Globalisation as a route to development in LEDCs

Overview

Foreign direct investment, export processing zones and special economic zones and main criticisms of globalisation as a route to development.

What you need to know

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Questions from this subtopic

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1. 1

   What is globalisation?

   Model answer

   Globalisation is the increasing interconnection of countries through flows of goods, services, capital, people, technology and ideas, so that economies and societies become more integrated and more interdependent. It has been driven by falling transport costs, especially containerisation and air freight, by the communications and computing revolution, by the removal of barriers to trade and investment, and by the growth of transnational corporations able to organise production across many countries.

2. 2

   Through what mechanisms can globalisation raise development in an LEDC?

   Model answer

   Foreign direct investment brings capital the country could not raise from domestic savings. New factories and service centres create formal, waged jobs, which raise household incomes above subsistence levels. Wages spent locally generate a multiplier effect supporting housing, transport, retail and services. Exports earn foreign currency needed for imports and debt servicing. Corporate and payroll taxes raise government revenue for schools, clinics and infrastructure. Workers gain skills and management experience, and technology and working practices are transferred. Infrastructure such as ports, roads, power and telecommunications is built or upgraded to serve investors and is then available more widely. Migration abroad generates remittances flowing back to households.

3. 3

   What is foreign direct investment, and why do transnational corporations invest in LEDCs?

   Model answer

   Foreign direct investment is investment by a firm based in one country in productive assets in another, such as building a factory, opening a call centre or buying a controlling stake in a local company; it differs from portfolio investment in shares because it involves lasting control. TNCs invest in LEDCs to reduce production costs, above all labour costs; to secure raw materials and energy; to reach growing domestic markets and to get inside tariff barriers; to exploit lighter regulation of labour, safety and pollution; and to take up incentives offered by host governments such as tax holidays, subsidised sites and duty-free import of components. Location decisions also weigh political stability, workforce skills, transport links and time zones.

4. 4

   What is the multiplier effect in the context of foreign investment in an LEDC?

   Model answer

   When a new plant opens, its wages are spent in local shops, markets, transport and housing, supporting further jobs and incomes; it also buys inputs and services locally, creating orders for suppliers; and the taxes it and its workers pay fund public services. Each round of spending generates further spending, so the total effect on the local economy is larger than the initial investment. The size of the multiplier depends on how much of the money stays in the country: if components are all imported, managers are all expatriate and profits are sent abroad, the multiplier is small and the plant becomes an enclave.

5. 5

   What are export processing zones and special economic zones, and what are they intended to do?

   Model answer

   They are designated areas in which firms producing for export enjoy conditions different from the rest of the country: exemption from import duties on components, tax holidays, streamlined customs, purpose-built factory units, reliable power and transport, and sometimes relaxed labour regulation. Their purpose is to attract foreign manufacturers by removing the obstacles they would face elsewhere in the economy, and so to create jobs, exports and foreign exchange quickly. They have been central to industrialisation in China and much of Asia. The criticism is that the tax exemptions cost the government revenue, that linkages to the domestic economy are often deliberately limited, and that labour protections inside them may be weaker.

6. 6

   What are the main criticisms of globalisation as a route to development?

   Model answer

   Profits are repatriated to shareholders in MEDCs rather than reinvested, so recorded production exceeds retained income. Wages may be very low and conditions poor, with long hours, weak safety enforcement and restrictions on trade unions. Competition to attract investors can push governments into a race to the bottom on taxes, wages and environmental standards, so the benefits are competed away. TNCs are footloose and may relocate when costs rise or incentives expire, leaving unemployment behind. Plants can form enclaves with few links to local firms. Environmental damage, from pollution to deforestation and resource depletion, is often the cost. Tax revenue is reduced by holidays and by transfer pricing, in which firms shift declared profits to low-tax countries. And the country becomes exposed to global recessions and commodity price crashes over which it has no control.

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