Using The Evaluation Framework Economics Essay

The possession of an ownership advantage gives a firm the opportunity to sell goods overseas but it fails to explain why this is carried out through production in the foreign market rather than exporting to the foreign market. As a result, there is the need for an evaluation framework.

LEARNING OBJECTIVES

By the end of this Unit, you should be able to understand and grasp the following:

the importance of an evaluation framework;

the 4 criteria of the evaluation framework;

assess the contribution of MNEs in a foreign country by using the Evaluation Framework.

THE EVALUATION FRAMEWORK

The contribution of MNEs to the development of the host nation, more particularly developing countries or LDCs has been the subject of much debate over the years. Whilst it is generally accepted that MNEs do contribute by way of technology transfer, skills diffusion and by bringing much needed finance capital, nevertheless criticisms abound as to the negative impact of MNEs in that they are viewed as exploiting the local labour force, they transfer outdated technology, and they strip the LDCs of much needed resources.

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However, MNEs were and still remain a very important ingredient of growth, especially for developing countries. This is why it is crucial for a host country’s government that it should be able to assess FDI in a policy context. The latter process is usually done by way of an Evaluation Framework. An evaluation framework usually encompasses 4 criteria.

3.3 Efficiency of Resource Allocation

Efficiency of resource allocation relates to the extent to which there exist complementarities between of economic interests between the multinationals and the host countries. In a similar vein, it highlights the following: under what conditions do the operations of the TNC in a host country contribute to the world economic welfare that could not be achieved before?

However, the presence of MNEs in host countries is often prompted by government-induced imperfections including protection from imports. Such a situation mainly occurred when countries were adopting an import substitution industrialization strategy.

Adopting an import-substitution strategy entailed a high level of protection, via tariffs, import restriction measures and quotas, which discriminated against exports via explicit and implicit tax of export activities and an overvalued foreign exchange rate. Also, the government used investment license, differential taxes, tax holidays, exemptions and remissions to influence resource allocation between industries and sectors.

The proponents of IS strategy firmly believed that they would be able to meet the domestic demand for manufacturing products; provide employment opportunities for skilled labour; ease pressure on the balance of payment and strengthen the long term productive capacity of the economy by importing the production technology via foreign firms [1] and by using the “infant” industry argument.

Under such an era of protectionism [2] , MNEs were mainly regarded as being of a “market-seeking [3] ” nature. Firms set up plant within foreign nations in order to supply their national markets in the most profitable way possible. The key location advantages (in Dunning’s terminology) which determined these market-seeking investments were the cross-border transport and communication costs; artificial barriers (import restrictions) to trade in goods and services; the size, income per capita and the expected growth of the local market. Though cost considerations were deemed important and even decisive in certain marginal markets, an efficiency-seeking motivation was deemed to be of a very secondary nature (Pearce, 1999).

However, the overwhelming consensus is that IS was a failure [4] . IS strategy has turned out to be self-defeating since it has resulted in huge increases in imports of equipment and inputs while transfer pricing constituted a severe drain on foreign exchange. Also, IS granted excessive protection to industries producing inefficiently non-essential goods for high-income elite. Furthermore, fiscal credit and exchange rate policies, coupled with subsidies on imports of capital goods, made it possible and advantageous to entrepreneurs to rely on high capital intensive equipment produced abroad and technology unsuited to the factor proportions prevailing in less developed countries.

As a result, a new orthodoxy emerged in the late 60’s and early 70’s which stressed the role of exports of labour intensive manufactures as an engine of growth. This represented a return to the static theory of comparative advantage with trade based upon different factor proportions prevailing in various countries which meant that the pendulum turned full swing for development policy in LDCs from import substitution to manufactured exports.

Export oriented strategy not only encourages free trade [5] , but also the free movement of capital, labour, enterprises and an open system of communication. It also entailed more efficient allocation of resources with firms competing internationally [6] based on their relative comparative advantages. These considerations, coupled with the emergence of trade blocks, were factors motivating changes in the strategic orientation of MNEs.

