financial system has its

own strengths. From a purely economic point of

view, these include its capacity to let the pendulum of market change swing rapidly. Periodic

bouts of excessive risk-taking are followed almost

predictably by excessive caution, but the system

usually adjusts. The wild takeovers of the 1980s,

for example, led to credit losses—and legal liabilities—for some financial institutions, and a retreat from excessive lending for leveraged

buyouts subsequently occurred. But this sort of

normal turbulence is no longer occurring in a system that is isolated. The swinging pendulum can

compound long-term adjustment costs for American MNEs when foreign rivals are playing by different rules. In the face of such costs, American

MNEs search for ways to shield themselves and

stabilize their financial foundations.

Despite the difficulties confronting their Japanese and German competitors, American MNEs

have reason to remain concerned. The planning

myopia that plagued them during the booming

1980s might be masked in the 1990s by a normal

upturn in the business cycle. Many of the corporations that realize this are now on a strategic track

conventionally labeled “globalization.” As discussed in the first report of this assessment, they

seem to be driven in part by a desire to hedge their

financial bets. Their treasurers are busy diversifying their capital foundations in a movement that

runs in tandem with the geographic spreading of

production facilities. In many of the leading

American MNEs, this appears to be part of a fundamental corporate strategy. The crafting of new

international alliances may be seen in the same

light (see box 8-1 ).

Similar trends are, of course, noticeable in Japan and Germany. In the case of leading Japanese

and German MNEs, however, the movement appears much more tactical. With respect to the fundamental financial foundations of such MNEs, an

observer would be hard-pressed to find evidence

of strategies truly aiming at deconcentration or decarte libation. The large Japanese keiretsu are certainly not coming apart. Similarly, hints of capital

diversification in Germany need to be interpreted

cautiously. The recent foray of Daimler-Benz into

American equity markets, for example, does not

appear to signal a new willingness on the part of

German industry to move away from traditional

financial and strategic relationships.

The dynamic nature of today’s multinational

corporate competition does, however, portend a

heightened competition between national financial systems. In such a world, despite recent good

news about the performance of many American

corporations, it is by no means certain that the

American system has proven its superiority. The

system has created the world’s deepest pool of

venture capital, but that pool is increasingly open

to non-U.S.-based MNEs. This is potentially very

positive not only for Americans but for the rest of

the world. Serious questions remain, however, as

to whether American firms enjoy reciprocal access to the functional equivalents that have been

developed abroad. Surely Japan’s equivalent, the

spinning off of new operations by established

firms once they have reached competitive maturity, is not open; nor have acquisitions become easier to undertake in either Japan or Germany. It is

also not clear that American venture capital can be

easily attracted to support the development of
190 I Multinationals and the U.S. Technology Base

“boring” improvements in basic and process and the time when product commercialization attechnologies, both of which will figure heavily in tracts routine financing.

future global competition across a range of German and Japanese MNEs have been able to

manufacturing industries. Indeed, in a number of take a longer-term view of their investment and

sectors in the United States, there remains a seri- strategic decisions. Contributing significantly to

ous funding gap between the time when initial their abilities in this regard have been the mainventure capital for product development runs out bank system, universal banking (in Germany),
Chapter 8 Corporate Finance and National Technology Systems I 191

and intricate corporate alliance structures (in both when they provide emergency support during

Germany and Japan). When such structures mere- downturns in economic cycles, they can help

ly shield shoddy or overly conservative manage- build strong international competitors. Those

ment practices, they have costly effects. But when same factors are now assisting leading German

they serve to keep corporate managers account- ant Japanese MNEs as they seek to adjust to radiable to the full range of stakeholder interests, and
192 I Multinationals and the U.S. Technology Base

cally altered domestic and international business

environments. 19

Business analysts frequently assume that competition between national systems of corporate financing will lead to the abandonment or

continuing erosion of the American system. Two

respected observers put the matter starkly:

We are beginning an era of international competition between the entire financial and industrial structures of countries. The efficient ones

will be those that survive this Darwinian competitive struggle. Legal and institutional impediments that fail this test will cease to exist. Our

belief, or perhaps our prejudice, is that many of

the present constraints on U.S. financial institutions will not survive.20

Universal banking and “corporate networking”

are often portrayed as better adapted to the competitive world of the future, where massive investments in new technology will have to be

undertaken and “stable” financial foundations—

as well as “orderly” markets—will be needed to

make those investments feasible. All of this may

be true, but there are at least two basic impediments to the evolution of that future. The first is

readily apparent in corporate America itself. Especially after the experience of the 1980s, when a

number of firms watched their trusted bankers

help raiders take them over, few corporate managers can be expected to be enthusiastic about the recreation of universal banking in the United States.

The managerial flexibility provided to those corporate leaders by decentralized capital markets,

even though it may force them to focus excessively on the short-term, is now highly valued. The

more important impediment is rooted more deeply in the traditional American political reaction to

financial concentration.21

19 Note Kester’s hyp)~esis ( W.c. Kester, “Governance, Contracting, and Investment Time Horizons,” working paper 92-m3, Hwmd

Business School, Division of Research, 1991) that, although the German and Japanese systems may not be ideal, “they maybe more efficient

than the Anglo-American system in coping with hazards posed by risky investment in new environments.”

ZO Edwards and Eisenbeis, op. cit., fOOblOte 9.

2 I me differences ~tween the Ameficm ~a~ti(~n t. financial ~oncentrati{,n ~d ~[,~ ~,f ~~~er c[~untfies als[, come out in me fje]d ~~f antitrust policy and its analogs. This is another area that will likely increase in importance as new multilateral roles for trade and investment are

sought. See appendix C. See also U.S. Congress, OffIce of Technology Assessment, Compe/ing Economies: America, Europe and ~he Pacific

Rim OTA-ITE-498 (Washington, DC: U.S. Government Printing Office, October 1991); U.S. Congress, General Accounting Office, Compeli -

Iiteness Issues: The Business Environment in rhe Unifed Stares, Japan, and Germany GAO/GGD-93- 124, (Washington, DC: U.S. Government

Printing OffIce, August 1993); J.F. Rill, ‘“COmpetitim Policy: A Force FcwOpen Markets,’ ’Anritrus( Law Journa16 1 :637-650, winter 1993; F.H.

