Foreign Direct Investment
Category : Articles
This paper will first compare the foreign direct investment (FDI) environment of three countries in South America: Chile, Peru, and Ecuador based on the most relevant factors in FDI consideration for a U.S. based company. Then, a conclusion identifies the best opportunity for FDI.
According to Ball, Geringer, Minor & McNett, 2010, the most important factors to consider before investing in another country are the countries??™: 1) political environment, 2) economic environment, and 3) legal environment (p. 44-59).
Stability and minimal government intervention lead to ideal FDI. Chile has a very stable political environment with the government??™s economic role limited to regulations and few enterprises. Peru has a relatively stable political environment. However, investors are concerned about current president Ollant Humala??™s potential to increase state interference in the economy and private sector policies. Conversely, Ecuador suffers from political instability, social inequalities, and tensions caused by dissenting political parties and high corruption (“globaledge,” 2012).
Foreign Trade Agreements (FTAs) between nations create a favorable investment climate by eliminating bilateral tariffs, lowering trade barriers, and promoting economic integration (Ball et al. p. 54). The United States formed FTAs with Chile (2003) and Peru (2006) but not with Ecuador (“Doing business in,” 2010). Therefore, investors prefer Chile and Peru over Ecuador.
Foreign market size and growth rates relative to domestic market size and growth rates determine ideal investment location (Ball et al. p. 55). Therefore, larger market sizes and growth rates yield increased returns on foreign investment and help absorb local production costs. Populations for Chile, Peru and Ecuador are about 17 million, 29 million and 15 million respectively. Their growth rates are 1.21%, 1.14%, and 1.95% (???globaledge???). Since the United States population growth rate is only 0.96% (2011), US investors seek foreign opportunities. Although Ecuador has the highest growth rate, market size takes priority and thus investors prefer Peru.
According to Ball et al., higher gross domestic product (GDP) per capita increases potential returns on FDI (p. 53).GDP per capita in Chile is $15,732 (2010). IMF??™s records show a 3.8% 10 year historical cumulative average growth rate for Chile. Peruvian GDP per capita $9,538 (2010) grows at 8.8%. Ecuador??™s GDP per capita of $8,028(2010) grows at 2.13% (???globaledge???). Investors weigh existing GPD against future GPD when determining FDI. Therefore, some investors prefer Chile??™s high GDP per capita but others prefer Peru??™s growth potential.
Regulatory frameworks, property/ownership rights, and corruption levels represent primary legal environment factors for FDI (Ball et al. p. 65). Foreign investors in Chile are allowed 100% ownership without time limits on property rights. Chile gives priority to transparency, non-discrimination and market-friendly policies (“Business cycle accounting,” 2008). The U.S.-Peru Trade Promotion Agreement of 2006 grants U.S. investors in Peru equal rights as local and other foreign investors. Additionally, it establishes a secure and predictable legal framework. Foreign ownership in Peru requires two shareholders and a Peruvian legal representative. Ecuador allows full ownership of privately owned companies but restricts and limits ownership of some service sectors – railway freight transportation and electricity generation. Corruption levels in Chile, Peru, and Ecuador are 0.7%, 21.4% and 11.8% (???globaledge???).
Investors determine foreign direct investment project locations based on political, economic, and legal environments.
Based on the above table, investors would primarily select between Chile and Peru. Although Peru offers a higher growth rate and market size, its corruption and lack of transparency increase the risk relative to Chile. Therefore, our company would choose the safer alternative of Chile.
Ball, D. A., Geringer, J. M., Minor, M. S., & McNett, J. M. (2010). International business: The challenge of global competition. (12 ed., pp. 44-59). New York, NY: McGraw-Hill Irwin.
globaledge. (2012). Retrieved from: http://www.globaledge.msu.edu/Countries/Chile/government
International Monetary fund, (2008). Business cycle accounting for Chile. Retrieved from website: http://www.imf.org/external/pubs/ft/wp/2008/wp0861.pdf
U.S. Department of Commerce, U.S.& Foreign Commercial Service. (2010). Doing business in chile. Retrieved from website: http://www.buyusainfo.net/docs/x_8459236.pdf