INTRODUCTION TO FOREIGN CAPITAL

Foreign capital may be defined as:-

“The capital available for any country other than the domestic
capital in order to finance any capital need for domestic
purpose is called as foreign capital.”
It may be:-
1) Permanent
2) Temporary

NEED FOR FOREIGN

CAPITAL
Rapid economic growth of developing countries depends upon
rapid industrialization. Rapid economic growth in the modern
times in the context of developing countries. Due to the influx
of foreign capital, the industrial structure of India has widened
and deepened. The multinational firms who develop
technology would like to benefit from it through commercial
exploitation and not sell it at a price. FDI constitutes long term
investment and transforms the domestic production process by
bridging the technological gap. The need for foreign capital in
the context of developing countries is explained more precisely
in the following paragraphs.

1.Sustaining a High Level of Investment:

Countries with a negative saving investment gap definitely

needs foreign capital to close the gap and achieve the
desired rate of economic expansion. Further, foreign
capital assumes importance given in the case of those
countries like India whose saving investment gap is zero.
Capital output ratio to bring about a higher economic
growth rate. It further widens and deepens the secondary
and tertiary sectors of the economy. The primary sector
remains unaffected because foreign capital is not allowed
in this sector in countries like India.

2.Sustaining a High Level of Entrepreneurship:

Developing countries have a smaller pool of entrepreneur.

The height and width of the entrepreneurial class is
smaller in developing countries.
Opening the door to foreign
investment means opening the
door to the sea of entrepreneurial
 class to your country so that it is no more a pool, it
becomes a sea.

3.Sustaining the Development of Basic Economic

Structure:

The development of transport and communication and

power generation is fundamental to rapid economic
growth. Poor transport and communication and
inadequate power generation means lower capacity
utilization and high cost. Foreign capital helps to bridge
the gap between potential and actual growth rates.

4.Sustaining a Favorable External Balance:

Developing countries being dependent on high value

imports and low value exports generally face a negative
balance on the trade account. If the deficit on the trade
account is small, it may be wiped out by small surpluses on
the invisible account, there by having either a balance or a
surplus on the current account.
 MULTINATIONAL CORPORATIONS

The term multinational is used to describe an organization

that produces in, markets in, and obtains the components
of production from one or more countries for the purpose
of increasing benefits to the overall enterprise. The
essential feature of a multinational firm is that it controls
production facilities in multiple countries which means
firms participating in international business purely by
exporting or by licensing technology, irrespective of their
size cannot be considered as multinational corporation.
According to Jacques Maison-rouge, President of IBM
World Trade Corporation, a firm should fulfill the following
five criteria to qualify to be an MNC.
1. It operates in many countries at different levels of
economic development.

2. Its local subsidiaries are managed by nationals.

3. It maintains complete industrial organizations, including

R & D and manufacturing facilities in several countries.

4. It has multinational central management.

5. It has multinational stock ownership.

A global corporation produces in home country or in a

single country and focuses on marketing these products
globally or produces the products globally and focuses on
marketing these products domestically. International
production systems includes variety of activities such as R
& D, manufacturing, accounting, advertising, marketing
and training, dispersed over host-country locales and
integrated to produce final goods and services. It believes
that the practices adopted in domestic operations, the
people and products of domestic business are superior to
those of other countries. It therefore extends the domestic
product, price, promotion and other business practices to
foreign countries.

GROWTH OF MULTINATIONAL
CORPORATIONS

The MNCs share in global investment, production,

employment and trade has assumed considerable
proportions. The global liberalization wave, paved the path
for faster expansion and growth of MNCs. The MNCs
controls about a third of world output and the total sales
of their foreign affiliates is almost equal to the GNP of all
developing countries, save oil-exporting developing
countries. A number of factors have contributed to the
phenomenal growth of MNCs. Some of the important
factors follows :

1.Expansion of Market Territories:

Rapid economic growth in a number of countries

resulting in rising gross domestic products and per
capita incomes contributed to growing standards of
living. This in turn contributed to the continuous
expansion of market territories.

2.Market superiorities:

In many ways, multinational corporations have an edge

over domestic firms, such as:
a) Availability of reliable and current data,
b) MNCs enjoy market reputation,
c) MNCs encounters relatively less problems and
difficulties in marketing the products,
d) MNCs adopt more effective advertising and sales
promotion techniques, and
e) MNCs enjoy faster transportation and adequate
warehousing facilities.
3.Financial Superiorities:

Multinational Corporation also enjoys a number of

financial advantages over the domestic firms.
These are:
a) Availability of huge financial resources with the MNCs
helps them to transform
business environment and
circumstances in their favor.
b) Multinational corporations
can use the funds more
effectively and economically
on account of their activities
in numerous countries.
c) MNCs have easy access to
international capital
markets, and
d) MNCs also have easy access to international banks
and financial institutions.

4.Technological superiorities:
 The multinational corporations are technological
prosperous on account of high and sustained spend on
Research and Development.

