Economic growth and development is a major consideration in many economies, especially in developing countries. Various strategies have to be looked at in order to identify the most suitable option for a proper economic growth. With growing corporations and their need to expand, the necessity to involve Multinational Corporations to stimulate growth and development has become inevitable as they bring considerable income, coupled with many other benefits. Foreign direct investment (FDI) is the direct investment in a host country by a company that originates from another country and that is located there. FDIs are the basis of the economies in the majority of developing countries. The entry of many FDIs to developing markets occurs in the form of Global Value Chains (GVC) that attempt to increase their global presence and supply. The reason for the influx of GVCs to developing countries is the numerous benefits that such countries offer to foreign companies. Among them are cheap labor, the availability of numerous resources, and lenient regulations of trade. Another reason for the increase in the FDI to developing countries is the effect of globalization, where more economies are reliant on each other. Therefore, it becomes necessary to access goods and services, previously only available in home countries. Developing countries, hinged on the benefits that FDI brings, have embarked on strong efforts to increase the attractiveness of their countries to GVCs. Nevertheless, FDI brings numerous disadvantages in addition to the advantages, causing the argument of whether the governments of these developing countries should have such investments discouraged.
Positive Effects of Transnational Companies in Developing Countries
Transnational corporations contribute to a great extent to the growth of the economies of developing countries. However, this extent depends on the frameworks that the host developing country implements to ensure that maximum benefit is achieved and felt. Some of the benefits of transnational corporations presence in developing countries include the following.
When entering a foreign market, transnational corporations bring various beneficial effects that are transferred to the developing countries, hosting them. These benefits can occur within the same market or in different markets due to forward and backward ties, with the use of local input to create high quality outputs respectively (Uttama and Peridy 315). The majority of new technological advancements is developed by transnationals because of their massive spending on research and development. Technology, which is used by foreign corporations, is introduced into the host country market when these corporations train their employees to increase the quality of their workforce. These corporations also provide better wage rates, which creates a response from domestic companies to increase wages to prevent losing their most qualified workforce to multinationals.
Increase in Competitiveness
Transnational corporations are capable of venturing into areas with high entry barriers due to their huge capital reserves, thus breaking down monopoly tendencies in the host country. However, the breakdown of monopolistic market structure may depend on the response of local firms (Blomstr?m). The existence of efficient methods by GVCs also creates a challenge to the domestic companies, thus resulting in improved provision of goods and service. Through innovation, these domestic companies offer newer and more attractive products and services that are supposed to compete on the same level with the ones, offered by MNCs. This competition for the share of demand creates growth of the market since more and more products and services are launched to appeal to consumers. Competitiveness on the market may also result from the creation of companies that supply goods and services to transnational corporations, operating in the host country.
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Increased Foreign Earnings
Developing countries are mostly characterized by the low inflows of foreign revenues, which leads to an unfavorable balance of payment. Capital inflows from foreign investments occurs through the transfer of expenditures by foreign companies to the host country markets. As these companies begin their operations in developing markets, they eventually bring the expenditure from their home country to the host one. The resulting foreign earnings also come from the increase in domestic productivity levels since transnational companies are more efficient, so this efficiency is transferred to the host countrys industries.
As a company establishes in a foreign market, the population benefits from new job opportunities. Developing countries are preferable due their competitive labor pricing and mostly large population, which is attractive to transnational corporations. There is also an inclination to labor-intensive products due to the abundance of affordable labor.
Negative Effects of Transnational Companies in Developing Countries
Despite the benefits associated with FDI, there have been plenty of arguments regarding the real effects of FDI. The continuous efforts by developing countries to attract transnational investors have faced great criticism from Keynesians who argue that benefits to a particular country do not mean that they will also be present in all others. In a country like Chile, for example, very few positive effects of FDI could be identified. Some of such negative effects of FDI include the following ones.
Crowding out Effect
Crowding out effect implies that government expenditure counteractively drives down private sector investment. In a bid to attract FDI, most developing countries spending significant funds on infrastructure facilities, causing the rise in the cost of debt. This rising cost of debt restricts the investment by smaller private firms since loans become expensive. The provision of higher quality products by GVCs additionally drives out domestic firms since the latter lack necessary financial resources to match the former. This results in lower productivity as fixed costs are spread across a small scale of production.
The presence of incentives to attract FDIs leads to the influx of transnational companies constraining resources in these countries. Pollution is also a major consequence of the concentration of FDIs in developing nations. Many of them less stringent measures regarding environment and natural resources, partly as an incentive to attract these GVCs, and lack of sufficient frameworks and tools to implement.
