Assessing the role of MNCs in fostering economic development in low income countries
By Luciano Figari Student number 604636 SOAS, University of London Graduate Diploma in Economic
Introduction: MNCs - powerful actors in the global economy A transnational corporation (TNC) is a company that operates in more than one country, whereas a multinational corporation (MNC) operates in several countries. MNCs‟ parent companies are located in a „home country‟ and have foreign affiliates in „host countries‟ (Harrod, J.W.J. 2007). According to this definition, in 1998 there were 60,000 MNCs in the world, owning 500,000 foreign affiliates. In 2012, about 80% of global trade was linked to the international production networks of MNCs (UNCTAD, 2013: 13). With the expansion of the Washington Consensus over the last 30 years, developing countries have become increasingly popular destinations for Foreign Direct Investment (FDI) by MNCs. Some of the causes of the increasing popularity of FDI in developing countries include the liberalisation of their capital accounts, the introduction of investment-friendly policies, the privatisation and sale of their public enterprises and the new international division of labour (Bargawi, 2014). Consequently, in 2012, for the first time in the history of humanity, developing countries absorbed more FDI than developed economies, as Graph 1 (UNCTAD, 2013: 3) shows: Graph 1
When MNCs enter host countries they seek new market opportunities, efficiency, resources or try to buy up foreign assets (Dunning, 1993). Therefore, when MNCs enter Low Income Countries (LIC) their main objective is to expand their operations in order to increase their profits regardless of the impact that their activity will have on the development of the host country. According to the World Bank (2014), LICs are those with a gross national income of $1,035 or less. The IMF (2003, 34) notes that, almost by definition, LICs are those that do not attract 1 of 8
significant private capital. Hence, MNCs are an important source of finance for LICs. As Lapalombara (1984: 13) notes: “What may be a small investment in a relatively minor operation by New York or London boardroom standards can be of crucial importance to the economy of the host nation”. The Nobel laureate in economics Joseph Stiglitz (2007: 187-188) gives a good example of the disproportion between the huge amounts of money that MNCs handle and the size of LIC economies when he mentions that U.S. retailer Wal-Mart‟s 2005 revenue was larger than the combined GDP of all sub-Saharan Africa countries. In this context, a fierce debate has arisen over the role of MNCs in fostering economic development in LICs. This essay reviews some of the main arguments on both sides of the debate. It concludes with some thoughts on the consequences of the findings.
Part 1: MNCs - the two sides of the coin a) Effects of MNCs on wages and working conditions
A common argument defending the contribution of MNCs to development is that they pay higher wages that their local counterparts (Bhagwati, 2007: 216). Several studies have found evidence in this direction. For example, a study of the OECD (2008) concluded that MNCs pay wages that are 40% higher than those paid by local firms. The study indicated that the average wage gains were partly caused by changes in the skill composition of firms after foreign takeovers and couldn‟t clarify the effect of expatriate wages. It should be noted that an increase in income without an improvement in working conditions doesn‟t necessarily mean development. Average wage increases directly affect economic growth more than economic development (Ahiakpor, 1990: 19). Meier (1989, 21) shares Ahiakpor‟s opinion and points out that the development experiences of Mexico and Brazil during the 1970s reinforce this argument. On the other hand, the 2008 OECD study concluded that foreign takeovers had little or no effect on working conditions. It also found that European MNCs have the most extensive formal policies relating to labour standards, while North American MNCs have the least extensive policies. These different labour standards can be explained by the different national cultures upon which the headquarters of the firm draws. There can even be differences between firms from the same country due, for example, to the religious views of the founders or the size of the firm (Buckley & Casson, 1991: 28). The Nobel laureate in Economics Joseph Stiglitz goes one step beyond this and states that when MNCs operate in host countries their moral responsibility is weakened. “Many executives would not even contemplate treating their workers or the environment at home the way they routinely do abroad. They may reason that overseas regulations are lax, that workers are lucky to have jobs, or that overall the country benefits from their investment”, Stiglitz says (2007, 196). 2 of 8
b) Effects of MNCs on inequality
