The Effects of TNCs activities

What is foreign direct investment?

Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country Once a firm undertakes FDI it becomes a multinational enterprise There are two forms of FDI A greenfield investment (the establishment of a wholly new operation in a foreign country) Acquisition or merging with an existing firm in the foreign country

MNC economic power

Foreign direct investment

Foreign direct investment reflects the objective of obtaining a lasting interest by a resident entity in one economy (direct investor) in an entity resident in an economy other than that of the investor (direct investment enterprise). The lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence on the management of the enterprise. Direct investment involves both the initial transaction between the two entities and all subsequent capital transactions between them and among affiliated enterprises, both incorporated and unincorporated.

Direct investment enterprise

OECD recommends that a direct investment enterprise be defined as an incorporated or unincorporated enterprise in which a foreign investor owns 10 per cent or more of the ordinary shares or voting power of an incorporated enterprise or the equivalent of an unincorporated enterprise. The numerical guideline of ownership of 10 per cent of ordinary shares or voting stock determines the existence of a direct investment relationship. An effective voice in the management, as evidenced by an ownership of at least 10 per cent, implies that the direct investor is able to influence or participate in the management of an enterprise; it does not require absolute control by the foreign investor.

Some countries may consider that the existence of elements of a direct investment relationship may be indicated by a combination of factors such as: a) representation on the board of directors; b) participation in policy-making processes; c) material inter-company transactions; d) interchange of managerial personnel; e) provision of technical information; f) provision of long-term loans at lower than existing market rates. Other relationships may exist between enterprises in different economies which exhibit the characteristics set out above, although there is no formal link with regard to shareholding. For example, two enterprises, each operating in different economies, may have a common board and common policy making and may share resources including funds but with neither having a shareholding in the other of 10 per cent or more. In such cases where neither is a direct investment enterprise of the other, the transactions could be treated as between related subsidiaries. These are not regarded as direct investment.

Main Types of FDI Resource seeking FDI in natural resources (minerals, raw materials, and agricultural products) FDI seeking low-cost or specialized labor . Market seeking FDI into markets previously served by exports, or into closed markets protected by high import or other barriers FDI by supplier companies following their customers overseas FDI that aims to adapt products to local tastes and needs, and to use local resources

 Efficiency seeking Rationalized or integrated operations (regionally/globally) leading to crossborder product or process specialization. Strategic asset seeking Acquisitions and alliances to promote long-term corporate objectives.

 Most FDI in developing and transition economies is resource seeking. This type of investment aims to exploit a countrys comparative advantage. For instance, countries rich in primary materials, such as oil or minerals, will attract companies seeking to develop these resources. Low-cost or specialized labor are two other factors that attract resource-seeking FDI. Resource-seeking FDI is generally used to produce goods for export.

 Market-seeking investment is aimed at reaching local or regional markets, often including neighboring countries. Companies making this type of investment typically manufacture a wide variety of household consumer products or other types of industrial goods in response to actual or future demand for their products. In some cases, market-seeking FDI occurs as supplier companies follow their customers overseas. For example, an auto components manufacturer may follow a car producer.

 Efficiency-seeking FDI frequently occurs as a follow-on form of investment. A TNC may make a number of resourceor market-seeking investments, and over time, it may decide to consolidate these operations on a product or process basis. Companies are able to do this, however, only if cross-border markets are open and well developed. As a result, this form of FDI is most common in regionally integrated markets, most notably in Europe and Asia.

 Strategic asset-seeking FDI occurs when companies undertake investments, acquisitions or alliances to promote their long-term strategic objectives. For example, a TNC may form a strategic alliance with a company based in another country to jointly undertake mutually beneficial R&D. Strategic asset-seeking FDI is common in industrialized countries.

