Assess the role of multinational corporations in fostering economic

development in low-income countries.

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According to the World Trade Organisation, the leading multinational corporations
control around 70% of global trade and this percentage has been rising over the
last twenty years. Multinational corporations (MNCs from now on) have become
extremely influential on the global economic landscape. They take advantage of
their economies of scale dominating certain industries where output and markets
are oligopolistic. For instance the five leading car and truck manufacturers are
responsible for around 60% of global motor vehicle sales, the top five oil companies
take up over 40% of oil sales worldwide.

The sheer size and the copious amounts of revenue that MNCs generate has made
them an important source of external finance to low income countries (LICs from
now on). This raises the question of the role they play in fostering economic growth
in LICs. Some authors applaud them saying they provide LICs with much needed
capital and are essential to the growth process. Moreover, LICs gain productivity
capabilities from spill they receive from MNCs. They view these acquired skills as
the spring board that will shift LICs from an inward to an outward looking
economic approach leading to industrialisation.
Others argue that MNCs exploit workers in LICs paying them measly wages and
crowding out domestic firms lacking their knowhow, technology and economies of
scale. The debate on the role that MNCs perform as an engine of growth is one that
is ongoing amongst economists. Most agree that low income countries are in dire
need of capital inflows but they disagree on how MNCs spur economic growth in
LICs.

This essay joins the debate and assesses the theoretical and empirical evidence and
comes to the conclusion that the benefits of capital flows to LICs via MNCs are
swallowed up by their profit seeking motives. As such the impact they have on
economic growth in low income countries is negligible. The first section briefly
defines MNCs and their scope. Next it assesses their role as conduits of capital
accumulation. We then explore the potential of spill overs from MNCs as a means
of productivity increases in LICs, bringing us to the argument of quantity versus
quality investment before concluding our assessment.

FDI and MNCs
FDI differs from other forms of capital flows in that there is an element of
ownership and management of a firm in another country. An important criteria for
FDI is that there has to be an ownership of at least 10% of the entity which gives
the investor some level of influence in decision making. There are many theories
that suggest that FDI directly impacts growth through capital accumulation and
introduction of new technologies and indirectly through the potential of spill overs
from technology and expertise to low income countries Although empirical evidence
on the impact of FDI on growth is mixed and ambiguous, there are studies that
show FDI does have a positive impact on economic development in low income
countries (Kose et al., 2009)

FDI is conducted by MNCs that usually have operations in more than one country
and operate typically in a number of global markets. Although they could easily
export to other countries, they prefer to take advantage of owning the subsidiary,
internalising their operations and the location of the host countries. This allows
them to protect their brand, technology and business strategies. They are capitalist
enterprises and as such are driven by the need to maximise their profits. They
provide much needed investments to LICs and simultaneously fulfil their own
commercial motives such as exploiting new markets for their sales, seeking optimal
efficiency via lower labour and resource input costs, securing control of strategic
Assess the role of multinational corporations in fostering economic
development in low-income countries.

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natural resources that will enhance their profits. MNCs contribute around 10% to
global GDP and about two thirds to global exports which means they are hugely
influential in the capital accumulation process of LICs the topic of our next
discussion.

Capital accumulation
Low income countries are labour abundant but poor in capital due to lack of
savings. To fill this savings gap low income countries rely on capital flows such as
FDI to accumulate capital that will assist in the growth process. Between 1993 and
1999, FDI in Asia averaged 8.5 %, Africa 7.5% and Latin America 14.1%. From
2003 to 2005 the average level of FDI expressed as a percentage of new capital
flows to developing countries was 10.9% (UNCTAD 2007:19). An example of this
capital accumulation at work is illustrated in the case of India and LG electronics a
South Korean MNC. LG invested heavily in the Indian market in 1997 by building
production plants and distribution networks for their electrical products. From the
ensuing capital accumulation through taxes and adoption of new production
methods, India was able to form its own electronics companies such as BPL who
have become competitive in the domestic market (Verma 2007).

