Foreign Direct Investment Through Multinational Enterprises

The emergence of Multinational Enterprise and Foreign Direct Investment in Developing countries signifies the welcoming atmosphere of acceptance to change. Coupled with the promise of economic growth and development through technology transfer, knowledge sharing and productivity improvement, undeniably, the opportunity is there.

This being the case, Foreign Direct Investment through Multinational Enterprise became an important factor for developing countries’ quest for economic cure. It only means that through the eyes of these developing countries, they have spotted a potential cure for their economic problems, increasing their potential to step up in the world market, along countries that dominate the international community.

The acceptance for Foreign Direct Investment rapidly increases as a number of developing countries emerge as a potential host country. Strengthening the idea of FDI as source of foreign capital is the fact that along with it, the idea of vast opportunities that lie ahead seems all the more intriguing.

 This study explores the nature of Foreign Direct Investment in developing countries and the impact of Multinational enterprise. Moreover, this study seeks to provide an in-depth understanding of FDI and MNEs relationship to developing countries, by providing an analysis of Pakistan as a developing country, relying heavily on FDI.

INTRODUCTION

The impact of Foreign Direct Investment over the past decade had tremendously increased the interest of developing countries to attract foreign investment (Ramamurti, 2004)[1]. In the age of globalisation, it has been widely accepted as the way to fast track the recognition of developing countries in the world market.[2]  Noteworthy, is the eagerness of developing countries[3] to emerge as a top player in the field of investment and trade. Aiming to rise to the ranks of countries having formidable economic growth and dominance in the international community, developing countries step up by highlighting their capacity to emerge victorious in the battle for sustainable growth and development by becoming a potential host country for foreign investors[4].

Multinational enterprises (MNEs) play a pivotal role in the development of many emerging economies (Meyer, 2004)[5]. It contributes to economic growth by linking rich and poor economies and in transmitting capital, knowledge, ideas and value systems across borders. Foreign Direct Investment (FDI) through multinational enterprises (MNE) has dramatically made its mark in emerging economies (Buckley and Casson, 1976)[6].

This rapid increase in FDI and MNEs is one of the highlights of Globalization (Cerny, 1994)[7]. Foreign Direct Investment and Multinational Enterprise, although having conceptual differences, are treated more often than not, synonymously. MNEs and FDI, have established recognized effects of spillover, marketing, financial services, knowledge and capital inflow (Keren and Ofer, 2002)[8].  These are among the inputs provided by foreign investment to the host country, once it accommodates foreign investors.

Foreign Direct Investment can play an important role in developing countries (Moss and Ramachandran 2005)[9]. Its impediments tend to be embedded deeper and more broadly within any country’s regulatory framework (OECD-Africa Investment Round Table 2003)[10].

For highly developed countries, FDI serves as an avenue to broaden their profit making capacity by generating opportunity for foreign firms to step in and make money.[11] This however, depends on the business conditions in the target countries, including objective hurdles and policy-driven barrier to entry and or to free operation (Keren and Ofer 2002).

Spearheading Foreign Direct Investments are countries espousing world dominance both in politics and economy.[12] This would ultimately include the First World Nations, highly developed countries, and quite possibly some of the so-called tiger economies (Jackson, H., 1985)[13]. The main objective is to locate and establish relations with countries possessing a great degree of potential for growth[14].

Given the apparent importance of Foreign Direct Investment and Multinational Enterprise in the economic growth of countries, it is the objective of this paper to present a critical analysis on the impact of FDI and MNEs on developing countries.[15] More specifically, this paper would endeavour in providing an analysis of FDI and MNEs’ impact to Pakistan, a relatively developing country, branded as a tiger economy. By doing this, the emphasis on FDI and MNEs’ impact to developing countries would be depicted in a more precise manner by providing a take off point on what a developing country is, by using Pakistan as point of reference.[16]

Chapter I Foreign Direct Investment Background

Foreign direct investment (FDI) is defined as a long term investment by a foreign direct investor (Aitken, 1999)[17]. The investment involves the participation of two different countries, one being the host country, the other the investor. According to the United Nations Classification, the FDI relationship consists of a parent enterprise and a foreign affiliate which together form a transnational corporation (TNC)[18]. Furthermore, in order to be considered as FDI, the foreign investor must have control over its foreign affiliate, or host country. Control takes in the form of ownership amounting to 10% of the ordinary shares or voting power of the firm, the controlling motive why investors continue to engage in investment.[19]

As a formal definition given by the OECD and IMF, “Foreign Direct Investment reflects the objective of obtaining a lasting interest by a resident entity in one economy (“direct investor”) in an entity resident in an economy other than that of the investor (“direct investment enterprise”).[20] The lasting interest implies the existence of a long term relationship between the direct investor and a significant degree of influence on the management of the enterprise (IMF, 1993 and OECD, 1996)”.[21] “Lasting interest” is established when, 10 percent or more of the ordinary shares or voting power of an enterprise abroad, has been acquired by the direct investor. This guideline given by IMF has placed distinction to FDI over other types of capital flows like Portfolio investments or Bank loans.[22] Unlike Portfolio investments, FDI entails control and thus allows the direct investor to have some bearing over the management of the enterprise invested[23].

Foreign Direct Investment (FDI) is considered to be the lifeblood for economic development as far as the developing nations are concerned (Indo-Canada Trade Relations, Economic Watch 1999)[24]. It has become the key component of development strategies for most countries over the globe. This is because FDI is considered to be as essential tool for jump-starting economic growth and development, by bolstering domestic capital, productivity and employment.

The FDI relationship consists of a parent enterprise and a foreign affiliate in which, together form a transnational corporation (TNC) or multinational enterprise (MNE).[25] The long-term investment typically involves the establishment of manufacturing facilities, warehouses, bank premises or other permanent organizations abroad and since the rapid growth in global investment pattern, this long term investment also included joint ventures and acquisition of an existing enterprise abroad.

The impact of Foreign Direct Investment is undeniable, making developing countries eager to attract the attention of foreign firms. The tremendous change in the economy of host country, is a promise that FDI, it seems, is bound to accomplish.[26]

Foreign Direct Investments come in different forms. Greenfield investment, Mergers and Acquisitions, Horizontal FDI and Vertical FDI are forms of investment from a foreign enterprise. To differentiate each, a Greenfield investment is a direct investment in new facilities or the expansion of existing facilities (Qurratulain)[27]. This creates new production capacity and transfer technology, which can create jobs and can lead to the global marketplace. This is the reason why host countries prefer this type of investment. On the other hand, such type of investment may also create new competition for the existing local companies.

The transfer of existing assets from local firm to a foreign firm is called Mergers and Acquisitions. When the assets and operation of the firm from different countries are combined to form a new legal entity, a cross-border acquisition takes place. The control of assets and operations is transferred to a foreign firm from a local company in cross border acquisition, with the local company becoming an affiliate of the foreign company (Qurratulain, 2006)[28].

Horizontal Foreign Direct Investment is the investment in a company that produces the same goods in multiple plants abroad. This is called “horizontal” because the multinational duplicates the same activities in a foreign country.[29] Horizontal FDI is the said to be an answer to the high cost of transportation and trade barriers brought by servicing other countries through exportation (Protsenko, 2003)[30].

Vertical Foreign Direct Investment is when different production stages take place in different locations or the firm separates its stages of production in various locations. This may take two forms: backward vertical FDI is when an industry from a foreign company provides inputs for a firm’s local production process while the forward vertical FDI is when an industry abroad sells the output of a firm’s local production process. The concept is more advantageous and economical for companies wanting to take advantage of the profit brought by the different prices of inputs in various locations.

In understanding the concept of FDI, it is important to know the difference between an FDI “inflow” and FDI “stock” (Zhang, K.H., 2001)[31]. Inflow measures the amount of FDI entering a country during a given period while “stock” is the total amount of productive capacity owned by the foreigners.

Foreign Direct Investment has an impact on a country’s trade balance, increasing labour standards and skills, transfer of new technology and innovative ideas, improving infrastructure, skills and the general business climate (Indo-Canada Trade Relations Economy Watch 1999)[32].

New marketing channels, cheaper production facilities, access to new technologies and skills, increased tax revenues, accessibility to export markets and lower-cost inputs for local suppliers are among the many benefits of FDI. Thus it is said to play an extraordinary and growing role in the global business providing a strong impetus to the development of economy (Graham ET al.n.d.)[33].

