BUSS 348 Final Notes

8/6/2019 BUSS 348 Final Notes

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PUBLIC ENTERPRISES / STATE OWNED ENTERPRISES (SOEs)

Associated with the problems of public administration in developing countries have been the

widespread activities of state-owned enterprises (SOEs), public corporations owned and

operated by the government. In addition to their traditionally dominant presence in utilities

(gas, water, and electricity), transportation (railways, airlines, and buses), and

communications (telephone, telegram, and postal services), SOEs have become active in such

key sectors as large-scale manufacturing, construction, finance, services, natural resources,

and agriculture. Sometimes they may dominate these sectors, particularly in the areas of

natural resources and manufacturing. Even though quite a number of countries in the

developing world dramatically reduced the number of state-owned enterprises through

privatization in the 1990s (Kenya included), state owned enterprises still employed most the

workforce and contributed immensely to industrial output despite the fact that most of them

operated at a loss.

State-owned enterprises have played a major role in the economies of developing nations,

contributing an average of 7% to 15% of their GDP, accounting for a substantial amount of

investment, absorbing substantial amounts of resources and in many cases impose a heavy

fiscal burden on governments. Its worth noting that SOEs differ from private firms in that

they are expected to pursue commercial and social goals.

Rationale for creation of State - Owned Enterprises

1. Persistence of monopoly power in developing countries led to government control to

ensure prices are not set above marginal costs of producing output. In cases of goods and

services that have high social benefits, these will be provided at a price below their costs or

free, and in this situation the private sector will not have the incentive to produce such goods

and services.

2. Capital Formationat the early stages of development (soon after independence) savings

were low and investment in infrastructure was crucial to lay the groundwork for further

investment.

3. Lack of private incentives to engage in economic activities (soon after independence)

because of factors such as uncertainty about size of domestic/ local markets, unreliable

sources of raw materials, absence of technology and skilled labour.

4. Desire by governments in developing countries to gain control over strategic sectors of the

economy such as defence over strategic sectors of the economy over foreign owned


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enterprises (i.e. multinational corporations MNCs) whose interests may not coincide with

those of the country, or over key sectors for development purposes.

5. Government involvement may also come about as a result of bankruptcy in a major private

industry.

6. Ideological motivations may also be an additional factor in the creation of state-owned

enterprises.

Characteristics of Public Enterprises

i). They are formed by an act of parliament, e.g. the Kenya Investment Authority (K.I.A)

was formed through the Kenya Investment Authority Act enacted by parliament, Central

Bank though the Central Bank Act enacted by parliament.

ii). Government Ownership: - Public enterprises are either wholly owned by the Central

government or local authority or jointly owned by the two or more of them.

Government ownership means that more than 50% of equity (or share holding) is being held

by the public authority.

iii). Government Control and Management: - The government has a right to control and

manage the affairs of the public enterprises.

iv). Public Accountability: - Since public enterprises are provided funds from the public

exchequer, it is important that they be accountable to the public though parliament.

v). Public enterprises are established on the basis of political decisions and their operations

are controlled by systems where politicians have the final say.

vi). Public enterprises are established to serve the welfare purposes of the citizens.

vii). They have a wide business coverage ranging from agriculture to trade, transportation,

banking, tourism etc.

Objectives of Public Enterprises: -

1. Public enterprises are established in order to ensure that theres balanced regional growth

in the country.

2. They are created with the aim of providing employment opportunities for the people.

3. To generate revenue for the government.

4. To provide infrastructural facilities e.g. Kenya Ports Authority, Kenya Airports Authority,

Kenya Railways, etc.

5. To establish key and basic industries e.g. in Kenya we created RIVATEX, KICOMI, KCC,

most of them collapsed.

6. To promote the living standards of the people.


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TYPES OF PUBLIC ENTERPRISES

1. Commercial Public Enterprises: - These actively participate in marketing and trading

activities. They are not involved in the manufacture of any product or delivery of services e.g.

Uchumi Supermarkets.

2. Manufacturing Public Enterprises: - These enterprises manufacture capital as well as

consumer goods.

3. Financial Public Enterprises: - These are engaged in the provision of finance and

financial services to business e.g. Kenya Commercial Bank, National Bank of Kenya etc.

4. Promotional Public Enterprises: - These are engaged in the promotion of businesses

producing goods and services e.g. Export Promotion Council, Kenya Investment Authority

etc.

5. Public Enterprises: - These provide services to the general public and these services are

essential by nature. Some may operate under monopolistic conditions e.g. Kenya Power and

Lightning Company Ltd, Kenyatta National Hospital, KEMRI, KARI, etc.

BENEFITS OF PUBLIC ENTERPRISES: -

1. Public enterprises help in the exploitation of natural resources in the country in order to

maximize social welfare e.g. Nyayo Tea Zones, Mumias Sugar Company.

2. They help to reduce national and regional disparities in income and wealth through a

planned dispersal of industries.

3. It helps in the industrialization of a country.

4. Public enterprises provide infrastructural facilities for the development of the economy e.g.

Kenya Telkom, Kenya Postal Corporation etc.

5. They provide a forum though which foreign assistance can be utilized for the benefit of the

whole economy especially when foreign governments insist that aid be given only to

government owned organizations.

6. They generate revenue for the government and create employment opportunities for the

people.

7. They stimulate research and development activities leading to the development of

indigenous technologies new products, services and the achievement of self-reliance.

8. They help in maintaining a favourable balance of payments by:

i) Ensuring a sound macroeconomic stability is maintained, i.e. Central Bank.

ii) Substituting Imported Products.


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LIMITATIONS OF PUBLIC ENTERPRISES: -

1. The lack of commercial approach in the functioning of public enterprises leads to

wastages, low productivity, low profitability and inefficiencies.

