Impact of Multinational Firms on the Economic Development - Essay Example

Topic 4: 'Do Multintionl firms hve positive impct on the economic development of developing ntions' Bsed on criticl exmintion the rguments for nd ginst, explin your position on the issue. Provide illustrtions to support your ides. Introduction The process of interntionliztion of locl orgniztions nd trnsformtion of orgniztions to multintionl firms hs different impcts on the economy of ntions. Prticulrly, flows of foreign direct investment (FDI) hve incresed rpidly during the pst decde nd impcted the economy of developing countries: in 2004, developing countries received 37.2 per cent of the globl flows of FDI tht equls to $147 billions (World Investment Report 2005). Furthermore, given the reltively smll economic size of these economies, even smll mount of foreign investment cn ccount for lrge percentge of their totl investment nd therefore generte significnt impct. The spred of multintionl firms ws often viewed with suspicion nd mistrust in such countries, prticulrly in those tht pursued strtegy of import substitution. In this pper I will tke look t both positive nd negtive effects of multintionl firms on the economies of developing ntions. I will rgue tht such compnies through their ctivity provide FDI in the economies tht re still under development nd spek bout pros nd cons of the globliztion in frmes of multintionl firms. The concept of linkges will be discussed in order to understnd the link between the multintionl firm nd the effect interntionliztion on the economies of developing ntions. Pros nd Cons of Multintionl firms Multiple mrket forces re behind the observed growth of multintionl firms: reduction in costs of communiction hs esed the constrints on globl rtionliztion of production nd the informtion technology revolution hs creted mrkets for mny new products nd services. Incresed world trde in services hs further contributed to globliztion of multintionl firms since services often require suppliers to hve physicl presence in mrket. However, chnges in the mrket environment do not cpture the whole story. Policy inititives hve plyed centrl role: mny countries hve gone further thn simply removing brriers to inwrd multintionl firms nd hve tken more pro-ctive pproch towrd ttrcting multintionl firms to enter the mrkets of developing countries through the use of fiscl nd finncil incentives. This new, more fvorble, policy environment in mny developing nd formerly communist countries contrsts shrply with historicl ttitudes towrd multintionl firms in these countries. The recent wve of liberliztion of trde nd FDI policies suggests tht the optimistic view of multintionl firms seems to be gining the upper hnd. One mnifesttion of this trend of liberliztion is the prolifertion of bilterl investment treties cross countries: there now exist 1,513 bilterl investment treties mong countries, compred with fewer thn 400 t the beginning of 1990 (UNCTD 1998). Of course, the filure of import substitution s strtegy for development is crucil reson behind this remrkble turnround in policies in mny developing countries. Within the more optimistic view of effects of multintionl firms to the economy of developing ntions is tht it pushes forwrd the process of industril development by creting linkges with the rest of the economy Fundmentl concepts In clssic work, Hirschmn (1958) developed the concepts of bckwrd nd forwrd linkges nd nlyzed their importnce for economic growth. In his own words: The setting up of n industry brings with it the vilbility of new expnding mrket for its inputs whether or not these inputs re supplied initilly from brod. This enhnced mrket exerts bckwrd pressure for estblishing industries tht supply the new entrnts. He clls this process bckwrd linkge effects: Every non-primry ctivity will induce ttempts to supply through domestic production the inputs needed in tht ctivity. Similrly, forwrd linkge effects re creted when one industry uses nother industry's outputs s its inputs: Every ctivity tht does not by its nture cter exclusively to finl demnds will induce ttempts to utilize its outputs s inputs in some industries. nother importnt point tht emphsizes the importnce of firms going brod ws mde by Hirschmn. He rgued tht multiple industries re likely to hve greter linkge effect when tken together, compred to simply dding up the individul effects. The presence of two or more industries my crete enough demnd to surpss the threshold required for estblishing new industries, wheres the presence of only one of them would not. Tking ll of these industries together my provide enough incentive to crete yet others. This cumultive effect my explin much of the ccelertion of industril growth seen erly on in the development