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The Benefits of FDI to Host Countries In this section, we explore the four main benefits of FDI for a host country: the resource-transfer effect, the employment effect, the balance-of-payments effect, and the effect on competition and economic growth. In the next section, we will explore the costs of FDI to host countries. Economists who favor the free market view argue that the benefits of FDI to a host country so outweigh the costs that pragmatic nationalism is a misguided policy. According to the free market view, in a perfect world the best policy would be for all countries to forgo intervening in the investment decisions of MNEs.5 Resource-Transfer Effects Foreign direct investment can make a positive contribution to a host economy by supplying capital, technology, and management resources that would otherwise not be available and thus boost that country's economic growth rate. The accompanying Country Focus describes how the Venezuelan government has been encouraging FDI in its petroleum industry in an attempt to benefit from resource-transfer effects. Capital Many MNEs, by virtue of their large size and financial strength, have access to financial resources not available to host-country firms. These funds may be available from internal company sources, or, because of their reputation, large MNEs may find it easier to borrow money from capital markets than host-country firms would. This consideration was a factor in the Venezuelan government's decision to invite foreign oil companies to enter into joint ventures with PDVSA, the state-owned Venezuelan oil company, to develop Venezuela's oil industry. Technology As we saw in Chapter 2, the crucial role played by technological progress in economic growth is now widely accepted.6 Technology can stimulate economic development and industrialization. It can take two forms, both of which are valuable. Technology can be incorporated in a production process (e.g., the technology for discovering, extracting, and refining oil) or it can be incorporated in a product (e.g., personal computers). However, many countries lack the research and development resources and skills required to develop their own indigenous product and process technology. This is particularly true of the world's less developed nations. Such countries must rely on advanced industrialized nations for much of the technology required to stimulate economic growth, and FDI can provide it. As we see in the Country Focus on Venezuela, a lack of relevant technological know-how with regard to the discovery, extraction, and refining of oil was one factor behind the Venezuelan government's decision to invite foreign oil companies into Venezuela. FDI is not the only way to access advanced technology. Another option is to license that technology from foreign MNEs. The Japanese government, in particular, has long favored this strategy. The Japanese government believes that, in the case of FDI, the technology is still ultimately controlled by the foreign MNE. Consequently, it is difficult for indigenous Japanese firms to develop their own, possibly better, technology because they are denied access to the basic technology. With this in mind, the Japanese government has insisted in the past that technology be transferred to Japan through licensing agreements, rather than through FDI. The advantage of licensing is that in return for royalty payments, host-country firms are given direct access to valuable technology. The licensing option is generally less attractive to the MNE, however. By licensing its technology to foreign companies, an MNE risks creating a future competitor--as many US firms have learned at great cost in Japan. Given this tension, the mode for transferring technology--licensing or FDI--can be a major negotiating point between an MNE and a host government. Whether the MNE gets its way depends on the relative bargaining powers of the MNE and the host government. Such was the bargaining power of IBM in Japan that it was able to get around Japan's preference for licensing arrangements and establish a wholly owned subsidiary. Management Foreign management skills acquired through FDI may also produce important benefits for the host country. Beneficial spin-off effects arise when local personnel who are trained to occupy managerial, financial, and technical posts in the subsidiary of a foreign MNE leave the firm and help to establish indigenous firms. Similar benefits may arise if the superior management skills of a foreign MNE stimulate local suppliers, distributors, and competitors to improve their own management skills. The benefits may be considerably reduced if most management and highly skilled jobs in the subsidiaries are reserved for home-country nationals. The percentage of management and skilled jobs that go to citizens of the host country can be a major negotiating point between an MNE wishing to undertake FDI and a potential host government. In recent years, most MNEs have responded to host-government pressures on this issue by agreeing to reserve a large proportion of management and highly skilled jobs for citizens of the host country. Employment Effects The beneficial employment effect claimed for FDI is that it brings jobs to a host country that would otherwise not be created there. As we saw in the opening case on Toyota in France, employment effects are both direct and indirect. Direct effects arise when a foreign MNE employs a number of host-country