MNEs underwent a complete restructuring of their global and regional supply profiles. This entailed locating [7] manufacturing operations in only a few countries but exporting for a wider market. Each subsidiary were opened to a fully competitive market situation which permitted the realisation of economies of scale and the attainment of optimal efficiency in production (Pearce, 1999). The “where” to produce clearly gained in prominence during such an era which led to MNEs redistributing their unchanged ownership advantages in order to create an international network of subsidiaries [8] which optimised their supply of established range of products. Thus, investments undertaken by MNEs were mainly of an efficiency-seeking nature.

However, one should not underestimate the crucial role played by the government during that period. It was not only the choice of trade strategy but also the appropriate role of government policy which was at the heart of the development issue. For example, export-oriented growth and appropriate macroeconomic policies [9] were mutually of economic development in the NICs. The integration of NICs into world and regional economies was essential for their long-term growth. This required less government intervention and greater reliance on private initiatives and market forces. It provided an environment conducive to foreign investment and domestic entrepreneurship. The Government was expected to actively promote economic growth and use its resources to direct and support the private industry.

It was the pursuit of such appropriate policies by these developing countries’ governments permitted shifts in their pattern of international specialisation in response to the changing structure of their comparative advantage at different levels of industrial development. As a result, the efficiency of resource allocation improved, the rates of growth accelerated, with benefits accruing to all concerned.

DISTRIBUTION

Distribution relates to the extent to which the gains arising from the MNEs operations are distributed between the partners. The host country would demand a fair share of the benefits created by the investment. However, the identification of a fair distribution is very difficult since it is almost impossible to price correctly some contribution such as technology diffusion and managerial expertise which are intangible in nature.

In addition, the issue of distribution is even more contentious especially when profits of the multinationals are due less to the efficiency of resource allocation and more to market distortions or imperfections created and sustained in the first place by the government to attract these foreign firms. Also, the distribution of such rent is influenced by the relative bargaining strength of the multinationals and the host governments in the light of factors such as tax concessions, tariff protection and labour training.

In this light, it may be argued that there is a direct relationship between the bargaining strength of the host country and its level of industrialization such that, the lower the industrialization level, the weaker its bargaining power. Finally, host nations are unable to extract their fair share of benefits because imperfections in the market for factors of production in which the multinationals are strong permits them to earn monopoly rent on these factors.

SOVEREIGNTY

Sovereignty relates to the ways in which the multinational may compromise the economic independence of host nations in either the short or long term. It highlights how the behaviour of multinationals may compromise the effectiveness of certain aspects of the host countries’ policies.

For example, the intra-group transfer of rent, via transfer pricing practices, may undermine the autonomy of the host countries in areas such as fiscal policy, monetary policy, trade policy and its attempt to control and organize the structure of industries.

SELF RELIANCE

Self-reliance relates to the ways in which the operations of the multinational may undermine the viability or independence of local firms or enhance their potential. The self-reliance issue also crops up during the investigations of the impact of multinationals on the industrial structure of the host nations; for e.g. the level of concentration and/or modes of operations.

It is also concerned with whether the operations of multinationals in the host nations may either enhance or hold back the availability of particular types of skills for local enterprises since there are claims that multinationals remunerate better their employees than local enterprises.

However, there is no reason as to why the relationship between local enterprises and multinationals should be a competitive one. They may in fact complement each other rather than act as rivals. For e.g. multinationals may have recourse to indigenous forms for their supply of inputs and this may lead to significant benefits for the indigenous firms by way of improved technology, better quality control procedures and diffusion of skills.

