The Effects of Multinational Companies on a Country's Economy - Essay Example

Transnational firms: analyzing the implications for development Multinational companies are increasingly becoming one of the most important parts of global trade and investment interactions1. Such significant presence of multinational corporations in the gradually integrating world economy has been an issue of controversy particularly in relation to the operations in the developing world (Novartis, 2000). The objective of the present endeavor is to present the implications such multinational companies have for the development of associated economies. To perceive what actually is implied by the existence and operations of multinationals for development, it is first necessary to grasp the true essence of their motivations. So, first we discuss the reasons for the existence of multinational firms and thereon attempt to interpret the implications of such motivations for the process of development. Since it is the effects on economic development that is the prime concern of the present essay, the effects of multinationals on the developing economies will be accorded higher analytical priority. Some empirical findings are reviewed and embedded into relevant parts of the discussion to illustrate the validity of the presented ideas before finally concluding with a short summary of what the present analysis has been able to derive. To understand the nature of motivations for the existence and operations of multinational firms it is essential to note that multinational presences are actually direct foreign investments on the part of the firm. The process of creating or expanding a subsidiary is basically a form of an international capital outflow. However, what sets this direct form of foreign investment apart is the fact that along with the usual transfer of resources, it also is associated with acquiring and sustaining control2. Though foreign subsidiaries are often provided with capital with the expectation of a repatriation of the profits, acting as modes of international lending and borrowing is not the primary objective of establishing multinational presences for business concerns. Transcending geographical and strong cultural boundaries do have negative efficiency impacts implying the alternative forms of foreign investments to be better options if earning profits from forwarded capital was the sole objective of multinational firms. Further, simply the existence of a transnational is not always associated with a net capital flow from any given nation another. Transnational corporations have often been found in the process of raising capital for investing in subsidiaries from the very nation where the subsidiary is located (Krugman & Obtsfeld, 1988). So, it must be the stronger motive of obtaining and expanding control that inspires firms to go international. It then becomes necessary to perceive why firms aspire to expand control. Three primary aspects of transnational enterprises have been identified as the central advantages that act in motivating certain firms to crossover to other nations by Ethier (1988). First, there is an advantage associated with ‘owner ship’. The second aspect is a derivative of the theory of locations. It is posited that certain geographical locations offers different efficiency generating scale and scope benefits and more importantly, resource advantages. This can be understood by considering the fact that while locating aluminum mining near bauxite sources shall be associated with cost advantages, smelting of aluminum will be cost efficient near cheap electricity sources (Krugman & Obtsfeld, 1988). For a firm which performs both, establishing subsidiaries in both locations can thus be explained. The third aspect is referred to as the advantage of internalization. Internalization refers to the integration of activities in separate economies under a single firm. There are primarily two views regarding what generates the advantages that make internalization lucrative enough to justify the existence of multinational firms. The first view recognizes the significant advantages resulting from internalization caused by technology transfers3. The other view identifies internalization advantages accruing to the opportunity of vertical integration4. The significance of identifying the motivations for firms to expand across national borders through subsidiaries lies in the emergence of what exactly capital, migrating abroad to subsidiaries seeks to attain as it is these which determine the impacts on the process of development. Given this enhanced understanding of the aspirations, the implications of transnational operations for the development of economies can therefore be addressed. Given that poverty and unemployment are two of the major concerns of the developing world, the impacts direct foreign investment has on the labor market of the host nation deserve primary importance. Extending productive activities at the outset directly implies an increase in the employment for the host country. More importantly, since developing countries are predominantly characterized by relative labor abundance, inflowing capital is likely to increase the productivity, particularly, if the inflow is associated with a transfer of advanced technology from the parent concern. Such productivity rises are likely to raise the wages for the workers employed in the subsidiary (Lipsey, 2002). Evidence of higher wages paid by foreign firms compared to local ones have been presented in a wide body of literature that covers developing countries like Venezuela, Morocco, Indonesia, Côte d’Ivoire5. However, such higher wages can be significantly beneficial for the development of the economy if they lead to wage hikes in the local industries as well. Moreover, of the evidence produced, a large part may be explained by the skill differential in the employment basket of foreign and local firms. While, admittedly the higher wages paid by foreign employers are beneficial for those domestic workers who are employed, these may have significantly adverse effects on the already high economic inequality persistent in less developed and developing economies. Further, it has been argued that the foreign firms introduce advanced technologies and resultantly generate higher demand for skilled workers and this leads to an increased wage gap between skilled and unskilled workers thereby supplementing the persistence of inequality if not strengthening it (Berman et al, 1994 cited in Lipsey, 2002; Machin et al, 1996 cited in Lipsey, 2002). So, with increasing number of multinational presences, a developing economy can be expected to exhibit a wage structure that gradually moves in favor of skilled workers at the cost of their lesser skilled counterparts. The result depends upon the relative capital intensity of the adopted technology. If labor intensive technologies can be introduced that raise productivity, poor and less educated low skilled workers can secure jobs. Generating this type of employment is more relevant to developing countries as the bulk of the workers who constitute the labor market are low on skill, thereby stuck in a perpetuating trap of low skill implying low wages leading to inability to acquire costly skills and thereby remaining low skilled and poor. A result that has important bearing for the labor market is that multinational corporations have been empirically found to have positive wage spillover effects in that average wages have been found to rise due to the increase in the presence and activities of foreign