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 government s inability to maintain expedient monetary policy. From the MNE s 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.

by buying insurance. one of the world s largest financial institutions. / Journal of World Business 39 (2004) 233 243 foreign exchange controls and restrictions on FDI. nowhere is this policy more evident than in the telecommunications sector.G. the ability to operate in these areas was seen as increasingly important to their plans to globalize operations. With economies of scale and scope becoming an increasingly important factor to foreign banks. in the process creating a more certain investment climate and opening the door for foreign banks to operate in the local market. they mustattempt to enforce a capital allocation system withstrict and transparent rules and regulations. political risk may alter operating cash flows via discriminatory policies and regulations. In the early years of reform. brokerageunderwriting and pension fund management. These included areas such as leasing and factoring. Mixon Jr. banks were invited to operate in markets in which they did not have prior access. During this timeframe. . thus. helped to create an environment with appropriate institutions and removed the entry barriers for foreign banks. and financial resources were allocated on the basis of supply and demand. At thesame time. 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. If governments maintain strict control over capital transactions. F. Trevin o. Capital markets liberalization. attracting large investments and substantial improvements in the telecommunications infrastructure. Interest rates were allowed to be determined by market forces. MNEs may deal with political risk by avoiding the risk altogether. In order for developing countries to attract FDI. many Latin American countries privatized their public telecommunications companies and allowed unprecedented foreign participation. instead of by fiat.Within Institutional theory lies political risk. The second phase of reforms created a regulatory environment similar to that of international banks home country environments. including a lack of public funds for investment and gaps in technology. then MNEs may be reluctant to invest due to fears about restrictions on new capital formation. Institutional reform was initiated in the early 1990s in much of Latin America in response to shortcomings in many sectors. they should not exert excessive controlover capital account transactions. From a financial perspective. During the first phase of reforms. such as viaexchange-rate controls and/or repatriation or foreignownership restrictions. One example of a multinational bank that has made significant inroads into Latin America in the postreform era is Citigroup. Although reforms took place in many sectors. or by negotiating with the governing body prior to investment. divestment and repatriation. which may be defined as the risk that a host country government will unexpectedly change the institutional environment within which businesses operate (Butler & Joaquin. governments introduced reforms designed to attract foreign private capital. 1998).J. enabling them to expand into Latin America and to gain an increasingly large market share in the region (ECLAC. 2003). such as via 236 L.

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