ChainWhat it assumes · how to break it
Start
A multinational builds an export-oriented electronics plant in an emerging economy to supply world markets.
1
As a result, the plant's output is sold abroad, so the value of the host country's exports of manufactured goods rises.
exports · trade in goods
exports · trade in goods
Assumes: The plant is built to export rather than to supply the local market.
But: Market-seeking FDI, such as a supermarket chain or a car plant serving a large home market, adds little to exports.
2
At the same time, the plant imports components and capital goods, so imports also rise.
import content · imports
import content · imports
Best link to attack
Assumes: Imported inputs are a small share of the value of exports.
Assumes: Imported inputs are a small share of the value of exports.
But: In an assembly plant, imported components can make up most of the export's value, so net exports rise much less than gross exports.
3
Therefore, the trade balance improves by the value added in the host country, which is the export value minus the imported inputs.
trade balance · value added
trade balance · value added
Assumes: Local value added is positive and growing.
But: In the building phase, imports of machinery can push the trade balance into deficit before exports begin.
4
In addition, the multinational sends its profits home, which is a debit in primary income and offsets part of the gain on the current account.
profit repatriation · primary income
profit repatriation · primary income
Assumes: Profits are sent to the parent company rather than reinvested locally.
But: Some multinationals reinvest a large share of profits in expanding the host plant.
End
The trade balance improves by the local value added, though profit repatriation offsets part of the gain on the wider current account.
Evaluation chain
- E1However, the improvement depends on how much of each export's value is produced in the host country.
- E2When the plant imports most of its components and only assembles them, local value added is a small share of the export price.
- E3As a result, imports rise almost as much as exports, and profit repatriation takes a further share abroad.
- E4So the gain to the trade balance is far smaller than the gross export figures suggest, and the current account may improve very little.
Another way to attack it: The initial investment is a credit on the financial account, which matches a current account deficit in the building phase; the trade gain only comes once the plant is producing.
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Questions this answers
- Assess the effect of inward FDI on the current account of an emerging economy.
- Discuss whether export-oriented FDI improves a developing country's balance of trade.
- Explain how profit repatriation by multinationals affects the balance of payments.
Diagram
No standard diagram. Use the balance of payments accounts: exports and imports in the trade balance, profit outflows in primary income, the investment inflow in the financial account.
Reverse and related
FDI outflow or plant closure → exports of manufactured goods fall, though imports of components and profit outflows also fall.