Capital Flow – Benefits and Disdavantages

According to my syllabus i have to have to be able to Evaluate the role and the benefits and disadvantages of capital inflows from MNC’s in an EU context. Could you give me a hand?

Capital inflows from MNC’s primarily refer to inward investment from MNC into European economies.

The effect of these capital inflows involves increased Levels of Investment. MNCs inject investment into the economy. This causes several benefits for the economy.

1. Increased Aggregate Demand. As a component of AD, higher Investment will boost AD, causing improved economic growth. This should lead to lower levels of unemployment.

• However, as a % of AD, inward investment from MNCs are quite small. Therefore, the impact on AD may be quite limited.

• The effect of increased AD depends on the situation of the economy. For example, when Ireland had low growth and high unemployment, inward investment helped to boost the economy. However, if the economy is close to full capacity, increased AD may cause inflation.

2. Increased productive Capacity. Inward investment will not only increase AD, but also increase Aggregate Supply. Investment in new factories increases productive capacity and AS should shift to the right. This enables an increase in economic growth without inflation.

3. Technological improvements. MNCs may not only invest in new capacity. They may also introduce new working practises that help increase labour productivity. For example, when Japanese firms invested in the UK, it was said that they helped to improve labour relations and get more out of the workforce. Therefore, it can contribute to increased labour productivity.

4. Surplus on the Financial Account of the Balance of Payments.

Capital inflows from abroad can help to balance out a current account deficit. Without the inflows, a current account deficit could cause a devaluation in the exchange rate.

5. Lower Prices for Consumers.

Investment from foreign firms offers the chance for goods to be produced more efficiently and could lead to lower prices for domestic firms.

Disadvantages of Capital Inflows.

If foreign firms increase their capital holdings in the UK, it means that the UK becomes more dependent on the health of other economies. For example, a severe recession in Japan, may cause Japanese firms to withdraw from the UK economy, leading to job losses.

• However, in an era of globalisation it is not really possible to insulate the UK economy from global effects. Also, despite the slowdown in the Japanese economy, most Japanese investment continued in the UK.

Domestic firms may lose out to the new multinational firms. This may lead to a decline in diversity for consumers.