Hinterland Economy

We now have a system of corporate empires, most of them centered in the United States. They extend into hinterland countries through branch plants and subsidiaries. Where the subsidiaries and affiliates are located in countries which are not themselves in a relation of metropolis to other countries there is extreme technological, financial and organizational dependence. But there exists a range of intermediate situations where a country stands, at one and the same time, in n metropolitan relation to some countries and in a hinterland relation to other Canada falls into this category. Both her resource , and her manufacturing industries are dominated by foreign controlled concerns. At the same time her financial institutions which have always been highly concentrated and powerful have extended to the Caribbean and other countries, through affiliated branches. So have some of her resources branch-industries, such as the aluminium industry which, however, is in turn financially-controlled from New York.          ·

It is widely believed that countries benefit from metropolitan direct investment because they thereby acquire entrepreneurship as well as funds.

This, so the argument runs, compensates for the weakness of the local entrepreneurial class and introduces the necessary “know-how” of modern industrial techniques into the hinterland economy. In the course of time, it is argued, the presence of modem enterprise will impart managerial and technical skills to the population, and local entrepreneurship will be stimulated.

Branch plant development, however, results in the erosion of local enterprise, as local firms are bought out and potential local entrepreneurs become the salaried employees of the multi-national corporation. Enterprises which remain locally­owned tend to be marginal in the sense that they are small, or inefficient or operation in industries which do not lend themselves to corporate organization. Exceptions to this pattern include publicly-owned or controlled enterprises or firms which have established an early technological lead over the metropolitan concerns.

The entrepreneur operating in a well-developed branch plant economy is increasingly confronted with an organizational and institutional complex which presents him with a choice of either joining bis resources with those of the international corporation as a salaried employee or contenting himself with a very limited role.

In the mineral resource industries, independent enterprises face a situation where the large established corporations control the terms of sale of raw materials. For independent markets are uncertain, prices too low to cover costs, and for these reasons, their capacity to borrow funds is limited. Their activities tend, therefore, to be of the riskier kind – drilling, prospecting, exploration, operation of marginal mines in abnormal market conditions, and sub-contracting for work where large companies enjoy the stronger bargaining position. Ironically, success increases the risk. At the point where a venture succeeds in reaching the threshold beyond which it could become really profitable, it discovers that the doors to entry are opened only by coming to terms with those already inside.

The nature of manufacturing industry makes entry very much easier, but independent entrepreneurs have less security against loss than to do branch plants. The latter can charge back losses against parent companies which can offset them against profits earned on their exports to subsidiaries and against royalties and fees received. The existence of the branch plant firm is thus justified even where its profits are small or negative. The disadvantage of the local firm is even greater where incentive programs are biased in favour of foreign concerns.

It is to be noted that entrepreneurship does not bear any simple relationship to high levels of income, or to high levels of education. Canada, as well as some countries of Latin America and some Caribbean countries today, have higher levels of per capita income than prevailed in the metropolitan countries during their heyday of private accumulation. They have far higher levels of per capita income than contemporary Japan, where private and public entrepreneurship is highly developed.

The lack of entrepreneurship in countries where branch plant economy has taken root has sometimes been explained in terms of religious or ethnic factors. The superficial nature of all these explanations is best illustrated by the case of Canada. The relative decline in local entrepreneurship in contemporary English-speaking Canada as compared with the late 19th century and early 20th century has occurred in a period of rising income, rising educational attainment and within a framework of “modern” culture and institutions.

One of the few economists who has suggested that branch plant economy may be the cause rather than the result of a lack of indigenous entrepreneurship is Dr.Stephen Hymer. Although addressed to the Canadian case, the following observation may well have general validity:

“The large volume of foreign investment in Canada seems to suggest a shortage of Canadian entrepreneurs. But which is cause and which is effect? We usually think of foreign investment as a consequence of a shortage of domestic entrepreneurs, but perhaps the former has helped to create the latter. Suppose in the extreme case, Canada forbade all foreign direct investment. This would entirely slow down the flow of technology and create a gap between techniques used in Canada and the best available technique elsewhere. What would happen then? Through time the gap would grow and there would be an increasing incentive for Canadians’ entrepreneurship? Once over their initial learning period, might not Canadian entrepreneurs be able to stand on their own feet? The shortage of entrepreneurs in Canada might disappear and with it the need for so much foreign investment.”

