Importance of FDI in the development of Emerging Countries Application to Colombia and the Philippines

scar Eduardo MEDINA ARANGO

Assistant Professor Academic Department of International Business EAFIT University Associated Professor of the Center of Asia Pacific Studies EAFIT University. Colombia

Table of Contents
Table of Contents ................................................................................................................ 2 Abstract ............................................................................................................................... 3 Introduction ......................................................................................................................... 4 Definitions........................................................................................................................... 5 Benefits of Foreign Direct Investment ................................................................................ 6 Different type of Policies implemented by Governments to attract Foreign Direct Investment ........................................................................................................................... 8 Capital Markets and the importance to Foreign Direct Investment .................................. 18 Comparison of Foreign Direct Investment between Colombia and Philippines............... 20 Conclusions ....................................................................................................................... 24 List of Figures ................................................................................................................... 25 Bibliography ..................................................................................................................... 26 Curriculum Vitae .............................................................................................................. 27

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Abstract
Countries continuously need investment for their development, especially Emerging Countries. This investment may be obtained through public or private funding, but the amounts required are generally above the capital that is available within the countrys boundaries. Foreign Direct Investment, therefore, becomes an important financial source for capital projects, vital for Emerging Countrys development. The flow of financial capital in the economies of the countries has become vital, shaping in occasions the policies and political decisions of governments to attract Foreign Direct Investment (FDI). Empirical studies have shown that some Emerging Countries opened to FDI have a higher growth rate than those that have not opened to it, with positive consequence in social and economic development. The purpose of this paper would be to: a) Identify the principal international financial markets and the possible influence they may have over the political decisions of Emerging Countries, specifically in Colombia and the Philippines. b) c) Establish the importance of FDI in the economies of Colombia and the Philippines in terms of development. Establish changes in policies with regards to FDI and the possible influence these changes may have had over the inflows of capitals into the economies of Colombia and the Philippines.

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Introduction
Capital Flows and therefore, Foreign Direct Investment (FDI), has been key in the degree of development for countries for centuries, from 1492 with the discovery of America, and even before. Colonization of territories by more developed nations has been possible due to FDI. Globalization has brought the interdependence of countries and their economies, with a clear acceleration of this in the past three decades. Less developed countries, especially those classified as emerging countries, have been avid in attracting investment to help with their development in important areas. In their search for this investment, governments have made changes in their policies to make their countries more attractive to the foreign investor. With this paper, it would be the purpose to establish what makes a country attractive to FDI, what governments have done to attract this investment and the importance the changes in policies with regards to FDI and the possible influence these changes may have had over the inflows of capitals into the economies of Colombia and the Philippines. The contents of this paper are the result of a research being conducted by Professors Juan David ESCOBAR VALENCIA and scar Eduardo MEDINA ARANGO at EAFIT University Colombia.

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Definitions
It is important to establish a definition of the type of Foreign Direct Investment that will be addressed throughout this document. Direct Investment: Will refer to the investment done by a foreign individual or corporation in a country with the purpose of having an influence over the development of a firms long term strategy. This type of investment may also be referred as productive investment, as it is done in companies that are part of productive sectors of a country, be it industrial, financial or services. According to the International Monetary Fund, direct investment reflects the aim of obtaining a lasting interest by a resident entity of one economy (direct investor) in an enterprise that is resident in another economy (the direct investment enterprise). The lasting interest implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence on the management of the latter1. Portfolio Investment: Will refer to the investment done through the capital markets acquiring shares, bonds or other financial instruments with the purpose of obtaining short or mid term profitability due to the yield or capital gains of the acquired assets. This type of investment will not be addressed in this document since the influence over an emerging countrys economy is questionable due to the short duration of the capital flow.