Easterbrmk, “Mon(qx)lizatim: Past, Present, Future,” Antitrust Luw Journal 61 :99-1 18, summer 1992; L.D. Tyson, Who’s Bashing Whom:

Trade Conjlict in High Technology ]nduswies (Washington, DC: Institute for International Ecw-wmics, 1992); C.F. Bergsten and M. Noland,

Reconcilable Ditierences: United S~ates-Japun Economic Conjlic~(Washington, DC: Institute for lntemational Economics, 1993); J.P. Trachtman, “lntemational Regulatory Competition, Externalization, and Jurisdiction,” Harvard international Law Journal, 34( I ):47-104, winter

1993; J.P. Gnffh, “United States Antitrust Laws and Translational Business Transactions: An Introduction,’” The International Lawyer21 (2)

spring 1987; R.P. Alford, “The Extraternt(}rial Applicatim of Antitrust Laws: The United States and European Community Approaches,’” Vir-

,ginia Journal oj’/nternationa/ lxn+’ 33:1 -50, fall 1992; P.D. Sutherland, “The Competition Policy of the European Community,” S~. Louis Unlversi~ Law Jourru-d 30: 149-170, 1992.
Affiliate

A business operation that is established through

direct investment by individuals or corporations

based in a foreign country. In the U.S. trade accounts, a foreign affiliate is defined as a business

establishment in which a foreign individual or

corporation owns or controls, directly or indirectly, 10 percent or more of the voting securities of an

incorporated business enterprise (or an equivalent

interest in an unincorporated business enterprise).

In the United States, foreign affiliates are a product of FDIUS; U.S. affiliates operating abroad are

a product of USDIA.

Affiliated trade

International trade among firms within the same

MNE group. Also called intrafirm trade (FI_’).

AG

Aktiengesellschaft. A publicly held firm with limited liability in Germany.

APEC

Asian Pacific Economic Cooperation.

ANBERD

The OECD’S principal database on business R&D

expenditures.

ATP

The Advanced Technology Program, under the

National Institute of Standards and Technology,

U.S. Department of Commerce.

Appendix A:

Glossary

BEA

Bureau of Economic Analysis, U.S. Department

of Commerce.

BERD

Business expenditures on research and development.

CFIUS

Committee on Foreign Investment in the United

States.

CNT

Conditional national treatment.

CEO

Chief Executive Officer.

Corporate governance

The rules and norms that guide internal relationships among the various stakeholders in a business enterprise. These stakeholders typically

include owners, directors, managers, creditors,

suppliers, employees, and customers.

CRADA

Cooperative Research and Development Agreements between private industry and U.S. government agencies.

DIA

Direct investment abroad.

I 193
194 I Multinationals and the U.S. Technology Base

Distributor keiretsu

A type of cooperative business arrangement in

which the manufacturer controls its distribution

system through a combination of equity relationships, low-cost capital, and rebates. This enables

it to reduce price competition among its distributors and can prevent competitors’ goods from being sold in the same store.

EU

The European Union, formerly the European

Community.

FDI

Foreign direct investment. In the United States,

FDI is defined by the International Investment and

Trade in Services Act as the ownership by a foreign person or corporation of 10 percent or more

of the voting equity of a firm located in the United

States.

FDIUS

Foreign direct investment in the United States.

Foreign affiliate

A subsidiary of a foreign corporation. See also

affiliate.

GATT

General Agreement on Tariffs and Trade.

GERD

Gross expenditures on research and development.

GmbH

Gesellschaft mit beschraenkten Haftung. A privately held German firm with limited liability.

Horizontal keiretsu

A type of cooperative business arrangement characterized by large groups of companies tied together through such institutions as stable

cross-shareholding agreements, president councils, and a common commercial bank, trust bank,

insurance company, and trading company.

IFT

Intrafirm trade. Cross-border trade among firms

within the same MNE group of companies.

Inward direct investment

Direct investment made in a country by residents

and legal entities located outside the host country.

Equivalent to foreign direct investment (FDI).

IRS

Internal Revenue Service.

Keiretsu

The cooperative arrangements formed by Japanese companies to reduce the risks of commercial

activity. Also see horizontal keiretsu and vertical

keiretsu.

Majority-owned affiliate

An affiliate in which foreign investors own or control, directly or indirectly, more than 50 percent of

the voting securities of an incorporated business

enterprise (or an equivalent interest in an unincorporated business enterprise). Compare with affiliate.

MNC

Multinational corporation.

MNE

Multinational enterprise.

MOSS

Market-Oriented, Sector-Specific trade talks between the United States and Japan.

NAFTA

North American Free Trade Agreement.

NSTC

National Science and Technology Council.

OECD

Organisation for

Development.

OSTP

Office of Science

OTA

Economic Co-operation

and Technology Policy.

and

Office of Technology Assessment.

Outward investment

Direct investment made by individuals and corporations outside the country in which they reside.
Appendix A Glossary [ 195

PNGV

Partnership for a New Generation of Vehicles.

Also known as the Clean Car Initiative.

PPP

Purchasing power parity.

R&D)

Research and Development.

R&D intensity

Research and development as a percentage of total

sales.

SEC

Securities and Exchange Commission.

Sll

Structural Impediments Initiative trade talks between the United States and Japan.

STI

Science and Technology Indicators, an OECD

database.

Supplier keiretsu

A type of cooperative business arrangement characterized by a vertical organization, with the

manufacturer at the apex and a series of lower tiers

consisting of smaller and more specialized firms.

Technology trade

Cross-border royal

representing sales

property.

Triad

ty and license fee transactions

and purchases of intellectual

The three major regional centers of industrial,

technical, and scientific capability, centered on

the United States, the advanced industrial economies of Europe, and Japan.

TRIMs

Trade Related Investment Measures.

TRIPs

Trade Related Aspects of Intellectual

Rights.

UBO

Ultimate Beneficial Owner.

U.K.

United Kingdom of Great Britain and

Ireland.

Unaffiliated trade

Trade conducted among firms with no

Property

Northern

common

ownership. Also known as arms-length trade.

Compare with affiliated trade or IFT.

Universal banks

Banks that are able to engage in all types of financial transactions under one roof,

holding of a controlling interest in

ers.

including the

their customUSDIA

U.S. direct investment abroad.

USTR

Office of the United States Trade Representative.

Vertical keiretsu

A form of cooperative business arrangement used

by Japanese manufacturing firms to organize their

supplier and distribution systems. See supplier

keiretsu and distributor keiretsu.

WTO

World Trade Organization.
Appendix B:

Summary of

the First

Multinationals Report

(September 1993)1

I

n the post-cold war period, the role of multinational enterprises (MNEs) in the world

economy is evolving far more rapidly than

the rules that govern their operations. The

policy challenge is to manage and defuse escalating trade frictions in ways that promote growth

and ensure a fair and sustainable distribution of

advanced technology and manufacturing assets

among competing national economies. Multinational enterprises are central to this process because they are international conduits of

technology, goods, and services. They also provide quality jobs and capital that support economic growth and a high standard of living.

