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"Spill-overs from multinational companies to the rest of the developing country are a dangerous myth" Discuss.

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Introduction

"Spill-overs from multinational companies to the rest of the developing country are a dangerous myth" Discuss. By Scott Crawford Introduction: The last 20 years has seen a large shift in the consensus of developing countries regarding their domestic markets. Whereas the preferred policy of government couple of decades ago would undoubtedly been that of protectionism - shielding their markets from any foreign influence, it now stands for many as that of active encouragement of FDI (foreign direct investment). Many governments will now offer incentives for potential foreign investors such as tax holidays, import duty exceptions and subsidies. In fact, in the 1990's, FDI became the largest single source of external credit for developing countries, with 50% of all private, and 40% of all total capital inflows to developing countries accounted for by FDI (Aiken & Harrison, 1999). Even though the degree of protectionism employed by developing countries will vary vastly between nations, these figures still represent a huge change in the perception of the role multinationals can play in domestic economies. Why has this change occurred? One of the reasons for this shift is the presence of perceived "spill-overs" from multinationals into the domestic economy. In this essay I will analyse the varying effects of these spillovers in an attempt to come to a conclusion as to the overall net effect that they have on an economy. ...read more.

Middle

However, the greater the technological advantage of the foreign firm, the greater the possibility any possible economies of scope can be exploited, and this may well lead to a market stealing effect where the multinational increase its market share at the expense of domestic firms in the short run as it will take some time for the domestic firms to adjust their working practices in order to become efficient enough to compete with the multinational firm. Aiken & Harrison, (1999) show that the initial reduction in the quantity produced by domestic firms will force many onto a higher average cost curve, due to the presence of fixed costs. This will prolong the "catch-up" period that it takes domestic firms to increase efficiency in order to remain competitive in the sector. The question to be asked now is which effect will dominate, and therefore what will be the net effect of the spill-overs from the multinational firm be? Empirical Evidence: Before looking at the empirical evidence given, it is important to note the following identification problem that econometricians have when attempting to capture the effects of a multinational on labour productivity in the domestic sector. The problem lies in the fact that foreign investors will naturally gravitate towards the more productive industries. Therefore, any attempts to model a relationship between foreign presence in a developing economy and labour productivity will overstate the effect that it has. ...read more.

Conclusion

As has been seen, different estimating techniques will yield differing results, there is the identification problem to be controlled for, and always the possibility of omitted variable bias within the regressions. Even at best, the variables used in the regressions are proxies for the actual unobservable variables that we wish to model. Due to the relative infancy of the fad of widespread FDI there is, unfortunately, no great volume of past research that present models can be judged against. We know neither which models give us the most "realistic" results, nor the appropriate time-length to base our judgements on. What has been shown is that, in the three studies looked at, the overall net effect of spill-overs is minimal, and that it many instances spill-overs are completely internalised by joint-ventures. In addition, it seems that any increase in domestic productivity caused by FDI seems to not be a result of technological or knowledge based spill-overs but rather of increased competition. Of course, there is no general rule - spill-overs may tend to be more prominent in export-orientated economies (firms competing on the world market will naturally be assumed to be more competitive than those competing solely domestically. The technology gap between multinationals and domestic firms is therefore more likely to be breechable), but the effects will vary country to country and firm to firm. Unfortunately, I have found no compelling evidence for or against the net impact of spill-overs on developing economies, but enough evidence to show that the perception of only positive spill-overs arising from multinational companies is indeed a misconception. Scott Crawford ...read more.

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