A branch plant economy dependent on imported technology is assured of a perpetual technological backwardness vis-a-vis the metropolis. Furthermore, dependence is addictive and the dynamics of dependence are cumulative. Countries with indigenous entrepreneurship and with consumption and behavioural patterns differing from those of the metropolis relinquish a potential advantage in production for domestic and foreign markets when they permit branch plant economy to take over indiscriminately and on a large scale.

These tendencies become more pronounced to the degree that product and technological innovation play an increasingly important role in international competition. The advantages of temporary monopoly acquired by manufacturers in some nations by producing new products or differentiating old ones have been offered as explanations for the pattern of trade in manufactured goods. This “technology-gap” theory coincides with the argument we have been presenting throughout this essay that advantages accrue to countries to the extent that they are innovators and not takers of technology. The importance of maintaining distinctive consumption and cultural patterns in encouraging the development of indigenous innovation has received less attention. It is noted in the literature, however, that there is a tendency for exporters of manufactured goods to find markets in countries where income levels are similar. Resistance to the importation of metropolitan values and consumption patterns and barriers to the absorption of a country’s intellectual, scientific and managerial resources into the world of the multinational corporation force the country to develop its own resources of entrepreneurship.

Obviously, products developed on the basis of particular climate, geographical and cultural factors, or traditional skills and crafts have an advantage similar to that accruing to the “temporary monopoly” acquired by producing new products of differentiating old ones. Obvious examples are small aircraft developed for use in the Canadian north, the small scale automobiles of Europe , the glass-ware of Czechoslovakia, the wood-working industries of Scandinavia, or the many Italian industries developed on the basis of excellence of artistry in design.

Indigenous entrepreneurship can “learn-by-doing”. It has been pointed out that the dynamic economies resulting from indigenous technological innovation are of particular importance for countries of limited size, and further that they are irreversible in that, a nation, having acquired them, will not lose them. The importance of these factors are best illustrated in countries which are relatively poor in resources, but perhaps for that reason, rich in resourcefulness, Examples include Japan, Switzerland, Israel and the Scandinavian countries. Branch plant economy destroys the mobilization basis of indigenous development.

The most direct expression of technological dependence in branch plant economies is found in the relative absence of research facilities in these countries. Technological and innovational activity is concentrated in the research laboratories board-rooms and academic centres of the metropolitan countries. Where research is carried out in hinterland it tends to be limited to the modification of products developed in the metropolitan country to special condition in particular hinterland countries.   ·

What is more, skilled personnel are attracted to the metropolitan industrial and academic centres by high salaries, superior facilities and the fact that the professionals involved have internalised the values of the metropolitan society. By means of the “brain-drain”, the brightest and ablest people from lower-income countries swell the technological resources of the richer countries. Similar processes are at work with respect to managerial skill. The following account of company policy provided by the Proctor and Gamble Company illustrates the point with respect to Canada:

“When Proctor and Gamble moves into a country for the first time, it has to bring in skilled top-management team, already developed – The initial cadre goes about building as organization in depth. Just as soon as local talent can be developed, it is. Of the American group in Canada Proctor and Gamble in 1947, only two of us are left. The others have gone to Geneva, to Venezuela, to Cincinnatti and elsewhere. More important, from the organization they built, we have taken cuttings. Today the General Manager of Proctor Gamble in France is a Canadian; The General Manger in Morocco is a Canadian, the General Manager in Mexico is a Canadian; and the man responsible for all our business in the “outer Seven”, including British is a Canadian. The important thing is that, in the total organization they were neither helped nor hampered by their nationality”.

These Canadians have become citizens of an international corporate empire. Their professional and management skills have been harnessed to the service of some particular international companies. Meanwhile there is much wailing that Canada is short of managerial talent.

The possibilities of developing new exports of manufactures is severely limited in hinterland economy. The number of activities which are attracted to cheap labour is limited and they are usually characterised by low income elasticity of demand for their output. Not only are wages differentials eventually narrowed by trade union organization, but there is little evidence that cheap labour at­ tracts foreign investment.

It is often assumed that the branch plant connection assists hinterland countries with the marketing of industrial output in the metropolitan country. However, the data on the exports of foreign subsidiaries of manufacturing corporations suggest otherwise. For example, sales by U.S. manufacturing subsidiaries abroad totalled 18.3 billion dollars in 1957 out of which exports lo the U.S. totalled only 1.1 billion.

These latter imports to the metropolitan country remained at $1.l billion even though total sales from U.S. manufacturing facilities had risen to $31.3 billion by l963. Further, the imports from subsidiaries were of a very special kind.

