Question

1. The theory of Foreign Direct Investment (FDI) through Multinational Corporations (MNCs) indicates that FDI/MNC has significant impacts on a host country through three major channels. List and explain each of these three channels.

Answer 1

Foreign direct investment is assumed to play a crucial role in economic restructuring and enhancing growth in developing countries. There are three channel through which the positive spillovers that FDI firms may generate in the development process can occur, that is ,competition affect human capital effect and demonstration effect.

1) Competitive effect.

Competitive effect is the most important indirect advantage that foreign firms may generate. Entry of FDI firms leads to the competitive structure of an industry. There will be more intense competition in the local industry, with domestic firms being forced to use existing resources and technologies more efficiently. Domestic firms may also be forced to acquire and introduce new technologies in order to maintain their market share. lncreased competition serve to eliminate monopolistic profits and enhance Welfare of a country.

However, the completion effect may also be harmful to domestic firms.

2) Human capital effect ( Effect of labour mobility)

The second channel of FDI spillovers is through labour mobility : skills for human capital acquired by employees in foreign firms can be transmitted to new or existing local firms through mobility of the work force.MNE's may ultimately provide training and conduits for human capital dissemination with in the host economy, their ability and willingness to do so will be determined significantly based on the broader enabling environment of the host country.

However, the degree to which MNE's engage in training and other efforts to enhance human capital-not least in developing countries-depends greatly on their own Profitability and company advantages.

3) Demonstration effect

Demonstration effect occurs when 4 in forms with advanced technologies enter a local market and introduce new technologies to the industry. Through direct contact with foreign affiliates of multinational local firms can watch and imitate the way forigmers operate and can become more productive - by reverse engineering.

This, FDI can impact the welfare of the host-country through both direct and indirect channels.A direct channel consists of spill overs to the private sector. FDI's indirect impact on the welfare occur at the macroeconomic level.