Question
The presence of multinational corporations (MNCs) in a low-income country always promotes economic growth in that country. Evaluate this statement. (20 marks)
Category:
Economic Growth & Development
CIE A Level October/November 2023
Answer
Multinational corporations (MNCs) and foreign direct investment (FDI) play pivotal roles in the economic development of in a low-income country. An MNC is defined as a company that has its headquarters in one country but operates and has production or service facilities in other countries. Prominent examples include global giants like Coca-Cola, Ford, Hilton Hotels, Nestlé, McDonald’s, Tata, and Toyota, which have extensive manufacturing and retail operations worldwide.
MNCs have the potential to stimulate economic growth in a low-income country, characterized by an increase in the production of goods and services.
(👉STEP 1: Explain how the presence of multinational corporations (MNCs) in a low-income country promotes economic growth)
The globalization of the economy has facilitated the expansion of Multinational Corporations (MNCs) into low-income countries, bringing with them a myriad of potential benefits and challenges.
➡️Transference of Skills and Knowledge to the local workforce
The presence of MNCs in low-income countries is often heralded for its role in transferring crucial managerial expertise and technical skills to the local workforce. This process is not merely about importing foreign talent but involves a comprehensive integration of global best practices and innovative technologies into the local economic fabric.
By introducing advanced business operations and production techniques, MNCs play a pivotal role in enhancing the productivity and efficiency of the local workforce. This skill transfer is instrumental in elevating the competitiveness of local industries on a global scale, thereby stimulating both immediate and long-term economic growth. The development of a more skilled labor force, in turn, fosters a culture of innovation and continuous improvement within the host country.
➡️MNCs contribute substantial tax revenues to the host country's government
Another significant benefit of MNCs operating in low-income countries is the enlargement of the tax base. Through corporate taxes, MNCs contribute substantial revenues to the host country's government, thereby augmenting its capacity to invest in essential sectors such as infrastructure, education, and healthcare. This increased fiscal capacity is crucial for economic development, as it allows for the enhancement of public services and the overall business environment. Such improvements not only benefit the immediate needs of the population but also serve to attract further foreign and domestic investments, creating a virtuous cycle of growth and development.
➡️ MNCs channel Foreign direct Investment (FDI) into the economies where they are active
Through their operations, MNCs channel FDI into the economies where they are active. FDI is essential for establishing or acquiring production facilities in a foreign country and involves the transfer of capital across borders. This is distinct from portfolio investment, which entails buying shares in foreign companies without direct control over them. Essentially, FDI involves setting up new business operations or buying existing ones abroad, contributing significantly to the host country's economic landscape.
➡️MNCs enhance the host country's aggregate supply
MNCs are often seen as agents of economic globalization, bringing foreign direct investment (FDI) into low-income countries. The impact of such investment is profound, potentially enhancing the host country's aggregate supply. MNCs can introduce cutting-edge technology, innovative management practices, enhance the gross domestic product (GDP) and exports, and create job opportunities.
Multinational corporations (MNCs) can cause an increase in aggregate supply in a low-income country through enhanced productivity, technology improvements, or the implementation of better supply-side policies. This is depicted as a rightward shift in the Aggregate Supply (AS) curve from AS to AS1, indicating an increase in the economy's real GDP from Y to Y1 and a potential decrease in the price level from P to P1, thus illustrating economic growth
(👉STEP 2: Explain how the negative impacts of multinational corporations on economic growth in a low-income country)
The globalization of economies and the expansion of Multinational Corporations (MNCs) into low-income countries have been met with both optimism and criticism. While the potential benefits of MNCs, such as economic growth and the transfer of technology, are often highlighted, it is crucial to also consider the negative impacts that these entities can have on the host countries.
➡️Environmental Degradation
One of the most significant criticisms of MNCs operating in low-income countries is their contribution to environmental degradation. In an effort to evade stringent environmental regulations imposed in their home countries, some MNCs relocate their 'dirty' industries to low-income countries where environmental standards are more lenient or poorly enforced. This relocation can lead to significant negative externalities, such as pollution and the depletion of natural resources, which can have long-term detrimental effects on the local environment and public health. The cost of these environmental damages often outweighs the economic benefits provided by the MNCs, leaving the host country to deal with the aftermath.
➡️Undermining of Local Industries
The presence of MNCs can also have a destabilizing effect on local industries. The scale, efficiency, and financial capabilities of MNCs allow them to dominate the market, often leading to the displacement or destruction of indigenous businesses. This competition can result in a net loss of jobs if the local industries are unable to compete, potentially outweighing the employment opportunities created by the MNCs. Furthermore, the loss of local businesses undermines economic diversity and can leave the economy more vulnerable to external shocks.
