MULTINATIONAL CORPORATIONS & FOREIGN DIRECT INVESTMENT
A firm is considered a multinational corporation (MNC) if it owns, in part or in whole, a subsidiary in a
second country. High profile MNCs have many subsidiaries.
There are different types of MNCs. Some are vertically integrated. The subsidiary provides inputs to
the parent which produces a final good. Oil companies are good examples of vertically integrated
MNCs. Oil exploration and production are accomplished abroad where the subsidiary exports crude
petroleum to the parent corporation which then refines the crude into gasoline. Another example is the
Maquiladora program. The US parent corporation exports components to an assembly Maquiladora
subsidiary which in turn re-exports the assembled good back to the parent corporation.
Other MNCs are horizontally integrated, meaning that the subsidiary produces a similar good to that of
the parent. The soft drink industry is an example of horizontally integrated MNCs. The subsidiary is a
bottling company which produces pretty much the same product as the parent.
Foreign direct investment (FDI) or the means by which an MNC obtains or expands a subsidiary can
take a variety of forms. FDI can be by merger or aquisition of an existing firm, by participating in the
construction of a new firm, or by expanding existing subsidiaries.
The following tables list amounts of FDI for the US by industry and countries. Hopefully they will be
updated soon.
Table 1 - Amounts of FDI -- US FDI abroad
- measured as a stock at the end of 1989 (book value)
Industry
Manufacturing
Finance excluding banking
Petroleum
Country/region
Europe
Canada
L.America
Asia & Pacific
excluding Japan
Japan
billions $
155.7
77.1
57.9
% of total
41.7
20.6
15.5
176.7
66.9
61.4
21
47.3
17.9
16.4
5.6
19.3
5.2
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Table 2 - Amounts of FDI -- Foreign FDI in US
- measured as a stock at the end of 1989 (book value)
Industry
Manufacturing
Wholesale Trade
Real Estate
Petroleum
Country/World
Europe
Japan
Canada
billions $
160.2
54.5
35.9
35.1
% of total
40
13.6
8.9
8.8
262
69.7
31.5
65.4
17.4
7.9
As of 1989 United Kingdom has the largest amount of FDI in US - 29.7%.
Second is Japan with 17.4% of the total, and third is the Netherlands with 15.1%.
Motives for Direct Foreign Investment
As with any investment, FDI reflects the firm=s decision to spend resources today in the expectation
that these resources will generate future profits sufficient to compensate the firm for these
expenditures. In the jargon of economics, the present discounted value of the future stream of
revenues will be greater than the present discounted value of costs.
The underlying factors which may have dictated these flows of revenues and costs are demand and
cost factors. The main decision for FDI is whether it is more profitable to set up production in one
form or another with a foreign subsidiary or to increase production at home and expand exports of
the good.
The advantages to setting up a subsidiary fall into two categories, demand factors and cost factors.
Demand Factors
On the demand side, by having a foreign subsidiary, the firm will be capable of monitoring the
foreign market more closely and, consequently, respond to changes in a more timely manner. This is
especially true if the foreign market is large and growing rapidly. A second consideration on the
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demand side is more direct. If foreign competition is eroding the firm=s market share, then simply by
buying the competitor maintains the firm=s market power.
Cost Factors
The impetus for the creation of a foreign subsidiary may be lower costs of production. The most
obvious is mineral extraction. The presence of large deposits of natural resources in foreign
countries where the cost of extraction is considerably less than continued domestic exploration and
extraction will lead to large amounts of FDI. There is a real danger in this type of FDI. Many
examples abound of expropriation of these types of subsidiaries, for example, oil MNCs in Mexico
and Libya, and bauxite MNCs in Jamaica.
Firms may relocate production to take advantage of lower labor costs. But as already discussed, the
attraction to lower labor costs must also take labor productivity into consideration. If foreign labor
productivity is sufficiently low so as to offset the gains from lower wages, then FDI will not be
profitable. Examples of FDI responding to labor costs include China, SE Asia, and the Mexican
Maquiladora program.
Probably the most significant motivation for FDI is the avoidance of trade restrictions. Recall the
firm's choice is to either produce at home and export or to produce abroad. If the firm's exports face
high barriers to trade, then FDI leading to production within the foreign country circumvents these
barriers. Examples of this are close to home. Much of the Japanese automotive transplants were as a
result of growing US protectionism against Japanese imports. Trade diversion occurring in Mexico
also represents this type of FDI.
Another factor which may encourage FDI is the idea of risk diversification. If the good produced is
highly sensitive to income changes, i.e., highly income elastic, then it would make sense to have
access to many different markets. The major national economies grow at different rates. While one
part of the world is in recession, other areas may be expanding. For example the US is showing
strong growth while Japan and Europe are coming out of recession. If a company only serviced the
European market, it would be suffering from the slow pace of the European economy. However, if
they also had production facilities in the US servicing the US market, then their losses in Europe are
offset by the performance of their US subsidiary. The recent mega-megers in the automobile
industry are examples of firms diversifying their markets.
Potential Benefits to the Host Country of FDI
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Much literature has been written about the effects of FDI on host countries. Generally the analysis
has been done from a developing country point of view. However, the controversy is overstated. In
my opinion, FDI generally benefits the host country. The pros and cons to the host country are listed
in the following table.
A.
B.
C.
D.
E.
F.
G.
H.
Pro
Con
Leads to greater output
A. Displacement of domestic firms
Increased wages
B. Inappropriate technology and investment
Increased employment
C. Loss of sovereignty
Increased exports
D. Benefits only the "elites" while
Increased tax revenues
exploiting the poor
Provision of new and better technology
Better managerial and technical skills
Increased domestic investment
The attitudes towards FDI have changed. Now, most developing nations actively attract MNCs as a
means of increasing investment and spurring economic growth.
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