ms-97 mba assignment july dec 2010 Question 5

5. Indicate the impact of FDIs on LDCs in terms of technology transfer and local technological capability.

Foreign Direct Investments In Ldcs

The magnitude of global flows of FDI has grown at a rapid pace over the past two decades thegrowth has bean particularly steep since the mid 1980s. Table 13.1 shows that FDI flows have grown from US $ 11 billion in 1970 to $ 225 billion in 1990. FDI’s originate   almost entirely in the industrialized countries. An increasing proportion of these flows is also destined towards the industrialized countries.

FDIs represent flows of resources, which can be instrumental in expediting the developmental process in LDCs. However, the distribution of FDI inflows between the industrialized and developing countries is increasingly uneven. The bulk of the FDI inflows are hosted by the industrialized countries themselves. Table 13.3 shows that the share of developing countries in average annual FDI inflows has actually declined steadily from about 35 per cent during the 1960s and 1970s to 16.9 per cent during 1988-89.

Thus, developing countries are being gradually marginalized in the distribution of the FDI flows. In the coming years, this trend is likely to intensify further in view of the emerging developments in the world economy, such as, Single European Market, formation of the North American Free Trade Area, Pacific Rim Community, and reform of East European countries.

The distribution of whatever little FDI that flows to the developing countries itself is highly uneven across countries. The bulk of these flows are destined towards a handful of middle income Newly Industrializing Economies (NIEs) in South-east and East Asia and Latin America. As is evident from the Table 13.4, nearly two-thirds of the FDI flows from the developing countries are accounted for by the ten largest host economies.

The least developed countries, for the development of which FDIs could be of critical importance receive only a marginal proportion of FDIs. The Table shows that proportion of the least developed countries in annual FDI flows to the developing countries actually declined from 1.52 per cent, during the early 1980s, to 0.58 per cent, in the late 1980s. Further, the least developed countries are the only group of countries, which have lost, not only in terms of shares, but also in absolute terms. The average annual flows to them were of the order of US $ 190 million during the early 1980s, which declined to $ 170 million during the late 1980s…

The sectoral distribution of FDI flows suggests that manufacturing has attracted only a small proportion of FDI flows. Table 13.5 shows that manufacturing accounts for only about 35 per cent of the total FDI stocks owned by the four major home countries of FDI, viz., the United States, the UK, Japan and Germany. Further, the share of manufacturing shows a declining trend in all the cases over the 1977-84 (from 42 to 36 per cent in the case of the U.S., from 45 to 43 for the U.K.; from 34 to 32 for Japan, and from 48 to 43 per cent in case of Germany). Extractive sectors and services account for nearly two-thirds of the FDI. Service sectors, especially trading and banking, finance and insurance, account for increasing proportion of FDI. The figures given in the Table relate to the overall FDI stocks. In the FDI stocks in LDCs, it can be expected that the proportion of the primary sectors (petroleum, mining, agriculture and' plantations) would be considerably higher, and that of the manufacturing sectors would be even lower

IMPACT OF FDIs ON LDCs

Direct Impact

FDls comprise inflow of productive resources, such as, capital and foreign exchange are, generally, accompanied by flow of entrepreneurial and managerial skills and technology. FDIs complement the domestic savings in financing the capital formation in the host country. Thus FDIs contribute to the generation of output and employment. The foreign exchange inflow augments the supply of foreign exchange, which is often scarce in the developing countries. In most cases, however, the project being set up with FDI is dependent upon imported plant and machinery, and technology. The foreign exchange -inflow takes care of these import requirements, partially or fully.

The direct cost of FDI to the host country comprises remittances made on account of dividends on the equity held abroad, interest on loans or suppliers^' credits extended by the foreign investors, royalties and technical fees, for transfer of technology and other services provided by the foreign partner.

Unlike foreign borrowings, servicing remittances, viz., dividends in the case of FDI begin after the project starts making profits. However, the servicing burden of FDI builds up very fast, and consumes considerable foreign exchange resources of the host country. Further, these remittances have the tendency to grow over time as the enterprise consolidates and prospers.

Thus, the direct impact of FDIs on the host country includes both positive and negative aspects. The favourable impact is by way of generation of output and employment by complementing the domestic savings and bringing in the much-needed entrepreneurial skills and foreign exchange resources for the developing countries. The adverse impact is on account of growing remittances of dividends, royalties and technical fees in the foreign exchange, which affect the balance of payments. It has been contended, however, that the direct remittances represent only a minor part of the total cost of FDIs on the developing host countries. More significant costs are indirect costs as discussed below.