However some economists argue this capital does not always stay in LICs as MNCs
use what is called transfer pricing to avoid paying taxes on profits. This allows
MNC subsidiaries to overcharge or undercharge each other to keep profits higher in
countries with low corporate tax. This was the case in Zambia where Mopani Mines
a subsidiary of the MNC Glenore was practising transfer pricing. A report revealed
that the Glencore subsidiary had an unexplained increase in operating costs of over
$380 million in 2007 and copper was being sold to Glencore at below market
prices. Consequently this lowered Mopani Mines net income substantially for the
periods between 2003 and 2008 lowering their tax obligations by millions of dollars
(OECD watch 2011). This loss of revenue is detrimental and retards the growth
process of Zambia. Although regulation exists (OECD guidelines) LICs do not have
the administrative capacity to see that they are carried out. LICs could pre-empt
such issues by negotiating better deals with MNCs before they set up shop. Clearly
investment by MNCs in such cases (which are all too common in LICs) does not
materialise into capital that can foster economic development.

This bargaining power that MNCs have has led to economists worrying that LICs
will face a race to the bottom on tax concessions as they compete with one another
in an effort to attract investment. Consequently LICs end up losing out on taxes as
they offer lower taxes than other LICs. For instance the Ugandan government fears
that tax incentives amongst Eastern African Community nations have become
harmful and are leading them to a race to the bottom. In 2010, the African
Development Bank estimated Ugandas losses due to tax concessions and
exemptions to be 2% of GDP which is around US$272 million (ADB 2010). LICs
could avoid this race to the bottom by having united regional trade treaties that
would reflect the same level of tax regulations across the region. Some scholars
argue that actually MNCs do not gain from these tax concessions due to the
competition from other MNCs who are attracted by the same tax breaks and they
still have to pay taxes as these are merely concessions. Nonetheless these tax
incentives seem to be counterproductive to the economic growth of LICs.
Additionally MNCs will usually take their profits back to their countries leaving a
small fraction in the host country in what is known as capital flight and some
MNCs repatriate their profits to dummy corporations in tax havens to avoid paying
taxes. It is estimated that Africa loses $148 billion annually to capital flight, four
times the amount received in foreign aid (ISS 2011). Still on the topic of capital
Assess the role of multinational corporations in fostering economic
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accumulation we now turn our attention to privatisation as a vehicle for capital
accumulation.

Privatisation
Evidence suggests that MNCs prefer to acquire existing companies as opposed to
investing in Greenfield investments possibly to avoid the cost of building new
facilities. Thus the majority of FDI in LICs has been through mergers and
acquisitions resulting from the privatisation of state owned enterprises. For
example Mexico was one of the top recipients of FDI in 2001 but 71% of investment
went to the acquisition of existing companies (Gazcon 2002). Whether this is an
avenue for capital accumulation is debateable because MNCs may engage in what
is known as asset stripping which is buying an undervalued company and selling
off its assets. For example in the 1990s, Spanish airline Iberia purchased some
Latin American airlines, swapping newly bought planes to use in Spain and giving
its old planes to the Latin American airlines. These old planes were used by the
Latin American airline but due to maintenance costs and poor service records some
airlines went out of business (Chang 2007). Nonetheless most economists do agree
that MNCs do offer LICs potential productivity increases via their managerial and
technological expertise in what has been coined spill over effects.

Spill over effects
One of the main arguments for MNCs fostering economic development in LICs is
that of spill overs that will flow from the technological and management techniques
that MNCs possess. The argument is that domestic workers will learn new
production techniques from MNCs, taking this new knowledge with them when
they join domestic firms. Gorg and Strobel (2005) used firm level data for a sample
of manufacturing firms in Ghana. They found that when workers trained by MNCs
moved to local firms they were more efficient than their colleagues. However it
could be argued that MNCs have no interest in training staff. Apple for instance
only need cheap labour to assemble iphones in Taiwan and Singapore, high skilled
labour is not needed hence there is no potential for productivity increases.

Some studies have shown that the effect of spill overs will depend on the
commercial motive of the MNC. If for instance the motive is resource seeking such
as mining which is capital intensive the spill over effects will be much less
compared to a manufacturing investment that requires a higher skill level. These
spill over effects will potentially spur economic growth by enabling increased
productivity capabilities in the host nation. However Aitkens and Harrison (1999)
found negative effects of spill overs from MNCs investment on a sample of
Venezuelan manufacturing plants between 1976 and 1989. The MNCs investment
decreased labour productivity by taking business away from domestic firms, forcing
them to have higher costs.


