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The role of foreign investment in development
Terms in this set (35)
Foreign direct investment
An investment in a business in one country by a company from another country.
The foreign investor establishes ownership control or at least has a controlling interest over the company purchased.
3 Types of FDI
- Horizontal FDI
- Vertical FDI
- Conglomerate FDI
- Investors form the same businesses that they operate in their home countries.
- E.g UK Telecoms company offering the same service in the Philippines
- Investors form a different but related business to investors' main business.
- E.g Japanese cosmetics manufacturer invests in a coconut oil firm.
- To have direct access to raw materials
- Investors acquire a business which is entirely different from investors' own existing business in their own country.
- This often involves a joint venture with a business operating in the country.
3 Forms of FDI
A company builds operations in a foreign country from scratch.
A company leases existing facilities and land.
A foreign company merges with/ acquires an existing local company.
Multinational Corporation (MNC)
- A large corporation incorporated in one country which produces or sells goods or services in various countries.
- FDI comes from them.
- e.g Apple, Amazon, Bic.
- Incorporated: where the business is registered & pays tax - e.g Apple in the U.S
Why MNCs want to invest in emerging economies
1. Increased revenue
2. Bypass trade barriers
3. Lower costs of production
4. Access to raw materials
5. Extract natural resources
- Markets in some developing countries are large and/or fast-growing (e.g India & China).
- If an MNC can capture a share of a developing market then it has the potential to gain a large increase in sales revenues, especially as these markets grow and household incomes increase.
- By basing themselves in a developing country many MNCs reason that it is easier to capture market share and for product distribution (getting their product to local customers).
Bypass trade barriers
- Tariffs and quotas may be imposed by developing countries on imported goods and services.
- By establishing themselves locally, the products of MNCs would not normally be classified as imports, and therefore not subject to such trade barriers.
Lower costs of production
- Often, the cost of labour forms a large proportion of a firm's costs of production.
- Developing countries have a lower wage rate than developed countries, often much much lower.
- This is one of the key reasons why many U.S manufacturing firms such as the Ford Motor Co. have established operations in Mexico.
- Although Ford moved back to the U.S in 2017. Sometimes a low-wage economy is not always beneficial.
Access to raw materials
- If raw materials form a relatively large proportion of the inputs into production processes, and these raw materials are significantly less expensive in developing countries, then MNCs may establish overseas operations.
- In a cost-benefit analysis, the costs of setting up a new operation in a developing country may be outweighed by the benefits of obtaining raw materials locally rather than having to import them.
Extract natural resources
- Some MNCs specialise in natural resource extraction (e.g oil and gas, iron, copper and aluminium).
- These MNCs will be attracted by extraction opportunities in developing countries which are rich in such resources and will locate operations to these resource-rich countries.
Possible advantages of FDI for the country
1. Foreign exchange earnings
2. Improved skills & technology
3. Supplement domestic savings
4. Boost to related local industries
5. Economic growth
7. Tax revenues
Evaluation of Foreign exchange earnings
However, MNCs also contribute to foreign outflows of capital and profits repatriated to the home country, so thus, the net positive effect on foreign exchange earnings may be rather more limited than initially anticipated.
Improved skills & technology
- MNCs have managerial and technical expertise and access to new technology that many less developed countries do not.
- These skills and technologies can be learned and adopted by the local workforce and transferred to local firms.
- Human capital increases in the developing country as new skills are learned. This increase in human capitals is one of the most important benefits that accrue to less developed countries with FDI from MNCs.
- e.g linked to rise in Chinese economy — learned & accepted technology.
Supplement domestic savings
- Often, less developed countries have low savings rates which leads to low rates of investment.
- FDI by MNCs supplements low savings and investment and the capital stock of the less developed country increases leading to increased productivity & economic growth.
Boost to related local industries
- MNCs that require inputs into their production processes may acquire those inputs from local firms.
- Firms and industry in the host country will become more developed and grow in scale & scope.
- Monopsony power: only the buyer of the good so can drive down the prices of raw materials.
Foreign exchange earnings
- In the balance of payments, inflows of FDI are credits in the financial account.
- Further, the activities of many MNCs are export-oriented and the host country's export revenues will increase, having an additional positive effect on the host country's balance of payments situation.
- Increased investment, technological improvements, increased productivity, improved human capital and expanding domestic firms & industry all increase aggregate supply in the less developed country where such FDI occurs.
- Increased aggregate supply leads to increased real economic growth as national output and income increases.
- Higher tax revenues from MNCs enable governments to increase spending on goods and services and transfer payments — aggregate demand increases.
- Further, increased employment leads to higher household income and consumer spending will increase — aggregate demand increases.
- With increased aggregate demand and increased aggregate supply, real economic output and incomes increase with relatively little impact on inflation.
- Can show the diagram using the supply side diagram & a PPF.
- FDI lowers unemployment in the host country. MNCs hire local workers.
- Often MNCs will choose to invest in a less-developed country because wage rates are relatively low, and operations are relatively labour-intensive.
- Thus, MNCs may require a large pool of labour and significantly reduce unemployment in an area,
Evaluation of Employment
- However, it is not necessarily the case that MNCs will significantly increase employment.
- This would likely be the case in a situation where the MNC has capital-intensive production processes and relies heavily on imported labour skills from the home country to operate technology.
- However, the MNC may still base itself in another country for other reasons.
If the government is successful in taxing the profits of MNCs then overall tax revenues for the host country will increase.
Evaluation of Tax revenues
- However, many MNCs establish themselves in less developed countries because they have been offered significant tax advantages to do so.
- This limits the amount of tax that host governments will be able to collect from MNCs operating locally.
- MNCs are also very good at lowering the amount of tax that they pay through various accounting procedures.
Evaluation of Boost to related local industries
- However, MNCs can have a negative effect on local firms and industries.
- Local firms that compete with an MNC may be forced out of business, and an MNC may use its monopoly power to restrict the ability of new local firms to enter the market and compete with it.
- Benefits businesses cooperating with MNCs & not businesses competing with it.
Possible disadvantages of FDI for the country
1. Environmental damage
2. Unwanted consumption
3. Opportunity cost on government
4. Bad influence of MNCs
5. Competition & "Race to the bottom"
- Some MNCs pursue activities that pollute the environment and/or deplete the natural resources of the host country.
- It is often more profitable for an MNC to invest in countries that have few environmental regulations and/or a poor track record in enforcing such regulations.
- e.g Coca-cola depleting/lowering water level & water locals can access in India.
- MNCs are often extremely good at marketing their products.
- When they bring their marketing powers to bear on consumers in less developed countries they can create new consumption wants.
- e.g tobacco companies because there are fewer regulations on tobacco advertising in some countries (demerit goods).
Opportunity cost on government
- To successfully operate anywhere, many MNCs will require good infrastructures such as road and rail networks, ports and airports, and telecommunications networks.
- Developing countries need to make such infrastructure available to attract MNCs to invest, at the opportunity cost of spending in other areas such as education.
Bad influence of MNCs
- MNCs are by their nature very large and this provides them with considerable political & economic power.
- This power can be wielded to influence the policy of host governments — policies that may benefit the MNC but work against the economic development of the host country.
- Such policies may include weakened labour protection regulations (e.g lower wage rates, no ability to unionise) and environmental regulations.
Competition &"Race to the bottom"
- MNCs can pick and choose in which country to invest.
- Less developed countries may see that they must compete to attract such foreign investment.
- Countries will compete on infrastructure, lowe taxes, trade liberalisation, labour laws & environmental regulations benefitting MNCs but lessening the positive effect that FDI can have on economic growth & development.
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