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UNIT 18 MULTINATIONALCORPORATIONS AND FOREIGNCAPITAL

Structure

18.0 Objectives

18.1 Introduction18.2 Capital Transfers and Economic Growth

18.2.1 Savings Gap

18.2.2 Trade Gap or Foreign Exchange Gap

18.2.3 Technological Gap

18.3 Types of Foreign Capital18.3.1 Sources of Private Foreign Capital

18.3.2 Types of FDI

18.4 Multinational Corporations18.4.1 Characteristics of Multinational Corporations

18.4.2 Importance and Significance of MNCs

18.4.3 Need for Regulation of MNCs

18.5 Foreign Capital in India18.5.1 Government Policy towards Foreign Capital

18.5.2 Policy Changes 1991-2005

18.6 Critical Evaluation of the New Policy18.6.1 Points of Concern to Foreign Investors

18.6.2 Criticism of Inflows and Need for Corrective Action

18.6.3 Suggestions

18.7 Let Us Sum Up

18.8 Exercises

18.9 Key Words

18.10 Some Useful Books

18.11 Answers or Hints to Check Your Progress Exercises

18.0 OBJECTIVES

After reading this unit, you shall be able to:

• state the role of foreign capital in the growth process of a developingeconomy;

• differentiate between different types and sources of foreign capital;

• explain the nature of multinational corporations and their role in the process of economic growth;

• describe the different phases in the growth of Government of India’s policy towards foreign capital;

• explain the changes in the policy towards foreign capital in the recentyears; and

• identify the weaknesses in the government policy and make relevantsuggestions in this regard.

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18.1 INTRODUCTION

Spread of information technology and recent technological advances haveopened up the economies the world over as never before, and, hence,increasing multinational role for enterprise and capital. For a developingeconomy, it is all the more critical, as it is required to fill: (i) investmentsaving gap, (ii) technology gap, and (iii) foreign exchange gap. Butunregulated flow of foreign enterprise and capital may go against theeconomic interests of sovereign nations, and, hence, the need for regulations.

Till 1991, India allowed selective foreign investment in collaboration withdomestic enterprise; the majority control was preferred to be with theresidents. Beginning with July, 1991, there has been a change in the policy. Alarge number of high-tech areas have been left open to foreign investment thathas come to be regarded as a better vehicle of capital inflows than loans.

The response of foreign capital to policy initiatives can only be described asmixed. Although proposals have been plenty, and approvals many, actualinflows have been limited. In this unit, we shall discuss the various issuesinvolved in the foreign capital and role of MNCs in this regard. Let us beginwith discussing the importance of foreign capital in economic growth.

18.2 CAPITAL TRANSFERS AND ECONOMICGROWTH

Inflow of capital from abroad is vital for the growth of a developing economy,especially in the initial stages of its economic development. Modern economichistory abounds with examples of countries which have successfully drawnupon the capital resources of the more advanced industrial countries for thesake of economic development.

The role of foreign capital can be explained in terms of gap-filling functions.Three such gaps can be identified, viz., (a) Savings gap, (b) Trade gap and (c)Technology gap. The function of foreign capital is to fill these gaps and create

conditions suitable for fast economic growth.

18.2.1 Savings Gap

The key to the development problem lies in raising the rate of capitalformation. Such a raise envisages a much higher level of investment than iswarranted by the present level of savings in a developing economy. The scopefor a sharp rise in domestic savings is limited by the prevailing low level ofincome, slow rates of growth and rising consumption needs in theseeconomies.

The gap between investment requirements and domestic savings can be filledin by foreign capital. A little simple algebra will show why.

The fundamental proposition of national income accounting is that

Y = C + I + (X – M)

Where Y = Gross national product (total spending), C = Consumption, I =Investment, X = Exports of Goods and Services plus income received fromabroad, and M = Imports of goods and services plus income paid abroad.

