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  • 1. UNIT 18 MULTINATIONAL CORPORATIONS AND FOREIGN CAPITALStructure18.0 Objectives18.1 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 Gap18.3 Types of Foreign Capital 18.3.1 Sources of Private Foreign Capital 18.3.2 Types of FDI18.4 Multinational Corporations 18.4.1 Characteristics of Multinational Corporations 18.4.2 Importance and Significance of MNCs 18.4.3 Need for Regulation of MNCs18.5 Foreign Capital in India 18.5.1 Government Policy towards Foreign Capital 18.5.2 Policy Changes 1991-200518.6 Critical Evaluation of the New Policy 18.6.1 Points of Concern to Foreign Investors 18.6.2 Criticism of Inflows and Need for Corrective Action 18.6.3 Suggestions18.7 Let Us Sum Up18.8 Exercises18.9 Key Words18.10 Some Useful Books18.11 Answers or Hints to Check Your Progress Exercises18.0 OBJECTIVESAfter reading this unit, you shall be able to:• state the role of foreign capital in the growth process of a developing economy;• 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 recent years; and• identify the weaknesses in the government policy and make relevant suggestions in this regard. 47
  • 2. Sectoral Performance-III 18.1 INTRODUCTION Spread of information technology and recent technological advances have opened up the economies the world over as never before, and, hence, increasing multinational role for enterprise and capital. For a developing economy, it is all the more critical, as it is required to fill: (i) investment saving gap, (ii) technology gap, and (iii) foreign exchange gap. But unregulated flow of foreign enterprise and capital may go against the economic interests of sovereign nations, and, hence, the need for regulations. Till 1991, India allowed selective foreign investment in collaboration with domestic enterprise; the majority control was preferred to be with the residents. Beginning with July, 1991, there has been a change in the policy. A large number of high-tech areas have been left open to foreign investment that has 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 as mixed. Although proposals have been plenty, and approvals many, actual inflows have been limited. In this unit, we shall discuss the various issues involved in the foreign capital and role of MNCs in this regard. Let us begin with discussing the importance of foreign capital in economic growth. 18.2 CAPITAL TRANSFERS AND ECONOMIC GROWTH Inflow of capital from abroad is vital for the growth of a developing economy, especially in the initial stages of its economic development. Modern economic history abounds with examples of countries which have successfully drawn upon the capital resources of the more advanced industrial countries for the sake 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 capital formation. Such a raise envisages a much higher level of investment than is warranted by the present level of savings in a developing economy. The scope for a sharp rise in domestic savings is limited by the prevailing low level of income, slow rates of growth and rising consumption needs in these economies. The gap between investment requirements and domestic savings can be filled in 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 from abroad, and M = Imports of goods and services plus income paid abroad. All this spending generates an identical flow of income (Y); this total income equals total spending: of all income, some is consumed (C) and some is saved (S). Thus, 48
  • 3. Y=C+S Multinational Corporations and Foreign CapitalThen, since total spending equals that income, by substitution C + I + (X – M) = C + SFrom 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 economyprimarily in two ways:One, It influences investment decisions. It makes possible construction ofmany projects which would not have been possible otherwise. Certainprogrammes of development can give optimum results if all the componentsof 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 GapA developing economy is faced with two structural constraints: (i) a minimumrequirement of inputs to sustain a given rate of growth of GNP, and (ii) anactual 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)nWhere, 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)nwill effectively set the limit to the increase in GNP. 49
  • 4. Sectoral Performance-III The constraint will be more severe if any of the following two situations obtains: One, some “Strategic Goods” like capital equipment and technical know-how, etc. are not available locally and could be procured only from external sources. Two, technical conditions of industrialisation require a complement of foreign resources along with domestic resources, so that the latter would lie idle if the former are not available. In either of the above two situations, the availability of foreign exchange can save an economy from an impasse in which it may find otherwise, and place at her disposal high quality factors such as improved machinery, technical know-how and qualified foreign technicians which may have a beneficial effect on her development by, what Harrod called, ‘fertilising productivity of common labour’. 