Puente @ Europa - Ao V - Nmero 3/4 - Noviembre 2007

European Foreign Direct Investment in Latin America

On the Road

by Nicole Moussa

Three Stages of FDI in Latin America The inflow of foreign direct investment (FDI) to Latin America has been clearly linked to the prevailing model of economic development throughout its recent history. From the early 19th century up to the period between the wars, within the framework of the primary-export-led growth model, FDI was directed mainly at the agricultural and mining sectors, representing the focal point of the accumulation process. However, foreign investments were also absorbed by the financial system and by transport activities (especially railroads) geared to the flow of good towards the main importers, initially mainly Great Britain, but then, increasingly, the United States (especially in the case of Mexico). During that stage, British capital was the main provider of FDI, followed by that coming from the United States. During the period of import substitution, a wave of nationalisation of public services and natural resources took place, along with a major push to industrialisation which relied heavily on domestic capital in its first stage, but became progressively transnational from the 1950s onwards. Transnational companies (TNCs) started to play a more and more important role in the industrialisation process. Although the FDI at that time was dominated by TNCs from the United States, there was large European investment in the manufacturing sector mainly from Germany and Great Britain and, to a lesser extent, from Italy and France. These investments were concentrated in three main activities: 1) the car sector, where companies like Volkswagen, Fiat, Citren, Peugeot, Renault and Scania were set up in Latin America in the 50s; 2) the food and drinks sector where some companies, such as Nestl and Unilever, had invested since the start of the last century and others, such as Parmalat and Danone, entered the field in the 70s; 3) the chemicals sector where companies such as Bayer, BASF, Rhne-Poulenc and Merck set up operations in Latin America during the primary-export-led period. During the import substitution stage, these companies were aimed mainly at penetrating trade barriers and have a direct access to local markets. Beginning with the debt crises of 1982, in the wake of the predominance of the neo-liberal model, external, trade and financial liberalisation become the central elements of the new policy aimed at reintegration into the international economy. Within this new model, foreign capital in its various forms - loans, portfolio investments and direct investment - was called to play a central role into the financing of economic activity and FDI was considered to be at the core of the

modernisation of the economy. The opening up of nearly all sectors to FDI, and the strong incentives offered to try and attract it, led to a large influx of investment directed towards all sectors, but which mainly found its way to those which had previously been blocked to private capital: the services sector (in particular financial and basic services) and natural resources.

Outward FDI Flows from Europe and the United States towards Latin America (billions dollars)

United States Europe

Source: UNCTAD, FDI Country Profile, www.unctad.org.

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The Boom Years of European FDI in Latin America Starting in the 90s European FDI soared in the second half of the 90s and became the main source of foreign investment in Latin America, overtaking that of the United States. According to figures from European investment countries, the outward flow of FDI from Europe to Latin America jumped from an annual average of US$ 6.300 million in the period 1991-1995 to US$ 35.000 million in 1996-2000, with the figure then falling to US$ 20.000 between 2001 and 2006, in line with the general fall in total FDI flows into Latin America during the period 2000-2003. The figures from some recipient countries in Latin America confirm that European companies have become the principle source of FDI in South America from the mid-90s on and that their importance has been growing in Mexico, where the United States, however, is still the main investor. For example, 43% of the total inflow of FDI to Brazil in 1995 came from Europe, and this percentage rose to 49% in 2000; 51% of accumulated FDI flows between 2001 and 2006

came from the same source. In Argentina, the percentage of total FDI coming from Europe jumped from 36% in 1995 to 50% in 2004. Also in Mexico, 22% of the net annual accumulated flow of FDI between 1994 and 2000 came from the same source, a figure which increased to 30% between 2001 and 2006. Spain has been the main European investor in Latin America, with an average of annual FDI of US$ 11.000 million between 1996 and 2003, representing 40% of the total of European investment in Latin America in this period. These investments were an integral part of the restructuring processes carried out by large Spanish economic groups within their strategy to acquire a better position on the market ladder after the liberalization of some sectors of the Spanish economy at the beginning of the 90s (energy, telecommunications, air transport, etc.). One of the characteristics of Spanish investment from that period is the strong concentration in the service sector (telecommunications, energy and banks), while other European investments, albeit mainly directed to the services sector, also gained access to industry.

