Strategic Factors Affecting Foreign Direct Investment Decisions | Foreign Direct Investment | Macroeconomics

Strategic factors affecting foreign direct investment decisions by multi-national enterprises in Latin America

The opening of markets in developing countries in recent years has brought with it burgeoning foreign direct investment (FDI) flows. governments in developing countries acknowledge that they need outside capital to achieve their development objectives, partly because industrial nations have stabilized foreign aid and development loans. Second, export-oriented FDI brings relief from rampant foreign exchange shortages. Third, recognizing that reversal of portfolio investment is less costly, a fact that exacerbated recent financial crises in a number of developing countries, governments now prefers FDI (UNCTAD, 1999). Fourth, host-country governments recognize that MNEs have access to resources other than capital, that can assist with their development (such as technology, management and access to foreign markets). Recognizing the long-term costs of failure to integrate their economies into the global environment, developing countries have opened up their markets in order to attract more FDI. The role that FDI plays in the modern Brazilian economy is different than that which it played in previous eras. Prior to WWII, FDI was concentrated in public utilities, including transportation, in the primary goods export economy, and in banking, with a small percentage in the manufacturing sector. Similar to Argentina, post-WWII FDI flows shifted to manufacturing as part of an import substitution industrialization strategy. In the 1990s, the role that FDI played changed considerably. Brazil adopted institutional and macroeconomic reforms, partially designed to stimulate FDI. Elements of these reforms included establishment of the real plan, privatization of stateowned enterprises, and implementation of the Mercosur free trade area. For developing countries to compete for FDI inflows, they must implement macroeconomic policies designed to reduce inflation, stabilize the exchange rate and increase the GDP of the host country. With market-oriented economies in Latin America effectively in operation for little more than a decade, instability of prices, employment and output would be expected. A high rate of inflation is a sign of internal economic instability and of a host governmentǯs inability to maintain expedient monetary policy. From the MNEǯs viewpoint, high inflation createsuncertainty regarding the net present value of a costly, long-term investment. For these reasons, companies may avoid making investments in countries with high inflation. By ceteris paribus, a constant real exchange rate is preferred by MNEs in order to reduce the exchange rate risk inherent with investment in a foreign country. The demand-side of FDI theory argues that investment will go primarily to markets large enough to support the scale economies needed for production. Although Tuman and Emmert (1999) used GDP as a surrogate for market size and found it to be insignificant in explaining FDI among Latin American countries, more recently Trevino et al. (2002) found that GDP was a significant and positive indicator of FDI flows in Latin America. Further, UNCTAD (1994) concluded that market size was the primary determinant of FDI.

they mustattempt to enforce a capital allocation system withstrict and transparent rules and regulations. Although reforms took place in many sectors. one of the worldǯs largest financial institutions. From a financial perspective. Capital markets liberalization. by buying insurance. enabling them to expand into Latin America and to gain an increasingly large market share in the region (ECLAC.Within Institutional theory lies political risk. Institutional reform was initiated in the early 1990s in much of Latin America in response to shortcomings in many sectors. banks were invited to operate in markets in which they did not have prior access. then MNEs may be reluctant to invest due to fears about restrictions on new capital formation. The relationship between capital markets liberalization in Latin America and the expansion strategies of international banks into the region is one example of FDI decisions made by MNEs in response to institutional reform. they should not exert excessive controlover capital account transactions. the ability to operate in these areas was seen as increasingly important to their plans to globalize operations. During the first phase of reforms. Mixon Jr. At thesame time. attracting large investments and substantial improvements in the telecommunications infrastructure. Trevinƿo. 2003). divestment and repatriation. many Latin American countries privatized their public telecommunications companies and allowed unprecedented foreign participation. F. In order for developing countries to attract FDI. such as via 236 L. During this timeframe. MNEs may deal with political risk by avoiding the risk altogether. such as viaexchange-rate controls and/or repatriation or foreignownership restrictions. 1998). governments introduced reforms designed to attract foreign private capital. . Interest rates were allowed to be determined by market forces. These included areas such as leasing and factoring. including a lack of public funds for investment and gaps in technology.J. and financial resources were allocated on the basis of supply and demand. brokerageunderwriting and pension fund management. in the process creating a more certain investment climate and opening the door for foreign banks to operate in the local market. / Journal of World Business 39 (2004) 233Ȃ243 foreign exchange controls and restrictions on FDI. thus. instead of by fiat. nowhere is this policy more evident than in the telecommunications sector. or by negotiating with the governing body prior to investment. In the early years of reform. helped to create an environment with appropriate institutions and removed the entry barriers for foreign banks. One example of a multinational bank that has made significant inroads into Latin America in the postreform era is Citigroup. The second phase of reforms created a regulatory environment similar to that of international banksǯ home country environments. If governments maintain strict control over capital transactions. With economies of scale and scope becoming an increasingly important factor to foreign banks.G. which may be defined as the risk that a host country government will unexpectedly change the institutional environment within which businesses operate (Butler & Joaquin. political risk may alter operating cash flows via discriminatory policies and regulations.

Sign up to vote on this title
UsefulNot useful