Fdi and Its Impact on Host Country Essay
Fdi and Its Impact on Host Country
Balance of payment
Transaction between one specific country and all other countries in a specified time period is balance of payment. It compares the cash inflow and cash outflow. For a healthy economy there should be balance in cash inflow and outflow. FDI has a vital role in maintaining balance of payment. With the introduction of FDI there is increase in the production and export for a host country. And increasing export increases cash inflow to the host country. Again when host country makes payment to other country or imports goods, there is cash outflow. So this whole process makes balance of payment. Balance of payment is one factor that helps develop the economy of a country and FDI has helped maintain the balance of payments of these countries due to the above mentioned activities.
Multinational enterprises are huge in nature. They need huge workforce to carry out their operations. When an MNC operates in a host country, it provides employment opportunities to many people. Along with employment they provide, good salary and other benefits and allowances. As a result, there is an increase in employment rate, per capita income as well as the standard of living of people improves in that particular country. Indeed, MNCs are a good source of income and employment for the host countries. It is only through the engagement of people in income generation activities that the economy of a country can boost and the financial sector can improve. Coca Cola, KFC, Dabur, Hyatt Regency and Pizza Hut are some of the MNCs operating in Nepal that have been employing huge number of Nepalese workers.
Before MNCs started their operations in the host countries, there could have been local firms that were monopolizing the markets. Consumers in the host country might be paying high prices for certain product and services that are not of good quality. This comes to an end when MNCs enter these markets because MNCs are definitely superior in terms of quality of products and services that they provide. The local firms have to provide good services and products to the customers in order to compete with the MNCs and to continue operating. This consequently improves the productivity, effectiveness and efficiencies of the local firms and the consumers too are directly benefited by quality products and services due to the competition among the firms
Source of income and tax revenue
MNCs are sources of income to the host countries in many ways. One such way through which the host countries can earn huge amount of money is the tax revenue. MNCs are large organisations which operate in large scale and their profit is also big. They are one of the huge tax payers to the host country because tax is paid in terms of profit made. Additionally, the operation of local firms that operate and collaborate with these MNCs too increases. The export of national products in international markets rises up with the links that the local firms can have with the help of MNCs. In the same way, the probability of financial borrowing within the host countries too increases and the interest charged on the huge borrowing is also a source of income to these countries. Thus it is clear that MNCs are good and huge sources of income which eventually improves the economies of the host countries.
Negative effects of FDI in host country
Transfer price is the price that an organisation buys or transfers its product and services from its subsidies organisation or related organisation. The main objective of FDI is to generate maximum profit. For this purpose they always try to minimize their tax liability and transfer pricing is one of the ways to do it. When they import materials or expensive equipment to the host country they lower the transfer price to minimize custom duties.
Sometimes because of host country’s foreign exchange restriction it becomes difficult for MNCs to transfer profit to the home country organisations. Therefore they high transfer price on export to the foreign nations and low transfer price on import to the host country. This way they can shift their profit away from host country. And if host country government uses price control policies, they high transfer price for import of materials from other countries and sell it for low price so, that they can show loss. MNCs do this kind of activities to avoid or minimize tax liability, which is a huge loss for host country.
Threat to small domestic industries
Foreign direct investment has various negative affect on host country, especially for small domestic industries its one of the biggest threat. Multinational organisations are generally big organisations; they have huge capital, skilled labour and possess latest technologies. They are international organisations that can compete in global market. It’s not easy for small domestic organisations to compete against them. Usually government of host countries provide protection to their domestic industries but when they welcome FDI, it might also create a situation for them to shut down their business.
And ultimately people involved in those industries will lose their jobs. With the increase in unemployment and shutting down of the domestic industries, slows down the economic growth in host country. For an example with the establishment of KFC restaurant in Nepal, although people have got chance to experience international standard of fast food but it has also become threat to small domestic restaurant. People are more attracted to KFC because of its brand, popularity and sophisticated outlet. Therefore small fast food restaurants are losing their business.
Crowding out effect
MNCs are organisations with huge investment. If they borrow in domestic economy, they borrow large amount of total supply of saving available for investment. With such large amount of borrowing, there will be increase in demand for savings but the supply remains same which leads to increase in the interest rate. Crowding out effect starts when interest rate reaches to such a level that individuals and small organisations can’t afford to borrow money. Eventually they have no other option than getting out of the business. Individual and small organisations consumption decreases because of crowding out effect, slowing down the host country’s economic growth.
Influence and political pressure
Many MNCs have sales revenue that is bigger than the budget of the developing host countries. These countries including other host countries believe that their economic growths totally depend on the FDIs conducted by MNCs and there are some who view FDIs as a major and important source of income. These countries in order to hold these investments for long term and attract other MNCs go to any extend. They develop plans and policies in favour of the MNCs not considering what might happen to their economies. MNCs too take full advantage of this and force the governments to work according to what they want. This intentionally or unintentionally affects the economies of these countries in a negative way.
Outflow of national currency and inflation
It is true that MNCs are good source of FDIs and capital in host countries but the incomes that they generate by operating in these countries cannot be considered as a part of national income because these corporations send profits and incomes back to their home countries. Indeed, the national currencies of host countries goes out when they transfer huge sum of money to home countries as part of their profit, dividends and royalty. As a result, this creates imbalance in payment in host country because currency outflow becomes more than inflow of currency, which also depreciates the value of host countries’ currencies.
FDI is one of the strategies of MNC to enter into foreign market. They can do it as a ‘Greenfield’ where MNC starts its operational facilities from zero level. They have their own manufacturing, marketing and administrative facility. Or as ‘merger and acquisition’ where MNC acquires existing facilities. FDI can be classified in terms of form, ownership and level of integration.
MNCs invest in foreign countries searching for resources and assets, market place and efficiency. Although FDI help developing countries to boost up their economy create employment opportunities, make balance of payment and etc. FDI also have negative effect to them. Therefore before permitting them to operate in country, government should analyse their intention and what benefits and drawbacks they can have in country’s economy because not all MNC are beneficial for country.
University/College: University of Chicago
Type of paper: Thesis/Dissertation Chapter
Date: 19 November 2016
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