The foreign affiliates of MNEs control a substantial portion of the world economy, perhaps as

much as one-quarter of all economic activity in

their host countries. In 1990, the last year for

which complete statistics are available, worldwide sales of foreign affiliates in host countries

reached an estimated $5.5 trillion as compared

with approximately $4 trillion in total world exports of goods and services. Because they are both

important and powerful, MNEs evoke a wide

range of concerns from home governments, host

governments, rival firms, and strategic partners.

Intensifying competition among firms in almost every sector of the international economy is

changing the structure of multinational industry.

At the same time, increasing competitiveness concerns and trade frictions among nations have led

to a heightened awareness of the activities of

MNEs. Because MNEs are the major force in international trade and are deeply enmeshed in local

economies, they are influential in national politics

and often essential to the industry of nations.

Congress is concerned about MNEs for several

reasons. Significant asymmetries in the national

policies of the major trading nations have developed, which may ultimately undermine the postWWII system of international trade and

investment. At the same time, the globalization of

business and intense competition in many industrial sectors threaten to increase trade friction

among nations to unmanageable levels. As tough

talk on trade escalates between the United States

and its principal trading partners, pressure builds

] U.S. Congress, OffIce of Technology Assessment, Multinationals and the Natiwud Interest: Playing by Diferent Rules, OTA-

[TE-569 (Washington, DC: U.S. Government Printing OffIce, September 1993).

196 I
Appendix B Summary of the First Multinationals Report I 197

for a coordinated response from Congress, the Administration, and U.S. business leaders.

As a further complication, the distinction between foreign and U.S. companies is breaking

down. As U.S.-based MNEs commit ever more

resources to foreign affiliates, and foreign-based

firms produce and invest in America, the question

of what constitutes an American company for purposes of public policy becomes even more critical.

The rapid expansion of the number and scope of

international strategic alliances among MNEs

adds complexity to this already difficult problem.

The answer to the policy question of what

should constitute an American company is tied

not so much to the ownership or home base of particular MNEs, but rather to how a firm affects the

well-being and standard of living in the local and

national communities where it operates. In this

view, MNEs should be considered American if

and when they act in the national interest, and as

American companies, they should be entitled to a

higher standard of consideration.

The interests of MNEs, however, do not always

conform to those of the United States. The United

States wants MNEs to conduct core business operations here, to interact with local firms to create

employment and wealth, and to retain the benefits

of that wealth for U.S. citizens. But MNEs are understandably less concerned with advancing national goals (which may conflict among different

nations) than with pursuing objectives internal to

the firm-principally growth, profits, proprietary

technology, strategic alliances, return on investment, and market power.

The present system of international trade and

investment can be characterized as one in which

the interests of nations and MNEs have been

drawn too tightly (as in Japan) or, conversely,

have been allowed to drift too far apart (the U.S.

case). This is the result of basic asymmetries, both

in the different national systems of policy that regulate trade and investment, and in the organization

of business (and business practice) within the

Triad of modem industrial economies.

Atone extreme, the United States has permitted

and encouraged foreign companies to take advantage of extraordinary access to its markets for

trade and investment purposes. Accordingly, foreign affiliates in the United States account for a

significant share of total U.S. assets, sales and, to a

lesser extent, employment. At the other extreme,

Japan has restricted foreign investment and imports, and has permitted foreign MNEs limited access to its markets, typically only through joint

ventures with Japanese partners. Foreigners have

often found it extremely difficult to invest in Japan, whereas Japanese investors have found man y

opportunities abroad.

The policy questions turn on two issues: 1 ) how

to achieve a rough balance between the need of

MNEs to achieve global efficiency on the one

hand, and the need of nations to retain technical

and industrial competitiveness on the other; and 2)

how to achieve an equitable and sustainable distribution of advanced R&D and manufacturing

capabilities among competing economies. Greater coordination among the advanced industrial nations is probably required to harmonize the rules

of multinational trade and investment.

PRINCIPAL FINDINGS OF

THE FIRST REPORT

1.

2.

3.

The policies and actions of governments may

be decisive in determining which MNEs prosper in global competition. At a minimum, they

will influence both which competitors will

succeed and where state-of-the-art technology

development and manufacturing take place.

Excess capacity and increasing competition

among MNEs are leading to consolidation and

shakeout in many global industries. A coherent

system of international trade, investment, and

monetary polices has not emerged to meet the

challenges of the global economy.

Broad asymmetries in the policy regimes of the

major trading nations have developed--especially market access, foreign direct investment,

financial, and industrial policies related to the

activities of MNEs. These asymmetries, when

combined with major shifts in the global economy and protectionist responses to them, con-
198 I Multinationals and the U.S. Technology Base

tribute to increasing trade frictions and tensions

in international relations.

4. Public policies and private sector initiatives

have combined to restrict foreign direct investment in some major trading nations to a level

far lower than that of others.

5. Governments remain influential in dealing

with MNEs. The U.S. government, however,

has opted to minimize its influence over many

aspects of MNE behavior in the United States.

This attitude, as reflected in government policies, is in stark contrast to Japan and several EU

member states.

6. The modem MNE is a highly flexible and

adaptable form of business organization.

MNEs configure and reconfigure their operations to meet diverse requirements, including

those imposed by different governments.

7. U.S.-based firms no longer dominate the list of

the largest MNEs. This decline reflects in part

the relative decline of the U.S. economy and the

rise of Japan. Of the 500 largest MNEs in the

world today, 157 are based in the United States,

168 in Europe, and 119 in Japan. In the late

1960s, 304 were U.S. companies, 139 were European, and 37 were Japanese.

8. Many MNEs are increasingly multi and less national than in the past; there appears to be a

growing divergence of national needs and the

needs of these MNE organizations. This finding is less true of Japanese and some Europeanbased MNEs, where companies tend to retain a

stronger national identity.

9. For an increasing number of firms, multinationalization represents a strategic response to a

changing financial environment characterized

by rising international capital flows, more open

capital markets, expanded financing options,

and volatile exchange rates.
Appendix C:

Competition Policy

Across the Triad

D

ue to the increasingly global character of

modern commerce, competition policy

has become an important element of international law and politics.1 The United

States has pursued overseas antitrust problems in

bilateral discussions with Japan and other countries, and has participated in OECD, GATT, and

WTO discussions of international competition

policy issues. In recent years, the Antitrust Division of the U.S. Justice Department has focused a

great deal of attention on international antitrust

problems involving multinationals in a wide variety of industries. International legal issues are

emerging rapidly and changing regularly, increasing the pressure on national governments to understand foreign competition policy regimes,

clarify existing policies, and develop channels for

cooperation and dispute settlement. As multinational firms become increasingly prevalent in foreign markets, the conflicts between different

national competition policy regimes are likely to

emerge ever more forcefully.

