FDIs and MNCs CREATE MORE MULTIPLIER EFFECT IN THEIR HOME COUNTRIES THEN THE

HOST COUNTRIES

In the valuable and stimulating guidance of

Prof. Pankaj Upadhayaya

Prepared by:

Shiv Prasad Chauhan 66

Introduction to Multiplier:

In economics, a multiplier is a factor of proportionality that measures how much an endogenous variable changes in response to a change in some exogenous variable.

That is, suppose a one-unit change in some variable x causes another variable y to change by M units. Then the multiplier is M.

The multiplier effect is a tool used by governments to attempt to stimulate aggregate demand. This can be done in a period of recession or economic uncertainty. The money invested by a government creates more jobs, which in turn will mean more spending and so on.

The idea is that the net increase in disposable income by all parties throughout the economy will be greater than the original investment. When that is the case, the government can increase the gross domestic product by an amount that is greater than an increase in the amount it spends relative to the amount it collects in taxes.

The difference is the fiscal stimulus. The net fiscal stimulus may be increased by raising spending above the level of tax revenues, reducing taxes below the level of government spending, or any combination of the two that results in the government taxing less than it spends.

Following are the various different types of the multipliers:

Money multiplier:

In monetary macroeconomics and banking, the money multiplier measures how much the money supply increases in response to a change in the monetary base.

The multiplier may vary across countries, and will also vary depending on what measures of money are considered. For example, consider M2 as a measure of the U.S. money supply, and M0 as a measure of the U.S. monetary base. If a $1 increase in M0 by the Federal Reserve causes M2 to increase by $10, then the money multiplier is 10.

Spending multiplier:

Multipliers can be calculated to analyze the effects of fiscal policy, or other exogenous changes in income and spending, on aggregate output. In economics, the multiplier effect or spending multiplier is the idea that an initial amount of spending (usually by the government) leads to increased consumption spending and so results in an increase in national income greater than the initial amount of spending. In other words, an initial change in aggregate demand causes a change in aggregate output for the economy that is a multiple of the initial change.

The existence of a multiplier effect was initially proposed by Ralph George Hawtrey in 1931. It is particularly associated with Keynesian economics; some other schools of economic thought reject, or downplay the importance of multiplier effects, particularly in the long run. The

multiplier effect has been used as an argument for the efficacy of government spending or taxation relief to stimulate aggregate demand.

For example, if an increase in German government spending by €100, with no change in taxes, causes German GDP to increase by €150, then the spending multiplier is 1.5. Other types of fiscal multipliers can also be calculated, like multipliers that describe the effects of changing taxes (such as lump-sum taxes or proportional taxes).

Keynesian economists often calculate multipliers that measure the effect on aggregate demand only. (To be precise, the usual Keynesian multiplier formulas measure how much the IS curve shifts left or right in response to an exogenous change in income or spending.) Opponents of Keynesianism have sometimes argued that Keynesian multiplier calculations are misleading; for example, according to the theory of rational expectations, it is impossible to calculate the effect of deficit-financed government spending on demand without specifying how people expect the deficit to be paid off in the future.

FDI Multiplier:

The level of FDI by a home country (where the TNC is headquartered ) in a host country(where branch plants are located) can be measured by either the stock or the flow of FDI. The stock is the present economic value of all previous FDI investments (plant, equipment and stocks of unused inputs and unsold outputs) and represents the accumulated presence of TNCs in the host country.

Encouraging the inflow of FDI can stimulate rapid growth by drawing on the external resources, but this is only effective as a development tool if this inflow leads to further beneficial

METHODS OF CALCULATING MULTIPLIER EFFECT:

General method

The general method for calculating long-run multipliers is called comparative statics. That is, comparative statics calculates how much one or more endogenous variables change in the long run, given a permanent change in one or more exogenous variables. The comparative statics method is an application of the Implicit Function Theorem.