firms. However, this rise in average may simply be a result of the introduction of the considerably higher wages in foreign firms, or they may be caused by the rise in demand for labor caused by increased production resulting from the entry of foreign firms (Lipsey, 2002). Multinational firms can beneficially influence the development process undoubtedly if there are significantly positive efficiency spillover effects that generate greater overall productivity. Local firms may raise efficiencies through imitation, or to survive in the face of foreign competition thereby leading to positive impacts upon the economy. Questions may arise regarding the definitive tone of the previous statement particularly citing the possible adverse impact of increased productivity on the terms of trade. The basic reason that the terms of trade effect have not been mentioned is that the productivity spillover is likely to be in the line of production that the country does not export. The foreign firm is likely to be producing an import competing product given the less developed state of the host nation. So, such an increase in productivity, if it occurs is likely to turn the terms of in favor of the host nation which in turn is likely to complement the direct positive effect of increased productivity (Krugman & Obtsfeld, 1988). In case of failure on the part of the local firms to enhance productivity through efficiency enhancements however, will lead to adversities for the local firms creating a possibility of them being competed out of the market. So the significance of technology transfer motivation as well as the factor intensity of the technology emerges strongly in this particular implication. Such possibilities of being out competed do evince the severity the presence of multinationals has for local firms. However, the extent of globalization pressures and the presence of competitive assets determine the spectrum of opportunities the local firms have. While in the presence of strong pressures of globalization given a lack of competitive assets retreating to a “locally oriented link in the value chain” (Dawar & Frost, 1999) remains as the viable option, if globalization pressures are relatively weaker and the local firm is better endowed with competitive assets, then considerable opportunities of profitable expansion into other markets with similar character exist (Dawar & Frost, 1999). Empirically, findings have been mixed in that while some studies report negative technological spillover effect on productivity and others report existing relations in specific cases only and find results being insufficiently conclusive to generalize, some studies do find positive correlations6. Apart from the labor market and productivity, another important implication of multinationals is on the environment of the host nation. Given the already introduced motivation of advantageous location, it can be assumed that foreign firms will prioritize the utilization and exploitation of the resources that have motivated its presence. In case of the motivation being natural resources, the impacts can be severe. With profits being the primary motive of its existence, ensuring sustainability of the local environmental resources are not likely to be accorded any importance and is essentially purpose defeating in a sense. Further, with the pollution control standards being relatively lower in developing nations like India, adopting cheaper and environment damaging production technologies in foreign firms may be motivated which hinders the potentiality of attaining sustainable development based growth paths for the host (Shah, 2007). So, what emerges is that direct foreign investments have a variety of associated implications particularly for the labor market, productivity, local firms, resources and environment, arguably the factors that play the most significant roles in shaping the growth path and development trajectory of an economy. For the over all economy, multinational products, services and most importantly investments can have positive supplementary effects in defining the course of development through the translation and application of advanced knowledge in areas like industry, agriculture and health, bridging the knowledge gap particularly in areas of technology and management, providing intensive skill enhancing training, though the extent to which these will be beneficial depends upon some particular structural, legal and financial specifics of the host nation (Novartis, 2000). The domain of operation, range of products, production structure etc of any multinational determines the nature and alignment of its interests in respect to the developmental goals of the host. If these are in conflict, chances are, development in the host will be adversely affected (Novartis, 2000). To conclude, we summarize the essence of the discussion. It was found that multinational corporations through their structure, factor intensity of technology, location, resource extraction patterns etc have crucial impacts on the major aspects of developing economies. While multinationals offer higher wages to workers, which significantly causes average wage to rise, they exhibit a higher predilection for higher skilled workers which contributes to compounding the pervasiveness of inequalities particular to developing nations. The exact effects of superior technology spillovers, in whether they exist, and if they do then the recognition of their impacts on productivity theoretically as well a empirically offer mixed results. In case of beneficial technological spillover effects it is the domestic participants of the relevant industry who gain the most, and ironically are the set of agents standing to lose most in case of negative spillover effects. The potential for efficiency gains remain open though, the possible excessive exploitation of natural resources leads to apprehensions regarding the relation with sustainability. Thus it emerges the effects on the net are ambiguous. There are tremendous potential opportunities if a cooperative association can be facilitated though possible conflicting interests can be severely damaging for the development prospects of the host. However, the necessity to establish some sort of control, along with lubrication of financial markets, communications and legal infrastructural development does appear to be imperative thereby implying the requirement of an economy attaining some extent of economic maturity before the development enhancing possibilities can be realized. So the prescription should be to protect the economy against direct foreign investments until the basic legal, and structural administrative machinery is in place to prevent the multinational from abusing its overwhelming financial strength to enter unethical practices to secure further advantages. References: Dawar, N. & Frost, T. (1999). Competing with giants. Harvard Business Review http://harvardbusinessonline.hbsp.harvard.edu/b02/en/common/item_detail.jhtml;jsessionid=3RBNF2CW1XQYOAKRGWDSELQBKE0YIISW?id=99203 Ethier, W.J., (1988) The Multinational firm, Quarterly Journal of Economics, 101: 805-834 Krugman, P.R. and Obstfeld, M. (1988) International economics: Theory and policy, Addison-Wesley Lipsey. R.E., (2002) Home and Host country effects of FDI, NBER Working Paper 9293 http://www.nber.org/papers/w9293 Novarist (2000) The effect of multinational companies on development [online]. Available at: http://www.urbana.org/_articles.cfm?Recordld=314%20 Shah, A. (2007). Corporations. 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