Market development

The economic systems can be divided into three types – command economies, mixed economies, and market economies. In a market economy, all productive activities are privately owned and production is determined by the interaction of supply and demand. The role of government is to encourage free and fair competition between private producers. In a mixed economy, governments tend to own firms that are considered important to national security, while other sectors are left to private ownership and free market mechanisms. In a command economy, the government plans the goods and services that a country produces, the quantity that is produced, and the prices as which they are sold. All businesses are state-owned, and governments allocate resources. Nevertheless, it tends to stagnate since there is little incentive to control costs and be efficient.

Friedman (1962) argued that market liberalization is the best strategy on the distribution of social resources and on the management of personal affairs. Scully (1988) showed that there is a positive relationship between level of freedom and economic growth. Barro (1991) found that countries with free enterprise systems have higher rates of economic growth than those with socialist systems, while it is insignificant between free enterprise systems and mixed systems. In addition, countries associated with good property rights protection tend to achieve greater economic growth rate than those associated with poor property rights protection. Hence, a country‟s economic system and property rights regime may constitute a good indicator of the potential long-run benefits of doing business in a country. This may suggest that MNEs are more likely to achieve goal and/or gain profit in host countries associated with greater degree of market development. Hence, we propose hypothesis 1 as follows:

Hypothesis 1：Market development will benefit MNEs’ overseas subsidiaries.

Due to the complexity of market development, Fan and Wang (2000, 2004, 2006, 2009) constructed the market development index from five dimensions: the relationship between government and market, the development of non-state-owned economy, the degree of goods market development, the degree of factor market development, and the degree of legal protection. Hence, we establish hypothesis H1a to H1e as follow:

(1) The role of local government

The different political system may increase the cost and uncertainty in communication between business and government (Dow and Karunaratna, 2006). The major change is to allocate the economic resources by market rather than by government plans for market reform. According to international experiences, the market will be more liberal when the government involves less in allocation of economic resources. After the market reform, the government of transitional economy should gradually withdraw from the field of investments, reduce the proportion of resources distribution, and decrease intervention in enterprises gradually. However, many companies are still intervened by local government when engaging in FDI. The overseas subsidiaries have to spend much time and money to communicate with local government. Paying additional costs is inevitable. In addition, some overseas subsidiaries will bribe the local government in order to get additional interests.

These opaque operations and inefficient systems will interfere with the normal operation of market mechanism and become a heavy burden to the overseas subsidiaries.

Blomström and Kokko (1996) and Sinani and Meyer (2004) found that the government of many developing or transitional economy adopt preferential policies in order to attract foreign investors. The government regards FDI as their strategy to encourage domestic economic development (Tatoglu and Glaister, 1998; Cheng and Kwan, 2000; Makino et al.,

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2002). Henisz and Delios (2001) pointed out that the government policies in host country may impact the foreign investment. However, local government still meddles with certain degree to overseas subsidiaries. The development of free market institution enable companies to make strategic decisions efficiently, including product selection, quality, product output and material input (Behrman and Rondinelli, 2000). Hence, the enterprises can implement favorable strategies according to the market conditions and circumstances to raise profitability. Therefore, Hypothesis 1a proposed as follows:

Hypothesis 1a: The weaker the role of the local government in the market is, the stronger the performance of MNE’s overseas subsidiaries has.

(2) The degree of non-state-owned economic development

Enterprises can be divided into state-owned enterprises and non-state-owned enterprises.

The economic reform is to turn state-owned enterprises into state-owned and non-state-owned enterprises and allows them to exist simultaneously. When economy is transiting from government planned to market-oriented, how to develop the non-state-owned enterprises become very important (Behrman and Rondinelli, 2000). Many studies discussed state-owned enterprises and non-state-owned enterprises separately. Huang and Meng (1997) found that non-state-owned enterprises have better performance than state-owned enterprises. Buckley et al. (2002) indicated that state-owned enterprises are more flexible in budget constraints. Their finance depends on central government in spite of performance condition. The objectives of state-owned enterprises are not only the production of goods, but also include government‟s political support like employment opportunities, provision of social services and welfares which conflict with the production efficiency.

The proportion of state-owned and non-state-owned enterprises is inconsistent in different locations. Thus, overseas subsidiaries face the diverse degree of competition when they operate in different location. If the host has a high proportion of state-owned enterprises, the location can not reflect its market conditions accurately. It is oriented by the government‟s policies. When the overseas subsidiaries operate in these locations, the market must be influenced by majority of state-owned enterprises. It will deprive the right of free competition. When the parent company invests in a host province with vigorous non-state-owned enterprises, it is committed to improving the company‟s efficiency and productivity. Because non-state-owned enterprises always consider economic conditions and company performance as primary goal, they will encourage vigorous competition.

