Elia Kim 5850733 IS FDI TOO GOOD TO BE TRUE?

Introduction Do multinational corporations (MNCs) bring greater good or adverse impacts on developing nations through their foreign direct investment (FDI) activities? This is a divisive question because of the conflicting theory and empirical results; nevertheless, this report endeavours to answer this question. In my analysis, it is pertinent to define what we mean by MNC, FDI and developing nations: MNC is a large company that operates productive capabilities in various countries (Cavusgil, Knight, Riesenberger & Rammal 2011). MNCs establish a physical presence abroad through FDI, which is the acquisition of productive assets such as land, plant and labour (Cavusgil et al., 2012). They carry out their business activities wherever it makes the most sense to and usually this is in developing nations those nations where there is a lack of resources, knowledge, education and technology. These three concepts interact and creates both benefits and costs to the developing nations who are host to the FDI. This report will first look at the economic benefits of FDI and then evaluate that against the negative effects of corruption. I recognise that there are a plethora of other positive spill overs and detriments to FDI than outlined in this report such as economic damage and cultural harm. However, the biggest issues that arise are that of an economic and political nature, which I will exclusively cover.

Economic benefits MNCs provide an overall positive effect economically to developing nations. These benefits can be further broken into primary contributions and spill over effects (Moran, Graham & Blomstrom, 2005).

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Primary contributions Firstly, FDI helps to increase the capital stock in developing countries allowing higher rates of growth than it would have had with just relying on domestic savings. The UN (2011) identifies developing nations as those with a gross national income (GNI) of $750 or less. With low income, there is little savings and therefore small levels of capital stock. Ultimately, this becomes a ceiling to domestic investment available and economic growth is limited. FDI fills these gaps in resources through capital investment and tax revenues. Tax revenues are an important factor in increasing funds for LEDC governments in order to improve infrastructure and investments. An example is China in 2000 when it was still a developing nation, 18% of its corporate tax revenues came from foreign companies (UNCTAD, 2001). With more capital available LEDCs have the ability to invest more and then higher levels of growth logically follow on from this. On the other side however, FDI has been predominately been eaten up by the same 20 countries, the largest receivers of FDI being China, US, UK and France (Moran, 2005). Those countries which are at the bottom of the LEDC list who truly lack basic infrastructure and have political instability do not attract FDI and the direct economic benefits that derive from it. FDI therefore helps to increase the inequality between certain LEDCs on the basis that some are not in a position to attract FDI.

This positive benefit only occurs though if MNCs do not loan from the local capital markets.

American MNCs that invested in South America financed 80% of it through borrowing local capital (Colman & Nixson, 1986). Although this was from a study done in 1986 the principle still holds true today. MNCs do not help reduce the gap in resources and capital if their FDI is financed through an already small stock of capital that exists domestically. MNCs deplete

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this already scarce resource and domestic investment is discouraged. This defeats the argument that FDI brings with it overseas capital which increases domestic levels. FDI helps increase investment and growth levels only if MNCs finance their FDI from another country and invest into the LEDC.

Secondly, FDI means that LEDCs can suddenly start producing products in industries that they have no prior experience. For example, Seagate from 1988 to 1996 has established manufacturing plants in Thailand for hard disk drives (Seagate, 2011). Without FDI Thailand would never had developed the skilled labour, knowledge or the capital necessary to start producing hard disk drives. Therefore, FDI helps to create manufacturing capabilities in novel industries.

Finally, FDI in the form of joint ventures (JV) allows horizontal integration to occur. Horizontal integration is where the expertise of MNCs allow the LEDC to engage more efficiently in its business activities allowing it to build higher-tech products. Whenever there is a JV, this means that there is a 50/50 equity stake in the production by both the MNC and the LEDC. The MNC takes advantage of the cost advantages of cheaper labour and raw materials while the LEDC absorbs the knowledge and technology present. An example of this is with Hyundai who under license from Ford to manufacture the Cortina in 1967 (Curbisde Classics, 2011). In 20 years, Hyundai gained the expertise it needed to start manufacturing its own car called the Pony. Joint venture leads to a direct transfer of skills and technology to developing nations.

An easy counter-argument to this however, is that MNCs who are required to enter in JVs or are forced to include local content by governments tend to not use the cutting

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technology in the production plants. Otherwise, they resort to only creating later models of products out of fear that the leak in technology will create competitors in the future. An example of this with the computer company Compaq and its Mexican affiliate. They produced computer models that were at least 3 to 4 years behind those of the models coming out in the US trying to capture profits from their older generation models (Moran, 2005). Therefore, forcing MNCs to participate in local content or JVs may not result in direct transfer of knowledge. However, when these policies in Mexico were abolished and Compaq was allowed to operate as a wholly owned subsidiary they started building cuttingedge export facilities and it was expanded 9 times its previous size (Moran, 2005). When assessing the effects of FDI government policies dictate whether it becomes a benefit or detriment. Otherwise, FDI that is wholly owned by MNCs tend to bring the latest technologies and willingness from MNCs to operate in a large scale.

Spill over effects I will now discuss the positive vertical externalities and leakages of FDI that affect third parties who arent directly involved.

Firstly, FDI causes vertical spill over of technology and management processes onto local suppliers. This helps to increase their labour productivity, efficient management and lower prices (Moran, 2005). This happens because MNCs are willing to collaborate and work closely with local suppliers so that high quality materials are delivered to their plants. At this point of contact between the MNCs and local suppliers is where the spill over of technology and efficient processes happens. The tangible benefits of this spill over is when contracted suppliers mature into international companies themselves. They are no longer exclusive suppliers to the MNC. Such an example is the Eng Tek Group which

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was a small subcontractor in Malaysia to American MNCs. It is now one of the leading manufacturers of Hard Disk Drive components with annual revenues RM500 million (USD 168 million) (ENGTEK Group, 2013).

