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Economic Reforms and Inflows of Foreign Direct Investment in Latin America 1
| Content Provider | Semantic Scholar |
|---|---|
| Author | Biglaiser, Glen |
| Copyright Year | 2007 |
| Abstract | This paper seeks to explain the effect of different economic reforms for attracting foreign direct investment (FDI) in Latin America. Controlling for macroeconomic and good governancefactors, wefind that governments that implement economic reforms are not always more likely to attract FDI inflows. Instead, attempts to minimize expropriation risk complement domestic financial and trade reforms, which enhances foreign investor interest. Elements of both good governance and reform are important. The results provide reasons for optimism-thefact that most economic reforms are not essentialfor attracting FDI suggests that countries seeking FDI will encounterfewer obstacles. Over the past two decades Latin America has experienced a foreign direct investment (FDI) revival (Birch 1991, 149; Grosse 2001, 119). Concurrent with renewed interest in FDI, most Latin American countries have implemented market-oriented reforms. Capital shortages, caused in part by protectionist, import-substitution industrialization (ISI) policies in the 1940s-1970s, led many countries to shift economic policy course in the 1980s. Latin American policy makers hoped that initiating reforms would signal their governments' creditworthiness and good intentions to prospective foreign investors (Rodrik 1996, 28).2 Despite the breadth of new investments and adoption of economic reforms, FDI has varied among countries. Do different market-oriented reforms affect FDI inflows to Latin American countries? 1. The authors acknowledge the help of David Brule, Hye Jee Cho, Harvey Kline, Monty Marshall, Uk Heo, Geoffrey Garrett, Ron Rogowski, Michael New, John Tures, and three anonymous reviewers. Special thanks to Nate Jensen for his many useful suggestions on this work. 2. See Gastanaga, Nugent, and Pashamova (1998), who show that host country policies can influence FDI. Latin American Research Review, Vol. 41, No. 1, February 2006 ? 2006 by the University of Texas Press, P.O. Box 7819, Austin, TX 78713-7819 52 Latin American Research Review Economic reforms including changes in tax laws, trade liberalization, privatization, domestic financial reform, and removing barriers to international capital flows are all posited as crucial for drawing in foreign investment. While several important studies have researched the economic effects of FDI on developing countries (Amirahmadi and Wu 1994; Baer and Miles 2001; Bajpai and Sachs 2000; Birch 1994; Ramirez 2001; Trevino, Daniels, Arbelaez, and Upadhaya 2002), a disaggregated study of economic reforms is needed to understand what types of reforms are most likely to attract FDI.3 Building on economic explanations, macroeconomic conditions are also expected to affect FDI. Economic growth rates, government consumption, previous FDI inflows, and per capita gross domestic product (GDP) are strong predictors of foreign capital inflows (Birch 1994; Crenshaw 1991; Oneal 1988; Pastor 1992; Rummel and Heenan 1978; Tuman and Emmert 2004). Foreign firms are attracted to countries with high growth and per capita GDP rates and to areas with previous FDI inflows, while they resist investing in big government-spending countries. Alternatively, host country characteristics influence FDI decisions. The term good governance stresses the impact of the host country to provide a stable investment climate on FDI.4 Many scholars link regime type, and especially democratic rule, with investor confidence (Jensen 2002, 2003; Li and Resnick 2003; Oneal 1994; Pastor and Hilt 1993; Tures 2003).5 The stability and credibility provided by democracies as well as their transparency that enhance enforcement of property rights attracts foreign monies (Biglaiser and Danis 2002; Jensen 2003; Li and Resnick 2003).6 Similarly, risk not necessarily linked with regime type also influences foreign investor decisions (Birch 1991; Crenshaw 1991; Haendel 1979; Levis 1979; Tuman and Emmert 2004). Investors prefer countries with secure property rights, low corruption reputations, and fewer societal conflicts to minimize FDI risk. This study tests existing theories to determine whether all forms of economic liberalization have the same effect on FDI inflows. We provide a multivariate analysis of FDI that includes three groups of 3. There are many areas of inquiry that draw interest in the FDI literature. See, for example, Rothgeb's (1990, 1991) work on the effects of foreign investment dependence upon domestic political conflict in Third World states. 4. For more details on the effects of good governance on economic choices and conditions, see Knack and Keefer (1995), Feng (2003), and Svensson (1999). 5. The effect of labor on FDI investment is another potential line of inquiry (see Rodrik 1996). However, because the focus of this paper is on assessing economic reforms as well as data limitations, we chose not to use labor explicitly as a control variable. GDP per capita does capture some of the wage issues. 