Pros and cons of direct foreign direct investment: a case of Intel in Costa Rica
"A Silicon Republic," Newsweek, August 28, 2000
Many large corporations establish their manufacturing plants in developing countries. The main economic advantages of such investments are low-wage workers who are unlikely to engage in a labor strike, a significant tax concession from the host country, and less stringent environmental restrictions. The advantages for the host country are the immediate and significant employment of often seriously unemployed or underemployed workers, the incomes these workers receive, an immediate transfer of often the most advanced technology, and an introduction of the host country into world market for its own future products.
Recently, Intel, the world's largest maker of silicon processors for personal computers opened a new plant in the Central American country of Costa Rica. What are the benefits and costs of this investment for Costa Rica and Intel? Before Intel's investment, the main exports of Costa Rica had been coffee and bananas. These are goods which can be consumed directly and without any further processing; therefore, the products move immediately from the farmers to the consumers without any intermediate steps or activities. These intermediate steps are called linkage effects, which encourage further economic activities and employment and significantly enhance national income.
The production process that occurs without linkage effects is referred to as the primary sector of the economy. Nations specializing in the primary-goods producing sector have a very limited scope for economic expansion. In addition, the world's demands for the primary sector's goods are very volatile and unpredictable. For example, in the last century, the invention of synthetic rubber practically destroyed overnight the economies of the natural rubber-producing countries of Southeast Asia. The recent banana war in which the European Union decided to import bananas only from their former colonies in Central America seriously disrupted other banana growing countries in the region. Therefore, it is wise for a country to move away from relying too heavily on the primary sector.
Naturally, Costa Rica, as well as many other developing countries, was very eager to attract Intel to open a computer chip manufacturing plant on its own soil. The immediate effect of Intel's investment in Costa Rica was that 2,000 mostly young and well-educated Costa Ricans were hired and trained intensively to work with the most advanced technology. The benefits of this training and transfer of the highest technology are enormously beneficial for the future of Cost Rican economy. The workers are paid an annual salary of $5,000, which is significantly lower than the wage of comparable workers in America but much higher than the $3,200 per capita income of of Costa Rica. In return, Intel has received significant concessions from Costa Rica in terms of taxation and greatly subsidized rates for electricity and water supplied to the company.
At the present, Costa Rica is not able to supply most of the raw materials needed by Intel. Yet in due time, Intel will encourage Costa Rica to supply up to 80% of the necessary raw materials for the company, as is the current practice of Intel in other host countries, such as Taiwan. This will significantly increase the Intel's benefits to Costa Rica. However, Costa Rica must realize that the primary responsibility of Intel is to its shareholders in America, and to discharge this obligation, the company may transfer a large part of its profits out of the country, instead of reinvesting in Costa Rica. Therefore, Costa Rica must view Intel as a catalyst to develop its own economy, instead of continuously depending on the goodwill of the company. Costa Rica must strive to produce computer chip-related products, such as calculators or transistor radios and try to export them. As its economy develops, the country can produce and export much more advanced goods. This is a proven road to a successful transition to economic growth and prosperity.
For Intel, the company continues to search for new manufacturing plants for its computer chip, instead of concentrating a mammoth plant in one country, because there is a definite economic reason for avoiding a mega-plant in one country. As size (or scale) of economic activities increases, initially there are cost savings due to a larger operation. This is called economies (cost saving) of scales. However, once the size reaches a certain point, a further increase in size introduces diseconomies (cost increase) of scale. One of the important determinants for diseconomies of scale is a strong organization of labor and its demand for higher wages.
When a new manufacturing plant opens, especially in a developing country, workers are very grateful for new employment opportunities, as well as significantly higher wages paid by the foreign firm. Soon, however, the workers take the higher wages for granted and start to compare their wages with the wages of workers performing comparable tasks in the investing country. When they realize the enormous difference between the wages of the two countries, the workers in the host country demand significantly higher wages. These workers rationalize with certain justification that if a firm can be profitable with such high wages in its own country, then certainly the firm can afford comparable wages in a foreign country. An ensuing labor strike can often be very militant and violent and almost always is settled in favor of labor. This type of activity will seriously increase costs of the firm and will significantly erode the benefit of hiring workers from the developing economy at low wages. The potential for a labor strike is one reason why foreign firms wish to maintain several similarly sized firms through the world instead of one mega-sized plant. The smallest size which maximizes the economy of scale is called the "minimum efficient scale" (MES), and a foreign firm seeks to maintain this MES in each plant in each individual country.