Foreign Direct Investment and Economic Growth in Host Countries - Example

Foreign direct investment and economic growth in host countries (Name) (Institution) (Module) (Course) (Tutor’s Name) 31st March 2010 Word count: 2120 Outline Introduction: Gives brief background information on foreign direct investment and the role multinational play in movement of capital across borders. Employment: This section shows how multinationals contribute towards employment in host countries as a fundamental factor in economic growth and development. Technology transfer: this section explains how technological know-how from home countries introduced in host countries filters into other industries thereby increasing efficiency across the board Source of revenue: Through taxation, corporations act as sources of revenue to host governments. However, this part also explains that tax holidays are best ways to attract FDI for poor countries. Trade opportunities: Where multinationals export goods and services as is common, host countries have a host of improving their foreign trade balance. Domestic investment: explains how multinationals encourage domestic investment where the firms are listed in local stock exchange markets. Conclusion: Wraps up the discussed issues in the paper and concludes the paper. Introduction Multinationals are responsible for foreign direct investment for major economic powerhouses globally. Corporations such as Coca Cola, Nike, Mobil, Toyota, Wal-Mart etc have an international presence spreading from the developed to the developing/underdeveloped world. Given that majority of the homes countries are developed, competition is usually high thus forcing these companies to explore foreign markets which more often than not are unexplored. Home governments have been known to offer subsidies and information to their corporations to explore other markets (Kehl 2009). The department of foreign trade and the foreign affairs offers up-to-date information to their corporations seeking to explore foreign markets. The United Nations Conference on Trade and Development (UNCTAD) publishes annual reports on national FDI changes. Between 1991 and 2002, UNCTAD noted that there were over 1,500 favourable changes on policies by various countries to encourage inward FDI as compared to only 100 that were deemed unfavourable (Lipsey & Sjoholm 2007). Therefore, majority of the countries are keen on encouraging inward FDI. So what are the benefits of inward FDI? The UN states that FDI from the developed to the developing and underdeveloped countries is one of the sure ways of reducing poverty in such countries while Moran, Graham and Blomstrom (2005) claim that FDI to the third world countries is more effective than financial and economic aid in alleviating poverty in such countries. As of 2000, the top fifty largest multinationals held $1.8 trillion in foreign capital and $2.1 trillion in sales (Kehl 2009). These multinationals afford economic benefits to the host countries through provision of employment, capital, revenue, trade, and technology transfer. Employment As new entrants in the market, multinationals offer employment opportunities to the host countries. However, given that most multinationals employ superior technology, expatriates have to be brought in1. As such, the locals do not get to enjoy the senior positions but tend to occupy the low level positions. Nonetheless, foreign owned corporations have a tendency to offer higher wages than other employers in the host country (OECD 2010; Lipsey & Sjoholm 2007). Multinationals may furthermore offer above-market wages in order to cut down employee turnover and prevent competitive advantage in technology spilling over to competitors. Kehl (2009) notes that worker turnout is one potential way through which technology from the multinationals spills over to the rest of the host country. An investigation by the OECD revealed that foreign ownership of automobile manufacturing units in Brazil had a positive effect on the domestic wage market ranging from 1-4%. The same situation is reported by Moran et al (2005) who say that foreign based automobile industries operating in Mexico have grown from a small base into a $7 billion dollar industry as of 2000 employing over 354 000 locals. Local people employed by the multinationals enjoy better working condition than their counterparts in the indigenous corporations where the FDI inflow is towards third world countries. These benefits and knowledge of standards working conditions soon find their way into the rest of the country thereby benefiting the workers and creating a possible increment in output as a result of better working conditions. According to the OECD (2008) report, In addition to having direct effects on workers employed by multinationals, FDI may also have indirect effects on workers’ employment conditions in domestic firms when there are knowledge spillovers associated with FDI. The effect on workers in domestic firms, however, is considerably weaker than the direct effect on employees of foreign affiliates of multinationals (p.5). The impact of inbound FDI on workers of developed countries has not been assessed yet. Nevertheless, the impact is not applicable to all workers but to different segments of the labor market (OECD 2010). Technology transfer Lipsey and Sjoholm (2007) say that multinationals are involved in technology transfer as they seek to attain efficiency and beat competition in their new markets hence they employ technology superior to the incumbent one in the host country. Efficiency leads to higher quality goods and services or