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The technology market

Large transnational firms own most of the production technologies available in the world. They are therefore the main technology suppliers to all countries, and in particular to the developing countries. Bizec [7, p. 36] states that 80 per cent of total receipts for technology supplied by the United States accrue to multinational firms, and for European firms, the share is 50 per cent. He also states that multinationals have been more dominant in North-South transactions than in intra-OECD transactions. Large multinationals normally have as their first preference production in their home countries, whence they export to other markets.

There are two types of circumstances in which these companies are interested in locating production facilities in other countries and therefore in transferring technology. In the first type, they may be attracted by the low cost of labour, premises, and other overheads, and perhaps less stringent regulations. The other type has a longer history and applies to firms involved in the extraction of natural resources, particularly oil and minerals. Such firms are forced to operate where the resources exist; the situation is similar for tropical agricultural products such as tea, coffee, and rubber. The main concern is to extract the local raw material as cheaply as possible for export to the industrialized country markets, which are the main users. All critical decisions regarding production, marketing, and finance are usually taken at the firm's head office. Other key management and production decisions are handled by expatriates, so that nothing more than basic operational know-how is acquired by the developing country. Beyond the initial extraction, most of the further processing is done in the industrialized countries, reducing forward and backward linkage effects in the developing country. Many of the contracts and practices are rooted in the colonial past, and this form of multinational operation has been the target of considerable hostility in developing countries.

Transfer of manufacturing operations became important in the 1960s, and the factors motivating such transfers had more to do with the circumstances facing the transnational firm than with the recipient country's objectives.

A firm can serve foreign markets in three different ways: it can export from its home base; it can set up a subsidiary to manufacture and service the foreign market; or it can sell its technology to a foreign firm and receive rent on its technological assets in lieu of profits from direct sale of its products.

When the environment dictates the location of production, as in mining and plantations, the first option has to be forgone. It is also not available if legal restrictions prevent imports or if tariffs and natural factors of distance or lower costs make imports unduly expensive. The second option, setting up a subsidiary, may be chosen so as to take advantage of low wages for regional and export markets. Sometimes the move of a competitor to produce in the foreign market forces the transnational firm to follow to protect market share, although this has often been limited to assembly and packaging operations, with most components and inputs supplied from overseas.

This option may also not be feasible due to legal restrictions, lack of sufficient resources within the firm, whether financial, managerial, or in knowledge of the foreign environment. In that case, the firm may consider taking a local partner in a joint venture or even sell its technology outright for some combination of a lump sum fee and royalty. When transferring the technology, the suppliers often enter into legal contracts with developing country firms that are highly restrictive. For example, restrictions on the right of the recipient firm to make any changes in product, process, or inputs without approval; requirements to transfer to the supplier knowledge of all improvements made in the technology with no reciprocal obligation on the supplier; tied purchases of capital goods and inputs; and imposed production or export restrictions.

The technology suppliers combine their ownership of technology with dominant market power, access to large financial resources, and skilled personnel to extract agreements from developing country firms and governments that result in high costs to the developing country. These costs include high royalty, licence, and technical fees even for outdated technologies. Firms have often transferred additional incomes to themselves through tied supplies of inputs, often by charging exorbitant prices for these inputs (prices of intermediates supplied were sometimes higher than the price of the final product in the international market).

A number of specialists have analysed technology transfer from the perspective of the suppliers [20, 31, 82, 9, 66, 14, 11].

The reappraisal of the 1970s suggested that in comparison with the suppliers, the buyers of technology suffer from a number of disadvantages. The first stems from the nature of technology itself. As Arrow [4] said, in any commercial transaction of knowledge and information, there is an inherent asymmetry between the seller, who knows what he is selling, and the buyer, who, to some degree, must remain ignorant of what is being purchased. The developing country buyer is particularly disadvantaged in that usually the developing country firm is smaller, less experienced, and technologically weaker in many areas in addition to the core proprietary technology being acquired.