2. Public enterprises are required to fulfil a large number of objectives, which are sometimes

conflicting with each other. The objectives are not clear and often there is lack of policy

clarification on various matters.

3. Public enterprises have shortage of skilled, experienced and confident managers because of

a relatively low remuneration. This has led to inefficient management of these enterprises.

4. Public enterprises are faced with the normal government bureaucracy which makes them

inefficient in what should be a competitive commercial environment. Even when they are

making losses, they may be allowed to continue operating because the decision making is

based on political rather than economic grounds.

PRIVATIZATION

Privatization as a process may have a number of interpretations but it is essentially regarded

as a Solution to the problems of state-owned enterprises in developing countries. Its a

process involving the reorganization of the state-owned enterprises through the transfer of

ownership and control from the public to the private sector.

It involves decentralization of decision making to allow for more flexibility and providing

better incentives for managers to increase production efficiency. Privatization hinges on the

neo-classical hypothesis that private ownership brings greater efficiency and more rapid

growth.

Privatization was actively promoted by major International bilateral agencies (USAID) and

Multilateral agencies (World Bank, IMF) in the 1980s and 1990s.

MEANINGS OF PRIVATIZATION: -

1. Liberalization approach: - Privatisation may be used in this sense to mean having fewer

controls and regulation by the state in economic activities. It also means, slowing or stopping

of new controls and regulations and also dismantling of existing controls and regulations.

2. A relative share enlargement approach: - Privatisation may relate to the relative

enlargement of the share of private enterprises in the production of goods and services in the

economy.


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3. Association of private sector management approach: - This means associating

personnel with long experience of private sector management of the board of directors and

other levels of management of public enterprises.

4. Transfer of minority equity ownership: - Privatisation may be defined in terms of

transferring minority equity ownership of the public enterprises to private individually so that

the ultimate control remains with the state.

5. Transfer of complete ownership: - Privatisation can also be used in the sense of selling

all the shares so that enterprises are converted into private enterprises.

NEED FOR PRIVATISATION

1. Resource Mobilization: - The government expenditure may be growing rapidly leaving

fewer resources for development. Deficits in the budget would be met through borrowing

which reduces the availability of resources for the private enterprises, or, simply crowds out

the private enterprises weakening their ability to produce goods and services. This process

can be reversed through privatization.

2. Reduction of extra tax burden on the people: - A continuous loss incurring public

enterprises force the goods to bear this loss as an extra fiscal burden. The government

compensates this loss by imposing new taxes, which affects the purchasing power of the

public. The remedy to this problem is privatization.

3. Flow of funds to the public exchequer: - The process of privatization directly contributes

to the flow of funds to the public exchequer in the form of realization of money on the sale of

shares of public assets to the private sector.

4. Improvement in Production: - The process of privatization leads to increased efficiency

and productivity and control of waste. This means more availability of resources for

implementation of development and welfare programmes.

5. Better Utilization of bureaucrats: - Privatisation leads to a release of highly trained

labour (the bureaucrats running the state-owned enterprises) from the public enterprises to

run public administration and implement public policies which they are specialized in.

6. Increase in competition: - Privatisation process results in more domestic and International

competition and thereby making management more responsive towards the needs of

customers and the changing technology.

FORMS OF PRIVATISATION


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1. Complete Privatisation: - This is a situation where ownership of the enterprise is fully

transferred to the private sector.

2. Partial Privatisation: - This may be effected in two ways i.e. minor and major. In minor

privatization a wholly owned government enterprise may offer minority equity i.e. not

exceeding 49% to private parties. In majority ownership the state may transfer majority

shares to the private sector. In this case the government may find it difficult to monitor such

an organisation to protect the social interest.

3. Privatization of Management: - This can be formally effected through a management

contract binding a private party to run the operations of a public enterprise e.g. leasing of

state mines, concessioning the railways etc.

4. Creating Competitive Conditions: - This is a situation where public enterprises compete

amongst themselves or with comparable private enterprises.

5. Reregulation: - Privatisation may also be resorted to in the form of decontrolling and

liberalizing measures for the private sector.

LIMITATIONS

1. It is difficult to evaluate the actual value of the assets to be privatized.

2. Privatisation may bring about unfair competition which could result in wiping out of

existing private sector business in the long run.

3. Privatisation process generally lacks transparency and in most cases there is a lot of

corruption.

4. Privatisation needs strategic planning efforts as well as appropriate administration

apparatus to carry it out. However in many developing countries this process is very

cumbersome due to bureaucratic systems.

5. It may lead to a situation where public monopolies are replaced by private monopolies if

no attempt is made to introduce competition and improve efficiency. It may also hinge on

how transparent the process is carried out.

6. It may lead to job losses.

Its difficult to create political consensus which is essential to decide which enterprises are to

be privatized.

CO-OPERATIVE SOCIETIES

A cooperative is an organization of members who come together to carry out economic

activities and sheer benefits equitably on the basis of cooperative principles. These principles


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are formulated by international cooperative alliance. These principles define the

characteristics of co-operative societies. Some of these principles include: -

(i) Voluntary and open membership.

(ii) Democratic administration.

(iii) Limited interest on shares.

(iv) Promotion of education to members.

(v) Non-profit motive.

(vi) Cooperation with other cooperatives.

FORMATION AND OPERATION OF COOPERATIVES: -

Cooperatives are registered by the commissioner of Cooperatives Department who has the

power to register or even cancel the registration of a cooperative society. All cooperatives are

required to operate in accordance with the cooperative Act of 1972 and also the relevant by-

laws. There are different by-laws for different types of cooperatives e.g. farming

cooperatives, housing cooperatives, savings and credit cooperatives etc.

