📈 Economies of scale
By selling in many countries, a firm can make far more units. As output rises, average costs can fall. This is a reminder of the lessons on economies of scale.
Globalisation » Multinationals and Foreign Direct Investment
What you'll learn this session
Study time: 30 minutes
Edexcel spec: 2.2.1 (d)
- What multinational corporations (MNCs) and foreign direct investment (FDI) are
- Four reasons why MNCs and FDI emerge
- The advantages of MNCs and FDI for the countries that host them
- The disadvantages for host countries, including tax, pollution and profits sent abroad
This topic is examined on Paper 2: Macroeconomics and the Global Economy.
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Unlock This CourseWhat are MNCs and FDI?
A multinational corporation (MNC) is a business that operates in more than one country. It usually has its head office in one country, called its home country, and factories, shops or offices in others. The countries where it sets up are called host countries.
When an MNC builds a new factory, buys land or buys a local firm in another country, it is putting money into that country. This is called foreign direct investment.
Key terms:
- Foreign direct investment (FDI): money invested by a firm from one country in a business or in assets, such as factories, in another country.
- Host country: the country that receives the investment and in which the MNC operates.
So FDI is how an MNC grows abroad. Remember from the lesson Globalisation and Why It Happened that MNCs have become more significant. This lesson looks at why they spread and what they mean for the countries they enter.
Why do MNCs and FDI emerge?
Multinationals open factories abroad to reach new customers and cheaper materials: foreign direct investment
Firms do not invest abroad just for fun. They do it because it can make them more profit. There are four reasons to learn.
⛏ Natural resources and cheap materials
A firm may set up where the raw materials are, such as minerals, timber or farmland, or where materials cost less.
🚢 Lower transport and communication costs
Cheaper shipping, flights, email and video calls make it easier and cheaper to run a factory or office far from the head office.
🛍 Access to customers
Building in a region puts the firm close to its customers there. It can sell more and may avoid trade barriers on imports.
Worked example
Zandor Motors is based in Country A. It builds a car factory in Country B. Country B has a large population who want cars (access to customers), and the factory makes parts for all of the firm's cars (economies of scale). The money Zandor spends building the factory is FDI. Country B is the host country.
Advantages for host countries
FDI can create jobs and train local workers in new skills
Host countries often welcome MNCs. They welcome them for these reasons:
- Creating jobs: the MNC hires local workers. Local suppliers and shops also gain jobs and sales.
- Investing in infrastructure: the MNC may build or improve roads, ports, power supplies or telecoms that it needs. Local people can use them too.
- Developing skills: workers are trained and learn new methods, which makes the labour force more skilled.
- Developing capital: new factories, machines and technology add to the country's stock of capital, so it can produce more.
- Contributing to taxes: the MNC pays taxes such as corporation tax, and its workers pay income tax. The government can spend this on schools and hospitals.
Disadvantages for host countries
There are costs as well.
- Avoiding paying taxes: large MNCs can arrange their accounts so that profits show up in countries with low tax rates. The host country then collects less tax than it hoped for.
- Environmental damage: factories, mines and transport can cause pollution and use up natural resources. Some MNCs choose countries with weak environmental rules.
- Moving profits abroad: profits belong to the owners of the MNC, who live mostly in the home country. Much of the profit may leave the host country instead of being spent there.
| Advantages | Disadvantages |
|---|---|
| Jobs created | Taxes may be avoided |
| Infrastructure improved | Environmental damage |
| Skills developed | Profits moved abroad |
| Capital developed | |
| Taxes contributed |
Common mistakes
Writing that FDI means an MNC "sells goods abroad". That is exporting. FDI is investing in a business or assets in another country. Another slip is only listing "jobs" without saying who gains. Say that local workers earn wages. Finally, do not forget that taxes appear on both sides: some are paid, but some are avoided.
Exam-style question
Country Tindra is a developing country. In 2024, a foreign food company, Brava Foods, opened three factories there. Brava Foods employs 4,000 local workers and trains them to use modern machines. The company sends most of its profit to its head office in Country Hallow. Some local people say its factories pollute the nearby river.
(a) Define foreign direct investment. [2 marks]
(b) Explain one reason why Brava Foods might have chosen to invest in Country Tindra. [3 marks]
(c) Evaluate whether Country Tindra gains from having Brava Foods as a multinational. [6 marks]
Model answer
(a) FDI is money invested by a firm from one country (1) in a business or assets, such as factories, in another country (1).
(b) Brava Foods may want access to customers in the region (1). By building factories in Tindra it can sell directly to people there (1) and avoid trade barriers such as tariffs on imported food, which makes its sales and profits higher (1).
(c) Tindra gains 4,000 jobs, so workers earn wages and spend them in local shops (1). The workers are trained, so they gain skills that are useful for future jobs (1). The company will also pay some taxes, which the government can spend on public services (1). However, most of the profit is sent to Country Hallow, so Tindra does not keep the full gain (1). The pollution of the river is environmental damage, which can harm local people and farming (1). Overall, Tindra probably gains if the jobs and training are worth more than the cost of the pollution and lost profit. This depends on whether the government makes the firm clean up and pay its fair share of tax (1).
Exam tip
In an evaluate question, use the details given in the case, such as the 4,000 workers and the river, and finish with a judgement that says what it depends on.
Recap
- An MNC operates in more than one country. FDI is investment by a firm in another country.
- MNCs and FDI emerge for economies of scale, natural resources and cheap materials, lower transport and communication costs, and access to customers.
- Advantages for host countries: jobs, infrastructure, skills, capital and taxes.
- Disadvantages: tax avoidance, environmental damage and profits moved abroad.