Nations define and administer competition

policy very differently.2 In the United States, antitrust law is constructed to protect consumers from

restraint of trade, monopoly power, and collusive

business practices. In Japan, competition policy

historically has subordinated consumer interests

to policies intended to strengthen and favor do-

‘ Outside the United States, the conventional term used [{~ describe the regulation of competition is “cmnpetiti(m policy”; the teml cmvcntionally used in the United States is “antitrust policy.” Com@ition policy generally subsumes antitrust policy and addresses a wider r,ange of

poli(icat and economic objectives.

2 For a discussion of the different competition policy regimes in Europe, Japan and the Untied States, see: M.C. Huie, “’Intrcxiuction—The

EEC & An[itrus[ in 1992,” The Journal ofReprints For Antitrust Lu~t and Economics 25( 1 -2):3-22, 1993; M.M. Mendes, Antitrusl [n a 14’orldt!f

Interrelated Economies: The Interplay Between Antitrust and Trade Poiicies in [he USandthe EEC(Bruxelles, Belgique: Editions de 1‘University de Bruxelles, 199 I); U.S. Congress, General] Accounting OffIce, Changes in Antikus/Enfurcemenl Po/ie[es and Acn\>ilies GAO/GGD-9 1-2

(Gaithersburg, MD: October 1990); U.S. Congress, General Accounting Office, Compe/iti\’ene.$sls.sues, The Business En\’ironmcnl In /he

Uni[ed Slates, Japan and Germany, GAO/GGD-93- 124 (Washington, DC: August 1993); J.D. Richards, “Japan Fair Trade Commissmn GuI(ieIines Concerning Distribution Systems and Business Practices: An Illustration of Why Antitrust Law Isa Weak’? Solution To U.S. Trade Problems with Japan,” Wisconsin Lm’ Retiew! (3):92 1-960, 1993; R.L. Cutts, “Capitalism in Japan: Cartels and Keiretsu,” Har\’ard Bu.sine.w Re\’iew

July-August 1992, pp. 48-55; and E. Fox, ‘The Tenth Milton Handler Lecture: Antitrust, Trade and the 2 1st Centu~—Rounding the Circle,”

The Record of the Association of the Bar of the City of Ne\%v York 48(5):535-588, June 1993.

I 199
200 I Multinationals and the U.S. Technology Base

mestic producers, although there have been some

signs that this emphasis may be changing.3 In the

European Union (EU), competition policy is designed to promote economic and political integration and enhance economic competitiveness,

although attention is also given to preventing

firms from abusing a dominant market position.

Asymmetries in the regulation and enforcement of

competition policy can affect the relative competitiveness of firms in both domestic and foreign

markets.

Some governments have been accused of permitting and even supporting cartels, exclusionary

practices, price fixing, market allocation schemes,

predatory pricing in third country markets, and

other restraints on competition. 4 Although governments can, in theory, enforce their laws against

anticompetitive practices in foreign markets, they

rarely do so due to intragovernmental conflicts.

Private parties have virtually no ability to pursue

anticompetitive behavior in foreign markets, apart

from bringing actions against local affiliates of the

alleged perpetrator. Matters are further complicated when the alleged perpetrators (a) do not have

operations within the jurisdiction of the concerned

government or (b) are located in jurisdictions that

do not allow or encourage private antitrust actions.

U.S. antitrust law prohibits foreign anticompetitive behavior that restricts U.S. exports or limits

market access by firms with operations in the

United States. Likewise, the European Union and

Japan claim extraterritorial jurisdiction over certain actions that have adverse consequences for

their domestic firms. Nevertheless, the extraterritorial extension of domestic competition policy

rules is frequently rendered ineffective by difficulties in gathering evidence from the alleged perpetrators. Negotiations and discussions aimed at

harmonizing review procedures and enhancing

cooperation among different national competition

policy authorities have not yet created a framework that ensures compliance with the discovery

process in foreign countries. 5 Despite precedents

established in the area of publicly traded securities, exchange of confidential information between agencies charged with the enforcement of

competition policy remains limited.

Ultimately, fundamental asymmetries across

the Triad imply that effective enforcement of existing national competition policy rules would be

insufficient to ensure fair and open global competition. In the long run, greater convergence

across competition policy regimes may be necessary. To move toward this goal, some analysts

have advocated a multilateral antitrust agreement

such as that proposed by the Havana Charter.6 But

even if countries pursued such an agreement, extensive differences in national policies, political

institutions, systems of corporate governance, and

cultural norms suggest that an international competition policy regime is a long-term prospect at

best. Consequently, it maybe preferable to pursue

3 Recently, the Japan Fair Trade Commission (JITC) has stepped up its enforcement efforts, and some government officials have begun to

recognize consumer interests in competition policy matters. To date, though, it remains unclear whether these signs foretell a significant reorientation in Japan’s competition policy regime.

4 Sm: Coalition For OFn Trade, Dealing wifhJapan: Responding to Private Practices in Restraint of 7?ade: An Assessment of Policy Tools

(Washington, DC: March 1994). Although its historical discussion is compelling, the report’s recommendations are controversial.

5 For a discussion of negotiations and agreements intended to enhance enforcement and cooperation, see: J.F. Rill and V.R. Metallo, “The

Next Step: Convergence of Procedure and Enforcement,” sponsored by 1992 Fordham Corporate Law Institute, B. Hawk (cd.), International

Antilrust L.uwand Policy (New York: Translational Juris Publication Inc., 1993), pp. 15-39; R. Pitofsky, “Proposals For Revised United States

Merger Enforcement in a Global Economy,” The Georgetown Luw Journal 81(2): 195-250, December 1992; J,F. Rill and V.R. Metallo,

“Convergence of Premerger Notification and Review: A Case Study,” Wake Foresr Luw Review 28(1 ):35-50, Spring 1993; and Fox, op. cit.,

footnote 2.

6 The Havana Chmer was never mtified. For the text of the charter, see: C. Wilcox, A Charterfor World Trade (New York: The Macmillan

Company, 1949), pp. 231-327.
Appendix C Competition Policy Across the Triad I 201

a more limited international agreement, such as a

nonbinding statement of core principles, that

could set a normative context for greater international cooperation on competition policy matters.

In the short term, governments may wish to focus on achieving more effective enforcement of

existing national competition policy laws and,

perhaps, improving the ability of national governments to pursue foreign anticompetitive practices

that directly affect domestic firms. For the U.S.

government, short-term policy strategies could

focus on four areas:

1. Providing resources for the U.S. government to

gather and analyze information on international

anticompetitive practices.