Chasing FDI

 A long line of Economic theorists, from Ricardo (1817/1948), writing in the early 1800s, to Samuelson (1980) in recent decade, have said that it would be advantageous for any nation to engage in trade with other nations, to specialize in producing and exporting certain, and to import good that can be produced more efficiently by others (Paul and Barbato, 1985)[34].

Undeniably, attracting FDI is understandable given the input it provides for the host country. Foreign Direct Investment comes with knowledge, capital, managerial services, marketing services, financial and information services. Given this plethora of seemingly beneficial inputs, attracting FDI is of paramount concern for host country (Keren and Ofer, 2002)[35].

Apart from the host country’s openness to Foreign Direct Investment, Investors consider various factors that contribute to the host country’s potential for investment. Such consideration would include political as well as social, cultural and economic factors[36].

What Foreign Direct Investors look for in a host country is the capacity to carry out the development needed in such a way they serve as an asset to the investor. By this, it means that there is something worth investing in that particular host country.[37] Furthermore, the host country offers benefits to the Foreign Investors that would prove useful to the expansion and development of such foreign firms.[38]

Thus, Foreign Direct Investors look for key markets that provide a wide array of options for investment.

Foreign Direct Investment: Promise of a Bright Future

 The economic development model of W.W. Rostow (1960) suggests that investment from abroad can “prime the pump” for less developed nations, setting the stage for less developed countries (Paul, K. and Barbato, R., 1985)[39].

The Role of Foreign Direct Investment (FDI) in developing countries has grown dramatically over the 1980s and 1990s (Zhang, K.H., 2001)[40]. The stock of foreign direct investment in developing countries nearly doubled from 1980 to 1990 and has since more than quadrupled, reaching $2340 billion in 2002.

In the process, FDI has become the single most important source of foreign capital for these countries (Ramamurti, R. 2004)[41].

This puts an emphasis on FDI and its growing popularity among developing countries. Putting premium on attracting FDI becomes one of the key economic strategies these countries have as a way to promote economic growth. Relying on FDI benefits the host country would be receiving, FDI instantly gains approval[42].

Foreign Investment might be able to enhance economic growth of host countries through spillover efficiency and technology transfer.[43] The spillover efficiency occurs when advanced technologies and managerial skills embodied in FDI are transmitted to domestic plans simply because of the presence of multinational firms (Zhang, K.H., 2001)[44].

This ultimately contributes to the eagerness of developing countries to attract FDI. If FDI enters developing countries, the potential for growth and development increase.[45] Improvements for various sectors of economy are made available, bringing the developing country one step up into increasing competence in the world market.[46]

However, the impact of FDI on economic growth may depend on, along with others, host country characteristics, such as trade strategy, human capital, and export propensities of FDI (Zhang, K.H., 2001). This of course, is not automatically done. Most of the projected benefits of FDI highly depend on host countries’ absorptive capability[47].

Inevitably, this means that if developing countries do believe that FDI is the way to accelerate economic growth and development, they must be ready to adapt change that may drastically affect their domestic economic settings.[48] Whether it is purely advantageous or at some point detrimental, the willingness of the host county to embrace FDI, along with the economic consequences it brings, is the step that determines it in the end.

Consequences of FDI

While one of the benefits of FDI is having a source of capital inflow, it does not always increase the welfare in the host country (Brooks, et.al, 2003)[49].  It also poses a risk to economy particularly affecting the country’s balance of payments. This is when a recipient country experiences a one-time inflow of capital and then later if the investment function properly may lead to a continuing outflow of funds due to profit repatriations (Deutsche Bundesbank, 2003)[50]. This effect can be similar to foreign lenders refusing to roll over short term loans leading to starvation of capital for the country and bad economic situation.[51] Thus this is taken as the major risks of FDI.

Another big risk is the so-called “negative spillover”. With all the transfer of skills and technology by MNEs, local firms are faced with a competition of matching these skills[52]. This then results to unemployment in the local country.[53] However, some would look at the positive perspective of this issue in the sense that competition may also be seen as a benefit to the economy by forcing local firms to modernize and improve efficiency.

Contrary to unemployment effect, when MNEs build local human capital through training of local employees, there is a possibility that these highly skilled and trained individuals may move to locally-owned firms or start their own entrepreneurial businesses, thus enhancing productivity throughout the economy (Meyer, 2004)[54].

Local investors may be crowded out and may even be put out of business when MNEs lead the market dominance[55]. The threat that MNEs can monopolize market power can make them raise prices and extract excessive profits resulting to the deterioration of the local county’s economy.[56] This can also lead to social disorder, hostile business environment and political stability especially of the monopoly is over something that is considered a “public good” such as water, electricity or telecommunication services.[57]

Chapter II Multinational Enterprises Background

Multinational enterprises play an important part in the economies of Member countries and in international economic relations[58]. This has brought an increased interest in governments, since through international direct investment; such enterprises can bring substantial benefits to home and host countries. This is accomplished by contributing to the efficient utilization of capital, technology and human resources between countries and can thus fulfill an important role in the promotion of economic and social welfare.

Strategies of MNEs

There are two main reasons for firms to go multinational: to serve a foreign market and to get lower cost inputs (Protsenko, 2003)[59]. This would probably explain why various strategies are being taken and used by MNEs in order to succeed. But first it is important to note that most of these strategies may be attributed to the three motives of MNE: market seeking, resource seeking and efficiency seeking. MNEs engage in FDI to gain market access in order to reduce transaction costs and to establish a good supplier relationship. They may also engage in FDI in order to gain access to resources in the foreign country such as labor, skills and technology. And MNEs may just aim to invest in country that would increase its efficiency through globalization and international specialization.

Location is another factor that is being strategized by multinational enterprises. MNEs evaluate all factors in order to invest in the most advantageous location. Selection of location by MNEs may be influenced by cultural proximity, economic stability, GNP, population and political stability which are otherwise known as “traditional” determinants for FDI. Furthermore, due to the bandwagon effect, MNEs are compelled to seek FDI destinations that offer low wage and cost plus new market opportunities in order to remain competitive.

By engaging in a FDI, MNEs are able to access Research and Development competences around the world, either by locating near major centers of innovation or by acquiring firms with R&D capabilities (Kuemmerle, 1999)[60]. This is a strategy undertaken by MNEs recently to gain access to knowledge and to benefit from localized R&D spillovers.

A further strategy is the integration of human resource management, centralization of decision making, and organization’s culture into the local investment company. Aside from the impact given to the local business environment, MNEs internal processes leads to an “intra-firm” knowledge transfer which may be a cause of a knowledge spillovers[61].

Are MNEs benefiting or exploiting the developing countries?

While many countries are competing to attract MNEs because of its benefits like economic growth and development, others will view it otherwise since it undermines local firms and threatens economic stability[62]. The debate over the pros and cons of MNE is as endless and as the arguments over why FDI is good or bad. Probably, the advantages or disadvantages of MNE will hold true depending on the situation where the MNE is into. However a discussion of MNEs benefits and disadvantages will probably be helpful in gauging its effect on developing countries.

Let us consider MNEs effect in the perspective of both the host country and home country. For the host country, the existence of MNE may result in a significant injection into the local economy. The investment will make the market become more competitive and thus eliminating monopoly of local firms. With the trainings and education provided by MNEs a spillover effect occurs, which means more jobs are available and productivity and efficiency of the human force of the local economy are improved. In the case of an MNE employing expatriate for the managerial roles and opt to hire low wage workforce locally, management skills are better transferred and income distribution is widened. MNEs also contribute to tax revenue to the government which may be helpful in upgrading the status of the host country’s economy[63]. In the same way that they can exert influence on governments to gain preferential tax concessions, subsidies and grants.

For the home country, if the investment made produces profit, shareholders will gain[64]. On the side of the home country’s workforce, employment becomes a problem since activities are transferred to another country. However, if a relocation of the production facility occurs in a company, an expansion of other production plants of that company may follow, addressing then the issue of unemployment.

With this sound analysis of MNE’s effects, it will be unreasonable to conclude that multinational enterprises are exploiting the developing countries. For a MNE, it will be best to consider all the factors that will be put at stake in the investment effort, take full advantage of its benefits and minimize if not eliminate the risks of the negative effect.

