Hosting Multinational Enterprises

1. Hosting Multinational Enterprises CHAPTER 21

2. Introduction • Costa Rica relies on foreign investment as a central part of its development strategy • Highlighted in late 1990s when Intel built a plant on outskirts of San José • As a result of this and other computer-related foreign investment, computer products accounted for 35 percent of Costa Rica’s exports in 1999 • Costa Rica Investment Board (CINDE) actively pursued this approach • CINDE officials have consciously attempted to promote a computer cluster in Costa Rica • What role does foreign direct investment (FDI) play in international economic development? • Is it a positive or negative force?

3. Benefits and Costs: Employment • If a foreign firm engages in FDI in a home-country sector in which there is unemployment • Benefit • It is possible for the FDI to increase the total number of jobs in the sector • Such direct employment benefits can be supplemented by indirect employment benefits when local firms supply the foreign MNE with intermediate products • Possible Cost • A simple transfer of jobs from local to foreign firms to occur with no net increase in employment

4. Benefits and Costs: Competition • If a foreign firm engages in FDI in a home-country sector characterized by imperfect competition • Possible Benefit • Increased competition in the sector • Tends to lower prices and increase quantities supplied • Possible Cost • In cases where the foreign MNE possesses a large amount of market power compared to the host country firms, FDI could worsen competition

5. Benefits and Costs: Education and Training • Accumulation of human capital via education and training is a crucial component of economic development • Benefit • Possible for foreign MNEs to provide education and training to host country workers that were not available from domestic firms • Cost • Possible for the foreign MNE to restrict education and training to its own transplanted employees and to even discriminate against host country workers

6. Table 21.1. The Benefits and Costs of Inward FDI

7. Benefits and Costs: Technology • Many developing countries lack access to the technologies available in developed countries • MNEs account for approximately three fourths of worldwide civilian research and development • Hosting MNEs from developed countries is one way to gain access to that technology • Problems include • MNEs will employ the technology that most suits their strategic needs • These needs can differ from the development needs of the host country • Empirical fact that most MNEs conduct their research and development in their home bases rather than in host countries • Limits to the transfer of new technologies to host countries

8. Benefits and Costs: Balance of Payments • FDI can affect a few of the components of both the current and capital accounts • Setting up of a production facility in the host country causes an inflow (positive balance) in the direct investment component of the capital account • Tends to improve the balance of payments • If subsidiary experiences positive earnings, some of these earnings will be eventually repatriated to the MNE’s home-base country • Causes an outflow (negative balance) on the net factor receipts component of the current account • If the good produced by the MNE is sold domestically and replaces previously-imported goods • FDI will make the trade balance component of the current account more positive (less negative)

9. Benefits and Costs: Balance of Payments • However, the MNE might import a significant amount of intermediate products • Tends to make the trade balance component of the current account less positive (more negative) • If the MNE exports the good it produces • Tends to make the trade balance component of the current account more positive (less negative) • Net effect of balance-of-payments influences need to be evaluated on a case-by-case basis

10. Table 21.2. Mexican Balance of Payments, 1993 (billions of US dollars)

11. Benefits and Costs: Health and the Environment • In resource extractive industries, certain MNEs have been grossly negligent • Dunning (1993) points out that MNEs are heavily involved in pollution-generating sectors • Affect the location of pollution-intensive production processes • Establish health and safety environments of their workforces • Involved in the international trade of many hazardous products • Sometimes, MNEs have utilized production technologies in host countries that were banned in their home countries

12. Benefits and Costs: Culture • MNEs serve as conduits of their home countries’ national and business cultures • Sometimes introduce new goods with cultural content into host countries • Can further the dominance of urban and Western culture over rural and non-Western culture • May exacerbate already existing tensions between these cultural/regional poles • MNEs can introduce progressive elements of business culture into their host countries • Such as new practices in the areas of organizational development and human resource management

13. Policy Stances • Can be grouped into • Ownership requirements, which may • Be absolute—as in the case of foreign firms being excluded from certain sectors on national security grounds • Limit foreign ownership to a maximum specified amount • Performance requirements • Place controls on the behavior of the foreign firm in a number of areas • Local content requirement • Requirements in the areas of training, technology transfer, exports, local research and development, and the hiring of local managers • Usually settled in negotiations between the host-country government and the foreign MNE

