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The Political Economy of FDI in Latin America 1986–2006: A Sector-Specific Approach

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Abstract

This study examines the political determinants of foreign direct investment (FDI) across 15 Latin American countries from 1986 to 2006. In contrast to existing scholarship, we focus on the causes of investment by economic sector—primary resources, manufacturing, and services. Additionally, a regional focus on Latin America helps to control for omitted variables by comparing relatively similar countries. We find substantial variation in the causes and characteristics of FDI across sector. Specifically, manufacturing investment is volatile and attracted to less democratic regimes. In contrast, investment in primary resources privileges greater democracy and property rights protection, while FDI in services is associated with public fiscal responsibility. These results yield important theoretical and practical implications for scholars and policymakers throughout the region.

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Notes

  1. The first report, “Snapshot Asia” (World Bank/MIGA 2003), examined two industry sectors in six Asian countries and analyzed the different factors associated with the attraction of FDI. Subsequent studies looked at differences across sectors within regions in the Western Balkans, Sub-Saharan Africa, the Caribbean, and Central America.

  2. One major exception to the lack of work on disaggregated FDI is Blanton and Blanton (2009) which examines the impact of human rights violations on investment across ten different economic sectors.

  3. Indeed, many authoritarian regimes are largely supported by domestic economic elites, and in turn support them, often at the expense of international investors.

  4. This logic stems from the work of Tsebelis (2002) who argues that more veto players lead to more policy coherence because there are smaller “win sets” for policy change.

  5. See John Dunning’s “ownership, locational, internalization” (OLI) framework (1971).

  6. See Garrett (1998, 2001) for an elaboration of these hypotheses.

  7. There are relatively fewer locales that offer highly skilled labor, most of which have high tax burdens compared to the developing world. Investors seeking specific skills may have even fewer choices. And the greater sophistication of installations associated with such ventures make them more permanent. Therefore, the argument that investors are vested in the community and will tolerate taxes (or at least not shop around for lower ones) has more applicability for a high-skilled wealthy country than one that is low-skilled and poorer.

  8. Montero (2008), however, finds no effect of property rights on investment flows.

  9. Ahlquist, however, argues that this is most likely to be true among portfolio investors, and not as important for FDI decisions.

  10. Because of the significant and overwhelming impact found by Montero, however, we nevertheless ran models with and without the current account and found no effect on FDI by sector.

  11. The countries examined are Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Honduras, Mexico, Nicragua, Paraguay, Peru, and Venezuela.

  12. We standardize the figures across years as constant 2005 dollars using GDP deflators reported in the World Bank’s World Development Indicators. There are a substantial number of missing observations for the dependent variables. This is exacerbated by the fact that, in order to compare across sectors, we removed observations that were not present in all three of the sectors in any given case/year.

  13. Because net flows are occasionally negative (the natural log of zero and negative numbers are undefined), Li suggests adding a constant to all observations so that they are all positive.

  14. We recognize that this is a problematic measure of trade liberalization, not least because increases in trade are likely a result of foreign investment as well as a potential cause. Due to weaknesses in indicators of trade liberalization, however, this is the variable that is employed in much of the literature on aggregate FDI, as well as an array of other scholarship. We nevertheless run alternate models employing the Fraser Institute’s index of trade freedom, with the same results we see for this proxy measure.

  15. We also reverse the index so that 10 is the greatest tax burden and zero is the least. This facilitates intuitive interpretation of the coefficients.

  16. The IMF data are “cash surplus/deficit.” The few missing points in the IMF data were filled with “fiscal deficit” data from the UN World Development Indicators. These included Argentina from 1985–1995, Chile 1985–1994, and 1 year each in Honduras, Nicaragua, and Paraguay (1989, 1989, and 1990 respectively).

  17. As with our FDI figures, GDP and GDP per capita are expressed in constant 2005 US dollars.

  18. Additionally, Hausman (1978) tests indicate the appropriateness of fixed effects over random effects models, and f tests further show the significance of the inclusion of country dummies.

  19. Nevertheless, at the risk that the inclusion of the LDV obscures the real effect of theoretically more meaningful variables, we also ran versions of the model with and without the LDV with insubstantial variation in the results. (Achen 2000; Wilson and Butler 2007)

  20. This is broadly consistent with Tuman and Emmert (2004) in their analysis of aggregate FDI in the region and with more specific treatments of the manufacturing sector (see Anner 2011; Carillo 2004, and Tuman 2003).

  21. Blanton and Blanton (2009) find that U.S. FDI is higher in cases of trade openness in the petroleum, mining, food, and electrical subsectors, while they do not find any relationship in the other 7 subsectors they examine. While one must be careful comparing U.S. outward FDI with overall Latin American FDI patterns, it does suggest the potential for further disaggregation in future work.

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Acknowledgments

We are grateful to John Doces, Jeff Drope, Maria Escobar-Lemmon, Matt Ingram, Andrew Schrank, and Strom Thacker for their helpful comments. We also thank Alfred Montero for sharing his data. All remaining errors are ours.

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Authors and Affiliations

  1. Department of Political Science, Bucknell University, Lewisburg, PA, 17837, USA

    R. Douglas Hecock

  2. Department of Political Science, The University of South Dakota, Vermillion, SD, 57069, USA

    Eric M. Jepsen

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Correspondence to R. Douglas Hecock.

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Hecock, R.D., Jepsen, E.M. The Political Economy of FDI in Latin America 1986–2006: A Sector-Specific Approach. St Comp Int Dev 49, 426–447 (2014). https://doi.org/10.1007/s12116-013-9143-x

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