Resource-Based FDI and Weak Host Government - Term Paper Example

Resource-Based FDI and Weak Host Government: The Curse of Underdevelopment Introduction Studies of the connection between economic growth and foreign investment have thus far been inadequate; rising foreign direct investment (FDI) does not automatically lead to economic development. Numerous studies have discovered that the nature of the connection between economic development and FDI depends on various aspects that differ from one host country to the other. To a certain extent, inconsistency in the effect of FDI is attributed to the fact that FDI can have both advantages and disadvantages to the host country. FDI can add to local reserves of investment resources, resulting in higher local tax returns and rate of employment. It can also have various favorable spillovers, like enhancing innovation and efficiency in local businesses, handing over new management and production and technological methods to the local industry, and providing higher-paying jobs for the local population. Yet, FDI could also have disadvantages to developing countries, especially if it is resource-based and the host country has weak government regulation. This paper argues that resourced-based FDI hinders the development of developing countries, especially if accompanied with weak host government. The first section provides a quick overview of the chosen topic or a summary of the disadvantages of MNCs to developing host countries that are later on thoroughly discussed in the paper. The second section generally analyzes the negative impact of resource-based FDI on developing countries; this part is divided into three subtopics: (1) conflict between extractive MNCs and developing host country; (2) dependency theory; and (3) adverse political, economic, and environmental impact of MNCs on developing host countries. The last section briefly explores how weak host government contributes to the adverse impact of FDI on developing countries. The academic sources or references used in this paper are peer-reviewed journals and scholarly books. Overview of the Problem Some scholars have reported about the negative impact of resource-based FDI on the economic growth of developing countries. Local investment could be saturated and local entrepreneurship and competition could be inhibited. Resource-based FDI could heighten income disparity as established industries weaken, and employees from these industries may experience difficulties entering new ones. Resource-based FDI may push the developing country to depend on exploitation of indigenous resources of benefit to foreign investors rather than building other productive economic zones (Gould et al. 145). In several instances, the operations of these multinational companies have had an adverse effect on environmental protection. The operations of MNCs in developing countries can have a considerable effect on human rights promotion and protection. Serious cases of human rights violation by foreign investors doing business in developing countries are known far and wide. International human rights law enforces duties on states to safeguard and promote the human rights of people under their jurisdiction and to create solutions for such violations. States have a duty to control effectively the activities of MNCs under their jurisdiction to make sure that they do not commit human rights violations. A small number of human rights treaties enforce direct obligations on non-state entities like multinationals. The specific combination of advantages and disadvantages of FDI for each developing country will rely on a set of local aspects, such as the characteristics and capabilities of its human capital, the strength of its human rights, labor, and environmental policies, its regulatory capability and its capacity to adopt technology. In addition, although it is evident that FDI has the ability to contribute to growth in developing countries, favorable development effects are not certain because the operations of MNCs or foreign investors are focused on profit maximization and not the boosting of economic growth (Chaudhuri & Mukhopadhyay 92). In the 21st century, MNCs have become the core entities of developing countries. These governments must be focused on industrial production, food security, and other goods and services that the local population requires. These necessities urge developing countries to receive foreign investment to meet these needs and demands. Many believe that globalization contributes much to the growth of developing economies due to the activities of these foreign investors (International Monetary Fund Staff 52). However, foreign investment is not the source of development of developing countries. The activities of MNCs, especially if they are extractive in nature, have more severe adverse effects on the economy, human health, and labor rights of the developing nations. The widespread belief is that the presence of foreign investors in developing economies creates jobs for the local population. In a globalized world, the entrance of these MNCs enables individuals to make higher earnings, without depending on others. Yet, these people tend to overlook the exploitation or oppression of labor rights, where workers get low wages, are dispossessed of labor rights, and forced to work in unsafe environment. For example, women in the labor force get a meager 10 percent of the overall wages given worldwide (De Schutter et al. 64-66). These resource-based MNCs are focused on the maximization of profit and they look for inexpensive labor, abusing the rights of workers in developing nations, particularly