All this spending generates an identical flow of income (Y); this total incomeequals total spending: of all income, some is consumed (C) and some is saved(S). Thus,

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Y = C + S

Then, since total spending equals that income, by substitution

C + I + (X – M) = C + S

From this equation, we can, by simple manipulation, easily discover theessential constraints on capital formation. Move (X – M) to to the right hand,reversing its sign; cancel C on both sides. The result is

I= S + (M – X)

The algebra is clear. A country’s investment opportunities are determined byits potential for domestic saving plus any net capital inflows from abroad(M > X). The only way for imports to exceed exports is for the country to getcapital from abroad; M > X is thus equivalent to a capital inflow.

The availability of foreign capital increases the availability of total resourcesin the economy. The increase in total resources helps a developing economy

primarily in two ways:

One, It influences investment decisions. It makes possible construction ofmany projects which would not have been possible otherwise. Certain

programmes of development can give optimum results if all the components

of the programme are undertaken simultaneously in a phased manner. Theavailability of foreign capital makes this type of investment possible.

Two, establishment of bigger projects and projects with a high investmentcomponent open up new opportunities of investment and, thus, encouragedomestic entrepreneurs and savers to supply their services and savings. Theaddition to the total volume of resources generated thereby exceeds theaddition made by foreign resources.

18.2.2 Trade Gap or Foreign Exchange Gap

A developing economy is faced with two structural constraints: (i) a minimumrequirement of inputs to sustain a given rate of growth of GNP, and (ii) an

actual or potential ceiling on export earnings which are insufficient to financethe required imports.

The foreign exchange gap, i.e., the difference between the required importsand total exports is given by

Mn – Xn = Mo + β (Vn – Vo) – Xo (1 + x)n

Where, Mo = Observed initial level of imports,

Vo = The GNP in the initial year,

Vn = Vo (1 + r)n, r being the compound growth rate and n the number

of years after o,

Xo = The initial level of export,β = The marginal rate of imports per additional unit of GNP,

r = Rate of growth of exports.

In a situation where the foreign exchange gap is dominant, the total importcapacity, i.e.,

Xn = Xo (1 + x)n

will effectively set the limit to the increase in GNP.

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The constraint will be more severe if any of the following two situationsobtains:

One, some “Strategic Goods” like capital equipment and technical know-how,etc. are not available locally and could be procured only from externalsources.

Two, technical conditions of industrialisation require a complement of foreignresources along with domestic resources, so that the latter would lie idle if theformer are not available.

In either of the above two situations, the availability of foreign exchange cansave an economy from an impasse in which it may find otherwise, and placeat her disposal high quality factors such as improved machinery, technicalknow-how and qualified foreign technicians which may have a beneficialeffect on her development by, what Harrod called, ‘fertilising productivity ofcommon labour’.

18.2.3 Technological Gap

The role of technology in bringing about economic growth is obvious. Thelevel of technology in a developing economy can be raised through: (a) theinternal evolutionary process of education, research, training and experience,or (b) the external process of importing from other countries. In respect of theimport of technology, contemporary developing countries have the added“advantages of the latecomers”. This has received much attention lately. Sincedevelopment has actually proceeded in the rest of the world, these countrieshave a rather whole range of technology to choose from and do not have torepeat the process of evolving it. The import of technology, however, raisestwo issues, viz., (a) the choice of technology and (b) local adaptation. The actof choosing a particularly technology is dependent on the state of domesticcomplementary research. Only then a country will be able to know thequantity and quality of the know-how to be imported and the price to be paidfor it. Adaptation of technology contemplates that the process of import of

technology should be accompanied by indigenous research and development.Analogous to technology gap is a gap in management, entrepreneurship andskill. Foreign capital can supply a “package” of needed resources that can betransferred to their local counterparts by means of training programmes andthe process of learning by doing.

To sum up, foreign capital touches three sensitive areas crucial in thedevelopment strategy of a developing country. It is almost true to say that thegrowth, at least in the initial stages, in the present times cannot be a self-generating process. Indeed, with a sole dependence on the domestic resources,it may be difficult to breach the vicious circle within which a developingcountry is usually caught.

Check Your Progress 1Note: i) Space is given below each question for your answer.

ii) Check your answer(s) with those given at the end of the unit.

1) What do you mean by saving gap? How foreign capital helps to fill thisgap?

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2) Explain the gap-filling functions of foreign capital.

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3) Explain the nature of technology gap faced by a developing economy.