In the past, the U.S. embassies were responsible for gathering information on international cartels. The embassies provided antitrust authorities

with much useful information on the number,

methods of organization, influence, and market

power of foreign business groups. At present,

however, no agency is charged with this information-gathering responsibility. Consequently, the

United States government may not be fully informed in international negotiations, and cannot

easily detect foreign anticompetitive behavior

that violates U.S. antitrust laws. The U.S. government might consider resuming some method of

information gathering to identify antitrust violations for potential prosecution, to support civil

suits (especially when brought by plaintiffs with

few resources), and to assist ongoing negotiations

intended to improve cooperation and harmonization.

2. Improving international cooperation among

competition policy authorities.

Increased cooperation among different competition authorities may be relatively easy to encourage when the action in question is illegal in

both jurisdictions and when the authorities vigorously enforce their laws and regulations.7 It will

be more difficult to foster cooperation when the

action in question is legal in one jurisdiction and

not in the other, and/or when enforcement is more

lax.

Two important agreements which have fostered

international cooperation are the Canada-United

States 1990 Mutual Legal Assistance Treaty

(MLAT) and the 1991 agreement between the

United States and the Commission of the European Union to cooperate in the application of their

competition laws. 8 The MLAT allows for mutual

cooperation in law enforcement for criminal antitrust violations, but it does not require coordinated

investigations by both countries.9 The U.S.-EU

Agreement seeks to reinforce competition policies by: a) requiring each party to notify the other

of transactions that may affect important interests;

b) requiring the antitrust authorities to meet on a

regular basis to exchange information regarding

pre-merger review, subject to confidentiality

agreements; c) allowing coordinated investigations by both parties, when deemed mutually ad7 For a brief discussion of legislation recently proposed by the Clinton Administration to foster greater international cooperation in the gathering of inftmmatl(m on cartels organized outside the United States, see: K. Bradsher, “U.S. Seeks Law on Foreign Cartels,” The New York 7imes,

p. D2, June 14, 1994; and J. Kahn “US Acts to Boost Anti-tmst Efforts,” Financial 7imes, p. 5, June 14, 1994.

8 The 1984 Memorandum of Understanding between the United States and Canada as to Notification, Consultation, and Cooperation with

Respxt to the Application of National Antitrust Law required notification and consultation with the other party when either the interests of the

other c(mntry were involved or the inf(mnation needed was located in the other country. Rill and Metal lo, op. cit., footnote 5.

9 A dramatic example of increased international cooperation was provided by the efforts, including joint raids, of the U.S. and Canadian

authorities that led to recent fines of over $8 million and the guilty pleas on the part of four executives in the plastic disposable tableware industry. See J. Davids(m, “Four Men Plead Guilty to Fixing Prices of Plastics,” The Wall Street Journul, p. A5, June 10, 1994.
202 I Multinationals and the U.S. Technology Base

vantageous; d) specifying means for determining

when either government might defer enforcement

responsibility to the other; and e) requiring consultation between the U.S. and EU competition

authorities. 10 When appropriate, the United States

might seek to negotiate similar bilateral agreements with other countries.

3. Eliciting more cooperation from foreign firms

in the discovery process.

Cooperation could be facilitated in the case of

mergers by the harmonization of merger reporting

requirements and waiting periods.11 This could

reduce the burden of compliance for firms and assist in the coordination of merger reviews when

several national competition policy authorities are

involved. Enforcement would be greatly facilitated if agreements could be reached with the

competition authorities to compel cooperation in

investigations and discovery on the part of firms

with operations located within their jurisdiction.

Such agreements would need to include adequate

safeguards to ensure that they could not be used to

harass firms engaged in lawful activities, and that

information of competitive interest but unrelated

to the activity under investigation was protected.

Compelling cooperation in discovery and gathering evidence from firms based outside the

United States, in the absence of active cooperation

and support from the other foreign competition

authorities, is difficult if not impossible. This is

especially so if the alleged anticompetitive actions

do not take place in or directly affect the U.S. market. Two possible measures could be considered to

deal with such situations: a) providing for a different burden of proof for those cases in which active

and effective cooperation proves impossible to

elicit in a timely fashion; and b) increasing the

damages and criminal penalties for firms convicted if they have failed to provide a satisfactory

level of cooperation.

4. Encouraging better enforcement of existing foreign competition policy laws.

The United States has long-standing political

and diplomatic channels through which it can encourage foreign governments to modify their

competition policies and practices. For instance,

some observers have noted that U.S. political

pressure is partly responsible for improving the

enforcement practices of the Japan Fair Trade

Commission (JFTC).

lo A recent exanlple of such c{x)~ration was provided by the ctxwdinated settlement reached by Microsoft with the U.S. Department of

Justice and the European Commission. See: E.L. Andrews, “Microsoft Grip on Software Loosened by Antitrust Deal,” The New York Times, p.

A 1, July 17, 1994; and L. Kehoe, “Microsoft Deal Settles Antitrust Investigation,” Financia/ 7imes, p.1, July 18, 1994. Recently, the European

Court ruled that 1991 agreement between the United States and the European Commission was void and should have been concluded by the

Council of Ministers instead of the European Commission. It is expected that the Council of Ministers will rapidly give their approval, restoring

the legal validity of the agreement. See: E. Tucker, “Commission’s Pact with US. Overturned by Euro-court,” Financia/ 7imes, p. 1, Aug. 10,

1994,

I I See ‘. Conflicts In International Merger Enforcement,” American Bar Association, Section of Antitrust Law, Special Commiffee On /international Antitrust Report, 1991, pp. 166-210; and OECD, Merger Cases In The Real World: A Study Of Merger Control Procedures (Paris,

France: OECD, 1994).
I

n order to minimize the distorting effects of

inflation on time series data, much of the data

in this report is presented in inflation-adjusted or “constant” 1987 dollars. This is

done by multiplying unadjusted “current” dollars

by price indices appropriate to the particular type

of data. ] For merchandise trade data, the report

uses merchandise export and import price indices

provided by the Bureau of Economic Analysis

(BEA). For R&D and technology trade data, an

implicit GDP price deflator is used; it also is provided by BEA. Time series data in this report are

presented in constant 1987 dollars; this presents

data values for all years as if the dollar was equal

to the value of the dollar in 1987.2

Direct investment is more difficult to measure,

because there are three different ways it can be valued at any given point in time. In the first report

of this assessment, OTA described the three principal methods for valuing direct investment: historical cost, current cost, and market value.3 The

Appendix D:

Data Note

historical cost method, which values direct investment at its initial cost, is the most widely used

measure. Most of the detailed direct investment

data provided by the BEA is stated in historical

cost terms. For this reason, and because historical

cost reporting is in many ways the most accurate

measure for comparative purposes, this report

provides data on investment position and composition in historical cost terms. To maintain consistency across all data on direct investment, the

value of direct investment flows (as opposed to

static direct investment position) is stated in current terms.

