How TNCs can really help developing countries
The key role of Western companies in formalising emerging markets
Investment by multinational corporations, mainly based in the US or Western Europe, in developing countries in Africa and Asia for example, produces a variety of advantages and disadvantages which have been debated in depth since the advent of globalisation in the post-war, post-colonial era of the late 20th century.
The key advantage of investment by multinationals is the multiplier effect that it provides. Investment by firms>Improved employment opportunities>Higher wages>Higher consumer spending and tax revenue>Greater government and private investment>Greater government spending to improve areas such as infrastructure and education>More firms are drawn to the country>Employment opportunities improve further>Repeat.
However, this also provides disadvantages due to the lower regulation found in developing countries. For example, looser environmental regulations due to a less advanced regulatory framework, as well as dangerous working conditions for employees.
This debate between the positive of economic development directly as a result of investment by firms, as outlined by the above multiplier effect, and the drawbacks of that investment is an important one to have. However, the focus of this blog will be on the indirect benefits of investment by foreign multinationals.
The multiplier effect is the key benefit of TNCs in emerging markets, however there are also a number of other benefits which may be of greater significance in the long run. It is these benefits which will enable developing economies to become self-sufficient and formalised with a thriving private sector and stable government finances. This benefit can be summarised as ‘Westernising’ developing economies- making them stable and dynamic economies with an effective balance between the private and public sector and a path to sustainable growth.
Western corporations in developing countries should focus not only on how their investment can increase their profits; typically gained through the lower costs of developing economies resulting from more relaxed labour laws resulting in a lower wage bill. Instead they should focus on how they can actually improve the culture and skills of the business environment in these countries. By creating a more business-friendly environment and having a more skilled workforce, the benefits to firms will be greater than simply investing in emerging markets due to their lower costs. This is due to a greater number of investable countries providing a greater choice to companies across industries, allowing them to relocate to an alternative country should the economic, regulatory or political environment in that country become inhospitable. By moulding countries in their image, TNCs can create the developed countries of the future which allow for the long-term survival and development of the business.
The benefits in question:
Formalisation: As TNCs are typically based in developed countries, they have a formal structure and practices. For example, in the UK, publicly-traded companies are legally required to disclose their financial statements to the public. Whilst this is an example that only applies to large companies, the sentiment is the same: Western companies of all sizes have formal, codified regulations to follow in all areas, ranging from financial reporting to their environmental impact. Western firms must apply this same formality in emerging markets; failure to follow best practice may result in damage to brand image and therefore incentivises firms to apply the same practices in emerging markets as they do in their home markets. The most infamous example of failure to maintain high standards in developing countries is the frequent oil spills in the Niger Delta as a result of Shell's operations. For consumers who wish to use environmentally sustainable brands, as well as Environmental, Social, Governance (ESG) investors, this may discourage them from filling their vehicle with Shell’s oil or investing in the company. Thus, in order to maintain brand image, firms must follow high legal and governance standards for their operations in emerging markets. This benefits developing countries not only by ensuring that the negative impact of TNCs in minimised but also the effect it has on the domestic business environment in these countries. The standards of TNCs can be used for instance to create a framework allowing for the development of more effective regulation. This regulation must then be followed by the businesses based in the country; meaning that local firms must conduct business in the way it is done in developed economies. This will enhance economic development as Western financial reporting means that governments will receive greater tax revenue as more effective regulation and enforcement can close loopholes that may exist. In addition, workers could see conditions improved due to Western labour laws and practices being implemented. Furthermore, a formalised management structure could improve the efficiency of firms and provide codified responsibilities for different positions within the firm. Therefore, if TNCs view developing countries as they do developed countries, domestic corporations have the potential to become akin to said TNCs. This improves economic development for a number of different stakeholders by creating a more responsible business environment which has better employee conditions, more efficient firms, higher taxation revenue, and a lower negative impact on communities.
Entrepreneurship: As countries develop, the skills of their workforce improve, and with this improvement in skills comes greater economic growth. This is due to the multiplier effect with which I started this post by outlining. Greater taxation revenue for the government due to development means that investment in education can increase, leading to better outcomes and thus a more qualified workforce. These greater skills should in turn attract more high-skilled and higher wage jobs to the country. A good example of this is China, which developed from an economy largely based on manufacturing into a country with a strong tertiary sector. Today China is home to some of the largest technology companies in the world; Bytedance, the most valuable private company in the world and owner of TikTok, being a perfect example. This shows how development through the economic sectors from primary to secondary to tertiary and quaternary can provide entrepreneurship as investment from foreign firms can provide the skills and experience to the workforce for them to be able to found their own firms. In addition, foreign investment can create a funding environment in these countries which allow for the successful start-up of these businesses. As Sebastian Mallaby notes in ‘The Power Law: Venture Capital and the Art of Disruption’, Chinese founders and venture capitalists “had studied at top US colleges, worked at US companies”. This shows how entrepreneurs in highly skilled industries can launch successful businesses due to a welcoming business environment created by international businesses’ investment. By providing local employees with skills, experience and funding, entrepreneurs can succeed in countries otherwise inhospitable to independent businesses. In ‘The Undercover Economist’, Tim Harford argues that economic development is held back by high regulation levels discouraging innovation. The experience provided by foreign businesses can spur the employees of these businesses to start their own firms, their experience giving them the skills to better succeed in the environment they find themselves in. As entrepreneurs solve problems in order to attract customers to their business, developing countries can be aided by this by virtue of the fact that they simply have so may problems: rapid urbanisation, a lack of infrastructure, water supply issues and an informal economy to name but a few. Hence, entrepreneurship can improve developing countries, whilst providing a profit to founders. As this can be facilitated initially by TNCs, these companies are highly important to economic development via their investment in human capital. This also helps emerging markets achieve autarky as if their businesses are owned by natives, managed by natives, and serve natives, an increasing number of sectors are no longer reliant on foreign companies. This self-sufficiency reduces risks to developing countries in the event of an economic downturn in developed economies resulting in reduced investment in emerging markets. For example, as explored in the case of China in the documentary ‘Too Big To Fail’, the 2008 Financial Crisis reduced investment. To avoid this happening in the future and to accelerate development, TNCs should invest in human capital in these markets.