On the Road

Outward FDI Flows of the Seven Largest European Investors in Latin America 1996-2003 Annual Average (millions dollars)

Spain

Germany

Switzerland

France

Netherlands

United Kingdom

Portugal

Source: UNCTAD, FDI Country Profile, www.unctad.org.

...in a Context of Economic Weakness of Hosting Countries At the beginning of the 90s, Latin America was emerging from the so-called dcada perdida during which, under the auspices of the International Monetary Fund, orthodox adjustment policies were implemented in response to the external debt crisis of 1982. Those policies stunned the region into economic stagnation, worsening the internal and external unbalances which they should help to overcome. Instead of adopting economic reactivation policies based on savings and national investment, Latin American countries, experiencing a time of high economic vulnerability, stuck to the recipes of structural reforms and strong incentives to attract foreign

capital imposed by the credit organisations. At the same time, at the beginning of the 90s, the international financial context was also changing, with the freeing of capital in search of business opportunities in emerging countries. ...which Offered Strong Incentives to Attract Foreign Capital. Foreign capital were mainly attracted to Latin American countries by the cut-price privatisations of large, state-run companies in sectors where they held a natural monopoly (such as the energy and basic services sectors), by the possibility to access numerous natural resources (gas, oil and minerals) and to penetrate new

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markets with the speeding up of the trade and/or customs union processes, by national treatment, by the liberalisation of the movement of capital, etc. These measures, which involved a radical change towards complete liberalisation of the economies, were accompanied by other processes aimed to guarantee its future viability and to limit the policy options of the governments involved concerning foreign capital. Guarantees on profits and tariffs were offered, as well as fix tax levels. Bilateral investment treaties (BITs) were signed, creating obligations for the host country towards investors from the other signatory and recognising international arbitration in the case of differences between the companies and the recipient state. BITs thrived from the 90s on, as the developed countries pushed at first aggressively to protect the investments made by their companies. Later, developing countries such as China, India and Thailand -whose companies have been looking to invest more in foreign markets- have also sought to sign this type of treaty with other countries in the Southern Hemisphere. This allowed foreign investors to fastrack commitments and obtain better conditions than those which could normally be obtained within a framework of multilateral negotiations. Up to the end of 2006, Latin American countries had signed 566 BITs, of which a total of 434 have been ratified. A Reconquest through Globalisation? Most European FDI in Latin America during the 90s consisted of the purchasing of existing companies (generally followed by an increase in the companys capital), rather than completely new investments. The acquisition of local companies was concentrated in the services and hydrocarbon sectors. Among the European corporations which took over private or state companies in Latin America there were: BBVA (Spain), Santander (Spain), HSBC (United Kingdom) which took over banks; Unin Fenosa, Endesa, Iberdrola, Electricit de France, Totalfinaelf, United Utilities and National Grid which bought electric companies; Vivendi, Suez, RWE, United Utilities, Aguas de Barcelona, Aguas de Valencia, Anglian Water which all acquired water companies; Telefnica, Telecom Italia, France Telecom, Portugal Telecom which took over telecommunications companies; finally, Repsol y British Petroleum, which bought oil companies, etc. This is how, in a short period of time, a small number of European companies, many of which did not have much international experience, achieved a leading position in highly strategic sectors of the economies of most recipient countries, such as banking, energy, telecommunications, and infrastructure in general. These are sectors which have a strong impact on the systemic competitiveness of any economy and a significant weight in the daily lives of the citizens who are, after all, the end users. Many of these services are critical and, when managed under the constraints of profit-making companies, they can affect basic aspects of the lives of large sectors of the population. The sheer size and speed of the investment influx into the continent carried out by European banks and companies (mainly of Spanish origins), as they bought up emblematic state companies, was viewed by some as yet another conquest, or a return to colonialism. This perception was reinforced by the weakness of the recipient countries, which sold off their public companies, in part, to comply with the conditions imposed by the international financial organisations which, in turn, were controlled by the governments of the countries from which those same investing companies came. What is the Evaluation of European FDI in Latin America? Conventional wisdom assigns to FDI many potential benefits for the country receiving the investment: access to new financial resources, technology and markets; the creation of links to the rest of the global economy; the generation of employment; an increase in exports;