But why do MNCs willingly cooperate and disseminate their know-how? The success of the MNC is inextricably linked to the performance of the local suppliers (Moran, 2005). The parts made in these factories still become part of the final product so they must be of consistent and high quality. For example, GMs plant in Brazil exports transmissions to Europe for use in car models there (GM, 2012).

Corruption

Short run In the short run there is a correlation between FDI and in the increase of corruption in a LEDC. Corruption is the abuse of public resources and allocating it for private benefits (Kwok & Tadesse, 2006). FDI in the short run presents an opportunity for corruption because of the following three reasons; a large amount of money coming into the country provides an elusive opportunity, the eagerness of foreign investors may trigger LEDCs to resort to corruption to secure the FDI, and finally MNCs having wide international experience are skilled in acting out bribery. In the next paragraph, I will concentrate on the first two reasons aforementioned.

The sudden influx of FDI in the short run presents itself as too elusive an opportunity for LEDCs to pass up. As countries look to increasingly use cheaper labour to cut costs to increase profitability, demand for investment and FDI in certain countries increase. As this demand increases, it causes a snowball effect where a cluster of factories

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and industry supporting firms form, which in turn attracts more foreign direct investment. Such an example is in Bangladesh that saw a 6-fold increase in FDI predominantly from South Korean and Chinese investors (Chowdhury, 2011). They are looking to invest in the growth of the textile and garment service sectors (Chowdhury, 2011). In order to satisfy this demand, those in power are motivated to grab land illegally, bribe officials and quickly build unsafe factories to secure the FDI from MNCs and the supply contracts. Corruption itself usually manifests in the end to negatively affect the overall economy, but corruption leads to a disregard for the building regulations, environmental externalities and a focus on only the private benefit. This ultimately leads to some kind of tangible accident. A very recent example from April 2013 that proves this assertion is the case of Mr Rana from Bangladesh whose garment factory building collapsed leaving 400 dead (Yardley, 2013). He bullied neighbours out of their land and bribed officials to give him a permit to build a plaza on that land even though he did not have the correct claims of title to the land (Yardley, 2013). The building collapsed due to poor construction.

Conclusion This report looked at the environmental and the social factor of corruption that arises from FDI by MNCs. Under economic factors, I further categorised it into primary contributions and spill over effects. Primary contributions were the direct benefits or costs that the LEDC was receiving from the effects of FDI. Whereas spill over effects tried to reconcile the indirect benefits and costs that operated on third parties because of FDI activity. Looking holistically at the economic factors, it is clear that FDI does bring economic benefit to the LEDCs. However, the retention of technology and knowledge is conditional on the point that the LEDCs has enough human capital to absorb this (Moran, 2005). Looking at

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corruption, I have balanced out the economic argument by providing a social cost of FDI from MNCs. Corruption in the short run increases and the effects of these have been clearly seen through the collapse of the Bangladeshi factor building (Yardley, 2013). Overall, theory says one thing about the effects of FDI and some case studies however contradict this. The interconnectedness of globalisation makes it especially hard to evaluate the overall goodness or detriment of FDI. This author however, presents the argument that overall, the economic benefits of FDI cannot be overlooked, and correct government policies to supplement FDI would create an overall benefit to developing nations.

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References

Chowdhury, S. T. (2011, June 23). FDI surge for Bangladesh. Asia Times. Retrieved May 6, 2013, from http://www.atimes.com/atimes/South_Asia/MF23Df02.html. Colman, D., & Nixson, F. I. (1986). Economics of change in less developed countries (2nd ed.). Oxford, OX: P. Allan Publishers. ENGTEK-History. (n.d.). ENGTEK GROUP. Retrieved May 6, 2013, from http://www.engtek.com/engtek/aboutus/history_eng.asp GM invests $415 Million in New Transmission Plant. (2012, February 23). GM. Retrieved May 6, 2013, from http://www.media.gm.com/media/us/en/gm/press_kits/press_kit_archive.detail.html/ content/Pages/news/us/en/2012/Feb/0223_brazil.html. Kwok, C. C., & Tadesse, S. (2006). The MNC as an Agent of Change for Host-country Institutions: FDI And Corruption. Journal of International Business Studies, 37(6), 767-785. Moran, T. H., Graham, E. M., & Blomstrom, M. (2005). How does FDI affect host country development? Using industry case studies to make reliable generalizations. Does foreign direct investment promote development? (pp. 281 - 314). Washington, DC: Institute for International Economics. Seagate Provides Update On Thailand Operations. Seagate Provides Update On Thailand Operations. Seagate (n.d.). Seagate Hard Drives. Retrieved May 6, 2013, from http://www.seagate.com/about/newsroom/press-releases/thailand-operations-floodseagate-pr/. The Hyundai Origin Myth Revealed: Theres A Ford In Your Pony. (2011, July 1). Curbside Classic. Retrieved June 5, 2013, from www.curbsideclassic.com/automotivehistories/the-hyundai-origin-myth-revealed-theres-a-ford-in-your-pony/.

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World Investment Report 2001. (n.d.). UNCTAD. Retrieved May 6, 2013, from www.unctad.org/en/Docs/wir2001overview_en.pdf Yardley, J. (2013, April 30). The Most Hated Bangladeshi, Toppled From a Shady Empire. NY times. Retrieved May 6, 2013, from http://www.highbeam.com/doc/1G1328243317.html?refid=bibme_hf