These by-laws are prepared by the commissioner of Cooperatives Development and must be

adopted by the cooperatives before they are registered. A cooperative cannot change its by-

laws without the approval by the commissioner for Cooperative Development. A cooperative

should have a minimum of ten (10) members. All major decisions of cooperatives must be

made at general meetings by a majority vote. A cooperative is run on the basis of one

member, one vote.

STRUCTURE OF COOPERATIVES IN KENYA: -

(1) Primary Cooperative Societies.

(2) Cooperative Unions.

(3) Countrywide Cooperatives.

(4) Kenya Natural Federation of Cooperatives.

TYPES OF COOPERATIVES: -

(1) Housing Societies e.g. East African Building Society.

(2) Producers Cooperatives: These are involved in production and marketing of product

collectively.

(3) Marketing Cooperatives: This is a case whereby producers form cooperative societies to

provide marketing facilities for their commodities.

(4) Banking Cooperatives e.g. the Cooperative Bank of Kenya. They are involved in

financial services.


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(5) Trade and distribution Cooperatives: These are established by an Act of Parliament

and they are responsible for controlling the production and marketing of primary and

processed agricultural commodities. They have the powers to buy and sell the whole of the

home produced commodity and prescribed the terms of sale. Such marketing board facilities

exist in Kenya e.g. Kenya Pyrethrum Board, Coffee Board of Kenya, etc.

NEED FOR MARKETING BOARDS: -

Marketing boards deal with economic activities which the government considers basic and

vital to the economy. Even though the boards are set up to serve economic functions they also

serve social and political functions i.e. Provide employment, mobilize savings and stimulate

investment. If the activities performed by the cooperatives were left to the private sector, the

social and political gains of the people are likely to suffer since economic gains or

considerations will take the upper hand.

GLOBALIZATION

It is a process over the past several decades in which the economies of the world have

become increasingly linked, through expanded international trade in services as well as

primary and manufactured goods through portfolio investments such as international loans

and purchase of stock, and through foreign direct investment especially on the part of large

multinational corporations.

At the same time foreign aid has increased very little and indeed has become dwarfed by the

now much larger flows of private capital. These links have had marked effects in the

developing world. Developing countries are importing and exporting more from each other,

as well as from the developed world, especially South East Asia but notably Latin America as

well, investments have poured in from developed countries such as the United States, U.K,

and Japan. The main features of the process are:

1. Integration of economies worldwide where the world economy is viewed as a single

market and production area with the regional and sub-regional sectors rather than a set of

national economies linked by trade and investment flows. This integration is personified by a

global policy making, for example through international agencies such as the World Trade

organization (WTO). It suggests also exciting business opportunities, more rapid growth of

knowledge and innovation, or the prospect of world too interdependent to engage in war.

2. Internationalization of corruption i.e emergence of a global culture in which people more

often consume similar goods and services across countries and use a common language of


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business, English; these changes facilitate economic integration and are in turn further

promoted by it.

3. Cross boarder operations of economic activity in production, investment and technology.

4. Optimal utilization of global resources including competitive sourcing of inputs for

achieving competitiveness in production, economies of scale in operations and efficient

technology utilization.

5. Easy movement of products and factor flows across borders involving merchandise,

services, investment, financial capital, technology and labour.

6. Competition, production and markets become global in nature and goods and services

become less distinguishable or identifiable with their country of origin.

INTERNATIONAL TRADE AND THE ROLE OF GOVERNMENT

Reasons for the development of international trade

(1) Some goods and services cannot be produced by a country at all because the country may

simply not process the raw materials that it requires, thus it has to buy them from other

countries.

(2) Some goods and services cannot be produced as efficiently as elsewhere and it makes

more sense to import them.

(3) It may be better for a country to give up the production of a good and import it instead in

order to concentrate its resources in producing something else.

(4) International trade would encourage competition and provide choice.

(5) International trade would fill in the gaps particularly when an economy experiences

shortages during a time of high domestic demand. In such a situation goods and services are

imported to overcome the shortages.

ADVANTAGES OF INTERNATIONAL TRADE

The main benefit of international trade is to make participating countries better off than they

otherwise would have been without it. This is due to a number of advantages that a country

can derive from international trade:-

1. Sale of surplus products.

2. Import of what cannot be produced.

3. Specialization according to comparative advantage

4. Stimulates competition

5. Introduction of new ideas.


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6. Widening of choice to the consumer

7. Creation and maintenance of employment.

ROLE OF THE GOVERNMENT IN INTERNATIONAL BUSINESS

The government establishes economic and foreign policies and also gives direct assistance to

business. The government may opt for a tariff policy, i.e. impose duties and restrictions on

imports and exports. There are two possible tariff policies:-

1. Free Trade

This is a policy where the government allows free flow of goods and services. This policy

rests on the argument that countries will specialize in the production of those goods and

services at which they are best qualified in terms of their resource endowment.

The theory of comparative advantage was advanced in justification of the argument that free

trade was of mutual advantage to every country. It was thought to be natural for every

country to specialize in the production of certain commodities on the basis of their own

advantage and exchange the surplus of specialized commodities for the surplus of other

countrys goods and services. The cost of production in both countries would be reduced

because of the economies of large scale production of only a few commodities.

This was part and parcel of the policy of laissez faire. The spirit of laissez faire is at the

centre of liberalization and globalization of business.

2. Protection

Protection is that policy when the government imposes both tariff and non-tariff barriers on

imports and exports. Protection reduces international division of labour, opportunities and

protects the relatively inefficient domestic producer. Protectionism may be carried out in a

number of ways:-

(1) By imposition of tariffs or duties.

(2) Quotas or quantitative restrictions.

(3) Allowing subsidies to home industries/producers to enable them to compete with imports

and reduce the quantity of imports.

