In general, the functions of foreign sources of three decades their growth has been explosive.

For
finance are the following: the greater part of the 20th century, foreign direct
investment originated in developed countries and was
• Helping countries acquire foreign exchange. also directed mainly towards developed countries.
Foreign sources of finance create credits in the Since the 1980s, developing countries have been
balance of payments. Therefore, if there is a deficit receiving an increasing share of total foreign direct
in the current account, which is likely to be due to a investment inflows, approaching half of total annual
trade deficit, these inflows lead to a supply of foreign FDI inflows (see Table 18.1 below).
exchange (credits) used to pay for this deficit.2 Multinational corporations have their headquarters
• Adding to insufficient domestic savings. mostly in developed countries, dominated by the
Developing countries, because of their relatively low European Union, Japan and the United States.
incomes, often have a low amount of savings, leading However, developing and transition countries are
to low levels of investment. Foreign sources of finance rapidly increasing their share in global foreign direct
can be used in addition to domestic savings to help investments. While in 1990 only 10% of total MNCs
countries increase investments in numerous areas had headquarters in developing countries, in 2009
that support growth and development. this share had risen to more than 25%.3 Whereas most
• Adding to technical skills, management multinational corporations are privately owned, there
skills and technology. Developing countries are also a few state-owned firms that are expanding
often have low levels of skills and technology. abroad, particularly from developing countries.
Some foreign sources of finance can help countries
develop their skills and technology levels, which are The scope and growth of multinational
a big push in favour of growth and development. corporations
The world of multinational corporations is vast and
growing very rapidly. In the early 1990s, there were an
18.2 Foreign direct investment and estimated 37 000 multinational corporations globally;
multinational corporations (MNCs) by 2009, they had increased to 82 000 and employed
80 million people in their foreign affiliates alone. The
The nature of foreign direct production of their foreign affiliates (i.e. excluding
production in home countries) amounted to 11% of
investment and multinational
corporations
Host region % of % of
! Describe the nature of foreign direct investment (FDI) and world developing
multinational corporations (MNCs). countries
World 100.0
Introducing multinational corporations Economically more developed 54.2
Foreign direct investment (FDI) is investment countries
by firms based in one country (the home country) Economically less developed 45.8 100.0
in productive activities in another country (the host countries
country). A firm that undertakes foreign direct investment
Latin America and Caribbean 11.2 24.4
is referred to as a multinational corporation
(MNC), because it operates in more than one country. A North Africa and Middle East 8.3 18.1
‘corporation’ is a type of firm composed of a legal entity Sub-Saharan Africa 3.9 8.4
that is separate from the individuals who own it. East Asia 14.8 32.4
Multinational corporations run business operations (of which, China) (9.1) (19.9)
in both the home country and in other (host)
South and South East Asia and 7.7 16.7
countries. Historically, MNCs have been active
Oceania
since about the middle of the 19th century. Their
importance grew in the 1950s when US multinationals Table 18.1 Geographical distribution of foreign direct investment inflows,
stepped up their investments in Europe as part of 2009
European postwar reconstruction. In the last two to Source: UNCTAD, World Investment Report 2010.

2It might be thought that foreign sources of finance are recorded in the 3 United Nations Conference on Trade and Development (UNCTAD), World

balance of payments as credits in the financial account, but this is not always Investment Report 2010.
the case. For example, grants and concessional financial flows, as well as
remittances are entered under ‘current transfers’ in the current account.

500 Section 4 Development economics

global GDP and the value of their exports was 33% of
global exports.4
The larger of the multinational corporations are
enormous in size. In 2008, the top ten non-financial
multinational corporations (ranked by size of foreign
assets) had total assets of US$3 trillion, and total sales
of $2.3 trillion.5 In 2008, the value of sales of the top
ten MNCs was about three times the total GDP of all
the countries of Sub-Saharan Africa combined, and the
value of their total assets was nearly four times Sub-
Saharan African GDP. Further, their total assets were
about the same as the GDP of China, and two and a
half times the GDP of India.6
Yet foreign direct investment remains a small share
of total private investment in developing countries;
total investment by local firms tends to be far greater
than total investment by multinational corporations.
This raises an interesting question. If foreign direct
investment forms only a small share of total private
investment in developing countries, why is it the subject
of heated discussions and controversy? The answer
is that foreign direct investment is qualitatively very
different from local investment. It differs because of
the very large size of MNCs, their significant economic
and political power, and their superior technical and
managerial expertise, know-how and technologies.