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18.3 TYPES OF FOREIGN CAPITAL

The inflow of capital from abroad may take place either in the form of: (a)foreign aid, or (b) private investment.

Foreign aid includes loans and grants from foreign governments and

institutions. This source of foreign capital, especially loans, has an importantlimitation in the form of repayment obligations.

As regards private foreign capital investment, the intense academic debaterelating to its effects remains inconclusive. The opponents of foreigninvestment have drawn attention to several imperfections and adverse effects,such as capital intensity of such investment, inappropriate technology, the

possible adverse effects on income distribution, transfer pricing and thenegative contribution that such investment often makes to the balance of

payments. The advocates of foreign investment, on the other hand, havehighlighted the beneficial effects in terms of encouragement to thedevelopment of technology, managerial expertise, integration with the worldeconomy, exports and higher growth. It has also been claimed that debtfinancing generates fixed debt servicing obligations, while equity needs to beserviced only after profits are made.

There is also sufficient empirical evidence to support both points of view. Forexample, in recent years, foreign investment seems to have contributedenormously to the growth of several Asian countries, including China. Thereare examples, particularly from Latin America and Africa, where thecontribution of foreign investment has not been so encouraging.

18.3.1 Sources of Private Foreign Capital

The two important sources of foreign private capital are: (a) PortfolioInvestment and (b) Direct Business Investment, also known as Foreign DirectInvestment (FDI).

a) Portfolio Investment

It comprises the following:

i) Equity holdings by non-residents in the recipient country’s joint stockcompanies,

ii) Creditor capital from private sources abroad invested in recipientcountry’s joint stock companies, and

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iii) Creditor capital from official sources in recipient country’s joint stockcompanies.

b) Foreign Direct Investment

There are three main categories of FDI:

i) Equity Capital: It is the value of the Multinational Corporations(MNCs) investment in shares of an enterprise in a foreign country. Anequity capital stake of 10 per cent or more of the ordinary shares or

voting power in an incorporated enterprise or its equivalent in anunincorporated enterprise is normally considered a threshold for thecontrol of assets. This category includes both mergers andacquisitions, and green field investment (the creation of new facilities).

ii) Reinvested Earnings: These are the MNC’s share of affiliate earningsnot distributed as dividends or remitted to the MNCs. Such retained

profits by affiliates are assumed to be reinvested in the affiliate.

iii) Other Capital: It refers to short-term or long-term borrowing andlending of funds between the MNCs and the affiliate.

18.3.2 Types of FDI

Looked at from the point of view of the investors, the FDI inflows can beclassified into three groups:

i) Market-seeking: These are attracted by the size of the local market whichdepends on the income of the country and its growth rate.

ii) Efficiency-seeking: In developing countries where capital is relativelyscarce the marginal efficiency of capital tends to be higher than in thedeveloped world where it is abundant. Assuming that interest rates

broadly reflect Marginal Efficiency of Capital (MEC), it follows thatlending rates in Western financial centres are below MECs in developingcountries. Hence, economic efficiency and commercial logic dictate thatcapital should flow from the relatively less-profitable developed world to

the relatively more profitable developing countries.

iii) Other Location Advantages: These include the technological status of acountry, brand name and goodwill enjoyed by the local firms, openness ofthe economy, trade and macro policies pursued by the Government andintellectual property protection granted by the Government. Whateverform of FDI, in modern times, Multinational Corporations (MNCs) have

become the major carriers of foreign capital and technical know-how. Weshall examine in brief the major characteristics of this form oforganisation.

18.4 MULTINATIONAL CORPORATIONS

An MNC is one which undertakes foreign direct investment, i.e., it owns orcontrols income generation assets in more than one country, and in so doing

produces goods or services outside its country of origin, i.e., engages ininternational production. As per the estimates made available by the UNCentre on Transnational Corporations, there are more than eleven thousandMNCs with more than eighty-two thousand subsidiaries in operation abroad.