Comparing data that is reported in different

currencies requires an exchange rate conversion.

For the type of international data analyzed in this

report, purchasing power parity (PPP) conversion

is the preferred method.4 When appropriate, a PPP

conversion schedule provided by the OECD was

used.

1 Current ddlars are often referred 10 as “nominal” dollars. Likewise, constant dollars can be referred to as “’real” dollars.

z Technically, any year can be used as the base year from which to adjust time series data. For the type of data analyzed in this repro, 1987 is

conventionally used as the base year.

3 U.S. Congress, Office of Technology Assessment, Multinationals and the National Interes6Playing by Diflerenr Rules, OTA-ITE-569

(Washingt(m, DC: U.S. Government Printing Office, September 1993); box 3-A, pp. 53-54.

4 See footnote 37 in ch. 3 regarding the use of PPP conversion for R&D data.

1203
I ndex

A

Accounting standards, 41-42, 174-175

Acquisitions. See Mergers and acquisitions

Advanced Technology Program, 11,28-29,32,33

Aeronautical Technology Consortium Act of 1993,

29

Affiliated trade, 133

American Technology Preeminence Act, 28-29

APEC. see Asian Pacific Economic Cooperation

Arms-length technology trade, 47,94-96

Asia. See also East Asia; specific countries by name

addressing the trade/investment deficit, 37-38

comparable market access issue, 26

FDI shifts, 112-114

investment trends, 111-112

Asian Pacific Economic Cooperation, 24

ATP. See Advanced Technology Program

Automotive sector, 16, 19, 145-148, 153

B

Bank Holding Company Act of 1956,42, 181

Banking Act of 1933,42, 181

Banks

German corporate finance and, 185-187

German corporate governance and, 171-173

importance in financing of corporations, 3,

19-21,42-43, 156, 179-180

Japanese corporate finance and, 183-185

U.S. corporate finance and, 181-183

Bureau of Economic Analysis, 38

Business expenditures on research and development,

47,52,60-65

c

Canada

investment trends, 111

Capital markets

effects on competitiveness, 3, 20, 157, 180, 189

financing of U.S. MNEs, 183

German corporate governance and, 173

CFIUS. See Committee on Foreign Investment in

the United States

China

investment trends, 101, 102, 106

market access issue, 26

U.S. direct investment in, 26

Civilian Technology Agency, 35

CNT. See Conditional national treatment

Co-Determination Act of 1976 (Germany), 171

Commerzbank, 171, 186

Committee on Foreign Investment in the United

States, 36

Comparable market access, 19,25-26,37, 102,

116-117

Conditional national treatment, 11,27-30

Consumer electronics market, 157, 177-178

Cooperative research and development, 96-99

Cooperative research and development agreements,

11

Coordination of federal technology programs, 34-35

Corporate governance and finance

accounting standards and, 41-42, 174-175

background and findings, 3, 19-21,40, 155-158,

159-160, 179-180

conclusions, 173-178, 187-192

financial rule harmonization, 42-43

Germany

corporate governance, 169-173, 176-178

financial market structure, 185-187, 188- I 92

improving transparency, 41

Japan

corporate governance, 41, 163-169, 176-177

financial market structure, 183-185, 188-192

responding to different systems of corporate governance, 40-41

Us.

corporate governance, 40, 160-163, 175-178

financial market structure, 180-183, 187-192

CRADAS. See Cooperative research and development agreements

1205
206 I Multinationals and the U.S. Technology Base

Critical technologies programs, 31-32,34

Cross-shareholding arrangements

executive summary and findings, 3, 19-21, 156

German corporate governance and, 172-173, 177

Japanese corporate governance and, 163-169

D

Daimler-Benz AG, 173, 174, 186, 189

Data collection and analysis regarding FDIUS, 38

Defense research and development

comparison of expenditures, 57-58

government promotion of indigenous technology,

31-32

as a percent of total government R&D

appropriations, 53

U.S. expenditures, 67,69

Department of Commerce,31, 38

Department of Defense,31, 34,69

Department of Energy, 1 )

Deutsche Bank, 171, 185, 186

Disclosure requirements for foreign firms, 41

DKB Group, 168

Domestic content among manufacturing affiliates,

145-148

Douglas amendments to Bank Holding Company

Act of 1956, 181

Dresdner Bank, 171, 185, 186

E

East Asia

FDI shifts, 102, 113-114

investment trends, 26, 101, 106

Eastern Europe

FDI shifts, 101, 102, 113-114

Economic issues. See National innovation systems;

United States technology policy in international

economic perspective

Eligibility requirements for U.S. government funding, 32-34

EU. See European Union

Europe. See also specific countries by name

corporate financing in, 156, 188

FDI sectoral composition, 140-143

IFT patterns, 103, 134-139

international technical alliances, 97

investment trends, 106, 108, 110-111

merchandise trade and the distribution of FDI,

131-134

R&D within multinational networks, 85-90

technology trade, 94-96

U.S.-European FDI, 2-3, 15-16, 102-103,

122-126

U.S.-European IFT, 2-3, 14-16,24, 103, 131-139

European Union. See also specific countries by

name

EU 1992 Initiative, 113

FDI shifts, 112-114

FDIUS, 119-122

market access issues, 116-117

mergers and acquisitions, 115

patent data, 70-72

prohibitions against M&As, 115-116

R&D

business expenditures on, 47,60-62

financing patterns, 51-53

gross expenditures on, 65-68

technological emphasis, 54-58

Executive summary, 1-4

Exon-Florio provision of Omnibus Trade and Competitiveness Act of 1988,37

Exports. See International trade and multinational

firms; Intrafirm trade; Technology trade

F

FDI. See Foreign direct investment

FDIUS. See Foreign direct investment

Finance. See Corporate governance and finance;

