Implications On Foreign Direct Investment In Argentina

Foreign Direct Investment plays an imperative role in generating sustainable development in an economy. It is considered to be a great source of employment generation, modernization, equity promotion, poverty alleviation, technology transfer and economic development. It can boost the economy through greater research, productivity and innovation (OECD, 2002). The Argentine government has always opened its arms to foreign investment, offering a favorable climate to their progress and development. However, there are several factors that constrain the FDI from reaching Argentina. These include bureaucratic mechanisms, corruption, excessive taxation, instability of the domestic currency, inflexible labor laws, extreme regulations and poor infrastructure. The government needs to address all such issues for FDI to prosper. Paul O’ Neill (Ex US Treasury Secretary) rightly stated, “No one wants to spend time and capital fighting a system that is unfriendly to success…”

FDI in Argentina has been quite unpredictable which engages hatred among potential investors. The Argentinean-US Bilateral Investment Treaty (BIT) in 1991 led to a favorable impact, causing FDI to accelerate from 1991-99(after a lot of uncertainty). However, it plummeted again in 2001-02 undergoing the worst implosion in the global economic slowdown. After that, it began to rise slowly and steadily until 2008 when it dropped from $8.9 billion to $4.9billion in 2009, rising again to $6.2billion in 2010, causing greater volatility. The graph in Appendix 1 portrays this, also indicating that the FDI in Argentina is below its counter countries-Brazil and Chile (UN Economic Commission; UNCTAD; infobae.com).

In this essay, I would discuss the implications on Foreign Direct Investment (FDI) from a Political, Economic and a Legal perception. Even though the other factors in the PESTLE analysis and Porters Diamond are important, but these aspects carry additional significance and are more relevant towards FDI.

Political:

The political conditions of an economy are vital in influencing the FDI. Studies have shown that most multinationals (MNC’s) pay great emphasis on the sociopolitical stability before allocating funds towards it (Fatehi-Sedah; Schulz). This advocates that FDI would be directed towards countries with a stable and effective political system in order to avoid being a victim of the vagaries of forces outside the investor’s control.

Argentina suffers from a politically instable climate as there is wide scale corruption in the public sector. It ranks 106th out of 180 countries in Transparency International’s Corruption Perceptions Index for 2009, indicating its adverse nature (Heritage, 2009). The graph in Appendix 2 shows that Argentina lags behind the rest of the world in terms of its Freedom from Corruption. Even though the government has imposed some regulations, but the enforcement is uneven and judiciary remains weak (GIP Group Report, 2011).This reduces consumer’s confidence to invest into Argentina, increases exploitation and uncertainty and thus FDI remains low. It has the lowest Financial Freedom out of all the G20 countries, hindering foreign investment (Datamonitor, 2009). It is constrained by government and political interference, an incompetent judiciary and other impediments. This also distorts competition, leading to a misallocation of resources and sluggish economic development.

Moreover, there have also been some clashes between the President and the Central Bank on public expenditure leading to a legislative deadlock, creating greater unrest and hindrance in attracting FDI. There seems to be a lot of ‘institutional uncertainty’ because of the government’s ‘intrusive attitude’ towards the market (Businessweek, 2010). At times the government is not able to communicate its political and financial policies due to the unrest. This is important in attracting foreign investment as the investors need to have symmetric information about the economy. Joseph Stiglitz (Former vice-president

of the World Bank) stresses the importance of having symmetric information to attract investment, pointing out that developing countries often fail to attract investment due to lack of information, markets or the government’s failure towards country’s industrialization.

Argentina has been ranked in the 42.1 percentile on political stability and absence of violence (Datamonitor, 2009). This further indicates its turbulent political history in deterring FDI due to its bureaucratic and administrative transparency plagues.

Argentina is trying its best to curtail the destructive effects of these factors on FDI by being a major member of MERCOSUR (BBC, 2010), enhancing trade and demand for international financial services (GIP slides, 2011). It has built strong foreign policies and is improving the accountability of government institutions and increasing private sector participation. These factors might lead to an increase in FDI and brighten Argentina’s prospects of becoming a developed economy in the future.

Economic:

The economic system of a country greatly influences FDI into the economy. Studies have found that there is a positive and direct correlation between FDI and economic growth (Xiaoying Li and Xiaming Liu, 2004). Several factors including infrastructure, human capital, GDP, Inflation, ease of doing business, trade etc. need to be taken into account to perceive the implications on FDI.

Argentina suffers from a high rate of inflation due to slack in the monetary and fiscal policies. The government tends to underestimate it to around 10%, when actually it is about 30% (BCRA, Business Monitor, 2011). High inflation leads to multifaceted effects on the economy, implying a high level of uncertainty and wage increases of almost 25% (The Economist, 2010). This would mean that labor would be paid more, leading to a decline in the net profits of companies. It would also reduce export competitiveness, destabilize the currency (Peso) and increase the lending rates. Moreover, the unreliability of the government inflation figures further decreases the investor’s credibility to invest in Argentina.

There is also an increase in the public debt in Argentina which stands at 50% of GDP in 2009 (Datamonitor, 2009). This could have severe consequences for the FDI as it could lead to a detrimental fiscal situation as foreign reserves are being used to pay off the debt.

Another notable factor is that it is very difficult to start business in Argentina. Investors would seriously take this into account to see how productive their investment would be and when it will pay them off. Argentina has been ranked 115 out of 183 countries in ease of ‘Doing Business’ (Doing Business, 2011).This is linked to the political factor of corruption, pointing that as there is so much bureaucracy, starting a business is highly cumbersome. It is also significant

to note that this ranking has declined from 113 in 2010 to 115 in 2011, meaning that it could even decline further, hampering FDI to a greater extent. This could be emphasized by the fact that there are approximately 14 procedures to register a firm to start a business in Argentina compared with 9.3 for Latin American and Caribbean countries and only 5.6 for the OECD countries (Doing Business, 2011). The chart in Appendix 3 portrays this situation in detail.