The overall technological and informational weaknesses of the buyer limit his search among possible technology suppliers. The buyer's ability to undertake direct technology transfers is often limited, and the transfer then has to be undertaken through an intermediary who packages the elements of required technology. The buyer suffers another information disadvantage in that there are no easily available figures of the price paid for similar transactions.

Furthermore, often owing to the protected markets of most developing countries, the private interest of recipient firms does not coincide with the social interests of the country in minimizing fees paid for technology transfer. The goods produced with the imported technology and carrying international trademarks can command high prices in the protected domestic markets, thus allowing the private firm to make sufficient profits even with high transaction costs.

A key result of the work of the 1970s was that the earlier notion of a freely available technology was replaced by that of transactions in a market. The structural features of the buyers, sellers? and the commodity give rise to a market for technology that is highly imperfect, made up of many weak and poorly endowed buyers and a few large, powerful technology suppliers and marked by information gaps and information inequality between buyers and sellers. In such a market, it is more than likely that suppliers will take advantage of their monopolistic position: the price of technology will be high and the amount of technology supplied smaller than optimal.

The analysis in the 1970s focused mainly on the issues of (excessive) costs of technology transactions and the many restrictive clauses that were imposed on the recipient by the supplier, thereby limiting the benefits to the recipient firm and country (UNCTAD [70] lists 46 practices deemed by developing countries to be restrictive). Two different sets of evidence pointed to the existence of excessive payments. The direct payments for technology, i.e. royalty and licence fees, can be compared for identical transactions, though this is difficult in practice. What has been documented in many cases is that after regulations controlling and reducing payments have gone into effect, there have been substantial reductions in the fees charged, thus supporting the view that the earlier payment levels were excessive. The studies also pointed out that the total magnitude of direct payments made by developing countries towards licences, patents, know-how, trade mark, and technical services amounted to 87 per cent of profits on foreign direct investment, 56 per cent of foreign direct investment flows, 8 per cent of imports of machinery, equipment, and chemicals, and 5 per cent of total export earnings for the decade 1960-1970 [70]. For some countries, these ratios were much higher: for Mexico, for instance, direct payments amounted to almost 16 per cent of total exports [70, p. 14]. When the indirect components are added, the amounts increase significantly.

The second concern regarding excessive payments arose from the evidence of tying input supplies to the technology contracts in many cases, where the supplier insisted that the recipient must also purchase raw materials, intermediates, and/or capital goods from the supplier. In the Philippines, such clauses affected 26 per cent of the contracts, in India 15 per cent, and in the Andean Pact countries, they were found in up to 83 per cent of the contracts in one country [70, p. 16]. Tied purchases resulted in monopoly control of the inputs by the technology supplier, even of items readily available in the market. Tied purchases were found to lead to overpricing of the inputs, which ranged, in a sample of cases studied in the pharmaceutical sector, from 19 to 155 per cent in Colombia, 30 to 500 per cent in Chile, 20 to 500 per cent in Peru, and 40 to almost 1,700 per cent in Mexico [70, p. 17]. Vaitsos [81] also cites a number of examples, with overpricing amounting to a high of 3,000 per cent in one case. Similarly, Rafi [52] cites a number of examples from Iran, in one instance the figure is 1,000 per cent.

Such possibilities that exist in transactions between two independent firms become multiplied many times over when the developing country firm is a subsidiary of a multinational. In intra-firm trade, there are many items that are intermediates and so no exact replica may exist for comparisons. The subsidiary may conduct all exports and imports through the parent company. Costs and revenues are determined by internal prices, and these can be adjusted to increase input costs and reduce export revenues for the subsidiary if it is to the global advantage of the parent company.

The widespread prevalence of this transfer pricing is documented by Vaitsos [81] for the Andean Pact countries; Murray [41] for Greece in metals, minerals, and chemicals; in Britain, by the Monopolies Commission [40], and in Iran, Rafi [52] for pharmaceuticals; by Lall [33] and Kaplinsky [29] in automobile production in Malaysia and Kenya, and recently by the US government in action against Japanese electronics and automobile companies (Newsweek, 15 April 1991). This practice led California to develop the unitary tax system to minimize loss of tax revenue from transfer pricing. Given the much larger scale of operations of multinationals in the industrialized countries, its significance for them must be greater.