Foreign direct investment; National innovation

systems

Financial Accounting Standards Board, 41

Ford Motor Company, 87

Foreign affiliates in the United States, research and

development by, 2,7-10,47,77-82, 151

Foreign content among manufacturing affiliates,

141-142

Foreign direct investment

background and findings, 1,2-3, 13-19,35-36,

101-103, 105

FDI in the U. S., 118-122

forms of FDI and contributions to U.S. technology base, 150-153

IFT variations and, 137-139

investment balances across the Triad, 122-127

inward and outward investment trends, 106-112

life cycle theory, 144-150

merchandise trade and the distribution of FDI,

131-134

mergers, acquisitions, strategic alliances, and

joint ventures, 115-118

monitoring developments in FDIUS, 38-39

multilateral approaches, 37

R&D

by foreign affiliates in the U. S., 2,8-10,77-82,

151

within multinational networks, 85-90

by U.S. affiliates in foreign markets, 82-85

sectoral composition variations, 139-143
shifts in, 112-115

specific reciprocity approach, 33, 39

the states’ role in FDIUS, 120-121

sustaining unrestricted FDIUS, 36-37

trade/investment deficit issue, 37-38

U.S.-European, 2-3, 14-16, 102-103, 122-126

U.S.-German, 47, 123, 126

U.S.-Japanese, 2-3, 15, 18, 102-103, 122-127

U.S. policy on, 36

Framework for a New Economic Relationship talks,

24

France

FDIUS, 151

IFT patterns, 137-139

investment trends, 111

market access issues, 116

mergers and acquisitions, 115

patent data, 70-72

prohibitions against M&As, 116

R&D

business expenditures on, 8,47,61-62

financing patterns, 51-53

by foreign affiliates in the U. S., 77-82

gross expenditures on, 66-68

by U.S. affiliates in foreign markets, 84-85

sectoral performance, 50-51

technological emphasis, 46-47,54-58

technology trade, 90-92, 94

trade deficit, 131

Fuji Heavy Industries, 168

Funding issues. See Foreign direct investment; National innovation systems; United States technology policy in international economic perspective

Fuyo Group, 167, 168

G

GAIT Treaty. See General Agreement on Tariffs

and Trade Treaty

GAIT Uruguay Round. See General Agreement on

Tariffs and Trade Uruguay Round

General Agreement on Tariffs and Trade Treaty, 11,

28,37, 102

General Agreement on Tariffs and Trade Uruguay

Round, 23-24,26,37

Germany

corporate governance and finance, 3, 19-21,

156-158, 169-178, 185-187, 188-192

FDI sectoral composition, 140-142

FDI shifts, 113-114

FDIUS, 123, 125, 150-151

IFT patterns, 102, 137-139

investment trends, 106, 108-111

market access issues, 116

patent data, 69-72

Index I 207

prohibitions against M&As, 115-116

R&D

business expenditures on, 8,47,61-62

financing patterns, 51-53

by foreign affiliates in the U. S., 77-82

gross expenditures on, 65-66,68

within multinational networks, 89

by U.S. affiliates in foreign markets, 84-85

sectoral performance, 50-51

technological emphasis, 46,54-58

technology trade, 90-92,94-96

trade deficit, 131

U.S.-German FDI, 47, 123

Glass-Steagall provisions of Banking Act of 1933,

42, 181

Global recession, 115

Globalization in perspective

background, 5-6

corporate governance and finance diverge across

the Triad, 19-21

multinationals develop core technology at home,

6-13

the technology policy debate, 12

trade follows investment in the 1990s, 13-19

types of MNEs, 6

Governance. See Corporate governance and finance

Government promotion of indigenous technology,

31-32

Gross expenditures on research and development,

50-51,65-69

H

Honda Motor Corporation, 16, 146-147, 153

Hong Kong

investment trends. 106

I

1~. See Intrafirm trade

Imports. See International trade and multinational

firms; Intrafirm trade; Technology trade

Indonesia

market access issue, 26

Industrial process technology, 47,94-96

Innovation. See National innovation systems; Research and technology development

Intellectual property, 37,90-96

Internal Revenue Service, 41

International strategic alliances, 190-191

International technical alliances, 96-99

International trade and multinational fim~s

background, 129

forms of FDI and contributions to U.S. technology base, 150-153
208 I Multinationals and the U.S. Technology Base

merchandise trade and the distribution of FD1,

131-134

national variations in IFT, 134-150

the trade and investment nexus, 130-150

Intrafirm trade

addressing the trade/investment deficit, 37-38

background and findings, 1,2-3, 101-103

merchandise trade and the distribution of FDI,

133-134

national variations in, 134-150

policy implications background, 35-36

U.S.-European, 2-3, 14-16,24, 103, 133-138

U.S.-Japanese, 2-3, 16-19,47, 103, 133-144

Investment issues. See Corporate governance and

finance; Foreign direct investment; Intrafirm trade

Inward investment trends, 106-112

IRS. See Internal Revenue Service

Italy

prohibitions against M&As, 116

J

Japan

corporate governance and finance, 3, 19-21, 41,

156-158, 163-169, 176-177, 183-185, 188-192

FDI life cycle theory, 144-150

FDI sectoral composition, 140-143

FDI shifts, 112-114

FDIUS, 37, 118-122, 151-153

IFT patterns, 103, 134-139

international technical alliances, 97

investment trends, 106, 108-111

market access issues, 25-26, 102, 116-117

merchandise trade and the distribution of FDI,

131-134

multilateralism beyond trade, 26-27

patent data, 69-72

prohibitions against M&As, 115-116

R&D

business expenditures on, 47,61-64

expenditures growth rate, 2,8,47,61-64,65-68

financing patterns, 51-53

by foreign affiliates in the U. S., 77-82

gross expenditures on, 65-68

within multinational networks, 88-90

by U.S. affiliates in foreign markets, 84-85

sectoral performance, 50-51

technological emphasis, 46,54-55,58

technology development funding, 34

technology trade, 90-92,94-96,99

trade/investment deficit, 37-38, 131

U.S.-Japanese economic relations, 24-25

U.S.-Japanese FDI, 2-3, 15-16, 18, 102-103,

122-127

U.S.-Japanese IFT, 2-3, 16-19, 103, 133-139

Joint ventures, 102, 115-118

K

Korea. See Republic of Korea

L

Latin America

FDI shifts, 113-114

investment trends, 101, 111

Local content among manufacturing affiliates, 16,

19, 144-148

Location of innovation. See National innovation

systems

M

Malaysia

market access issue, 26

Manufacturing Extension Partnerships, 11

Manufacturing research and development of U. S.-

based multinational enterprises, 7,85-86

Market access issues, 19,25-26,37, 102, 116-117

M&As. See Mergers and acquisitions

McFadden Act of 1927, 181

Merchandise trade, 1-3, 130-134. See also Intrafirm

trade; Trade deficits

Mergers and acquisitions, 115-118, 151-153, 188

Metallgesellschaft AG, 185, 187

Mexico

FDI shifts, 114

Mitsubishi Group, 165, 168

Mitsui Group, 164, 168

Multilateralism beyond trade, 26-27, 102

Multinational networks, research and technology

development within, 7-11,85-90

Multinationals and the National Interest: Playing by

Di#erent Rules, 23

Multinationals develop core technology at home.

