4.5: Foreign direct investment and economic development

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    Definitions

     

    1. Foreign direct investment (FDI) is a long-term direct investment made by a company based on one country, into a company based in another country.
    2. Multinational corporation (MNC) is a company that has productive units in more than one country.

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    Foreign direct investment

    • Long-term investment by private multinational companies in countries overseas.
    • Occurs in two ways:
      • MNC’s build new plants or expand their existing plants in foreign countries.
      • MNC’s merge or buy existing firms in foreign countries.

     

    Reasons why Multinational Corporations are attracted to developing countries

    • Developing countries are rich in natural resources → MNCs have an opportunity to raise profits from using the technology and expertise to extract natural resources.
    • Some developing countries, such as India, China, Brazil, have growing markets → MNCs have better access to large no. of potential customers.
    • Lower production costs in developing countries → Allows firms to sell at a lower price and make higher profits.
    • Governments in developing countries have less stricter government regulations → Makes it easier to set up businesses → Lowers production costs.

    Possible advantages of Foreign Direct Investment (FDI)

    • Helps fills the savings gap in developing countries → Might lead to economic growth.
    • MNCs can provide employment, education and training in the country → Improves the skills level of the workforce and managerial capabilities.
    • Developing countries have greater access to research and development, technology, marketing expertise → Enhance industrialization.
    • Increased earnings and employment → Multiplier effect → Stimulate economic growth.
    • Host government can use the tax revenue earned from MNCs profits to invest in infrastructure, improve public services → Improves growth and promotes development.
    • If MNCs buys existing firms in developing countries, they inject foreign capital → Increases aggregate demand in the economy.
    • MNCs can improve the physical and financial infrastructure of the developing country’s economy, or persuade the government to improve the infrastructure.
    • Existence of MNCs can provide more choice and lower prices for consumers.
    • MNC activities + Liberalized trade → More allocatively efficient of world’s resources.

     

    Possible disadvantages of Foreign Direct Investment (FDI)

    • MNCs tend to use their own management teams, uses low-skilled labor and provides no education and training → Limits the access to new technologies for developing countries.
    • MNCs have too much power because of their size, gain large tax advantages and subsidies → Reduces potential government income in developing countries + Exert too much influence on decisions made by institutions such as WTO.
    • MNCs take advantage of low tax reward in developing countries for their profits → Governments potentially lose a large portion of their revenue.
    • MNCs operate in a place where legislation on pollution isn’t very effective → Reduces private costs + Creates external costs → Damages the environment of the country.
    • MNCs take advantage of poor labor laws → Allows exploitation of workers in terms of low wage levels and poor working conditions.
    • Extraction of resources and leaving the country after receiving it → Unrest in the host country as locals might see as profits from their resources are being used for foreigners rather than the local people.
    • MNCs tend to use capital intensive production method → Doesn’t improve levels of employment in the country.
    • The actual money earned by the owners of the firm, purchased by the MNCs, may not be used in the developing country’s economy.
    • MNCs may repatriate their profits → They send the profits earned from the host country and send it back to the country of origin.