and, consequent to all of these, a positive impact on growth and development. However, quite frequently the reality does not match with the theory as described and the blame is then put on the policies which could not take full advantage of the potentialities of FDI. At the same time, however, the adoption of FDI-friendly policies is also usually recommended in order to attract investment. This mainly entails the liberalisation of the economy, a free hand for investors and lack of intervention on the part of the state. Politics do make a difference on the impact of FDI in the host countries. How can we otherwise explain the different impact that FDI has had, for example, on manufacturing in countries such as China and Mexico? In the former, it contributed to the transfer of technology and the development of domestic companies, while in the latter it remained limited to the area of the northern border with the United States, strongly linked to the companies and the market of that country. In the case of China, investments were accompanied by an interventionist policy, which was liberal in the case of Mexico. In Latin America, the spread of FDI has been coupled with a sudden trade liberalisation which has led to an increased dependency on imports of finished and semi-finished products and capital, a growing specialisation in primary production and a reduction in research and development competences. Yet another important difference between the countries of Asia and Latin America lies in the fact that the former have been more selective in attracting FDI and, more recently, in the opening up of services, above all of the non-exportable ones. This reluctance can be explained by some of the characteristics of the FDI in these areas which make them less attractive than those allocated to the manufacturing sector, producing for internal consumption. This type of FDI does not, by definition, generate foreign currency and the initial capital inflow is rapidly overtaken by external payments (in terms of imports of equipment and technology, repatriation of profits, etc.). Moreover, the high fixed costs and the existence of externalities transform the provision of some infrastructure services, such as telecommunications, energy, water, transport, etc. into natural monopolies. Sectors which are essential to the competitiveness of the economy and the wellbeing of the population at large find themselves exposed to the dangers of abuse of dominant position. Developing Asian countries have generally preferred to keep state control of these areas, resorting to service contracts with TNCs when they see fit. In a sharp contrast to this, the highpoint of FDI in Latin America in the 90s was due to the opening up of the services sector and the great interest of European companies, and particularly Spanish ones, to invest in this area. The process of liberalisation of the services sector in Latin America has turned into a controversial issue. In general, opinions tend to split along the lines of supporters and critics of privatisation, the former being generally those who are involved in the implementation of the process and who point to working documents or publications of the World Bank, the Inter-American Development Bank (IADB) and the International Monetary Fund to back up their claims. Not seldom, different investigations come to different conclusions (and indeed sometimes opposite opinions) on the same cases or general aspects. Those who defend the process, while admitting that problems exist, take an overall positive view and emphasize aspects such as an improvement of the quality and reach of the services, an increase in competitiveness and a decrease in prices, increases in profitability and productivity, a raise in tax earnings and a fall in the subsidies previously granted to state companies1. Meanwhile, those who oppose the reform processes reply that they did not fulfil their stated objectives and, in many cases, they simply replaced a state monopoly with a private one, transforming the logic of a public service aimed at satisfying a demand into a logic of profit to be obtained, therefore damaging the poor sectors of society and workers in general. Although they recognize that some

On the Road

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Percentage of Public Opinion in Favour of Privatisation in Latin America between 1998 and 2005 1998-2005
Venezuela Brazil Colombia Mexico Chile Uruguay Ecuador Peru Honduras Nicaragua Guatemala Argentina Bolivia Paraguay El Salvador Costa Rica Panama Latin America

