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Foreign Direct Investment by Multinational Corporations and Impact on Development

Introduction

The presence of multinational corporations in developing countries has been viewed both as an advantage and disadvantage. The resulting resource gap in countries in the global south may be viewed as a need to increase the possibility for more foreign investment. In addition, these corporations are looking for locations of business that avails cheaper costs such as production and labor costs in addition to favorable regulations and other conditions.

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Although most of these firms have contributed to developments that aid in spurring economic growth in the developing nations, they have been considered and indeed misrepresented in the Marxist and dependency theory advocates. Multinational corporations have helped people in the poorer regions of the world in the consumption of improved quality of goods and services, as well as extending the opportunities for earning higher incomes. Because many originate from the developed countries like the U.K. and the U.S, Canada, they have been perceived as imposing western cultures in developing countries (Ahiakpor, n.d.). multinational corporations play an important role in the flow of trade and real-world FDI inflows grew by 17.7% from 1986 through 1999 (Blonigen, n.d.).

Economic gap and foreign investment

Foreign investment is essential in the global south to fuel development because of the resulting economic gap. Most of the developing countries concentrate on improving on foreign investment and attracting multinational corporations to invest in their countries.

The impact of foreign investment whether in form of aid, Foreign Direct Investments, or debts must, however, be carefully considered, and leaving the gap wide open for foreign investment must not be the only option available for developing countries to spur economic growth and development. This is because these foreign investments have negative effects as shall be seen later on. Formulation of investment policy that defines and regulates foreign investment is important so as to ensure that the countries promote positive aspects while mitigating the negative impacts of foreign investment.

Advantages and disadvantages of Foreign Direct Investment

Foreign Direct Investment has helped countries in the global south in a number of ways, namely, creating employment, raising the levels of exports, aiding in industrialization, bringing in foreign expertise and productive capital, providing linkages for marketing among other benefits.

Although there has been a general perception that FDIs results are good and have no bad effects, studies have shown or indicated otherwise. Assuming this general assumption should not be the main issue, but that the costs or disadvantages to the FDIs need to be effectively managed to realize a net positive outcome.

A research case study investigating the impact of FDIs on the trade, Balance of Payment and trade using Malaysia as a case study for developing countries, carried out by Ghazali, documents that increasing domestic savings rate to a higher level and productively investing the savings is the essential foundation for successful growth in the aforementioned countries and is more important than the role played by foreign capital including FDI. This means that countries could realize growth by concentrating on raising domestic savings and investing them productively (Khor, 2006).

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FDIs make the recipient countries increase consumption and therefore negatively affect domestic savings. In addition, there are negative impacts on the accounts of finance and trade. FDIs can be blamed for leading to large outflows of profit and other investment income although they can be applauded for bringing in capital. The impacts of the large outflows of the income and profits have been considered as leading to ‘decapitalization’.

This decapitalization resulting from FDIs is indeed greater than that resulting from aid or debt because FDIs have a much higher rate of return than the two aforementioned (Khor, 2006). The outflow of income and capital as well as increased imports that are encouraged by FDIs may be disastrous if not balanced by export earnings and new capital inflows. Even this balancing may not be easy and in some cases, regulation may be the answer.

The establishment of new factories, companies, and mines may be considered advantageous because it leads to raising employment for the locals, in addition to contributing to industrialization. However, it has been known that this employment is mostly of low or no skills at all. In fact, dangerous trends such as the employment of foreigners in skilled well-paying positions may be observed even when the recipient countries can provide a skilled workforce.

Where direct investment has produced good fruits, locals have had to enjoy high-quality products and higher levels of living. Multinational Corporations also fund other projects in an attempt towards social responsibility. FDIs involve foreign investment ownership of factories, mines, and land and therefore may lead to the problem of balancing ownership of these things between the foreigners and the citizens. Increased foreign direct investment will worsen this situation. According to Sutcliffe, expansion of foreign investment into the global south was mostly due to privatization rather than the establishment of new factories (2001; qtd. in Blonigen, n.d.).

Privatization of companies may be perceived as having a negative impact because it allows control of these corporations by foreign investors whenever they invest more than the locals. There is a possibility that the profits gained from the firms owned and controlled by foreign investors will be reinvested outside the country and this will manifest as profit outflow which has an impact on the balance of payment.

However, privatization may be considered an advantage if the trend being implemented is the privatization of non-performing or poor-performing corporations. Allowing these corporations to be run and improved by investors may result in such advantages of provision of employment and returns to government through taxation and other regulatory fees. However, these foreign investors may again, out of control of these corporations, bring in people from their countries for employment.