18.4.1 Characteristics of Multinational Corporations

The MNCs have certain characteristics among which the more important areas follows:

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i) Giant Size: The assets and sales of MNCs run into billions of dollars andthey also make supernormal profits. The Economist estimates that theworld’s top 300 MNCs now control over 25 per cent of the 20 trillionstock of productive assets. No size, howsoever big, is perceived to besufficient. Hence the MNCs keep on growing even through the route ofmergers and acquisitions.

ii) International Operations: In such a corporation, control resides in thehands of a single institution. But its interests and operations sprawl across

national boundaries. MNCs have become in effect “global factories”searching for opportunities anywhere in the world.

iii) Oligopolistic Structure: Through the process of merger and takeover,etc., in course of time, an MNC acquires awesome power. This coupledwith its giant size makes it oligopolistic in character.

iv) Spontaneous Evolution: MNCs usually grow in a spontaneous andunconscious manner. Very often they develop through “creepingincrementalism”. Many firms have become international by accident. Attimes, firms have also established subsidiaries abroad due to wagedifferentials and better opportunities prevailing in the home country.

v) Collective Transfer of Resources: An MNC facilitates a multilateraltransfer of resources. Usually this transfer takes place in the form of a‘package’ which includes technical know-how, equipments andmachinery, raw materials, finished product, managerial services and so on.MNCs are composed of a complex of widely varied modern technologyranging from production and marketing to management and finance.

18.4.2 Importance and Significance of MNCs

With the retreat of socialism, MNCs have become a powerful force in theworld economy.

The Case for MNCs

The case for MNCs revolves around that the potential benefits that adeveloping economy can hope to get from MNC operations. These benefitsare summarised in Table 18.1.

Table 18.1: Potential Benefits from MNC Operations

Impact Area Potential Benefits

1. Capital Provision of scarce capital resources

⎯ internally generated

⎯ externally generated.

(privileged access to global capital markets)

2. Technology Provision of sophisticated technology and other

technology not available in the host country.3. Exports and Balance of

PaymentsAccess to superior global distribution and marketingsystems

⎯ MNCs may increase exports and create positive balance of payments effects.

4. Diversification MNCs command technology and skills required fordiversification of the industrial base and for thecreation of backward and forward linkages.

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A recent study on the subject concludes that in today’s world of globalcapitalism, foreign investment is the only instrument that can reduce theinequalities between nations.

The Case against MNCs

In actual operations, in the past half a-century or so, the experience withMNCs has not been an unmixed blessing. Main points of criticism can besummarised as in Table 18.2.

Table 18.2: Actual Impact of MNCs Operations

Impact Area Potential Benefits

1. Capital Insignificant net inflow,

Large dividend remittances,

Large technical payments,

Progressive fall of foreign participation incorporate capital formation.

2. Technology Costly ‘over-import’,

Problems with advanced technology and updating,

Problems with technical support.

3. Exports and Balance ofPayments

Export performance at par with domesticcompanies,

Higher import propensity than domesticcompanies,

Some import substitution but negative BDPeffects.

4. Diversification Preemption of growth opportunities andsubstitution of domestic capital in several promisive areas,

Increased foreign influence in key sectors.

In a partial response to the above propositions, it may be stated that themodern MNCs acknowledge their responsibility to the concerns and interestsof the host country and basically operate on the basis of mutuality of interests.In fact, in present times international capital has no loyalty towards anynationality. MNCs realise they cannot be oriented toward the state of theirorigin. They have to be the citizens of the country they are in. If they are not,they cannot succeed.

18.4.3 Need for Regulation of MNCs

In view of the fact that MNCs do possess a potential that can be gainfullyexploited, most of the developing countries have chosen to regulate theiractivities rather than to dispense with them altogether.

i) Threat of nationalisation is an important tool of regulation.

ii) The Government may allow or deny permission in identified areas.

iii) MNCs may be allowed to invest for specific periods. Thus, after a certain period of time, restrictions may be imposed on foreign holdings, or theremay be provision for gradual disinvestments.

iv) A multi-tax system may be followed by the Government. The MNCs may be taxed at a higher rate.

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v) The host country may lay down certain export criteria.

vi) MNCs may be asked to carry out a minimum fixed share of their totalresearch and development activities within the host countries.

