Multinational Business: Challenges and Prospects

In the eyes of developing economies, foreign direct investment (FDI) not only serves as an engine of growth but also provides a channel for international trade and technology transfer. Host countries that are positive towards FDI inflows tend to respond by providing incentives such as subsidies, tax holidays and other fiscal concessions, duty exemptions, and upgraded infrastructure, among others. However, these incentives are costly to taxpayers and do not always achieve what is intended.

For instance, attracting the wrong kind of FDI may have adverse effects on national interests and the natural environment. Local firms fear foreign competition as that could result in them losing market share or being pushed out of the industry altogether. Environmental groups have also alleged that foreign affiliates use less sustainable technology that tend to degrade the environment.

On the other hand, the entry of foreign firms could promote healthy competition resulting in productivity improvement for stronger local firms that are willing to innovate, adopt better technology or business practices of foreign affiliates, and recruit skilled workers, who were previously trained by foreign affiliates.

Drawing Advantage from FDIs

To capitalise on FDI inflows, local firms should forge production linkages with foreign affiliates such as being their suppliers (and customers) in the supply chain. For example, the presence of foreign affiliates in the downstream or upstream sectors could lead to local firms enhancing productivity because there is an incentive for foreign affiliates to provide training and technical assistance to their local suppliers or buyers in order to ensure intermediate inputs supplied (purchased) meeting the technical standards and requirements. The extent of the diffusion of technological know-how is dependent on the scale and scope of inter-industry linkages between foreign affiliates and local firms, the level and relevance of technology diffusion, and the indigenous technological absorptive capacities.

Recently, there has been a change in FDI landscape, specifically, the developing and transition economies (DTEs) have turned into an important source of FDI as a result of economic reform and progressive liberalisation in trade and investment. The 2011 World Investment Report stated that DTEs contributed 29% to global FDI outflows.

The drastic increase in FDI outflows has raised an interesting empirical question on what drives Malaysia’s FDI outflows in the long run. According to an empirical study, which has since been published in the Journal of Policy Modeling, my coauthor Goh Soo Khoon and I reveal that the key drivers of Malaysia’s FDI outflows are foreign market size, real effective exchange rate, trade openness and international reserves.

The main findings suggest that a larger foreign market relative to home market could influence local firms’ decision to invest abroad. Big local firms may have incentive to acquire foreign operations due to lower start-up cost attributable to the appreciation of the ringgit exchange rates. The adoption of liberal policy on capital outflows as well as outward-oriented policies are instrumental in encouraging Malaysia’s FDI outflows in the long run.

However, there is a concern as to whether the increase in FDI outflows would crowd in or crowd out domestic investment activities, which are an important source of growth for DTEs. Providing a much-needed empirical study of the effect of FDI outflows on domestic investment using Malaysia as a country case study, Goh and I also published a recent journal article in Prague Economic Papers, which found that the effect on domestic investment by FDI outflows is substitutional (crowding-out effect) while that by FDI inflows is complementary (crowding-in effect).

With reference to the magnitude of the estimated elasticity, FDI inflows is very elastic relative to FDI outflows, implying that the former could overcome the crowding-out effect by the latter if pragmatic policies could be formulated to attract more FDI inflows, such as to remove barriers to FDI by reviewing existing policies, regulations and procedures that may impinge on the high transaction costs of doing business in the domestic economy.

Attracting the Right Kind of FDIs

In the era of globalisation, host countries like Malaysia should attract the right kind of FDI that could potentially generate technological knowledge and productivity growth to local suppliers and buyers through firm-to-firm interactions along supply chain. To benefit from foreign outsourcing activities, local suppliers have to upskill and expand capacities of their personnel, and invest in high-technology intensive production.

With the recent change in FDI patterns, it is time for Malaysian companies to seize opportunities abroad to exploit the regional growing market opportunities and expand their market reach. They do not have to shift the entire operations away as some of these production and business activities can be performed cheaper or better based on locational cost competitive advantage.

Internationalisation of business activities is instrumental in expanding markets abroad for local firms, integrating themselves into the global supply chain and becoming regional and international players in the long run. There are perceived high entry costs in relation to setting up a subsidiary or a production platform abroad to test new markets. Local firms may have to overcome various barriers like locating foreign buyers and suppliers, and incur transaction costs in connection with linguistic, cultural, legal and regulatory differences.