of women’s by granting them lower wages and exploiting their rights. Hence, existence of MNCs is encouraging the presence of an oppressive and indifferent environment for workers in developing countries. Ultimately, it is argued that presence of MNCs alleviates poverty in developing countries. Almost all countries are engaged in free trade, and they trade goods and services with one another. While trade barriers are weakened, the wealthy countries flood poor countries with cheap, substandard goods and the MNCs work as facilitators of this process (Wheeler 230). On the contrary, the dynamics of globalization has taken advantage of producers in developing nations, and has brought about serious problems in living conditions. As MNCs have surfaced in developing nations, domestic producers have to contend with these major companies, negatively affecting the domestic economy (Saadi 394). Most importantly, these foreign investors also exploit the natural resources of these poor countries like human resources and infrastructure. Therefore, globalization hinders the growth of developing countries by negatively affecting the economy, human health, and labor. The presence of MNCs in developing countries has numerous disadvantages, which are frequently overlooked by people (Spilker 113). As wealthy countries exploit the resources of poor countries, the current pattern of globalization should be transformed and poor countries should liberate themselves from the grip of MNCs for genuine growth. Resource-based FDIs Bring Few Benefits to the Larger Economy and Population of Developing Countries For centuries, businesses already hunted down natural resources, like oil and minerals, abroad so as to fulfill local needs. Today, resource-based MNCs intend to protect the reserves of natural resources for the operation of the company itself. Clear proofs of such are oil companies, mining companies, and food companies with agricultural estates in tropical countries. MNCs will desire to operate in ways that are as cost-effective and as productive as possible and such practices may not consistently be amenable to the environment (Saadi 402). They will regularly appeal to the government to make sure that they can profit from loose regulations and because of their economic value to the host nation this appeal will frequently be highly successful. Conflict between Extractive MNCs and Developing Host Country MNCs will at times invest in developing countries simply to acquire access to abundant reserves of natural resources or raw materials and host countries are usually more interested in the temporary economic gains than the long-range disadvantages to their economy in terms of the overexploitation of natural resources. Such disadvantages do not take place until a foreign investor has decided a financial investment and has been successful in unearthing and cultivating resources (Gould et al. 138). The preliminary contract, if one exists, legalizing the terms of entry includes negotiating or bargaining between the seller of the enterprise (or other contract for resource exploitation) and the foreign buyer. If competition exists among a number of foreign firm bidders, the enterprise may be awarded to the highest bidder, considering the different terms of the contract. Yet, this is entirely an issue of marketplace bargaining. When a huge investment has been committed and has been successful, conflict could develop over payments to the government like taxes, the sum of net revenues that could be sent home, the zone that has been exploited by the firm and wherein it is allowed to produce or manufacture, the prices levied for the good, the degree of productivity, the fees paid by the firm for local products and services, the utilization of local goods and services, as well as labor, and the exchange rate appropriate to purchases in local currency (Chaudhuri & Mukhopadhyay 83). Besides tension with the national government, there could be tensions with local labor unions over terms of employment and wage rate and with municipal or state governments concerning various issues vital to operations. The disadvantages of resource-based FDI to developing countries can be grouped into three (Mottaleb & Kalirajan 385): (1) the local effect of MNC operations; (2) the regulation of output, prices of export, and other aspects influencing the extent of overall revenues; and, (3) the separation of overall net profits from activities between the host government and foreign investors. A fourth group of problems is associated with the legal aspect of control of the exploitation of resources themselves, such as the level of foreign ownership. Hence, the problem of control over different features of resource exploitation could be settled by one of various legal types of operation. Furthermore, the legal type of control could have more political than operational or economic value. Foreign investors and the host country could have differing opinions with regard to the maximization of profits from resource exploitation and consumption. These emerge from dissimilarities in viewpoint in relation to long-term prices or from the use of various discount rates for future returns. The government could aim to restrict the level of exploitation so as to safeguard assets or resources for future utilization and consumption or it could anticipate that the long-range pattern in prices will be upward (De Schutter et al. 116). In contrast, the MNCs may desire to sustain their share of the global market by increasing productivity with respect to demand or by lowering prices to the detriment of bigger exports whereas the government may desire to enlarge