The effect of this trend is an increase in competition for job markets. Although on the one hand it may be considered as important in helping to bring in new expertise and increasing the chance for exchange of this expertise to locals, sometimes it may be used in an unfair manner to provide employment to foreigners even when the type of expertise is readily available in the local scene.

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Privatization may lead to “de-nationalization” where the local share of the nation’s wealth stock increases compared to foreign share and in order to avoid the possible economic and social problems, it is necessary to ensure that the rate of growth of FDI remains lower than that of domestic investment according to Moffat’s rule (Khor, 2006). FDI starts to impact growth negatively and then worsens later on, and decapitalization was the factor payment effect according to findings by Ghazali (1996; qtd. in Khor, 2006).

A tendency of concentration of FDIs in few countries has been documented. Only a few industrializing nations were found to experience higher FDIs concentration that others with about 9 nations taking home 71% of the foreign direct investment in the global south in 1997. China took home 30% of these investment in the same year according to Todaro (2000; qtd. in Blonigen, n.d.).

Countries have been increasingly desirous to increase Foreign Direct Investment in their countries in order to bridge the capital gap as seen earlier. Attracting investments especially in the developing world is a competitive venture; countries face a lot of competition from developing and developed countries in attracting the investments from foreign corporations, and this is aggravated by the fact that all countries are not in a level playground.

Some countries are well endowed with resources than others, such as oil and natural gas which pulls more investments into these countries. Countries which are at a disadvantage are faced with the challenge of improving their investment and trade policies that give them a competitive edge, procedures such as procurement, importation and exportation among other aspects of trade. This results to quicker, cheaper and easier business processes and procedures in these countries, which may in turn benefit citizens in the host country through provision of better investment opportunities. Countries would respond to the current competitive trend to attracting investments by multinational corporations by lowering trade tariffs and taxes, shortening the licensing process and improving infrastructure among other things.

This either offers a better opportunity for local investors when the offer is open to them or quickens the investment by the multinational corporations which in turn may provide more opportunities for local investors to invest in complementary business activities. In addition, improvement of infrastructure and legal requirements to lure investments may roll on as benefits to the locals because they will enjoy high quality commodities and services.

Other benefits include improved exchange and availability of information to the locals on procedures and processes of investment, benefits of investments, performance of companies and the available investment opportunities. Information benefits come along as developing countries may try to pull FDIs by providing such information about locally available opportunities and benefits. This may be conceived in the fact that countries will require much information to make a decision on investing location; information on coordination of suppliers and regulatory environment among other.

Local industries in the recipient countries face high competition – which is a times unfair – following the entry of multinational corporations in the competition field. This is because these corporations strive and apply various techniques to have their products sell and because they may have advantages over local firms such as large-scale income, they are able to influence patterns in the market through for example offering cheaper commodities and absorbing the related costs.

These corporations also posses the ability to improve on the production processes through investing in lean production technologies and new research methods which lead to cutting the production costs and hence they can offer cheaper market prices. Multinational corporations are also capable of introducing large amounts of products in the market. Increased competition in the local scene may result to the collapse of local corporations leading to loss of jobs and domestic benefits such as taxation by the government. In fact, big losses may be felt where skilled workers in the domestic-owned corporations loose their jobs after the collapse of these corporations, whereas there is increased employment of unskilled employment in the privately-owned multinational corporations.

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Importation of intermediate and capital goods may reduce the positive impacts of FDI and the situation may be worse where the countries are not able to provide local goods as raw materials (no saving on imports) (Khor, 2006). These are some of the negative trade effects that need be reversed to strong positive status so as to offset the impacts of decapitalization and hence realize a positive effect on the balance of payment according to Ghazali (qtd. in Khor, 2006).

Developing countries have also been exposed to political manipulation and influence through outside political manipulation through FDIs operations. This is because multinational corporations may themselves not be free from political manipulations and so their interests may be politically motivated especially by the developed nations who a times seek to settle political scores through manipulating the investment trends. Political manipulations by FDIs may also be effective when the local share of the national wealth is less or compromised against foreign share.

In order to result to positive impacts of FDI, Ghazali proposes minimization and prudence management of factor payment cost, encouragement or requirement of joint ventures to ensure that locals retain and attain part of the returns, and thirdly, ensuring that foreign capital does not detract from own savings effort (Khor, 2006). In addition, there should be efforts to increase local content over time so as to improve trade effect, increasing of saving rate for the developing countries in addition to ensuring sound economic and political conditions, and having the foreign firms listing themselves on local bourses.

Conclusion

Countries in the developing world realize economic capital gap and therefore require external support to fund activities that they could otherwise not or would do it with difficulty. On the other side, multinational corporations are looking for investment opportunities with low costs or other benefits such as favorable regulatory framework. Developing countries are a good target for these multinational corporations because they have favorable conditions such as cheap labor.