6. On the importance of stable property rights for economic development, see North (1990) and de Soto (2000). ECONOMIC REFORMS AND FDI IN LATIN AMERICA 53 independent variables: 1) economic reforms; 2) macroeconomic conditions; and 3) good governance factors. Controlling for macroeconomic and good governance factors, we test whether some economic reforms are more conducive to FDI inflows than others are. The economic reforms we analyze are: tax, trade, and domestic financial reform, privatization, and international capital liberalization. Using panel data for fifteen Latin American countries from 1980 to 1996, this study shows that, with the exception of domestic financial and trade reform, governments that implement economic reforms are not more likely to attract FDI. We find that a unified model combining some political and economic variables best explains governments' foreign investment decisions. Our results suggest that enforcement of property rights influences FDI.7 Because of the high sunk-capital costs associated with initial investments, foreign investors fear nationalization. Efforts to minimize expropriation risk are especially relevant in Latin America, a region known for appropriating foreign investments since the 1930s. Lessened expropriation fears complement domestic financial and trade reforms and reinvestment by multinational corporations (MNCs). Financial reforms that provide local capital at low interest rates draw in foreign investors.8 Low initial interest rates also reduce investment loss if the firm is expropriated. In addition, policy changes since the 1980s appear to enhance foreign interest in trade reform. Given the collapse of ISI and the loss of rent-seeking opportunities in host countries, MNCs are most interested in export opportunities. Host countries have similarly shifted to an export-oriented strategy, which supports efforts to reduce expropriation and gain investor trust. Previous positive experience with investment in the host country also is significant for FDI decisions. MNCs are likely to expand existing operations in host countries where there is low expropriation risk and growing profit potential. Despite the limitations of a broad aggregate study, our findings hold important implications for the relationship between foreign investment and structural reform. First, the results provide reasons for optimismthe fact that most economic reforms are not necessary for attracting FDI suggests that countries seeking FDI will encounter fewer obstacles. Second, our findings contribute to the debate on the effect of good governance on foreign investor preferences. The results complement work by 7. See also Globerman and Shapiro (2002), who argue for the importance of protecting privately held assets from arbitrary appropriation as part of a positive governance infrastructure. 8. We also found that increased government consumption negatively affects FDI flows, which complements financial reform concerns, as greater government spending tends to crowd out available local capital sources. 54 Latin American Research Review Grosse (1997,148), Li and Resnick (2003), and Tuman and Emmert (2004), indicating the relevance of property rights for obtaining greater FDI. In the first section, we discuss the possible determinants of FDI with an emphasis on economic reforms. Issues of model specification are presented in section two. The results are presented in section three. We provide an explanation for the results in section four. Section five concludes the paper. THE POLITICS OF ECONOMIC REFORM AND FOREIGN DIRECT INVESTMENT FDI, defined as private capital flows that provide a parent firm with some control over an enterprise outside the home country, has a long legacy dating back hundreds, if not thousands, of years. FDI fell in the early part of the 1900s only to take off in the mid-1950s with U.S. MNCs leading the way.9 At the same time that FDI expanded, many developing countries questioned the merits of foreign investment. In Latin America, nationalist sentiments fought foreign expansion. In fact, in the 1930s-1970s most Latin American countries expropriated U.S. MNCs, converting these firms into state-owned enterprises (SOEs) (Toral 2001, 62).10 In addition to nationalizations, Latin American countries also implemented ISI policies, imposing high tariffs on foreign industrial goods in order to promote the development of a domestic industrial base. Initially, success resulted from ISI policies, as Latin American countries averaged annual growth rates of over 5 percent between 1945 and 1972 (Thorp 1998, 15). However, by the 1970s, ISI forced domestic consumers to buy overpriced goods from uncompetitive domestic industries, contributing to foreign exchange shortages (Edwards 1995, 117-23). Market distortions linked with ISI also generated severe balance of trade and payment deficits and capital scarcities in the 1970s.11 To compensate for capital shortfalls, Latin American countries borrowed heavily from international financial institutio |
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| Language | English |
| Access Restriction | Open |
| Content Type | Text |
| Resource Type | Article |