exports. This common form of situation wherein the host government and the foreign investor hold diverging opinions in relation to the best strategy for maximizing overall returns over time could be discerned from the second scenario. In such, the interests of the host country and the foreign investor differ in relation to the favorability of maximizing overall revenues. For instance, the foreign firm may wish to sustain low prices for transactions to its partners in other nation because the greater the price (and overall revenues), the bigger the sum of overall returns which should be allocated to the host country (Spilker 57). The foreign firm may also wish to restrict output from a reasonably costly supply source in fulfilling its marketing duties overseas in return for more cost-effective substitute sources. Where the core interests of the foreign investor differ from the interests of the host country in relation to overall revenues, the condition becomes severely complicated because not merely is the conflict related to the splitting of the revenues, but the major players do not have a shared interest in capitalizing on the overall revenues to be distributed (Saadi 398). In certain instances, the subject of control becomes more vital than that of the distribution of returns. The point of disagreement over local outcome, as well as the purchases of local products and services and local processing of natural resources, entails both political and economic aspects. When government returns are established as a share of overall net return, greater production expenditures cut down the government’s allocation. However, the government could realize that it is politically beneficial to support labor in a disagreement over wages (Wheeler 233). Host countries may insist that resource-based MNCs process minerals instead of shopping ores, yet these MNCs may turn down these demands although local processing of raw materials could provide considerable cost benefits. These disadvantages of resource-based FDI to developing countries are thoroughly explained and clarified by the ‘dependency theory’. Dependency Theory The dependency theory argues that foreign investment does not generate substantial economic growth. The theory promotes the idea that almost all investments are provided by MNCs which have their base of operations in rich countries and work through subsidiaries in least developed countries (LDC) (Chaudhuri & Mukhopadhyay 44). The argument is that the subsidiaries formulate its policies and strategies to the benefit of its parent corporation and its investors or stockholders in the home country. In consequence, MNCs only bring benefit to the wealthy countries wherein they have their head offices. The home countries become the core global economies, and the developing countries become peripheral or inferior economies benefitting and serving the home countries. Economic growth and progress becomes unlikely in the peripheral countries except if they can free themselves of the situation wherein they are bound by the core economies through FDI. The resources, which enter into the host country as an outcome of FDI, are viewed as serving only the interests of the powerful or upper classes in the developing country, which eagerly build partnerships with foreign investors (International Monetary Fund Staff 28). This leads to violations of human rights, as circumstances beneficial to the activities of MNCs have to be sustained by force or regulation. Indigenization policies and attempts to wield control by allowing FDI through joint enterprises are viewed as unsuccessful. The foreign investor is capable of overcoming these efforts to exercise control through its partnership with the powerful groups. Dependency theory specifically claims that foreign investment is harmful to poor countries due to their extractive nature. It states that, instead of advancing growth, foreign investors keep poor countries in a status of long-term dependency on wealthy economies. Unless a poor country can release itself from such dependency or enslavement, economic growth becomes impossibly difficult in that country. The solution that is proposed is to turn down resource-based FDI rather than encourage it (Mottaleb & Kalirajan 373). The theory reveals the longstanding resentment to foreign investment in the Latin American countries because of its vigorous exploitation of natural resources. It is a possibly a natural result of the power of the United States over the economy of Latin America. The net benefits from foreign investment do not accumulate spontaneously, and their value varies according to the conditions within the host country. Acceptance of the economic advantages provided by the free flow of capital at times conflict with worries about weakening of national sovereignty and other potential negative outcomes; FDI has long been creating these clashing concerns, since FDI entails a powerful interests and networks by usually major MNCs over which local governments have weak control (Wheeler 239). The debates have largely centered on inward foreign investment, because of concerns about foreign control over the host government and economy. In developing countries, MNCs can and usually do, exploit their powerful market status. According to some studies, it is widely known that resource-based FDI is not constantly in the best interest of the host country and thus it must be regulated (Wheeler 239-40). Adverse Political, Economic, and Environmental Impact of MNCs on Developing Host Countries Countries experiencing greater influxes of resource-based FDI have generally experienced apprehension. Numerous developing