TOPIC 10: DIRECT FOREIGN INVESTMENT AND FOREIGN AID:

CONTROVERSIES AND OPPORTUNITIES

The International Flow of Financial Resources

The international flow of financial resources becomes necessary given the fact that
almost all developing nations incur deficits on their current account balance. It takes two
main forms:
1) Private foreign investment
This includes foreign direct investment by large multinational corporations and flows
of financial capital by private international banks.
2) Foreign Aid
This could be from individual national governments and multinational donor agencies.

Private Foreign Direct Investment and the Multinational Corporation

A multinational corporation (MNC) is simply a corporation or enterprise that owns and
controls productive activities in more than one country. The MNCs provides opportunities and
also, problems for developing countries where they conduct their business. The growth of private
foreign direct investment in the third world has been so rapid and can be attributed mainly to
MNCs. MNCs carry with them technologies of production, tastes and styles of living, managerial
services and diverse business practices.

Traditional Economic Arguments in support of Private Investment

1) Private foreign investment fills the resource gap between targeted or desired investment and
locally mobilized savings. Given the fact that mobilized savings are not sufficient in generating
the desired investment, it becomes necessary for private foreign investment to fill the gap.
2) If the foreign owned enterprise can generate a net positive flow of export earning, and
Sallow of private foreign capital can reduce the deficit on the balance of payments over lime.
This is the foreign exchange or trade gap.
3) A lot of limes, there are discrepancies between targeted governmental tax revenues
and locally raised taxes. (Revenue gap) By taxing MNCs profits and participating financially
in their local operations, LDCs governments are thought to be better able to mobilize public,
financial resources for development projects.
4) Private foreign direct investment usually fill the gap in management,
entrepreneurship, technology and skills (Management gap) by providing financial resources
and new factories to poor countries, providing a package of needed resources including
management experience, entrepreneurial abilities and technological skills, and by
transferring modern machinery and equipment which brings knowledge, skills and
technology desirable and productive for recipient nations.

Arguments against Private Foreign Investment

1) MNCs may tend to lower domestic savings and investment rates by inhibiting
competition through exclusive production agreements with host governments, f a i l i n g to
reinvest much of their profits, generating domestic incomes for those groups w i t h lower
savings propensities inhibiting the expansion of indigenous firms that might supply with
intermediate products by importing these goods from overseas affiliates, and on capital
borrowed by host governments.
2) MNC investment may tend to reduce foreign exchange earnings on the Balance of
Payments Accounts through a substantial importation of intermediate products and capital
goods and the overseas repatriation of profits, interest, royalties, management fees e.t.c
3) The contribution of MNCs to public revenue is lower than what it should be because of
liberal tax concessions, excessive investment allowances, disguised public subsidies and tariff
protection provided by the host government.
4) The dominance of MNCs in the local markets of LDCs can hinder the growth of
indigenous entrepreneurship even though management, entrepreneur: s k i l l s , technology, and
oversea contacts are provided by MNCs.
These are counter arguments to the gap-filling pro-foreign investment positions. However,
there are more fundamental criticisms.
1) MNCs worsen income inequalities and reinforce dualistic economic structures by:
a) Promoting the interests of a small number of well-paid modern-sector workers
against the interests of the rest by widening wage differentials.
b) Diverting resources from food production to the manufacture of sophisticated
products in favour of a few rich.
c) Increasing the imbalance between rural and urban economic opportunities by local
primarily in urban areas and contributing to the accelerated flow of rural-urban migration.
2) MNCs may through, inappropriate technologies produce inappropriate products (as
influenced by the demand pattern of a rich minority), increase inappropriate consumption
patterns through advertising and their monopolistic market power.
3) Local resources may tend to be allocated f o r socially undesirable projects which may
further widen the inequality between the r i c h and the poor.
4) MN'C's may use their power to influence government policies in directions unfavourable
to development through excessive protection, tax rebates, investment allowances and
the cheap provision of factory sites and essential social services.
5) MNCs may suppress domestic entrepreneurship, drive out local competitors and hinder
the establishment of small-scale enterprises through their superior knowledge,
worldwide contacts, advertising s k i l l s , and range of essential support services.
6) MNCs may gain control over local assets and jobs and can exert considerable
influence on political decisions at all levels

FOREIGN AIDS
Why donors give aid
The two broad reasons why donors give a i d are economical and political. The reasons
are:
1) Aids play an important role in supplementing domestic resources in order to relieve
savings or foreign exchange bottlenecks. Th i s is needed because most developing nations
have insufficient savings to match investment opportunities and insufficient foreign
exchange to finance needed imports of capital and intermediate goods.
2) Aids generate additional savings which is expected to facilitate and accelerate the
process of development.
3) Aids supplemented by technical assistance in the form of high-level manpower transfers '
ensure that the aids are most efficiently utilized to generate economic growth.
4) Aids are given in accordance with the absorptive capacity of the recipient country.
Why LDC Recipients accept aid
1) It is generally believed that aids play an important role in the development process by
supplementing scarce domestic resources, transforming the economy structurally and
contributing to the achievement of LDC takeoffs into self-sustaining economic growth.
2) Aid is seen by both the donor and recipient as providing greater political leverage lo
existing leadership to suppress opposition and maintain itself in power.
3) Aid is seen as a moral motivation. It is believed that rich nations have an obligation to
support the economic and social development of the third world.

The effects of aid

There are disagreements on the effects of aid. On one side are those that argue that aids
have indeed helped to promote growth and structural transformation in many LDCs. On
the other side are those who argue that aids have actually been substituting domestic
savings and investment and increasing LDC' balance of payments deficits as a result of
rising debt repayment obligations and the linking of aid to donor country exports.
Aids have also been criticized for stimulating, the growth of the modern sector,
thereby increasing the gap in living standards between the rich and the poor in Third
World countries.