EXERCISES

1. MAURITIUS CASE STUDY

Mauritius is unique in having had a wealthy class of sugar plantation owners who were actively seeking to diversify their investments in the first years of independence. They have experimented with horticultural and industrial exports, as well as with tourist facilities, for many years. It took the arrival of Hong Kong and Taiwan textile firms to get industrialization going, however. And South African hotel chains first brought the tourist facilities up to world class standards. Why couldn’t they do it alone? The key missing ingredient was the much vaunted keystone of the “new economy:” knowledge. Mauritian investors lacked the depth and breadth of knowledge needed to create viable industry and tourism on their own.

The overseas Chinese and South African investors brought in-depth knowledge of how to run an efficient firm. They also had intimate knowledge of customers and their preferences, as well of what the competition was offering. They were able to train the Mauritian workforce, interspersing production lines with faster Chinese workers and more flexible Indian ones to bring up productivity. Domestic investors, whether the sugar barons or more locals of more modest and ethnically diverse origins, unanimously reported that they were not squeezed out by foreign investment. On the contrary, they worked with, learned from, and in many cases bought out foreign investors.

Ethnicity has been handled delicately in Mauritius, in surprising contrast to analysts’ predictions at independence. The few dozen Franco-Mauritian sugar barons who controlled the economy at independence in 1970 faced the classic South African nightmare of being washed into the sea. The majority of the electorate comprised landless descendants of cane-cutters brought in from the Indian subcontinent as contract labor. Yet Mauritians found a stable accommodation, in both politics and the economy. The constitution explicitly recognizes ethnic minorities, providing for 10 percent of parliamentary seats to go to “also rans” from ethnic minorities that would otherwise not be represented. The tiny new polity attained in two decades an economic transition from monocrop Sugar Island to a balanced economy in which textiles, tourism and sugar are the pillars.

New forays are being made into business services, information technology and other diverse export products. Indo-Mauritians are still minimally represented as entrepreneurs, though they dominate the civil service. Sino-Mauritians, hitherto concentrated in smallscale commerce, enhanced their status through association with Hong Kong and Taiwan industrialists whose knowhow and investment initiated the textile sector. Economic tensions are worked out in annual tripartite negotiations between labor, government and employers, most of whom are Franco-Mauritians. Sound institutions have played a critical role in the process. The rule of law has prevailed consistently. The sturdy financial sector, led by Mauritius State Bank since 1828, provides investment capital to both domestic and foreign investors. The British tradition schools graduate fully bilingual, often tri- and quadrilingual students, whom employers find a great asset in the new global economy.

Foreign And Local Investment In Mauritius

Mauritius was chosen as a case study because it has a reputation as a country in which foreign investment has played a critical and unanticipated role in industrialization, driven largely by good policies. The case study bore this out, but added great complexity to the portrait. Ethnicity was a complicating factor that could have derailed growth, and sound institutions played as important a role as policies in its success.

An Overview of Investment Policy and Performance in Mauritius

In the 1960s as independence from Britain approached, James Meade and Burton Benedict published several studies that foresaw a bleak economic and political future for Mauritius.11 Meade proposed strategies to improve the standard of living while taking into consideration projected continuing rapid population growth (then over 3% per year). He foresaw pressures of population growth on economic resources on this small volcanic isle and suggested several mitigating strategies, including increasing productivity, encouraging emigration and family planning. Burton Benedict challenged Meade’s proposed solutions, asserting that even if Meade’s suggestions on ways to increase productivity were followed, this would not produce results strong enough to counter the population growth problem.

To the Malthusian logic in these first analyses, Benedict added concern over the future political stability of Mauritius. He analyzed the 1953 and 1962 censuses and documented the impact of ethnic, religious, caste and linguistic fragmentation on local politics-from the national level to the squabbles over a repair contract for a small town road. He began with the observation that Mauritians rarely identified themselves and others as Mauritians. In 1962 people from the Indian subcontinent were the majority, but did not comprise a single ethnic group. 50.5 percent of the population was Hindu and 16.2 percent Muslim Chinese comprised 3.4 percent of the population, and the “General Population,” mainly Creoles and Franco-Mauritians constituted 29.9 percent. Although Africans had been brought to Mauritius in slavery, African languages and ethnic groups had melded into a mixed population speaking the Creole French patois that gradually became a lingua franca of the Island. The Indo-Mauritian population was 63 percent Hindu Sanatan and 19 percent Muslim Hanafi. There were generally endogamous minority sects of both major religions (the largest of which were Arya Samaj and Ahmadiyya), as well as Indian Christians. Castes had consolidated into a bipolar mode.