3. Liberalization

Liberalization refers to opening up markets through the use of different measures, i.e.

(i) Reduction of tariffs and non-tariff barriers.

(ii) Increasing transparency of trade policies and regulation.

(iii) Deregulation of domestic regulatory measures including liberalization of investment and

capital.


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(iv) Simplifying customs procedures and practices as part of trade facilitation measures

If the government wants to attract foreign investments it must create a favourable

environment. The policies and actions that can be used by the government to promote or

attract foreign business include the following:-

(1) The use of tariff and non-tariff barriers.

(2) Providing a favourable domestic interest rate environment.

(3) Giving tax concessions to business.

(4) Ensuring there is political stability in the country.

(5) Ensuring there are adequate provisions for repatriation of profits

(6) The government should maintain macroeconomic stability to ensure that the country is

able to achieve a favourable balance of payment position.

Other factors that are used in attracting foreign investments:-

Elimination of bureaucratic delays. Ensuring that there is reasonable rate of economic growth The government can assist in setting up socio economic infrastructure and provide

legislation to guarantee security of property.

By setting up institutions, the Export Promotion Council (E.P.C.) The ExportProcessing Zones (EPZ) and the Kenya Investment Authority (KIA) set up by the

Kenya Government to promote trade and investment and assist businessmen with

information, technical assistance, provide incentives and assist in the formulation and

implementation of trade and investment policies.

FACTORS BEHIND GLOBALIZATION AND LIBERALIZATION

The economic circumstances and factors that have encouraged globalization and

liberalization:-

1. Improvement in transport, communication, information, technology networks that has led

to lower cost of transactions and of doing business globally.

2. Increased efficiency in production made possible by increased specialization and excess

capacity utilization which could easily be stifled by a small domestic market.

3. Increased production levels due to better exploitation of economies of scale made possible

by increased sources of raw materials and markets.


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4. Greater worldwide acceptance and commitment to the free trade principle and market

economy and dismantling of planned economies.

5. Easy movement of factors of production across national borders. This has facilitated

borders. This has facilitated firms to locate different parts of their production process in

different countries.

6. Dismantling and lowering of tariff and non-tariff barriers and deregulation of trade,

investment and capital flows both at national or international levels.

BENEFITS OF OPENING UP MARKETS

The benefits of opening up markets include:-

1. Promotion of a conducive environment for business which is necessary for their continuous

growth.

2. Promotion of a cost effective business environment.

3. Encouragement of competition and increased efficiency.

4. Liberalization of trade and investment, as well as deregulation and privatization of

business opportunities generates opportunities for trade and investment and technology flows.

5. Provision of a wider choice of goods and services and reduced prices resulting from

increased international competition.

6. Countries can obtain reciprocal market openings by trading partners particularly in the

context of multilateral, regional, or bilateral negotiations.

BENEFITS OF GLOBALIZATION

The benefits of globalization include:-

1. Allows greater realization of potential, economies of scale of operations and productivity

improvement through cross border specialization and utilization of global factors of

production and technology. Globalization makes it possible for the less developed countries

to more effectively absorb the knowledge that is one of the foundations of the wealth of

developed countries.

In 1776 Adam Smith wrote: the division of labour is limited by the extent of the

market. The larger the market that can be sold to, the greater the gains fromtrade and the

division of labour. Moreover, the greater is the incentive forinnovation, because the potential

return is much greater.

2. More productive application of capital worldwide, maximization of the rate of saving and

investment which national opportunities are unable to provide.


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NEGATIVE EFFECTS OF GLOBALIZATION

The negative effects include:-

1. Leads to loss of employment as low technology, labour intensive production shift to low

income countries.

2. There is loss of sovereignty of national objectives and priorities to multilateral global rules,

i.e. set by World Trade Organization (WTO), International Monetary Fund (IMF), World

Bank, Universal Postal Union (UPU), World Tourism Organization (WTO), which may

sideline national priorities.

3. Inadequacy and unreadiness of domestic national capacity to participate actively may lead

to marginalization and inability to realize the benefits of globalization.

PRIVATE FOREIGN INVESTMENT, MULTINATIONALS AND ECONOMIC

DEVELOPMENT

Private foreign capital flowed to the underdeveloped countries at the turn of the 20 th century

in the form of indirect investments from Europe. In the 1920s the capital that flowed to the

underdeveloped countries was in the form of direct investments which went mainly into

production of export. Very little of it went into manufacturing for the domestic market. But

since World War II, over half of the private investments have been direct. Direct foreign

investment has been concentrated mainly in the extraction of raw materials like iron, crude

oil, manganese, bauxite, copper, electric energy, etc. Only a small percentage has gone to

manufacturing and distribution. Until such time an underdeveloped economy takes off, very

little foreign direct investment has been realised in manufacturing the main reasons why

direct foreign capital in manufacturing flows to those countries which are industrially

advanced and have large domestic markets.

ADVANTAGES OF PRIVATE FOREIGN INVESTMENT

1. Private foreign investment (P.F.I) provides not only finance but also managerial,

administrative and technical personnel, new technology, research and innovations in products

and techniques of production which are in short supply in LDCs.

2. P.F.I. encourages local enterprises to invest in two ways: - directly by fostering local

enterprise with men, money and material and by imparting training and experience to its

personnel, and indirectly by creating demand for ancillary or subsidiary services like


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transport and training agents which are uneconomical for private foreign enterprise to

provide.

3. By bringing capital and foreign exchange, P.F.I, helps in filling the savings gap and the

foreign exchange gap in order to achieve the goal of national economic development in

LDCs.

4. Part of the profits from P.F.I are ploughed back into expansion, modernisation or

development of related industries.