18.2.3 Technological Gap The role of technology in bringing about economic growth is obvious. The level of technology in a developing economy can be raised through: (a) the internal evolutionary process of education, research, training and experience, or (b) the external process of importing from other countries. In respect of the import of technology, contemporary developing countries have the added “advantages of the latecomers”. This has received much attention lately. Since development has actually proceeded in the rest of the world, these countries have a rather whole range of technology to choose from and do not have to repeat the process of evolving it. The import of technology, however, raises two issues, viz., (a) the choice of technology and (b) local adaptation. The act of choosing a particularly technology is dependent on the state of domestic complementary research. Only then a country will be able to know the quantity and quality of the know-how to be imported and the price to be paid for 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 and skill. Foreign capital can supply a “package” of needed resources that can be transferred to their local counterparts by means of training programmes and the process of learning by doing. To sum up, foreign capital touches three sensitive areas crucial in the development strategy of a developing country. It is almost true to say that the growth, 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 developing country is usually caught. Check Your Progress 1 Note: 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 this gap? ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... 50
  • 5. 2) Explain the gap-filling functions of foreign capital. Multinational Corporations and Foreign Capital ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………...3) Explain the nature of technology gap faced by a developing economy. ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………...18.3 TYPES OF FOREIGN CAPITALThe 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 andinstitutions. 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, thepossible adverse effects on income distribution, transfer pricing and thenegative contribution that such investment often makes to the balance ofpayments. 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 CapitalThe 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 stock companies, ii) Creditor capital from private sources abroad invested in recipient country’s joint stock companies, and 51
  • 6. Sectoral Performance-III iii) Creditor capital from official sources in recipient country’s joint stock companies. 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. An equity capital stake of 10 per cent or more of the ordinary shares or voting power in an incorporated enterprise or its equivalent in an unincorporated enterprise is normally considered a threshold for the control of assets. This category includes both mergers and acquisitions, and green field investment (the creation of new facilities). ii) Reinvested Earnings: These are the MNC’s share of affiliate earnings not 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 and lending 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 be classified into three groups: i) Market-seeking: These are attracted by the size of the local market which depends on the income of the country and its growth rate. ii) Efficiency-seeking: In developing countries where capital is relatively scarce the marginal efficiency of capital tends to be higher than in the developed world where it is abundant. Assuming that interest rates broadly reflect Marginal Efficiency of Capital (MEC), it follows that lending rates in Western financial centres are below MECs in developing countries. Hence, economic efficiency and commercial logic dictate that capital 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 a country, brand name and goodwill enjoyed by the local firms, openness of the economy, trade and macro policies pursued by the Government and intellectual property protection granted by the Government. Whatever form of FDI, in modern times, Multinational Corporations (MNCs) have become the major carriers of foreign capital and technical know-how. We shall examine in brief the major characteristics of this form of organisation. 18.4 MULTINATIONAL CORPORATIONS An MNC is one which undertakes foreign direct investment, i.e., it owns or controls income generation assets in more than one country, and in so doing produces goods or services outside its country of origin, i.e., engages in international production. As per the estimates made available by the UN Centre on Transnational Corporations, there are more than eleven thousand MNCs 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 are as follows: 52
  • 7. i) Giant Size: The assets and sales of MNCs run into billions of dollars and Multinational Corporations they also make supernormal profits. The Economist estimates that the and Foreign Capital world’s top 300 MNCs now control over 25 per cent of the 20 trillion stock of productive assets. No size, howsoever big, is perceived to be sufficient. Hence the MNCs keep on growing even through the route of mergers and acquisitions.ii) International Operations: In such a corporation, control resides in the hands 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 coupled with its giant size makes it oligopolistic in character.iv) Spontaneous Evolution: MNCs usually grow in a spontaneous and unconscious manner. Very often they develop through “creeping incrementalism”. Many firms have become international by accident. At times, firms have also established subsidiaries abroad due to wage differentials and better opportunities prevailing in the home country.v) Collective Transfer of Resources: An MNC facilitates a multilateral transfer of resources. Usually this transfer takes place in the form of a ‘package’ which includes technical know-how, equipments and machinery, raw materials, finished product, managerial services and so on. MNCs are composed of a complex of widely varied modern technology ranging from production and marketing to management and finance.18.4.2 Importance and Significance of MNCsWith the retreat of socialism, MNCs have become a powerful force in theworld economy.The Case for MNCsThe 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 Benefits1. 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 Access to superior global distribution and marketing Payments systems ⎯ MNCs may increase exports and create positive balance of payments effects.4. Diversification MNCs command technology and skills required for diversification of the industrial base and for the creation of backward and forward linkages. 53