MNE’s: How it Works

FDI flows through MNEs. In order to create, acquire or expand a foreign subsidiary, MNEs undertake FDI. MNEs create, leverage and arbitrage capabilities on a world scale (Caves, 1996)[65]. They can take advantaged of new economic opportunities easily and thus to contribute to the creation of economic growth. MNEs are bound by international standards and market competition and usually offer better employment conditions and product qualities than national firms. This results to a competition among countries to attract the investments of multinational enterprises[66]. Thus, these two terms become synonymous to each other despite their conceptual difference.

But then again, the fact remains that Multinational Enterprises are firms that operate in more than one country, conduct research and development activities in addition to manufacturing, have stock ownership and management which is multinational in character, and carry on the international reallocation of capital[67]. A typical MNE has a ratio of foreign sales to total sales of more than 25%.

In a way, vertical integration generally results in the establishment of foreign subsidiaries that supply inputs going into the finished good[68].  Oil companies have subsidiaries in the Middle East, while their refining and marketing operations are in the industrialized countries. On the other hand, horizontal integration occurs when the parent firm sets up a subsidiary to produce an identical product Coca-cola and Pepsi-cola locate their bottling subsidiaries all over the world close to customers. Conglomerate integration results in a firm’s diversification into non-related markets. Oil companies may acquire copper-mining, etc subsidiaries in other countries.

MNEs conduct worldwide operations via FDI.  FDI means acquisition of a controlling interest in overseas company. The forms of FDI include obtaining common stock in a foreign company to assume voting control; construction or purchase of new plants and equipment; and the expansion of foreign subsidiary with new capital or reinvested earnings.

In recent years, most of the US FDI flew to Europe (55% of all US FDI) and Canada (13%). Most FDI into the US came from Europe (72%) and Canada (8%).  Foreign investment into the US by far exceeds those that come from the US[69].

Naturally, FDI flow into regions with high expected rates of return on investments in developing (host) countries exceed those on investments in industrial (source)countries in part reflecting political risks and fears of expropriation. More open economies attract FDI.

Motives for encouraging FDI by host countries: foreign capital helps achieve higher growth, create jobs, increase wages, improve management and gain access to technology. MNE chooses the most efficient among several ways to access foreign markets[70].

The factors that matter for a MNE’s decision to undergo direct foreign investment include    Import tariff structures, the size of the foreign market in relation to the firm’s most efficient plant size, and labor productivities and wage levels. MNEs try to hold costs down by locating in countries with cheap labor.  It is however important to understand that higher wages in the US do not necessarily mean higher labor costs. Oftentimes US workers are more productive than foreigners, and thus higher wages are offset by higher productivity[71].

Transportation costs are important in determining the location of MNE. If the cost of transporting raw material is much higher than the cost of shipping final products, production facilities are located closer to raw materials than to markets (lumber, steel, aluminum)[72]. The opposite is also true: Cola companies are located closer to markets where they bottle the product because transporting concentrate is relatively cheap. In clothing, shoe and electronics industries transportation costs are minor, so companies choose location based on minimizing manufacturing costs[73].

Market competition with local firms may be tough. One way to deal with it is to acquire foreign firms.

The MNE analysis is in accord with the theory of comparative advantage[74]. Both contend that a given good will be produced in the lowest cost country. As resources are transfers to higher productive uses, the world allocation of resources is improved.

Among the advantages[75] that MNEs enjoy over arm’s-length transactions between firms of different countries is that they can (a) apply know-how that could not otherwise be used in foreign markets, (b) internalize transaction costs, (c) make up for missing international financial markets, (d) exploit economies of scale across borders, (e) jump over trade restrictions, ( f ) avoid some taxes and regulations, (g) make use of their reputations, and (h) reduce exchange rate risk.

Another area of multinational enterprise involvement is the international joint ventures[76]. Join venture is a business established by two or more companies. They differ from mergers in that they involve the creation of a new firm rather than the union of existing firms. Two countries may form a joint venture in the third country, for example, U.S and British company form a venture in the Middle East. Foreign companies can create a joint venture with a domestic firm. It is also possible for the local government to participate in joint ventures.

One of the factors that encourage formation of joint enterprises is local government restrictions on foreign ownership of local businesses[77]. Such restrictions are usually trying to prevent foreign political influence and minimize transfer of dividends abroad. For foreigners, joint ventures are a way to overcome protectionist barriers to import. Japanese Toyota and US GM formed a joint venture permitting Japanese production to enter the US.

Welfare effects of joint ventures include 1) a cost-reduction effect, and 2) a deadweight loss of consumer surplus[78]. Welfare gains occur when the newly established firm adds to productive capacity and foster competition enters markets that the parent firms could not enter, and yields cost reductions unavailable to the parent firms.

Welfare losses occur if the formation of a joint venture results in greater amounts of market power so that output is restricted and price is raised.

Jobs in host countries: MNE often create jobs in the host countries[79]. However when MNE purchases existing plants, it doesn’t have much effect on local employment. For the home country, outsourcing is a concern.  In the short run, the source country experiences employment decline in the industry that moves overseas. Thousands of white-collar jobs are moving overseas every year, and at least 3.3 million jobs in service industries, accounting for $136 billion in wages, will leave the United States by 2015 for lower-cost countries. India is a leader in terms of services provided – about $6 billion worth. Over time, other industries may find foreign sales rising as income in foreign countries goes up.

Technology transfer: technology is knowledge and skills applied to how goods are produces[80]. FDI is the most effective method of technology transfer. Technology transfers increase productivity and competitiveness of the recipient nations. Donor’s export potential can decrease and can lead to job losses. By sharing technology donor nations can lose their international competitiveness. The 1990s was marked by movement of capital into China, the process as accompanied by technology transfer. It’s largely considered risk free because a competitive challenge from China is decades away.  In the long run, transfer of technology overseas promotes welfare.

Developing countries may experience “brain drain” of skilled labor into the US. US immigration laws encourage brain drain[81]. The most recent wave of immigrants is less skilled than before; most of them are in California.

Still, many individuals will be faced with the hard reality that they are not as competitive in an increasingly globally-sourced job market as they have been in the past[82]. Just as companies have no guarantee that their products and services will always enjoy the same customer demand and price they do today, neither do any of us as employees. Some may find themselves doing the same work for less money. Others will find ways to continue to command current and even higher salaries by learning the latest technologies and doing so ahead of the pack.  Others will move away from the technical parts of their jobs toward solution design work that requires more customer face-time.  Still others will find themselves moving into careers that leverage their skills in entirely new ways.

Chapter III A Critical Analysis on the effects of Foreign Direct Investment and Multinational Enterprise on Developing Countries

Developing Countries are more popularly termed less developed countries or LDCs[83]. This term often connote those countries falling under this category lack the necessary tools in order to compete in the global arena. More often, reference to these developing countries involve the term less economically developed countries or LEDCs. Naturally, these countries crave for ideas and ways to elevate their status and increase their chances of one day becoming recognized in the international community as a strong economic force.

Multinational Corporations, given their nature and role in developing countries, often create a wide following. It exudes an appealing image for developing countries, given the fact that MNEs promise a bright future[84].

Developing countries include Albania, Argentina, Brazil, Burkina Faso, Colombia, East Timor, Indonesia, Pakistan, Russia, Sierra Leone and Zimbabwe among others. These countries take part in the development of various strategies for economic growth and development[85]. The most potent option being, the capacity to attract MNEs and FDI as source of capital inflow and technology transfer, supposedly, maximizing the potential of their economy.

Multinational enterprises play a pivotal role in the development of many emerging economies. They act as a link between rich and poor economies, and in transmitting capital, knowledge, ideas and value systems across borders. Their interaction with institutions, organizations, and individuals is generating both positive and negative spillovers for various groups of stakeholders in both home and host countries (Meyer, 2004).

These issues are particularly relevant and important for emerging economies – that is, low- or middle-income economies with growth potential that makes them attractive to foreign investors. These economies typically have less sophisticated market supporting institutions and fewer locational advantages based on created assets, such as infrastructure and human capital (Hoskisson et al, 2000; Narula and Dunning, 2000).

With this, a solid understanding of MNEs, as a result of FDIs, in emerging and developing economies is vital for both the policymakers and for the MNEs themselves. The effects of FDI and MNEs on developing countries have been a subject to a number of debates, i.e., whether this has been on a positive side, or otherwise.