14. Policy Stances • Many of the requirements are also known as trade-related investment measures (TRIMs) • Marrakesh Agreement on Trade in Goods included an Agreement on TRIMs • Prohibits some types of TRIMs in the case of goods, including • Domestic content • Trade balancing • Foreign exchange balancing • Domestic sales requirements

15. Table 21.3. Types of Trade-Related Investment Measures

16. Table 21.3. Types of Trade-Related Investment Measures

17. Policy Stances • A number of countries offer potential MNEs located incentives in the form of tax breaks • “Customs-free zones” in which tax rates have been lowered • Set up an export processing zone or EPZ • Area of the host country in which MNEs can locate and enjoy, in return for exporting the whole of their output, favorable treatment in the areas of • Infrastructure, taxation, tariffs on imported intermediate goods, and labor costs • Popular policy • Usually involve relatively labor-intensive, “light” manufacturing • Such at textiles, clothing, footwear, and electronics • Studies show that in many cases, benefits outweigh costs • Accumulating evidence that net benefits can be gained by promoting linkages between foreign MNEs and host-country firms

18. Promoting Linkages • One way of maximizing benefits of FDI in areas of employment and technology is through facilitating use of local suppliers on part of foreign MNE • Backward linkages have historically been weak • Particularly in developing countries • Increased role of MNEs in an economy without significant backward linkages results in “enclaves” • Little connection to the rest of the economy and little contribution beyond direct employment effects

19. Promoting Linkages • New thinking suggests that local content requirements should be replaced by efforts to support local suppliers in their efforts to secure contracts with foreign MNEs • If a foreign MNE can be induced to source inputs locally, a number of important benefits can result • Employment can increase since the sourced inputs are new production • Balance of payments can improve since the inputs will no longer be imported • Production technologies can be better adapted to local conditions • Tangible and intangible assets can be, to some degree at least, passed from the foreign MNE to the local, host-country suppliers • Local suppliers can coalesce into a spatial cluster that supports innovation and upgrading

20. Promoting Linkages • How to foster backward linkages between foreign MNEs and potential local suppliers? • Process involves many players, including • Government • Foreign MNEs • Local suppliers • Professional organizations • Commercial organizations • Academic institutions

21. Role of Government in Promoting Linkages • The key role of the government is one of coordination • Attempting to bridge “information gaps” among players • Information • Attempts can be made to provide a matching service between MNEs and local suppliers • Technology • Provide support in standards formation, materials testing, and patent registration • Human resource development • Provide technical training and managerial training • Finance • Remove obstacles to access on the part of small firms • Efforts in these and other areas typically must be coordinated by a lead agency

22. Transfer Pricing • A common practice among MNEs that can sometimes be detrimental to the countries hosting them • Problems arise from the fact that MNEs are global corporations, whereas tax systems are locally defined • MNEs can therefore adjust the internal pricing of their intra-firm trade to shift declared profits of subsidiaries to low-tax countries • Goal is to maximize the post-tax profits of the firm • Solution is multifaceted • Options include • International guidelines and codes of conduct • International standardization of invoicing and customs procedures • Global tax harmonization • Negotiating and concluding international conventions • Establishment of international arbitration procedures

23. Institutional Considerations • No counterpart to the GATT/WTO and IMF exists in the realm of international production • The institutional framework for international production is confusing • Organization for Economic Cooperation and Development (OECD) promotes multinational approaches to FDI and has sponsored • 1961 Code of Liberalization of Capital Movements • 1976 Declaration of International Investment and Multinational Enterprises • In 1991, tried to develop a comprehensive set of investment rules but failed

24. Institutional Considerations • Any further progress in this area should take place under the auspices of World Trade Organization (WTO) in future multilateral trade negotiations • WTO possesses a number of advantages over the OECD • Much more representative membership in comparison to the OECD • Experienced in developing managing complicated negotiations and rules • Has a dispute settlement mechanism already in place • Some argue that given the close links between trade and investment, the WTO is a natural venue • More scope for compromises and tradeoffs between issues • Option exists of developing a plurilateral agreement, which only a subset of members would sign