There are many points of views about the viability of FDI, which are outlined below (Negandhi & Baigon, 1981).
2.9.1 Classical Theory
Classical economists believe that FDI entails various benefits, which return to MNCs;
foreign investment is a game having only one winner which is those companies and not the host countries. Classical economists depend on a number of justifications:
1. Technology transfer by MNCs is dominated by a technology level not appropriate to the required levels for economic and social development in the host country.
2. MNCs tend to transfer maximum profits from its investments to the mother country, instead of reinvesting it in the host country.
3. The presence of MNCs leads to unequal distribution of income between individuals of the society, offering high wages as compared with local companies, leading to the creation of a new social class.
4. The production of MNCs leads to the creation of a new pattern of consumption in the host countries that does not match comprehensive development policies in these countries.
5. The presence of MNCs leads to the dwindling sovereignty of the state and its independence and, where the development of technology depends on a foreign state, it also assists in the support of economic dependency, which might lead to pressure on the political forces in the host country.
The researcher is of the view that the risk of marginalisation is more harmful to developing countries than subordination (assuming that FDI leads to subordination or dependency). Sovereignty is not as it was, which is the case for all countries, whether developed or developing, and FDI is not usually for the benefit of a specific country as companies tend to strive for profit wherever they are, irrespective of the degree of the benefits for the host country. The degree of growth in the host country therefore depends on the policies implemented by it, the incentives granted for the MNCs and whether common interests were maximised for both the country and the company, which depends on the country rather than the company (Alam, 1992). The classical school of thought was affected by the general climate of investment in a previous period, while international changes increased the importance of these investments.
However, the risks raised by the classical school are not as severe as before; the creation of certain patterns of consumption are due to the media more than to MNCs.
2.9.2 Modern Theory
This theory is based on a principal assumption, that all parties of investment (Multinational Companies and the host country) are linked by common interest, each one of them benefits from the other to attain an objective or a group of specific objectives. In other words, there is no one winner as assumed by the classical school of thought; it is a game, where each party accomplishes many benefits. However, the size of outcome attained by each party depends on the strategies and practices which symbolise the basis and essence of the relation between them (Abou-Khaf, 1985).
The proponents of this theory believe that FDI in the host country assists in attaining the following:
1. The flow of foreign capital.
2. Participation in capacity building of local human resources.
3. Transfer of technology in the fields of production, marketing, administration and others.
4. Exploitation of financial resources, as well as benefiting from human resources in these countries.
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5. Participation in the creation of economic relations between the production sectors and services inside the specific country which facilitate the desired economic development.
6. Creating new export markets, leading to the creation and development of economic relations with other foreign states.
7. Decrease in imports.
8. Based on the above benefits, the balance of payments will be improved in the host country.
9. The economic, political and social development in the host country depends greatly on the above mentioned outcome.
The ideas of the new economic theory are supported by much practical evidence.
Currently many states compete for the attraction of foreign investment which is, in reality, encouraged by the grant incentives, guarantees, and various facilities for the foreign companies and Multinational Companies.
In spite of the differences and conflicts of interests between the objectives of Multinational Companies and host countries, the controversy about the viability of relations between these parties might depart from objectivity. In this respect Zenoff, Negandhi and Baliga (1981) indicate the following:
1. For host countries to achieve the maximum benefits or to maximise its revenues, it needs to try and impose certain conditions on the Multinational Companies so as to increase employment opportunities, participate in the capacity building of human resources and carry out programmes of research and development (R&D) in the fields of production, sales, promotion of national participation in investment, the development of local resources and its exploitation, improvement of products, increase in exports and decrease in imports.
2. At the same time, it was observed that Multinational Companies demand from host countries a reduction in bureaucracy, the provision of all services related to infrastructure, improvements in the special conditions of work, and diminishing control on production, marketing and other activities, in addition to absolute ownership of investment projects.
The researcher is of the opinion that, when analysing the objectives of each party (host countries and Multinational Companies) and taking the requirements such as procedures and decision-making into account, such procedures reveal the expectations of each party to the other, therefore the narrowing or widening of the unconformity gap between the expectations of host countries and Multinational Companies depends greatly, not only on the set objectives, but also on a better understanding of the common goals between them.
2.9.3 The Comparative Advantage Theory
Ricardo’s comparative theory (1817) is one of the most important traditional trade theories that represent the core of the literature. It provides the fundamental explanation for international trade. According to Ricardo, international trade takes place as a result of countries’ different comparative advantages, which are attributable to international differences in labour costs; the latter arising from a disparity in labour productivity which reflects, in turn, technology and production function differentials.
In the context of his theory, each country is likely to specialise in the production of a commodity in which it enjoys a comparative advantage. As a result, total world output per commodity would increase, and all nations would be better off (Hood & Young, 1979; Krugman & Obstfeld, 1988; Chacoliades, 1990).