Effects of FDI on macroeconomic growth, which is commonly considered as the most potent source of poverty relief, particularly in the poorest to developing countries are recognizable. Beyond the initial macroeconomic stimulus from the actual investment, FDI may influence growth by raising total factor productivity in the recipient or host economy. This works through two channels, namely (i) the spillovers and other externalities vis-à-vis the host country’s business sector, and (ii) the direct impact on structural factors in the host economy[86].

Effects of MNEs and FDI: The UPSIDE

The effects of MNEs and FDI have always been the subject of a heated debate. The reason for this, being, that MNEs and FDI posed benefits and detriments to developing countries[87]. On account of this, no conclusion has been reached as to ultimately brand the effects of MNEs and FDI as positive or negative. However, in order to shed light to both sides, the following e effects of MNEs and FDI to developing countries are provided as follows:

Most empirical studies conclude that FDI generally does make a positive contribution to both factor productivity and income growth in host countries[88]. It is, however, more difficult to assess the magnitude of this impact — not least since large FDI inflows to developing countries often concur with unusually high growth rates triggered by unrelated factors. As regards the question of whether FDI tends to crowd out domestic investment, thereby dampening its overall impact on growth, the evidence is generally mixed. Some studies find evidence of crowding out, while others conclude that FDI may actually serve to increase domestic investment.

The extent of technology transfer through the presence of MNEs is a crucial point, not least since multinational enterprises are among the world’s most important players in creating and developing technology[89]. Since many cutting edge technologies are not taken to the market, developing countries have increasingly come to view investment as one of the most important means to acquire knowledge and upgrade their domestic production base, as well as to improve the environment. Current empirical evidence would appear to support the following generalizations:

The most frequent channel for technology benefits to the host economy from FDI works via the vertical linkages that MNEs create. MNEs attempt to minimize the value of explicit and implicit transfers toward their host country business partners, but they are rarely able to wholly avoid them[90]. Backward linkages (with suppliers) are found to contribute to the technological level of suppliers though MNEs’ demand for quality improvements, which in many cases even induces foreign-owned enterprises to train their subcontractors and suppliers.

Forward linkages (with clients) are particularly important where MNE presence makes a higher quality of input goods available to the host country business sector. An additional route for technology transfers are horizontal linkages, whereby competing host country enterprises learn via demonstration or direct competition. Also, recent studies have concluded that labor migration (trained employees shifting employment from MNEs to domestic companies, or setting up their own enterprise) is important.

The most important point for policy makers lies in the interaction between for human capital development and technology diffusion. Policies to further the latter will inevitably involve action by government and other public agencies to enhance human capital, as requirements and opportunities become apparent. Also, technological diffusion will increase the incentives for companies to take a stronger interest in human capital enhancement[91]. Finally, such policies could serve to attract, in particular, FDI into relatively high value added areas.

In the field of employment, the presence of MNEs have the potential, but not the certitude, to raise labor standards a par t of the way toward the levels prevailing in the investors’ home countries. Also, a higher share of employment by MNEs in developing countries often lifts members of the labor force out of the informal and into the formal economy[92].

Evidence abounds of a positive initial impact of FDI on competition. Where competitive local markets already exist, additional competition brought about by the entry of an MNE generally encourages local firms to enhance their quality and increase their productivity. Where local markets are weak or dominated by monopolistic incumbents, FDI has in many cases helped create a competitive environment — inter alia because of their greater ability to overcome access barriers — and it has helped nurture the creation of national markets. Moreover, the entry of one MNE is often followed by others, particularly in sectors which are, at the international level, characterized by a degree of oligopoly.

MNEs and FDI: The Downside

On downside, concerns have been voiced that the technologies transferred by MNEs, being usually enterprise specific, are often ill-suited to the host economy at large. An even graver concern, particularly to emerging economies, is the risk that the takeover of a national technology-intensive enterprise by a foreign competitor could actually lead to a technology transfer out of the host economy[93]. Some of the noticeable effects of MNEs and FDI that do account as benefits are as follows:

In the least developed economies, FDI seems to have a markedly less benign effect on growth, which has been attributed to the presence of “threshold externalities”. Apparently, developing countries need to have reached a certain level of development in educational and infrastructure levels before being able to benefit from a foreign presence in their markets. An additional factor that may prevent a country from reaping the full benefits of FDI is imperfect and underdeveloped financial markets[94]. Weak financial intermediation hits domestic enterprises harder then MNEs, and may in some cases lead to a scarcity of financial resources that effectively precludes them from seizing the business opportunities that arise from the foreign presence.

There are significant differences between host countries’ ability to benefit from technology transfers from various kinds of FDI. In particular, if the relative difference between the technological level of host country enterprises and MNEs (the “technology gap”) is large technology transfer is usually impeded. In addition to the relative levels of technology, an absolute minimum of human capital is found to be crucial if domestic enterprises are to be able to appropriate foreign technology. These findings are observationally equivalent with the externalities thresholds identified in the economic growth chapter.

An aspect of FDI that affects social concerns alongside with purely economic objectives is the potential for human capital enhancement[95]. The major impact of FDI on human capital appears to have occurred not principally through the efforts of individual MNEs, but rather from government policies seeking to attract FDI via enhanced human capital. Once individuals are employed by MNE subsidiaries, their human capital may be further enhanced through training and on the job learning. Those subsidiaries may also have a positive role on human capital enhancement in other enterprises with which they develop links, including suppliers. To the extent that human capital is thereby enhanced, this can have further knock-on effects both as that labor moves to other firms and to the extent that it leads to employees becoming entrepreneurs. Thus, the issue of human capital development is intimately related with other, broader development issues.

Human capital enhancement may be related in various ways to the issue of the transfer of technical knowledge[96]. In some Asian economies there has been a rather low level of transfer of both technical knowledge and management techniques, and also of training in general, as the majority of FDI inflows have been in low to medium technology industry that does not require much skill. Even in the high technology sectors, the wide technology gap has inhibited the ability of the local employees to learn, either because the gap is so great that it is hard to bridge, or because the perceived gap simply deters MNEs from attempting to bridge it.

The most important point for policy makers lies in the interaction between for human capital development and technology diffusion[97]. Policies to further the latter will inevitably involve action by government and other public agencies to enhance human capital, as requirements and opportunities become apparent. Also, technological diffusion will increase the incentives for companies to take a stronger interest in human capital enhancement. Finally, such policies could serve to attract, in particular, FDI into relatively high value added areas.

In the field of employment, the presence of MNEs have the potential, but not the certitude, to raise labor standards a part of the way toward the levels prevailing in the investors’ home countries. Also, while the overall employment effects of FDI are not always clear, a higher share of employment by MNEs in developing countries often lifts members of the labor force out of the informal and into the formal economy[98].

The relationship between FDI and corporate sector competition is a complex one. Clearly, the entry of foreign competitors in itself acts to a spur to competition, particularly in economies where competition policies are weakly enforced and market incumbents assert undue influence on pricing. On the downside, however, a higher incidence of Mergers and Acquisitions (M&A) and strategic alliances, higher concentration ratios and, in some cases, higher entry and barriers have raised host country concerns about their domestic competitive environment.

The benefits of MNE entry via competition presuppose that domestic enterprises are sufficiently healthy to face the foreign competitors (or, alternatively, that the host market is large enough to accommodate several MNEs). In some well-documented instances, a few MNE entrants have crowded out all the domestic competitors[99]. While this need not be a problem if the host markets are fully contestable, developing countries’ experience show that it can be a significant problem in practice and the development of an adequate competition law framework is necessary. There may also be a need to accompany competition policies by policies to enhance the competitiveness of domestic sectors (e.g. eliminating obstacles to business development such as excessive regulation).

Finally, the successful introduction of competition may have a negative short-term effect on the host countries’ employment rates, but in the longer term this trend should be reversed by the stronger economic growth stemming from more competitive markets. This accentuates a general need for labor market flexibility, and it may present national authorities with difficult policy choices[100].

FDI and MNEs on developing countries: a CONTINUED PATRONAGE

A number of developing countries have increasingly seen foreign direct investment (FDI) as a source of economic development and modernization, income growth, and increased employment. These countries have essentially opened up their economy and liberalized their FDI regimes[101]. Their policies focused on attracting similar types of investments. Needless to say, they have addressed the issue on how to best put their local policies into optimal advantage with the presence of FDI in the domestic economy.