 The key factors by which different locations are rated can be broken into general categories. Market characteristics (local and regional) Costs (including labor, transport and other inputs) Natural resources (availability and quality) Infrastructure Policy framework Business support and promotion

 The importance of each of these factors varies, according to the type of investment. For example, resource-seeking TNCs examine closely the availability and quality of natural resources. Other important factors, such as the countrys basic infrastructure; economic, political, and social stability; and policy framework are then evaluated.

Foreign Direct Investment in the World Economy

Historically, most FDI has been directed at the developed nations of the world, with the United States being a favorite target FDI inflows have remained high during the early 2000s for the United States, and also for the European Union South, East, and Southeast Asia, and particularly China, are now seeing an increase of FDI inflows Latin America is also emerging as an important region for FDI

Foreign Direct Investment in the World Economy

The majority of cross-border investment involves mergers and acquisitions rather than greenfield investments

Firms prefer to acquire existing assets because:

it is easier, faster, and perhaps less risky for a firm to acquire desired assets than build them from the ground up
firms believe that they can increase the efficiency of an acquired unit by transferring capital, technology, or management skills

In the last two decades, there has been a shift towards FDI in services

The Direction of FDI

Figure 7.3: FDI Inflows by Region ($ billion), 1995-2006

 Why would a firm go to all the trouble and expense of setting up operations in a foreign country?
FDI is expensive because a firm must bear the costs of establishing production facilities in a foreign country or of acquiring a foreign enterprise

Economic Rationale for FDI: a closer look

FDI is risky because of the problems associated with doing business in another culture where the rules of the game may be different

Why Foreign Direct Investment?

Why do firms choose FDI instead of:
exporting - producing goods at home and then shipping them to the receiving country for sale or licensing - granting a foreign entity the right to produce and sell the firms product in return for a royalty fee on every unit that the foreign entity sells

Why Foreign Direct Investment?

An export strategy can be constrained by transportation costs and trade barriers Foreign direct investment may be undertaken as a response to actual or threatened trade barriers such as import tariffs or quotas

Why Foreign Direct Investment?

Theory suggests that licensing has three major drawbacks:
1. It may give away valuable technological knowhow 2. It does not give a firm tight control over operations 3. The firms competitive advantage may not be amenable to licensing

Host-Country Benefits
Inward FDI has four main benefits: 1. resource transfer effects FDI can make a positive contribution to a host economy by supplying capital, technology, and management resources that would otherwise not be available

2. employment effects
FDI can bring jobs to a host country that would otherwise not be created there

Host-Country Benefits
3. balance of payments effects
FDI can help a country to achieve a current account surplus if the FDI is a substitute for imports of goods and services, and if the MNE uses a foreign subsidiary to export goods and services to other countries

4. effects on competition and economic growth

FDI in the form of greenfield investment increases the level of competition in a market, driving down prices and improving the welfare of consumers

Host-Country Costs
Inward FDI has three main costs:
1. possible adverse effects of FDI on competition
subsidiaries of foreign MNEs may have greater economic power than indigenous competitors

2. adverse effects on the balance of payments

outflow of capital as the foreign subsidiary repatriates earnings to its parent country import of inputs creates debit on current account

3. perceived loss of national sovereignty

MNE affects key government decisions

THE HOST COUNTRY ROLE IN ATTRACTING FDI Economic and Other Benefits from FDI. Capital. A new investor will bring in capital with which a new production facility will be constructed, or a local company acquired. Employment. While the number of jobs created varies in accordance with the size of the investment and the production process itself, the most common benefit associated with FDI is increased or protected employment. And, of course, with new employment comes additional income and spending power for local residents.

 Revenue benefits. FDI widens the local tax base and contributes to government revenues. Even if foreign investors are granted complete relief from taxes for a short period of time through investment incentives, governments can earn increased revenue from the payment of personal income taxes because of the new jobs created by FDI. In addition, exportoriented investment generates foreign exchange earnings.

 Favorable impact on local investment. FDI inflows tend to lead to an increase in domestic investment as companies gain access to distribution channels opened by TNCs, become suppliers to TNCs, or respond to competition from TNCs.