On the Road

2005

Question: Do you agree strongly, agree, disagree, or disagree strongly with this sentence: Has the privatisation of state companies been beneficial for the country? These figures only reproduce the agree strongly and agree answers. Source: Latinobarmetro press releases, 1998 to 2005 (www.latinobarometro.org).

of the privatised companies improved their service performance and productivity, they argue that the progresses were a long way below the contractual commitments and that the reduction in the companies operating costs ended up in increasing profits as opposed to decreasing tariffs2. In terms of social perception, opinion polls have been recording a rising discontent and mobilisation against privatisation and the opening up of public services, something which could affect the mid and long-term sustainability of private investment in some of these activities. Attempts to privatise state companies in recent years have been paralysed by strong rejection and large social protests, such as the water war in Cochabamba, Bolivia, and the refusal to allow electricity distribution in Peru and Ecuador to fall into private hands. Surveys carried out by Latinobarmetro show that 46% of the inhabitants of Latin America thought that the privatisations had been beneficial to their countries in 1998. This figure dropped to 31% in 2001 and then to 19% in 2004. The percentage of people who were dissatisfied with the process was 71% in 2003 and 75% in 20043. This dissatisfaction increased even in Chile, a country which had been frequently cited as an example of the success of privatisations: the percentage of satisfieds decreased from 58% to 37% between 1998 and 2005. Although those who defend the opening up to private and foreign capital admit that there is a general rejection of the process in Latin America, this has not brought them to question their positive evaluation of the process. In the opinion of specialists from the World Bank, for example, these negative attitudes have arisen in spite of the positive results achieved. Their analytical efforts are therefore focused on the divergence between reality and social perception4 and their findings show that the failings in communication [are] amongst the main deficiencies of the programmes. According to these specialists, the countries involved failed to develop a proactive communication strategy prior to, during and after the reform process [] In particular, the governments

involved were wrong in that they didnt give any publicity to the improvements achieved in the process5. Latin America was one of the first regions to put into practice the opening up of public service activities to private capital, anticipating the majority of developed countries. Among this group of developed countries, only the United States and the United Kingdom already had private companies working in the area in the 80s (although these were exclusively made up of domestic companies, as opposed to foreign ones). The service companies which invested in Latin America at the time, mainly European, lacked experience both in the international arena and in the management of private business as many of them were still state-run companies or had only recently been privatised when they landed in Latin America. In many cases, the setting up of regulatory bodies, or at least regulatory policies, was a rushed affair which was carried out at the same time as, or even after, the FDI arrived. This haste resulted in weak regulatory frameworks which allowed for the renegotiation of the contracts soon after they were awarded. It is estimated that 30% of the more than 1,000 infrastructure project contracts signed in Latin America and the Caribbean between 1985 and 2000 were renegotiated. This figure rises to 55% in the transport area and 74% for water and sanitation6. These renegotiations took place on average 2,2 years after the awarding of the contracts and most resulted in significant benefits for the private contract holders which were not anticipated in the original contract. This generalised practice of renegotiating could be put down to the lack of experience and excessive optimism on the part of the winner of the contract, but also to a malicious and reckless lowering of the cost of the service offered, based on the hope of the contract winners that, once the contract awarded, they could ask for a renegotiation with an administration which would be vulnerable to their blackmail due to the key role played by the service they guaranteed within the economy7.

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Results of the Infrastructure Contract Renegotiations in Latin America and the Caribbean

Investment obligations postponed Investment obligations brought forward

69% 18% 62% 19% 59% 38% 62% 31% 17% 46% 22%

On the Road

Increase in charges Reduction in charges Increase in the cost components which could automatically be transferred to increases in charges Contract duration increases Reduction in investment obligations Adjustment in the annual charge payed by the operator to the government Favourable to the operator Unfavourable to the operator Changes in the capital-to-asset ratio Favourable to the operator Unfavourable to the operator

Source: Luis Andrs, Makthar Diop, and Jos Luis Guasch, Un balance de las privatizaciones en el sector infraestructura, in Nueva Sociedad, 207, January-February, 2007.

