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Foreign direct investment

Foreign direct investment is mainly undertaken through multinational corporations (MNCs). An MNC is a firm that has productive capacity in a number of countries. The profit and income flows that they generate are part of the foreign capital flows moving between countries.

The total value of MNC investment worldwide is over $1 trillion ($ 1,000,000,000,000) of which around one third is in the developing world. Given low levels of GDP in the developing world, this foreign direct investment (FDI) can mean that the MNCs can hold a disproportionate amount of power over the countries they operate in.

As countries adopt more open, outward-oriented approaches to economic growth and development, the role of MNCs or transnational corporations becomes more important. As local markets throughout the world are being deregulated and liberalised, foreign firms have looked to locate part of the production process in other countries where there are cost advantages. These might be cheaper sources of labour, raw materials and components or preferential government regulation. Although developing countries may present high levels of risk, they also present the potential for higher levels of profit. Many developing countries with growing economies and increasing incomes may provide future growth markets and they will often offer significant incentives to try to attract the MNCs to locate there.

The benefits of MNCs

  • Proponents of outward - oriented economists maintain that the cycle of poverty will not be broken just from within the domestic economy. Developing economies themselves cannot raise enough finance to fund the necessary investment. Thus FDI through MNCs is essential.
  • By investing in areas and utilising the factors of production where the LDCs have an absolute and comparative advantage, it is argued that MNCs will lead to a more efficient allocation of the world's resources. However, if this leads to overspecialisation and overdependence in certain sectors of the economy, then the host country will be vulnerable, especially if the MNC decides to leave.
  • Investment into an economy will help to boost the rate of economic growth by shifting the economy's long run aggregate supply curve to the right (increasing their productive potential).
  • Investment will help inject money into the local economy. This may provide jobs directly or through the growth of local ancillary businesses such as banks and insurance companies. This may contribute to a multiplier process generating more income as newly employed workers spend their wages on consumption.
  • MNCs may provide training and education for employees thus creating a higher skilled labour force. These skills may be transferred to other areas of the host country. Often management and entrepreneurial skills learned from MNCs are an important source of improved human capital and, as we have seen in previous sections, this is an important contributory factor to development.
  • MNCs will contribute tax revenue to the government and may contribute other funds to local development projects or may perhaps invest in other related assets.

The problems of multinational enterprises

  • The MNC may employ largely expatriate managers ensuring that incomes generated are maintained within a relatively small group of people. The attraction for the MNC may be a large and cheap supply of manual labour. This may worsen income distribution. It will also mean that there is no 'skills transfer' to the local people.
  • Investment in developing countries often uses capital-intensive production methods. Given that many developing countries are often endowed with potentially large low wage labour forces and have high levels of unemployment, this might be considered inappropriate technology. More labour intensive production methods might help more with alleviating poverty.
  • MNCs engage in transfer pricing where they shift production between countries so as to benefit from lower tax arrangements in certain countries. By doing this, they can minimise their tax burden. This means that the host country will not benefit from the higher tax revenues and this in turn limits their ability to spend on infrastructure improvements and improvements in health and education.
  • The size of MNCs means that they can exert disproportionate power and influence on governments to get tax breaks, grants and subsidies. This will particularly be the case after they have operated in the country a number of years and are thinking of re-investing. At this point, they can 'threaten' to move elsewhere.
  • Growth and development, which are largely dependent on FDI via MNCs, may give rise to a range of other problems, such as a widening of inequalities between rural and urban sectors, the exploitation of local labour through the payment of low wages, the stifling of domestic competition and the establishment of an outward directed pattern of growth in which profits are repatriated to the host country of the MNC rather than being re-invested in the developing country.