➡️Establishment of Monopolies
MNCs have the potential to establish monopolies or oligopolies in the host country, exploiting their dominant market position to the detriment of consumers. By controlling significant portions of the market, MNCs can dictate prices and reduce output, leading to higher prices for consumers and a decrease in consumer surplus. This monopolistic behavior not only affects the affordability and availability of goods and services but also stifles competition and innovation within the local market.
➡️Transfer Pricing
Transfer pricing is another contentious issue associated with MNCs. This practice involves setting prices for transactions between subsidiaries of the same corporation in different countries to shift profits to low-tax jurisdictions. While technically legal, transfer pricing can significantly reduce the tax revenues of the host country, depriving it of much-needed funds for public services and infrastructure. This erosion of the tax base can hinder the government's ability to invest in economic development and social programs.
➡️Nature of Employment
The employment opportunities created by MNCs in low-income countries are often criticized for their quality and sustainability. Many jobs offered by MNCs are low-skilled and low-paid, with more senior and skilled positions frequently filled by expatriate workers. This practice limits the development of local talent and perpetuates a cycle of dependency on foreign expertise. Moreover, the focus on low-skilled jobs does not contribute to the long-term development of the local workforce or economy.
(👉STEP 3: Provide an analysis)
➡️Sustainable growth
For economic growth to be truly inclusive and sustainable, it is essential that the benefits derived from the presence of MNCs are distributed equitably and that adverse impacts are mitigated. This requires a proactive approach from both governments and MNCs. Governments in low-income countries need to implement and enforce robust regulatory frameworks that protect the environment, ensure fair labor practices, and promote the development of local industries. Policies aimed at enhancing the capacity of local firms to compete and integrate into global value chains are crucial.
Moreover, MNCs should adopt responsible business practices that prioritize environmental sustainability and social equity. This includes investing in local capacity building, adopting green technologies, and engaging in fair trade practices. The integration of corporate social responsibility (CSR) into business models can help ensure that economic growth benefits are more broadly shared across the host country's population.
➡️ACTUAL VS POTENTIAL ECONOMIC GROWTH
MNCs contribute to actual economic growth by bringing in FDI, which often leads to an increase in the utilization of previously unemployed resources. For example, when an MNC establishes a new factory, it not only creates jobs but also increases the demand for local materials and services, thereby boosting the host country's output from one point on the PPC to a higher point, indicative of economic expansion.
Actual economic growth occurs when output increases. It can be achieved as the result of greater utilisation of existing resources or as the result of the utilisation of more resources.
Figure 1 uses a production possibility curve (PPC) diagram to show economic growth resulting from greater use of existing resources.Th e economy is initially producing at point X. Th en the production point increases to point Y and more goods and services are produced
However, for an economy to sustain growth over the long term, potential economic growth is necessary. This concept refers to the increase in the economy's capacity to produce goods and services, illustrated by an outward shift of the PPC.
Potential economic growth can be spurred by MNCs through the transfer of technology and managerial expertise, which enhances the productivity of the workforce and the efficiency of production processes. By investing in training and development, MNCs can help expand the host country's productive potential, making higher output levels achievable.
For an economy to continue to grow, it is necessary for potential economic growth to occur. The figure below shows potential economic growth using a production possibility curve. It illustrates an increase in the maximum output the economy is capable of producing
The presence of MNCs and the influx of FDI have the potential to significantly impact both actual and potential economic growth in low-income countries. By understanding and leveraging this relationship, host countries can maximize the benefits of MNCs, ensuring that economic growth is not only immediate but also sustainable and inclusive over the long term.
👉Conclusion
The economic growth narrative associated with MNCs in low-income countries is not black and white. While the short-term economic benefits of FDI and skill transfer are undeniable, the long-term sustainability of this growth hinges on addressing the challenges of environmental degradation, social inequality, and the erosion of local enterprise. Achieving inclusive and sustainable growth requires a concerted effort from both MNCs and host country governments to ensure that economic development does not come at the expense of social and environmental well-being.
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Preview:
• Transference of skills and knowledge: managerial and workshop.
Increased tax base giving opportunities to government to invest in the economy.
• Definitions of MNC and short term (actual) and long-term (potential) economic growth.
• Impact of foreign direct investment (FDI) on a country’s aggregate supply/PPF. Analysis may be in terms of the multiplier, the circular flow of income or AD/AS.
• The improvement of education and health and the promotion of long term growth AO3 Evaluation
• Evasion of enhanced legal limits in home country: environmental impact - FDI can be used to export ‘dirty’ industry and transfer negative externalities to another country. Evasion of home employment/health and safety laws which increase costs.
• Destruction of host country’s indigenous industry by large scale MNC production. Negative impact on employment exceeds benefit of MNC employment.
• The MNC may establish a local monopoly that exploits the consumers with higher prices and lower output.
• MNC may practice transfer pricing to remove profits from developing country to tax haven.
• The impact on macroeconomic aims of the government is analysed.
• The jobs created in the local environment may be low-skilled, with the multinational employing expatriate workers for the more senior and skilled roles
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