What Potential Effects do Multinationals Have on Developing Countries?

What potential effects do multinationals have on developing countries?

Introduction The Multinational Corporation (MNC) has been a central feature of economic activity in the past decades. According to the World Investment Report 2001, Foreign Direct Investment (FDI) by MNCs in 2000 grew faster than any other economic aggregated indicator1. The spread of MNCs around the globe continues to generate controversy about their benefits and costs to host countries. However, before commencing an analysis of the pertinent issues, it is important to briefly define the terms MNC as well as FDI: an MNC is most simply defined as a “cooperation or enterprise that conducts and controls productive activities in more than one country”2. Cross border expansion takes place through Foreign Direct Investment (FDI), which is defined as “international capital flows in which a firm of one country creates or expands a subsidiary in another”3. Importantly, the distinguishing feature of MNC expansion through FDI in comparison to other forms of capital flows, is that it “retains the control and ownership over its proprietary technologies”4. In this essay the benefits and costs of MNCs are assessed mainly by looking at FDI in developing countries. The essay’s discussion is divided into 3 parts: the first part deals with a general theoretical cost benefit analysis, the second lists some general criticisms of MNCs, and the third part discusses a number of case studies. The discussion will attempt to illustrate that the effects of MNCs on developing countries depend often on
P.1, UNCTAD World Investment Report 2001- Promoting Linkages, Overview, Internet Edition p.534, Todaro, M. and S. Smith (1997) Economic Development, 6th ed Addison-Wesley 3 p. 168, Krugman, P. and Obstfeld, M. (1997) International Economics Theory and Policy, Addison and Wesley 4th edition. 4 P.4, Blomstrom, M and A. Kokko (1996) ‘The Impact of Foreign Investment on Host Countries: A Review of Empirical Evidence, Working Paper www.worldbank.org/html/dec/publications/workpapers/wps1700series/wps1745/wps1745.pdf
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policies and that there is no directly positive or negative effect in general between FDI and economic development in developing countries. Costs and Benefits of FDI/MNC Foreign Direct Investment flows may serve to supplement capital scarcities in developing countries, influencing investment levels and the balance of payments positively or they may actually lead to a reduction of domestic capital. Firstly, according to the two-gap model, capital and savings are low in developing countries, thereby limiting investment and economic growth5. The benefit of FDI is to fill these two gaps through providing capital as well as higher tax revenues6. The tax revenues benefit the government through increasing the funds available to improve public infrastructure and induce investment. For example in China foreign affiliates tax contributions accounted for 18% of the country’s total corporate tax revenues in 20007. Generally, raising investment levels through higher capital availability increases growth. However, Coleman and Nixon argue that although in the short-run a positive effect on growth may take place, in the long-run the effect is likely to be negative as the “repatriation of profits, negotiated tax concessions, transfer pricing and intra-firm trading as well as payments of royalties, technical, and managerial fees to the parent company” result in a negative outflow of capital8. Further, MNCs might lower the domestic capital availability by borrowing on local capital markets. In Latin America for example, American MNCs financed over 80% of their investments from local borrowing9, which means that MNCs did not supplement domestic scarcities but consumed them further. This is likely to discourage local investment rather than stimulate it. The impact of FDI therefore depends on whether it discourages domestic investment or stimulates it by providing additional incentives. However, the negative capital outflow might be offset by other factors such as technology and knowledge transfer, backward linkages and increased export competitiveness. Firstly, FDI can lead to technology transfer and knowledge transfer
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p. 13, Byres, T.J. (ed) (1972) Foreign Resources and Economic Development p.538, Todaro, M. and S. Smith (1997) Economic Development, 6th ed Addison-Wesley 7 p.4, UNCTAD World Investment Report 2001- Promoting Linkages, Overview, Internet Edition 8 p.368-370, Coleman, D. And F.Nixon ‘ The Transnational Corporation and LDCs’ in D.Coleman and F. Nixon (eds) The Economics of Change in Less Developed Countries 9 p.369, Coleman, D. And F.Nixon ‘ The Transnational Corporation and LDCs’ in D.Coleman and F. Nixon (eds) The Economics of Change in Less Developed Countries

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of managerial and marketing expertise which otherwise is more difficult to obtain through trade10. Secondly, with new more advanced technology in place, as well as managerial know-how, there is a possibility for spillovers (unofficial technology transfer) and linkages (increasing local economic activity) into the economy. Local firms can copy the new technology, or they are forced through increased competition to upgrade their technology and innovate11 in order to remain as suppliers to the market. Thirdly, the higher product quality brought about by new technology in addition to the fact that MNCs bring to the country certain knowledge of international market conditions and improved access to foreign markets should increase exports12. As Gemmell points out these possible higher export earnings can increase the balance of payments to offset the negative impact of repatriation of profits13 as outlined in the paragraph above. On the other hand others argue that that the transfer of capitalintensive technology might be either of an inappropriate nature for developing countries facing excess labour supply14, or take place as a one-off demonstration effect15 instead of being diffused throughout the economy. In general it is argued that MNCs creates enclaves in the economy, which have little connection with the rest of the economy16. As a result the spillover and linkage effects may be insignificant. The impact of FDI thus depends on how far integrated the MNC is in the local economy in that potential spillovers can be captured.

p.13, Byres, T.J. (ed) (1972) Foreign Resources and Economic Development p. 7, Blomstrom, M and A. Kokko (1996) ‘The Impact of Foreign Investment on Host Countries: A Review of Empirical Evidence, Working Paper www.worldbank.org/html/dec/publications/workpapers/wps1700series/wps1745/wps1745.pdf p. 276, Held, D. et al (1999) Global Transformations, Stanford University Press 12 p.24, Blomstrom, M and A. Kokko (1996) ‘The Impact of Foreign Investment on Host Countries: A Review of Empirical Evidence, Working Paper www.worldbank.org/html/dec/publications/workpapers/wps1700series/wps1745/wps1745.pdf 13 p. 92, Gemmell, M. (1987) Surveys in Development Economics 14 p. 96, Gemmell, M. (1987) Surveys in Development Economics 15 p.16/17, Byres, T.J. (ed) (1972) Foreign Resources and Economic Development 16 p.14, Byres, T.J. (ed) (1972) Foreign Resources and Economic Development
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