citizens. Indirect effects arise when jobs are created in local suppliers as a result of the investment and when jobs are created because of increased local spending by employees of the MNE. The indirect employment effects are often as large as, if not larger than, the direct effects. The opening case revealed that Toyota's investment in France created 2,000 direct jobs and perhaps another 2,000 jobs in support industries. Cynics note that not all the "new jobs" created by FDI represent net additions in employment. In the case of FDI by Japanese auto companies in the United States, some argue that the jobs created by this investment have been more than offset by the jobs lost in US-owned auto companies, which have lost market share to their Japanese competitors. As a consequence of such substitution effects, the net number of new jobs created by FDI may not be as great as initially claimed by an MNE. The issue of the likely net gain in employment may be a major negotiating point between an MNE wishing to undertake FDI and the host government. Balance-of-Payments Effects FDI's effect on a country's balance-of-payments accounts is an important policy issue for most host governments. To understand this concern, we must first familiarize ourselves with balance-of-payments accounting. Then we will examine the link between FDI and the balance-of-payments accounts. Balance-of-Payments Accounts A country's balance-of-payments accounts keep track of both its payments to and its receipts from other countries. A summary copy of the US balance-of-payments accounts for 1995 is given in Table 7.2. Any transaction resulting in a payment to other countries is entered in the balance-of-payments accounts as a debit and given a negative ( - ) sign. Any transaction resulting in a receipt from other countries is entered as a credit and given a positive (+) sign. Table 7.2 US Balance-of-Payments Accounts for 1995 (figures in $ millions)
Balance-of-payments accounts are divided into two main sections: the current account and the capital account. The current account records transactions that pertain to three categories, all of which can be seen in Table 7.2. The first category, merchandise trade, refers to the export or import of goods (e.g., autos, computers, chemicals). The second category is the export or import of services (e.g., intangible products such as banking and insurance services). The third category, investment income, refers to income from foreign investments and payments that have to be made to foreigners investing in a country. For example, if a US citizen owns a share of a Finnish company and receives a dividend payment of $5, that payment shows up on the US current account as the receipt of $5 of investment income. A current account deficit occurs when a country imports more goods, services, and income than it exports. A current account surplus occurs when a country exports more goods, services, and income than it imports. In recent years, the United States has run a persistent trade deficit. Table 7.2 shows that in 1995 the current account deficit was $113,079. The capital account records transactions that involve the purchase or sale of assets. Thus, when a Japanese firm purchases stock in a US company, the transaction enters the US balance of payments as a credit on the capital account. This is because capital is flowing into the country. When capital flows out of the United States, it enters the capital account as a debit. A basic principle of balance-of-payments accounting is double-entry bookkeeping. Every international transaction automatically enters the balance of payments twice--once as a credit and once as a debit. Imagine that you purchase a car produced in Japan by Toyota for $12,000. Since your purchase represents a payment to another country for goods, it will enter the balance of payments as a debit on the current account. Toyota now has the $12,000 and must do something with it. If Toyota deposits the money at a US bank, Toyota has purchased a US asset--a bank deposit worth $12,000--and the transaction will show up as a $12,000 credit on the capital account. Or Toyota might deposit the cash in a Japanese bank in return for Japanese yen. Now the Japanese bank must decide what to do with the $12,000. Any action that it takes will ultimately result in a credit for the US balance of payments. For example, if the bank lends the $12,000 to a Japanese firm that uses it to import personal computers from the United States, then the $12,000 must be credited to the US balance-of-payments current account. Or the Japanese bank might use the $12,000 to purchase US government bonds, in which case it will show up as a credit on the US balance-of-payments capital account. Thus, any international transaction automatically gives rise to two offsetting entries in the balance of payments. Because of this, the current account balance and the capital account balance should always add up to zero. (In practice, this does not always occur due to the existence of statistical discrepancies which need not concern us here.) Governments normally are concerned when their country is running a deficit on the current account of their balance of payments.7 When a country runs a current account deficit, the money that flows to other countries is then used by those countries to purchase assets in the deficit country. Thus, when the United States runs a trade deficit with Japan, the Japanese use the money that they receive from US consumers to purchase US assets such