Indeed, the comparative advantage law is signalled out as Ricardo’s greatest contribution to economic thought. It has been represented as the core of all international trade theories. In fact, he has motivated his successors to follow the same path using the concept of comparative advantage. For instance, some have offered different explanations for the comparative advantage as H/O has, as illustrated below.
Haberler (1930) widened the concept itself. He rejected Ricardo’s emphasis on labour as the only production factor. Instead, he recast the comparative advantage in terms of the opportunity cost. Each country should specialise and export commodities in which it enjoys the lowest opportunity cost (Chacoliades, 1990).
Being limited to classical assumptions, Ricardo thereby could not provide any explanation for FDI. Firstly, he assumes the labour is the only factor of production, thereby ignoring other factors (e.g., capital). Secondly, in Ricardo’s theory, labour is
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considered homogenous, ruling out ownership advantage which is a major explanatory variable of FDI flows. Thirdly, the theory assumes complete international factor immobility which contradicts the nature of FDI as a movement of factors across national boundaries. Fourthly, the underlying assumptions of the theory are perfect competition and constant economies of scale. These propositions are, again, inconsistent with FDI which operates in oligopolistic markets and which activities are based on economies of scale.
In addition, Ricardo ignored several factors that were considered later by other economists as important FDI explanatory variables. Among these factors are the technological differences. Although he did refer to differences in productivity due to technology disparity among countries, he did not focus on the significance of this issue or its implications beyond labour productivity. This factor has been studied by Posner, Vernon (1979) and others and has formed the base for several FDI explanations.
Moreover, in Ricardo’s theory, trade barriers and tariff cost are neglected. This issue was raised by Johnson in the late 1960s, who verified the neo-classical international trade theory and presented a dynamic form of the comparative advantage. He explicitly introduced transport costs, tariff and non-tariff barriers. He also referred to differences in taste and preference among countries shaped by cultural and political conditions, and how they represent an additional cost of acquiring information.
Johnson’s main contribution is quite evident in moving closer to the realities and dynamics of international trade and, besides which, he overlapped trade with FDI, particularly by introducing the importance of trade barriers which created a raison d’être for FDI (tariff-jumping investment). Accordingly, FDI and trade could be regarded as substitutes (Dunning, 1971; Hood & Young, 1979).
2.9.4 Determinants of FDI
The success of foreign investments depends on many variables; the success of investments in one market does not imply its success in other markets or its success at the same level. The principal factor is the variable environmental elements, which differ from one state to another. These variables could be divided into three main groups, linked by the basis and nature of the factors and the characteristics of the
country, which include each of the economic, political and legal factors, social and cultural elements, and variation in average individual income.
The rate of growth in national income, the habits and tastes of consumers, the attitudes of governments and population towards foreign investments all affect the degree of success of the company in a specific market; it does not only stop at such limits, it also affects generally the company’s decision on foreign investment. Also, the successes of Multinational Companies depend on various elements:
1. The characteristics of the Multinational Company.
2. The advantages and obligations between the mother and host states and between the host states on the other side.
Companies might tend to decrease risks in the local markets through investing part of its financial and human resources overseas, or aim at acquiring raw materials through this investment. As to the objectives of the mother state, it frequently seeks the creation of employment opportunities abroad, opening up of new markets for exports, spreading its political and social culture in other countries, or attempting to exercise some sort of economic and political pressure to involve the host state in some sort of military or economic alliance. In regard to relative costs or the competitive advantages of the host country, it might be useful to present the international trade theory in this respect. The trade theory is based on the assumption that the state specialised in the production and marketing of commodities in which it has some competitive advantages as compared to other states. These specialisations enable the state to increase the expected benefits; such benefits might be in other products or in the form of protection for its resources (Robock & Simmonds, 1993).
In spite the logic of the assumption of the theory, it faced a lot of criticism, such as difficulties in explaining the reasons for the variation of the costs of production between different countries. Heckscher and Ohlin attempted to explain the causes of cost variations between states as result of the degree of availability of natural resources, in addition to the contribution of Stopler and Samuelson (Zied, 1981).
However, Simmonds and Robock (1993) had significant reservations about the theory, which is summarised in the following points:
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The protection and opening of new foreign markets for a certain company could be achieved by other forms, excluding export through economic consortia, which not only eliminates barriers of trade but it also eliminates other forms of investment restrictions.
International trade theory did not present other alternative activities for any company to carry out overseas.
The theory ignored the technological level difference between the countries in the various economic aspects such as production, marketing and administration.
Assuming some impractical factors, such as availability of information about investment opportunities in different countries and restrictions on the flow of factors of productions, it also overlooks monopolisation and it assumes perfect competition.