process. Hirschmn rgued tht prt of the difficulty for developing economies is lck of multintionl firms competing with ech other. Consequently, the development process must commence with industries tht cter to finl demnd. This requirement leves two possibilities: trnsformtion of either primry goods or semi-mnufctures into finl products. Since the ltter my provide stronger possibilities for linkges, Hirschmn suggests tht governments in such countries should ssist industries involved in intermedite ctivities since these hve strong potentil for creting both bckwrd nd forwrd linkges. The entry of firms, especilly lrge multintionl firms in developing countries, my expnd the totl output of n industry through incresed scle, enhnced competition, technology diffusion to locl rivls, or generl trining of workers. This expnsion in output of n industry my ply crucil role in bringing the scle of existing industries up to levels sufficient to generte bckwrd nd forwrd linkges needed for industril development. s we shll see next, the theoreticl economics literture on multintionls hs indeed dvnced this rgument. Multintionls nd linkges: theory The recent surge in the literture on industry linkges nd interntionl trde provides severl concrete models of concepts originting in the development literture. In recent pper, Rodrguez-Clre (1996) tkes up Hirschmn's concept of linkges nd develops forml model to nlyze the effects of multintionls on economic development. He relies on three premises to develop model of the linkge concept. First, greter vriety of inputs leds to higher production efficiency, s cptured by ssuming love of vriety for inputs in the production of finl goods ( weker form of Hirschmn's ssumption tht certin inputs were necessry for production). Second, mrket size limits the vilble vriety of specilized inputs due to inputs being produced with incresing returns to scle (relted to Hirschmn's specifiction of minimum economic size). Third, proximity of supplier nd user is required, since domestic firms must buy ll of their inputs loclly (to ensure tht domesticlly produced inputs re essentil to developing n industry in finl goods). Under such circumstnces, n economy will exhibit multiple equilibri: good equilibrium with high wges (which coincides with the production of complex finl goods nd wide vriety of inputs) nd bd equilibrium with low wges (which coincides with the production of simple finl goods nd smll vriety of inputs). If the number of vrieties of the intermedite good exceeds threshold, then country specilizes in producing the more complex good. Since profits re zero due to the ssumption of free entry, the higher wges in the good equilibrium imply tht it Preto domintes the bd equilibrium. To give multintionls role in the process of industril development, Rodrguez-Clre supposes tht two economies exist with one in the bd equilibrium ( developing country) nd the other in the good equilibrium ( developed country). (Krugmn, Venbles, 2006) Under this scenrio, firms in the high-wge economy my wish to tke dvntge of the chep lbor overses by estblishing plnt in the host country, while mintining hedqurters t home to enjoy ccess to the wide vriety of specilized inputs vilble there. (Krugmn, Venbles, 2005) The crucil ssumption is tht specilized inputs cnnot be exchnged interntionlly through rm's-length trnsctions nd thus cnnot be used by firm unless it opertes in the country where the inputs re produced. Consequently, only multintionls cn combine the wide vriety of specilized inputs from the developed country with the chep lbor from the developing country. (Krugmn, Venbles, 2006) Positive linkges re most likely to result when the good tht multintionls produce is more complex, the communiction costs between the hedqurters nd the fctory re higher, nd the source nd host countries re more similr in terms of the vriety of intermedites produced. The cost of communiction is modeled s n iceberg-type trnsporttion cost: frction of the composite input (produced from specilized source inputs) melts en route from the source hedqurters to the host fctory. n increse in the cost of communiction between the fctory nd hedqurters cuses firm to purchse more goods loclly, nd hence rises its linkge coefficient. In ddition, since the multintionl is only ble to purchse more inputs loclly if they re produced, the linkge coefficient is incresing in the vriety of intermedite goods produced in the host economy. Since firms using greter vriety of inputs tend to estblish plnts in countries with smller vriety of intermedites, n impliction of this nlysis is tht developing countries my not enjoy substntil linkges becuse multintionl firms import their inputs from the source country. In nother interesting pper, Mrkusen nd Venbles (1999) construct