nations have until in recent times been cautious of inward resource-based FDI. Even in the U.S., the outpouring of Japanese foreign investment in the 1980s resulted in prevalent worries about too much foreign influence and detrimental impact on national security. Opponents of resource-based FDI, and foreign investment as a whole, claim that there is unfavorable political and economic impact on the host country. The perceived economic impact include the potentially adverse environmental effect of resource-based FDI, reduced employment, crowding-out of local companies, reduced competition, and weakened local research and development, particularly in the heavy extractive industries (e.g. oil, mining) (Spilker 84-86). Furthermore, at times some calculated advantages may be vague if the host country, in its present status of economic growth, is not capable of maximizing the expertise or technologies transmitted through FDI. The aspects that hinder the full advantages of FDI in several developing economies involve the insufficient regulatory mechanisms, reduced competition, inadequate acceptance of trade, the technological capability of host-country industries, and the status of general health and education (Saadi 412). Critics of FDI stress that not all the new employment opportunities generated by FDI signify net gains in employment. With regard to the foreign investment by Japanese auto firms in the United States, several claim that the jobs generated by this FDI have been more than counterbalanced by the workers laid off in US-held auto firms, which have been dominated by its Japanese rivals in terms of market share (Gould et al. 163). As a result of this substitution impact, the net total of new jobs generated by foreign investment could not be as substantial as originally reported by a multinational enterprise. As regards the Republic of Macedonia case the high rate of unemployment embodies the major economic issue and it has a direct impact on poor economic development and the few newly created jobs. The streamlining efforts of the companies throughout the shift led to higher unemployment in the short term. As predicted, the earlier foreign investment in the Republic of Macedonia cannot meaningfully affect the employment in the nation, not in quality or scale (De Schutter et al. 127). In the recent decades the usual sum of FDIs is approximately US$ 80 million per annum, which is not adequate for substantial impact on the economic development as a whole, and employment specifically (Gould et al. 165). In addition, host governments at times fear that the subsidiaries of MNCs could have more economic influence than domestic competitors. If it is a unit of a major international corporation, those MNCs may be capable of obtaining funds produced somewhere else to finance its expenditures in the host country, which may force local businesses to shut down and enable the company to take over the market. This issue has a tendency to be more severe in developing nations that have a smaller number of large companies of their own or trivial issue in most developed countries. Another serious issue concerning resource-based FDI is its effect on the environment. Local policing of environmental conservation laws that is lax or weak with respect to foreign companies has resulted in adverse outcomes in numerous parts of the globe. Nevertheless, in the worldwide competition among the governments of developing countries to draw FDI, there is frequently a ‘race to the bottom’, which pushes developing nations to implement more laidback regulations so as to draw FDI (Wheeler 227). The workers’ working conditions in companies financed by foreign investment have also been an issue. The operations of sweatshops in a number of countries, which expose workers, who are at times child workers, to unsafe, poor working conditions, usually in breach of domestic organizational regulations, is a grave problem. The pattern of ‘race to the bottom’ is also existent at this point, as governments reduce the implementation of workplace policies so as to draw foreign investment (Wheeler 229). Even though MNCs compensate their employees more than their competitors, a large number of people have protested that MNCs exploit their employees in sweatshop settings, and have insisted that goods from these sweatshops be prohibited from the American markets. So as to regulate sweatshops, two important anti-sweatshop groups have developed: (1) Workers Rights Consortium (WRC), and (2) Fair Labor Association (FLA). FLA is more directly related to the apparel industry, while WRC more directly related to unions (Spilker 134). The FLA and WRC have formulated ethical codes and implementation systems. These potentially negative consequences of FDI, especially the resource-based, must not be taken for granted. Nevertheless, although FDI offers net benefits to an economy, the existence of a wide range of negative outcomes from foreign investment, particularly for specific sectors or groups, implies that countries should fully take into consideration the level to which they pay off those who are negatively affected (De Schutter et al. 72-74). Weak Host Governments Contribute to the Adverse Impact of FDI on Developing Countries Numerous multinational corporations are much richer than numerous of the countries wherein they do business with or invest. They hence have significant corrupting and bargaining power to make sure they obtain the most favorable operating and entry conditions from weak, poor host countries. Multinationals offer goods and/or services that poor nations direly need. It is simple for multinationals to go against one weak country