arguments for and against MNCs

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					NAME: SAMEER GHAI Module: Economics of Developing Countries 1 Tutor: SEDAT AYBAR The arguments in favour of and against receiving private foreign investment, with particular reference to investment by multinational enterprises

The aim of this paper is to examine the case for and against private foreign direct investment and question its validity as a method of aiding developing nations. This will be done through the evaluation of both the positive and negative effects of such investments and through the observation of various multinational corporations and how they operate. This effectively creates a firmer grounding in the comprehension of foreign direct investment and allows the creation of a case for criticism. Should data be forthcoming, the validity of multinational enterprise as a means of aiding development may become substantiated. As with many economic theories, it is often difficult to produce a clear-cut answer, as theory does not always duplicate reality. However, a likely outcome of this paper is to make the reader aware that the benefits of private foreign direct investments should not be over sold but neither should they be ignored. Before the question can be addressed, the concept private foreign investment must be understood. Private foreign investment can take on six forms. 1. Management contracts – where foreign firms agree to supply skills and technical information for a particular fee 2. Technical collaboration agreements – where technology and know how are sold for royalties and technical fees 3. Joint ventures – where previously fully owned enterprises are now compliant with local ownership regulations 4. Private export credits – medium term credit to importers of particular goods

5. Private portfolio investments- this includes the flow of money capital sometimes called hot money, often chasing high returns in the stocks and bonds markets. 6. Direct private foreign investment – this is more than just money capital where foreign firms can acquire control of domestically based enterprise

For the purpose of this paper, I will concentrate on private portfolio investments, especially private direct foreign investment in which multinational corporations are involved. In portfolio investments, money chases the highest returns. In developing countries, development requires a high level of capital investment, which cannot always be supplied locally. In the absence of financial institutions to spearhead and consolidate investment, hot money allows for the supply of capital in an automatic and selfregulating manner whereby the promise of such high returns is motive enough for foreigners to invest. In the case of bonds, foreign capital flows in to purchase bonds with a high possibility of return. In effect this acts as a loan to the government which may enable them to invest in low risk ventures or help stimulate the local economy through bettering the infrastructure. As for stocks, companies purchase stock and in effect the producer is able to re-invest this money and increase efficiency and production therefore making the product more competitive in both the domestic and foreign markets. Further more, if large financial institutions are investing in the market, investor confidence increases and further attracts smaller investors to the market causing a positive investment spiralling effect.

However, these theoretical benefits may be outweigh by negative effects of such types of investment. As portfolio investments chase the highest returns, investments are not stable and are often withdrawn and moved around. Often, as such investments are financed by the banking sector, loan rates are not fixed and are often subject to oscillation. In such a case, high interest rates may deter investment as the interest rates may be higher than the investment return rate, therefore prompting withdrawal from the investment market. Such short term investments tend to have very marginal if any effect in aiding development nations. Such investments are often subject to speculation and if anything many smaller investors lose money as rapid withdrawal occurs. Having sited the success of the Asian Tiger economies as an example of successful private foreign investment, many economists believed this was the way to go for developing countries. However, with the recent Asian financial crash the wisdom of such economic theory has become even more controversial. Dani rordik believes that the reason for the crash was a lack of regulating institutions which left the markets open to fraud and un-lawful practices. It must therefore be stated that for portfolio investments to remain active to a beneficial level, there must be stern regulation and this obviously takes up resources. This is not always possible in developing economies as policing the investment activities is itself extremely laborious, and hard to monitor without using valuable resources. Moving on to direct foreign investment (DFI). Firstly, to understand why foreign enterprise would like to invest in another country, we must consider the theory of location and the theory of internationalisation. In the case of the theory of location, firms may wish to locate their production plants near locations where resources exist. For example, it would be highly cost inefficient to have an iron smelting plant in a country far away from the iron ore, as transporting it

would be extremely costly as almost 70% of the input of production is removed as a waste product. Similarly, it would be cheaper to establish a subsidiary in a foreign country so one could provide the product for domestic consumption as transport costs are removed and also, in the case of import taxes and quotas, such situations can be avoided. In the case of internationalisation, establishing a subsidiary may allow bypassing of monopolies. In this case, an example would constitute 2 firms. The first creating a consumer product and the second the inputs for the second firm. If the firm

manufacturing inputs for firm 2 were a monopoly, the second firm would have to be a price taker with respect to its inputs making input costs higher. By establishing a subsidiary, this situation may be avoided as basic integration has occurred. The strongest case for the existence of multinational corporations (MNCs) is the transfer of technology and technical know-how. As developing countries have little money for research and development, foreign firms can transfer advanced technologies to such developing economies allowing them to compete in international markets and increase production. This is done through training of the local labour force as well as bringing in foreign factors of production such as capital. Further more, Haddad and Harrison (1993) offer a general assumption that “Multinationals are larger, pay their workers higher wages, have higher factor productivity, are more intensive in capital, skilled labour, and intellectual property are more profitable and are more likely to export”. even IMF argues that MNCs often have wage rates higher than those offered in traditional sectors and high enough to the extent that hundreds of thousands of people have been lifted out of poverty. Further more, MNCs create ancillary benefits such as health care, housing, education and even general benefits

