Question

“Foreign direct investment theory suggests that firms are seekers and exploiters of imperfections.” What are multinational corporations “seeking” and “exploiting” and what could be the effect on countries they choose to invest in (i.e., the host country)? The essay must be between 400 and 500 words.

Answer 1

A foreign direct investment (FDI) is an investment in the form of a controlling ownership in a business in one country by an entity based in another country. It is thus distinguished from a foreign portfolio investment by a notion of direct control.

The foreign direct investor may acquire voting power of an enterprise in an economy through any of the following methods:

• by incorporating a wholly owned subsidiary or company anywhere
• by acquiring shares in an associated enterprise
• through a merger or an acquisition of an unrelated enterprise
• participating in an equity joint venture with another investor or enterprise.

Multinational corporations are profit seeking enterprises having international power, capital, manpower, and resource-seeking practices. We can say that an organization that performs its business in two or more countries is a multinational company. These companies operate worldwide through their own branches and subsidiaries or through agents who represent them.

Multinational corporations are sometimes perceived as large, utilitarian enterprises with little or no regard for the social and economic well-being of the countries in which they operate, but the reality of their situation is more complicated.
The World Trade Organization (WTO), the International Monetary Fund (IMF), and the World Bank are the three institutions that underwrite the basic rules and regulations of economic, monetary, and trade relations between countries.

Multinational corporations also make use of a procedure known as sequential market entry when seeking to penetrate a new market. Sequential market entry often also includes foreign direct investment, and involves the establishment or acquisition of concerns operating in niche markets related to the parent company's product lines in the new country of operation.

Incidents such as the improper use in the Third World of baby milk formula manufactured by Nestle, the gas leak from a Union Carbide plant in Bhopal, India, and the alleged involvement of foreign firms in the overthrow of President Allende of Chile have been used to perpetuate the ugly image of MNCs. The fact that some MNCs command assets worth more than the national income of their host countries also reinforces their fearful image. And indeed, there is evidence that some MNCs have paid bribes to government officials in order to get around obstacles erected against profitable operations of their enterprises.

Several governments, especially in Latin America and Africa, have been receptive to the negative images and have adopted hostile policies towards MNCs. However, a careful examination of the nature of MNCs and their operations in the Third World reveals a positive image of them, especially as the allies in the development process of these countries.

The potential benefits of MNCs on host countries include:

• Provision of significant employment and training to the labour force in the host country
• Transfer of skills and expertise, helping to develop the quality of the host labour force
• MNCs add to the host country GDP through their spending, for example with local suppliers and through capital investment
• Competition from MNCs acts as an incentive to domestic firms in the host country to improve their competitiveness, perhaps by raising quality and/or efficiency
• MNCs extend consumer and business choice in the host country
• Profitable MNCs are a source of significant tax revenues for the host economy (for example on profits earned as well as payroll and sales-related taxes).

The potential drawbacks of MNCs on host countries include:

• Domestic businesses may not be able to compete with MNCs and some will fail
• MNCs may not feel that they need to meet the host country expectations for acting ethically and/or in a socially-responsible way
• MNCs may be accused of imposing their culture on the host country, perhaps at the expense of the richness of local culture. Might MNCs reduce cultural diversity around the world as they continue to expand, particularly into less developed or developing countries?
• Profits earned by MNCs may be remitted back to the MNC's base country rather than reinvested in the host economy.
• MNCs may make use of transfer pricing and other tax avoidance measures to significant reduce the profits on which they pay tax to the government in the host country.