ECONOMIC IMPACT OF THE MNE
ECONOMIC IMPACT OF THE MNE
Balance-of-Payments Effects
Place in the Economic System Of international economic relationships few topics elicit as much discussion as the balance-of-payments effect of trade and investment transactions.5 Discussion itself often leads to incentives, prohibitions, and other types of governmental interference as countries try to regulate the capital flows that parallel trade and investment movements.
The distinction between balance-of-payments arguments and other cross-national problems is that gains are a zero sum, meaning that one country's surplus shows up as another country's deficit. If both countries were looking only at a limited time period and if both were interested only in the balance-of-payments effect of international transactions, then one country might justifiably be described as a winner at the expense of the other. In fact, objectives are not this limited. A country may be willing to endure deficits in order to achieve other aims, such as price stability or growth, or it also may be willing to forgo short-term surpluses in favor of long-term ones or vice versa.
Effect of Individual Direct Investment Two extreme hypothetical examples of the impact of direct investment illustrate the need to evaluate each activity separately if a person wants to determine the effect on the balance of payments. In the first case, a foreign firm purchases a Haitian-owned company by depositing dollars in a Swiss bank for the former owners. No changes are made in management or operations, so profitability remains the same. Dividends now are remitted to the foreign owners rather than remaining in Haiti, so there is a net drain on foreign exchange for Haiti and a subsequent influx to another country. In the next case, a foreign firm purchases unemployed resources (land, labor, materials, and equipment) in Haiti that it converts to the production of formerly imported goods. Because of rising demand, all earnings are reinvested in Haiti, so the entire import substitution is a gain in foreign exchange.
Most investments or nonequity arrangements (such as licensing or management contracts) fall somewhere between these two simplistic and extreme examples and are not evaluated so easily, particularly when policymakers attempt to apply regulations to fit aggregate investment movements. There are numerous measurement difficulties, but guidelines are gradually emerging and are being used by both recipient and donor countries. A basic equation for making an analysis is
B = m + x + c - (ml + xl + c1) where
B = balance of payments effect, m = import displacement, m1 = import stimulus, x = export stimulus, xl = export reduction,
c — capital inflow for other than import and export payment, and c1 = capital outflow for other than import and export payment.
Although the equation is simple, the problem of choosing the proper values to assign is formidable. Take the case of the net import change (import displacement less import stimulus) that results from the direct investment. To determine the value of m, we would need to know how much would be imported in the absence of the foreign production capability. Clearly, the amount the firm has produced and sold locally is only an indication, since the selling price and quality of products may be different from what would otherwise be imported. Furthermore, some of the local sales may have been at the expense of local competitors. The value of m1 should include equipment, components, and materials brought in for manufacturing the product locally. It should also include estimates of import increases due to upward movements in national income caused by the capital inflow. For instance, if national income were assumed to have risen $2 million from the investment and the marginal propensity to import were calculated to be 10 percent, imports should have risen by $200,000.
The net export effect (export stimulus less export reduction) is particularly controversial in donor countries, since conclusions vary widely depending on the assumptions made. The argument is much like the riddle of whether the chicken or the egg came first. For example, some critics in the United States have argued that when U.S. firms develop foreign production capabilities they merely substitute for what would otherwise be produced in the United States. These critics have argued that the foreign output sometimes is a substitute for U.S. exports and sometimes imported to displace domestic output. MNEs' response to the critics has been that moves abroad are defensive; that is, restrictions of foreign governments and shifts in cost advantages make foreign production inevitable. By moving abroad, U.S. MNEs pick up business that would otherwise go to foreign firms. MNEs have argued further that the investments stimulate exports from the United States because of the purchase by foreign subsidiaries of equipment, materials, components, and complementary products. Figures show, in fact, that U.S. companies investing the most abroad are the ones whose exports are also growing most rapidly.6 Again, we must make assumptions about the amount of these exports that could have materialized had the subsidiaries not been established.
The net capital flow (capital inflow less outflow for other than import and export payment) is the easiest figure to calculate because of controls at most central banks. The problem in using a given year for evaluation purposes is the time lag between the outward flow of investment funds and the inward flow of remitted earnings from the investment. Thus what appears at a given time to be a favorable or unfavorable capital flow may in fact prove to be the opposite over a longer period. The payback period (the time it takes to recoup the capital outflow) is affected by differences in company philosophy, type of industry, ability to borrow locally, the host country's balance-of-payments situation, and the perception of relative risk in the recipient country. Consequently, the capital flows may vary widely from one project to another. A further complication arises because of the possibility that international companies transfer funds in disguised forms, such as through transactions between parent and subsidiary operations at arbitrary rather than market prices, thus misstating the real consequences of the investments.
Although the equation is useful for broadly evaluating the balance-of-payments effects of investments, it should be used with caution. In addition to some of the data problems mentioned earlier, an investment movement might have some indirect effects on a country's balance of payments that are not readily quantifiable. For example, an investor might bring new technological or managerial efficiencies that are then emulated by other firms. What these other firms do may therefore affect the country's external economic relations.