Dynamic multipliers can also be calculated. That is, one can ask how a change in some exogenous variable in year t affects endogenous variables in year t, in year t+1, in year t+2, and so forth. A graph showing the impact on some endogenous variable, over time (that is, the multipliers for times t, t+1, t+2, etcetera), is called an impulse-response function.[1] The general method for calculating impulse response functions is sometimes called comparative dynamics.

HISTORY OF FDIs AND MNCs IN INDIA:

The post financial liberation era in India has experienced huge influx of 'Multinational Companies in India' and propelled India's economy to greater heights.

Although, majority of these companies are of American origin but it did not take too long for other nations to realize the huge potential that India Inc offers. 'Multinational Companies in India' represent a diversified portfolio of companies representing different nations. It is well documented that American companies accounts for around 37% of the turnover of the top 20 firms operating in India. But, the scenario for 'MNC in India' has changed a lot in recent years, since more and more firms from European Union like Britain, Italy, France, Germany, Netherlands, Finland, Belgium etc have outsourced their work to India. Finnish mobile handset manufacturing giant Nokia has the second largest base in India. British Petroleum and Vodafone (to start operation soon) represents the British. A host of automobile companies like Fiat, Ford Motors, Piaggio etc from Italy have opened shop in India with R&D wing attached. French Heavy Engineering major Alstom and Pharma major Sanofi Aventis is one of the earliest entrant in the scene and is expanding very fast. Oil companies, Infrastructure builders from Middle East are also flocking in India to catch the boom. South Korean electronics giants Samsung and LG Electronics and small and mid-segment car major Hyundai Motors are doing excellent business and using India as a hub for global delivery. Japan is also not far behind with host of electronics and automobiles shops. Companies like Singtel of Singapore and Malaysian giant Salem Group are showing huge interest for investment.

2006-07 was a watershed year for foreign direct investment (FDI) in India. At about $19 billion, the inflow was more than the cumulative FDI between 1991 and 2000. This has emboldened the government to set an FDI target of $30 billion for 2007-08. Reasons Ajay Dua, Secretary in the Department of Industrial Policy and Promotion (DIPP): "The confidence level in India is very high among foreign investors. Besides, there are many projects in the pipeline."

But is this a blip? Perhaps not, given that the country has shifted gears over the last four years to notch up average GDP growth of 8.6% per annum. Per capita income at current prices has risen to Rs 29,382 during 2006-07 from Rs 18,899 in 2002-03. Consumer spending, too, has kept pace—the shopping malls and multiplexes springing up across India are evidence enough. Indian stock markets have been also on a roll—the Sensex rose from 5,838.96 on December 31, 2003, to a peak of 14,723.88 on February 9, 2007, as foreign investors raised their wager on Indian growth.

Foreign Interest

A majority of multinational corporations operating in India have rated the country as a better investment destination on various parameters than China, Brazil, the UK, France, Australia and Singapore.

India scores over China on skilled labour force and its market growth prospects are brighter than the UK and Singapore, according to a perception survey conducted by Federation of Indian Chambers of Commerce & Industry (Ficci) among 135 MNCs in India. These include Procter & Gamble, Nestle, Hyundai, Ford and Colgate Palmolive.

India is considered a better investment destination for MNCs when compared to Brazil. Both rate of return and tax regime in Brazil are considered major impediments by the investors when

compared to India. Interestingly, foreign investors have put India’s labour law and tax regime as better than France. The survey compared Russia, China, Malaysia, Thailand, Brazil, Australia, UK, France and Singapore with India on eight investment parameters. The eight criteria are policy framework for foreign direct investment (FDI), market growth, consumer purchasing power, rate of return, infrastructure, labour force skills, labour laws and tax regime.

Profitability of MNCs in the Indian soil is major attraction for investing in the country. About 62 per cent respondents reported making profit in their Indian operations while 9 per cent are breaking even, highlighting the result of the survey Ficci senior vice- president YK Modi said. In the last Ficci FDI survey, only 36 per cent MNCs were making profits, while 25 per cent were breaking even.

