Consider the Arguments In Favour of and Against Receiving Private Foreign Investment, With Special Reference to Investment by Multinational Enterprises.

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Economics of Developing Countries I                Tarandeep Baxi

BSc Development Economics                117514

Consider the Arguments In Favour of and Against Receiving Private Foreign Investment, With Special Reference to Investment by Multinational Enterprises

 

Private foreign capital is credited with a major role in the development of the new world in the 19th century.  It is also held responsible for debt crises and macro instability in developing countries today.

Private foreign investment (PFI) can take various forms, firstly, private portfolio investment, which includes an acquisition of securities without associated control, flows of money capital enabling flows of real capital.  ‘Bank sector lending’ is an important aspect within portfolio investment in contemporary circumstances.  Secondly, direct private foreign investment (FDI), which involves purchasing power to exert control over decision-making processes.  FDI involves the participation of large multinationals and usually requires more than money capital.  Thirdly, private export credits, which should be of more than 1 year’s duration. This is often in the form of medium-term credit to importers of particular types of goods, preferably capital goods.  Another form of PFI is through technical collaboration agreements, where the sale of technology and know-how by a particular firm are exchanged for specified royalties and technical fees.  Joint ventures are also a form of PFI; where previously firms had 100% control; they would now be required to act in accordance with local ownership regulations.  The last form taken by PFI is under management contracts.  These contracts are agreements by foreign firms to supply packages of skills and techniques for a specified fee.

The first three forms of PFI described above are often regarded as the most significant.  

Foreign direct investment (FDI) is the investment by a multinational company in establishing production, distribution or marketing facilities abroad.  Sometimes FDI takes the form of ‘Greenfield investment’, with new factories, warehouses or offices being constructed overseas and new staff recruited.  Alternatively, FDI can also take the form of takeovers and mergers with other companies located abroad. Foreign investment in financial assets, also known as portfolio investment, in particular by institutional investors such as unit trusts and pension funds is undertaken primarily to diversify risk and to obtain higher returns than would be achieved on comparable domestic investments.

FDI differs from overseas portfolio investment by financial institutions, which generally involves the purchase of small shareholdings in a large number of foreign companies.

The 19th century saw a great expansion of private investment in developing countries, especially in the United States, Canada, Australia and Argentina, as well as in Brazil, Mexico and India. It is important to establish the changing composition of private capital flows; beginning from the pre-1914 period.  During this period private portfolio investment was the essential form of investment, contributing to 90% of total PFI, direct investment by the progenitors of the multinationals made up some of the remaining 10%.  During the inter-war years, 1919-1929, the previous position continues.  However, it is important to note that PFI was gradually expanding during this period.  The collapse of the world monetary system in 1930 brought about a dramatic change within PFI; portfolio lending virtually disappeared, leading to the ‘march of the multinationals’.  Post 1945 there was an evident change in the percentage share of PFI;

                                                        1956        1969        1980        1988

PRIVATE PORTFOLIO INVESTMENT                        6        27        65        22

DIRECT PRIVATE FOREIGN INVESTMENT                78        41        14        67        

PRIVATE EXPORT CREDITS                                15        32        21        22

Table 1

The relative decline of direct investment and rise of portfolio investment between 1956 and 1980 can be explained by the efforts of poor countries to restrict direct investment, therefore, stagnating aid and domestic investment programmes now supported by the portfolio bond market.  In the 1970’s oil price shocks led to a dramatic increase in bank sector lending.  The 1970’s also saw a significant rise in direct investment.  The 1980’s experienced a notable decline in total PFI.  A decline in export credits and portfolio investment was a result of the debt crisis in 1982. Direct investment rose steadily over the 1980’s and by the late 1990’s FDI contributed approximately 50% of total foreign investment.

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Arguments for or against PFI are of a relatively recent date.  In classical economic theory, capital movements were generally considered to benefit both the host, as well as the investing country.  In the traditional approach, international capital movements imply a flow of investment funds from countries where capital is relatively abundant to countries where capital is relatively scarce.  It could also be said, that investment moves from countries with low marginal productivity to countries with high marginal productivity of capital.  The host country in this situation benefits from the foreign investment, to the extent that the productivity of the investment ...

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