Foreign Investment and Sustainable Development: Lessons from the Americas

IMGXYZ911IMGZYXOn June 19, 2008, the Carnegie Endowment for International Peace and the Heinrich Boll Foundation co-sponsored the launch of a report from the Working Group on Development and the Environment in the Americas.  Foreign Investment and Sustainable Development: Lessons from the Americas explores the link between foreign investment liberalization and sustainable development in Latin America. Co-editor Kevin P. Gallagher and contributing authors Andres Lopez, Eva Paus and Nicola Borregaard presented the report. Maryse Robert from the Organization of American States and Sara Anderson from the Institute for Policy Studies offered comments.  Liane Schalatek of the Heinrich Boll Foundation moderated the event and Eduardo Zepeda of the Carnegie Endowment gave the introductory remarks.

Kevin Gallagher, assistant professor at Boston University and research associate at Tufts University’s Global Development and Environment Institute, opened the discussion with a theoretical overview of the possible contributions of foreign direct investment (FDI) for sustainable development.   Foreign investment is argued to support development through horizontal and vertical positive spillovers to local firms as well as increases in production, employment and income.  Many Latin American countries have undertaken extensive investment liberalization, often in the form of bilateral investment treaties (BIT) with the Untied States, in pursuit of the expected benefits of foreign investment. Investment liberalization includes the elimination of performance requirements for foreign investors to source domestic firms or to export a set percentage of production and the imposition of restrictions on the government’s ability to exclude certain sectors from FDI, screen foreign investors for development goals and require joint ventures on research and development facilities.  Some investment treaties also enable transnational companies (TNCs) to sue host governments in international tribunals over investor complaints. 

Gallagher then presented the main findings of the report.  FDI has increased overall in Latin America, but is concentrated in a handful of countries.  Meanwhile total investment as a percentage of GDP has decreased, suggesting that foreign investment displaces local investment. Foreign firms tend to have higher levels of productivity and wages, yet do not transfer productivity and knowledge to local firms. Simply attracting foreign investment is not enough to generate sustainable development.  FDI policy must be conducted jointly with domestic policies that develop the capabilities of national firms and set benchmarks for environmental protection.  International investment treaties must leave host countries the policy space to pursue those domestic policies necessary to foster sustainable development through FDI.

Andres Lopez, director of the Centro de Investigaciones para la Transformación and professor of economics at the University of Buenos Aires, discussed the impact of FDI in Argentina and Brazil. FDI has increased dramatically in both countries over the past ten years, but manifests primarily as mergers and acquisitions of existing companies rather than the creation of new productive capacity.  TNCs account for a majority share of exports from large firms, have the highest productivity levels of firms and pay high wages to white-collar workers.  Yet Lopez found no net impact of FDI on growth or employment in these countries.  He reported limited evidence of productivity spillovers to domestic firms.  In Brazil, large domestic firms lost productivity as their market share decreased while small domestic firms that did not compete directly with TNCs experienced small productivity improvements.  Argentine firms that supplied TNC affiliates experienced productivity improvements. FDI contributed to the development of human capital among white-collar workers in Argentina which, in turn contributed to increased inequality.  Lopez attributed limited productivity improvements in national firms to the position of Argentine and Brazilian affiliates in the value chain of TNCs; they primarily export low-technology products to regional markets.

Eva Paus, professor of economics and director of the McCulloch Center for Global Initiatives at Mount Holyoke College, discussed the case of Costa Rica.  Foreign investment in Costa Rica differs from that in Argentina and Brazil.  The majority flows to manufacturing rather than services; contributes to productive capacity rather than mergers and acquisitions; and concentrates in the automotive, eco-tourism, and real estate markets.  Private real estate accounts for 25% of total FDI.  Paus argued that Costa Rica’s strategic location as an export market to the United States, historical investment in infrastructure and human capital, and proactive government policy have positioned the country to attract foreign direct investment.  Chile received copious inflows of foreign investment to high-tech industry after Intel built a microchip testing factory outside of San Juan in 1997.  Yet the country has not enjoyed the promised productivity and knowledge spillovers. Paus faults, in part, Costa Rica’s low tax rate and lack of a coherent development strategy for the country’s insufficient national capabilities to take advantage of foreign investment.