DUCE, Maitena (2003). Definitions of Foreign Direct Investment (FDI): a methodological note. Banco

de Espaa.
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Benefits of Foreign Direct Investment

There are several benefits of FDI over the economy of the receiving country. These benefits could be classified mainly in four types: A. Growth and Employment Productive FDI usually brings long lasting and stable capital flows as they are invested in long term assets. These funds are introduced into a countrys economy contributing to the aggregate demand of the economy, and therefore to the growth of the economy of a country. Companies within the country, due to the competition brought in by FDI, tend to become more productive to effectively counter the threat of the competitor from abroad. Higher productivity of companies contribute to the growth of a countrys economy (Baracaldo (2005)). Employment generation is another positive effect of FDI. As a country becomes more productive, its competitiveness increases as has been referred by several works, including Porter in its book The Competitive Advantage of Nations. With increases competitiveness, employment is created and the introduction to the world economy is more feasible (Castilla (2005)). B. Technology and Know How FDI allows for the transfer of technology and specialized knowledge which in turns favors and increase in productivity (Ramrez (2006)).

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C. Access to Goods and Services FDI may bring new goods and services, allowing the receiving country access to these with the benefit of the local consumers. D. Fill the Savings Gap FDI becomes a way to fill the gap between the required funds for growth and the internal savings capacity of a country.

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Different type of Policies implemented by Governments to attract Foreign Direct Investment

There are different types of policies that governments can implement with the objective of attracting FDI. Transnational Corporations are always on the search of new places to establish their investment. Countries are typically in the lookout for these investments. This goes beyond the ideological point of view of the different countries. Such could be the case of the Bolivarian Republic of Venezuela. There have been a number of articles and comments regarding the hostility of Venezuela to FDI, but this hostility is mainly towards western countries with capital economic models. In 1996, 44% of the investment came mainly from countries such as Argentina, France, Japan, United Kingdom and United States of America. By 2004, these same countries had des-invested USD 243.7 million, leaving to other non specified countries the investment (113%) as official figures reported by the Central Bank of Venezuela show2. The growth of investment from countries such as China, Iran and Russia contribute to the above hypothesis of the country of origin of FDI in Venezuela. Official figures are not available since 2005 by country of origin; therefore, the above statement has been implied from press information. We could classify policies as Passive and Active. Passive Policies: These usually refer to the policies implemented by governments where they do not actively seek for FDI, leaving the possibility of flow to the comparative advantage of the nation, such as geographic position, natural resource availability, labor

http://www.econolatin.com/inversion-latinoamerica/inversion-venezuela/total-venezuela.pdf
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cost, amongst others, or to a general legal and administrative framework that will regulate FDI flows. Active Policies: Governments seek for FDI not only based on their comparative advantages, but in establishing a clear legal framework, macroeconomic stability, intellectual property and equity investment protection. The frameworks should be designed according to the countrys strategic objectives regarding their economic development with a positive effect over the level of foreign investment received. The results of focalized government policies, its high relationship with the development objectives of the country, the attraction of FDI and its effect on economic growth, can be seen in different emerging countries, such as Malaysia, South Korea, Singapore or Thailand or in transition economies, as is the case of Hungry or Check Republic. Active policies are more related with productive investment, rather than attracting Portfolio investment. We could summarize the above in the following chart: Foreign Direct Investment

Direct (Productive) Investment

Portfolio Investment

Active Policies

Passive Policies

Aligned with Countrys Development Objectives

Left Mainly to the Comparative Advantage of a Nation

Figure 1. Foreign Direct Investment and types of Policies Own Construction

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It is also important for Governments to align their strategies with the needs of the Transnational Corporations (TNCs), which at the end will become the customers of the country offering different options to investors. That is, countries may be in the need to adjust their infrastructure, labor legislation, international trade and tax regulations, availability of qualified suppliers for raw materials and services, amongst others. Understanding the different needs of the investor and the draw backs of the country, is key in developing Active Policies. In synthesis:

Figure 2. Public Policies. Comisin Econmica para Amrica Latina (CEPAL (2006)), page 92 Own Translation

The design of Active Policies requires a long term strategic plan by the government in order to implement the different structural reforms and thus increase a countrys competitiveness and attract the desired FDI. This is the real challenge for developing economies. It is important to note that FDI is neither the answer nor the solution to the problems of development and economic growth; it is also important for countries to integrate into the worlds trade economy.