Spillover effects also depend on the size of the host nations domestic market and
its industrial capabilities. LICs with small markets and weak local industries tend
to have MNC subsidiaries with reduced or truncated operations. These truncated
subsidiaries which are usually sales and marketing offices or resource extracting
investments offered LICs little in the way of productivity increasing spillovers (Lall
& Narula 2004). Bigger countries i.e. Brazil and India that did have technological
capabilities had less truncated subsidiaries and often had higher value added
investment projects such as research and development. This was instrumental in
enhancing their transition to becoming middle income countries.

Assess the role of multinational corporations in fostering economic
development in low-income countries.

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Quality and not quantity of FDI
MNCs will usually take factors such as favourable location, strong capabilities and
agglomeration economies before they set up production plants in developing
countries. In other words the absorptive capacity of the host nation will determine
the quality of FDI that MNCs will provide. So countries with strong absorptive
capacity are likely to receive higher quality FDI with greater potential to enhance
the productive capabilities of local workers.

For example prior to liberalisation during its ISI period, South Korea managed to
establish industries that had some level of technical ability and they had a highly
educated work force. Moreover the government targeted specific sectors keeping out
any investment that was not deemed necessary. They adopted policies that
promoted technological investment such as subsidies and building infrastructure
while simultaneously supporting training, special programmes that encouraged
relationships between firms and universities as well as coordinated learning across
firms. They imposed transfer requirements to domestic firms to encourage
technology transfer and they advocated joint ventures and licensing between MNCs
and domestic firms (Nicolas 2003). The existence of this absorptive capacity
attracted MNCs to invest in South Korea. However, liberalisation has increased the
bargaining power of MNCs making some policy measures that South Korea used
such as local content requirements no longer possible.

Exploitation of labour
Most LICs focus on the quantity of FDI as they use their comparative advantage in
labour. This has led to an argument that MNCs exploit labour by paying very low
wages. MNCs such as NIKE are said to exploit workers in LICs subjecting them to
very long hours with low pay. For example the average hourly wage in Vietnam paid
by foreign owned businesses was merely 0.42cents in 1998 (Glewwe 2000). Other
scholars however argue MNCs on average pay wages higher than those paid by
domestic firms. Furthermore to be competitive domestic firms have to increase
wages to attract workers. A study carried out on the Indonesian manufacturing
sector in 1996 found that domestic firms that were in sectors that had a greater
MNC presence paid higher wages (Lipsey and Sjoholm (2001). So it could be argued
that MNCs actually contribute both directly and indirectly to growth via high wages
which will lead to higher consumption.

Productivity gains
The presence of MNCs also creates competition which forces domestic firms to be
more efficient and innovative. In a bid to survive, domestic firms could imitate the
MNCs production techniques or they could innovate their existing techniques
leading to higher productivity. However in some cases this could lead to crowding
out of local firms by the larger more resourceful MNCs. Agosin and Machado
(2005) found evidence of crowding out in some LICs in Africa and Latin America
their study found that positive impacts of FDI on domestic investment were not
guaranteed. In contrast, domestic firms having acquired skills from MNCs could
create their own local industrial sectors. These sectors could also learn how to
export from MNCs who have established distribution networks and have business
experience of dealing in other markets. This could lead to the sectors growing to the
point where they crowd out MNCs which was the case in South Korea where the
electronics sector has expanded and become more competitive crowding out MNCs.

Conclusion
Most economists agree that MNCs provide LICs with capital that plugs their
savings gap allowing them to be productive thereby fostering economic
Assess the role of multinational corporations in fostering economic
development in low-income countries.

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development. More importantly they offer LICs the potential of spill overs in
technology, managerial expertise, export capabilities and possible wage increases.
Attributes that will allow them to increase productivity and enhance economic
growth. However a closer look at the impact MNCs have on fostering growth in
LICs shows some interesting results. Firstly it is debatable whether capital does
accumulate, what with capital flight, tax avoidance and transfer pricing being
practised by MNC it is clear that it is more a case of capital transit than
accumulation. Secondly evidence on spillovers suggest MNCs will only offer high
quality FDI to LICs with absorptive capacity while those who dont have this
capacity will have little in the way of productive spillovers. Finally existing
regulation favours MNCs giving them more bargaining power in negotiations with
LICs and naturally they will exploit this to their advantage. As such the productive
growth enhancing effects that MNCs are supposed to provide to LICs are engulfed
by their need to optimise profits hence their impact on fostering economic growth is
negligible.
Assess the role of multinational corporations in fostering economic
development in low-income countries.

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