However, on the positive side of Argentina, there has been an increase in GDP in 2010 and 2011, increase in trade surplus and a decrease in unemployment. A financial aid package has also been announced which will help to refinance most of their debt and there is also the prospect of higher infrastructure spending. If all of these factors work well, then Argentina may keep their expectations high and anticipate immense FDI into their economy.

Legal:

The legal system has tremendous effects on many different factors affecting FDI. Some of these factors are interlinked to the political aspects of the economy, causing multitude effects on FDI. Considerable research has established that foreign investors are attracted towards countries with an efficient and predictive legal system (Perry, 2000).The emphasis is on the fact that the manner in which laws are implemented in a country can act as an attraction or prevention to potential foreign investment.

Argentina suffers from judiciary problems as there is a general slack in the investor’s level of confidence in the judiciary. They use procedural obstructions and a regressively bureaucratic approach to provide unfair advantages. Due to this reason, a lot of time is wasted comprehending with government regulations, noting that managers spent more than 14% of their time dealing with such regulations and taking more than a year to enforce a single contract (Datamonitor, 2009). This leads to manifold effects; boosting labor wages, increasing the cost of business for foreigners, limiting FDI and reducing the effectiveness of the legal system on the whole.

The Argentine economy is also a victim of excessive taxes. The income and corporation tax rates are 35% and corporations are required to pay taxes on worldwide incomes as well (World Bank, 2009). The graph in Appendix 4 compares the tax rate of Argentina with other Latin American countries. Rising taxes would decrease the investors retained earnings, reduce the investment in R & D, leading to a lack of innovation and growth. It would also reduce consumption, aggregate demand and purchasing power in the economy. Therefore, there would be less enticement towards FDI due to lower demand, higher wages and less profitability. However, the government is going to try to change by having a comprehensive legal structure, corporate governance and labor market reforms to counteract the disincentives.

Conclusion:

The political, economic and legal factors are indispensable tools to indicate whether potential foreign investors would be attracted or restrained by the Argentine economy. Also, different investors have varied perceptions which alter the way they would think towards investing in a specific country. A risk-averse investor might want to keep it safe and invest in a country whereby there are greater chances of being secure. However, a risk-loving investor might want to put his stake at risk and take his chances by investing in a country where he can earn or lose a multitude of money.

It would also depend on the perception and sensitivity of the investor as they may or may not be able to judge the impact of the investment in the specified country. Moreover people from different nationalities may have varied sensitivity as Western investors are usually more sensitive than the others. Likewise, Argentineans prefer to work with their native people, but Chinese like to do business on the basis of trust and personal connections.

After analyzing all of the factors in detail, I think it would be correct to say that Argentina has a vast potential to grow massively but the instability in the system become an obstacle. The elections at the end of this year may improve the situation and attract some lucrative FDI in the prospective years.

Critical Reflection:

I was motivated to do a research on FDI as it forms a vital part of an economy and I wanted to expose the factors that attract and restrain it. We had merely listed FDI as a bullet point in the Group Presentation and I thought that this should have been given more importance as it required a thorough examination.

Coming from a developing country which lacks FDI, this matter was of great interest to me as I realized that there may be several similar reasons that restricted it to my country. It opened a whole new sphere of the possible deterrents and attractions to FDI for me.

My research consisted of readings from numerous academic and scholarly journals, news articles and different international financial websites. Most of the articles were of high-quality as they reflected the views and research of internationally respected authors and researchers. However, I felt a bit of bias in the data that was reported by some of the government organizations. For example the actual inflation figures reported by INDEC were far lower than the official figures, as being a government institute, they window-dressed their figures. Therefore, there seemed to be a lack of transparency between different sources.

Most of the sources in journals seemed comprehensive; however some of them were outdated, whereby I had to verify them from different sources. Moreover, I just focused on the PEL from the PESTLE; however, a few points seemed to overlap as they affected more than one section. I could have used the social aspect of education as well, but due to word limit, I tried to accommodate with these aspects only. Overall, I hope to benefit from it and apply it to my understanding of global issues in the future.

Appendices:

Appendix 1:

Net Foreign Direct Investment (FDI) Flows from 2000-2009

The diagram below shows that the FDI in Argentina is lower as compared to the other Latin American countries due to all the various reasons stated above.

-MEASURE: US Dollars at current prices and current exchange rates in millions.

Source: UNCTAD

Appendix 2:

Freedom from Corruption from 2001-2011

(Comparison between Argentina, Brazil and the rest of the world)

The graph below shows that that Argentina is quite repressed in terms of its Freedom from Corruption as it is below Brazil and the rest of the world for almost a decade.

Source: 2011 Index of Economic Freedom

(http://www.heritage.org/index/visualize)

Appendix 3:

Ease of Doing Business in Argentina in 2010 and 2011.

The chart below shows the deterioration of the Argentine’s Doing Business Rank. Even though it was much below average in 2010, it has declined even further, obstructing FDI further.

Source: Doing Business (World Bank)

http://www.doingbusiness.org/data/exploreeconomies/argentina/

Appendix 4:

Corporate Tax rate in Argentina

The chart below shows that Argentina has the highest tax rate out of all of these Latin American countries in 2009.

Source: World Bank

(GIP Slides)