Foreign direct investment is by far the most
important source of foreign finance flows to
developing countries. However, for many low-income
developing countries that are almost completely
bypassed by MNCs, foreign aid is the main source of
foreign finance.
Why MNCs expand into economically
less developed countries
! Explain the reasons why MNCs expand into economically
less developed countries.
Multinational corporations expand into developing
countries (as elsewhere) in the hope of securing higher
profits. Developing countries offer possibilities for
MNCs to:
• increase sales and revenues. Some developing
countries have large or rapidly growing markets
(for example, China, India and countries in Latin
America), which offer the potential for large
increases in sales and revenues. If the firm is located
4 UNCTAD, World Investment Report 2010.
5 UNCTAD, World Investment Report 2009. The top ten non-financial
firms (ranked by foreign assets) and their respective home countries were
General Electric (United States), Vodafone Group (United Kingdom),
Royal Dutch/Shell Group (Netherlands/United Kingdom), British Petroleum
(United Kingdom), ExxonMobil (United States), Toyota Motor Corporation
within the country, it can more easily capture
a market share, as well as speed up delivery of
products and save on transportation costs.
• bypass trade barriers. Producing in countries
with trade barriers allows MNCs to bypass these and
secure access to local markets.
• lower costs of production. Labour costs as a rule
take up a large proportion of total production costs,
and developing countries generally have lower
labour costs than in developed countries. This is a
key reason for example, why the United States has
multinational corporations operating in Mexico.
• use locally produced raw materials. If an
MNC needs raw materials in the form of natural
resources for its production, it is far less costly
to obtain them locally than to import them, on
account of transportation costs.
• further their activities in natural resource
extraction. Some MNCs specialide in the
extraction of natural resources (oil, aluminium,
bauxite, etc.). Many developing countries are very
rich in natural resources (for example in Africa), and
therefore it is natural for MNCs to want to locate in
such resource-rich countries.
Developing country characteristics
that attract multinational
corporations
! Describe the characteristics of economically less
developed countries that attract FDI, including low cost
factor inputs, a regulatory framework that favours profit
repatriation and favourable tax rules.
Geographical distribution of foreign
direct investment
Table 18.1 shows the distribution of global foreign
direct investment inflows between developed and
developing countries, as well as between geographical
regions. In 2009, the share of developing country
inflows was over 46% of global inflows.
Foreign direct investment in developing countries
is not evenly distributed throughout geographical
regions, as Table 18.1 indicates. In 2009, East Asia
(mainly China) and Latin America and the Caribbean
had the largest shares of FDI inflows, while Sub-
Saharan Africa was lagging far behind. However,
(Japan), Total (France), EDF (France), Ford Motor Company (United States),
E.ON AG (Germany).
6 Calculated from data in UNCTAD, World Investment Report 2010, and
United Nations Development Programme, Human Development Report
2010.
Chapter 18 Foreign sources of finance and foreign debt 501
though small, Sub-Saharan Africa’s share is growing
rapidly, as it was only 2% of the world total in 2005.
Four developing countries alone, Brazil, Russia,
India and China, received 19% of world FDI inflows,
corresponding to 40% of developing country inflows.
These countries are known as ‘BRIC’ (from the first
letter of each country); they are similar in that they
have very large and rapidly growing domestic markets,
liberalised economies and a great wealth of natural
resources. By contrast, many of the poorest countries
in the world receive negligible amounts of foreign
direct investment.
Attractive characteristics of developing
countries
The above pattern suggests that multinational
corporations are highly selective in their choice of
hosts, preferring to invest in countries that display
certain characteristics. Aside from seeking host
countries that provide low-cost labour and natural
resources, they are attracted to countries offering
an economic and political environment that is
most likely to ensure profitability and safety. The
most important of these characteristics include the
following:
• political stability and political institutions that
ensure a stable political environment
• a stable macroeconomic environment (low
inflation, stable currency, acceptable levels of
foreign debt, absence of major balance of payments
problems)
• an institutional environment that favours foreign
direct investment, such as
" freedom to repatriate profits (i.e. send profits to
the home country)
" freedom to engage in foreign exchange
transactions (no exchange controls, thus
can import possible needed inputs without
restrictions; see page 495)
" favourable tax rules (to ensure low tax payments)
" lack of restrictions regarding foreign ownership
" well-established property rights
" rules that minimise the risk of nationalisation (a
takeover of private property by the state)
• a liberalised (free market) economy with limited
government intervention (including privatisation of
state-owned enterprises)
• liberal (free market) trade policy with an emphasis
on exports
• large markets
• rapid economic growth and expectations of
continued rapid growth
502 Section 4 Development economics
• well-functioning infrastructure, including
transportation and communications, that will
facilitate imports and exports
• a well-educated labour force.