Indirect Impact

The indirect impact of FDIs on LDCs also has both favourable and adverse elements as follows:

Among the indirect favourable effects of FDI one could include improvement in the access of the host country to the international markets through association with the MNEs, exposure to new technologies and organisation and management systems. The MNEs can help their developing host countries to expand the manufactured exports with their captive access to marketing outlets in the industrialised countries. They can also help in saving scarce foreign exchange by substituting imports of the host countries. A predominant proportion of FDIs in India has gone into import-substituting projects. Some studies for the Latin American countries have found evidence of favourable spill-overs of the presence of foreign enterprises on local enterprises in terms of improved labour productivity.

FDIs can have adverse effects on different parameters of development, such as, balance of payments, local technological capability, employment, market structure, etc.

Balance of Payments

Besides remittances of dividends, royalties and fees, as discussed above, operations of the MNE affiliates can affect the balance of payments of the host countries through their import dependence and export performance relative to that of their local counterparts, and through manipulation of transfer prices.

Import Dependence

            The dependence of foreign controlled enterprises on imported capital goods, raw materials, components and spares is, generally, higher than that in the case of their local counterparts. This could be because of the greater familiarity of the foreign investors with the foreign sources of goods, and to provide a market for the products of the other group companies. A number of studies of different countries confirm the tendency of the foreign firms to buy a lesser proportion of inputs from the local markets than their local counterparts.

Export Promotion

It is argued that the foreign enterprises are better equipped to undertake the manufactured exports because of their captive access to information and marketing outlets in the industrialised countries, and their ability to use internationally renowned brand names. The experience has shown, however, that the MNEs are very selective about using the developing countries as platforms for exports. Except for a few countries in the Southeast and East Asia, the experience of the developing countries has been disappointing in this regard. The studies from a number of countries have shown that export performance of foreign affiliates has not been any different, if not worse, than that of their local counterparts. Further, a considerable proportion of agreements concluded between the MNEs and their local affiliates include clauses restricting exports of the latter.

Transfer Pricing

The MNEs also use manipulation, of transfer prices to covertly transfer surpluses of the affiliates to the headquarters. The transfer price is the price at which intra-firm (i.e., between two affiliates of a MNE) trade takes place. Hence, imports of raw materials, spare parts and capital goods of the affiliates from the parent or other associates (and exports of affiliates to them) take place at transfer prices. Since the transfer prices are determined by the foreign parent, there is ample scope of their manipulation to their advantage. There is considerable evidence from India and other developing countries of indulgence of the MNEs in manipulating transfer prices to the disadvantage of the host nations. The extent of manipulation in certain cases exceeded 100 per cent.

Thus, FDIs affect balance of payments of the host countries, not only through initial capital inflows, foreign exchange spent on capital goods imports and servicing remittances, but also through foreign exchange generated through exports or saved through import substitution, imports of raw materials and components, which could be unreasonably high, and through possible manipulation of transfer prices.

Technology Transfer and Local Technological Capability

FDI is considered to be a vehicle of technology transfer. It is contended, therefore, that the FDI flows provide their host countries access to sophisticated and complex technologies. But the theoretical propositions and empirical findings suggest that FDI by itself does not necessarily improve the access of the host countries to more complex technologies.

Over the past four decades, arm's length licensing has emerged to be a viable and increasingly significant alternative to FDI for technology acquisition. Internalization theory is presently used to explain the FDI flows and foreign operations of firms. According to this theory, FDI is likely to be preferred as a mode of foreign production, if goodwill assets like brand names are included in the transfer (because of the need of maintaining quality) or where knowledge is idiosyncratic and, hence, its transfer requires movement of the personnel. New proprietary process technology, or process technologies that are standardized, and which can be written down and transmitted objectively, can be transferred easily through licensing.

The recent empirical studies confirm that it is not the more complex or sophisticated technologies that are transferred most through FDI. It is the technology for production of differentiated goods, sold under brand names with high advertising and marketing outlays that is most likely to be transferred through FDI. It is because of these tendencies that most developing country governments have evolved entry regulations to screen proposals of FDI and licensing collaborations; according to the national priorities and technological gaps.

In any case, FDIs or licensing agreements envisage transfer of production know-how. The know-how, or design capability is rarely provided by the foreign collaborators to the recipient enterprises, and that is the most important component of building local technological capability. The know-how is to be absorbed through learning by doing, reverse engineering, or during the process or product adaptations and R & D activities. In the case of FDI, the foreign collaborator is also participating in the management, controlling the technical functions. In these cases, therefore, the chances of the importing enterprise learning through processes, such as, reverse engineering are very limited. In-house R & D activity of the MNEs is usually centralised on a global or regional level, feeding all the affiliates. Several surveys have confirmed the MNE's tendency to concentrate R & D activity near headquarters or in the developed countries.