increased production of the goods (Kehl 2009). Moran et al (2005) say that as observed by an instrument executive, majority of the US based telecommunication corporations operating in Malaysia are better equipped than those in the US. This in the long run improves welfare for the people and also increases competition hence a fall in prices (Lipsey & Sjoholm 2007). In the long run also, the technology spills over to the rest of the industry thereby spurring growth. The spillover of technology is also achieved through collaboration of the foreign based operators with the indigenous operators preferably in a different or same industry. The foreign based operators, in a bid to ensure quality of their products and services, engage the local suppliers in quality training and also ensure that they can produce at the same level as them. Moran et al (2005) note the case of electronics multinationals operating in Malaysia which have engaged local suppliers in countless programs to enhance quality and increase economies of scale for the supplies. This is in realization of the fact that it is more economical to have a large supplier than many of them supplying the products or services. QDOS Microcircuits of Malaysia started off as a supplier to Motorola and benefited from technology empowerment from the giant American based telecommunication company. This positioned QDOS Microcircuits to win similar contracts with other telecommunications companies such as Siemens and Hewlett-Packard in Penang. QDOS Microcircuits have been able to achieve business as a result of the presence and interaction with a multinational in the name of Motorola. Such examples exist in many countries where the presence of foreign multinationals has encouraged and influenced other industries and even competitors to grow2. However, host government polices may deter such technology spillover. Moran et al (2005) note that the Vietnamese government required that automobile plants established in the country by Japanese based automakers, Daewoo and Mitsubishi to use manual labour in order to provide employment to the locals in large numbers as opposed to the highly automated factories in the home country. On the other hand, the government sought to influence the local industry by setting a law that required that the automakers used a certain percentage of the components from the local market. Another example involves China which in the 1990’s required that foreign based corporations wishing to operate in the country needed to shed a certain percentage of their ownership to the local investors. Such requirements by host countries, though aimed to promote FDI limit it (UNCTAD). Technology transfer is also limited by host country policies which tend to price technology transfer more in order to protect host country’s competitiveness on the global platform (Feldstein, Hines & Hubbard 1995). Consequently, multinational are forced to employ lower technology in their foreign subsidiaries especially when they are not fully owned by the parents company. Moran et al (2005) note that a company such as IBM which had partially owned subsidiaries in Mexico in the 1990’s employed manufacturing technology that was on average late by ten years. However, on full acquisition of the subsidiary, the company updated its technology in the Mexican factories to match that of the US. It would seem that the host countries are keen on limiting the benefits available to host countries as a result of FDI. Source of revenue Multinationals contribute immensely to the GDP of the host countries in various ways corporate taxation being the chief revenue earner in majority of the cases (Kehl 2009). In host countries that have many levels of government, the benefits are higher as each level of government such as the federal and the local authority impose different levels of taxes. While the global economic equality forces encourage flow of FDI from the developed to the developing and underdeveloped countries, the situation is different. As of 2000, 86% of global FDI capital outlay was generated by the developed world notably the OECD while 65% of the total FDI was directed to the developed countries. On a positive note however, FDI flow to the third world is increasing as shown by an increase from 28% to 33% between 1999 and 2000 (Goodspeed 2006). This increase in attributable to increased interest in exploring mineral resources specifically in Africa and also the need for multinationals to set base in Asian countries which have relatively higher technology levels as compared to Africa but have cheap skilled labour (Kehl 2009). Taxation is a sensitive issue in international trade and foreign direct investment that might affect bilateral trade relations between home and host countries. As such, governments willing to rely on FDI to power their economies offer tax incentives to multinationals so as they can set base in other countries3. This is most common in third world countries which offer tax holidays to multinationals they cannot compete with subsidies and subsidized loans offered by developed countries (Goodspeed 2006). However, the same author (Goodspeed 2006) warns that taxation incentives is not the only consideration by multinationals in investing in foreign market but says that corruption, political climate and the rule of law also determine greatly where multinationals invest in (Habib & Zurawicki 2002). Goodspeed (2006) notes that while third world countries might offer better tax incentives, poor governance and corruption deny them opportunities to host multinational companies. On the other hand, parent countries