Discuss the impact of FDI inflows in developing countries in terms of the direct and indirect implications...

Discuss the impact of FDI inflows in developing countries in terms of the direct and indirect implications that the FDI has for the national income, employment, balance of payments etc. in the host economies.

FDI inflows, generally, have important direct and indirect implications for the national income (output), employment, balance of payments, technological capability, market structure, and other parameters of development in the host economies.

FDIs comprise inflow of productive resources, such as, capital and foreign exchange are, generally, accompanied by flow of entrepreneurial and managerial skills and technology. FDIs complement the domestic savings in financing the capital formation in the host country. Thus FDIs contribute to the generation of output and employment. The foreign exchange inflow augments the supply of foreign exchange, which is often scarce in the developing countries. In most cases, however, the project being set up with FDI is dependent upon imported plant and machinery, and technology. The foreign exchange inflow takes care of these import requirements, partially or fully.

The direct cost of FDI to the host country comprises remittances made on account of dividends on the equity held abroad, interest on loans or suppliers’ credits extended by the foreign investors, royalties and technical fees, for transfer of technology and other services provided by the foreign partner.

Unlike foreign borrowings, servicing remittances, viz., dividends in the case of FDI begin after the project starts making profits. However, the servicing burden of FDI builds up very fast, and consumes considerable foreign exchange resources of the host country. Further, these remittances have the tendency to grow over time as the enterprise consolidates and prospers.

Thus, the direct impact of FDI on the host country includes both positive and negative aspects. The favourable impact is by way of generation of output and employment by complementing the domestic savings and bringing in the much-needed entrepreneurial skills and foreign exchange resources for the developing countries. The adverse impact is on account of growing remittances of dividends, royalties and technical fees in the foreign exchange, which affect the balance of payments. It has been contended, however, that the direct remittances represent only7 a minor part of the total cost of FDIs on the developing host countries. More significant costs are indirect costs as discussed below.

Indirect Impact

The indirect impact of FDIs on LDCs also has both favourable and adverse elements as follows:

Among the indirect favourable effects of FDI one could include improvement in the access of the host country to the international markets through association with the MNEs, exposure to new technologies and organization and management systems. The MNEs can help their developing host countries to expand the manufactured exports with their captive access to marketing outlets in the industrialized countries. They can also help in saving scarce foreign exchange by substituting imports of the host countries. A predominant proportion of FDIs in India has gone into import-substituting projects. Some studies for the Latin American countries have found evidence of favourable spillovers of the presence of foreign enterprises on local enterprises in terms of improved labour productivity.

FDIs can have adverse effects on different parameters of development, such as, balance of payments, local technological capability, employment, market structure, etc.

Balance of Payments

Besides remittances of dividends, royalties and fees, as discussed above, operations of the MNE affiliates can affect the balance of payments of he host countries through their import dependence and export performance relative to that of their local counterparts, and through manipulation of transfer prices.

Import Dependence

The dependence of foreign controlled enterprises on imported capital goods, raw materials, components and spares is, generally, higher than that in the case of their local counterparts. This could be because of the greater familiarity of the foreign investors with the foreign sources of goods, and to provide a market for the products of the other group companies. A number of studies of different countries confirm the tendency of the foreign firms to buy a lesser proportion of inputs from the local markets than their local counterparts.

Export Promotion

It is argued that the foreign enterprise are better equipped to undertake the manufactured exports because of their captive access to information and marketing outlets in the industrialized counties, and their ability to use internationally renowned brand names. The experience had shown, however that the MNEs are very selective about using developing countries as platforms for exports. Expect for a few countries in the southeast and east Asia. The exercise the of the developing countries has been disappointing in this regard. The studies forma number of countries have shown that export performance of foreign affiliates had not been any different, if no worse, than that of their local counterparts. Further a considerable proportion of agreements concluded between the MNEs and their local affiliates include clauses restricting exports of the latter.

Transfer Pricing

The MNEs also use manipulation of transfer process to covertly transfer surpluses of the affiliates to the headquarters. The transfer price is the price at which intra-firm trade takes place. Hence, imports of raw materials spare parts and capital goods of the affiliates from the parent or other associates take place at transfer prices. Since the transfer process are determined by the foreign parent there is ample scope of their manipulation of their advantage. There is considerable evidence form India and other developing countries of indulgence of the MNEs in manipulating transfer prices to the disadvantage of the host nations. The extent of manipulation in certain cases exceeded 100 per cent.
Thus, FDIs affect balance of payments of the host countries not only through initial capital inflows, foreign exchange spent on capital goods imports and servicing remittances, but also through foreign exchange generated through exports or saved through import substitution, imports of raw materials and components which could be unreasonably high and through possible manipulation of transfer prices.

Technology Transfer and Local Capability

FDI is considered to be a vehicle of technology transfer. It is con tended therefore that the FDI flows provide their host countries access to sophisticate and complex technologies. But the theoretical propositions and empirical findings suggest that FDI by itself does not necessarily improve the access of the host countries to more complex technologies.

The recent empirical studies confirm that it is not the more complex or sophisticated technologies that are transferred most through FDI. It is the technology for production of differentiated goods sold under brand names with high advertising and marketing outlays that is most likely to be transferred though FDI. It is because of these tendencies that most developing country governments have evolved entry regulations to screen proposals of FDI and licensing collaborations according to the national prorates and technological gaps.

In any case FDIs or licensing agreements envisage transfer to production know-how. The know-how or design capability is rarely provided by the foreign collaborators to the recipient enterprises and that is the most important component of building local technological capability. The know-how is to be absorbed through learning by doing, reverse engineering, or during the process or product adaptations and R&D activities. in the case of FDI the foreign collaborator is also participating in the management controlling the technical functions. In these cases therefore the chances of the importing enterprise leering through processes such as reverse engineering are very limited. In house R&D activity of the MNEs is usually centralised on a global or regional level, feeding all the affiliates. Several surveys have confirmed the MNEs tendency to concentrate R&D activity near headquarters or in the developed countries.

Thus FDI makes only a limited contribution to local technological capability building in the host countries. They appear to be inferior to licensing or outright purchases of technology as a channel of technology acquisition in terms of contribution to local technological capability.

Choice of Techniques and Employment

An excessive induction of such technologies in labour surplus economies may, therefore create distortions like growing capital scarcity and unemployment. A number of studies comparing factor proportions of technologies employed by the foreign and local firms in a number of developing countries have found evidence of the capital intensity in the former case. Therefore FDIs create fewer jobs per unit of investment than other investments in LDCs.

Market Structure

Entry of the MNEs can affect host country market structures adversely. Possession of intangible assets, such as globally known brand names and their reliance on non-price mode of rivalry viz., through product differentiation and advertising and heavy market promotion raise barriers to the entry of potential local entrants. Besides the MENs sometimes engage themselves into restrictive practices, which are aimed at eliminating the existing or potential competition by margers and acquisitions or by forming cartels. Hence the presence of the MENs generally leads to market concentration. Empirical studies of few countries have confirmed a correlation between FDIs and market concentration even after controlling for common factors.

FDIs can have a wide-ranging impact on the national incomes of host countries, employment balance of payments local technological capability and market structures. Impact on these parameters of development of individual FDI projects can vary widely, depending upon several factors such as its place in the host country’s development priorities organizational structure extent of local participation, choice of technique location, size of market relative to that of the project etc. Host country policies and regulations can play an important role in maximizing the positive impact and minimizing the negative impact.