Besides overpricing, critics found foreign controls to be associated with excessive imported inputs, often tied, which increase foreign exchange costs and limit backward linkages. Studies in Mexico, Australia, Canada, and Nigeria showed that firms with greater foreign ownership and control tended to have higher import content in their products [52, p.207]. Rafi confirms similar results for a sample of Iranian firms and states that for the foreign-controlled firms, imported materials accounted for 30-86 per cent of costs, 73 per cent of the imports were tied to the foreign firm, margins on tied imports were often over 100 per cent, and the suppliers charged an average royalty of 21 per cent [52, p. 223]. He suggests that "given the evidence of transfer prices, sales of inputs were typically a much more significant source of income to the parent than knowhow charges" [52, p. 227]

In addition to the impact on costs from royalties, fees, and tied inputs, a number of other restrictive practices reduced the benefits from technology transfer, e.g. restrictions on exports. Analysis showed that most technology-supply contracts restricted the recipient to produce for certain markets only. Often that was limited to the home market, and exports were prohibited. In other cases, exports were allowed to selected countries. All studies show that such restrictions are widespread and are based on the suppliers' need for control over the market to minimize competition and maximize profits [70].

Other clauses that were seen to reduce benefits were those limiting production amounts, type, or quality, and fixing selling prices for the product. Similarly, clauses guaranteeing a fixed payment instead of a percentage of production and calculating royalty on final sales prices instead of value-added increased the cost of technology. Clauses that prevented the recipient from making any changes to the product or process limited the capacity to innovate and adapt it to local needs. Many contracts required the recipient to grant back to the supplier any improvements made without reciprocal obligations on the supplier. Developing countries were also unhappy with contracts that barred the recipient from sub-licensing; this they felt reduced its diffusion and required them to pay repeatedly for identical know-how.

While the main focus of UNCTAD's work and similarly inspired work was on the issue of imperfect markets for technology leading to excessive financial costs and unfair and restrictive practices, a host of other arguments were raised around the same time that suggested that, without careful controls, unrestricted transfers of technology can lead to many other undesirable impacts on development and costs to the developing country's economy. Additional questions raised about transferred technologies included their characteristics and longer term impacts on the structure of the economy, on domestic technological capacity, and on the political autonomy of importing countries.

INAPPROPRIATENESS. One set of arguments pointed out that technologies available in the world market had evolved over a period of time in the currently industrialized countries. The trend had been towards capital and skill-intensive and labour-substituting production methods that were congruent with the historical growth paths of the industrialized countries. The available technologies are often designed for mass production methods meant to satisfy the demands of large markets. The material inputs similarly tend to be those available in the countries of origin and do not necessarily make good use of material resources abundant in the developing countries, where inputs are more readily supplied from abroad than from the domestic economy, leading to weak linkage effects and increased dependency on imports. Furthermore, the products that the imported technologies produce are also inappropriate as they are designed to meet the needs of higher income consumers. So the production using these technologies displaces more appropriate products but at the same time the new products can be purchased only by a small number of relatively affluent customers. This creates welfare losses and limits the potential for scale economies, expansion, and competition, placing further limits on possibilities of growth and technical efficiency [65].

The inappropriateness of the technical processes reduces employment opportunities. In addition, the more productive imported technology sector demands higher skilled labour inputs and can pay significantly higher wages to the small pool of skilled workers it uses, who in turn demand more "inappropriate" products and form the economic and political groups in favour of continued economic development along the inappropriate path. This process leads to a dual economy with one sector using modern technologies, higher skills, and providing high wages side by side with growing poverty and unemployment in a large fraction of the economy cut off from the former.

