(Ben's Angels Group) The Negative Impacts of FDI On Host Countries

THE NEGATIVE IMPACTS OF
FDI ON HOST COUNTRIES

[INTERNATIONAL ECONOMICS COURSE ]
2014
[BENS ANGELS GROUP]
4/7/2014
THE NEGATIVE IMPACTS OF FDI ON HOST COUNTRIES
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I. ABSTRACT:
The attraction of foreign direct investments (FDI) is often underlined as a precondition
for a successful economic venue by most governments of less developed countries. Strategists in
high developed countries seem to be more cautious.
Foreign direct investment (FDI) influences the host countrys economic growth
through the transfer of new technologies and know-how, formation of human resources,
integration in global markets, increase of competition, and firms development and
reorganization. However, there is also evidence that FDI is a source of negative effects. The
main idea that stands out in this review is that the effects of FDI on economic growth are
dependent on the existing or subsequently developed internal conditions of the host country
(economic, political, social, cultural or other). Thus, the host countries authorities have a
key role in creating the conditions that allow Multinational Corporations (MNCs) for the
leverage of the positive effects or for the reduction of the negative effects of FDI on the host
countrys economic growth.
II. INTRODUCTION:
Usually FDI is defined as an investment involving the transfer of a vast set of
assets, including financial capital, advanced technology and know-how, better management
practices, etc. This investment is carried out by an entity (a firm or an individual) in foreign
firms, involving an important equity stake in, or effective management control. Countries with
weaker economies consider FDI as the only source of growth and economic modernization.
For this reason, many governments, particularly in developing countries, give special treatment
to foreign capital. It is common that countries have public agencies whose aim is to attract
foreign investments using public funds, which shows that governments are willing to bear some
costs to attract such investments.
There are three kinds of FDI: Horizontal, Platform and Vertical FDI.
In the early stage of market economy, foreign direct investments may produce some
externalities in the formof higher employment rates and technology transfers, often filling the idea
gaps between old and emerging market economies. Nevertheless, they often cause a lot of harmtoo
as not a charity but the aspiration to earn more via cheep(er) resources- land and labor is the primary
aim of investors. Foreign investors can reduce employment by dismissing local workers, by
crowding out local businesses that cannot compete with multinationals; technology transfers may
not occur if the degree of market integration is insufficient; positive capital flows often turn to
negative if investors use cheep local rawmaterials and resources and sell expensive final goods.
Therefore, the article analyses the reasons that FDIs shortcomings or drawbacks stem from
and answer whether FDI is the best means to stimulate the development rate of host countries
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III. CONTENT:
There are several mechanisms / channels through which FDI can affect the host country
economic growth. The following sectors are examined to make out how these factors negatively
influence FDI.
1. FDI and the transfer of new technologies and know-how:
The transfer of technology can bring negative effects. Although, the MNCs have access to
new and cutting edge technology, they do not transfer the latest technology to the host country
with a fear that their home country may lose its competitive advantage. To be more specific,
multinationals may have an adverse reaction to host country R&D in order to continue to hold a
technological advantage compared to local firms. With the same aim multinationals only
transfer inappropriate technologies. The host country can become dependent on technologies
introduced by multinationals. There is a decline in local firms interest in the production of
new technologies. In these circumstances, the host country dependence on
multinationals. Technology will be perpetuated. Their fore the maximum potential of the host
economy cannot be achieved as a result of old technology transferred.
Summarizing the 25 years of FDI in Vietnam, according to the data from the Ministry of
Planning and Investment showing that up to 80% of FDI companies using the world-average-
level technology for investment in Vietnam. Only 5-6% of them use high technology and 14%
use outdated technology.
Importing outdated technology then transfer the price to "premium" is one of the way
that many FDI companies apply and bypass the management in Vietnam for a long time.