They had no corporate organization, but were generally endogamous. Chinese were nearly evenly split between Christians and Buddhists. Indo-Mauritians were further split by language, which sometimes had ethnic connotations. Hindi was the mother tongue of 36 percent of the total population and Urdu of 13.5 percent. Smaller Tamil and Telugu groups rarely intermarried with other Hindus. The “General population” of metisse, Franco-Mauritians and others was 96 percent Roman Catholic. The Franco-Mauritian families, are mostly descendants of French nobility who fled there during the French Revolution. The British gained control of the island during the Napoleonic wars andgoverned it until 1968, but the French families dominated the domestic society and economy.

For the dependency theorists of the 60s, Mauritius was an archetypical monocrop colonial economy. It depended on sugar for 99 percent of exports and one third of GDP. Cane fields occupied 90 percent of arable land. Of that, 55 percent was owned by 25 Franco-Mauritian families, often dubbed sugar barons. The remaining 45 percent of sugar estates were owned by 84,000 small farmers, predominantly of Indian origin. Almost no food was produced on the island. The majority who would dominate numerically in a democratic Mauritius was a land-poor population of former indentured laborers on sugar plantations from the Indian subcontinent. Until recently they had been considered transients, not counted as members of the population.

Benedict’s complex analysis of the ethnic situation did little to lift the prevailing pessimism about Mauritius’ future. The colonial government commissioned Meade to head an appointed commission to produce an economic strategy. The Meade Report was to strongly influence the government in creating its initial import substitution industrialization policy. The key recommendations in the Meade Report included tariff protection for certain local industries, a decrease of corporate tax from 40 to 30 percent, tax holidays for five of the first eight years of a company, priority of capital expenditure for projects leading to productive employment and the abolition of tariffs on importation of machine tools and equipment. These policies already focused on investment promotion, a policy which successive Mauritian governments have consistently favored. Even as early as 1960, investment in Mauritius reached 30% of GDP, a figure only recently achieved by the most successful economies in East Asia and largely unheard of in the developing world.

At this time, however, neither the new government of Mauritius, nor others in the developing world, had recognized the connection between investment policy and the larger political and economic context. A number of trends of the first government, which was dominated by the Mauritian Labour Party from independence in 1968 until 1982, limited the effectiveness of investment promotion incentives. One concern of foreign investors was political stability. There had been some communal violence just before independence, and the new Hindu dominated government maintained a fragile truce with minorities, including Muslim, Chinese and Franco-Mauritians. Other concerns centered around macroeconomic policies. Currency controls and protective tariffs designed to nurture import substitution industries [for the tiny national market], raised energy and transaction costs and times for potential exporters. The involvement of government in labor/ management negotiations and the creation of state corporations in key sectors led investors to take a wait and see attitude toward government. And the fledgling transport and telecommunications infrastructure was barely adequate.

The idea of creating an export promotion zone (EPZ) was added to the policy mix in 1970, only two years after independence. It was inspired by the success of Taiwan. Within a year the EPZ legislation was passed. In a stroke of brilliance, industrial leaders and policy-makers realized that Mauritius, being a small island with readily controlled access, could declare the whole island an EPZ-it did not need to have a fenced area. This allowed investors to build in dispersed locations, to facilitate transport for their workers and/or their products. Only a few foreign investors took advantage of the EPZ law in the 1970s, however.

Mauritius’ isolated location in the Indian Ocean, its currency controls and uncertain political situation reportedly influenced the first investors to limit their commitments. What became the flagship textile firm, for example, was set up initially to do only the manufacturing – marketing and management were based in Japan and Hong Kong respectively.

