Plan
- give an example of a method of promoting FDI
- lower corporation tax
- link point to how FDI increases economic development
- job creation
- greater incomes
- greater savings
- greater investment
- greater economic growth
- knowledge share
- external economies of scale
- evaluation
- opportunity cost and time lag
- it is not guaranteed that people will understand the importance or the ways to improve their family's health and education
- if this doesn't improve - economic development may not be possible
One way an LEDC can promote economic development is by reducing corporation taxes. This will promote FDI. FDI stands for foreign direct investment. It is the flow of capital from one country to another country, and can happen when businesses in different countries form partnerships. It comes from MNCs (multinational corporations) who operate their business in more than one country.
A country can promote FDI to increase its chances of economic development. Economic development is measured by HDI (human development index) which tracks improvement in education (average years at school) , healthcare (life expectancy at birth), and living standards (gdp per capita). There are different ways of measuring economic development but HDI is used often as it is well rounded. Economic growth is necessary for economic development but it does not guarantee economic development will happen, as this will also depend on the improvement on health and education levels in that country.
The government of a developing country can promote FDI by keeping corporation tax rates low and income tax rates low. If the MNC sees two similar opportunities to invest, it would choose the country which has lower corporation tax because it will incentivised to keep more of its profits. Also, lower income taxes could benefit the MNC because it allows them to attract more skilled workers, or pay a lower salary as the salary is not taxed as heavily. The aim of the MNC is to profit from these opportunities, but the developing country also benefits from job creation as well as external economies of scale.
The MNC will hire cheap labour in the given area and this creates jobs. More people will be given the opportunity to earn a disposable income. This means that real GDP per capita will increase. This will lead to greater savings. This will lead to an increase in banks liquidity, which will mean that they are more willing and able to lend money at lower interest rates. This allows businesses access to cheaper loans which allows them to increase investment (spending on capital goods). This can lead to both short run and long run economic growth through an increase in aggregate demand, as well as an increase in productive potential due to better machinery. Overall, economic growth will lead to greater incomes and greater savings (as described by the Harrod Domar Model). This is also important for economic development because it allows people to invest in their family's education and healthcare in the form of doctor visits, vaccinations, and school uniforms and books which they may not have been previously able to afford. FDI from MNCs also allow nearby firms to benefit from external economies of scale. This is when long run average costs fall as firms grow in size. For example. the MNC will want to ensure their staff are highly skilled and that nearby roads and infrastructure are of a high quality. This is beneficial for the MNC and their staff, but it also benefits other firms because knowledge can be shared amongst locals, and all firms can benefit from things like cleaner and safer roads.
In evaluation, supply side policies that are used to promote FDI often have a high opportunity cost and time lag. For example, the government are foregoing tax revenue. Tax revenue is important for economic development because it can enable the government to invest in basic healthcare such as free vaccinations, safe drinking water, and doctors checkups for children. Without this basic investment, MNCs may not be attracted to invest in the first place. However, there is also a huge lack of knowledge or chance or corruption in developing countries so tax revenue may be mis-spent.