Effect of Multinational Corporation on Local Economy

Table of contents:

Abstract

Introduction

FDI impact on economic growth

FDI and Technological Transfer

Employment and Foreign Direct Investment

FDI contribution to capital inflow of private capital

Adverse effects of FDI on the local Environment

FDI Influence on Exchange Rates

FDI and Unemployment

FDI and Modern-Day Economic Colonialism

Summary

References

Abstract

The purpose of this paper is to glimpse into the effect Foreign Direct Investment (FDI) on the Host economy. The effect FDI has on the host economy has ranged from technology transfer and know-how, integration in global market formation of human resources, increase in competition between firms and firm’s development and reorganization to meet current market trend (Moura, R., 2010). There has also been some adverse effect brought about by Foreign Direct Investment. This paper tends to take a look at both the positive and negative impact of FDI on host economy development.

Introduction

The investment of a firm in a foreign country is known as Foreign Direct Investment. This investment could either be through partial ownership, a joint venture, acquisition, or a greenfield investment (Hill, 2016). Foreign Direct investment is considered as an engine for sustainable growth of a host economy. FDI involves the transfer of large assets which includes capital, "advanced technology and know-how, better management practices" (Moura, R. & Forte, R., 2010), and better buying options for the consumers, just to mention a few. Between 1990 and 2015, there has been a steady raise in Foreign Direct Investment, FDI reached its highest peak in 2008 (unctad.org, 2016). FDI are general taken by firms over licensing and exporting when its product cannot be license. Furthermore, firms decide on FDI when the cost of production in the foreign country is cheaper or for easy/closer access to raw materials. Also, a firm may decide on FDI when the host country's policy does not favor import or when such product cannot be licensed or exported (Hill, 2016).

Foreign Direct investment has stood the test of time especially during the financial meltdown of recent time. Before a Multinational company can embark on foreign direct invest, it first has to choose what country to invest. The issue faced by most MNEs is in deciding on the best country to invest in depends on different variables. The variables include the political stability of the country, accessibility to raw materials, will the FDI be a greenfield investment or an acquisition? Furthermore, the culture and the profitability of such investment by the firm has to be taken into account. For instance, Walmart did not get return on its investment in the German market due to ethics and cultural differences between the United States and Germany (Hill, 2016).

This paper also takes a look at the direct benefits foreign direct investment has on the host economy. The aim of this paper is to highlight both the positive and the adverse effect FDI has on the economic development of host countries. Some of the gains of FDI will be looked at in great details. FDI's impact on economic growth of the host country, technology transfer, employment opportunities created by FDI and FDI contribution to capital inflow of private capital. Furthermore, FDI has also led to increase competitions within the host country, as well as a vehicle for global integration. Conversely, empirical study also shows that FDI has also had some negative impact on its host countries. Some of which will also be touched upon.

There are many possible effects of an inflow of FDI on a host country. It is generally taken for granted that the investing firms possess some technology superior to that of local, host country’s firms. One possible impact would be the production of goods and services of higher quality than previously available or at lower prices, resulting in higher consumer welfare. That topic seems to be almost completely absent from the literature and may be of little interest to policy makers, although it should be of interest to economists (Lipsey, E., R., & Sjoholm, F., 2004).

FDI impact on economic growth

The impact FDI has on the economic growth on its host has been through factor accumulation and total factor productivity (TFP). "According to neoclassical growth theory and endogenous growth theory respectively" (Moura, R., et al., 2010). Factor accumulation is the increase in the four main factors of production used in the production of goods (land, labor, capital, and entrepreneurship). An increase in these factors of production leads to a proportional increase in production of goods and services as the case may be. It follows thus that FDI increases the economic growth of the host country by increasing the productivity of these factors of production.

For instance, between 2000 and 2015, the total direct investment of United States Companies to China "were valued at 74.56 billion dollars. The total direct position of the United States abroad amounted to 5.04 trillion U.S. dollars in 2014" (statista.com, 2015). The direct investment of United States owned firms into the Chinese economy as definitely expedited the economic growth of the Chinese economy. Conversely, "total factor productivity (TFP) "measures the residual growth in total output of a firm, industry, or national economy that cannot be explained by the accumulation of traditional inputs such as labor and capital"(Boundless.com, 2016). TFP measures the judicious use of production inputs. The contribution of TFP to the overall growth of the economy is seen from the perspective of human capital and technological changes. TFP also "reflects not just technology but also organizational innovations, improvements in the allocation of capital and labor, returns of scale" (IIboudo, P., S., 2014). Which are direct derivatives of foreign direct investment.

FDI and Technological Transfer

Most developing economies embrace free trade because it brings with it foreign direct investment. Apart from FDI being a vehicle of sustainable growth, it allows developing countries close the gap between them and the developed economy. This is evident in the gains that comes with FDI which had made attracting foreign direct investment (FDI) a priority of most developing countries. "The basic premise underlying the existence of FDI spillovers is that foreign-invested firms are technologically superior and that knowledge is transferred through their interactions with domestic firms, which, in turn, leads to productivity improvements" (sciencedirect.com, 2015). A good example of the impact of FDI on the technological advancement of the host economy is China. There is a direct correlation between the open door policy of the Chinese governments to free trade and the growth in the Chinese economy. "The report by the Minister of Commerce, multinational subsidiaries in China have formed a product value chain with local companies. MNCs, through purchasing and supplying, have greatly advance the technology-level of both upstream and downstream corporations in local areas"(Zhu Y., 2010).

A study survey conducted by Sciencedirect of over 4000 manufacturing firms in Vietnam between 2009 and 2012. Using a two stage econometric approach, show that in the first stage, the productivity estimate and the relationship between productivity are direct and indirect spillovers from FDI (sciencedirect, 2015). The conclusion of the result was that there is a direct correlation between foreign direct investment and technological advancement of host country. Empirical study also shows that the influence of multination companies on the upstream has an adverse effect on the downstream of firms in the host country.

While these results are broadly consistent with the existing body of empirical evidence, our analysis adds a new dimension to the understanding of the nature of these spillovers. We find that direct forward linkages from foreign-invested input suppliers to domestic customers are positively related to productivity. Moreover, having a direct link with an upstream FDI firm (where the link is associated with a technology transfer) mitigates part of the negative externality from the dominance of wholly-foreign owned firms in upstream sectors. Our findings suggest that the standard measures used in the literature to capture FDI spillovers do not adequately account for the effects of direct linkages or technology transfers between foreign and domestic firms (sciencedirect.com, 2015).

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