as stocks, bonds, and the like. Put another way, a deficit on the current account is financed by selling assets to other countries; that is, by a surplus on the capital account. Thus, the US current account deficit during the 1980s and 90s was financed by a steady sale of US assets (stocks, bonds, real estate, and whole corporations) to other countries. Countries that run current account deficits become net debtors. For example, as a result of financing its current account deficit through asset sales, the United States must deliver a stream of interest payments to foreign bondholders, rents to foreign landowners, and dividends to foreign stockholders. Such payments to foreigners drain resources from a country and limit the funds available for investment within the country. Since investment within a country is necessary to stimulate economic growth, a persistent current account deficit can choke off a country's future economic growth. FDI and the Balance of Payments Given the concern about current account deficits, the balance-of-payments effects of FDI can be an important consideration for a host government. There are three potential balance-of-payments consequences of FDI. First, when an MNE establishes a foreign subsidiary, the capital account of the host country benefits from the initial capital inflow. (A debit will be recorded in the capital account of the home country, since capital is flowing out of the home country.) However, this is a one-time-only effect. Set against this must be the outflow of earnings to the foreign parent company, which will be recorded as a debit on the current account of the host country. Second, if the FDI is a substitute for imports of goods or services, it can improve the current account of the host country's balance of payments. Much of the FDI by Japanese automobile companies in the United States and United Kingdom, for example, can be seen as substituting for imports from Japan. Thus, the current account of the US balance of payments has improved somewhat because many Japanese companies are now supplying the US market from production facilities in the United States, as opposed to facilities in Japan. Insofar as this has reduced the need to finance a current account deficit by asset sales to foreigners, the United States has clearly benefited from this. A third potential benefit to the host country's balance-of-payments position arises when the MNE uses a foreign subsidiary to export goods and services to other countries. Effect on Competition and Economic Growth Economic theory tells us that the efficient functioning of markets depends on an adequate level of competition between producers. By increasing consumer choice, foreign direct investment can help to increase the level of competition in national markets, thereby driving down prices and increasing the economic welfare of consumers. Increased competition tends to stimulate capital investments by firms in plant, equipment, and R&D as they struggle to gain an edge over their rivals. The long-term results may include increased productivity growth, product and process innovations, and greater economic growth. FDI's impact on competition in domestic markets may be particularly important in the case of services, such as telecommunications, retailing, and many financial services, where exporting is often not an option because the service has to be produced where it is delivered.8 As we saw in the Management Focus, foreign direct investment has helped increase competition in the South Korean retail sector. The increase in choices, and the resulting fall in prices, clearly benefits South Korean consumers. Under a 1997 agreement sponsored by the World Trade Organization, 68 countries accounting for more than 90 percent of world telecommunications revenues pledged to start opening their markets to foreign investment and competition and to abide by common rules for fair competition in telecommunications. Before this agreement, most of the world's telecommunications markets were closed to foreign competitors, and in most countries the market was monopolized by a single carrier, which was often a state-owned enterprise. The agreement will dramatically increase the level of competition in many national telecommunications markets. Three benefits from this agreement were touted. First, advocates argued that inward investment and increased competition will stimulate investment in the modernization of telephone networks around the world and lead to better service. Second, supporters maintained that the increased competition will benefit customers through lower prices. Estimates suggested that a deal will soon reduce the average cost of international telephone calls by 80 percent and save consumers $1,000 billion over three years.9 Third, the WTO argued that trade in other goods and services invariably depends upon flows of information matching buyers to sellers. As telecommunications service improves in quality and declines in price, international trade increases in volume and becomes less costly for traders. Telecommunications reform, therefore, should promote cross-border trade in other goods and services. In sum, although it is difficult to be precise about these matters, Renato Ruggiero, the director general of the WTO, argued:
Telecommunications liberalization could mean global income gains of some $1 trillion over the next decade or so. This represents about 4 percent of world GDP at today's prices.10 |
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