In a heavyweight prize fight, all eyes are on the action in the ring. But in international business, the interesting action might be on the other side of the ropes. In 2018, when the United States entered a trade dispute with China, most of the world's attention was paid to the two warring titans. Research into trade disputes has likewise focused on how that fight goes for the headliners. Considerably less attention has been paid to how countries not involved in a trade war (here called "third countries") experience, or even flourish during, that conflict.
In their article "Third-country MNEs, trade wars, and competitive opportunities: a real-options perspective," Gies College of Business professor Joe Clougherty (right) and Hyewon Ma of Indiana University explore the possible benefits of being an outsider in a trade war. Their research examined 3,600 Chinese subsidiaries of large multinational corporations from 51 of those "third countries" - firms whose nations otherwise had no direct involvement in the dispute - to learn what how outsiders respond to trade disputes. As Ma and Clougherty learned, they do a lot.
The research started with a question when Ma began her dissertation research as a PhD student at Gies Business. She noticed a gap: actual trade policy rarely entered the picture of international business research employing a real-options perspective.
"I found quite a big gap in this area of research," said Ma. "I think that made sense from the early 90s until recently...the trade policy environment had been very friendly. A lot of countries were joining and promoting free trade agreements. That's changed now."
When the trade war with China broke out in 2018, it complicated that picture – but it made studying the problem considerably easier. Trade disputes are messy things. They tie into exchange rates, the world market, and involve enough macroeconomic chaos to intimidate any researcher. To make arguments about the impacts of trade policy, scholars often need a control - a similar set of actors that a policy change didn't affect.
Tariff escalation between Washington and Beijing in 2018 only impacted certain industries. That division allowed Ma and Clougherty to isolate changes and compare similar third country subsidiaries. For Clougherty, a scholar affiliated with the Illinois Strategic Organizations Initiative, the data set was unique.
"If you notice now, tariff actions have been somewhat selective, but they're a little more across the board now," said Clougherty. "The data from 2018 involved sectors where the US raised tariffs and then the Chinese retaliated in those same sectors. Then there were sectors in which the US did not raise tariffs and the Chinese also didn't retaliate."
Scaling Up While Others Step Back
Ma and Clougherty analyzed the patterns and found a clear result. Third country MNE subsidiaries in tariff-affected industries scaled up their operations in China significantly more than their peers in industries unaffected by the dispute. Those subsidiaries increased headcount by 11 percent and brought in about 15 percent more revenue. The firms also expanded their asset base by 20 percent. Far from discouraging investment, the trade war caused MNEs from Europe, Japan, and elsewhere to grow their stakes in China.
"The biggest thing I found out is actually that there were third country MNEs, including European or non-Chinese Asian MNEs, that actually increased their investment in China as soon as the trade war happened," said Ma. "My reasoning behind it is that as their rivals make room, like the US companies losing their competitiveness within the Chinese markets or leaving, there's scope for them to redeploy their resources from elsewhere and take advantage of the market opportunities available in China."
It's tempting to think of this as a matter of luck, or "the moment" being right. For Clougherty, it's not as simple as being in the right place at the right time.
"It's important to remember that they took action," said Clougherty. "So it's more than it just came to them. They saw the opportunity and did something."
Three important characteristics shaped whether an outsider firm scaled up operations in China during the 2018 trade dispute: the degree to which the parent firm was truly multinational, whether the subsidiary in question had a local Chinese partner, and whether the parent firm's home country was already in a trade agreement with China. While multinationality might at times slow and encumber companies, spanning the globe with a sprawling network of subsidiaries can be an asset.
"Simply put, it just gives you options," said Clougherty. "Different options for different matches. If your organization has some slack capacity at the moment in some locations, you might be able to transfer some talent and scale up elsewhere like in China."
So the companies that could respond to the opportunity benefited. But it's not just that big multinational firms have slack capacity. Geography is also important.
"It's not just having slack, or having resources," said Ma (right). "It's being able to actually distribute your operations geographically. You don't have to be big. The point is the dispersion of your operations."
Firms with operations in different markets, for example, can redirect efforts from one place to another. A firm with all of its geographical eggs in one basket can't do that. Multinationality affords the capacity to be flexible as trade conditions change and shift. Other factors also shaped these outcomes. Local partners, for example, can reduce trade uncertainty by granting an “outsider” firm legitimacy, or access, or a kind of cover that it wouldn’t be able to secure on its own.
“Sometimes when you do these international ventures, you do it alone,” said Clougherty. “Sometimes you do it with a local partner – and in a world in which there are more frictions, it increasingly makes sense to have a local partner. Because they can help. As we say in international business, you never want to be in legal preceedings while being the foreign entity. You always want to be the native party. That’s part of what we refer to as ‘the liability of foreignness’ in international business.”
“You Always Need to Think about the Uncertainty”
Ma and Clougherty’s scholarship expands on real option theory – the theory that an investment’s value is shaped by the flexibility and choice it offers amidst uncertainty – with the idea that trade policy can be a source of uncertainty. The 2018 trade war might have been one event, but the years since have proven that uncertainty in trade policy is becoming the norm. Clougherty doesn’t see it slowing down any time soon.
“There is little doubt that we’re going to see more frictions,” said Clougherty. “For organizations, that’s the reality of the next decade to 15 years. Global business isn’t going away, but it’s going to become much more complicated than it was previously. Organizations are going to need to be able to adapt to these frictions, to the increased manifestation of shocks like a trade war.”
Another implication, perhaps more concerning, is that the framework most multinational organizations have become accustomed to no longer reflects the world in which they operate.
“I would say, don’t rely on net present value anymore,” said Ma. “The era of net present value has passed, and you always need to think about the uncertainty. You cannot assume that whatever global supply chain target destination, host nation, or the host nation’s environments will stay the same over the next years. Based on the assumptions, I think the real option perspective becomes increasingly valuable as it highlights the value of flexibility.”