18.5 FOREIGN CAPITAL IN INDIA

In the planned economy of India, foreign capital has been assigned asignificant role, although it has been changing over time. In the earlier phaseof planning, foreign capital was looked upon as a means to supplement

domestic investment. Many concessions and incentives were given to foreigninvestors. Later on, however, the emphasis shifted to encouragingtechnological collaboration between Indian entrepreneurs and foreignentrepreneurs. In more recent times, efforts are on to invite free flow offoreign capital. It would be instructive in this background to examine theGovernment’s policy towards foreign capital.

18.5.1 Government Policy towards Foreign Capital

Foreign investment in India is subject to the same industrial policy as all other business ventures, plus some additional policies and rules specially governingforeign collaborations.

The first articulate expression of free India’s attitude towards foreign capitalwas embodied in the Industrial Policy Resolution, 1948 (IPR, 1948). The IPR,1948 emphasised the need for carefully regulating as well as inviting privateforeign capital. It laid special stress, inter-alia, on the need to ensure that in allcases of foreign collaboration, the majority interest was always Indian. Thiswas followed by the Fiscal Commission of 1949-50 which recommended thatforeign investment may be permitted, first, in the public sector projectsneeding imported capital good, and secondly, in new capital industries whereno indigenous capital or technical know-how was likely to be available.

This was followed by a statement on policy towards foreign capital made bythe Government on April 6, 1949. The underlying principles of the policy by

and large are valid even now. These may be enumerated as follows:

• Foreign capital once admitted will be treated at par with indigenouscapital.

• Facilities for remittance of profits abroad will continue.

• As a rule, the major interest in ownership and effective control of anundertaking should be in Indians hands.

• If an enterprise is acquired, compensation will be paid on a fair andequitable basis.

• The Government would not object to foreign capital having control of aconcern for a limited period and each individual case will be dealt with onits merits.

In short, the Government promised non-discriminatory treatment of foreigninvestment and free remittance facilities for both profits and capital. Anemphasis was laid down on the employment and training of the Indians inhigher positions. In keeping with these guidelines, the general policy was toallow such foreign investments and collaborations as were in line with the

priorities and targets of the Five-Year Plans. The policy was to restrict foreigncollaboration to those cases which would bring technical know-how into thecountry such as was not available indigenously for developing new lines of

production.

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These principles define the broad contours within which the state policytowards foreign capital has been framed all through the different five-year

plans. Beginning with the First Five-Year Plan in 1951, three distinct phasesas follows can be marked:

• The First Phase lasted till 1965 and was characterised by a liberal attitudetowards foreign capital. Many concessions and incentives were given toforeign capital participation in the industrial development of the country.

• In the Second Phase beginning with the mid-1960s, the liberal attitude ofthe state yielded place to strict controls and the broad policy was to restrictthe area of operation of foreign capital.

• The Third Phase, beginning with the adoption of economic reforms programme since July, 1991, has adopted a more liberal attitude towardsforeign capital and has aimed at attracting a free flow of FDI.

18.5.2 Policy Changes 1991-2005

The New Industrial Policy, 1991, can be described as a minor revolution as faras decisions concerning foreign investment and foreign technologyagreements are concerned.

The various changes in the policy can be broadly classified into fourcategories as follows:

1) Choice of Product: The number of products in which foreign investmentis freely permitted has been significantly increased.

2) Choice of Market: The foreign investors are now free to compete withthe domestic producers in the Indian market.

3) Choice of Ownership Structure: In most cases, the foreign investor isfree to own a majority share in equity.

4) Simplification of Procedures: India has opened two routes for FDIinflows. First, the RBI route (or the Mumbai route). This is transparent in

the sense that the guidelines are clear. If projects satisfy the guidelines, theapprovals are practically automatic.

