chapter  4
29 Pages

Regional integration and its effects on inward FDI in developing countries: A Comparison between North–south (Mexico) and South–South (Brazil) integration: Thomas Goda

By(Mexico) and South–South (Brazil) integration THOMAS GODA

As already discussed in the introduction, ‘new regionalism’ is expected to lock-in reforms and to push further liberalisation. On the one hand, RIAs contain provisions which increase the security for investors who are located inside the region and as a result promote FDI flows within the region. These investmentfriendly regulations normally consist of most favoured nation rules, national

treatment for regional investors, protection of intellectual property rights, unrestricted capital flows, rules regarding dispute settlement, and the non-existence of performance requirements (Medvedev, 2006). On the other hand, ‘new regionalism’ often also lowers discriminatory barriers against the rest of the world (ROW), i.e. external barriers to trade and capital. As a result, MNCs are more likely to integrate the region in their global production chain and build new affiliates to exploit the locational advantage of the region (te Velde and Bezemer, 2004). Accordingly, Medvedev (2006, p. 2) states: ‘[T]he most immediate impact of . . . [RIAs] on foreign investment is the direct response of FDI to the implementation of various investment provisions in an agreement’. While Dunning (1997) argues that the integration of regions, i.e. the harmonisation of standards and increased investor security, is necessary for countries to attract FDI in the future. This is due to the fact that companies – in order to become more efficient and competitive – increasingly undertake joint ventures. Thus, countries/regions that do not support this new alliance character of capitalism run the risk of being left out. However, there is an emotional discussion if investor protection and the lock-in of liberalisation reforms in the course of RIAs are really that important to attract FDI because a more predictable investment climate seems to be only decisive for new investment inflows if ex ante the conditions for investors have been unpredictable (te Velde and Bezemer, 2004) and in most cases restrictions for investors have been lowered considerably and reforms have been undertaken before RIAs have been signed. Accordingly, liberalisation policies and provisions regarding investor protection in the course of RIAs perhaps are the least important conditions for increasing inward FDI flows (UNCTAD, 1998). Nevertheless, after the implementation of RIAs the liberalisation of some sectors might accelerate because countries that have deregulated less than other member countries might be pressured to open up some sectors more radically Therefore, RIAs might be important for FDI inflows because they can open up the service sector – which in most cases consist of non-tradables and accordingly only can be served by foreigners through FDI (Medvedev, 2006). Another reason why inward FDI might increase is that production processes for goods that are aimed to serve the domestic market are different from production processes for goods which serve a regional market.5 Therefore, due to regionalism, such FDI inflows are encouraged which are aimed at the restructuring, i.e. modernisation and enlargement, of existing plants (IADB, 1998). In addition, because of harmonisation and lower trade barriers regionalism contains better possibilities for investors to build clusters for the production of similar goods or goods that consist of similar inputs, respectively. In other words, agglomeration economies can take place regionally (i.e. between bordering countries) and are not limited to one country anymore. Hence, regions become a more attractive location for FDI (UNCTAD, 1998). However, the static effects of RIAs on FDI depend on the pre-existing situation (like pre-existing barriers) and factor endowments. Therefore, the effect might be negative for single countries within the region, while for the region as a

whole it is likely to be positive (UNCTAD, 1998). For example, if a country has no locational advantage in comparison to the other member countries and ex ante was a host to a lot of ‘tariff-jumping’ FDI – which tried to circumvent tariff barriers – the removal of such barriers would most probably lead to a decreasing stock of FDI in that country. In contrast, if a country has attractive factor endowments and the economy was not closely linked with the new partners before, the positive effect of a RIA on new FDI inflows presumably is significant (Blomström and Kokko, 1997). Furthermore, some member countries might witness the relocation of existing FDI stocks to other members, if ex ante MNCs had market-seeking FDI in more than one member country and ex post relocate their investment to one location which they use as platform to serve the regional market to exploit economies of scale (Levy Yeyati et al., 2003). Next, with respect to factor endowments and the pre-existing situation, it should be noted that investment provisions, the opening-up of sectors, non-tariff barriers within the region, and external barriers can be seen as important determinants for FDI inflows and changes in FDI stocks. In addition, the regional transport and communication infrastructure is a crucial factor because without sufficient infrastructure transaction costs are so high that platform investment will not take place and (regional) production networks will not emerge (UNCTAD, 1998). In addition, the size of the individual market and plant-level economics of scale still play an important role in the decision making process if, and to what extent, this relocation will take place (Levy Yeyati et al., 2003). However, if one wants to examine the effects of RIA on inward FDI more closely, it makes sense to divide the effects into intra-regional effects6 and interregional effects7 because ‘insiders’ and ‘outsiders’ will be treated differently after the RIA comes into existence.