International Trade — Assignment
Does inward FDI benefit developing countries or are they exploited by MNEs?
Globalization has brought about different changes over the last year. Different countries now do trade freely without the restrictions that existed in the past (Hill, 2000). Globalization can be defined as the integration of nations that has brought about the free flow of goods and services, people, and ideas from one country to another. Many companies have taken advantage of globalization and have expanded their operations overseas (Hill, 2000). Going overseas is not a simple task for multinational companies. There are a number of market entry modes that are available for companies wishing to go international into foreign markets overseas. When an organisation has decided to go international, there are a number of options open to it (Hill, 2000). Examples of entry modes include exporting, foreign direct investment, strategic alliance, licencing and joint ventures to name a few. These entry modes vary on the basis of cost, risk, degree of control and return on investment. Foreign direct investment is the investment of capital in a chosen business enterprise operating in foreign countries (Hunya, 2000). This essay will answer the question; does inward FDI benefit developing countries or are they exploited by MNEs?
The transaction theory is based on the notion of why companies exist and why they expand into foreign markets (Jenkins and Thomas, 2002). The theory argues that organisations attempt to reduce the cost of exchanging resources and bureaucratic costs. The theory argues that companies can expand and succeed as long as their operations can be done cheaply. Foreign direct decision is based on transaction costs. Multinational companies can succeed in foreign markets when it keeps its operation cost down (Jenkins and Thomas, 2002). Multinational corporations often balance the internal transaction costs against the external ones before deciding to implement foreign direct investment. If foreign direct investment is able to keep the operation costs down, then the company will succeed in the foreign markets. FDI is considered advantageous to developing companies (Jenkins and Thomas, 2002).
Traditionally, inward foreign direct investment was a concept that linked to highly developed economies (UNCTAD, 2006). Developed economies made up a higher share of foreign direct investment compared to the developing countries. However, in recent years, inward foreign direct investment has increased in developing countries as compared to developed countries. Inward foreign direct investment has brought about many benefits to the developing countries (UNCTAD, 2006). Foreign direct investment is considered a form of international capital movement. Thus, foreign direct investment brings about many benefits as other forms of capital flow. Nevertheless, FDI is very unique in its incentive structure and in producing stronger integration between the host country’s economy and the global economy. As a result of this integration, there is easier transfer of technology from developed economy to the developing host country of a multinational corporation (UNCTAD, 2006). Economists argue that inward foreign direct investment is a great form of capital flow due to its spill-over effect.
Short-term capital flow is beneficial for a limited amount of time but transfer of technology which is possible through foreign direct investment brings about long-lasting results (Glyn, 2004). Therefore, foreign direct investment is able to enhance the growth and development of the host economies. Many economists have emphasized on the benefits of inward foreign direct investment. Inward foreign direct investment allows the import of technologies in terms of managerial, marketing and firms-specific technologies (Chetty and Campell, 2003). These technologies can be transferred through the institution of Multinational Corporation in developing countries. The transfer of technologies has enabled the growth and development of local companies in the developing economies (Chetty and Campell, 2003).
In addition, inward foreign direct investment has also benefited developing countries since it encourages high income levels among people by enhancing proficient use of limited resources (Jenkins and Thomas, 2002). When foreign-owned companies enter a developing country, there is a direct transfer of knowledge. Foreign-owned companies like multinational corporations tend to be larger than the domestic companies and operate with huge labour and capital. Therefore, this leads to economies of scale. This also leads to higher wage levels among employees in the host country (Krugman, 2008). In addition, MNCs raises the skills of local workers through knowledge transfer. Taking this into consideration, inward FDI leads to high income levels in the developing countries. Also, by transferring knowledge, multinational corporations assist in increasing stock of knowledge through new managerial practices as well as labour training (Jenkins and Thomas, 2002).
Inward foreign direct investment has positive employment effects; directly and indirectly (Jenkins and Thomas, 2002). The creation of employment is among the prominent benefits of inward FDI especially in economies with scarce capital and huge labour abundance. The direct effects on employment arise when multinational corporations hire local employees from developing countries (Jenkins and Thomas, 2002). On the other hand, indirect effects come into being when employment is created due to local spending by MNCs employees. For instance, one company that has brought about employment benefits is Toyota which invested in France (Jenkins and Thomas, 2002). According to research done in the country, Toyota was able to create more than 2000 direct jobs and 1500 jobs in subsidiary industries. Examples of other countries that have benefited from inward direct investments include China, Saudi Arabia and Japan among others (Jenkins and Thomas, 2002).