Machinery sales by U.S. direct investment rums abroad increased from 3.9 billion in 1957 to 6.5 billion in 1963. Of these sales exports to the U.S.were only 93 million in 1957 and 117 million in 1963.

Either they were semi-processed raw materials or, when final goods, they were specialty items such as European cars which were not produced in the metropolis. Or again, they were from countries having some special relationship with the metropolis. The major portion of total imports of manufacturing subsidiaries originates in Canada and enters the U.S. at relatively early stages of the production process.

A study of 155 U.S. companies with producing facilities abroad concluded that:

 “A strong bias exists towards investing and producing within the U S. whenever possible. Specific examples were given of products that would be sold at great profit if they were made abroad for import but which are and would continue to be produced at home for reasons of risk-avoidance of for patriotic or other political reasons unless the producers were forced by competitive pressure to do otherwise.”

The same survey found evidence to the effect that the motivation of setting up overseas production facilities is rarely to obtain a cost advantage in the metropolitan market or even in third country markets. Less than 20 per cent of manufacturing affiliates sales were exported to third countries and even here, a major portion of this trade was in near raw materials or was located in large trading blocs- principally the European Common Market. A Department of Commerce study made in 1963 showed that 70% of third country exports of manufactured goods originated in Europe and was directed at other European countries within the same trading bloc.

It is quite clear that, in the great majority of cases, the purpose of setting up manufacturing brunch plants in foreign countries is to service the domestic market of these countries. These branch plants generally produce a great range of products. They tend to fragment the industrial structure of the country in which they locate. The high cost structure of branch plant industry typically producing too many products for the size of the domestic-market makes it difficult to develop exports of manufactured goods, even where company policy is not explicitly biased against such exports. An interesting corollary of this is that the independent local company operating within the same industry would be equally unable to compete abroad.

Another result of the individual structure of branch plant manufacturing is that import substitution in many developing countries appears to have surpassed its economic limits. But this apparent over industrialization may in fact be, again simply a result of the combination of high protective barriers with incentives to attract branch plants. Often the local national market for a product is quite large enough to reap of scale, so long ns production is not fragmented into a whole set of similar and competing goods, produced by different international companies, or their licensees. This taste for variety has a very high cost.

Once the branch plant economy takes root, whether in the resources industries, or in the manufacturing industries, or in both, it tends to be self-perpetuating. We have already pointed out the opportunities for the development of large scale local enterprise become progressively more circumscribed – even where income and purchasing power are expanding.

Although the total savings generated by the activities of branch plants are considerable, the access to these savings by local enterprise is limited. The major part of the contribution which the branch plant sector makes to national income comes in the form of wages and salaries and government revenue. The overwhelming part of profit income, whether distributed or retained, accrues as factor income to shareholders of the parent corporation or to the corporation itself and makes no direct contribution to national income. The branch plant economy thus chokes the development of local capitalists. Kierans once complained that international corporate “free enterprise” discriminates against capitalism in the hinterland.

“The advantages of a capitalist system are that it provides income from savings and investment, as well as from labour. To deny local participation abroad is to confine the benefits of capitalism to the United States. We need capitalists in all parts of the world”.

The savings out of employment income, even when the latter are high, come in the form of contributions to insurance and pensions plans, and are channelled through financial intermediaries whose placements seldom provided for investment of risk capital. This is in contrast to the classical mechanism by which high personal income accrued to men of property, who were in fact the· transactors on both sides of the capitol market and could match savings with investment opportunities.

In a branch plant economy, the re-invented profits of the subsidiaries from a significant portion of private domestic savings. The increasing indebtedness of the hinterland countries is thus financed largely from its own domestic savings. The decision to dispose of these domestic savings of the hinterland country are really part of the national economy of the metropolitan country.

The increase in foreign investment which occurs in the hinterland when subsidiaries finance expansion from retained earnings can have a serious impact on the current balance of payments situation, in the event that the corporations decide to transfer capital out of the country, as such transfers normally take the form of heavy payments of dividends, and a halt to re-investment, or even liquidation of reserves held by subsidiaries.

It is characteristic of branch plant economy that funds flow more freely with in the multi-national corporation than they do between sectors of the national economy. In fact, the distinction between the payment of dividends and the withdrawal of capital, and the difference between the retention of earnings and the inflow of capital are not too meaningful in transactions between parent companies and their subsidiaries.