Foreign direct investment and multinational corporations: concept, nature, role and operation

1. Foreign investment: meaning and kinds

Foreign investment is the flow of capital from one country to another. It takes two forms:

• Foreign direct investment (FDI): investment by a foreign enterprise that gives it a lasting interest in, and a significant degree of control over the management of, an enterprise in the host country. The IMF and OECD treat ownership of 10 per cent or more of voting power as direct investment. In India, under the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, an investment of 10 per cent or more of the post-issue paid-up equity of a listed company (or any investment in an unlisted company) is FDI.
• Foreign portfolio investment (FPI): purchase of shares and bonds for return, without control (below the 10 per cent threshold in a listed company).

2. Nature and forms of FDI

• Greenfield investment: setting up a new plant or enterprise.
• Brownfield investment: acquiring or merging with an existing enterprise.
• Joint ventures with domestic partners, and wholly owned subsidiaries.
• Horizontal FDI (the same product abroad), vertical FDI (an earlier or later stage of production), and conglomerate FDI.
• Reinvested earnings of foreign companies also count as FDI.

Determinants (why firms invest abroad)

Size and growth of the host market, cheap labour and raw materials, infrastructure, political stability, a liberal and predictable policy regime, tax incentives, avoidance of tariff barriers (“tariff-jumping”), and firm-specific advantages. Dunning’s eclectic (OLI) framework sums these up: a firm invests abroad when it has an Ownership advantage (technology, brand), the host has a Location advantage, and it gains by Internalising the activity rather than licensing it.

3. Role of FDI in a developing economy

1. Fills the savings-investment gap and adds to capital formation.
2. Fills the foreign exchange gap and supports the balance of payments without creating debt.
3. Transfer of technology and modern management and marketing skills.
4. Employment and training of workers; spillovers to local suppliers.
5. Exports: access to the global production networks of the investor.
6. Competition and efficiency in domestic industry; better products for consumers.
7. Infrastructure development (power, telecom, ports).
8. Government revenue from taxes on foreign firms.

Drawbacks

• Outflow of profits, royalties and dividends, which burden the balance of payments later.
• Concentration in consumer goods and in urban, developed areas.
• Crowding out of domestic firms; monopoly power.
• Inappropriate, capital-intensive technology; limited real transfer of technology.
• Transfer pricing and tax avoidance.
• Loss of economic sovereignty; environmental damage.

FDI in India (outline)

FDI policy was liberalised from 1991. FDI comes in through the automatic route (no prior government approval) or the government route (prior approval of the ministry concerned). A few sectors are prohibited, such as lottery, gambling and betting, chit funds, Nidhi companies, real estate business and the manufacture of tobacco cigarettes. The policy is issued by the Department for Promotion of Industry and Internal Trade (DPIIT) and given legal force by the rules under FEMA.

4. Multinational corporations

A multinational corporation (MNC), also called a transnational corporation, is an enterprise that owns or controls production or service facilities in more than one country, with its headquarters in one (the home country) and operations in others (host countries). The ILO describes it as a company with its management headquarters in one country, known as the home country, and operating in several other countries, known as host countries. MNCs are the main vehicle of FDI.

Features

• Giant size: the turnover of the largest exceeds the GDP of many countries.
• Operations in several countries through branches and subsidiaries.
• Centralised control by the parent company with decentralised operations.
• Advanced technology and heavy research and development.
• International marketing and global brands.
• Oligopolistic market power.

Modes of operation

• Branches and wholly owned subsidiaries;
• joint ventures with local firms;
• franchising (the franchisee uses the brand and system for a fee);
• licensing and technical collaboration (for royalty);
• turnkey projects (building a plant and handing it over);
• contract manufacturing and outsourcing.

In India a foreign company with a place of business here must register and comply with Part XXII (sections 379 to 393) of the Companies Act, 2013; section 2(42) defines a “foreign company”.

Role and merits

MNCs bring capital, technology, management and access to world markets; create employment and train workers; raise exports and foreign exchange; increase competition and consumer choice; and spread research and development. India’s automobile, telecom, electronics and IT industries grew with MNC participation.

Demerits

• Repatriation of profits and transfer pricing drain the host country.
• They may kill local enterprise and create monopolies.
• Technology transferred may be outdated or tied to costly imports from the parent.
• Focus on luxury goods for the rich, and cultural influence (consumerism).
• Exploitation of natural resources and pollution (the Bhopal gas disaster, 1984, involved the subsidiary of an American MNC).
• Political interference and pressure on host governments.

Control of MNCs

Host countries regulate MNCs through foreign investment and exchange laws, competition law (the Competition Act, 2002), tax rules on transfer pricing, environmental law, and sector caps. At the international level there are voluntary codes: the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights (2011).

How this is examined

For a six-mark FDI note, give the definition with the 10 per cent threshold, FDI versus FPI, and five points on its role. For “role of FDI”, the eight points in section 3 with drawbacks. For the MNC essay, define, give features and modes of operation, then merits and demerits, and end with a line on control. Keep the economics in front: the sectoral caps and FEMA rules belong to the law notes linked above.