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Corruption is the use of fraudulent practice to achieve unfair gains. The competition to gain entry to developing countries due to the economic benefit, associated with it, leads to corruption. Specifically, wealthy transnationals resort bribes to bypass the bureaucratic tendencies in the host countries to obtain favors in areas such as permits, tax assessments, and protection (Al-Sadig). The presence of corruption in these countries has become a necessary rule of entry and affected the expected profitability after factoring in the cost of bribes. The presence of large wealthy transnationals also influences the autonomy of various functions of the government. Corruption has hazardous effects on growth and development because inveterate corruption will deter the further entry of GVCs to the host markets.
Difficulty in Implementing Development Policies
With the main focus on attracting FDI, investment, for example, into the development of infrastructure is observed mostly the in areas that favor the requirements of this GVC. The governments focus on the development of selected areas leads to the deprivation of other areas and their skewed development, which opposes development policies.
The Balance of Payment Problem
The presence of many large multinationals results in the large outflows of capital, contrary to what FDI is expected to achieve. Transnationals import technology and manufacturing supplies from their home countries as they mostly work with their original suppliers, while the majority of these resources are not readily available in most developing countries. GVCs also repatriate the biggest share of their profits to their home countries; eventually, the benefits gained in the host country are canceled by the outflows, occurring from repatriation (The Hindu Business Line). This repatriation of profits, therefore, makes the presence of FDI counteractive since huge benefits will only be felt at home and not in the host countries
Case Study: FDI in China
This study intends to focus on the opening of China’s economy to foreign investments, unlike in the past, when China opted to operate in seclusion. According to the United Nations Conference on Trade and Development, China is the worlds third largest recipient of FDI, with $133 Billion worth of investment, after the USA and the UK (75). Foreign firms now contribute to 30% of Chinese industrial output (World Bank), which is a major source of revenue to the Chinese economy. Previously, China was a closed economy, but after 1979, it began eliminating barriers to foreign direct investments. A proper framework was also developed to ensure that the maximum benefits were attained with the liberalization of the economy, for example, the requirement for joint ownership of transnational corporations with domestic companies. In the process of attracting FDI, China opted for a more transparent and suitable regulatory framework and business environment that made investors feel the need to enter the market. During the first years after the elimination of barriers, FDI growth was slow, but it increased in later years, with a vast majority of investments arriving from the overseas Chinese nationals based in Hong Kong and Taiwan. The subsequent entry of GVCs has been witnessed in China to the extent of which it has become today.
The main reason why China has proved attractive to FDI is the presence of cheap labor due to the huge population in the country. Initially, China also had a weak purchasing power in its currency, and demand was not that complicated, which opened a huge market for foreign companies. The liberalization of the Chinese market in addition to prudent policies has resulted in a huge growth of the Chinese economy between 8-9% per year since 1980. Other positive effects included the advancement in technology, where companies like Huawei, Haier, and Lenovo emerged as Chinese transnational corporations themselves. The transfer of a wide variety of technical skills to the Chinese population has led to the creation of a more skillful workforce, turning China into a global competitive giant.
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Despite these advantages, FDI in China has also brought few disadvantages. Among them is lack of investments in particular areas, thus resulting in bias towards particular industries. There has been a growing concern over the state of pollution of the Chinese environment by mostly transnational manufacturing companies. A study established that the pollution in the eastern province, where most FDI is located, suffers from higher pollution than the inland regions. China has also struggled with the balance of payment problems, numerously devaluing its currency (Xing 203) to favor export, albeit this occurred eventually after liberalization. The outflow of capital has been attributed to diminishing investment opportunities in the country as FDI has utilized an almost full potential, available in the market.
FDI is a major growth stimulant in developing countries. As clearly indicated, many benefits accrue from FDI; however, there must be a proper framework and policies to fully attain the subsequent benefits. Developed countries have improved their technologies significantly and trained their workforce to be more skilled, thus contributing to the general output of the economy. The development in infrastructure has also been achieved, and domestic industries have been globalized and rendered more efficient. However, the issues of creating incentives to attract FDI should be properly observed to prevent counteractive effects that usually arise, mostly in the long run. Examples include the balance of payment problems, corruption, and pollution of the host countrys environment. Nevertheless, FDI brings more benefit to an economy than the costs that it takes away. Mostly, these costs occur eventually, as seen in Chinas case where after the liberalization of its economy to allow FDI, this country has grown to become a global economic giant, with its own transnational corporations in other countries. Transnational corporations will always be willing to venture into new markets if benefits exist there such as cheap labor force. The governments of developing world therefore should not stop attracting foreign investments since they benefit their economies despite some disadvantages.
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