5. P.F.I adds more value added to output in the host country than the return on capital from

foreign investment. In this sense, the social returns are greater than the private returns on

foreign investment.

6. P.F.I generates tax revenues to LDCs when foreign firms are taxed and also generates

royalties from concession agreements.

7. P.F.I raises productivity through the introduction of new technology and hence real wages

of the local labour. If foreign investment induced industrialisation takes place, real wages rise

for newly employed workers are higher than the real wages of workers in the rural sector. If

P.F.I is in export-oriented industries, it may create forward and backward linkages in the

economy and also create employment opportunities.

8. If P.F.I is in agriculture and extractive industries which produce primary products for

export, it helps in easing off balance of payments position of LDCs.

9. May encourage entrepreneurs in LDCs to invest in other LDCs, e.g. firms in India have

started investing in Nepal, Ethiopia and Kenya and other LDCs.

DISADVANTAGES OF FOREIGN DIRECT INVESTMENT

1. The recipient country may be required to provide basic facilities like land, power and other

public utilities, concessions in the form of tax holiday, development rebate, rebate on

undistributed profits, additional depreciation allowance, subsidised inputs, etc. Such

concessions involve costs in absorbing LDCs resources that could have been utilised by the

government(s) elsewhere.

2. To attract P.F.I, LDCs must provide sufficient facilities for transferring profits, dividends,

interest and principal and this may create serious balance of payments problems.

3. Capital and other resources may flow to foreign businesses in preference to domestic

businesses. This may affect the distribution of income and wealth in LDCs negatively and

may reduce profits in the affected local business firms and thereby discouraging local

enterprises.


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4. Many foreign companies in LDCs reserve all senior executive posts for their nationals and

pay them high salaries plus other benefits which are a huge drain on the resources of the

recipient country.

5. P.F.I brings in highly capital intensive technologies which do not fit in the factor

proportions of LDCs. Often obsolete and discarded machines and techniques are imported

which involve high social costs in terms of replacement after a few years.

6. P.F.I also involves costs in the form of loss of domestic autonomy when foreign firms

interfere in policy making decisions of the government of an LDC which favours foreign

enterprises

MULTINATIONAL CORPORATIONS AND LDCs

A multinational corporation (MNC) is a company, firm or enterprise with its headquarters in

a developed country such as U.S.A, Britain, Germany, Japan and operates in other countries,

both developing and developed. They are spread not only in the LDCs of Asia,

Africa, Latin America, but also on the continents of Europe, Australia, New Zealand, and

South America. They are engaged in mining, tea, rubber, coffee and cocoa plantations, oil

extraction and refining, manufacturing for home production and exports, etc. Their operations

also include such services such as banking, insurance, shipping, hotels and so on. These firms

are also called transnational because they engage in international production. These firms

may also be distinguished as ethnocentric (home-oriented) polycentric (host-oriented) and

geocentric (world-oriented), on the basis of attitudes revealed by their executives.

Multinationals invest in many countries for several reasons: -

1. To exploit cheap raw materials in developing countries e.g. minerals, etc

2. To exploit cheap non-unionisable labour in LDCs.

3. To exploit fast growing markets overseas

4. To exploit the agricultural potential in developing countries

FACTORS INFLUENCING THE DESTINATIONS OF INVESTMENT BY MNCs

MNCs set up their plants in countries where they can realise quickly their returns. MNCs

locate their investments in countries where the following conditions are satisfied: -

1. Stable political conditions exist to enable them enjoy long term benefits to their

investment.

2. High rates of economic growth to ensure high sales and profits.

3. Large domestic markets to provide, a market for their products.


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4. Favourable tax systems e.g. low taxes in profits, tax holidays, etc

5. Favourable government policies like freedom to export products, to import raw materials,

freedom to repatriate profits, etc.

6. Stable macroeconomic environment i.e. low inflation, stable exchange rates, stable interest

rates, stable balance of payments, manageable national and domestic debt, etc to promote

business activities

7. Availability of a pool or pools of educated and skilled labour

8. Well developed physical and social infrastructure facilities i.e. roads, water,

telecommunications, power supply, health, education, housing, etc.

FEATURES OF MNCs

1. Operate in more than one country.

2. Most have a lot of capital for investment

3. Use same strategy in marketing, production, etc

4. Use the same patents, copy rights and trademarks.

5. Most of them are old and well established businesses.

Roles / Benefits / Advantages of MNCs in LDCs

1. Create employment to citizens of the host country. Those employed earn income and this

helps improve their standard of living.

2. Introduce to LDCs new advanced technology, new ideas and new methods of production in

LDCs. This improves productivity and efficiency in production leading to increased

output, employment, incomes and GNP/GDP.

3. Provide ready market for raw materials e.g. minerals found in host country

4. Multinationals are strong and provide large and cheap capital to LDCs by the way of direct

investment.

5. Undertake heavy risks by investing their capital in LDCs in the face of imperfect

infrastructural facilities e.g. power supply, transport, poor administrative services, and lack

of skilled labour.

6. May start new ventures and bring into LDCs advantages of superior management, training,

education and entrepreneurial skills.

7. Competition between foreign firms and domestic firms may lead to production of high

quality goods for consumers.


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8. They will generate higher government tax revenues which will be used to finance various

development projects in LDCs.

9. MNCs production of goods and services may lead to reduction in the level of imports and

hence favourable Balance of Payments (B.O.P) in LDCs. Goods that were initially

imported could now be produced locally by such companies.

10. Generates foreign exchange earnings through production export of goods and services

11. LDCs gain access through MNCs to the international financial markets through sale of

securities, i.e., shares, bonds in foreign markets to raise capital.

12. People in the host country enjoy a wider selection of high quality goods and services

produced by MNCs, a sign of improved standard of living for the people.