Agglomeration: The third benefit of TNCs in developing countries is closely linked with the second. Agglomeration is when there is a high concentration of human and financial capital within a dense urban area; allowing for cross-fertilisation between businesses, spurring innovation and increasing future profits. As Edward Glaeser outlines in ‘The Triumph of the City’ this cross-fertilisation has led to the development of the financial sector in Manhattan and the development of the tech industry in Silicon Valley. These highly productive regions combine financial capital through Venture Capitalists in Silicon Valley and Wall Street as the original base of finance in the United States, human capital through elite universities such as Stanford in Silicon Valley and Columbia in New York, along with technical expertise brought by experience working at the existing firms in these cities. The reason why this links so closely to entrepreneurship is that this concentration of expertise within firms in a dense area means that employees have the ability to leave their firms and found their own start-ups, whilst the availability of finance increases the likelihood that these ventures succeed. For instance, in New York, most hedge funds are founded by managers who had spent the early part of their career working for a large investment bank. This can be applied in developing countries through increasing ties between TNCs and governments. Governments in developing countries tend to believe strongly in the value of flagship infrastructure projects as they believe that these projects will create better connected and more dynamic economies. TNCs can exploit this desire by reaching agreements with governments to create designated business districts in the cities of these countries for multinationals who wish to invest in the tertiary sector of developing economies; as agglomeration through skilled workers is most prevalent in the skill-intensive tertiary sector. Therefore, if multinationals locate in a specific area of a city, and partially finance the expense of constructing these business districts, the benefits of agglomeration can be realised. This would be enhanced if the business districts were located nearby to universities within the cities. Therefore, the most highly skilled workers in developing economies are concentrated in one specific area with the greater access to financial capital of TNCs. Employment at these TNCs would bring experience to the highly-skilled population, which combined with increased investment into the country as well as the network effects provided by agglomeration, would enhance the potential for entrepreneurship and independent businesses to be formed by ex-employees of the TNCs. This process would be enhanced by the more collaborative working environment and improved working facilities and infrastructure provided by the concentration of human and financial capital in agglomeration. This would accelerate the economic independence brought by entrepreneurship mentioned earlier.
Sustainability: Many TNCs are (or provide the impression that they are) introducing aims and strategies within their operations to reduce their environmental impact. This is due to governments and consumers alike in Western countries aiming to reduce their emissions and as such investigating the emissions of their firms. Hence, as damage to brand image as well as punishment for infringement of regulation threaten firms, they have an incentive to reduce their emissions. Despite levels of regulation likely being lower in developing countries, there is increasing pressure on companies to increase accuracy in reporting their emissions. Therefore, to avoid the repetitional damage of auditors finding that there are inaccuracies in reporting, TNCs are incentivised to ensure accurate monitoring of emissions in developing countries, despite there being little legal reason in these countries for them to do so. If TNCs in developing economies increase investment in technology to monitor their emissions there, it is possible that this culture of accountability for emissions can spread to firms based solely in these countries. This links to the earlier point on formalisation, in which Western business practices become followed by firms in developing countries. This same effect can be applied in regards to sustainability. Therefore, if more firms introduce measures to increase accuracy in monitoring emissions, take methods to reduce emissions such as planting trees to increase carbon neutrality and implement sustainability as a key facet of their operations, the overall sustainability of the economies of developing countries improves.
Conclusion:
At the start of this post I mentioned some of the drawbacks of TNCs in developing countries: environmental destruction, exploitation of workers, and a lack of accountability.
However, as outlined throughout this post, if these TNCs come to view emerging markets as they would view the Western countries in which they are based, the positive impact greatly outweighs the negative.
In Western countries the threat of regulation and repetitional damage is enough to ensure they minimise the impact of their activities. ‘Westernising’ their view of developing countries means that the impact on developing countries can be reduced to the level in developed countries. TNCs should adopt this view as rising incomes in emerging markets, as a result of the multiplier effect their investment creates, means that, in the future, the population of developing countries will not only be employees but will also be customers who can afford the Western products of the firms that employ them. In order to gain these future customers, TNCs should minimise their negative impact.
As well as reducing their drawbacks, TNCs can provide a range of benefits besides from the all-important multiplier effect. Investment and employment increases the skills and experience of the workforce, improving the long-term employment opportunities in the country and enabling entrepreneurship, allowing for economic self-sufficiency in developing countries.
Therefore, TNCs, whilst providing the investment necessary to grow developing economies, provide a range of long-term benefits which make the business environment of these countries more akin to that of a Western, developed country.
Instead of questioning the activities of TNCs in Africa we should embrace the multi-faceted benefits that they can bring if they are incentivised to conduct their operations in an ethical manner.