FDI proposals which fall under the automatic route are listed in AnnexureIII of the industries list; it consists of 42 industries. This annexure has fourcategories: industries where foreign equity capital limit is pegged at 50 percent, 51 per cent, 74 per cent and 100 per cent, respectively. 50 per centthrough the automatic route is allowed in the mining sector. 51 per centthrough the automatic route is allowed in 51 industries, whereas 9industries quality for 74 per cent equity. 100 per cent foreign equitythrough the automatic route is allowed only in a handful of industries,such as power, roads and ports. In this category, there is a maximum

foreign investment limit of Rs. 1,500 crores.The second route is the Foreign Investment Promotion Board (FIPB) route(or the Delhi route). Foreigners are welcome to make proposals that do notfit into the first case. Such proposals are considered case by case. Detailedguidelines covering this route were issued on January 20, 1997. TheGovernment has also set up Foreign Investment ImplementationAuthority, independent of the FIPB, to act as a single point interface

between the investor and Government agencies.

The above changes are pointers to the fact that, lately, the Government is keento attract more of foreign investment. It seems it has come to be believed that:

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• It is better to allow equity than to go out to borrow. For one thing,dividend remittance on equity will start only when the unit starts

producing.

• Capital is generally never repatriated. Profit also is normally reinvested.The company meanwhile makes a substantial contribution to GNP anddomestic market becomes competitive.

• FDI brings technology. This technology spills over into other sectorswhich supply components and inputs. Also when FDI firms producecheaper and better capital goods or intermediate products, thecompetitiveness of sectors which use these, improves. The competitiveedge will spur development and accelerate the growth process.

Check Your Progress 2

Note: i) Space is given below each question for your answer.


1) Distinguish between loans and private investment as sources of foreigncapital.

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2) Distinguish between foreign direct investment and portfolio investment assources of private foreign capital.

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3) What are multinational corporations? Highlight their role in the growth process of a developing economy.

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4) Discuss the different changes in the Government policy towards foreigncapital.

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18.6 CRITICAL EVALUATION OF THE NEWPOLICY

The economic reforms have, undoubtedly, improved the foreign investmentenvironment in India. As a matter of fact, the success of the new economic

policy hinges in a large measure on the liberal response of the foreign capital.

Let us examine what has been the response of the foreign capital to the policyinitiatives.

The response of the foreign capital, however, going by the trends, has not been ungrudging. Where a deluge was expected, only trickle has flowed in, aswould be seen from Table 18.3.

Table 18.3: Inflows of FDI ($ billion)

Year Amount

1990-91 .001

1991-92 .013

1992-93 .032

1993-94 .0591994-95 1.32

1995-96 2.15

1996-97 2.82

1997-98 3.56

1998-99 2.46

1999-2000 2.16

2000-01 2.34

2001-02 3.90

2002-03 2.58

2003-04 3.20

Note: The Government has reorganised FDI data for 2000-01, 2001-02 and 2002-03along the lines recommended by the IMF to include some hitherto uncapturedelements of capital. The fresh items have been classified under equity capital,reinvested earnings and other capital. As per the revised data, FDI inflowsduring 2000-01 would now be $4.03 billion, while these would be $6.13 billionin 2001-02, and $4.67 billion in 2002-03.

Less than 40 of the top 100 MNCs – and none of the top small MNCs –

operate in this country. This shows what a long way we have to go to becomea multinational heaven.

18.6.1 Points of Concern to Foreign Investors

It might be of interest to analyse main points of concern at this stage toforeign investors in relation with the new policy.

1) Comparative Advantage among Different Investment Markets: Indiaoffers three basic advantages to foreign investors:

i) Availability of inexpensive manpower.

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ii) Existence of vast domestic market.

iii) Easy availability and lower costs of inputs.

Foreign investors have their own apprehensions in regard to each of these.

As to the first, it is argued that low wage levels may be offset by productivity level to a large extent. For example, notwithstanding sizeableimprovement in productivity in almost all the sectors over the last fivedecades, labour productivity is one of the lowest in the world. Productivity

in China is 30 per cent higher than here. Other Asian countries likeThailand and Indonesia have productivity levels that are 300 to 400 percent that of India.

Further, industrial relations may have a direct bearing on productivity.This is consequence of the fact that the FDI operations in developingcountries are labour rather than capital intensive.

As to the second, for taking hard investment decisions, consumption patterns are more relevant than classifications based on incomes. In thisregard, India may not score very high in foreigners’ projections.