According to the survey, 78 per cent of the companies have expansion plans for their Indian operations, as compared to 51 per cent in the 2002’s survey. More than 53 per cent of the MNCs reported 50-75 per cent capacity utilisation. Majority of companies feel government’s efforts to attract FDI are “average” to “good”. Growth prospect of Indian market was “medium” as judged by 66 per cent MNCs while 16 per cent viewed it as “high”.

These apart, major Asian economies—Japan, South Korea and Taiwan—have shown a greater interest in India in recent years. Japanese investment agencies have been studying the market closely and may eventually set up a whole range of manufacturing industries here. "In particular, they have shown an interest in manufacturing automobile and its components as well as telecommunication equipment," says Dua.

The Japanese may also invest in the development of embedded IT software. The Koreans’ interest in India, which had waned after a spurt in the mid-to-late ‘90s, is showing signs of renewing. Taiwanese companies are now keen to invest in IT hardware and non-leather footwear, among others.

More recently, the UK has stepped up its engagement with India. Several high level delegations, including one led by the Chancellor of the Exchequer Gordon Brown, have travelled to New Delhi to explore partnerships.

Governments Interest in FDIs and MNCs:

DIPP is identifying sectors where the ceiling on FDI can be lifted, prior approval dispensed with and the compulsory divestment clause scrapped. The Industry Ministry is also identifying sectors prohibited or restricted for foreign investors for opening up. "We intend to make the policy and procedures more investor-friendly," reveals Dua.

A segment that could see sweeping changes in FDI policy is aviation, particularly in ground-based services like passenger handling, training of personnel and aircraft maintenance.

Restrictions are also expected to be eased in the petroleum and petrochemical sectors. The ceiling on FDI in public sector oil refining companies may be raised from the existing 26%. This

could see steel baron LN Mittal’s proposal to pick up 49% stake in HPCL’s Rs 3,506-crore Bhatina refinery seeing the light of day.

To attract greater investment in petroleum marketing, foreign investors could be freed from the clause of compulsory offloading of 26% equity stake to Indian residents or partners. "We want foreign investments to come into sectors which are capital-intensive and where Indian companies may not have the capacity to invest," emphasises Dua. Some easing of regulations in single brand retailing, where the cap currently stands at 51%, is also expected.

Railways could also see FDI participation once ambiguity on whether or not manufacturing for railways is reserved for the public sector—under the Industrial Development and Regulation Act of 1956—is settled.

Yet, liberalisation may not result in an immediate surge in inflows in the specified areas. "Much of the targeted $30 billion is expected to flow into the sectors that have traditionally attracted FDI," points out Dharmakirti Joshi, Principal Economist, with rating agency Crisil. This would mean electrical equipment including IT hardware and services.

Ajay Dua Secretary, DIPP said that "We want foreign investment to come into sectors which are capital-intensive and where Indian companies may not have the capacity to invest"

Any FDI relaxation in the insurance sector could attract about $1 billion in fresh FDI over the year. Real estate mutual funds, too, could attract a similar amount if regulations are liberalised further.

While the government expects money to flow into manufacturing, financial services and R&D in pharmaceuticals and biotechnology, the retail revolution could see FDI flow into the food processing industry. Also, consolidation in the airline industry would make a case for foreign investment. Rising telephone penetration and demand for value-added services would attract investments into the telecom sector. Already Vodafone has said it would invest $2 billion in the next couple of years. Among other sectors with the potential to absorb significant foreign capital are mining and cement manufacturing.

But how easy is it to hit the $30-billion mark? Difficult would be the answer, should there be a slowdown in foreign acquisition of stakes in Indian businesses. For now, however, Indian assets are being chased. "Given the size of M&A deals being concluded, the target of $30 billion is achievable," says Ketan Dalal, Executive Director at PricewaterhouseCoopers. But mergers and acquisitions are only one part of the story. Huge investments are needed in other critical areas, such as infrastructure—requiring $475 billion over the next five years—and various other sectors.