The corporations invest through Foreign Direct Investment which involves acquire of assets in the host countries, such as land, mines and companies. Foreign Direct Investment is another source of capital for these countries and others include debt and aid. The rate of return of Foreign Direct Investment is higher than the two aforementioned and therefore its impact on growth is higher.

The general conception that FDIs are for absolute benefit is not true. Foreign Direct Investment as an alternative source of capital for the host countries has been commended for a number of reasons and the strategy criticized for a number of others.

The advantages of FDI include increase in employment rates for the recipient countries when the corporations set new or revive existing investment opportunities, benefits of taxation and other fee to the government, assist in industrialization, foreign exchange, may foster technological exchange to the developing country, raise export earnings among others. The disadvantages include competition for the local industries, outflow of income, and possibility of political manipulation of the recipient country among others.

The recipient country may suffer through decapitalization and this is the major influence of the overall impacts of growth from FDIs. Decapitalization is the resultant of outflow of income and profits from FDIs which counters capital inflow from these FDIs. The negative effects (e.g. decapitalization) need be minimized and/or regulated to ensure that net positive effects are realized.

References and Bibliography

  1. Ahiakpor James C. W. Multinational Corporations in the Third World: Predators or Allies in Economic Development? Web.
  2. Anderson J.E. and E. van Wincoop, (2001). Gravity with Gravitas: A Solution to the Border Puzzle. NBER Working Paper No. 8079, and American Economic Review, 93(1), 2003, pp. 170-92.
  3. Blonigen B.A., (2005). A Review of the Empirical Literature on FDI Determinants,” NBER Working Paper No. 11299.
  4. Blonigen B.A. and R.B. Wooster. (2003). CEO Turnover and Foreign Market Participation. NBER Working Paper No. 9527.
  5. Blonigen B.A., R.B. Davies, and K. Head. (1998). Estimating the Knowledge-Capital Model of the Multinational Enterprise: Comment, NBER Working Paper No. 6773, and American Economic Review, 93(3), pp. 980-94.
  6. Blonigen Bruce. Foreign Direct Investment Behavior of Multinational Corporations. Web.
  7. Bernard A.B., Jensen J.B., and Schott P.K. (2005). Importers, Exporters and Multinationals: A Portrait of the Firms in the U.S. that Trade Goods, NBER Working Paper No. 11404.
  8. Blonigen B.A. (1997). Firm-Specific Assets and the Link Between Exchange Rates and Foreign Direct Investment. American Economic Review, 87(3), pp. 447-65.
  9. Easterly, W. R. (2001). The elusive quest for growth: economists’ adventures and misadventures in the tropics. Cambridge, Mass., MIT Press.
  10. Helpman E., A Simple Theory of International Trade with Multinational Corporations. Journal of Political Economy, 92(3), pp. 451-71.
  11. Kiely, Ray (1998). Industrialization and development: a comparative analysis. London, Bristol, Pa., UCL Press.
  12. Khor Martin. (2006). The Investment Issue in Trade Agreements: A Development Perspective. Web.
  13. Markusen J.R. Multinationals, Multi-Plant Economies, and the Gains from Trade. Journal of International Economics, 16(3-4): pp. 205-26.
  14. Sutcliffe, Robert B. (2001). 100 ways of seeing an unequal world. London; New York:, Zed Books.
  15. Todaro, Michael (2000) Economic Development. Adison Wesley Longman.
  16. Wade, Robert (1998). The coming fight over capital flows. Foreign Policy 113(41).
  17. Zarsky, L. (2002). Foreign Direct Investment: No Miracle Drug. Ultimate Field Guide to the US Economy. Web.

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StudyCorgi. (2021, November 12). Foreign Direct Investment by Multinational Corporations and Impact on Development. Retrieved from https://studycorgi.com/foreign-direct-investment-by-multinational-corporations-and-impact-on-development/

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StudyCorgi. (2021, November 12). Foreign Direct Investment by Multinational Corporations and Impact on Development. https://studycorgi.com/foreign-direct-investment-by-multinational-corporations-and-impact-on-development/

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StudyCorgi. "Foreign Direct Investment by Multinational Corporations and Impact on Development." November 12, 2021. https://studycorgi.com/foreign-direct-investment-by-multinational-corporations-and-impact-on-development/.

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StudyCorgi. 2021. "Foreign Direct Investment by Multinational Corporations and Impact on Development." November 12, 2021. https://studycorgi.com/foreign-direct-investment-by-multinational-corporations-and-impact-on-development/.

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StudyCorgi. (2021) 'Foreign Direct Investment by Multinational Corporations and Impact on Development'. 12 November.

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