As to the third, the number of industries where India can offer such inputadvantages are few and not all of them will be considered by foreign

companies that are sensitive to the possibility of their technologies beingcloned in an environment where patent laws are weak. For suchcompanies India’s trained manpower may even be a liability, as thismanpower has the ability to recreate technology that they have worked on.The benefit of lower costs of inputs can also be eroded if increaseddemand raises prices.

2) Permanence of New Policy: The foreign investors would wish to beassured of the liberalisation policy in the future. The absence of trust

provides formidable obstacles to the creation of public institutions.

3) Exit Policy: Disinvestment by foreign partners in joint ventures in India isat present under a highly restrictive control by the Government. Required

approvals are both cumbersome and time-consuming and the sale price ofequity shares to be disposed of by foreign investors are virtually dictated

by the RBI. While the underlying thinking behind such a system is notincomprehensible, it has probably been making potential foreign investorsmore cautious in considering investment proposals in India.

4) Procedural Simplifications: In this respect, the country seems to beknown more for erecting hurdles in the investors’ path.

5) Removal of Comparative Disadvantages: Foreign investors would haveto be convinced that the existing comparative advantages are not offset bythe comparative disadvantages they have to cope with:

i) They would wish to examine security situation and living conditionsaffecting foreign residents in India.

ii) They would also be concerned with the availability, quality andreliability of local vendors producing parts and components.

iii) They would have to look into whatever shortcomings may be found ininfrastructural facilities and services, including telephone andtelecommunication services, power supply, water supply, and road andrailway transportation.

iv) Cost of doing business in India continues to be high.

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v) The regulatory system is still non-transparent. Bureaucratic maze andredtapism abound.

vi) Intellectual property rights regime continues to be weak.

A recent editorial comment has to say: “Indian form of controlling economicactivity has proved as hardy and survival-prone as the cockroach.”

18.6.2 Criticism of Inflows and Need for Corrective Action

MNCs are being increasingly criticised for their investment policies and behaviour, specially on the following counts:

One, cowboy approach of landing in India, hastily choosing a partner, makinga mistake and then breaking the relationship.

Two, leverage an Indian partner to get in, and then move quickly to a 51 percent equity, and if possible a near total takeover. Indeed, a recent study bringsout that 35 to 40 per cent of FDI inflows in recent years have been trigerred bymergers and acquisitions by foreign companies and not for fresh projects.

Three, setting up a 100 per cent owned subsidiary despite a joint venture. Itonly goes to show how sensitive foreign firms are about the managerialcontrol. However, it is often argued that majority equity holding is necessary

for international firms to be assured enough to bring in the latest technologythat could have positive spillover in the host economy.

Four, some of them have transferred their brands to 100 per cent subsidiaries.Indeed, a recent study on the subject concludes that the days of the jointventures were over.

Five, supply second hand plant and machinery declared obsolete in theircountry.

Six, short-term focus for quick results.

Seven, sales approach to India as distinct from manufacturing.

Lastly, using expatriate management and CEOs rather than competitive

Indian management.

18.6.3 Suggestions

Policy reform is an on-going process. Following suggestions can be made tomake policy towards foreign capital more meaningful and effective:

1) State infrastructure is a major constraint and things can worsen if quickaction is not taken to watch the quality and size of all infrastructurecomponents like transport, communication and energy, comparable withthat in other countries competing for the same capital.

2) Attention need be paid to restructuring education, training and skills – the process must begin at the level of primary education upwards withemphasis on absorption of appropriate skills and through upgradation.

3) India should promote quality standards. The present mindset favouringcheapness of the cost of capital needs a change.

4) The existing framework of legislation and practices related to industrialaction should be reorganised so as to make it conducive to the promotionof productivity – oriented measures.

5) The operating environment need be made ‘investor-friendly’. For this purpose, following suggestions can be made:

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i) At the entry level, there are two alternative routes, viz., the AutomaticApproval Route (AA) of RBI and the Foreign Investment PromotionBoard (FIPB). The policy framework should be liberalised to make theAA route more effective. An increased share of the AA route in theFDI approvals will concurrently reduce the pressures on the FIPBroute.

ii) The efficiency of the state-level frontline bureaucracy is absolutelycritical to keep up investors’ confidence to prevent cost and time

overruns which, unless prevented, will have adverse effect not only onindividual investors but also on the economy as a whole.