Nicola Borregaard, former? Director of the National Energy Efficiency Program of the Chilean government and advisor to the Chilean Minister of Economy, discussed the role of FDI in Chile.  Chile is an important case study; the country is often cited as the Latin American country most successful in achieving sustainable development, and foreign investment has played a crucial role in that success.   FDI accounts for 55 percent of Chile’s GDP, significantly more than the global average of 25 percent.  In recent years, FDI has shifted away from the exploitation of natural resources—except for the case of mining—and toward the service sector and industries that process natural resources.  The use of domestic financial resources has increased, investment flows facilitating mergers and acquisitions are bidirectional, and 95 percent of FDI consists of reinvested profits.  Borregaard highlighted several factors critical in shaping this success, including the existence of social capital, enforcement procedures and capabilities, mechanisms of information disclosure and specific policies and institutions regarding the exploitation of natural resources. Borregaard also discussed the challenge to the Chilean economy presented by large-scale industries supported by foreign investment.

Liane Shalatek introduced panel commentators Maryse Robert, chief of the Trade Section in the Department of Trade and Tourism of the General Secretariat of the Organization of American States, and Sarah Anderson, director of the Global Economy Project at the Institute for Policy Studies.  The commentators focused on the bilateral investment treaties (BIT) that many Latin American countries have signed with the United States.

Maryse Robert offered three observations.  In her view, BITs provide the policy space necessary for Latin American countries to pursue individual development strategies.  But Latin American countries have the responsibility to position themselves to exploit that policy space by developing their infrastructure and human capital.  Robert argued that while indeed foreign investment has concentrated in Brazil, Mexico, Argentina and Chile, foreign direct investment as a share of GDP is very important in many countries across Central and South America.  Finally, she noted that the structure of the U.S. BITs has been adjusted in response to past experiences; BITs allow significantly more policy space today than they did ten years ago.

Sarah Anderson lauded the report’s conclusion that foreign investment is not a panacea for development and disagreed with Roberts that BITs provide sufficient policy space.  The sales pitch supporting U.S. BITs was that Latin American countries could only attract foreign investors by granting them sweeping powers.  Swayed by this argument, Latin American leaders signed investment agreements that tie the hands of host governments.  National governments, fearing lawsuits in international tribunals, allow international investors free reign.  She cited the example of a dispute between Argentina and Uruguay over a paper mill constructed on the border of the two countries, financed by Finnish investors.  Argentina requested a halt in construction to carry out an environmental assessment of the plant.  Uruguay refused to grant the request out of fear that Finnish investors would sue the government in international court.  

In the subsequent question and answer session, an international finance professor at American University wondered whether the lack of backward linkages in Latin America can be attributed to the incentive structure of domestic sourcing: TNCs do not buy inputs from local companies because the host country cannot provide adequate human capital and infrastructure to act as suppliers.  Panelists recognized that TNCs respond to incentives and argued that it is the domain of host governments to shape those incentives.  Many policy tools that previously allowed national governments to shape domestic sourcing incentives, including domestic content requirements, are eclipsed by BITs.  Nicola Borregaard highlighted the importance of using tax revenue efficiently and Eva Paus underscored the responsibility of national governments to exploit the policy space available to develop human capital and infrastructure.

In response to other questions, Andres Lopez acknowledged that foreign investment has benefited consumers by building steady infrastructure.  Yet he pointed to the Argentine crisis of 2001/02, in which foreign and domestic banks both failed to return deposits to creditors, to argue that foreign investors are not inherently more reliable than domestic investors.  Kevin Gallagher discussed relative levels of policy space in multilateral investment treaties.  South-south investment agreements provide host countries with the most policy space while U.S. BITs and FTAs are the most constraining.  TRIMS—the WTO investment clause—and E.U. bilateral investment treaties fall between these two extremes.

Foreign Investment and Sustainable Development: Lessons from the Americas is a policy summary of longer and in-depth case studies performed by members of the working group on development and the environment in the Americas.  The case studies will be released the form of an edited book in 2009.  Two other reports from the working group on globalization and the environment and agricultural trade liberalization are available in PDF form here.