For example, a line of old machines that costs only $ 400,000, was raised prices up to $
16 million, 40 times higher than the original price when Hualon Corporation (belong to Venture
of Malaysia - Taiwan-British Virgin Island) imported into Vietnam. Information is from Dong
Nai tax Department in 2013
2. FDI and the formation of the human resources:
Wage spillovers of the FDI are considered to be mostly positive as workers of MNCs can
come into contact with new cultural environment ,working styles and higher salaries, which will
increase the competitiveness of domestic firms. However, it might cause negative consequences
as well, especially, if MNCs hire the best workers, either through their economic power or
through better career possibilities they are able to offer and thereby leave lower-quality workers
at the domestic firms. Local firms may also suffer from the increase in FDI due to their reduced
structure compared to the multinationals. In these cases, local firms are more dependent on
the government, including in some cases government subsidies that will be reduced or even
canceled.
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One possible reason of the negative results in some developing countries is that the gap
between MNCs and domestic firms is very large for one party to influence another. Moreover,
the labour markets in some developing economies are too segmented for wages in one party to
influence another.
A survey conducted by VietNam Work will show top ten attractive employment
companies in VietNam, which consists of eight FDI companies out of ten
Name of
companies
Additional Information
Topcom
the official distributor of Piaggio in Vietnamwith
over 500 staffs and networks of showroomsaccording to 3S
Standard ( Europe) in HCM City and Hanoi. It has been
recognised as the most acttractive employment company
with 463 applicants for each position
Panasonic
one of the biggest corporations in electronic
industry in Japan with 433 applicants/position
Mizuho Bank Japan Bank
Rex English
Center
the number-one English Center in HCM City and
Hanoi with the numbers of Ielts students and the students
gaining high prizes in competitions, has 376
applicants/position
Orion Food Vina
Co.Ltd
one of the most famous candy factories in Korea,
has distributors in more than 65 countries in the world. It
has 368 applicants/ position
Vietnam Posco
E&C
Founded in 1995, this company supplies designing
methods for infrastructure projects, building ships
Sony 347 applicants/position
LG 332 applicants/ position
Kyocera Factory 311 applicants/ position
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PwC 283 applicants / position
The danger of Brain drain :In non-state places, especially FDI companies, the very high
rate of growth has allowed them to recruit( or compete to acttract) talented employees from state
corporations. In some recent surveys about salary of staffs, FDI companies has been superior to
Vietnamese companies in high-level employee competition. The salary for staffs in FDI
companies is approximately 12 million VND/month, whereas Vietnamese companies is lower(
government companies: 4.3 million VND/month and private companies: 3 million/month). So
FDI companies has become a real rivalry of government companies in the high-level markets of
employment
3. FDI and integration into global economy:
The further integration into the global economy provided by FDI can have negative
effects on the host country. FDI has a far greater impact for imports than for exports, which
influences negatively the balance of payments.
This strong impact on imports is due to the fact that multinationals have great need
of goods and raw materials, and most of the time, these are not available, either in quantity or
in quality, in the host country . Another explanation is that the investment made may have as its
main objective the supply of the local market and thus does not encourage exports . FDI is the
easiest source of spreading economic problems occurring in the world, particularly those
that have occurred in the multinationals countries of origin. Host countries become more
open economies and more subject to changes in the global economy.
But the negative aspects do not stop there. In fact, the purpose of improving the balance
of payments through the initial financial flows received is not always achieved in the long run.
These effects can be mitigated or contradicted (in stages of low FDI inflows) through the usual
repatriation of multinationals subsidiaries profits to their countries of origin , or through the
payment of licenses and royalties due to the use of technology held by headquarters show that
in the long run the repatriation of profits is higher than the positive impact of the initial
investment. The negative impacts caused by these outflows of capital, can be extended if
these funds are obtained through credits obtained in the host country .
An increase in FDI inflows from the home country will result in an increase in imports in
the host country from the home country. It can be due the fact that the MNCs purchases inputs
from its traditional suppliers or increased inflation rate speeded up by foreign capitals in the
home country. As more investment flows in, the host country economy becomes more and more
dependent on the production technology of MNEs home country. The host country will have to
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import more inputs and intermediate goods from the MNEs home country, which might
constrain the development in the domestic industry. If these investments are not export-oriented,
the host country can suffer from trade deficits
FDI, especially, made in the developing countries can lead them to have a dual economy,
which has one developed sector mostly owned by foreign firms and underdeveloped sector
owned by domestic firms. Often this developed sector is the capital-intensive, while another one
is labour-intensive. Therefore, dual economy effect hampers the economic development of
countries as most of their citizens are located in the non-developed labour-intensive sector. This
effect is visible in most oil-rich countries, where foreign investments made in the oil and gas
sector resulted in the resource boom and left the agriculture and manufacturing sectors
underdeveloped.