The impact on the host economy varies between FDI with different modes, at least in the short term. For example, in the case of a foreign ownership takeover, it may be that in the short term, the takeover may require layoffs of employees, but if the alternative would be even more drastic adjustment, the foreign investor may in fact save jobs. A foreign investor taking over non-viable local firm can add crucial resources, and thus ensure the survival of the firm. Empirical evidence suggests that foreign ownership has improved productivity and profitability in many developing countries in Eastern Europe (Djakov and Murrel, 2002; Estrin, 2002)[102].

For the long term, as another case in point, another advantage of FDIs and MNEs are the development of entrepreneurial skills of local business practitioners. Entrepreneurs are a major source of economic growth in emerging economies. They are moreover an important source of innovation, often developing new knowledge by combining knowledge obtained from foreign partners and local knowledge.

There are points which scholars and business researchers themselves do not agree even with enough data at hand. These are matters that are cannot be agreed upon by the members of the academic and practicing community due to different weights on values. Caves (1996), in fact, argued in his paper:

“The relationship between less developed country’s stock of foreign investment and its subsequent economic growth is a matter on which we totally lack trustworthy conclusions” (page 237)[103].

In fact, despite the policy relevance, the impact of MNEs on host developing economies is not well understood. Some FDI is good, Wells (1998) argued:

“Some FDI is good, almost certainly some is harmful. But exactly what kind of investment falls in each category is frightfully difficult to determine, even if the effects are measured against economic criteria only.”

From the premise that MNEs are profit maximizing, we wouldn’t know, even with all the positive spillovers mentioned above, if MNEs really have these intentions. In fact, it could be deduced that they are not interested in creating benefits for others without being paid for it. Whenever foreign investors allow positive externalities depends on their opportunity costs of sharing the knowledge, and the transaction costs of establishing barriers to knowledge flows (Meyer, 2004)[104].

It also addresses concerns about potential drawbacks for the host economies, economic as well as non-economic. The potential drawbacks include the deterioration of the balance of payments as profits are repatriated, the lack of positive linkages with local communities, the environmental impact of FDI, especially in the extractive and heavy industries, the social consequences of an accelerated commercialization in less developed countries, the effects on competition in national markets and the risk that host countries, especially small economies, may experience a loss of political sovereignty[105]. Even some of the expected benefits may prove elusive, if, for example, the technologies or know-how transferred through FDI turn out to be ill-adapted to the host economy, depending on its current state of economic development.

On balance, the benefits of FDI exceed the costs. Benefits are, however, not homogenously distributed across sectors and countries. Clearly, for maximizing the benefits of FDI, policies matter. Many challenges befall the host country authorities, who often need to improve economic structures, infrastructure and human capital, while at the same time putting in place environmental, social and competition safeguards[106]. Home countries’ authorities do, however, share a responsibility for maximizing the benefits of FDI for development, for example by pursuing policies of openness to trade and technology transfer that do not unduly hold back the activities of MNEs in developing economies. Corporate responsibility is also an issue, particularly where MNEs provide large sources of government revenue, or otherwise wield significant economic power relative to the host country authorities[107].

Developing Trends: Acceptance of FDI and MNEs by developing countries

The magnitude of FDI flows continued hitting new records in the course of the previous decade, before falling back in 2001. In 2000, world total inflows reached US$ 1.3 trillion — or four times the levels that were recorded five years earlier. More than 80 per cent of the recipients of these inflows, and more than 90 per cent of the initiators of the outflows, were located in “developed countries”. Even the minority of FDI that does go to developing countries is spread very unevenly, with two-thirds of total OECD FDI flows to non-OECD countries going to Asia and Latin America. However, these FDI inflows do represent significant sums for many developing countries, several of them even recording FDI-to-GDP ratios in excess of 50 per cent. In most developing countries, the manufacturing sector is by far the largest recipient of FDI (Asian Development Outlook, 2004).[108]

In recent years, an increasingly large share of the FDI flows has been through mergers and acquisitions. This partly reflects a flurry of transatlantic corporate takeovers, partly the large-scale privatization programmes that were implemented throughout much of the world in the 1990s. However, in developing countries Greenfield investment has remained overall the predominant mode of entry for direct investors[109].

Cross-border trade in developing Asia has grown rapidly since 1970[110]. Global exports of goods and services rose by an annual average of 5.6% in real terms and 9.5% in nominal terms from 1970 to 2001. As a share of output, exports increased from less than 14% in 1970 to more than 29% in 2001. While South Asia has more or less followed the world trend, East Asia has seen increasing exports relative to output, surpassing the world average since 1979. Southeast Asia has consistently achieved a higher ratio of exports to gross domestic product (GDP) since 1970 than the world average.

Among the favored Asian destinations for FDI, there has not been as much change. Indonesia and Kazakhstan, two of the top 10 FDI destinations in the early 1990s, dropped from the list primarily due to uncertainties in their domestic economies and were replaced by India and Viet Nam in the late 1990s. Meanwhile, Hong Kong, China; Singapore; Korea; and Thailand overtook Malaysia as preferred FDI destinations[111].

Among the countries in developing Asia, the top 10 recipients of FDI inflows in 2002 accounted for over 97% of total FDI in the region, with the top three recipients alone accounting for 81% Asian Development Outlook (2004)[112]. Azerbaijan, however, which is not even in the top 10 developing Asian FDI recipients, had the highest ratio of FDI to GDP, reflecting the importance of FDI in its hydrocarbons development. On the other hand, four out of the top 10 FDI recipients in developing Asia have FDI-to-GDP ratios lower than the average of 2.6% of GDP. This means that FDI to developing Asia is somewhat concentrated-only 10 out of 36 economies for which data are available have FDI shares equal to or exceeding their GDP shares in developing Asia.

FDI and MNES: Developing countries’ increased interest

There is increasing interest in FDI and its importance as an external source of capital for developing countries. However, if FDI contributes to average growth and productivity, can we also say that it reduces poverty? To answer this question, we need to understand how the gains from FDI are distributed within a country[113].

In a case study presented by D. Willem te Velde entitled “Foreign direct investment, skills, and wage inequality in East Asia,” theory would suggest that FDI has a more beneficial effect on the wages of skilled than unskilled workers because of:

Raises the demand for skilled workers by locating skill-intensive sectors and introducing skill-biased and more efficient technologies;
May change the bargaining position of labour, with a differential impact on wages;
Because MNE training generally goes to skilled workers.

In this study, it found out that while FD raised the wages of both skilled and unskilled workers, there was no consistent impact on wage inequalities in countries examined (Hong Kong, Korea, Singapore, Thailand, Philippines) except in Thailand owing to the composition effect (i.e., FDI actually goes to the high skilled sectors rather than ‘exploiting’ unskilled labour) and the impact on bargaining (MNEs pay more not because they are more efficient than local forms but because there is a shortage of the type of labour that MNEs require due to the lack of appropriate education provision)[114].

Developing Countries: the role it plays for MNEs

Developing countries often view MNEs in its most glorious state. To be more precise, developing countries accept the presence of MNEs because it provides them benefits. But what role do developing countries play for these MNE? Do developing nations, as host countries receive what they deserve or are they giving more without noticing it. Perhaps, it is attributable to the fact that the subtlety in which MNEs use developing countries has been overpowered by the MNEs promise of economic development[115].

One example is  MNEs taking operations offshore and offshore outsourcing, which  are receiving unprecedented attention – in executive suites, in the reports and recommendations of consultants, in countries such as India that are recipients of much of the work, and in the media[116].  To some, offshoring is one of the most important opportunities for improving businesses performance available today; to others it’s yet another example of companies seeking short-term gains at the expense of employees and customers, alike.

A careful review of what’s really happening and why leads to the following conclusions:

1. Offshore outsourcing represents an irrefutable opportunity for businesses to reduce costs and improve other aspects of their operations.
2. The benefits are not, however, automatic and management needs to exercise real care in planning and implementation.
3. The impact on U.S. employees may not be all bad – as many in the media would have us believe.

Although there are certainly examples of companies moving the majority of their back-office operations offshore, they are few and far between[117].

