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Objectives
Introduction
Capital Transfers and Economic Growth
18.2.1
18.2.2
18.2.3
18.3
18.4
18.0
18.7
18.8
18.9
18.10
18.11
18.6
Multinational Corporations
18.4.1
18.4.2
18.4.3
18.5
Savings Gap
Trade Gap or Foreign Exchange Gap
Technological Gap
Let Us Sum Up
Exercises
Key Words
Some Useful Books
Answers or Hints to Check Your Progress Exercises
OBJECTIVES
explain the changes in the policy towards foreign capital in the recent
years; and
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Sectoral Performance-III
18.1
INTRODUCTION
48
All this spending generates an identical flow of income (Y); this total income
equals total spending: of all income, some is consumed (C) and some is saved
(S). Thus,
Y=C+S
Then, since total spending equals that income, by substitution
Multinational Corporations
and Foreign Capital
C + I + (X M) = C + S
From this equation, we can, by simple manipulation, easily discover the
essential constraints on capital formation. Move (X M) to to the right hand,
reversing its sign; cancel C on both sides. The result is
I= S + (M X)
The algebra is clear. A countrys investment opportunities are determined by
its potential for domestic saving plus any net capital inflows from abroad
(M > X). The only way for imports to exceed exports is for the country to get
capital from abroad; M > X is thus equivalent to a capital inflow.
The availability of foreign capital increases the availability of total resources
in the economy. The increase in total resources helps a developing economy
primarily in two ways:
One, It influences investment decisions. It makes possible construction of
many projects which would not have been possible otherwise. Certain
programmes of development can give optimum results if all the components
of the programme are undertaken simultaneously in a phased manner. The
availability of foreign capital makes this type of investment possible.
Two, establishment of bigger projects and projects with a high investment
component open up new opportunities of investment and, thus, encourage
domestic entrepreneurs and savers to supply their services and savings. The
addition to the total volume of resources generated thereby exceeds the
addition made by foreign resources.
Sectoral Performance-III
The constraint will be more severe if any of the following two situations
obtains:
One, some Strategic Goods like capital equipment and technical know-how,
etc. are not available locally and could be procured only from external
sources.
Two, technical conditions of industrialisation require a complement of foreign
resources along with domestic resources, so that the latter would lie idle if the
former are not available.
In either of the above two situations, the availability of foreign exchange can
save an economy from an impasse in which it may find otherwise, and place
at her disposal high quality factors such as improved machinery, technical
know-how and qualified foreign technicians which may have a beneficial
effect on her development by, what Harrod called, fertilising productivity of
common labour.
...
Multinational Corporations
and Foreign Capital
...
...
...
3) Explain the nature of technology gap faced by a developing economy.
...
...
...
...
18.3
The inflow of capital from abroad may take place either in the form of: (a)
foreign aid, or (b) private investment.
Foreign aid includes loans and grants from foreign governments and
institutions. This source of foreign capital, especially loans, has an important
limitation in the form of repayment obligations.
As regards private foreign capital investment, the intense academic debate
relating to its effects remains inconclusive. The opponents of foreign
investment have drawn attention to several imperfections and adverse effects,
such as capital intensity of such investment, inappropriate technology, the
possible adverse effects on income distribution, transfer pricing and the
negative contribution that such investment often makes to the balance of
payments. The advocates of foreign investment, on the other hand, have
highlighted the beneficial effects in terms of encouragement to the
development of technology, managerial expertise, integration with the world
economy, exports and higher growth. It has also been claimed that debt
financing generates fixed debt servicing obligations, while equity needs to be
serviced only after profits are made.
There is also sufficient empirical evidence to support both points of view. For
example, in recent years, foreign investment seems to have contributed
enormously to the growth of several Asian countries, including China. There
are examples, particularly from Latin America and Africa, where the
contribution of foreign investment has not been so encouraging.
Sectoral Performance-III
iii) Creditor capital from official sources in recipient countrys joint stock
companies.
b) Foreign Direct Investment
There are three main categories of FDI:
i) Equity Capital: It is the value of the Multinational Corporations
(MNCs) investment in shares of an enterprise in a foreign country. An
equity capital stake of 10 per cent or more of the ordinary shares or
voting power in an incorporated enterprise or its equivalent in an
unincorporated enterprise is normally considered a threshold for the
control of assets. This category includes both mergers and
acquisitions, and green field investment (the creation of new facilities).
ii) Reinvested Earnings: These are the MNCs share of affiliate earnings
not distributed as dividends or remitted to the MNCs. Such retained
profits by affiliates are assumed to be reinvested in the affiliate.
iii) Other Capital: It refers to short-term or long-term borrowing and
lending of funds between the MNCs and the affiliate.
18.4
MULTINATIONAL CORPORATIONS
The MNCs have certain characteristics among which the more important are
as follows:
i) Giant Size: The assets and sales of MNCs run into billions of dollars and
they also make supernormal profits. The Economist estimates that the
worlds top 300 MNCs now control over 25 per cent of the 20 trillion
stock of productive assets. No size, howsoever big, is perceived to be
sufficient. Hence the MNCs keep on growing even through the route of
mergers and acquisitions.
