Foreign direct investment: focus on quality not quantity

Added 19 Aug 2013

Last month Latindadd member, Fundación Jubileo Bolivia, published a briefing depicting the major trends in foreign direct investment (FDI) in the country. This briefing is a valuable country case study that confirms many of the findings of the United Nations Conference on Trade and Development (UNCTAD)’s World Investment Report 2013 released a few weeks earlier: the massive increase of resources invested in South America; the strong focus on natural resource-seeking activities; how important it is to target development-oriented investments; and how it does not happen.

In line with Eurodad’s analysis last year, the briefing stresses that it is important to focus on the quality and not on the quantity of foreign investments. This article summarises some of the figures, graphs and trends that I found the most striking.  

Global trends: developing countries are now at the centre

According to UNCTAD, FDI in 2012 was marked by two special features. On the one hand, global FDI fell by 18 per cent and its recovery might take longer than expected, mainly due to continued economic fragility and policy uncertainty for investors. On the other hand, developing countries received – for the first time ever – more FDI than developed countries, accounting for 52 per cent of global FDI flows. This is partly because FDI inflows to developed countries fell drastically by 32 per cent – a level last seen almost 10 years ago.

FDI inflows to South America and Bolivia: how much and of what kind 

FDI flows to Latin America and the Caribbean in 2012 maintained almost the same level as in 2011, declining by just 2 per cent to $244 billion. However, there are significant differences in sub-regional performances. While FDI to South America increased by 12 per cent, it declined substantially in Central America and the Caribbean (-17 per cent). This was mainly because of a growing interest in natural resources – due to high international prices. To a lesser extent, it was also due to the domestic markets of South American countries becoming increasingly attractive due to continued economic growth. Despite these impressive figures, the key issue here is how to use these private flows to contribute to poverty reduction strategies, drive development and fight inequality in a region that is still the most unequal in the world.

Bolivia is one of the countries in the region with a higher increase in FDI inflows in 2012. It received $1.060 billion during the year, which represents a growth rate of 23 per cent from 2011 to 2012. Although FDI inflows amount to 90 per cent of the total foreign private capital reaching the country, it still represents just 3.9 per cent of its gross domestic product (GDP). In addition, FDI inflows to Bolivia, as a percentage of GDP, have been highly volatile and pro-cyclical – a key feature of private capital flows already stressed by Eurodad in its 2012 report. During the 1990s it peaked at over 12 per cent. It even turned to negative in the early 2000s, and since 2006 it is increasing once again. This feature poses a challenge when it comes to thinking about these private flows as a reliable source of development finance.

Foreign investors’ desire to exploit South America’s natural resources plays a key role in the increase in FDI income in the region and particularly in Bolivia. According to Fundación Jubileo, in 2011 the extractive sector (oil, gas and mining) attracted 60 per cent of FDI inflows, trailing well behind key sectors such as manufacturing (21 per cent) and agriculture (almost non-existent). This trend was even stronger in 2012 when the extractive sector amounted to 77 per cent of FDI inflows.

A key reason for this strong focus on natural resources is the high profitability of resource extraction at times of high commodity prices. Therefore, resource-rich countries of the region such as Peru, Colombia and Bolivia are in the top 20 list of economies with highest inward FDI rates of return (see list from UNCTAD report below). Their rates of return are particularly high in comparison to the average of the whole region (7.1) and the average of the developed world (4.8). The return on investment in mining, in particular, has remained high and has outstripped the figure for other sectors for a number of years. According to the Economic Commission for Latin America and the Caribbean (ECLAC), “in the mining sector, profits as a percentage of regional GDP nearly quadrupled during 2004-2009 in relation to the previous decade; in the hydrocarbons sector, the increase was about 60%”.

As a result, Fundación Jubileo argues, foreign investment promotes a ‘reprimarisation’ of the Bolivian economy (shifting back to raw materials dependency), expanding and intensifying the exploitation of natural resources, which includes projects with highly questionable environmental and social impacts, leading to social conflicts and fights for people’s rights.  

FDI and job creation: worrying figures from Bolivia

The example of Bolivia is also striking in terms of the poor contribution of FDI to job creation and sustainable development. It is well known that FDI can have positive and negative effects on a host country and on people living in poverty. This depends on a number of factors, such as the nature and type of investment, including the sector, the quantity and quality of job creation, whether profits are reinvested or repatriated, payment of taxation, and the way in which the investment is initially financed, i.e. the external debt to equity ratio, among others.

As ECLAC acknowledges in its report on FDI, “after the market reforms, most of the governments of Latin America were convinced that foreign direct investment was an engine of development with automatic positive impacts for the receiving economy”. However, “experience suggests that the impact of FDI on the economies of receiving countries depends on the type of inward investment and the regulatory framework in each country”.

On this point, Fundación Jubileo raises a red flag in terms of the real contribution of FDI inflows reaching the country. In Bolivia, FDI inflows (mainly natural resource-intensive activities) create one direct job per $1 million invested. This contrasts with labour-intensive manufacturing, which creates seven jobs per $1 million. The following figure also shows the average per sub-region, which in the case of South America is 2.5 jobs. 

Thus, FDI in Bolivia contributes little to upgrading the economy and strengthening sectors with higher and local value added. For this reason, as Fundación Jubileo also concludes in its briefing, national and long-term development strategies should lead to a change in the production pattern to serve the needs of people rather than businesses. According to Eurodad research, the focus should be placed on maximising the value of domestic resources, including further support to domestic industries through, for example, procuring goods and services locally, while effectively managing external finance.  

tags: FDI