The Contagion Effect: An Inquiry into the Positivity of Foreign Direct Investment

Globalization has driven governments across the globe to enter into a fierce competition to secure international capital through foreign direct investments – FDI. Although multinational enterprises are driven by a specific factor that underlines location choice – for instance resource seeking (Dunning, 1994), the incentives provided by host government equally play a role in the location choice. Krugman and Obstfeld (1994) argue that there are two types of capital movement: the international borrowing and lending – which has been viewed as intertemporal trade; and foreign direction investment – capital flows in which a firm in one country creates or expands a subsidiary in another (Zilinske, 2010). The government policies that attract these capital flows include: industrial space, tax exemption or abatement, red tape waiver and land grants (Mudambi, 1995). Host country governments’ design these policies with the aim that there will be positive spillovers from the capital flow of these multinational organizations. Advocates of Keynesian approach (e.g. Lipsey, Pourvis & Courant, 1994; Epstein, 1999; Sims & Lake, 2000) argue that because market failures exist, a free market structure does not ensure market efficiency . Their argument is based on two key ideas: imperfect information – information is not always perfect thus incorrect information can lead to the wrong kind of investment; and divergent interest – Multinational Corporation’s interest is perhaps different for that of the host government. Conversely, Neo-liberals (e.g. IMF, 1999; Ciburiene and Zaharieva, 2006; Tong and Hu, 2003) argue that the positive spill overs from foreign direct investment far outweighs the negatives. This essay will enumerate and analyse two key positive spillover effects of foreign direct investment, then suggest how host nations can benefit from the capital flow of multinational organizations. One of the benefits of foreign direct investment is technology diffusion (Borensztein, Gregorio and Lee, 1997). According to Findlay (1998) foreign direct investment increases the rate of technological progress of the host country through a process referred to as the “contagion effect”. This process takes place through an array of avenues thus benefiting the host country in the transmission and generation of ideas and new technologies. Borensztein, Gregorio and Lee (1997) identify three channels of technology diffusion: imports of high-technology products – creates awareness for the host country helping the country keep abreast with modern products; adoption of foreign technology – host country can build on the technological idea to manufacture indigenous products; and acquisition of human capital – host country can hire the manufactures to train local producers in the latest technology. Aside these benefits, Borensztein, Gregorio and Lee (1997) note that foreign direct investment by multinational corporations is considered as one of the major means by which developing nations access advanced technologies. This is because multinational corporations are among the most technologically advanced institutions in the world and they account for a considerable amount of the world’s research and development (R&D) investment. Likewise, the development of human capital can be achieved through foreign direct investment. Blomstrom and Kokko (2003) argue that technology is not embodied only in machinery, equipment and patent rights but also in human capital of the affiliates’ local employee, thus developing them through direct and indirect training is vital for the success of the multinational enterprise in the host country. Blomstrom and Kokko (2003) suggest three avenues that the human capital of the host country can be developed: formal education, employee education and service industries education. Because multinational corporations increasingly demand for highly skilled graduates in the fields of natural sciences, engineering and business science (Blomstrom and Kokko, 2003), the host country government is driven to invest in higher education. In addition, the opportunity of gaining employment with a multinational enterprise is an added incentive for gifted students; this gives them an added impetus to start and complete tertiary education. Further, Blomstrom and Kokko (2003) argue that multinational corporations are actively involved in sponsoring higher institutions; this financial support helps the institutions in the area of research and development. Human capital is also developed through multinational employee education; Blomstrom and Kokko (2003) suggest this is done on the basis on of the industry, the mode of entry of the firm, type of operations and the local conditions. Regardless of the training, employees are developed in areas that add value to their knowledge, making them mobile within and outside the industry that they currently work. According to Blomstrom and Kokko (2003), the education in the service industry is focused on strengthening skills and know-how embodied in employees. In addition, UNCTAD (1994) suggest that the reason training is vital is because services are not tradable across international borders, thus multinational corporations in the service sector are compelled to invest in more training as they go abroad. Blomstrom and Kokko (2003) argue that the training in large service sectors – finance and IT – and simpler services industries – hotels and restaurants – have received great attention from multinational corporations. This paper has given an account of two benefits of foreign direct investment and elucidated the capital flow of multinational organizations. Although there are valid arguments against foreign direct investment, the benefits outweigh the disadvantages. For a country to successfully attract foreign direct investment that will benefit its people, the host government is required to first draft a strategic economic plan that clearly states how it wants to achieve economic growth and the types of multinational institutions that can play a role in accomplishing such a goal. Once this is successfully done, the host government has been able to narrow down the investors that match their economic development objectives. -------- Notes 1. Keynesian economics is considered to be a “demand-side” theory that focuses on changes in the economy over the short run. An economic situation that suggests that in any given market scenario, the quantity of goods demanded by consumers does not equate to the quantity of goods supplied by the suppliers 2. A market economy based on supply and demand with little or no government control. A completely free market is an idealized form of a market economy where buyers and sellers are allowed to transact freely (i.e. buy/sell/trade) based on a mutual agreement on price without state intervention in the form of taxes, subsidies or regulation. 3. The degree to which stock prices reflect all available, relevant information. 4. Neo-liberal approach in economics and social studies is synonymous with control of economic factors and the shifted from the public sector to the private sector. Drawing upon principles of neoclassical economics, neoliberalism suggests that governments reduce deficit spending, limit subsidies, reform tax law to broaden the tax base, remove fixed exchange rates, open up markets to trade by limiting protectionism, privatize state-run businesses, allow private property and back deregulation. The term "liberal" in economics is different from its use in politics. Liberalism in economics refers to "freeing up" the economy by removing barriers and restrictions to what actors can do. Neoliberalism's policies seek to create a laissez-faire atmosphere for economic development. ---------- References 1. Blomstrom, M. and Kokko, A. (2003) Human capital and inward FDI. Working Papers Series, No. 167, The European Institute of Japanese Studies (Stockholm School of Economics, Sweden). 2. Borensztein, E., De Gregorio, J., & Lee, J. W. (1998). How does foreign direct investment affect economic growth?. Journal of international Economics, 45(1), 115-135 3. Ciburiene, J., & Zaharieva, G. (2006) International Trade as a factor of competitiveness: comparison of Lithuanian and Bulgarian cases. Inžinerinė Ekonomika-Engineering Economics (4). 48-56. 4. Dunning, John. H. (1994). Re-evaluating the benefits of foreign direct investment. Transnational corporations, 3(1), 23-51. 5. Epstein G. (1999). A critique of neo-liberal globalization. Third World Network. 6. 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