against the other poor countries to obtain the most favorable deal. By vying against one another to bribe powerful people for investment licenses and other amenities, MNCs often worsen current corruption. Officials who are engaged in bribing and other corrupt activities may acquire wealth but by granting the MNCs unrestricted and financed investments, the development of the country is adversely affected and wealth moves out of the country (Chaudhuri & Mukhopadhyay 97). When a government attempts to restrict the amount of revenue that can be sent home or repatriated, the multinationals avoid the restraint by means of ‘transfer pricing’ or levying huge fees on the things and resources imported to their venture from other subsidiaries (Mottaleb & Kalirajan 387).The multinational does not actually pay a larger amount because it is compensating itself. It is merely a process to transmit profits abroad and evade taxes and at times capital regulations. As an outcome, the subsidiary repatriates profit that otherwise could have been used to purchase more inexpensive components from local industries. By maneuvering their accounts to falsely show that their subsidiaries are unprofitable, the multinational usually in the end become excluded in taxation, paying a small amount or even no taxes to the host country. Numerous FDIs become reserves wherein little if any capital moves to the local economy; the FDI absorbs domestic wealth and expatriates it. In such manner multinationals lessen their own risk and exploit that of their host country and domestic investors so that they will give all the assistance and support they are able to. The MNCs usually control the most developed sectors of the host country, hence having power over any important local growth. Once in a weak state, the multinational usually eats up other domestic industries. A small number of domestic businesses can contend against a multinational, and numerous are cleared out or acquired by the new MNCs. Productivity is often much greater in the multinational than similar local enterprises. Hence unemployment increases because domestic companies are usually much more labor demanding than the multinational. These MNCs can offer higher compensations and benefits, and more favorable working conditions to indigenous workers and hence frequently wipe up a nation’s most skilled and talented workers (Gould et al. 162). In the meantime, there is no substantial transfer of technological expertise or resources. The technology that is financed or invested is either outdated or highly sophisticated that it is unsuitable for that country. The outcome is usually a net drain on a nation’s resources and the growth of underdevelopment. Over time, majority of developing countries have cultivated their bargaining capabilities so that they capitalize on the gains and reduce the disadvantages of foreign investment. Bureaucratic institutions are employing professionals in international law, business, taxes, and other expertise needed to negotiate effectively with representatives of MNCs and afterward thoroughly regulating longstanding foreign investments (Chaudhuri & Mukhopadhyay 58-59). The power of developing countries strengthens even more after the multinational has operated. New regulatory mechanisms can be implemented and the multinational often complies because the costs of compliance are lesser than the costs of disinvestment. Laws can be implemented, which restrict the volume of royalties, profits, and other revenue an MNC can send home, and the volume of resources a multinational can import. Conclusion From the above discussion, it is evident that the disadvantages of FDI or MNCs to developing countries are often brought about by two factors—resource exploitation as the primary goal of FDI and weak host government. To gain the optimum benefits from MNCs a healthy conducive setting for business is vital, which promotes local as well as FDI, offers incentives for enhancement of talents and innovation and heightens a competitive corporate environment. The net gains from foreign investment do not build up spontaneously, and their value varies based on the host country and circumstances, particularly the level of resource exploitation and stability and strength of the host government. Works Cited Chaudhuri, Sarbajit & Ujjaini Mukhopadhyay. Foreign Direct Investment in Developing Countries: A Theoretical Evaluation. New York: Springer, 2014. Print. De Schutter, Olivier et al. Foreign Direct Investment and Human Development: The Law and Economics of International Investment Agreements. UK: Routledge, 2012. Print. Gould, David et al. “Attracting Foreign Direct Investment: What Can South Asia’s Lack of Success Teach Other Developing Countries?” South Asia Economic Journal 15.2 (2014): 133-174. Print. International Monetary Fund Staff. Foreign Private Investment in Developing Countries. Washington, DC: International Monetary Fund, 1985. Print. Mottaleb, Khondoker & Kaliappa Kalirajan. “Determinants of Foreign Direct Investment in Developing Countries: A Comparative Analysis,” Margin: The Journal of Applied Economic Research 4.4 (2010): 369-404. Print. Saadi, Mohamed. “Technology Transfer, Foreign Direct Investment, Licensing and the Developing Countries’ Terms of Trade,” Margin: The Journal of Applied Economic Research 5.4 (2011): 381-420. Print. Spilker, Gabriele. Globalization, Political Institutions and the Environment in Developing Countries. UK: Routledge, 2013. Print. Wheeler, David. “Racing to the Bottom? Foreign Investment and Air Pollution in Developing Countries,” The Journal of Environment & Development 10.3 (2001): 225-245. Print. Read More