EC207 Lecture Notes - Lecture 11: Foreign Portfolio Investment, Multinational Corporation, Portfolio Investment
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Lesson 3.3: Foreign Finance, Investment and Aid
This lesson will discuss the international flow of financial resources. The international flow of financial resources
takes three main forms:
1. Private foreign direct and portfolio investment, consisting of:
a. foreign direct investment by large multinational corporations (MNCs) and,
b. foreign portfolio investment (e.g., stocks, and bonds) in developing countries’ credit and equity
markets by private institutions (banks, mutual funds, corporations) and individuals;
2. Remittances of earnings by international migrants; and
3. Public and private development assistance (foreign aid); foreign aid could originate from:
a. Individual national governments and multinational donor agencies and,
b. Private nongovernmental organizations (NGOs)
• Explain the role of multinational corporations (MNCs) in economic
development
A multinational corporation (MNC) is a corporation that conducts and controls productive activities in more than
one country. MNCs are mostly based in North America, Europe, and Japan. Recently a growing number of MNCs
are based in newly high-income economies such as South Korea and Taiwan. On one hand, MNCs present a unique
opportunity but on the other hand, they may pose serious problems for the many developing countries in which they
operate. We will discuss both sides in this lesson.
MNCs are interested in maximizing their profits. They are not interested in developmental activities of local
governments concerning issues of poverty, inequality, employment conditions, and environmental problems. There
are two main characteristics of multinational corporations. The first one is their large size. The second one is that
their worldwide operations and activities tend to be centrally controlled by parent companies. They constitute a big
force in the rapid globalization of world trade. MNCs search for profitable opportunities in the world to establish
their operations. They can be considered as global factories whose various operations are distributed across a
number of countries to take advantage of existing price differentials.
Due to their enormous size, MNCs obtain substantial economic/political power over the countries in which they
operate. They are able to become so influential that they can manipulate prices, collude with other firms in
determining areas of control, and restrict the entry of potential competitors by dominating new technologies and
special skills.
Due to MNCs’ enormous size and power, they tend to use influence government policies in directions that are
unfavourable to development.
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• Identify the nature, significance, and controversy of private direct and
portfolio investment and foreign aid in the context of the changing world
economy
A 20% annual net saving rate is needed but the country has only 17%. In this case 20-17=3% of a “savings gap” is
said to exist. If the nation can fill this gap with foreign financial resources, it will have a chance to achieve its target
rate of growth. Therefore, the first contribution of private foreign investment to national development is its role in
filling the gap between targeted investment and local savings. (Please also note that the model is not perfect. There
are empirical evidence that would contradict the findings of the model.)
A second contribution is similar to the first one. Foreign investment contributes to filling the gap between targeted
foreign-exchange requirements and those derived from net export earnings. This is known as the foreign-exchange
or trade gap. The gap would be filled over time if the foreign-owned enterprise can generate a net positive flow of
export earnings.
A general conclusion would be that private foreign investment can be an important stimulus to economic
development as long as the interests of MNCs and host-country governments coincide.
• Discuss the ways in which private investment and foreign aid can
contribute to development, and the ways in which they may be harmful to
development
One concern would be regarding whether large and volatile private portfolio flows into stock markets or short-term
bond markets of developing countries could be a destabilizing force for the financial markets of these countries.
There are some developing countries that rely too heavily on private foreign portfolio investments to mask
weaknesses in the economy such as Mexico, Thailand, Malaysia and Indonesia. Unfortunately, such countries are
likely to suffer serious long-term consequences. Similar to MNCs, portfolio investors are not interested in
development of the countries in which they invest. In the event that interest rates rise in developed countries or
perceived profit rates in developing countries decline, foreign investors will not hesitate to withdraw their funds.
This turns the private portfolio investment into speculative capital. Developing countries do not need speculative
investments. They need true long-run economic investment (plants, equipment, physical and social infrastructure,
etc.).
NOTE
We can conclude that the allocation of foreign aid is only partly determined by the relative needs of developing
countries. It seems like much of the aid is distributed based on political and military considerations.
We will consider two broad categories for foreign-aid motivations of donor nations:
• Political
• Economic
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2 gap model
Algebraically, we can use the following equations to formulate the two-gap model:
1. The savings gap: exists if the following inequality holds.
where F is the amount of capital inflows, sY is the domestic saving, I is domestic investment.
2. The foreign-exchange gap: exists if the following inequality holds.
where is marginal import share, which typically ranges from 30% to 60%. is the marginal
propensity to import, which is usually around 10% to 15%. E is the exogenous level of exports.
Document Summary
This lesson will discuss the international flow of financial resources. Individual national governments and multinational donor agencies and: private nongovernmental organizations (ngos, explain the role of multinational corporations (mncs) in economic development. A multinational corporation (mnc) is a corporation that conducts and controls productive activities in more than one country. Mncs are mostly based in north america, europe, and japan. Recently a growing number of mncs are based in newly high-income economies such as south korea and taiwan. On one hand, mncs present a unique opportunity but on the other hand, they may pose serious problems for the many developing countries in which they operate. We will discuss both sides in this lesson. They are not interested in developmental activities of local governments concerning issues of poverty, inequality, employment conditions, and environmental problems. There are two main characteristics of multinational corporations. The second one is that their worldwide operations and activities tend to be centrally controlled by parent companies.