model with linkges to ddress the potentil for cumultive custion in industril development - the bility of the formtion of n upstrem industry to generte the lter formtion of downstrem industry. The entry of multintionls ffects the host economy in two potentilly opposing directions. On one hnd, multintionls replce domestic firms through competition effect: the entry of multintionls lowers the price index for the finl good, which cuses the exit of domestic producers of finl goods to restore equilibrium. On the other hnd, multintionls my crete conditions beneficil to locl industries through linkge effect: the entry of multintionls my rise the demnd for intermedites, which cuses the domestic production of intermedite goods to expnd. 10 n importnt vrible for ssessing the linkge effect is the input-output coefficient, which mesures the rtio of the intermedite required reltive to the per unit totl input requirement of the downstrem industry. Whether this rtio for the multintionl firms exceeds the rtio for the domestic firms influences whether the linkge effect is positive. The two rtios my differ due to differences in technology (the multintionl firms my use more intermedites reltive to primry fctors thn do domestic firms) or differences in sourcing (multintionls my source from brod). If this rtio is greter for multintionl firms thn for domestic firms, then the multintionl uses locl intermedite goods more intensively thn the domestic industry. Thus, this rtio is the nlogue to Rodrguez-Clre's employment-bsed mesurement. Mtouschek nd Venbles (1999) tke deeper look t the interction between competition effects nd bckwrd linkges creted by the entry of multintionl firm into the locl mrket. They nlyze the effects of investments in the downstrem nd then the upstrem industry. They brek the overll effect of multintionl entry into two prts: n initil production effect nd feedbck effect. The initil production effect is the immedite chnge in locl production: the multintionl production lters the output levels of domestic firms (through crowding out) in tht industry s well s in upstrem production. The number of downstrem firms djusts to restore zero profits, but the number of upstrem firms is held constnt in determining this piece of the overll effect. Next, the feedbck effect occurs once chnges in the upstrem industry impct the downstrem sector through chnges in the price of upstrem vrieties (which re felt s cost chnges to those downstrem). Here, entry nd exit of upstrem firms ffect both the vriety of intermedites vilble s well s the intensity of competition. Conclusions In this pper, we hve provided selective survey of the theoreticl nd empiricl literture on the effects if multintionl firms on the economy of developing ntions. It cn be therefore concluded, tht there re positive nd negtive effects of firm going to the mrket of developing countries. Incresed competition, technology trnsfer, incresed ccess to world mrkets due to spillovers to locl firms, nd worker trining re some of the positive effects for the economy becuse FDI mde by the multintionl firm cn benefit the host economy, nd such benefits cn be relized despite the bsence of linkges. Hence, policy formultion should be bsed on more holistic view of FDI. Hostility towrd multintionls ws bsed on the perception tht the entry of such firms ws detrimentl to domestic industriliztion. The infnt industry rgument, or some derivtion of it, often served s n intellectul justifiction for such policies. Bibliogrphy: 1. itken, B., Hrrison, . nd Lipsey, R. (2001) 'Wges nd foreign ownership: comprtive study of Mexico, Venezuel, nd the United Sttes', Journl of Interntionl Economics, 40: 345-71. 2. Bldwin, R. (2005) 'gglomertion nd endogenous cpitl', Europen Economic Review, 43: 253-80. 3. Hddd, M. nd Hrrison, . (2003) 're there positive spillovers from direct foreign investment Evidence from pnel dt for Morocco', Journl of Development Economics, 42: 51-74. 4. Hirschmn, . (1958) The Strtegy of Economic Development. New Hven: Yle University Press. 5. Krugmn, P. nd Venbles, . (2005) 'Globliztion nd the inequlity of ntions', Qurterly Journl of Economics, 110: 857-80. 6. Krugmn, P. nd Venbles, . (2006) 'Integrtion, speciliztion, nd djustment', Europen Economic Review, 40: 959-67. 7. Mrkusen, J. nd Venbles, . (1999) 'Foreign direct investment s ctlyst for industril development', Europen Economic Review, 43: 335-56. 8. Pug, D. nd Venbles, . (2004) 'The spred of industry: sptil gglomertion in economic development', Journl of the Jpnese nd Interntionl Economies, 10: 440-64. 9. Rodrguez-Clre, . (2002) 'Multintionls, linkges, nd economic development', mericn Economic Review, 86: 852-73. 10. UNCTD (1998) World Investment Report: Trends nd Determinnts. New York: United Ntions. Read More