The offshore program at consumer products giant Procter & Gamble is representative of what is actually happening. In 2001 Procter & Gamble began a pilot global sourcing program for its information technology work, particularly software development[118].  The goal was to create $100 million worth of capability around the world that could be leveraged on-demand by its individual business units.  Through the pilot, about 600-people worth of work was relocated to lower-cost P&G locations in places like Manila in the Philippines and Warsaw, Poland.

Additionally, another few hundred contractor positions were consolidated and taken offshore through outsourcing.  What P&G found was that offshore labor rates were, on average, about 1/5th those in the U.S. and other more advanced economies.  For example, a contract Java programmer that might cost $98 an hour in Cincinnati costs $20 to $22 dollars an hour in India and Manila.  But P&G found that it wasn’t just lower local labor rates that created the cost difference; it was also the competition between outside organizations bidding for P&G’s work[119].

The company found that productivity differences were an important contributor, as well. These highly educated and well trained individuals were extremely motivated to work hard to improve their standard of living – individually, for their families and for their countries[120].  They are often on the job at 7:00 am handling emails before beginning their regular work at 8:00.  Similarly, internal meetings and training are typically deferred until the evening hours in order to maximize productive time during the day.  In other words, it was the rates, competition and the work ethic that combined to create the offshore cost advantage.

Other advantages, not necessarily dependent upon the offshore aspect of the pilot, were also found.  P&G was able to build a more dynamic operating structure.  Resources could be added and removed quickly[121].  Flexibility, as measured by the percent of the company’s IT workforce that could be ramped up and down on short notice, increased.  Economies of scale were created because the program centralized purchasing for skills that could be used be multiple business units.  With the ability to objectively measure a provider’s processes against standard industry benchmarks, quality increased.

Overall, during the first twelve months of the pilot, P&G saved an estimated $28 million dollars – a relatively small number given the total information technology spending of a Fortune 500 company, but still an important benefit in any economy.  Expansion of the program is underway.

Procter & Gamble’s experience is not unique[122].  Companies ranging in size from the giants of corporate America, such as, American Express and General Electric, to a small plastics products company like Waxman Consumer Group of Bedford Heights, Ohio, are finding that outsourcing and taking operations offshore can reduce costs, improve quality, and increase speed and flexibility.

The simple truth is that the sophistication and resources of any one company pale when compared to the world outside its corporate campus.  Take Microsoft.  The company employs about 50,000 of many of the best and brightest programmers from around the world.  But, that’s still only a tiny, tiny fraction of the estimated 12 million programmers worldwide.

Microsoft’s recent investments in offshore capabilities in Hydrabad, India and in Beijing, China (where one-third of Microsoft’s 180 new programmers have PhDs from U.S. universities) reflect its emerging acceptance that Redmond, Washington is not the center of the programming universe[123].  Bill Gates has said that outsourcing mission-critical work offshore is now “a common-sense proposition.”  Does that mean that the Redmond campus will shrink dramatically over the coming years?  Not likely.  What it does mean is that Microsoft will learn from its experiences and expand its offshore program in a consistent, thoughtful way – as long as it continues to add value to the company’s business.

General Electric, with its 315,000 employees worldwide, has been doing this for sometime now.  The company began setting up operations in India in the late 1990s and today there are 15,000 GE employees there processing financial transactions such as receivables, payables and credit verifications, and handling customer calls.  GE also has about 6,000 non-employees working at India technology companies, like TCS and Satyam.

Companies are right to be looking off-campus for solutions.  And off-campus has to mean down the street and half-way around the world.

The fact that offshore operations and outsourcing, used separately or in combination, can add to the success of an organization is well established.  But, just because the potential is there doesn’t mean that every organization will realize it. These are not panaceas.  They carry their own set of challenges and risks.  Problems can and do occur, and companies can get less or more out of the program than they expect.

When American Express first began outsourcing its call centers, it found that the performance of the outsourced operations for high-end customer interactions was quite poor, abandoned the project and pulled the work back in-house.  On the other hand, it found that the performance of outsourced call centers for simpler customer interactions was actually better than at its internal centers – and that these outside operators did a better job of up-selling callers on additional products and services.  As a result, that part of the project quickly took root and grew rapidly[124].

The right questions then are: How might offshore outsourcing specifically create value for my company at this time?  How can we test the approach and build experience?  And, are we prepared to abandon failures while increasing our investment in successes?

In the end, organizations should probably not outsource unless they are prepared to make an ongoing investment of time and talent to learn how to create and leverage long-term relationships with outside companies – relationships that will become an integral part of their strategic, tactical, financial and social fabric[125]. Similarly, organizations should probably not go offshore unless they are prepared to make the investment needed to learn how to successfully integrate elements of businesses running at significant distances, under differing cultural and legal frameworks.  It goes without saying that they should not outsource offshore unless they are prepared to do both.

The more successful companies seem to be taking a longer-term view of the value of offshore outsourcing and are building toward advantages beyond cost savings, such as, the ability to operate the company in real-time 24-hours a day with operations that follow the sun and reducing business risks by diversifying and distributing the company’s operations[126].

The media is filled with stories about American jobs being exported offshore.  One estimate that has received a lot of attention forecasts that between now and 2015, 3.3 million U.S. information technology jobs and $186 billion in wages will move offshore.  What the stories and estimates like this don’t tell us is that the information technology industry as a whole continues to grow and is actually creating new jobs faster than what’s being lost.

In the fourth quarter of 2002 the U.S. IT industry created 148,000 net new jobs, even with a slower economy and with the offshore movement in full swing[127].  Furthermore, offshore companies are themselves creating onshore jobs right here, particularly in the marketing, sales and client relationship parts of their businesses.  In fact, the services sector of the U.S. economy loses about 10 million jobs every year while creating 12 million brand new ones.  So, while churn should be expected, net job loss is less likely.

If history is any teacher, there will be a period of disruption, one that may well be painful for some, but in the end, the U.S. economy is likely to create even-more exciting, higher-paying jobs in fields we can’t even imagine today.

What may be needed the most is for companies to be more open and honest with their employees about what they are seeing and planning[128].  They could be more pro-active in helping individuals assess their marketability in this new global economy and in helping them develop the needed skills – ones that produce more value for the company, as well. In the end, the appeal of offshore outsourcing will continue as long as it creates value for the businesses employing it.

Eventually, the companies in India and elsewhere that are the recipients of today’s work will find their cost advantages eroding.  The natural dynamics of supply and demand, emergence of the next low-cost labor pool, government actions, and the constant drumbeat of new and better technologies will at first reduce and eventually eliminate the current differentials.

If, however, these companies are able to use today’s cost advantage to build long-term value for their customers then the offshore trend will continue.  If they can’t, then offshoring will eventually level off and we’ll all move on to the next opportunity[129].

Chapter IV Linking Pakistan to Foreign Direct Investment and Multinational Enterprise

Background

Pakistan was basically an agricultural economy upon its independence in 1947. Its industrial capacity was not highly adept at manufacturing locally produced agricultural raw material. This concern made it necessary for succeeding governments to improve the country’s manufacturing capacity.[130] In order to achieve this objective, industrial policies have been implemented in different times with a changing focus on either the private sector or the public sector.[131] During the 1960s, government policies were directed at encouraging the private sector while during the 1970s, the public sector was given the priority.[132] In the 1980s and 1990s, the private sector was again assigned a leading role. Noteworthy is the fact that during the 1990s, Pakistan adopted liberal, market-oriented policies and declared the private sector the engine of economic growth. Moreover, Pakistan offered package incentives to encourage further interest of foreign investors.[133]

Pakistan has a long history of poverty ridden economy. It survived with the help of economically strong countries such as the United States, when it provided Pakistan with US aid. However, Pakistan managed to prove itself worthy of attention from the international community when it slowly showed economic improvement[134].

At present, Pakistan is still a developing country. Its economy is still slowly finding its way to achieve growth and development. This of course, entails, grabbing opportunities that will ultimately lead Pakistan to success[135]. By this, it means that Pakistan, like most developing countries, wants to increase capital inflows, strengthen human capital and increase technological advancement. This amounts to the fact that Pakistan is also set to promote itself as a viable host country for FDI and MNEs.

Globalization and Challenges for Pakistan

It may be said therefore, that for Pakistan, globalization is a double-edged sword. Globalization is a powerful vehicle that raises economic growth and increases living standards in many countries, but it is also an immensely controversial process that can assault national sovereignty, erode local culture and tradition, and threaten economic and social stability[136].