By the end of the 1970s Mauritius was experiencing many of the same problems that other African countries had with state corporations, protective tariffs, and currency controls. With no petroleum resources, it had been hit hard by OPEC’s escalation of oil prices and the global economic distortions that ensued. Government was running unsustainable annual deficits, the balance of trade was negative, industry was stagnant, and foreign exchange rationing slowed down all transactions. A devastating cyclone catalyzed a change in direction and in government. An alliance of former opposition parties, the Mauritian Militant Movement (MMM) and Mauritian Socialist Party (PSM), won the 1982 elections, changing the dominant party position for the first time since electoral politics was introduced in 1947.

The new government scrapped the mixed strategy of the 1970s, liberalized the currency, retreated from subsidizing state corporations, and put its full efforts into voluntary structural adjustment and promoting export-led growth. In retrospect, a recent government report sees that decision as an inevitable logical consequence of Mauritius’ geographic situation. The report, Mauritius at Crossroads (1995) explains that as a small island, physically limited by lack of arable land and relying solely on sugar for foreign exchange, “Mauritius was condemned to turn to an aggressive export strategy. However, it was not until the early 80s that foreign investment actually took off. And, it appears, partly as a consequence so too did domestic investment take off.

Today, according to Mauritius at Crossroads, every Mauritian is taught the concept “Export or Die.” This philosophy has led to the development of a sound business environment which is friendly to investors, both local and foreign, and which offers an attractive investment incentives package to compensate for the lack of resources and the no-longer inexpensive labor force. The older generation of industrial and government leaders also stresses that Mauritians have learned to make a virtue of their ethnic diversity. The switch to an export-led strategy came at a time of crisis. The ill-paid labor force was still predominantly of Indian origin, as was the government, whereas the industrial sector was led by Franco-Mauritians, Hong Kong/Taiwan investors and a few Sino-Mauritians.

Several interviewees described the moment as if they had looked at one another, then at the surrounding hundreds of miles of ocean, and decided that they would sink or swim together. For the export strategy, Mauritius needed to reach out to Hong Kong and Taiwan textile magnates, who had the capital and skills to organize a competitive industry. Franco-Mauritian local capital and know-how, and contacts were needed to open up European markets. A cooperative, trainable labor force was needed to attract investors. And government needed to be fully committed to its investor-friendly strategy. Mauritius had hard-working bilingual predominantly male labor force. They were skilled in farming, not industrial work. Most analysts doubted that Hindu or Muslim women would ever come out of the home and into the workplace. Within six or seven years, Mauritius had full employment, and industrial workers were mainly women.

Policies were the main, but not the only factor in investment decisions. Promoting investment has been on the top of the government’s industrial agenda throughout the different development phases, but the understanding of what works for investors, for government and for the society as a whole, has evolved continuously. The first clearly defined policy came in 1961, as the colonial government began to prepare for an independent Mauritius, with the Industrial Development Tax Relief Act. The Export Processing Zone took effect in 1971, as one of the first acts of the newly independent government. Support services for exporters were given a fillip in 1981 with the Export Service Zones Act.

In 1985, the Mauritius Export Development and Investment Authority (MEDIA) was established as the executive arm of the Ministry of Industry. Its main responsibilities are to attract investment, promote exports and manage industrial estates. Investors clearly weighed these incentives against the inconveniences created by location, lack of local food and fuel supplies and small market size. The only major policy disincentive for foreign investors is that they are not allowed to own land. Government has compensated by providing fully equipped industrial sites for lease. Hotel investors generally partner with a local landowner. In the 1980s Mauritius offered inexpensive labor, but within a decade the development of the textile and hotel sectors had brought wages to a middle level, by world standards. From the late 1980s through early 1990s, Mauritius experienced full employment. Rising wages have gradually priced the textile industry out of its mass-production T-shirt lines, and forced both government and industry to rethink development strategies.