The characteristics required of host countries are
those that provide MNCs with the freedom to pursue
their economic interests with the least amount of
government interference, in a safe economic and
political environment that minimises uncertainties
and potential risks of losses on their investments.
Recipients of the largest amounts of foreign direct
investment are countries that best satisfy these
conditions, and are mostly concentrated in the
middle-income groups (upper middle and lower
middle) of developing countries.
In view of the requirements of MNCs, it is easy to
see that the rapid growth of foreign direct investment
around the world in the past two to three decades
has been driven by the liberalisation of the global
economy and the domestic economies of many
countries. Since the 1980s, as developing countries
turned more and more toward the market as the
basis for policy, so MNCs have found it profitable to
establish affiliates in hospitable foreign countries that
accommodate their needs.
Advantages and disadvantages of
FDI for economically less developed
countries
! Evaluate the impact of foreign direct investment (FDI) for
economically less developed countries.
Multinational corporations are profit-seeking entities;
they are not organisations concerned with the growth
and development problems of developing countries.
Why then do developing countries view them as
a mechanism that can help accelerate growth and
development?
Potential advantages of MNCs for host
developing countries
• MNCs can supplement insufficient foreign
exchange earnings. Investment funds flowing
into a country from abroad appear as credits in the
financial account, and can help offset a current
account deficit. As the activities of multinational
corporations are usually export oriented, the
country’s exports are expected to increase, resulting
in increased export earnings and positive effects on
the country’s balance of payments position.
• MNCs can supplement and improve upon
local technical skills, management skills and
technology. When multinational corporations set
 up affiliates in developing countries, they bring with
them technical and managerial expertise, as well as
new production technologies, which can be learned
and adopted by the local labour force (workers
and managers) and local businesses. This involves
technological improvements as well as improvements
in human capital (the acquisition of new skills
and knowledge by the local labour force), and is
considered to be one of the important advantages of
foreign direct investment for developing countries.
• MNCs can supplement insufficient domestic
savings and increase investment and new
capital formation. The inflows of FDI funds into
a country can supplement insufficient domestic
savings, increasing the amount of investment.
• MNCs can lead to greater tax revenues in the
host country. If multinational corporations are
taxed by the government of the host country, this
will contribute to increased tax revenues.
• MNCs can help promote local industry. When
MNCs buy locally produced goods and services as
inputs into their production, they promote the
development of local industries. This may lead to the
growth of existing local firms, or the establishment
of new local firms to provide inputs to the MNC.
• MNCs can increase local employment and
help lower unemployment in the host
country. By establishing productive facilities
(investing) in the host country, MNCs can increase
employment by hiring local workers. In addition,
the promotion of local industry also contributes to
increasing domestic employment.
• MNCs can lead to higher economic growth in
the host country. Increased levels of investment,
improved technology and increases in human
capital as well as the promotion of local industry
and greater tax revenues, can lead to higher
economic growth in the host country with increased
possibilities for pursuing development objectives.
Potential disadvantages of MNCs for host
developing countries
We will now consider the point of view that the
benefits listed above may not come about. In addition,
we will consider some possible negative effects of
MNCs on growth and development.
Why the benefits listed above might not
come about
• MNCs may not always supplement
insufficient foreign exchange earnings.
MNCs usually do bring foreign exchange into
the host country. However, MNCs also engage in
activities that result in foreign exchange outflows.
These outflows may occur because of repatriation
of profits (profits sent back to the host country);
or because MNCs import raw materials and other
inputs for use in production; or because they
finance their activities by borrowing from the
parent corporation in the home country, in which
case they must repay the loan plus pay interest. The
result is that the net inflows of foreign exchange
(inflows minus outflows) may be small.
• MNCs may not improve on local technical
skills, management skills and technology.