Aggregate Assumptions and Responses In spite of the formidable task of evaluating investments from a balance-of-payments standpoint, there is near consensus that, while investments are initially favorable to the recipient country and unfavorable to the donor country, the situation reverses after some time. This occurs because nearly all investors plan eventually to remit to the parent organization more than they send abroad. If the net value of the foreign investment continues to grow through retained earnings, dividend payments for a given year ultimately may exceed the total capital transfers required for the initial investment. The time period before reversal may vary substantially, and there is much disagreement as to the aggregate time span needed.
In the case of U.S. firms' direct investment abroad, for example, more than half of the net value increase in recent years typically has come from the reinvestment of funds earned abroad. This means that the increase in claims on foreign assets has not been coming primarily from a flow of capital to the foreign operations. It also means that the return flow of funds to the United States from foreign earnings exceeds the outward flow to increase investment abroad.
From the standpoint of donor countries, restrictions on the outflow of
capital improve short-term deficits, since there should be an immediate im-
provement in the capital account of the balance of payments. But restrictions
°n outflows reduce future earnings and inflows from foreign investments, Consequently, the restrictions are useful only in buying the time needed to
institute other means for solving payments difficulties.
Governments also have sought to attract inflows of long-term capital as
a means of developing production that will either displace imports or generate exports. This has been particularly true of LDCs. They have sought locally manufactured production in order to ease dependence on their traditional agricultural products and raw materials. The problem for recipients, then, is how to take advantage of the benefits of foreign capital while also minimizing the long-run adverse effects on their balance of payments.
Many countries have tried to ensure that the long-term negative impacts of capital outflows are minimized. Sometimes countries have required that the valuation of new foreign investment be based only on contributions of freely convertible currencies, industrial equipment, and other physical assets but not on contributions of goodwill, technology, patents, trademarks, and other intangibles. These requirements are often tied into regulations in those countries on maximum repatriation of earnings. The maximum is stated as a percentage of foreign investment value; by holding down the stated amount of investment, eventual repatriation of earnings and the investment is minimized. In this respect, governments exert greater control over the prices of equipment brought in, especially when the investor is also the equipment supplier, so that the investment value is not overstated. Governments also are often interested in receiving part of the capital contribution in the form of loans and in local holdings of equity so that the future outward capital flow is reduced and has an upward limit.
Balance-of-Payments Effects
Place in the Economic System Of international economic relationships few topics elicit as much discussion as the balance-of-payments effect of trade and investment transactions.5 Discussion itself often leads to incentives, prohibitions, and other types of governmental interference as countries try to regulate the capital flows that parallel trade and investment movements.
The distinction between balance-of-payments arguments and other cross-national problems is that gains are a zero sum, meaning that one country's surplus shows up as another country's deficit. If both countries were looking only at a limited time period and if both were interested only in the balance-of-payments effect of international transactions, then one country might justifiably be described as a winner at the expense of the other. In fact, objectives are not this limited. A country may be willing to endure deficits in order to achieve other aims, such as price stability or growth, or it also may be willing to forgo short-term surpluses in favor of long-term ones or vice versa.
Effect of Individual Direct Investment Two extreme hypothetical examples of the impact of direct investment illustrate the need to evaluate each activity separately if a person wants to determine the effect on the balance of payments. In the first case, a foreign firm purchases a Haitian-owned company by depositing dollars in a Swiss bank for the former owners. No changes are made in management or operations, so profitability remains the same. Dividends now are remitted to the foreign owners rather than remaining in Haiti, so there is a net drain on foreign exchange for Haiti and a subsequent influx to another country. In the next case, a foreign firm purchases unemployed resources (land, labor, materials, and equipment) in Haiti that it converts to the production of formerly imported goods. Because of rising demand, all earnings are reinvested in Haiti, so the entire import substitution is a gain in foreign exchange.
Most investments or nonequity arrangements (such as licensing or management contracts) fall somewhere between these two simplistic and extreme examples and are not evaluated so easily, particularly when policymakers attempt to apply regulations to fit aggregate investment movements. There are numerous measurement difficulties, but guidelines are gradually emerging and are being used by both recipient and donor countries. A basic equation for making an analysis is
B = m + x + c - (ml + xl + c1) where
B = balance of payments effect, m = import displacement, m1 = import stimulus, x = export stimulus, xl = export reduction,
c — capital inflow for other than import and export payment, and c1 = capital outflow for other than import and export payment.