In contrast, the room for manoeuvre for governments trying to introduce regulatory changes was reduced, especially when these could have been perceived by the involved companies as affecting their interests, mainly in the case of BITs signed with their countries of origin. As a matter of fact, many multi-million dollar cases have been brought against Latin American countries by public service transnational companies before the International Centre for Settlement of Investment Disputes, or ICSID. Of the 116 pending complaints from transnational companies against host countries before ICSID, 56 are against Latin American countries, of which 32 against Argentina. 73% percent of the cases against Latin American countries concern the service sector and 60% hydrocarbons and mining, that is to say the areas which opened up to FDI in the 1990s. Argentina was the most emblematic case in terms of the loss of sovereignty and space for political manoeuvre implied in the massive process of privatisation and the placing of state-owned companies into foreign hands in the public service sector. In fact, the transnational companies, many of them European, went so far as to take the government before international tribunals because macroeconomic policies adopted since 2002 were supposedly harmful to their interests, even if these policies were effective in taking the country out of its serious economic crisis. Moreover, the IMF accepted some of the companies demands -in particular for an increase in charges- including them on the list of conditions with which the Argentine government had to comply to access the refinancing of its foreign debt. The loss of legitimacy suffered by the liberal model of market opening and privatisation in Latin America and the strengthening of the economies of the region as a result of the sharp increase in the price of commodities have created a new context in which the countries of the region have improved their negotiating position with international organisations and transnational companies. Some countries such as Argentina, Bolivia, Brazil and Venezuela are entering into a new dynamic of regional integration which, if effective, will place them in a better position to face the challenges of globalisation. So as not to miss the Latin American boat, European companies should readjust their investment strategies and their relationships with the governments of and civil society within the host countries in the light of this new reality. Foreign direct

investment in general, and that which is carried out in search of local markets in particular, cannot prosper in the long term to the expense of the wellbeing of the recipient country. Notes See, for example, Marianne Fay and Mary Morrison, Infrastructure in Latin America & the Caribbean: Recent Developments and Key Challenges, Report N 32640-lcr, The World Bank Finance, Private Sector and Infrastructure Unit Latin America & the Caribbean Region, 2005; Alberto Chong and Florencio Lpez de Silanes (eds.), Privatization in Latin America. Myths and Reality, World Bank Bank/Stanford University Press, 2005; Ioannis Kessides, Infrastructure Privatization and Regulation: Promises and Perils, in World Bank Research Observer, Vol. 20, n. 1, Spring, 2005, pp. 81-108. 2 For example, see Eduardo Basualdo, Daniel Azpiazu et al., El proceso de privatizacin en Argentina, rea de Economa y Tecnologa de FLACSO-Buenos Aires, Universidad Nacional de Quilmes / IDEP/ Pgina 12, 2002; Julio Gambina, Polticas de promocin del sector privado en Amrica Latina, preliminary report prepared for CLACSO, Buenos Aires, 1999; John Nellis and Nancy Birdsall, Winners and Losers: Assessing the Distributional Impact of Privatization, Center for Global Development, Working Paper n. 6, May 2002. 3 The percentage of interviewees who didnt respond or who didnt know represented 8% in 2003 and 2004. 4 These arguments remind us of Groucho Marxs famous phrase when, on being found with another woman by his wife, asked the latter: Who are you going to believe: me or your own eyes? 5 Luis Andrs, Makthar Diop, and Jos Luis Guasch, Un balance de las privatizaciones en el sector infraestructura, in Nueva Sociedad, n. 207, January-February, 2007. 6 Luis Guasch, Granting and Renegotiating Infrastructure Concessions. Doing it Right, Washington D.C., World Bank Institute, Development Studies, 2004. 7 Manuel Conthe, Inversiones en infraestructura y riesgo regulatorio, in Universia Business Review, n. 3, Third Quarter, 2004, pp. 124-135.
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