such as creating improved infrastructure that may benefit even those un-associated with the MNC. Foreign firms are governed by additional legal constraints such as OECD convention on bribery and thus, theoretically, ruthless and immoral practices are severely restricted which may not be the case in domestically run firms. For countries to attract FDI, they must improve institutional structures such as judicial, political and policing establishments. This has the external effect of raising welfare of the community in general as well as creating a more attractive and uncorrupt economic environment for the domestic commerce to thrive in. When compared to portfolio investments, FDI is resilient during times of economic crisis. This resilience was further exemplified during the Mexican crisis of 1994-95 as well as the Latin American debt crisis of the 1980s. MNCs bring in capital through taxation. This tax is then useful when the government wishes to enforce fiscal and monetary policy. However, they also have additional benefits such as the theoretically efficient global resource allocation process, reducing the immediate shortfalls of economic scarcity. Gao(1999) puts forward an economic model in which MNCs act as a catalyst (or cause) of the diffusion of industries from more to less industrialised countries. This has additional benefits as it increases the welfare of the hitherto less industrialised countries. The arguments in favour of multinationals are rooted in precarious economic theory. Although theoretically beneficial, they rely heavily on neo-classical economic theory and ignore factors on the ground that makes such theory unsound. Where as the advocates of multinational corporations put forward an idealistic model of free trade, beneficial to all involved and guided by men of high morals, LEDCs have

proven to be a new wild west, virgin territory to be exploited and pillaged by ruthless corporate villains. Unhindered by heavy regulations from their home markets, and subject to tacit disapproval by corrupt governments. In reality, corruption bribery and indifference facilitate an environment where the disincentives for immoral practices are minimal or non-existent. Multinationals are directed solely by the rates of return, which they can derive in a given market. “The rates of foreign return on foreign direct investment were higher in Africa in 2000 – 19.4% compared with 18.9% in the Middle East, 15.1% in Asia pacific, Latin America 8.3% and 10.9% in Europe”1. However, Mbaye correctly points out, using the largest recipients of FDI as examples (Nigeria, Angola and Mozambique) that investment is primarily for unsustainable enterprises. Money goes to finance the „systematic‟ exploitation of resources. The effect of this is two fold. Firstly, the failure to create and stimulate industry and commerce prevents the formation of a self-perpetuating revenue base, thus dispelling illusions of investments creating an upward spiral in welfare. Secondly, resource exploitation is dependent on FDI and multinational management. Therefore the country is forever dependent on foreigners to exercise judgement in their resource management. Added to these inefficiencies there is an additional factor of insecurity as fluctuating international markets make multinationals an unreliable investor. This was exemplified in

Jamaica‟s free trade area. The government created incentives for foreign firms to become established through creation of plants, tax free concessions and even went to the extent of providing MNCs with production facilities. In effect the MNCs had no set-up costs leaving them with no barriers to exit and as soon as alternative and cheaper production locations were created, MNCs withdrew. This rendered many


Sanou Mbaye, NEPAD the wrong plan, 2002

jobless and the country open to the ravages of foreign competition now that IMF policies had been instigated. This has further implications as the unreasonable

economic conditions force locals to engage in illegal trades such as the production and traffic of illegal drugs. Such activities have become the only viable means of earning a living because of irresponsible economic policy. Likewise, many countries in the African regions entered into shady privatisation programmes, set as conditions of the Breton woods institution. In the absence of the stock markets to act as efficient conduits to privatisation, these transactions were little more than oversized car boot sales, with strategic industries and amenities at stake. For countries in the franc zone, this proved to be most evident as the anticipated devaluation of the franc saw French industrial groups purchase strategic industries on credit assets. The eventual devaluation saw theses countries lose most of the value earned from the revenues. One can consider this to be „legalised fraud‟. Where firm face insecure property rights, insufficient economic liberalisation and competition their ability to effectively monitor activities of the state is impaired. The ability of firms to influence corrupt policy formation especially through bribery of corrupt officials provides reason enough to participate in such shady practices. Often, foreign firms possess inter company debt which is often alleviated through borrowing from the domestic market using local assets as collateral. This effectively forms a situation where FDI is being reversed and begs the question as to how productive it actually is. Having examined all the analysis above, it is an extremely presumptuous to expect a clear-cut answer with regard to the question posed in this paper. However, it can be stated there are both benefits and costs to multinational operation and perhaps if we lived in a world of ideals, ruthless practices would be eliminated. As this is not

the case in reality, one must consider the merits and pitfalls of each MNC with particular reference and analysis on how it‟s operation would affect the developing nation in which it is based. As usual, the main point to be made is that policies should be adapted to particular situations as opposed to the use of generalised „off the rack‟ policy propositions. Further more, it should be the aim of governing organisations to ensure practices are not ruthless but have a net benefit to developing nations.

Reference Are foreign investors and multinationals engaging in corrupt practices in transition economies?, Joel Hellman, Geraint Jones and Daniel Kaufmann, 2000 Facts and fallacies about foreign direct investment, Robert C. Feenstra, Revised, December 1998 How beneficial if foreign investment for developing countries, Prakash Loungani and Assaf Razin, 2001 UN G-24 discussion paper series, Should countries promote foreign direct investment, Gordon H. Hanson, February 2001 NEPAD: the wrong plan, Sanou Mbae, July 2002 Economic development, eighth edition, Michael P. Todaro and Stephen C. Smith, 2003