Critics argue that penetration of MNCs in LICs goes together with higher income inequality. Moreover, they say that high income concentration will adversely affect LICs‟ investment and reduce mass consumption because the savings of the rich in LIC are only translated to investment or consumption to a limited extent. Even if there were considerable savings they would likely be channelled into non-productive investments (Bornschier and Chase-Dunn, 1985: 133). In Graham‟s view (2000: 86) there is nothing wrong with higher income inequality because it‟s the result of skilled workers earning more and not the result of unskilled workers earning less. However, Graham‟s view can be criticized because an increase in skilled workers‟ wages increases price levels; and if unskilled workers, who usually are in the weakest bargaining positions, don‟t adjust their nominal wages to the inflation rate, then their real wages will be lower. Trajtenberg (1978) signals the enormous difference between wages paid by MNCs in their home countries and those paid in host countries. For example, in 1971 in Haiti the minimum daily wage in the industrial sector was of $1 and MNCs paid $1.60 a day, whereas in their home country they paid $25 a day for the same job. This kind of wage differential maintains the inequality between the workers of the centre and those of the periphery. c) Effects of MNCs on unemployment
Another argument against MNCs is that they intensify structural unemployment because their production is usually excessively capital intensive in relation to the abundance of cheap labor in LICs (Bornschier and Chase-Dunn, 1985: 133). Ahiakpor (1990: 21) gives a counterargument to this reasoning in pointing out that the use of more machinery increases the demand for more skilled personnel in substitution for unskilled labour. This counterargument is consistent with the conclusions of an OECD study (2008). d) Effects of MNCs on technology transfer and spillovers
MNCs usually employ more advanced technologies and techniques than domestic firms. Therefore, it is expected that they will contribute significantly to the growth potential of the host countries. The technology transfer to the host country can occur either when an MNC acquires a domestic firm and restructures its production model or when an MNC trains their subcontractors. Spillovers of technology and techniques can also occur when workers move from MNCs to domestic firms or when domestic firms acquire new technologies to compete against MNCs. However, Germidis (1984, 249) says that the transfers of technology to subcontractors are very limited because they only take place when a subcontracting agreement is the first step towards a joint venture or, in some cases, when the MNC gives technical assistance to enable the subcontractor to comply with its standards.
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In order to avoid leakages to their competitors, MNCs usually concentrate their research and development activities in their home countries (Newfarmer, 1985). This situation, combined with the fact that most of the foreign patents in LIC are held by MNCs, increases the technological dependence of LICs, which has a negative effect on GNP per capita growth, according to Meyer-Fehr (1980). On the other hand, spillovers through movement of labour seem to be more effective than technology transfer. After analysing firm-level data from a sample of manufacturing firms in Ghana, Görg and Strobl (2005) demonstrated that when workers trained in MNCs move to domestic firms or create new start-ups they often apply the knowledge they gained whilst working for foreign firms. e) Effects of MNCs on Domestic firms
Dos Santos (1970) argues that MNCs outperform local firms because they employ better technologies, techniques and marketing strategies. In this sense, Lapalombara and Blank (1984, 90) cite a Brazilian industrialist who complained that MNCs operations in his country had increased the already existing competition gap between them and national firms. If MNCs use X units of savings, raw materials, land or labour, logically domestic firms cannot use those same X units of resources. That is why there exists an opportunity cost to the employment of resources of the host country by MNCs. However, Ahiakpor (1990: 60) points out that if MNCs didn‟t operate in LICs, some resources may not be employed. Therefore, the very presence of MNCs in LICs may be beneficial for the economy if resources are being underutilized. Critics claim that when MNCs enter a LIC through mergers, acquisitions or privatisation they don‟t really add anything new to the host country‟s economy because they only continue operating an already existing firm. However, MNCs tend to improve the efficiency of privatised firms by employing new technologies and using managerial skills, thus adding value to the economy (Boubakri et al., 2009). Moreover, when local firms are bought by foreign firms, their purchase prices constitute potential investment funds which can be employed elsewhere in the economy of the host country (Ahiakpor, 2007: 23). Additionally, the bullish investment climate that accompanies privatization policies has a wake-up call effect amid domestic and foreign investors, multiplying investment in the LIC and therefore contributing to its economic growth (Boubakri et al., 2009). f) Effects of MNCs on finances
MNCs expand the host country‟s GDP by contributing to the stock of capital, technology and access to foreign markets. They also relieve the shortage of financial capital that most LICs have and make increased production possible (Ahiakpor, 1990: 23). However, according to Bornschier and Chase-Dunn (1985), the positive effects of MNCs only last for the short term and in the long run the presence of MNCs in the host country has a negative impact.