To avoid its disastrous impact, the underdeveloped countries, with the help of forums like the United Nations Conference on Trade and Development, must request a relief period for industries that are life and blood for the poor people before opening their markets to the world[137]. We also must raise a united voice against the tariff and quota violations committed by the developed countries. As far as Pakistan in particular is concerned, the government must educate itself on the laws and standards affecting its industries, and then help train and prepare industry for the globalization era.

If it does not want globalization to have bad effects on its economy, the Government of Pakistan must create a long term development plan[138]. Social safety nets and alternative skill development options for the poor to enable them to survive the risk of unemployment should be part of the plan.

The proponents of globalization will argue that if China can gain so much from globalization, why can’t other developing countries? The answer is that China had the social fundamentals in place before it started opening to the world economy[139].

Globalization can be an opportunity if the leadership of the country focuses on human and social development, and diversifies its industries and trade to an extent where laws and standards do not affect underprivileged people.

Pakistan is now slowly taking steps to comply with international health, environment, labor, and social standards in their factories and offices to meet a 2005 deadline, stipulated by the WTO[140]. Groaning under a crippling taxation structure, an unbearable utility tariff levy, and a high financial cost, the industrialists have found cuts in expenditures at factories and offices the most convenient place to save. Employees remain under-paid and insecure in Pakistan. They have been denied weekly and annual holidays, as well medical facilities, and are forced to work in unhygienic environment in many factories and offices[141].

A stocktaking meeting of the eight textile manufacturers was held recently at the textile commissioner’s office to review 36 industry-related laws and working conditions, as a good number of foreign buyers have already started taking notice of working conditions in their business partners’ premises in Pakistan.

Foreign buyers of Pakistani goods in Europe and the US now want their business partners to attend to the needs of their employees[142]. They want the factories and offices to be equipped with modern fire-fighting equipment, cross ventilation, air conditioning, and all modern tools for the workers.

Obviously, upgraded facilities for employees and compliance with all social conditions would entail substantial investment for the industrialists, who fear closure of quite a number of factories in the coming years[143]. “More unemployment and social upheaval” is the prediction of frightened local investors. With globalization moving on a fast track, both government and industrialists in Pakistan have apparently been left behind, as far as their comprehension and compliance with new laws is concerned.

It may be argued that the economy of Pakistan is characterized by a relatively well developed agrarian sector, and a manufacturing sector primarily engaged in the production of goods that embody relatively modest levels of labor and technology specialization. The same is true for the service sector in the Pakistan economy, also generating outputs embodying relatively modest levels of specialization. The overall GDP for Pakistan recorded a moderate to high growth rate of 4-6% since its independence until the mid-1990s, making it one of the faster growing economies in South Asia. The subsequent dramatic slowdown in its growth rate is attributable in part to the international sanctions imposed on Pakistan after it (and India) conducted a series of subterranean nuclear explosions in May 1998.

Following the attacks on the United States on September 11, 2001, it enlisted the support of Pakistan in its global war on terrorism, restoring the “front-line” status of that country in the US strategic calculus. This has resulted in the US waiver of economic sanctions, fresh aid exceeding $2.5 billion, help in renegotiating longer payment terms for prior international loans, and fresh allotment of multilateral loans with an extended payment window (over 3b from the World Bank, IMF and the Asian Development Bank)[144]. This period has also seen most advanced industrial countries lifting their sanctions and renewing economic aid to Pakistan. The net result has been that Pakistan has secured valuable breathing room to implement much-needed economic reforms and put its economic house back in order[145].

But before turning to the future, it is important to ask the question: if the international economic sanctions effectively lasted for only a brief period (1998-2001), how does one interpret the gradual slowdown in Pakistan’s economy, especially a trend that preceded the imposition of international sanctions?

In this context, it must be noted that Pakistan briefly attempted economic reforms in the early 1990s, but its momentum and scope were constrained by longer-standing structural problems and the adverse role of entrenched politico-economic forces[146]. The unfinished agenda of land reforms from the early decades set this stage.

It resulted in distorting the size of individual land holdings, and uprooting peasants and share-croppers from their ancestral lands without offering them viable employment in the formal agrarian sector. Over the years, the land-owning elite with political patronage consolidated their hold over economic decision-making, and have extended their influence on the industrial sector as well. Income inequality in Pakistan has worsened to the point where over 80% of the national wealth is controlled by the top 10% of the population, severely limiting the rise of the middle class, and voice of progressive forces in economic agenda-setting[147].

In spite of the sectoral and structural distortions, Pakistan’s economy has never been completely “insulated” from international influence[148]. A private consortium called “Independent Power Producers” has made Pakistan an electricity-surplus country since the mid-1990s, while a host of MNCs in the apparel and textile industry continue to operate from Pakistan to service their global markets.

The pathology of the malady that has plagued Pakistan’s economy over the decades is the monopolistic stranglehold of entrenched domestic interests that resist opening the economy to free competition, both from within and without. A revealing example is the refusal to export surplus electricity to India, and removal of quantitative restrictions and quotas on imports from India. Worse, Pakistan has refused to grant MFN (“most favored nation”) status to India, although as a member of the WTO (and GATT before that), it is obligated to do so.

Pakistan: Moving towards attracting FDI

The success of Foreign Direct Investment policies can be judged by the size of the inflows of capital. Efforts were made to attract Foreign Direct Investment and have been further intensified with the advent of deregulation, privatization, and liberalization policies initiated at the end of the 1980s.[149]

The amount of foreign investment rose from $10.7 million in 1976 to1977 to a whopping $1296 million in 1995 to 1996, thus growing at the annual compound growth rate of 25.7 percent. However, it declined to $950 million in 1996 to 1997. With the beginning of the overall liberalization program (1991/1992 onwards) the inflow of foreign investment grew at the compound growth rate of 15.2 percent.[150] Investment inflows in 1995 to 1996 increased by 93.3% mainly due to the inflow of investment in power sector.

The increase appears trivial when compared to the relatively more buoyant economies of East and Southeast Asia. While FDI flows to all developing countries reached $150 billion in 1997, East and Southeast Asia received the bulk of this share.[151] Total foreign investment consists of direct investment. However, with the beginning of liberalization policies in 1991/1992, portfolio investment crossed the $1.0 billion mark in 1994/1995.[152] This impressive increase does not reflect the true picture of the trends in portfolio investment witnessed during the post-liberalization period.[153]

FDI and MNEs: Positive effects on Pakistan

The economy of Pakistan has grown dramatically over the past few years. Foreign Direct Investments have entered Pakistan and invested in the country. This is attributable to the fact that Pakistan has taken the necessary steps to encourage investment by providing tax incentives to whoever wants to do business in Pakistan[154].

As a member of WTO, Pakistan has established bilateral and multilateral agreement with organizations in the international arena. This prompted to a recognizable improvement with Pakistan’s trade relations with other countires.  Moreover, foreign trade increased Pakistan’s chances of achieving economic growth and development[155].

Presence of foreign trade in Pakistan would help in promoting the economic growth of the country. Foreign Direct Investment answers the urgent need of Pakistan to boost its economy through the mobilization of foreign resources[156]. This contributes to the creation of more opportunities for growth in the economic sector and opens up new avenues for development by adding up opportunities for investment.

Recently, it has been noted that Pakistan’s share of Foreign Direct Investment has increased to 95%, far greater than other neighbouring economies such as Bangladesh and Sri Lanka[157]. This signals that the international community, particularly the big players in the economic sphere, recognizes the viability of Pakistan as host country.

This is attributable to Pakistan’s high economic growth for the past few years. Its aim of attracting FDI is a success due to the fact that Pakistan’s economic growth is overwhelming, given that its FDI inflows reached 165 billion dollars in 2005. This led to a heightened interest among multinational companies to engage and do business with Pakistan[158].

Of late, a wave of foreign investment has been sweeping across the developing countries. Studies made by the UN for its World Investment Report show that there has been an upsurge of foreign investment into the developing countries as the industrially developed countries have become less and less attractive for massive investments[159]. While 17 per cent of the Foreign Direct Investment (FDI) went to the developing countries in 1986-1991, the percentage spiraled up to 32 per cent in 1992 and it has since continued to surge forward.