DEPENDENCY. Another strand of analysis focused on the political dependency of developing countries that went hand in hand with the technological dependency. It was pointed out that the overwhelming body of knowledge and technology was developed in and resided in the North. Thus, both the R&D establishment and the productive enterprises looked towards the industrialized countries for the problems and their solutions, as well as for scientific recognition. Importing knowledge, production know-how, and capital goods could be cost minimizing for individual transactions but would in the long term have negative effects for local problem-solving capacity and technology development. Restrictions on technology imports would force domestic producers to pay greater attention to developing in-house R&D capacity and increase linkages to domestic input suppliers, capital goods, and research establishments. In this view, multinational companies transfer little know-how, stifle local initiative and problem-solving capacity, and thereby perpetuate dependency. The distribution of R&D activities by these firms between the parent company and affiliates reinforces the existing imbalance. For instance, in 1982 US multinationals spent US$41 billion on R&D, of which over 91 per cent was spent in the United States, a little over 8 per cent in other OECD countries, and less than 1 per cent in developing countries, while the developing countries accounted for 20 per cent of the technology receipts for the companies [78, p. 181].

The policy responses of developing countries were guided from the 1970s by the negative implications of technology transfer practices as they were seen to prevail. The imperfect markets for technology, the tendency of suppliers to derive payments above "reasonable" levels, their resort to unfair practices, and the likely divergence between private returns to the technology-receiving firm and the costs and benefits to the national economy all suggested the need for government action. Measures were required to increase the information available to recipients, to strengthen the bargaining capacity of recipient firms, and to outlaw practices that were deemed to violate national interests. The new regulations also sought to increase the scope of national enterprises and to reduce control by foreign enterprises. They also sought to increase the possibilities for arms-length transactions and reduce transfer pricing abuses by new controls on the scope, methods, and practices of foreign direct investment.

The policy response in most countries was to promulgate laws to regulate and control foreign direct investment to specific sectors that were highly export-oriented or involved transactions accompanied by significant inputs of technology. They also established institutions to review, regulate, and register all technological contracts, and the laws generally forbade most of the restrictive practices discussed earlier, prescribed royalty levels, and reduced rates for technology payments.

The laws enacted in the 1970s in many countries were especially severe with regard to the scope for foreign direct investment. Many countries nationalized foreign-owned mining companies, declaring earlier practices and privileges to be remnants of the colonial past. This was often followed by new contractual arrangements for specific services such as exploration, management, and sales. India passed new laws in 1973 requiring wholly foreign-owned companies to reduce the share of foreign ownership. Companies providing mainly for exports or in designated high technology sectors were allowed to retain a higher percentage of foreign ownership. The Andean Pact countries inserted provisions for a "fade out" of foreign ownership over a period of 10 years [42, 3].

Besides the policy changes in individual countries, a major effort was mounted by the Group of 77 to establish an international code of conduct for the transfer of technology and for a more favourable environment for technology. This has been in the process of negotiations since 1975, but it has not yet been possible to ratify such an international code due to continuing fundamental differences in the position of the developing and the industrialized countries.

By the beginning of the 1980s, most developing countries had enacted regulatory mechanisms and rules governing investments and technology broadly following the UNCTAD guidelines and recommended by the yet to be agreed upon Code, though there were considerable differences between countries in the degree of comprehensiveness and stringency of application. The policy response of the developing countries followed largely from the composite picture of disadvantaged trade in technology that had emerged and attempted to imitate the policies of state guidance that had earlier been followed successfully by Japan [35, 50]. Briefly, the key elements of the picture include the following. The supply of technology is dominated by large multinationals. They actively pursued a global strategy for markets within which technology was a key element, and their profit maximization strategies led them to offer packages of unbundled technologies, excessive imports, especially intermediates, at high costs. The self-interest of the suppliers limited the quantity and quality of transferred know-how. The suppliers then reinforced their dominance in oligopolistic markets by their own knowledge and experience and the lack of comparable expertise among the recipients. The suppliers supported little R&D in the developing countries and inhibited local learning in a number of ways. Finally, since the marginal cost of technology transfer was close to zero, this implied that all payments were excess profits and exploitative [6, p. 31].

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