Multinational Corporations 11
WhatAre Multinational Corporations?
Amultinational corporation (MNC), also known as a multinationalenterprise or an international corporation is an organisation thatpartly or entirely owns a subsidiary abroad other than the hostcountry. MNCs spread out their operations through foreign directinvestments (FDI) by owning a subsidiary, building new businesses,expanding existing ones or through marketing (Hill,2014).Examples of such corporations include Caterpillar, Samsung, Unilever,Vodafone, Disney, Walmart, Adidas, Google, Ernst & Young,Coca-Cola and McDonald`s among others (Rugmanand Collinson, 2012).
MNCscan either be vertically or horizontally integrated. Verticalintegration means that the subsidiary takes part in providing inputsto the parent organisation that in turn produces the finishedproducts (Chung,Mitchell and Yeung, 2003).A good example is oil companies. The Maquiladoraprogram is another example of a vertically integrated MNC. The UnitedStates parent company exports raw materials to the Maquiladorasubsidiary (that assembles them to finished goods) and thenre-exports them back. On the other hand, for horizontally integratedMNCs, both the parent company and the subsidiary manufacture the sameproducts. A good example of this is the soft drink industry.
Whatmotives do multinational corporations have for foreign directinvestment (FDI)?
Asaforementioned earlier, FDI’s are the means through which MNCsexpands their operations overseas through merger and acquisition orGreenfield investment. FDI is a vehicle through which corporationstransfer knowledge, capital and technology mostly from developed todeveloping nations. Examples of FDIs encompass: A British companyVodafone acquired Oskar Mobil based in Czech Gallaher Group aBritish cigarette maker was acquired by Japan Tobacco Inc. and eBay,a company based in the United States acquired Luxembourg’s SkypeTechnologies.
FDImirrors the decision of a company to expend resources with the hopethat in the future, they will generate adequate profits to compensatesuch expenditures (Chung,Mitchell and Yeung, 2003).In economics, it is anticipated that the current discounted value ofprojected flow of returns will be high compared to the discountedvalue of costs. In this case, cost and demand factors play a centralrole in dictating revenues and costs streams.
Ontop of that, the impetus of establishing a foreign subsidiary islinked with the need to utilise resources in terms of low costs ofproduction and physical assets as minerals among others (Bakkalcıand Argın, 2013). Takefor example the extraction of minerals. When a foreign country hashuge amounts of natural resources combined with low extraction costscompared to persistent exploration and extraction in the homecountry, then that results in extensive FDI. Examples include oilMNCs in Libya and Mexico, as well as bauxite MNCs based in Jamaica.In view of that companies transfer production in order to capitaliseon low cost of labor. Cases of FDI acting in response to the cost oflabor encompass southeastern Asia, China as well as the MexicanMaquiladora program just to mention a few. Also, Sony does much ofits production in China in order to gain from low production costs.
Besides,the notion of diversifying markets or risks is another factor thatmight support FDI. It applies in cases where the manufacturedproducts are extremely susceptible to changes in income, that is,they are income elastic. In this case, it seem sensible to enter tonumerous and diverse markets. Indeed, the rate of economic growth ofcountries varies from one nation to the other. Some companies thathave sought growth opportunities through market diversificationencompass Harley-Davidson, Sony and Whirlpool. In order to gainaccess to novel markets, firms such as McDonald’s Boeing and Toyotahave gone international and have managed to amplify their sales(Cavusgil,Knight and Riesenberger, 2012).
Moreover,FDI is also motivated by the need to seek efficiency, for instanceavoid trade restrictions or capitalise on government incentives(Göçer, Mercan and Peker, 2013). Thus, if a company’s exportfaces high trade barriers, the same is prevented by the FDI resultingin the production in abroad. Setting up a physical presence in anoverseas nation helps the investor to enjoy similar benefits as localcompanies. A good example of such FDI is the Japanese automotiverelocations due to the rising protectionism in the United Statesagainst Japanese imports. Therefore, the need to evade traderestrictions is an explanation why Japanese automakers preferred toestablish factories in the US during the 1980s. Generally, themajority of MNEs have penetrated regional trading blocks with theintention of evading import duties in Asia and European Union.
Lastly,foreign direct investments are applied when there is stiffcompetition in the market (Andrewand Jensen, 2007).For instance, when foreign competition is stiff in such a way that itthreatens the erosion of a company’s market share, acquiring thecompetitor may therefore sustain its market power. Others areestablished in order to deal with international rivals in a moreeffective way, or prevent competition in the home nation. Forinstance, Haier, a Chinese appliance maker, set up operations in theUS fairly to achieve competitive knowledge regarding its keycompetitor, Whirlpool.
Positiveand Negative Effects Surrounding FDI by Multinational Corporations inDeveloping Countries
Inthe current time, developing countries have been highly targeted bymultinational corporations. For instance, Eastern Europe and Chinahave attracted the majority of foreign investors. In spite ofuncertainties, it has been shown that investing in the Eastern Europeis quite lucrative. Other countries such as Mexico have alsoattracted the interest of MNEs. In fact, according to the UNCTAD,over 50 per cent of FDI by US and Japanese companies are directed todeveloping nations goes to China, Brazil, Singapore and Mexico(UNCTAD, 2007). Despite that, the main question is whether FDI byMNEs in developing countries has negative or positive effects.