13. Developing and developed countries benefit from reasonably well priced goods and

services like textiles that the MNCs produce with cheap resources, labour, etc found in

LDCs.

Disadvantages / Costs

1. Labour in LDCs doesnt benefit by getting employment opportunities to improve standard

of living. This is because most MNCs import skilled workers from their own country

rather than employ the local people.

2. MNCs import inappropriate technology mainly capital intensive in production that creates

few jobs in LDCs.

3. All MNCs repatriate the profits to their mother countries instead of re-investing them

domestically to generate further economic growth in LDCs.

4. MNCs cause environmental damage due to the depletion of natural resources and

generation of negative externalities. MNCs cause mass exploitation of non-renewable

resources of the host country leading to environmental degradation and leave the poor

country even poorer.

5. Many MNCs introduce different working conditions in LDCs, i.e., long working hours and

low wage rates leading to poor industrial relation problemsstrikes.

6. MNCs may engage in dangerous economic activities e.g. chemical production which they

may not be allowed to produce in their own countries.

7. Breed socio-economic inequalities e.g. favour and pay imported workers more than the

local employees. This leads to unrest and discontent among workers employed in the local

industries.


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8. MNCs transfer second rate and obsolete (already used), and yet overpriced technology to

LDCs.

9. MNCs locate their business firms in urban centres already developed i.e. having social

amenities/infrastructure ignoring the rural areas and this worsens the dualistic

development between the urban and rural areas in LDCs. As a result, the masses miss out

in economic development reinforcing the vicious cycle of poverty in the countryside.

10. MNCs cause unfair competition to local firms by undercutting them, e.g., charge low

prices for their products. This may cause the local firms to collapse and if they are few

whats likely to happen is that the MNCs may buy them (through acquisitions or mergers)

and exercise control over them.

11. May influence the internal politics of a country at the expense of LDCs citizens welfare

by bribing the political leadership. They do so by offering posts in the higher levels of

their companies to the friends, relatives, etc to the local politicians.

12. MNCs are not easily controlled by governments in the host countries and even by mother

countries because branches are spread all over the world.

INTERNATIONAL TRADE AND ECONOMIC DEVELOPMENT

Economic Integration

Economic integration also referred to as regional economic groupings has been advanced by

many economists as one of the modern promising ways in which countries can improve their

trading relations and speed up their industrialisation processes and achieve rapid economic

growth and development. Economic integration occurs when a group of countries in the same

region come together and cooperate with each other in order to promote free trade to achieve

certain economic objectives. Such countries do so by forming trading blocs/or common

markets by removing trade barriers, e.g., quotas, tariffs, total ban, etc. Examples of economic

integration efforts around the world include: European Union, COMESA, East African

Community (E.A.C), ECOWAS, etc.

Forms / Levels of economic integration

1. Free Trade Area: -

It is the simplest form of economic integration. In this case member countries allow free trade

by eliminating trade barriers e.g. tariffs, ban, quotas, etc. Each country, however, establishes

its own protection measures against products from non-member countries.

2. Customs Union


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Member countries promote free trade by removing trade barriers. The countries have a

common external tariff imposed on products from non-member countries.

3. Common Market

There is free trade among countries, i.e., no trade barriers. There is a common external tariff

on products from outside the trading bloc, member countries allow free movement of factors

of production within member countries e.g. COMESA

4. Economic Union

Member countries allow free internal trade. There is a common external tariff on products

from non-member countries and free movement of factors of production within the region

under the economic union. Member countries may have common public services, e.g., rail,

transport and common currencyEuro in the European Union.

Advantages of economic integration

1. Firms in the region are able to enjoy a wider market for their products. Firms produce on a

large scale, enjoy economies of scale, more output and economic growth.

2. Provides a good ground for countries to coordinate the development of industries. This can

be done by the grouping agreeing to assign certain industries to each of the members.

3. It promotes specialisation. Each country can concentrate in producing the commodities

which are best suited to it depending on its resource endowment. This will lead to better

utilisation of resources, avoid unnecessary wastage of resources through duplication,

increased output and incomes and the region is able to achieve rapid economic growth.

4. The member countries enjoy greater economic strength by having a common front when it

comes to bargaining with non-member countries. For example, by acting as a group they

have more bargaining power when dealing with non-member countries rather than

operating as individual countries.

5. Economic integration promotes peace and good neighbourliness among countries.

6. Economic integration increases competition among member countries. This promotes

efficiency and production of high quality goods and services at lower costs enjoyed by

consumers.

7. Enables consumers of member countries to obtain a variety of goods and services produced

in the other countries easily.

8. Establishment of industries and subsidiaries in the other member countries becomes easier.

This increases employment opportunities and output in the region/grouping.


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9. Free movement of factors of production e.g. labour reduces unemployment as labour

moves from areas where there is excess labour to areas where you have deficits or where it

is needed. This leads to the increase of national incomes (GNP) of member countries.

10. The transfer of technology which is necessary to increase production and promote

economic growth between member countries becomes easier.

Disadvantages of economic integration

1. The abolition of import duties (i.e. tariffs) leads to the loss of government revenue needed

for financing productive economic activities in developing countries.

2. In the process of promoting internal free trade in the bloc/or grouping among member

countries and discouraging external trade, a country may find that it has become or created

to be a low cost source of goods, services, raw materials, etc from outside the market to a

high cost source inside the bloc. Such a country, therefore, may be worse off after the

integration.

3. Some countries within the bloc/grouping benefit more than others due to differences in

levels of economic development. A more advanced country exports more than a country

less advanced hence benefits more than the others. Which country in E.A.C benefits more

than others.

4. Some countries dump cheap goods in other countries leading to unfair competition among

countries and weak industries close down.