6) We need to be tough with MNCs. But the real way to be tough withMNCs is to make the domestic market a ruthlessly competitive place bydoing away with discretionary FDI approvals. Otherwise, corporateswould be back at the old game of maximising gains by taking advantageof opportunities to politically manage the market place.

7) FDI may actually be harmful to the recipient country if the economy ishighly protected and foreign investment takes place behind high tariffwalls. This type of investment is generally referred to as the ‘tariff-

jumping’ variety of foreign investment, whose primary objective is to take

advantage of the protected markets in the host country. The longer theGovernment shields its home market with tariffs, the more will theforeigner come in to exploit that protected market, and more acute will bethe conflict between him and the domestic entrepreneur. In view of this,an appropriate policy framework must respond to two conflictingobjectives: the need to liberalise rules governing such investment in viewof the growing integration of the world economy, and the need to ensurethat such investment has positive effects on the country’s economy anddoes not lead to negative welfare effects.


Note: i) Space is given below each question for your answer.


1) State the major drawbacks in the inflows of foreign capital as experiencedin recent times.

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……………………………………………………………………………...2) Make suggestions to remove hurdles in the path of inflow of foreign

capital.

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18.7 LET US SUM UP

In an increasingly globalising world where the different economies are gettingmore integrated than ever before, flows of capital from one place to anotheracquire added significance, both quantitative and qualitative. Capital movesfrom less productive uses to more productive ones. Developing economies

provide foreign capital with an opportunity to earn better returns. Hence,developing economies always work as magnets for multinational corporations,the carriers of foreign capital. Foreign capital performs three critical gap-filling functions. However, for foreign capital to play a critical role, it isnecessary that a suitable environment is provided. A suitable environmentenables an MNC to work at and exploit its potential. India has virtuallythrown open its doors to foreign capital. Despite that, however, the responseof foreign capital has not been very encouraging. It is important to have afresh look at the policy framework so that a balance is struck between theinterests of the host country and foreign capital.

18.8 EXERCISES

1) Critically examine the role of multinational corporations in a developingeconomy. In this context, would you advocate a policy of encouraginginvestment by multinationals in India?

2) What are the arguments advanced against multinational corporationsoperating in India?

3) “Response of foreign capital to recent policy initiatives is considered aslukewarm.” Make suggestions to change this trend.

4) “The new industrial policy can be described as a minor revolution as far asdecisions concerning foreign capital are concerned.” Elaborate what hasthe impact of the new policy.

18.9 KEY WORDS

Capital Transfers: Inflows and outflows of capital from one country toanother.

Savings Gap: The difference between the required rate of investment and theactual rate of saving available in an economy.

Trade Gap: The difference between the expenditure of foreign exchange andreceipts of foreign exchange in transactions of goods and services.

Multinational Corporations: A business organisation which owns orcontrols income generation assets in more than one country, and in so doing

produces goods or services outside its country of origin.

Foreign Direct Investment: More generally refers to the value of the MNC’sinvestment in equity shares of an enterprise in a foreign country.

Greenfield Investment: Refers to an investment in building up a new production facility.

Portfolio Investment: Refers to equity holdings by a non-resident in therecipient counry’s joint stock companies.

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18.10 SOME USEFUL BOOKS

Basu, Kaushik (ed.) (2004); India’s Emerging Economy, MIT Press.

Bhagwati, Jagdish (2004); In Defence of Globalisation, Oxford UniversityPress, New Delhi.

Bhattacharya, Aditya and Marzit, Sugata (eds.) (2004); Globalisation and the Developing Economies: Theory and Evidence, Manohar, New Delhi.

Jha, Raghbendra (ed.) (2003); Indian Economic Reforms, Hampshire, U.K.Kalirazan, K.P. and Sankar, U. (eds.) (2002); Economic Reform and the Liberalisation of the Indian Economy, Cheltenham, Edgar Elgar.

18.11 ANSWERS OR HINTS TO CHECK YOURPROGRESS EXERCISES


1) See Sub-section 18.2.1


3) See Sub-section 18.2.3Check Your Progress 2

1) See Section 18.3







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