In the era of globalisation over the last two decades, the pro-business environments fostered by governments in many less developed countries involves, inter alia, encouragement of foreign direct investment (FDI)—i.e. ownership of productive assets by a foreign firm—in their economies. In this milieu, the question that is debated concerns whether LDCs gain or lose due to increasing FDI or presence of multinational corporations.
Those who argue in favour of multinational corporations (MNCs) refer to their potential growth stimulating role through capital formation, technology transfers and superior organisational methods. The most classic argument is that LDCs are deficient in physical capital formation and so FDI will have a positive effect on the growth rate of a poor nation. However, the empirical truth since the 1980s has been that new FDI constitutes only a small proportion of total physical capital formation in any given year in LDCs. The absolute amount of capital formation by MNCs in relation to total investment in LDCs is less than 10 per cent and usually less than 5 per cent. Moreover, even if a nation receives large amounts of FDI, such flows do not imply new capital formation because multinational investments purchase existing plant and machinery of local capitalists so much so that denationalisation in terms of declining ownership of domestic capitalists has occurred. This is not all. Even if a new facility is built by an MNC, it does not increase total investment in the country because multinationals raise financial capital to make the required physical capital from within the poor nation itself either from the banking sector or equity markets thereby diverting funds that would otherwise have been available to the national entrepreneurs. In other words, FDI does not complement local investment but rather acts as a substitute.
Thus, the aggreagate approach to examining the FDI in LDCs reveals its quantitative insignificance on the above lines but the so-called modernization perspective about MNCs points out that MNCs do impact the LDCs a lot through their qualitative significance in the following ways. First, FDI is often directed to a narrow range of industries—manufacturing and services—that are important for economic growth via significant increases in productivity due to new investments. Secondly, FDI has substantial impact on productivity and output of the host nation through non-equity arrangements such as licensing, long-term subcontracting, franchising agreements and non-equity joint ventures with local capital. Through these arrangements, the MNCs facilitate and augment diffusion of product and process technologies, management-labour skills, advanced organisational methods in marketing, advertising, finance, R&D, etc. A major point in this connection is that MNCs promote export culture which is missing in the domestic businesses of LDCs.
However, the critics refer to many many costs associated with the presence of MNCs in LDCs as follows:
1. Transfer Pricing
Intra-firm transactions of inputs and semi-finished final goods of MNCs are singnificant and they adopt transfer pricing (through overpricing of inputs) as a measure for avoiding taxes in one country or another and for avoiding restrictions on profit repatriation imposed by a host nation.
2. Income Transfers
There are net resource outflows apart from transfer pricing because (a) parent corporations make loans to their subsidiaries which hence do interest payments and amortization of principal; (b) declared profits are repatriated; and (c) as unique owners of product/process and organisational and information technologies, MNC sell or lease them via non-equity arrangements in such a way that the prices charged are far greater than the cost of creating such technologies.
3. Diversion Effects
It has been found that strong presence of MNCs has led to no net addition to R&D process in the host country or that the R&D process is directed away from finding out appropriate domestic technologies. To put it differently, indigenous R&D is curbed or redirected towards mere adaptive inquiry. Further, the capital intensive methods used by the MNCs has not solved the problem of growing urban unemployment in LDCs. Furthermore, there is internal brain drain in that top managers/best graduates are taken by the MNCs so that indigenous capitalists are short of managerial talent.
4. Income Inequality
Increasing presence of MNCs is associated with increasing industrial concentration in terms of monopoly and oligopoly power which in turn worsens the income distribution in the host country.
5. Export Promotion and Fallacy of Composition
There is evidence to the effect that new manufacturing exports due to MNC presence has resulted in falling prices realized for them. In other words, the terms of trade for LDC manufactured exports have fallen.
6. Environmental Degradation as a Long-term Cost
MNCs are in the LDCs as environmental predators in order to escape from stringent environmental laws in their own home countries. Various kinds of pollution have been on the rise due to the increasing presence of MNCs.
7. Export Processing Zones
These are dreamlands constructed by LDCs in order to promote FDI. But it has been found that even as the foreign exchange earned by host countries is very small, there is greater exploitation of workers through hazardous working conditions; there is a lot of fraud and deception in the disposal of toxic substances; and there are no forward or backward linkages with the rest of the economy.