Limitations of economic integration

1. Communication problems due to language barriers given that different countries have

different languages.

2. Political instability especially in poor countries which are ever in war. This makes business

activities difficult to accomplish.

3. Most LDCs produce primary products which are similar hence there is no need to

integrate.

4. Differences in currencies among countries create payment problems.

5. Differences in the levels of economic development and growth among countries mean that

some countries gain more than others in the grouping.

6. Differences in ideological orientation e.g., some may be inclined towards capitalism and

others inclined towards socialism, thus may cause a rift among them and lead to the

breakdown of the grouping as was the case with the East African Community during the


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time of the late Julius Kambarage Nyerere in Tanzania, late Idi Amin of Uganda and Mzee

Jomo Kenyatta of Kenya.

7. Poor physical and social infrastructural services, e.g., roads, telecommunications, power

supply, railways, water supply, education, health, housing, etc affects the performance of

the grouping, i.e., movement of goods and services, capital, adoption of new technology,

upgrading of skills the overall performance and economic growth of the grouping

suffers.

BRETTON WOODS INSTITUTIONS

Bretton Woods Institutions refers to the international financial institutions i.e. World Bank

and IMF. They were established following a conference held at Bretton Woods, New

Hampshire, U.S.A in 1944 to discuss the problems of post World War II. World War II ended

in 1945. The conference agreed to establish the International Bank of Reconstruction and

Development (IBRD) and the International Monetary Fund (I.M.F).

WORLD BANK GROUP

The World Bank Group consists of 5 closely associated institutions all owned by member

countries. Each institution plays a distinct role in the mission to fight poverty and improve the

living standards for people in developing countries. The term World Bank

Group encompasses all 5 institutions whereas the term World Bank refers specifically to

the IBRD and IDA.

THE WORLD BANK (IBRD & IDA)

1. THE INTERNATIONAL BANK FOR RECONSTRUCTION AND

DEVELOPMENT (I.B.R.D): -

It was established in 1945. Kenya became a member on February 3, 1964.

Aim: To reduce poverty by lending to developing countries loans, guarantees, and

providing non-lending services such as advisory services. IBRD does not aim at maximising

profits but has over the years earned a net income since 1948. Owned by member countries,

and voting power is linked to member-country subscriptions. The subscriptions are based on

a countrys relative economic strength.

2. THE INTERNATIONAL DEVELOPMENT ASSOCIATION (I.D.A)

It was established in 1960. It helps the worlds poorest countries reduce poverty levels by

providing interest free credit with 10 year period grace period and maturities of 35 to 40

years.


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Most countries supported by I.D.A have per capita incomes of less than US$500 per year.

Kenyas per capita income is US$580.

The I.D.A assists in providing access to better basic services such as health and education and

supports reforms and investments aimed at employment creation and productivity growth.

3. THE INTERNATIONAL FINANCE CORPORATION (I.F.C.)

It was established in 1956. The mandate of the IFC is to further economic development

through the private sector. In association with business partners it invests in sustainable

private enterprises in developing countries and also provides long term loans, guarantees and

risk management and advisory services to its clients.

The IFC invests in regions and projects in regions and sectors which are insufficiently served

by private investment and seeks new ways to develop promising opportunities in markets

which are considered too risky by commercial investors in the absence of IFC participation.

4. THE MULTILATERAL INVESTMENT GUARANTEE AGENCY (MIGA):-

It was established in 1988.

It promotes F.D.I into emerging/developing economies improve standards of living and

reduce poverty.

MIGA offers political risk insurance in the form of guarantees to investors and lenders

thereby helping developing countries to attract and retain foreign investment. These non-

commercial risks include expropriation, currency inconvertibility and transfer restrictions,

and war and civil disturbances. MIGAs guarantee coverage requires investors to adhere to

high social and environmental standards. MIGA provides technical assistance to help

countries disseminate information on investment opportunities. MIGA also offers investment

dispute mediation on request.

5. THE INTERNATIONAL CENTRE FOR SETTLEMENT OF INVESTMENT

DISPUTES (ICSID):-

It was established in 1966. Encourages foreign investment by the provision of international

facilities for conciliation and arbitration of investment disputes. Helps create an environment

of mutual confidence between states and foreign investors. Many international agreements in

the area of investment refer to arbitration facilities provided by ICSID. Recourse to ICSID

reconciliation and arbitration is voluntary ICSID has research and publishing activities in

areas of arbitration law and foreign investment law.


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INTERNATIONAL MONETARY FUND (I.M.F.)

The I.M.F was established in 1945 and according to Article 1 of the Articles of Agreement of

the International Monetary Fund, it has the following aims: -

1. To promote international monetary co-operation through a permanent institution which

provides the machinery for consultation and collaboration on international monetary

problems.

2. To facilitate the expansion and balanced growth of international trade, and to contribute

thereby to the promotion of maintenance of high levels of employment and real income and

to the development of the productive resources of all members as

primary objectives of economic policy.

3. To promote exchange rate stability to maintain orderly exchange arrangements among

members, and to avoid competitive exchange depreciation.

4. To assist in the establishment of a multilateral system of payments in respect of current

transactions between members and in the elimination of foreign exchange restrictions which

hamper the growth of world trade.

5. To give confidence to members by making the general resources of the fund temporarily

available to them under adequate safeguards thereby providing them with the opportunity to

correct maladjustments in their balance of payments without resorting to measures

destructive of national or international prosperity.

6. In accordance with the above, to shorten duration and lessen the degree of disequilibrium

in the international balance of payments of members.

Membership of I.M.F so far is 184 members including Kenya and carries out work in 3 main

areas: -

1. Surveillance: - this involves monitoring economic and financial development and the

provision of advice aimed at crisis prevention.