But the $30-billion story is not convincing to everyone. Ashvin Parekh, Partner and National Industry Leader (Financial Services) at Ernst & Young, is circumspect about that kind of FDI flowing in this fiscal. "It is for the government to make it feasible, more by way of reforms rather than by way of any promotion," he points out.

The government, aware that high decibel sales pitch at investor fora and bilateral meetings would not be enough to ensure sustained FDI inflows, is moving to ease the rules and make the environment more business friendly. Announcements are expected in early July.

HOW FDIs AND MNCs CREATE MULTIPLIER EFFECT?

When the FDIs or MNCs comes to India they invests/spends a huge amount of money for the purpose of purchasing land, building the necessary infrastructure, machines and the labour pool. The money in-turn paid to all these results to immediate multiplier in the economy but it apparently enhances drastically as all these expend the money they got for various goods and services resulting in multiplier effect of higher degree.

ADVANTAGES OF MNCs AND FDIs:

Boost to the economy of the host country by means of: Higher employment generation Higher purchasing power Technological improvement and enhancement process Improvement in the living standard of the people Improve local markets and quality of goods Improved reserve generation for government through process of taxation. May also create demand for home country exports of equipment & goods

Increased knowledge from operating in a foreign environment

DISADVANTAGES OF MNCs:

MNC stock owned by parent company - host has no control of MNC operation MNC reserves key mgt position for expatriate - do not contribute to development of host-

country personnel MNC does not adopt / transfer technology to host country MNC concentrates R&D at home, restrict technology transfer MNC does not produce essential consumer goods

o not sensitive to host market o usually produce luxury goods

MNC purchases existing host firms, not developing new productive facilities MNC dominates major industrial factor

o contribute to inflation by manipulating demand for scarce resources eg: petroleum MNC does not concerned with host country plan and development - only respond to law

COMPARISION OF ADVANTAGES AGAINST DISADVANTAGES OF MNCs:

Benefits Costs

Capital market effect

- broader access to outside capital

- foreign exchange earning

- risk sharing to joint venture with foreign company

- increased competition for local scarce resources

- increased interest rate as supply of local capital declined

- capital service effect of balance of payment

Technology and production effect

- access to new technology, R&D development

- export diversification

- technology transfer is always not appropriate

- government infrastructure investment is more than expected benefit

Employment

- direct creation of new jobs

- income multiplier effect on local community business

- opportunities for management development

- low % of managerial job to local people

- employment instability because of ability to move production operation freely to other country

- competition for scarce skills

- limited skill development and creation

DISADVANTAGES OF FDIs:

Adverse effects on competition

MNE subsidiaries may have greater economic power than indigenous firms

Adverse effects on balance of payments

Too much outflow so restrict the amount that can be repatriated

Too much importing of components vs local sourcing

Perceived loss of national sovereignty

Key decisions that affect host economy will be made by foreign parent with no commitment to & no control by host country

HOW FDIs AND MNCs CAUSE MORE MULTIPLIER EFFECT IN HOME COUNTRY?

1. The amount of investment done by FDIs and MNCs in the host country is just only 30% of the earnings which are required for just meeting the basic needs of the company like salaries to employees, procurement of raw material, transportation etc. and the remaining in the home country and the money is invested in the research and development etc.

2. The subsidies and exemptions that the government offers for setting up the industries to the MNCs is also a major area of exploitation. The MNCs take the advantage of these subsidies to minimize their production cost and eventually they sell the processed goods in the developed markets at higher cost for making huge amount of profit.

3. MNC’s usually hire host population for lower level jobs and these MNC’s are headed by Foreigner who generally draw higher packages and perks as compared to their host employees.