See National innovation systems; Research and

technology development

Mutual funds, 160-161

N

NAFTA. See North American Free Trade

Agreement

National accounting standards, 41-42, 174-175

National benefits test, 32-33

National Competitiveness Act of 1993,29-30,33

National Critical Technologies Institute, 31,34

National Critical Technologies Panel, 31

National Defense Authorization Act, 30

National innovation systems. See also Research and

technology development

background and findings, 2,6-13,45-47,49-50
Index I 209

conclusions, 72-73,99-100

international technical alliances and, 96-99

patents, 69-72

performance patterns, 59-72

R&D

business expenditures on, 52,60-65

financing patterns, 51-53

gross expenditures on, 50-51,65-69

location of, 75-90,99-100

sectoral performance, 50-51

structural differences, 50-59

technological emphasis, 53-59

technology trade and, 90-96

National Science and Technology Council, 34-35

National technology innovation and multinational

firms. See National innovation systems; Research

and technology development

The Netherlands

investment trends, 111

prohibitions against M&As, 116

Nissan Motor Co., 147, 153, 168

North America. See also specific countries by name

FDI sectoral composition, 143

FDI shifts, 112-114

mergers and acquisitions, 115

North American Free Trade Agreement, 24,37, 102

NSTC. See National Science and Technology

Council

o

Oceania

investment trends, 111

OECD. See Organisation for Economic Co-Operation and Development

Omnibus Trade and Competitiveness Act of 1988,

24,38

Organisation for Economic Co-Operation and Development, 28, 53, 59. See also specific member

countries by name

Outward investment trends, 106-112

Overseas research and development. See National

innovation systems; Research and technology

development

P

The Pacific nations, 111-112

Partnership for a New Generation of Vehicles, 11,

32

Patents, 69-72

Pennsylvania

law freeing corporate directors from fiduciary

obligations, 188

Philips Electronics N. V., 87, 177-178

Plaza Accord, 13, 16, 110

PNGV. See Partnership for a New Generation of

Vehicles

Policy issues and options. See United States technology policy in international economic perspective

R

R&D. See National innovation systems; Research

and technology development

Reciprocal equity ownership, 164

Republic of Korea

IFT patterns, 138

investment trends, 106

market access issue, 26

U.S. direct investment in, 26

Research and technology development. See also

Defense research and development; National innovation systems

cooperative R&D, 11.96-99

coordination of federal technology programs,

34-35

corporate governance effects on, 162-163

eligibility requirements for U.S. government

funding, 32-34

executive summary, 2

financing patterns, 51-53

by foreign affiliates in the U. S., 2,7-10,47,

77-82, 151

findings on, 2,6-13,45-47

government promotion of indigenous technology,

31-32

location of, 75-90,99-100

within multinational networks, 85-90

policy implications background, 31

technology funding and foreign economic policy,

32

by U.S. affiliates in foreign markets, 47,82-85

Robert Bosch GmbH, 172

Russia

FDI shifts, 114

s

Sanwa Group, 168

Sectoral composition and concentration of business

research and development, 53-59

Sectoral composition of foreign direct investment,

139-143

Sectoral performance data for national innovation

systems, 50-51

Securities and Exchange Act of 1934, 162

Securities and Exchange Commission, 41,42, 162

Securities and Exchange Law (Japan), 183-184, 185

Stevenson-Wydler Technology Innovation Act of

1980,29

Strategic alliances, 115-118, 190-191
210 I Multinationals and the U.S. Technology Base

Sumitomo Group, 166, 168

Supervisory boards’ composition in German enterprises, 171, 185

Switzerland

prohibitions against M&As, 116

R&D by foreign affiliates in the U. S., 78

T

Taiwan

investment trends, 106

market access issue, 26

U.S. direct investment in, 26

Technical alliances, 96-99

Technological emphasis of national innovation systems, 46-47,53-59

Technology development. See National innovation

systems; Research and technology development

Technology Reinvestment Project, 11

Technology trade, 2,8-9,46,90-96

Thailand

investment trends, 106

Thomson Consumer Electronics, 177-178

Toyota Motor Corporation, 145-148, 153

Trade agreements. See specific agreements by name;

United States technology policy in international

economic perspective

Trade and investment issues. See Foreign direct investment; International trade and multinational

firms; Intrafirm trade; Technology trade

Trade balances, 131-134. See also Intrafirm trade

Trade deficits

addressing the trade/investment deficit, 37-38

executive summary, 2

findings on, 13-16

the trade and investment nexus, 103, 130-131

U.S.-Japan economic relations, 24-25

Trade Related aspects of Intellectual Property

Rights, 37

Trade Related Investment Measures, 28,37

TRIMs. See Trade Related Investment Measures

TRIPs. See Trade Related aspects of Intellectual

Property Rights

u

Unaffiliated technology trade, 47,94-96

United Kingdom

FDI sectoral composition, 141-142

FDIUS, 118, 151-153

IFT patterns, 137-138, 139, 141-142

investment trends, 106, 108, 111

mergers and acquisitions, 115

patent data, 70-72

prohibitions against M&As, 116

R&D

business expenditures on, 8,47,61-63

financing patterns, 51-53

by foreign affiliates in the U. S., 77-82

gross expenditures on, 66-68

within multinational networks, 89

by U.S. affiliates in foreign markets, 84-85

sectoral performance, 50-51

technological emphasis, 46-47,55,57-58

technology trade, 90-92,94-96

trade deficit, 131

United States. See also Foreign direct investment;

International trade and multinational firms; United

States technology policy in international economic

perspective

corporate governance and finance, 160-163,

175-178, 180-183, 187-192

dynamic character of FDI in, 118-122

FDI shifts, 112-114

investment trends, 106-112

patent data, 69-72

R&D

business expenditures on, 47,60-62,64-65

financing patterns, 51-53

by foreign affiliates in, 2,7-10,47,77-82, 151

gross expenditures on, 65-69

by U.S. affiliates in foreign markets, 7,47,

82-85

sectoral performance, 50-51

technological emphasis, 46-47,53-55,57-58

technology trade, 2, 8-9,90-96

U.S.-European FDI, 2-3, 14-16, 102-103, 111,

122-126

U.S.-European IFT, 2-3, 14-16,24, 103, 131-150

U.S.-German FDI, 47, 123, 125, 126

U.S.-Japanese economic relations, 24-25

U.S.-Japanese FDI, 2-3, 15-16, 18, 102-103, 110,

118-119, 122-127

U.S.-Japanese IFT, 2-3, 16-19,47, 103, 131-150

United States technology base in comparative perspective. See Corporate governance and finance;

National innovation systems; Research and

technology development

United States technology policy in international

economic perspective

background, 3-4,23-24

comparable market access, 25-26

conditional national treatment, 27-30

corporate governance and finance, 40-43
laws and legislation based on a CNT framework, U.S.-Japanese economic relations, 24-25

29 Universal banking systems, 42, 171-173, 186-187,

multilateralism beyond trade, 26-27 188-192

the policy context, 23-30

policy issues and options, 30-43

research and technology development, 31-35 w

trade and investment, 35-39 World Trade Organization, 23