2. Lending: - IMF lends to countries with B.O.P difficulties as a means of providing

temporary financing and in order to support policies aimed at correcting the underlying

problems. In addition loans are provided to low-income countries which are especially aimed

at poverty reduction.

3. Technical assistance and training: - these are provided by the I.M.F in its areas of

expertise.

4. Research and statistics: - this function is aimed at supporting the previous three aspects

of the work of the I.M.F. Recently, the I.M.F. has applied its surveillance and technical


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assistance work to the development of standards and codes of good practice in its areas of

responsibility and to areas of financial sectors. Standards and codes have been improved in

data standards, fiscal transparency and transparency in monetary and financial policies.

I.M.F. LENDING

Loansa country must meet certain conditions to access the loan. These arrangements are

based on economic programmes formulated by countries in consultation with I.M.F.

Loans released in phases as per the agreed programmes.

Lending by I.M.F. can be either CONCESSIONAL or NON-CONCESSIONAL. I.M.F.

discourages excessive use of its resources by imposing a surcharge (an interest rate premium)

on large loans.

CONCESSIONAL IMF FACILITIES: -

Poverty Reduction and Growth Facilities (PRGF)

In 1999 the Enhanced Structural Adjustment Facility (ESAF) was replaced by PRGF.

For a long period financial assistance to developing countries was given under the ESAF

window. Loans are based on poverty reduction strategy paper which is prepared in

collaboration with civil society and other development parties, especially the World Bank.

PRGF loans 0.5% interest rate and has repayment 5 10 years.

NON-CONCESSIONAL I.M.F. FACILITIES

These loans are based on I.M.F. market related interest rate based on SDR interest rate,

reused weekly to take into account the changes in the major international money markets.

The non-concessional facilities include: -

1. Standby Arrangement (SBA) to deal with B.O.P problems, 1218 months and

repayments is expected within 24 years.

2. The External Fund Facility (EFF)established in 1974 to deal with B.O.P problems rooted

in the structure of the economy. Repayment period 47 years

3. Supplementary Reserve Facility (SRF)1997

4. Contingent Credit Facility (C.C.F)1999

5. Compensatory Financing Facility (C.F.F.)established in the 1960s

6. Emergency assistance against natural disasters or countries emerging from conflicts. Loans

repayable 35 years.


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STRUCTURAL ADJUSTMENT PROGRAMMES (S.A.Ps) /ECONOMIC REFORM

PROGRAMMES

Structural adjustment programmes/economic reform programmes use a combination of fiscal,

monetary and sectoral policies to formulate regulations and create institutions that are used to

change relative prices and the level of government spending. The implementation of

structural adjustment programmes is usually undertaken in exchange for financial assistance

from multilateral organisations such as the International Monetary Fund (I.M.F) and the

World Bank. The structural adjustment programmes were meant to help the LDCs to recover

from their economic problems and achieve economic growth and development. They were

introduced by IMF and World Bank and carried out during 1980s and 1990s. These structural

adjustment programmes incorporate the following measures: -

1. A liberalization of the foreign currency market. The primary intention of liberalising

the foreign exchange market is to make it more efficient by ensuring that it accurately reflects

the relative scarcity of different currencies. In countries where a fixed exchange rate exists,

the Central Bank is encouraged to fix the exchange rate at a competitive level usually through

further devaluation.

2. The reduction of government spending aimed at reducing the budget deficit . This

usually involves a reduction of subsidies, a reduction of the civil service and cost sharing,

e.g., in the education and health. Its desirable to reduce the budget deficit because budget

deficits are inflationary and lead to the crowding out of private investment through high

interest rates.

3. Trade liberalisation involves the reduction of protectionist measures like tariffs, quotas

and exchange controls with the aim of improving the efficiency of domestic producers by

opening them to foreign competition.

4. Privatisation of state enterprises where the role of the public sector in the economy is

reduced and most non-strategic state enterprises are sold off to the private sector.

Privatisation generates revenue for the government while at the same time improving

efficiency and resource allocation in the formerly state-controlled enterprises.

5. Price liberalisation whereby price controls are gradually abolished and prices are

determined by the forces of demand and supply. The abolition of price controls is done with

the intention of enhancing efficient resource allocation.

NEGATIVE EFFECTS OF SAPs


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1. SAPs have led to increased unemployment due to reduction of government expenditure.

This is because governments of most poor countries retrenched workers and froze

employment.

2. Promotion of market economies through liberalisation has led to rich countries dumping

cheap goods in poor countries and promoting unfair competition between foreign and local

firms and in turn has led to the collapse of local industries. This has increased unemployment

and poverty in the rural areas.

3. Reduction of subsidies to producers has led to the collapse of the agricultural sector and

other sectors in poor countries and in turn has hindered economic growth and development

4. The unfair trade which has been brought about liberalisation (see no.2 above i.e. opening

up of markets by poor countries) has led to unfavourable balance of payments (B.O.P) for the

economies of poor countries.

5. Privatisation has made essential goods and services very expensive and beyond the reach

of the poor people in developing economies. The state owned enterprises (S.O.Es) that were

privatised in the LDCs laid-off workers in the process of cutting down costs leading to

unemployment, suffering and poverty in these countries.

LIMITATIONS OF I.M.F

1. I.M.F is dominated by the rich countries (USA and Britain) and poor countries have no say

when it comes to formulating policies and decision making. Policies are made by the rich

countries and in most cases favour them and not LDCs.

2. I.M.F. discriminates against Africa and Asian countries when giving out loans. In most

cases there are conditional ties attached to the loans.

3. I.M.F. has failed to achieve free conversion of exchange rates.

4. I.M.F does not provide adequate funds according to the needs of LDCs.

Documents

BUSS 348 Final Notes