Critics argue that MNCs’ influence on the
development of local skills may be very small, as in
practice the links between MNC activities and the
local economy are often limited, in which case local
workers do not have the opportunity to learn from
the MNC. Also, MNCs often hire personnel from the
home country, thus limiting learning opportunities
for the local labour force.
• MNCs may not lead to greater tax revenues in
the host country. While MNCs are taxed by host
country governments, they enjoy many tax privileges
and benefits, often lowering the amount of tax paid.
Tax benefits are offered as an incentive to attract MNCs
into the host country. Another reason why MNCs pay
less tax involves the practice of transfer pricing, which
allows MNCs to lower their stated profits. Transfer
pricing works in the following way. Many MNCs buy
and sell inputs and intermediate products from their
various affiliates in other countries. By claiming to
local tax authorities that the prices they have paid for
the purchase of inputs from their affiliates abroad is
higher than the actual price paid, their profits appear
lower than true profits. Since the amount of tax paid is
a percentage of profit, lower-stated profits mean lower
taxes (sometimes significantly lower). It is estimated
that lost tax revenues due to transfer pricing are in the
billions of dollars each year.
• MNCs may not help promote local industry. The
operation of MNCs sometimes forces local competing
firms to go out of business, or alternatively does not
permit new local firms to establish themselves in
industries that are directly competitive with the MNC.
• MNCs may not help lower unemployment
in the host country. If, as noted above, MNCs
prevent the development of local industry, then
their job-creating impact will be limited. In
addition, some MNCs may sometimes import into
the host country capital-intensive technologies
that are inappropriate to local conditions given
large labour supplies, thus contributing to
unemployment and underemployment, and the
growth of the urban informal sector. (However,
Chapter 18 Foreign sources of finance and foreign debt 503
 some MNCs engage in labour-intensive activities
that make extensive use of cheap local labour).
Further possible negative effects of MNCs
• MNCs and environmental degradation.
MNCs often pursue activities that cause serious
environmental degradation. They prefer to invest in
countries that impose few environmental restrictions,
and they have been known to engage in activities that
have caused tremendous environmental damage.7
Moreover, MNCs are responsible for the production
of the bulk of industrial pollutants (such as
chlorofluorocarbons, a main cause of ozone depletion,
as well as pesticides, plastics, petroleum, industrial
chemicals, and many others). It has been estimated
that about 80% of greenhouse gas emissions are
caused by substances produced by MNCs.
• MNCs promote inappropriate consumption
patterns in developing countries. Critics
charge that MNCs, through advertising, create new
consumption needs and promote inappropriate
consumption patterns. This charge applies to
the role of MNCs in developed countries as well,
but what makes it more powerful in the case of
developing countries is that populations plagued
by hunger, malnutrition, disease and lack of basic
services can less afford to spend their small incomes
on unnecessary goods while their basic needs
remain unsatisfied. Examples include consumption
of soft drinks, sweets, fast foods, white bread,
expensive brand name goods, and many others.
• MNCs may use government resources to
build infrastructure needed by MNCs rather
than for poverty alleviation. MNCs sometimes
require infrastructure (road systems, ports,
telecommunications, etc.) which the developing
country must make available if it is to become
attractive as a host country. To build these types of
infrastructure, it may have to shift some of its scarce
resources away from needed merit goods (clean
water, sanitation, schools and health care services)
and toward infrastructure for MNCs.
• MNCs may use their economic and political
power to bring about policies that may work
against economic development. The very large
size of many MNCs gives them exceptional economic
and political power that they can use to influence
host governments to pursue policies that are in their
own interests but against economic development.
For example, MNCs are interested in investing in
countries that have weak labour protection laws,
7One of the greatest disasters caused by MNCs involved an
explosion in a Union Carbide plant in India in 1984 that killed
more than 20 000 people and left more than 100 000 with serious
504 Section 4 Development economics
because little or no labour protection results in
lower costs of production; and they are interested
in investing in countries with weak environmental
regulations, as this allows them to avoid costs
associated with environmental protection. When the
interests of MNCs and those of developing countries
conflict, developing country governments find
themselves in a weak bargaining position because
if they do not give in to MNC demands, they will
lose the investment to another developing country
that is more willing to compromise. For example, in
Thailand and Peru, MNCs threatened to relocate to
other countries if environmental regulations were
enforced. In Peru, a mining company pressured
the government not to undertake health tests for
children living close to the mining operations.