Role of Multinational Corporation

ILO observation on the role of Multinational Corporation

has both the positive as well as the negative side. Looking
at the positive role played by the MNCs, the following can
be stated in favor of the multinational corporation:
1. MNCs help argument the level of investment,
employment and income in the host countries.
2. MNCs have become the media for the transfer of
technology, particularly to the developing countries.
3. MNCs have been solely responsible for the initiation
managerial revolution, particularly in the developing
ones.
4. MNCs contribute to factor-cost equalization around the
world.
5. MNCs contribute to the rapid integration of the global
economy.
The multinational corporations also have their negative
side. The negative role played by the MNCs can be
explained as follows:
1. MNCs do not cater to the development needs of the
poor countries, particularly, employment generation
and factor scarcity.
2. The multinational corporation can avoid or undermine
national economic independence and control their
activities may be harmful to the national interests of
host countries.
3. The multinational
corporation, in the
process of destroying
domestic monopolies
may end up becoming
monopolies unto
themselves.
4. The MNCs have the potential power to undermine the
sovereignty of independent nations.
5. The MNCs may cause rapid depletion of some of the
non-renewable national resources in the host country.
 Merits and Demerits of
Multinational Corporations
Multinational corporations create both advantages and
disadvantages to the host country as well as the home
country. The merits or advantages of MNCs to the host
country are as follows:
1. The economy is benefited through the availability of
state-of-art technology made available by the MNCs
from their home countries.
2. The multinational corporations spend a substantial
amount on Research and Development. R & D spend in
developing countries is extremely poor.
3. The entry of MNCs augments the production capacity of
host country. It also helps the economic growth of the
host country through backward and forward linkages.
4. MNCs helps to fill the saving investment gap and in the
process raises the level of investment, employment and
income and demand in the host country.
5. On account of the entry of MNCs, the intensity of
competition goes up and in the process increases the
competitive ability of firms in the host country.
6. MNCs help to expand the export basket of host
countries and also contract the import basket, thereby
improving their trade balance.

The Disadvantages are:

1. The developing countries of Asia in particular are labour
abundant and capital scarce. The MNCs perform an
important role in filling up the saving-investment gap in
these poor countries.
2. Substantial sums of money through the repatriation
route in the form of profits, dividends and royalties goes
back to the home countries of MNCs.
3. Multinational investments get attracted to the most
lucrative sectors and sub-sectors of the economies of
the host country to the neglect of essential
infrastructure industries and essential consumers as
well as capital goods industries.
4. Powerful MNCs with global reach and access to the
ruling class of rich nations may indulge in political
interference and influence both economic and
commercial policy of host countries to their advantage.
 Foreign Direct Investment
“FDI is defined as a long term international capital flow,
made for the purpose of productive activity and
accompanied by the intention of managerial control or
participation in the management of foreign firm.”

Advantages of FDI
1. It can narrow down or even bridge the gap between
available invertible resources in a country and the
desired level of investment to achieve a certain rate
of growth of economy.
2. Along with the inflow of foreign capital, the host
country is also benefited from managerial expertise,
entrepreneurial skills and organizational and
technological inputs.
3. It helps to expand the modern industrial and service
sectors of the economy and also accelerates the
process of employment generation.
4. It encourages domestic investment through backward
and forward linkages, and
5. It enhances consumer welfare by adding variety and
qualify to the availability of goods and services.
 Limitations of FDI
1. FDI must be complementary and supplementary to
domestic industry. It should not result in
supplanting and displacing the domestic industry.
2. The inflow of FDI in the non-core sectors of the
economy may increase income inequalities and
widens the socio-economic dualism particularly in
developing countries.
3. Foreign firms may add very little to the public
revenue of host countries through corporate taxes
by wresting undue tax concessions, investment
allowances, disguised public subsidies and tariff
protection, etc.
4. Private benefit of foreign investment may be
greater than the social benefits derived from it.

Determinants of FDI
1.Market Size:
One must understand that the multinational
corporations are in search of lucrative business
opportunities and they are in search because
their native countries do not have such
 opportunities. Market size refers to the size of
the consumer base.

2. Stable Political and Economic

Environment:
Political stability imports stability to the
economic environment in a country. The
economic policies of a country are determined
by the government. Only stable and strong
governments can impart continuity in economic
policies.

3.Macro-economic Management:
Sound macro-economic management of the
economy should result in price-stability. Price
stability should bring about exchange rate
stability and interest rate stability.

4.Regulatory and Legal Conditions:

The legal and regulatory framework available in
a country should be consistent with the
requirements of a free market economy. In this
context rules regarding foreign investments,
foreign collaboration, repatriation of profits,
 remittances taxation etc should be put in place
comprehensively and unambiguously.

5. Availability of Factor Inputs:

Easy availability of factor inputs reduces the cost
of production. Availability of educated and
technically competent human power,
competitive wages, easy availability of natural
resources and other raw materials, sound
infrastructure etc. contributes to the lowering of
the cost of
production and
attracts foreign
investment.