Multinational Corporations
and Foreign Capital
Potential Benefits
1.
Capital
2.
Technology
3.
4.
Diversification
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Sectoral Performance-III
1.
Impact Area
Potential Benefits
Capital
2.
Technology
Costly over-import,
Problems with advanced technology and updating,
Problems with technical support.
3.
Export performance
companies,
Higher import
companies,
at
par
propensity
with
domestic
than
domestic
Diversification
Preemption of growth
substitution of domestic
promisive areas,
opportunities and
capital in several
18.4.3
In view of the fact that MNCs do possess a potential that can be gainfully
exploited, most of the developing countries have chosen to regulate their
activities rather than to dispense with them altogether.
i) Threat of nationalisation is an important tool of regulation.
ii) The Government may allow or deny permission in identified areas.
iii) MNCs may be allowed to invest for specific periods. Thus, after a certain
period of time, restrictions may be imposed on foreign holdings, or there
may be provision for gradual disinvestments.
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iv) A multi-tax system may be followed by the Government. The MNCs may
be taxed at a higher rate.
Multinational Corporations
and Foreign Capital
55
Sectoral Performance-III
These principles define the broad contours within which the state policy
towards foreign capital has been framed all through the different five-year
plans. Beginning with the First Five-Year Plan in 1951, three distinct phases
as follows can be marked:
The First Phase lasted till 1965 and was characterised by a liberal attitude
towards foreign capital. Many concessions and incentives were given to
foreign capital participation in the industrial development of the country.
In the Second Phase beginning with the mid-1960s, the liberal attitude of
the state yielded place to strict controls and the broad policy was to restrict
the area of operation of foreign capital.
The above changes are pointers to the fact that, lately, the Government is keen
to attract more of foreign investment. It seems it has come to be believed that:
FDI brings technology. This technology spills over into other sectors
which supply components and inputs. Also when FDI firms produce
cheaper and better capital goods or intermediate products, the
competitiveness of sectors which use these, improves. The competitive
edge will spur development and accelerate the growth process.
Multinational Corporations
and Foreign Capital
57
Sectoral Performance-III
Amount
1990-91
.001
1991-92
.013
1992-93
.032
1993-94
.059
1994-95
1.32
1995-96
2.15
1996-97
2.82
1997-98
3.56
1998-99
2.46
1999-2000
2.16
2000-01
2.34
2001-02
3.90
2002-03
2.58
2003-04
3.20
Note: The Government has reorganised FDI data for 2000-01, 2001-02 and 2002-03
along the lines recommended by the IMF to include some hitherto uncaptured
elements of capital. The fresh items have been classified under equity capital,
reinvested earnings and other capital. As per the revised data, FDI inflows
during 2000-01 would now be $4.03 billion, while these would be $6.13 billion
in 2001-02, and $4.67 billion in 2002-03.
Less than 40 of the top 100 MNCs and none of the top small MNCs
operate in this country. This shows what a long way we have to go to become
a multinational heaven.
Multinational Corporations
and Foreign Capital
Sectoral Performance-III
18.6.3 Suggestions
Policy reform is an on-going process. Following suggestions can be made to
make policy towards foreign capital more meaningful and effective:
1) State infrastructure is a major constraint and things can worsen if quick
action is not taken to watch the quality and size of all infrastructure
components like transport, communication and energy, comparable with
that in other countries competing for the same capital.
2) Attention need be paid to restructuring education, training and skills the
process must begin at the level of primary education upwards with
emphasis on absorption of appropriate skills and through upgradation.
3) India should promote quality standards. The present mindset favouring
cheapness of the cost of capital needs a change.
4) The existing framework of legislation and practices related to industrial
action should be reorganised so as to make it conducive to the promotion
of productivity oriented measures.
5) The operating environment need be made investor-friendly. For this
purpose, following suggestions can be made:
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i)
At the entry level, there are two alternative routes, viz., the Automatic
Approval Route (AA) of RBI and the Foreign Investment Promotion
Board (FIPB). The policy framework should be liberalised to make the
AA route more effective. An increased share of the AA route in the
FDI approvals will concurrently reduce the pressures on the FIPB
route.
Multinational Corporations
and Foreign Capital
61
Sectoral Performance-III
18.7
LET US SUM UP
18.8 EXERCISES
1) Critically examine the role of multinational corporations in a developing
economy. In this context, would you advocate a policy of encouraging
investment by multinationals in India?
2) What are the arguments advanced against multinational corporations
operating in India?
3) Response of foreign capital to recent policy initiatives is considered as
lukewarm. Make suggestions to change this trend.
4) The new industrial policy can be described as a minor revolution as far as
decisions concerning foreign capital are concerned. Elaborate what has
the impact of the new policy.
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18.10
Multinational Corporations
and Foreign Capital
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