The case of VietNam is the most germane here because the balance of payments has
deficited for many years.
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underdeveloped.
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underdeveloped.
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4. FDI and increased competition
The increased competition does not produce only positive effects on the host country.
This increased competition leads inevitably to the closure of some local firms (that cannot
compete with multinationals due to the advantages they have), which leads to increased
concentration in the sector, and in turn will lead to decreased competition. In order to face
the strong competition from multinationals, concentration can also occur between local firms
to achieve gains in economies of scale, reducing competition . Other factors related to FDI
could result in the disappearance of local firms. The increase in income in the national
economy is not equal for all players in the economy: multinationals have increased income
which justify the increases at the national level, but local firms are suffering a decline in
income which may lead to their disappearance. The possibility of the emergence of a situation
of multinational oligopoly which lead to the disappearance of local firms.
MNCs have large economic and pricing power due to their large sizes. They do not have
much problem with regards to financial capital and can hence resort to using advertising which is
a costly affair. Also, these companies are global players who have their operations spread across
countries and have effective supply chains which enable them to have economies of scale which
smaller players in the domestic market of the host country cannot compete with. All this results
in the MNC having cheaper products and more visibility due to the higher amounts of
advertising and have been known to push out smaller industries out of business
Another effect that is recorded is that caused by the competition created in access to
credit, which will bring negative consequences to the host countrys economy. In fact,
multinationals tend to be partly financed by the host countries financial markets. This
increase in financing needs in the country will have effects in that market, so it is predicted that
the costs of credit increase and that the access to credit changes . Multinationals financed in host
countries will reduce their ability to grant loans, making it difficult for local firms to obtain
loans. Additionally, FDI can cause a loss of domestic savings which further makes the
availability to grant loans worse. These problems in access to credit are mainly experienced
by local firms which have a smaller structure, and then find it difficult to support the increased
costs of credit, plus their weak bargaining power with financial institutions (compared to
multinationals). This competition for funding could preclude some local firms from necessary
investments for their development or even for their maintenance, which may lead to their
disappearance.
This diversity might be due to the fact that various economies attract different types of
FDI. Countries that attract mostly domestic market-seeking investments will experience
crowding out as the establishment of foreign subsidiaries results in tough competition with
domestic firms. But for export-oriented investment, it might be less so.
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MNCs with lower marginal costs increases production relative to its domestic competitor,
when imperfectly competitive firms of the host country face fixed costs of production. In this
environment, foreign firms that produce for the domestic market draw demand from local firms,
causing them to reduce the production. The productivity of local firms falls as their fixed costs
are spread over a smaller market which forces them to back up their average cost curves. When
the productivity decrease from this demand effect is large enough, total domestic productivity
can diminish even if the MNCs transfers technology or its firm-specific asset to local firms .
Example is the domination of Coca cola and PepsiCo in Vietnam: Many kinds of product
of these two are very popular to customers of Vietnam while many products from national
companies in Vietnam are not known. According to the Vietnam Beer, Alcohol and Beverage
Association (VBA) the total revenue in 2010 of Coca cola and PepsiCo accounted for 80% of the
beverage market in Vietnam.
5. FDI and the difficulty of implementation economic policies
In the past, there have been many instances in which MNCs have resorted to political
lobbying in order to get certain policies and laws implemented in their favor. At times, these
MNCs are so large that their revenues even exceeded the Gross Domestic Product (GDP) of
some smaller nations and compel or threaten them to pass judgments and policies in their favor.