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Taxes paid by MNCs can be considered an important contribution to the development of LICs, considering the pivotal role Governments play in redistributing income and wealth (Meier, 1984: 324). MNCs‟ greater capacity to export can also improve LIC Government finances because they increase the volume of foreign reserves (Ahiakpor, 1990: 24). However, in the short term MNCs‟ activities worsen host countries‟ balances of payments because they excessively import capital equipment (Frank, 1980: 96). Furthermore, many analysts accuse MNCs of illegally extracting huge amounts of money from LDCs through a mechanism known as “transfer pricing”. “Transfer pricing” consists of inflating the value of MNCs‟ imports to the host country (technology, machinery, materials, amongst other factors) and undervaluing their exports. This process is feasible because intrafirm trade between parent firms and foreign affiliates accounts for a major part of MNCs‟ transactions. By inflating imports and undervaluing exports MNCs can dodge host countries‟ foreign exchange restrictions or shift profits from high-tax jurisdictions to those with low taxes. According to this argument, the amount of taxes MNCs avoid with transfer pricing more than offsets what they pay (Natke, 1985). After Frank (1980, 96) interviewed several MNCs, only five admitted using transfer pricing to gain special advantages and no-one admitted using this mechanism to evade host country taxes. Ironically, several interviewees maintained that the use of special transfer prices is probably widespread among MNCs. g) Effects of MNCs on Governments
MNCs are politically powerful in LICs because if the Government decides to tax them or regulate them in ways they don‟t like, they threaten to move to another country, taking with them jobs and investment. This wouldn‟t be an issue in a perfectly competitive market but some industries, for example mining or oil, have large barriers of entry; the development of mines or oil fields are risky investments that cost billions of dollars. Therefore, if an MNC leaves a LIC, another MNC may never come to fill the gap or, if it does, it may demand even more unfavorable terms (Stiglitz, 2007: 187-195). In some cases, MNCs may even go from threat to action. A popular example among MNCs‟ critics is the active role that U.S. MNCs Pepsi and ITT played in the coup, overthrow and de facto assassination of Chilean President Salvador Allende. Pepsi and ITT‟s involvement in Chile‟s coup d‟etat was a reaction to Allende‟s leftist economic policies towards foreign investment (Bhagwati, 2007: 214). Lapalombara and Blank (1984, 14) note that armed intervention to protect foreign owned property was common long before the era of the MNC, so it is logical to see this trend continuing over time. Stiglitz (2007: 191) adds that MNCs in many industries pay bribes to Government officials to get all manner of favours, such as protection from outside competition or the overlooking of violations in environmental or safety regulations.
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h) Effects of MNCs on Host Country consumption
Some LIC assert that MNCs produce inappropriate products because their goods and services are “too sophisticated, too highly designed and too elaborately packaged� to meet the needs of the poor masses (Frank, 1980: 73). In this sense, MNCs are accused of introducing products which only satisfy the tastes of a rich minority, failing to increase the general welfare of LIC populations (Griffin, 1977). Jenkins (1988) stressed that MNCs promote the consumption of these inappropriate products through heavy advertising campaigns. However, three years later the same author (1991) conducted a cross sectional study which revealed that foreign-owned companies spent slightly more on advertising relative to sales than domestic firms did.
Conclusion: MNCs - double-edged swords MNCs can have both a positive and a negative impact on the development process of LICs. They can stimulate growth, increase wages, transfer technology and generate spillovers of knowledge. In the same way, they can avoid taxes, bribe Government officials, increase inequality, intensify unemployment or even overthrow a democratically elected Government. Any generalization about relationships between LIC and MNCs inevitably oversimplifies a highly complex issue. LICs represent a wide diversity of colonial experiences, market sizes, political orientations and cultural attributes. Likewise, MNCs behaviour depends on a number of variables such as the sector in which they operate, the country in which their headquarters are located or the religious beliefs of their founders (Frank, 1980: 25). It is therefore impossible to draw a final conclusion stating whether MNCs are beneficial or detrimental for the development of LICs. Case studies can be found showing evidence in both directions. Consequently, each case should be carefully analyzed individually and the temptation to extrapolate its results to every situation should be avoided because, as this essay has shown, MNCs are double-edged swords.
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