A recent study found the foreign controlled firms in India to have lesser propensity to undertake in-house R & D than their local counterparts, who obtained technology on a licensing basis. This tendency has been explained in terms of three factors. Firstly, though the foreign collaborators often restrict any changes in the original specifications/ designs supplied through restrictive clauses inserted in the collaboration agreements, the propensity to adhere to these restrictions may be less in case of a locally controlled firm than in the case of a firm controlled by the foreign collaborator itself. Secondly, unlike the MNE affiliates, the unaffiliated licensees do not enjoy continued and captive access to the research laboratories of the technology supplier. Hence, they have to set up their own laboratory. Finally, the technical collaboration agreements are of a finite duration (up to 5-10 years), while FDI entails a life-long relationship. Due to restrictions placed on the renewals of technical collaborations by the government, the local licensees may be anxious to absorb the technology before their expiry. Besides, independence of decision-making in the case of licensing collaborations or outright purchases allows the local firm to selectively delink and diversify the sources of technology resulting in cost effectiveness and greater technological competence.

Thus, FDI makes only a limited contribution to local technological capability building in the host countries. They appear to be inferior to licensing or outright purchases of technology (purely technical collaborations) as a channel of technology acquisition in terms of contribution to local technological capability.

In this context, there is a lot to learn from the experience of South Korea, which succeeded in building local technological capability and climb the technology ladder very fast. South Korea imported technology selectively on licensing or contractual basis, and absorbed it through reverse engineering. FDIs were restricted only to the export-oriented or to cases where closely held nature of technology would not allow it to be obtained on a contractual basis. The Korean enterprises promoted their own brand/trade names and trading houses instead of depending upon the western multinationals. Therefore, the Korean enterprises enjoyed independence of decision-making from the foreign collaborators, enabling them to absorb and adapt technologies with reverse engineering and in-house R & D activity.

Choice of Techniques and Employment

It is widely believed that, because of relative scarcity of labour and abundance of capital, the technologies developed-and employed by the western MNEs are progressively labour displacing and relatively more capital intensive. An excessive induction of such technologies in labour surplus economies may, therefore, create distortions like growing capital scarcity and unemployment. A number of studies comparing factor proportions of technologies employed by the foreign and local firms in a number of developing countries have found evidence of the higher capital intensity in the former case. Therefore, FDIs create fewer jobs per unit of investment than other investments in LDCs.

Market Structure

Entry of the MNEs can affect host country market structures adversely. Possession of intangible assets, such as, globally known brand names and their reliance on non-price mode of rivalry, viz., through product differentiation and advertising and heavy market promotion raise barriers to the entry of potential local entrants. Besides, the MNEs sometimes engage themselves into restrictive practices (RBPs), which are aimed at eliminating the existing or potential competition by mergers and acquisitions or by forming cartels. Hence, the presence of the MNEs generally leads to market concentration. Empirical studies of a few countries have confirmed a correlation between FDIs and market concentration even after controlling for common factors.

6. Write short notes on

a) Visible and Invisible Trade

Visible trade is trade in goods, physical things you can touch and weigh. Invisible trade is trade in services, like tourism and banking.
Governments that have any sense actively promote foreign trade because it brings more prosperity to the people who elect them. Places like Hawaii and the Greek islands earn their income from tourism, places like China and Bangladesh earn theirs from cheap labour manufacturing, and places like London and New York earn theirs from the arts and sport and financial services and company HQs. Then everybody sells what they do best and buys what others do better and the result is everybody is better off than if we all tried to be self-sufficient like we had to be 1500 years ago.

b) Environmental Scanning

Environmental scanning is a process of gathering, analyzing, and dispensing information for tactical or strategic purposes. The environmental scanning process entails obtaining both factual and subjective information on the business environments in which a company is operating or considering entering.

There are three ways of scanning the business environment:

• Ad-hoc scanning - Short term, infrequent examinations usually initiated by a crisis
• Regular scanning - Studies done on a regular schedule (e.g. once a year)
• Continuous scanning (also called continuous learning) - continuous structured data collection and processing on a broad range of environmental factors.

Most commentators feel that in today's turbulent business environment the best scanning method available is continuous scanning because this allows the firm to act quickly, take advantage of opportunities before competitors do and respond to environmental threats before significant damage is done.

c) ASEAN

The Association of Southeast Asian Nations, commonly abbreviated ASEAN  in English, the official language of the bloc), is a geo-political and economic organization of 10 countries located in Southeast Asia, which was formed on 8 August 1967 by Indonesia, Malaysia, the Philippines, Singapore and Thailand.^[5] Since then, membership has expanded to include Brunei, Burma (Myanmar), Cambodia, Laos, and Vietnam. Its aims include the acceleration of economic growth, social progress, cultural development among its members, the protection of the peace and stability of the region, and to provide opportunities for member countries to discuss differences peacefully.

ASEAN spans over an area of 4.46 million km² with a population of approximately 580 million people, 8.7% of the world population. In 2009, its combined nominal GDP had grown to more than USD $1.5 trillion.^[7] If ASEAN was a single country, it would rank as the 9th largest economy in the world in terms of nominal GDP.