The host country economy may be affected by the difficulty of implementation of
economic policies, resulting from FDI inflows. In fact, FDI inflows are sources of instability
by the difficulty or even impossibility, of predicting these flows. This may destabilize the
country's economic development and affect negatively the implementation of economic policies
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. Another harmful event to the host country economy occurs if there is a sudden and high
capital inflow because it is likely to increase inflation in proportion to that inflow .
Additionally, FDI can cause a decline in the local authorities autonomy. Large
multinationals get control over assets and employment, which enables them to influence the
political and economic decisions of the host country authorities. Pressures exerted by
multinationals on local authorities to achieve gains in their operations can also be observed,
which may result in policies that are not favorable to host country economic growth, only
benefiting foreign investors . Due to the multinationals size and their impact on local
economies, their strategic decisions can cause significant changes in the host country,
independent of the local authorities strategies, and could even be contrary to the desired
national policies .
Typical case-Royal Dutch Shell interfering with politics in Nigeria
Oil and politics have a lot to do with each other. The home states of Royal Dutch Shell
are the United Kingdom and the Netherlands. These countries might want to secure their oil/gas
imports and the economic benefits of having an international oil company based within their
territory. These interests might overpower ethical interests, such as the protection of human
rights in countries hosting the oil company. Home states often might have the same business
interest than their oil companies.
Oil companies may lobby their home states, so these will pay more attention to oil
business possibilities. Oil companies may speak kindly of regimes that are in fact abusing human
rights. Oil companies might keep their finger on the pulses of home as well as host states, in
order to keep informed of the latest political developments.
In October 2009, Shells Executive Vice President (EVP) for Shell Companies in Africa,
Ms Ann Pickard met with the United States Ambassador to Nigeria. According to the cable from
the U.S Embassy in Nigeria, the Shell EVP told the ambassador that the Government of Nigeria
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had forgotten that Shell had seconded people to all the relevant ministries and that Shell
consequently had access to everything that was being done in those ministries.
Following the disclosure of this cable, Shell has stated that the suggestion of infiltration
by Shell in the Nigerian government is far from the truth, and that this infiltration would not be
in line with Shells General Business Principles. According to Shell, it has a total of 11 staffs
seconded to the Nigerian government, mainly technical specialists. Shell stated that it is usual in
the oil industry for governments and businesses to keep close contact with each other. The
reasons for this would be the importance of energy for society and the fact that governments
often directly or indirectly participate in oil and gas activities.
6. Environmental issues
A large volume of FDI is concentrated in natural resource sectors of developing and less
developed countries. Most of these countries have a less strict or non-existent regulatory regime.
Sometimes countries deliberately attempt to exempt or loosen their regulatory requirements to
attract FDI. However, while these countries can benefit from positive effects of investment, the
negative effects of FDI on host countrys ecosystems and environment might bring disaster in the
long run .
The solution to these problems is to raise host country capacity to regulate and construct
international environmental standards. NGOs and other civil society groups from home and host
countries can also play a significant role in the improvement of government regulations and
increase of MNEs responsibility on environmental issues.
Exploitation of natural resources of a host country is not an very uncommon phenomenon
in the case of FDI. MNCs of other countries have been known to indiscriminately exploit the
resources of hosts countries in order to get short run gains and profits and have even chosen to
ignore the sustainability factors associated with the local communities and local habitat, very
much like what happened in the 17
th
century colonialism.
Deputy Minister of Natural Resources and Environment, Mr.Bui Cach Tuyen confirmed,
one of the factors making Vietnam become an attractive investment is its low standards of
environmental costs for waste treatment and waste requirements are greatly reduced in
comparison with other countries. Therefore, along with the exporting pollution trends from
developed countries to developing countries through increasing FDI, Vietnam can become one of
the countries that have high importing level of pollution. Together with importing outdated
machines, recently, a series of FDI enterprises did pollute the natural environment.
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VEDAN: The Taiwanese-invested company, among other violations, allegedly released
nearly 110,000 cu.m of post-fermentation molasses waste and other solid substances each month
into the Thi Vai River over a 14-year period through a sophisticated underground pipeline.