The Industrial Expansion Act of 1993 was a partial response to this dilemma. Through it Mauritius confirmed its commitment to permanent zero tax rates for exporters, and added a bundle of new-targeted incentive programs, providing for high technology investors, offshore financial services and freeport services. The full range of incentive programs Mauritius which were offered is shown in Table 6.1. To increase confidence in the industrial sector in general, corporate tax for manufacturers who do not qualify for the EPZ zerorate was cut from 35 to 15 percent.

Table 3.1: Manufacturing – Fiscal Incentives

INCENTIVE SCHEMES

QUALIFYING ACTIVITIES INCENTIVES

Export Enterprise

(EPZ)

·€ All manufactured goods for exports

·€ Produce of deep sea fishing (Including fresh or frozen fish)

·€ Printing and publishing as well as associated operations

·€ IT activities

·€ Agro Industries

·€ No customs duty, or sales tax on raw materials and equipment

·€ No corporate tax

·€ No tax on dividends

·€ No capital gains tax

·€ Free repatriation of profits, dividends and capital

·€ 60% remission of customs duties on buses of 15-25 seats used for the transport of workers.

·€ Exemption from payment of half the normal registration fee on land and buildings by new

enterprises.

·€ Relief on personal income tax for 2 expatriate staff

Pioneer Status Enterprise

·€ Activities involving technology and skills above average existing in Mauritius and likely to

enhance industrial and technological development.

·€ Applicant companies may come under one of three broad categories:

(a) new technology,

(b) support industries and

(c) service industries.

·€ No customs duty, or sales tax on scheduled equipment or materials.

·€ 15% corporate tax

·€ No tax on dividends

·€ Free repatriation of profits, dividends and capital

Strategic Local Enterprise

·€ Local industry manufacturing for the local market and engaged in an activity likely to promote

and enhance the economic, industrial and technological development of Mauritius.

·€ 15% corporate tax

·€ No tax on dividends

Modernization and Expansion Enterprise

·€ Two broad categories:

·€ Investment in productive machinery and equipment, such as automation equipment and

processes and computer applications to industrial design, manufacture and maintenance

CAD/CAM)

·€ Investment in anti-pollution and environment protection technology to be made within 2 years

of date of issue of certificate.

·€ No customs duty on production equipment

·€ Income tax credit of 10% (spread over 3 years) of investment in new plant and machinery,

provided at least Rs 10 million are spent and this occurs within two years of date of issue of

certificate. (This is in addition to existing capital allowances which amount to 125%of capital

expenditures.)

·€ Enterprises incurring expenditure on anti-pollution machinery or plant benefit from a further

incentive, i.e. an initial allowance of 80% instead of the normal 50%

Industrial Building Enterprise

Construction for letting purposes of industrial buildings or levels thereof, provided floor space is

at least 1000 square meters. Special conditions:

The applicant can only be a company intending to erect an industrial building to be let to the holder of a certificate (other than an industrial building enterprise certificate) issued under this Act or to an enterprise engaged in the manufacture or processing of goods or materials except the

milling of sugar.

·€ 15% corporate tax

·€ No tax on dividends

·€ Registration dues for land purchase: 50% exemption

·€ There is also a non-fiscal incentive, namely the disapplication of the Landlord and Tenant Act,

i.e. rent control

Source: Destination Mauritius, Mauritius Export Development and Investment Authority (MEDIA).

Table 3.2: Services – Fiscal Incentives

INCENTIVE SCHEME QUALIFYING ACTIVITIES INCENTIVES

Offshore Business

Conduct of business with non-residents and in currencies other than the Mauritian Rupee. Activities include: offshore banking, offshore insurance, offshore funds management, international financial services, operational Headquarters, international consultancy services, shipping and ship management, aircraft financing and leasing, international licensing and franchising, international data processing and other information technology services, offshore pension funds, international trading and assets management, international employment se