  • 8. Sectoral Performance-III A recent study on the subject concludes that in today’s world of global capitalism, foreign investment is the only instrument that can reduce the inequalities between nations. The Case against MNCs In actual operations, in the past half a-century or so, the experience with MNCs has not been an unmixed blessing. Main points of criticism can be summarised 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 in corporate capital formation. 2. Technology Costly ‘over-import’, Problems with advanced technology and updating, Problems with technical support. 3. Exports and Balance of Export performance at par with domestic Payments companies, Higher import propensity than domestic companies, Some import substitution but negative BDP effects. 4. Diversification Preemption of growth opportunities and substitution 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 the modern MNCs acknowledge their responsibility to the concerns and interests of the host country and basically operate on the basis of mutuality of interests. In fact, in present times international capital has no loyalty towards any nationality. MNCs realise they cannot be oriented toward the state of their origin. 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 gainfully exploited, most of the developing countries have chosen to regulate their activities 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 there may 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. 54
  • 9. v) The host country may lay down certain export criteria. Multinational Corporations and Foreign Capitalvi) MNCs may be asked to carry out a minimum fixed share of their total research and development activities within the host countries.18.5 FOREIGN CAPITAL IN INDIAIn 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 supplementdomestic 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 CapitalForeign investment in India is subject to the same industrial policy as all otherbusiness 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 byand large are valid even now. These may be enumerated as follows:• Foreign capital once admitted will be treated at par with indigenous capital.• Facilities for remittance of profits abroad will continue.• As a rule, the major interest in ownership and effective control of an undertaking should be in Indians hands.• If an enterprise is acquired, compensation will be paid on a fair and equitable basis.• The Government would not object to foreign capital having control of a concern for a limited period and each individual case will be dealt with on its 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 thepriorities 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 ofproduction. 55
  • 10. Sectoral Performance-III These principles define the broad contours within which the state policy towards foreign capital has been framed all through the different five-year plans. Beginning with the First Five-Year Plan in 1951, three distinct phases as follows can be marked: • The First Phase lasted till 1965 and was characterised by a liberal attitude towards foreign capital. Many concessions and incentives were given to foreign capital participation in the industrial development of the country. • In the Second Phase beginning with the mid-1960s, the liberal attitude of the state yielded place to strict controls and the broad policy was to restrict the 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 towards foreign 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 far as decisions concerning foreign investment and foreign technology agreements are concerned. The various changes in the policy can be broadly classified into four categories as follows: 1) Choice of Product: The number of products in which foreign investment is freely permitted has been significantly increased. 2) Choice of Market: The foreign investors are now free to compete with the domestic producers in the Indian market. 3) Choice of Ownership Structure: In most cases, the foreign investor is free to own a majority share in equity. 4) Simplification of Procedures: India has opened two routes for FDI inflows. First, the RBI route (or the Mumbai route). This is transparent in the sense that the guidelines are clear. If projects satisfy the guidelines, the approvals are practically automatic. FDI proposals which fall under the automatic route are listed in Annexure III of the industries list; it consists of 42 industries. This annexure has four categories: industries where foreign equity capital limit is pegged at 50 per cent, 51 per cent, 74 per cent and 100 per cent, respectively. 50 per cent through the automatic route is allowed in the mining sector. 51 per cent through the automatic route is allowed in 51 industries, whereas 9 industries quality for 74 per cent equity. 100 per cent foreign equity through 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 not fit into the first case. Such proposals are considered case by case. Detailed guidelines covering this route were issued on January 20, 1997. The Government has also set up Foreign Investment Implementation Authority, 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 keen 56 to attract more of foreign investment. It seems it has come to be believed that:
  • 11. • It is better to allow equity than to go out to borrow. For one thing, Multinational Corporations and Foreign Capital 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 and domestic market becomes competitive.• FDI brings technology. This technology spills over into other sectors which supply components and inputs. Also when FDI firms produce cheaper and better capital goods or intermediate products, the competitiveness of sectors which use these, improves. The competitive edge will spur development and accelerate the growth process.Check Your Progress 2Note: 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) Distinguish between loans and private investment as sources of foreign capital. ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………...2) Distinguish between foreign direct investment and portfolio investment as sources of private foreign capital. ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………...3) What are multinational corporations? Highlight their role in the growth process of a developing economy. ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………...4) Discuss the different changes in the Government policy towards foreign capital. ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... 57
  • 12. Sectoral Performance-III 18.6 CRITICAL EVALUATION OF THE NEW POLICY The economic reforms have, undoubtedly, improved the foreign investment environment 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 policy initiatives. 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, as would 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 .059 1994-95 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 2002-03 along the lines recommended by the IMF to include some hitherto uncaptured elements of capital. The fresh items have been classified under equity capital, reinvested earnings and other capital. As per the revised data, FDI inflows during 2000-01 would now be $4.03 billion, while these would be $6.13 billion in 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 become a 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 to foreign investors in relation with the new policy. 1) Comparative Advantage among Different Investment Markets: India offers three basic advantages to foreign investors: i) Availability of inexpensive manpower. 58
  • 13. ii) Existence of vast domestic market. Multinational Corporations and Foreign Capital 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 sizeable improvement in productivity in almost all the sectors over the last five decades, labour productivity is one of the lowest in the world. Productivity in China is 30 per cent higher than here. Other Asian countries like Thailand and Indonesia have productivity levels that are 300 to 400 per cent that of India. Further, industrial relations may have a direct bearing on productivity. This is consequence of the fact that the FDI operations in developing countries 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 this regard, India may not score very high in foreigners’ projections. As to the third, the number of industries where India can offer such input advantages are few and not all of them will be considered by foreign companies that are sensitive to the possibility of their technologies being cloned in an environment where patent laws are weak. For such companies India’s trained manpower may even be a liability, as this manpower has the ability to recreate technology that they have worked on. The benefit of lower costs of inputs can also be eroded if increased demand raises prices.2) Permanence of New Policy: The foreign investors would wish to be assured 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 is at present under a highly restrictive control by the Government. Required approvals are both cumbersome and time-consuming and the sale price of equity shares to be disposed of by foreign investors are virtually dictated by the RBI. While the underlying thinking behind such a system is not incomprehensible, it has probably been making potential foreign investors more cautious in considering investment proposals in India.4) Procedural Simplifications: In this respect, the country seems to be known more for erecting hurdles in the investors’ path.5) Removal of Comparative Disadvantages: Foreign investors would have to be convinced that the existing comparative advantages are not offset by the comparative disadvantages they have to cope with: i) They would wish to examine security situation and living conditions affecting foreign residents in India. ii) They would also be concerned with the availability, quality and reliability of local vendors producing parts and components. iii) They would have to look into whatever shortcomings may be found in infrastructural facilities and services, including telephone and telecommunication services, power supply, water supply, and road and railway transportation. iv) Cost of doing business in India continues to be high. 59
  • 14. Sectoral Performance-III v) The regulatory system is still non-transparent. Bureaucratic maze and redtapism abound. vi) Intellectual property rights regime continues to be weak. A recent editorial comment has to say: “Indian form of controlling economic activity 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, making a mistake and then breaking the relationship. Two, leverage an Indian partner to get in, and then move quickly to a 51 per cent equity, and if possible a near total takeover. Indeed, a recent study brings out that 35 to 40 per cent of FDI inflows in recent years have been trigerred by mergers and acquisitions by foreign companies and not for fresh projects. Three, setting up a 100 per cent owned subsidiary despite a joint venture. It only goes to show how sensitive foreign firms are about the managerial control. However, it is often argued that majority equity holding is necessary for international firms to be assured enough to bring in the latest technology that 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 joint ventures were over. Five, supply second hand plant and machinery declared obsolete in their country. 