• Competition between developing countries
to host MNCs and the ‘race to the bottom’.
Many developing countries compete with each
other over which will create better conditions to
attract MNCs. Yet MNC demands may conflict with
what is in a country’s best interests. This has been
termed ‘the race to the bottom’, because the desire
to host MNCs may involve sacrifices of needed
development, lowering government tax revenues,
and use of local resources for infrastructure instead
of merit good provision. Additional sacrifices may
involve too much economic and trade liberalisation.
Test your understanding 18.1
1 (a) Describe foreign direct investment (FDI) and
multinational corporations (MNCs). (b) Explain
why MNCs have an interest in expanding
into developing countries. (c) In view of their
relatively small share in total private investment
in developing countries, why are MNCs a highly
controversial topic?
2 (a) What characteristics of developing countries
do MNCs look for when deciding where to
invest? (b) How can you account for the fact
that low-income countries receive negligible
amounts of foreign direct investment?
(c) What factors account for the massive growth
in foreign direct investment in developing
countries in recent years?
3 Explain some advantages and some
disadvantages of MNCs in developing countries.
4 Why have some observers referred to the
competition between developing countries to
attract MNCs as the ‘race to the bottom’?
and permanent health problems. While destruction on such a
scale is unusual, there are numerous well-documented cases of
MNCs undertaking environmentally unsustainable activities.
Real world focus
MNCs, pollution, and social responsibility
Oil MNCs in Nigeria
The Niger delta (in Nigeria), with 606 oil fields, has been
termed the ‘pollution capital of the world’. It is estimated
that more oil is spilled in the delta each year than was lost
in the Gulf of Mexico from the leak in BP’s Deepwater
Horizon rig in the spring of 2010. Local people can
hardly believe the measures taken in the United States
to protect the Louisiana shoreline from the effects of the
spill. The head of Friends of the Earth International (an
environmental NGO [non-governmental organisation])
says, ‘We see frantic efforts being made to stop the spill in
the US. But in Nigeria, oil companies largely ignore their
spills, cover them up and destroy people’s livelihood and
environments. The Gulf spill can be seen as a metaphor
for what is happening daily in the oilfields of Nigeria and
other parts of Africa.’
Source: John Vidal, ‘Nigeria’s agony dwarfs the Gulf oil spill. The US
and Europe ignore it’ in the Guardian, 30 May 2010.
Measures to increase MNC responsiveness to
developing country needs
Nobel Prize-winning economist Joseph E. Stiglitz suggests
a ‘five-pronged agenda’ that would help developing
countries gain the potential benefits of MNCs while
reducing corporate abuses:
• Improving corporate social responsibility.
Multinational corporations are highly visible, and
are keenly aware of their public image. They can be
held in check by the knowledge that practices that do
not meet with ethical standards are likely to damage
their reputation with the public. A negative image of
a corporation held by its customers can lower profits
Applying your skills
How can the global community help Nigeria
(and other countries) reduce the environmental
destruction caused by oil (and other) MNCs?
Chapter 18 Foreign sources of finance and foreign debt 505
by lowering sales. Therefore, corporations face an
incentive to engage in socially beneficial behaviour.
Issues of particular concern are the environment and
workers’ rights.
• Limiting the power of corporations. MNCs are usually
large oligopolies that try to increase their market power
by limiting competition between them. Governments
in the home countries should try to discourage the
growth of excessive market power by preventing anti-
competitive behaviour and promoting competition
between them.
• Improving corporate governance. Laws should
be enacted that would make corporations behave in
ways that are consistent with the broader public interest.
For example, just as cheating stockholders is a crime, so
new laws could be passed that would consider causing
environmental damage to be a crime.
• Global laws for a global economy. The establishment
of an international legal framework would allow parties
across national boundaries who have been injured by a
particular activity to band together and file a single suit
against the offender. Moreover, developed countries
could (and should) provide legal assistance for the poor
in developing countries.
• Reducing the scope of corruption. It is well known
that MNCs engage in corrupt behaviour, which includes
everything from bribing officials to be allowed to bypass
laws and regulations, to evading taxes and engaging in
transfer pricing. Efforts on an international scale should
be made to reduce corruption.
Source: Adapted from Joseph E. Stiglitz (2006) Making Globalization
Work, W. W. Norton.