Overseas subsidiaries must also improve their efficiency, productivity, and performance to maintain competitiveness in order to survive in the host. Therefore, Hypothesis 1b proposed as follows:

Hypothesis 1b: The non-state-owned economic development will benefit MNEs’

overseas subsidiaries.

(3) The degree of goods market development

The producers and consumers trade in the market to maintain the flows of goods, and to obtain products‟ prices with a balance of supply and demand. However, many products‟

prices are decided by the government instead of by the market mechanism, the phenomena are more obvious in transition economies. Although the transition economies have gradually transferred its role in determining the products‟ prices to the market, the government still holds a relatively higher proportion in making the decisions. In addition, some provinces even develop regional trade protection to protect local enterprises, creating barriers to foreign products, including the different standards of technical inspection, quality

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competition, reduced the efficiency of resource allocation, and impacted the competitiveness of MNEs. Dunning (2001, 2002) and Gatignon and Kimberly (2004) found that the liberalization of capital markets and the high mobility of products have impacted MNE‟s strategies.

When overseas subsidiaries operated in a location with lower degree of goods market development, higher proportion of local government intervention will lead to inability of the local market to reflect supply and demand accurately. The overseas subsidiaries can not implement the advantageous strategies, raise prices, and reduce costs in order to obligate the government‟s stipulation. Moreover, the regional trade protections increase the production costs of overseas subsidiaries. Conversely, when the location has a high degree of goods market development, the products‟ prices will be determined by market. The resources would also be allocated efficiently. Therefore, overseas subsidiaries are able to compete fairly with local enterprises, and enhance the profit for the companies. When regional protection is reduced, overseas subsidiaries and its products will increase the competitiveness.

Due to the free flow in the market, the goods obtain more sales opportunities. Therefore, Hypothesis 1c proposed as follows:

Hypothesis 1c: The degree of goods market development is positively related to the performance of MNE’s overseas subsidiaries

(4) The degree of factor market development

Factor markets are composed of many aspects which include land, labor, capital, and so on. The factors enable enterprises to operate normally. Whether these elements can be easily acquired or not is an important consideration for companies to invest and operate in foreign market. Many enterprises invest in developing countries in order to reduce the factor cost. Zhao and Zhu (2000) indicated that costs affect the location choice for FDI,

especially labor costs. Dunning (2001, 2002) and Gatignon and Kimberly (2004) found that MNE‟s strategies are influenced by the high mobility of people. When the degree of factor market development is higher, the local factors are easier to obtain. In general, due to the consideration of risks, capital acquisition is more difficult than other factors. Because the bank's loan conditions are different, it is more difficult for overseas subsidiaries to obtain finance in host country. It will impact the overseas subsidiaries‟ operation.

When the overseas subsidiaries operate in low degree of factor market development, they would not operate normally. Due to the lack of local factors, they can not expand factory or increase funding easily, it must reduce the chances of making profit. When the factor market development is high, it will attract the labor inflow from other locations. It also attracts more foreign investment, so the competition between financial industries would be more intense. If the overseas subsidiaries operate in high degree of factor market development, the abundant factors are accessible to the overseas subsidiaries. The financial industries will also relax the standards for loans due to intense competition. Overseas subsidiaries can easily acquire the factors according to the company‟s condition, and increase its profitability and capabilities. Therefore, Hypothesis 1d proposed as follows:

Hypothesis 1d: The degree of factor market development and the performance of MNEs’ overseas subsidiaries are positively related

(5) The degree of legal protection

Since the law institution and business environment do not develop completely in developing countries, it would cause information asymmetry and risk easily (Hoskisson et al., 2000; Wright et al., 2005). Wan and Koskisson (2003) found that political and legal institutions have influenced firm‟s diversification strategies. Regardless of FDI is from developed countries to emerging markets, or from emerging economies to emerging markets,

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the investment risk always exist. Bevan and Estrin (2000) indicated the risks in transition economies include balance of government, regional development, industrial development, reserves and corruption. In order to promote industrial development, protecting the manufacturers‟ rights is a prerequisite in market. These protections include judicial, administrative law enforcement agencies, and so on. Although legal regulations are stipulated by the state, the degree of law implementation is inconsistent in each province.

Hence, overseas subsidiaries face diverse legal environment while operating in different province. If the laws are enforced more fairly in the province, the overseas subsidiaries are protected more under the legal rights. It would reduce investment risks and encourage overseas subsidiaries to develop and invest.

Patent law makes the patent holders clear their own distribution of patent rights. (Hu and Jefferson, 2009) If the host country does not respect the patent protection, the research and development of overseas subsidiaries are easily imitated by other companies in the host country. It would damage the firms‟ rights and reduce the motivation to research and develop. If the overseas subsidiaries have more patent protection, they will have more willingness to research and innovate in order to maintain the company's core competence and performance. Therefore, Hypothesis 1e proposed as follows:

Hypothesis 1e: The degree of legal protection has positive impacts on the performance of MNEs’ overseas subsidiaries.