Oneof the positive effects is transfer of resources, as new corporationsbring with them capital investments (Chungand Mitchell, 2003).Due to their status and size, FDI companies are able to gain accessof global capital markets more easily. Unlike other forms of privatecapital inflows, the motive of FDI originates from the long-termneeds of investors to make profits in manufacturing activities whichthey control directly. For example, FDI has provided countries suchas Nigeria with adequate capital investments (Onu, 2012). Accordingto the Financial Times, capital investments directed to Africa arestill high, with investments in gas and oil accounting for 33 billionUSD and real estate attracting 12 billion USD. In 2014, Egypt, whichwas ranked as the leader, received 18 billion USD as capitalinvestments. Most of the FDI was in the energy sector with Mac Optic,a Greece corporation planning to set up a 5 billion USD refinery inthe Suez governorate. In the same year, other countries such asMozambique received 9 billion USD in capital investment. Real estateindustry was the key attraction with Pylos, a Belgium company,planning to establish numerous shopping malls.
Ontop of that, FDI result in economic growth effect (trade in products)(Chungand Mitchell, 2003).It achieves that both quantitatively and qualitatively.Quantitatively in the sense that they boost factor inputs such ascapital stocks, which in turn leads to economic growth. Inquantitative terms, FDI enhances the utilisation of production byboosting productivity. This is explained by new endogenous growththeory, for instance, by guaranteeing quality human capital throughmanagerial practices, training and organisational arrangements. Thus,FDI enhances productive efficacies of local firms resulting in higherproductivity, low costs of transactions, and better quality products,all of which promote economic growth. According to the FinancialTimes, IBM, one of the major global investors made a number ofinvestments in Africa in 2014. For instance, the MNC set up aMainframe Linux and Cloud Innovation Centre in Kenya, besidesestablishing novel innovation centres in South Africa (Johannesburg),Nigeria (Lagos) and Casablanca.
Moreover,developing countries that attract FDI have access to novel andup-to-date technologies. FDI companies possess an enhanced researchand development capacity and capability to advance technologyembodied products. When MNCs invest in certain country, they bringnovel technologies thus exposing nationals of the host country to newways which in turn boost productivity. Also, local companies benefitthrough indirect productivity. According to studies, technologicalspillovers may also take place because of amplified level of rivalryin developing countries. The result is augmented productivity amongineffective local companies. For instance, Lenovo, a Chinese basedtechnology company acquired the personal computer division of IBMbased in the US, and the acquisition of Cytomatrix of US by Cordlifeof Singapore UNCTAD,2007). MNCs also establish research and development centers as a wayof technology transfer in developed nations. For instance, ZTECorporation and Huawei Technologies, both of which are Chinese firmsstarted centers in Sweden, Ranbaxy Laboratories, an Indian basedcompany established centers in the US, while Haier set up a center inGermany among others (Amann and Virmani, 2015).
FDIalso result in employment creation (trade in services) eitherdirectly indirectly for people in developing nations (Bakkalcıand Argın 2013). Directly, by employing domestic nationals, who receive higher wagestherefore enhancing their lifestyle and indirectly through backwardlinkages. Production and manufacturing processes are also enhancedthrough the creation of new industries (Karlsson,Lundin and Sjöholm, 2009).However, the general effect of FDI on employment relies on the kindof manufacturing techniques as well as the level of complementaritybetween domestic companies and FDI (Göçer, Mercan and Peker 2013).According to the Financial Times, Enviro Board, located in New Jerseyplans to set up a building-board production system in Zambia that isanticipated to generate 3,200 jobs. On top of that, Cummins, anIndian company that focuses on making power generation products andengines, has invested profoundly in Kenya through alternative energy,also creating numerous jobs. Also, foreign owned companies in theCzech Republic used 4.6 times on hiring as well as training comparedto local firms.
Positiveeffects of FDI could also be explained using OLI (ownership, locationand internalisation advantages) framework. Ownership advantages referto the competitive advantage possessed by MNCs over domesticcompanies. They include factors such as superior management skills,patents, technical knowledge and trademark, which provide anincentive of selling to international markets. Secondly, locationadvantages are defined as the motivations of producing in foreignmarkets. They encompass availability of protected markets, low costsof production and transportation, enabling regulatory environment,favorable tax treatments and attractive government policies.Internalisation advantages on the other hand allow the carrying outof businesses through FDI more lucrative as compared to licensingproprietary assets (Rugmanand Collinson, 2012).
Despiteits benefits, FDI can also pose negative impacts to the hostcountries. This is so particularly in strategically fundamentalindustries in which investors are likely to strip local firms theirvalue making them insolvent.
Amajor negative effect relates to environmental issues. This mayinclude environmental pollution (noise, water, air), loss of culturalheritage sites, destruction of habitants, land scars, as well assafety and health risks among others. It has been shown that variouscountries including South Africa, Ghana, Tanzania, China and Malihave relatively evidenced negative environmental disturbance in theirendeavors to develop their economies. In China specifically,industrial pollution has been a major problem. Sulfur dioxideemission resulting from automobile exhaust, industrial processes andburning of fuel accounted for 15.6 million tons in the year 2002.Another example is South Africa, which has been a key receiver of FDIin the mining sector since 1994. However, the main effects of miningis associated with atmospheric emissions, mine dewatering as well asacid mine drainage.
Inspite of its advantages, FDI are deemed to be risky and expensive. Itcould be risky due to various factors including country, culture,commercial and exchange risks, as well as expensive Greenfield, mergeand acquisitions. Apparently, some countries are characterised byunfavorable government policies, high rates of corruption, and strictregulatory environment. For instance, Ukraine is known to be amongthe most corrupt nations in Eastern Europe. Therefore, although FDIcould be beneficial to Ukrainians, it could however face variousrisks such as graft and bribery.
Additionally,foreign investment has a high probability of displacing domesticcompanies. Certainly, such companies have superior technologies whichin turn result in production efficiency. They also pose stiffcompetition to local companies and may remove them out of the market,besides bringing inappropriate technology to the host countries(Andrew and Jensen 2007). In spite of these impacts, MNCs have becomea solution of boosting investment and driving economic growth.
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