In order for inward FDI to bring benefits to developing countries, there is need for trust and corporation between the parties (Chetty and Campbell, 2003). Game theory argues that organisational decisions involving many actors often present itself as a strategic and sequential game. Co-operative behaviour is generated when actors in decision making interact on repeated basis (Chetty and Campbell, 2003). Repeated interactions ensure that people know each other more and trust is able to be built thereafter. When there are no repeated interactions or when the intention of one actor is unknown, the actors will behave competitively. According to the theory, actors are rational but often faced with information problem (Chetty and Campbell, 2003). However, they are ready to co-operate to create greater value and utility. From the theory, a multinational corporation is expected to form a trusting and transparent relationship with the host company and vice versa, sharing information through methods such as open book costing in order to enhance their commitment to business issues. Lack of trust may lead to failure of inward foreign direct investment (Chetty and Campbell, 2003).
However, although multinational companies through inward foreign direct investment bring about many benefits to developing countries, they are considered a curse to developing countries (UNCTAD, 2006). Multinational corporations have more severe negative impacts on developing economies. The common assumption among people is that multinational corporations provide additional resources in form of knowledge, technology and capital. However, multinational corporations through inward FDI bring about exploitation of resources (UNCTAD, 2006). There is always uncertainty about the intention of multinational corporations in developing economies. The main purpose of inward foreign direct investment by multinational companies is to make profit. Therefore, in the process of doing so, these companies may end up exploiting limited resources of the developing countries. Exploitation of resources by one part can be explained using common pool resource theory (Chetty and Campbell, 2003).
Common pool resource theory shows how different parties come together to manage common resources. The theory argues that common resources need to be managed effectively in order to prevent resource depletion (Chetty and Campbell, 2003). Each party involved in a project use resources for personal benefits and this may result to overuse of a country’s resources. The theory highlights that in order for the resources to be managed effectively; there is need for a local control. Because outsiders do not understand the condition of the host country and lack a close relationship with the community, it may be very difficult for them to effectively manage the resources (Chetty and Campbell, 2003). The common pool resource theory disagrees with Hardin’s theory that pool of resources need to be managed by the government or be privately controlled. The government may lack a close relationship with companies and society and may manage resources poorly. Therefore, in order to effectively manage resources of a country, insiders should be given a say and should be given an opportunity to control and manage the resources (Chetty and Campbell, 2003). Multinational corporations lack close relationship with host communities and therefore may manage resources poorly. This may lead to resource depletion of developing countries.
In this global economy, the integration of multinational corporations and host companies in the developing countries allow businesses to earn profits among other reimbursements (Nunnenkamp, 2002). However, inward foreign direct investment may lead to labour exploitation. Local workers may be subjected to poor working environment and may also receive low wages (Nunnenkamp, 2002). If multinational corporations lead to development of developing nations, why are people in these countries still receiving low wages and work under hazardous environments? MNCs are profit minded and thus tend to look for cheap labour and this may lead to exploit of labour rights (Krugman, 2008). Therefore, MNCs are exploitive as they promote hazardous environment for local employees in developing countries.
Developing countries with huge inward FDI are concerned and uneasy (Jenkins, 2002). Developing countries are concerned about the increase in foreign control as a result of increased number of multinational corporations in the third world countries. Multinational companies boost competition which enhances economic development and higher productivity in local companies (Jenkins, 2002). However, this competition may bring about adverse competition. Multinational companies operating in third world countries often have higher economic power compared to local counterparts. MNCs are able to generate funds elsewhere which work in their favour (Jenkins, 2002). This may drive the local companies out of business and dominate the market. In effect, many local employees will lose their work and this affects the entire economy of the countries.
Multinational companies have received little credit for the benefits they bring to the developing countries (Chetty and Campbell, 2003). For instance, since many multinational companies operate in the western countries such as the United States, Australia, United Kingdom and Canada, they are considered instruments that impose western culture on developing countries. As a result of this, some economists have argued that there is need for close regulation of these enterprises (Hunya, 2000). Several governments in developing countries have implemented hostile policies to limit the power of MNCs. However, according to invisible hand theory proposed by Adam Smith, there is no need for strict government regulation on companies. Industry operation with few restrictions may offer the greatest value. When companies pursue their own interests including making profits, they also promote the interests of the community (UNCTAD, 2006). According to the theory, the intention of the government to protect their people from exploitation of companies has little moral justification. Therefore, governments should not impose laws to protect the citizens from MNCs’ exploitation.
In conclusion, globalization has provided an opportunity for companies to do business with few restrictions. Many companies have taken advantage of globalization and have expanded their operations overseas. One major entry mode adapted by many multinational corporations is foreign investment. Foreign investments have brought about many benefits to developing countries. For instance, foreign direct investment has led to transfer of knowledge, capital and technology from developed countries to third world countries. Employees have acquired knowledge and skills from working for MNCs and may transfer the knowledge to local companies. In addition, MNCs have increased employment and income levels for local people. However, although developing countries benefit from multinational corporations, there are some challenges that come as a result of FDI and institution of MNCs in developing countries. MNCs have led to employee exploitation in terms of low wages and poor working conditions. In addition, MNCs have the ability to take local companies out of business due to intense competition and this may be disadvantageous to the developing economies. Generally, MNCs are predators and allies of developing countries. It brings about both positive and negative impacts on the developing countries.
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