7. Profit repatriation
When MNCs make investments in foreign countries their main objective is to maximize
their profit. Some advantageous characteristics of these countries, such as cheap labour force,
natural resource abundance or high quality expertise, allow MNCs to enhance their economic
performance. MNCs regularly repatriate their profits from investment to the account of their
parent companies in the form of dividends or royalties transferred to shareholders as well as the
simple transfer of accrued profits. It also helps them avoid larger taxes by using transfer prices.
However, this profit repatriation results in huge capital outflows from the host country to the
home country and negatively affects the balance of payment of the former. Thus the host
countries often set limits on the amount of profits that MNCs can repatriate in order not to have
balance of payment deficits or reduced foreign exchange reserves. Such policy can induce these
MNCs to invest profits in different projects within the host country .
But there is also a possibility that such limitations might discourage MNCs from
investing in these countries, which will move FDI to the countries with less profit repatriation
limitations. For example, a survey of chief executive officers from 193 American MNEs
revealed that nearly 70% of them viewed profit repatriation as a main factor positively
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motivating the FDI behaviour of them . One of the biggest FDI receivers in the world, India,
permits 100% profit repatriation for foreign investors in most sectors .
Example :
Coca-cola suspected major tax avoidance scam
Coca-cola advert in Vietnam
Coca-cola has continuously reported losses in the last decade of operations in Vietnam
despite it being one of the biggest players in the domestic beverage market.
In 2006, the company reported VND228 billion in losses, with the figure for 2011
recorded at VND39 billion. Coca-cola's average losses in Vietnam have been around VND100
billion (USD4.8 million) per annum according to the company.
According to HCMC Department of Taxation, Coca-cola's revenue in Vietnam increased
from VND1 trillion to over VND2.5 trillion during the 2007-2010 period. Their sales also
increased three-fold during this time.
Nguyen Trong Hanh, former Vice Director of HCMC Department of Taxation said Coca-
cola might blame the losses on the high price of raw materials.
In October, Muhtar Kent, Coca-Cola Company President and Chief Executive Officer
visited Vietnam, saying that it represented one of the most important markets for the company
and that the firm would invest USD300 million into the country
IV. CONCLUSION:
There are several channels through which FDI can affect the host countrys economic
growth and the effects can be negative. In general, it is agreed that the negative impact of FDI
on host countries economic growth depends on certain factors that exist or not in those countries,
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such as human capital, the trading system, the degree of openness of its economy , the
economic and technological conditions , and legislation and political stability .
The most important features that authorities of host countries should take into
consideration is that they ought to regulate flexible and appropriate strategies that is suitable for
each stage of development. Moreover, the authorities should have policies that stimulate FDI
inward capital flows into green fields.
V. REFERENCE:
1. Moran, T. (1999), Foreign direct investment and development: a reassessment of
the evidence and policy implications in OECD, Foreign Direct Investment, Development
and Corporate Responsibility, Paris: OECD.
2. Balasubramanyam, V., Salisu, M. and Sapsford, D. (1996), Foreign direct
investment as an engine of growth, Journal of International Trade &Economic Development, 8
(1): 27 40.
3. Rui Moura, Rosa Forte (2010): The effects of Foreign Direct Investment on host
country economic growth Theory and empirical evidence.
4. Blomstrm, M. and Kokko, A. (1998), Multinational corporations and spillovers,
Journal of Economic Surveys, 12 (3): 247 277.
5. Borensztein, E., De Gregorio, J. and Lee, J-W. (1998), How does foreign direct
investment affect economic growth?, Journal of International Economics, 45: 115 135.
6. Carkovic, M. and Levine, R. (2002), Does foreign direct investment accelerate
growth? in: Does Foreign Direct Investment Promote Development? Ed. T. Moran, E.
Graham and M. Blomstrom, Washigton.
7. Websites are used to collect data:
http://www.customs.gov.vn/lists/tinhoatdong/Print.aspx?ID=18993
http://www.thanhnien.com.vn/pages/20131226/mat-trai-cua-fdi.aspx
http://fia.mpi.gov.vn/News.aspx?ctl=news&mID=8
http://mpi.gov.vn/portal/page/portal/bkhdt
http://kinhdoanh.vnexpress.net/

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