The World Bank has estimated that the flow of FDI into the developing countries shot up from $45 billion in 1989 to a whooping $170 billion in 1994 in response to the unification of markets across the world. According to estimates transitional corporations now Control one-third of the World’s private sector productive assets. The US and UK are the biggest owners, followed by Japan. Japan dominates in Asia, the United States in Latin American and the European Community countries, and Eastern European and Africa[160].

It is the cheap labour and the location advantage that has proved a catalyst in triggering off the upsurge of foreign investment into the developing countries[161]. The German worker earns as much in four hours as his Vietnamese counterpart does in a month or the Indian counterpart in 20 days. Many companies in Hong Kong, in order to escape coming under the sovereignty of China, have been planning to relocate themselves in Manila or elsewhere.

In Pakistan, the high yield in economic growth has made the foreign investors to increase their investment. In 2005[162], foreign firms focused on the business and service sector.  More specifically, Pakistan attracted multinational companies’ into investing in financial services and high technology industries. This ultimately leads to more foreign investment, improvement of participation in the world market and economic growth.

During recent years when the yen has been constantly rising in value, rendering Japanese exports less competitive, Japanese companies, in order to stay competitive, have been sourcing more and more of their components as well as their entire products from affiliates in other countries[163].

In view of Pakistan being strategically located at the month of the Gulf, commanding easy access to the Middle East and Central Asia, with an abundance of manpower of which a good portion is trained and skilled, has, in its own right become a centre of attraction for foreign investment.

Risks and Consequences of FDI:  Negative Effect on Pakistan

Pakistan as a developing country could not be blamed for wanting to emerge as a strong economic figure in the international sphere. Foreign direct Investment per se, was not the cause of certain fall back of its economy. In carefully scrutinizing the case of Pakistan, it could be inferred that the reason for such adverse effects lie in the management of the Foreign Direct Investments of the country.[164]

Noticeably, some areas were neglected, causing it to experience deficiency. Thus what it leaves us is the fact that the problem was rooted in the manner of allocating such FDI.

If such allocation were done effectively, so as to focus on more important aspect of the economy, such as man power and production, the capacity to maximize FDI remains. Hence, the economy will be able to sustain growth and development.

During the last couple of years, Pakistan received Foreign Direct Investment, which at the time, seemed to bolster its potential economic growth. The Foreign Direct Investment was allocated to its maximum. Unfortunately, the distribution of FDI in Pakistan has not been very rewarding. The Telecom Sector received the highest investment, and the energy sector pales in comparison to it. Such growth is a very good indication, however, it more often than not, leads to the neglect of more important needs, like food & clothing and energy.[165] This could create adverse effects.

Looking at the distribution of Foreign Direct Investment in the country during  2005 to 2006, the more important and very basic interest like food and clothing, education and manpower planning, infrastructure development for transportation facilities do not acquire any position in the list of top six priorities.[166]

Allocation of Foreign Direct Investment in Pakistan was largely placed in urban regions. This, in effect, caused results that can be considered detrimental to the country.[167]  First, it made population of these urban cities double in number, amounting to overpopulation. This is because, the effect of FDI was to see this urban areas in a different light, more specifically, a breeding ground of opportunities.[168] What happened was an increase in population resulting to deficiency in resources for those who are living there. Second, since the urban areas have been crowded, no actual change on the standard of living happened for those who came from the rural areas.[169]

In light of the above, a brief review of the principal challenges facing the Pakistani economy would enable us to make an objective assessment of its longer-term viability.[170] The GDP of Pakistan in 2000 was approximately $67b in constant 1997 US dollar terms. When one adds the total debt, interest payments on the debt, and the defense budget, it nearly equals the total GDP for the country! This leaves precious little resources in the hands of the government to allocate for economic development or making investments in education, infrastructure or other targeted spending to stimulate growth.

One possible avenue to generate additional resources for the government would be to enhance its tax receipts, an endeavor that has proved to be a limited success so far. Another avenue would come from enhanced domestic investments, given the relatively modest per capita domestic savings rate (about 25%), but even this is limited by two factors. One, the disposable income at the hands of the average Pakistani for medium-to-longer term investment is relatively modest. And two, given the uncertainties on the return on investment in the national market, a majority of Pakistanis instead opt to invest their money abroad.

This has changed somewhat during 2001-02 because U.S and EU efforts at tracking and freezing financial networks suspected of supporting Al Qaeda has scared many expatriate Pakistanis who have started to remit their savings, causing a sharp rally of the Karachi Stock Exchange. But this phenomenon is not expected to last long, and in any case does not provide sufficient capital to finance the enormous developmental requirements of the country.

A third avenue to stimulate domestic growth, especially in the high-end manufacturing and services sector, would be to attract foreign investment. However, an external investor bases his decision, among others, on the political stability of the country and its macroeconomic policies[171]. Inflamed rhetoric about Kashmir and war with India, plus very high levels of defense spending, do not generate requisite investor confidence. Equally, refusal to join international security regimes means restrictions on access to advanced technology even for the civilian sector. Since Pakistan does not have much of an indigenous industrial base to begin with, its ability to generate and sustain high levels of economic growth on its own remains severely limited.

The multiplicity of the Government agencies dealing with the foreign investors and the lack of transparency in processing cases of foreign investment is also said to affect negatively the country[172].

Assessing Benefits and Consequences: A Balancing Act

The noticeable gain in economic value of Pakistan as a country has earned it a place among the priority list of foreign companies. Although considered a developing country, Pakistan is also branded as a so-called tiger economy[173]. This is attributable to the fact that basing on its rapid economic growth for the past four years, Pakistan has tremendously improved.

However, it is undeniable that despite the benefits afforded by Foreign Direct Investors to host countries, there also exist some consequences that ultimately affect the economy of the host country[174]. Take for example the heightened competition among producers in the domestic sphere. FDI makes the already difficult competition among domestic firms more complicated with the involvement of foreign firms ready to compete with the production capabilities of domestic companies. This inevitably leads to major setbacks in the economy of host countries.

On the other hand, problems exist because solutions are bound to be discovered. Pakistan, in recognizing both the beneficial and detrimental effects of FDI and MNEs towards their economic growth and tremendous potential for development, has been prompt in dealing with the predicament at hand.

The government, upon acknowledging the existence of an economic concern, has played an active part in trying to address the issue. It provided for policies to address such concerns, including debt management, tax reforms and policies to increase revenues. This depicts the willingness of the government to find a meeting point as to the conflicts posed by FDI and MNEs’ existence in the domestic sphere.

Now, it is recognizable that Pakistan significantly increased it economic base further strengthening its macroeconomic policies and implementing its planned economic reforms[175].

Chapter V Conclusion

The apparent need for foreign direct investment and multinational enterprise is deeply rooted in the desire to elevate one’s country into the global scene[176]. Foreign direct investment has immensely increased the anticipation of developing countries to achieve economic stability.
More often, it has promoted the idea of increased potential for development and growth through foreign investment.

This sudden interest to attract foreign direct investment is highly understandable and acceptable. Developing countries need to find ways to expand their economy and branch out into industries that promise high potential for growth[177].

The existence of Multinational Enterprises and Foreign Direct Investment highlights the need of countries to prioritize their economic policies and programs. To better afford the necessary incentives to foreign investors, developing countries maximize it resources and inherent capacities. This is highly attributable to the current trend nowadays which is to attract as much foreign direct investment as possible. It is viewed as the answer for economic problems faced by most developing countries.

Emerging economies focus on attracting FDI and MNEs in the hopes of increasing their economic potential for growth and development. This is mainly due to the fact that foreign direct investment connotes knowledge sharing, investing in information technology and advancement. It is now the motivating factor for developing countries to seek foreign investors and offer their skills as host country.

Multinational enterprise provides opportunities to increase employment add up to the capital inflows and catapult the host countries’ capacity to compete globally, through technological advancements. Developing countries follow this trend because it is the most viable source of capital inflows for their country. Take Pakistan, for having suffered a history of poverty, the moment it was able to surface into the economic scene, it did not waste time in attracting foreign investors. This action has been fueled by the desire to achieve economic sustainability.

Thus, MNEs and FDI cannot be branded as beneficial or detrimental. It all depends on sound economic policy to be implemented by the respective developing countries dealing with foreign investments[178].

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