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 to make policy towards foreign capital more meaningful and effective: 1) State infrastructure is a major constraint and things can worsen if quick action is not taken to watch the quality and size of all infrastructure components like transport, communication and energy, comparable with that 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 with emphasis on absorption of appropriate skills and through upgradation. 3) India should promote quality standards. The present mindset favouring cheapness of the cost of capital needs a change. 4) The existing framework of legislation and practices related to industrial action should be reorganised so as to make it conducive to the promotion of productivity – oriented measures. 5) The operating environment need be made ‘investor-friendly’. For this purpose, following suggestions can be made: 60
  • 15. i) At the entry level, there are two alternative routes, viz., the Automatic Multinational Corporations Approval Route (AA) of RBI and the Foreign Investment Promotion and Foreign Capital Board (FIPB). The policy framework should be liberalised to make the AA route more effective. An increased share of the AA route in the FDI approvals will concurrently reduce the pressures on the FIPB route. ii) The efficiency of the state-level frontline bureaucracy is absolutely critical to keep up investors’ confidence to prevent cost and time overruns which, unless prevented, will have adverse effect not only on individual investors but also on the economy as a whole.6) We need to be tough with MNCs. But the real way to be tough with MNCs is to make the domestic market a ruthlessly competitive place by doing away with discretionary FDI approvals. Otherwise, corporates would be back at the old game of maximising gains by taking advantage of opportunities to politically manage the market place.7) FDI may actually be harmful to the recipient country if the economy is highly protected and foreign investment takes place behind high tariff walls. 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 the Government shields its home market with tariffs, the more will the foreigner come in to exploit that protected market, and more acute will be the conflict between him and the domestic entrepreneur. In view of this, an appropriate policy framework must respond to two conflicting objectives: the need to liberalise rules governing such investment in view of the growing integration of the world economy, and the need to ensure that such investment has positive effects on the country’s economy and does not lead to negative welfare effects.Check Your Progress 3Note: 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) State the major drawbacks in the inflows of foreign capital as experienced in recent times. ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………...2) Make suggestions to remove hurdles in the path of inflow of foreign capital. ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... ……………………………………………………………………………... 61
  • 16. Sectoral Performance-III 18.7 LET US SUM UP In an increasingly globalising world where the different economies are getting more integrated than ever before, flows of capital from one place to another acquire added significance, both quantitative and qualitative. Capital moves from 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 is necessary that a suitable environment is provided. A suitable environment enables an MNC to work at and exploit its potential. India has virtually thrown open its doors to foreign capital. Despite that, however, the response of foreign capital has not been very encouraging. It is important to have a fresh look at the policy framework so that a balance is struck between the interests of the host country and foreign capital. 18.8 EXERCISES 1) Critically examine the role of multinational corporations in a developing economy. In this context, would you advocate a policy of encouraging investment by multinationals in India? 2) What are the arguments advanced against multinational corporations operating in India? 3) “Response of foreign capital to recent policy initiatives is considered as lukewarm.” Make suggestions to change this trend. 4) “The new industrial policy can be described as a minor revolution as far as decisions concerning foreign capital are concerned.” Elaborate what has the impact of the new policy. 18.9 KEY WORDS Capital Transfers: Inflows and outflows of capital from one country to another. Savings Gap: The difference between the required rate of investment and the actual rate of saving available in an economy. Trade Gap: The difference between the expenditure of foreign exchange and receipts of foreign exchange in transactions of goods and services. Multinational Corporations: A business organisation which owns or controls 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’s investment 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 the recipient counry’s joint stock companies. 62
  • 17. Multinational Corporations18.10 SOME USEFUL BOOKS and Foreign CapitalBasu, 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 theDeveloping 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 theLiberalisation of the Indian Economy, Cheltenham, Edgar Elgar.18.11 ANSWERS OR HINTS TO CHECK YOUR PROGRESS EXERCISESCheck Your Progress 11) See Sub-section 18.2.12) See Sub-section 18.2.23) See Sub-section 18.2.3Check Your Progress 21) See Section 18.32) See Sub-section 18.3.13) See Sub-section 18.4.14) See Sub-section 18.5.2Check Your Progress 31) See Sub-section 18.6.22) See Sub-section 18.6.3 63