Although the equation is simple, the problem of choosing the proper values to assign is formidable. Take the case of the net import change (import displacement less import stimulus) that results from the direct investment. To determine the value of m, we would need to know how much would be imported in the absence of the foreign production capability. Clearly, the amount the firm has produced and sold locally is only an indication, since the selling price and quality of products may be different from what would otherwise be imported. Furthermore, some of the local sales may have been at the expense of local competitors. The value of m1 should include equipment, components, and materials brought in for manufacturing the product locally. It should also include estimates of import increases due to upward movements in national income caused by the capital inflow. For instance, if national income were assumed to have risen $2 million from the investment and the marginal propensity to import were calculated to be 10 percent, imports should have risen by $200,000.
The net export effect (export stimulus less export reduction) is particularly controversial in donor countries, since conclusions vary widely depending on the assumptions made. The argument is much like the riddle of whether the chicken or the egg came first. For example, some critics in the United States have argued that when U.S. firms develop foreign production capabilities they merely substitute for what would otherwise be produced in the United States. These critics have argued that the foreign output sometimes is a substitute for U.S. exports and sometimes imported to displace domestic output. MNEs' response to the critics has been that moves abroad are defensive; that is, restrictions of foreign governments and shifts in cost advantages make foreign production inevitable. By moving abroad, U.S. MNEs pick up business that would otherwise go to foreign firms. MNEs have argued further that the investments stimulate exports from the United States because of the purchase by foreign subsidiaries of equipment, materials, components, and complementary products. Figures show, in fact, that U.S. companies investing the most abroad are the ones whose exports are also growing most rapidly.6 Again, we must make assumptions about the amount of these exports that could have materialized had the subsidiaries not been established.
The net capital flow (capital inflow less outflow for other than import and export payment) is the easiest figure to calculate because of controls at most central banks. The problem in using a given year for evaluation purposes is the time lag between the outward flow of investment funds and the inward flow of remitted earnings from the investment. Thus what appears at a given time to be a favorable or unfavorable capital flow may in fact prove to be the opposite over a longer period. The payback period (the time it takes to recoup the capital outflow) is affected by differences in company philosophy, type of industry, ability to borrow locally, the host country's balance-of-payments situation, and the perception of relative risk in the recipient country. Consequently, the capital flows may vary widely from one project to another. A further complication arises because of the possibility that international companies transfer funds in disguised forms, such as through transactions between parent and subsidiary operations at arbitrary rather than market prices, thus misstating the real consequences of the investments.
Although the equation is useful for broadly evaluating the balance-of-payments effects of investments, it should be used with caution. In addition to some of the data problems mentioned earlier, an investment movement might have some indirect effects on a country's balance of payments that are not readily quantifiable. For example, an investor might bring new technological or managerial efficiencies that are then emulated by other firms. What these other firms do may therefore affect the country's external economic relations.
Aggregate Assumptions and Responses In spite of the formidable task of evaluating investments from a balance-of-payments standpoint, there is near consensus that, while investments are initially favorable to the recipient country and unfavorable to the donor country, the situation reverses after some time. This occurs because nearly all investors plan eventually to remit to the parent organization more than they send abroad. If the net value of the foreign investment continues to grow through retained earnings, dividend payments for a given year ultimately may exceed the total capital transfers required for the initial investment. The time period before reversal may vary substantially, and there is much disagreement as to the aggregate time span needed.
In the case of U.S. firms' direct investment abroad, for example, more than half of the net value increase in recent years typically has come from the reinvestment of funds earned abroad. This means that the increase in claims on foreign assets has not been coming primarily from a flow of capital to the foreign operations. It also means that the return flow of funds to the United States from foreign earnings exceeds the outward flow to increase investment abroad.
From the standpoint of donor countries, restrictions on the outflow of
capital improve short-term deficits, since there should be an immediate im-
provement in the capital account of the balance of payments. But restrictions
°n outflows reduce future earnings and inflows from foreign investments, Consequently, the restrictions are useful only in buying the time needed to
institute other means for solving payments difficulties.
Governments also have sought to attract inflows of long-term capital as
a means of developing production that will either displace imports or generate exports. This has been particularly true of LDCs. They have sought locally manufactured production in order to ease dependence on their traditional agricultural products and raw materials. The problem for recipients, then, is how to take advantage of the benefits of foreign capital while also minimizing the long-run adverse effects on their balance of payments.
Many countries have tried to ensure that the long-term negative impacts of capital outflows are minimized. Sometimes countries have required that the valuation of new foreign investment be based only on contributions of freely convertible currencies, industrial equipment, and other physical assets but not on contributions of goodwill, technology, patents, trademarks, and other intangibles. These requirements are often tied into regulations in those countries on maximum repatriation of earnings. The maximum is stated as a percentage of foreign investment value; by holding down the stated amount of investment, eventual repatriation of earnings and the investment is minimized. In this respect, governments exert greater control over the prices of equipment brought in, especially when the investor is also the equipment supplier, so that the investment value is not overstated. Governments also are often interested in receiving part of the capital contribution in the form of loans and in local holdings of equity so that the future outward capital flow is reduced and has an upward limit.
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