Effects on whom?
Different companies, people, groups, classes are likely to be affected differently. The effects span more than the economic domain. There are effects on society in general, on politics, on the environment, on culture etc. Besides some obvious direct effects, there are many effects that come about in more indirect ways.

Effects of International Production on Performance

The performance of companies, industries and macroeconomies
Cumulative processes, short- and long-term issues: direct and indirect effects

Indicators of performance
Profitability; sales; productivity; output growth; innovation

TNC and innovation

Effects of International Production on Labour

Employment effects
Direct:
Greenfield versus mergers and acquisitions FDI Host and home country effects

Indirect:
Value chain; repercussions on the vertical and horizontal chains Income

Wider effects on labour

Quality of labour (productivity, skills development, wages) Labour fragmentation and its bargaining power

Effects of International Production on Trade

Trade and international production; substitutes or complements?
Resource-based production Market-oriented production

Effects on trade patterns

Benefits of FDI to the host-country

domestic firms Linkage effects: Backward and forward Crowd-in investment and growth upstream and downstream Competitive pressure in product, labour and credit markets Crowd-out domestic investment and innovation Force efficiency gains Knowledge Spillover effects Technology and management skills and export market access.

Benefits of FDI to the host-country

workers Employment and wages of workers hired by the Investor Productivity: Non-volatile Capital and Knowledge Ambiguous effects on employment of domestic established producers Governments Force good policies Raise tax revenues on foreign capital Tax incentives competition dilute these gains

 Finance & Development, March 2003 - Managing Oil Wealth Finance & Development, June 2001 - How Beneficial Is Foreign Direct Investment for Developing Countries? http://www.unctad.org/en/docs/pogdsmdpbg24d9.en.pdf http://homepages.ulb.ac.be/~dtraca/TITSD/slides%2006/ session7%20-%20effects%20of%20FDI.pdf http://homepages.ulb.ac.be/~dtraca/TITSD/readings/McK inseyFDI.pdf

Pro-FDI outlook of the political framework Stability and reliability of political and business environment Availability and low-cost of Skilled and Semi-skilled labor Infra-structure (transport, electricity) Other factors: Security, No Unions, Low Trade Barriers, Presence of other foreign firms, Special incentives to FDI (and to Intel)

Key factors in Intels choice of Costa Rica Educated, technical workforce and No labor unions Political and Economic stability; Transparent legal system; Pro business and FDI outlook, including commitment of government and competence of CINDE Good logistics infrastructure and access to airport No capital controls A good package of incentives, made available to similar investors (Intel inspired reforms!?)

Spillovers effects
Spillovers effects from MNC activity in host countries exist and they may substantial both within and between industries, but there is no strong evidence on their exact nature and magnitude.
Recent research suggests that [they] vary systematically between countries and industries and that the positive effects of FDI are likely to increase with the level of local capability and competition. (Blomstrom and Kokko (1998) Empirical research shows mixed support for the idea that FDI generates positive spillovers for domestic industry. While MNCs tend to be highproductivity firms which pay relatively high wages, on average their presence appears to depress the productivity of domestic plants (perhaps by driving them into less profitable market segments). Hanson (2001)

The overall effect of FDI on national welfare in the host economy is perhaps weakly positive, depending on whether the superiority of foreign firms compensates for the loss of profits (through repatriation) and for the potentially slower productivity growth [negative spillovers] in domestic firms. Dirk Willem te Velde (2001)

The gains to host countries from FDI can take several other forms: FDI allows the transfer of technologyparticularly in the form of new varieties of capital inputsthat cannot be achieved through financial investments or trade in goods and services. FDI can also promote competition in the domestic input market. Recipients of FDI often gain employee training in the course of operating the new businesses, which contributes to human capital development in the host country. Profits generated by FDI contribute to corporate tax revenues in the host country.