are keen on protecting their revenue collection from multinationals in form of taxes when they invest in foreign markets (Feldstein et al 1995). Neumayer (2008) notes that developed countries such as the US deny beneficiaries of FDI revenue in form of taxes through double taxation treaties (DTTs). He says these treaties bind host countries to exempt certain corporations from taxation but to allow the home country to carry out the taxation. The US is notorious for such practices but in return offers more FDI to such countries (Neumayer 2008). This implies that some economic benefits meant for the host countries are not achieved though this is covered for through increased FDI as reported by Neumayer (2008) when other benefits such as increased employment and technology transfer are attained. Trade opportunities FDI recipients are bound to increase their presence in the global market place as a result of increased exports by multinationals. Kehl (2009) observes that majority of multinationals set up new factories in host countries with the major aim not being to serve the local market but regional and international markets. She cites the GM units operating in Brazil, Kenya and Nigeria. She says that the Nigerian units serves the West Africa regional market, Kenya serves the east and central Africa market while the Brazilian one serves the South American market. As such, the host countries become well involved in exporting rather than importing. This is proves to be an important point for poor countries such as Kenya which happen to be net importers. As such, the presence of multinational corporations serving the wider foreign market offers them an opportunity to balance their foreign trade deficit and hence a plus point for the domestic currency. Domestic investment Multinationals can also encourage domestic investment through public listing of their shares in the respective domestic stock exchange markets where earnings by investors are subject to taxation4. This way, the local investors are offered an opportunity to invest and be part of international corporations. However, as discussed earlier, many developed countries are opposed to partnerships with local host country investors due to taxation and competition issues (Egger et al 2004). When such corporations are listed in the respective host stock exchange markets, they are exempted from tax holidays and other incentives enjoyed by fully foreign corporations (Feldstein et al 1995). Conclusion International trade is the basis of FDI and expansion into foreign markets by major companies. Countries that have a majority stake in international trade also enjoy higher FDI inflow and also higher FDI outflow. Nonetheless, high FDI outflow does not imply loss of capital to foreign countries as appropriate measures such as DTTS are placed to ensure that the home countries also benefit from the expansion of such multinationals and also tax evasion in the sense that some countries have lower taxes that may encourage some companies to shift base into such countries. Multination companies have multiple ways of enhancing economic growth of their host countries. Unfortunately, protectionist policies by home governments place the host countries as a poorer state. In fact, many FDI are accused of fleecing poor countries when it comes to minerals and other natural resources as profits are ploughed back into homes based parent companies. As a result, despite the high capital flow from developed into third world countries in form of FDI, these recipient countries remain economically deprived with a minor role in international trade. References Egger, P, Loretz, S, Pfaffermayr, M & Winner, J 2004, ‘Corporate taxation and multinational activity.’ Oxford University centre for business taxation working paper 09/04, Viewed on 31st March 2010, http://ideas.repec.org/s/btx/wpaper.html Feldstein, M Hines, J & Hubbard, R 1995, The effects of taxation on multinational corporations University of Chicago Press, Chicago Goodpseed, T 2006, Taxation and FDI in developed and developing Countries in Alm, J Marines-Vazquez & Rider, M (edts) The challenges of tax reform in a global economy, Birkhäuser, Geneva Habib, M & Zurawicki, L 2002, ‘Corruption and Foreign Direct Investment,’ Journal of international business studies Vol. 33 No.2, pp.291-308. Javorcik, BS 2004, ‘Does Foreign Direct Investment Increase the Productivity of Domestic Firms? In Search of Spillovers through Backward Linkages.’ The American Economic Review, Vol. 94, No. 3 pp. 605-627 Kehl, R 2009, Foreign Investment and Domestic Development: Multinationals and the State, Viewed 31st March 2010 http://www.rienner.com/uploads/493d4da7bbeab.pdf Lipsey R & Sjoholm, F 2007, The impact of inward FDI on host countries: why such different answers? In Liebsher, P (edt) Foreign direct investment in Europe: a changing landscape, Edward Elgar Publishing, New York Moran, T. Graham, E. Blomstrom, M. (2005). Does foreign direct investment promote development? Peterson Institute, New York Neumayer, E 2008, Do double taxation treaties increase foreign direct investment to developing countries? Journal of Development Studies, Vol. 43, No 8, pp. 1501- 1519 OECD 2008, The Social Impact of Foreign Direct Investment. Viewed 31st March 2010 http://www.oecd.org/dataoecd/53/8/40940418.pdf The Challenges of Tax Reform in a Global Economy, Viewed 31st March 2010, http://aysps.gsu.edu/isp/files/ISP_CONFERENCES_TAX_REFORM_GOODSPEED_PAPER.pdf UNCTAD Tax Incentives and Foreign Direct Investment: A Global Survey, Viewed 31st March 2010 http://www.unctad.org/en/docs/iteipcmisc3_en.pdf Read More