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In some Latin American economies, the application of the Washington Consensus3 has steered the policies around Foreign Direct Investment, especially in designing and implementing macroeconomic stability policies. Establishing Foreign Direct Investment strategies is one of the ways countries may seek the way to break the cyclical pattern of the Gross Domestic Product growth and set their economies in a sustainable growth path. Country competitiveness is not only improved by implementing economic policies that bring forward growth and stability, but also by promoting changes that will strengthen democracy, law & order, and a coherent institutional framework that is in synch with the dynamism of international trade, markets and practices (Montoya (2007)). By a coherent institutional framework, there are many instances in which governments have to work and redouble their efforts. Areas such as political transparency, low corruption, applicability of legislation to business decisions and protection of rights, will create trust in the investor, increasing the chances of attracting FDI. The following figure may establish a summary of the different conditions to make a country competitive, from a Foreign Direct Investment point of view:

Comparative Geographic Location Raw Material Availability

Economic Stability GDP Growth Tax Stability o Industry Related

Strong Institutions Strengthening: o Democracy o Law & Order

The Washington Consensus was coined by Mr. John Williamson in the 1990s to refer to the ten different

policies that countries should implement to be regarded as countries with economic orthodoxy. The list was drafted by Washington-based international financial institutions and has served over time as a guide for developing countries who aspire to obtain financial funds from capital markets.
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Comparative Low Labor Cost Adequate Infrastructure

Economic Stability o Income o Labor Devaluation Trade Tariffs and Barriers according to international standards Deregulation of economic activities Free movement of capitals Protection to Property o Equity Investment o Intellectual

Strong Institutions o Political Transparency Lower Corruption

Figure 3.What makes a country attractive to FDI? Own Construction

The different actions that governments implement to positively work on the above factors will increase a countrys competitiveness. Global institutions have designed ranking tools to assess different topics which measure a country competitiveness year on year, generating reports with rich information on different topics and areas. Such a report is Doing Business, co-published by The World Bank and the International Finance Corporation (IFC), which describes themselves as:

Doing Business provides a quantitative measure of regulations for starting a business, dealing with construction permits, employing workers, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts and closing a businessas they apply to domestic small and medium-size enterprises. A fundamental premise of Doing Business is that economic activity requires good rules. These include rules that establish and clarify property rights and reduce the costs of resolving disputes, rules that

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increase the predictability of economic interactions and rules that provide contractual partners with core protections against abuse.4 In recent years, countries have placed an effort in working positively on policies described in Figure 3 above. Others, such as Venezuela, report negative grades due to institutional barriers such as violation of property rights, higher corruption, and low transparency in judicial decisions, amongst others. Taking into account that Venezuela is a country rich in natural resources, mainly oil, the Inward Foreign Direct Investment has decreased importantly:

Venezuela - Inward Foreign Direct Investment

5,000 4,701

4,000

3,683

3,000 USD Millions

2,589 2,040

2,000 1,483 1,000 782

646

0 2000 2001 2002 2003 2004 2005 2006 (590) 2007

(1,000)

Figure 4. Inward Foreign Direct Investment Venezuela Own Construction5

4 5

http://www.doingbusiness.org/documents/DB09_About.pdf With data from http://stats.unctad.org/FDI/TableViewer/tableView.aspx

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Venezuela - FDI/GDP
4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 2000 -0.5% -1.0% 2001 2002 2003 2004 2005 2006 2007

Figure 5. Inward Foreign Direct Investment/Gross Domestic Product Venezuela Own Construction6

When compared with the rankings provided by Doing Business, there seems to be a relationship between the ranking and the decrease in Foreign Direct Investment received (the higher the number, the lower in the world ranking, implying a worse position):

With data from http://stats.unctad.org/FDI/TableViewer/tableView.aspx and

http://websie.eclac.cl/sisgen/ConsultaIntegradaFlashProc.asp
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Venezuelas Ranking Doing Business General Ranking Starting a Business Dealing with Construction Permits Employing Workers Registering Property Getting Credit Protecting Investors Paying Taxes Trading Across Borders Enforcing Contracts Closing a Business
Figure 6. Venezuelas Ranking Doing Business
7

2009 2008 2007 174 142 96 180 92 163 170 177 164 71 149 175 138 94 180 84 161 168 177 163 70 149 163 127 95 177 75 132 165 171 111 69 145

In contrast, we can examine the same information for Colombia and its relationship with the same Doing Business ranking.

Colombia - Inward Foreign Direct Investment

12,000

10,000

8,000 USD Millons

4,411

6,000 9,250 4,000 6,920 5,663 2,000 1,103 2002 2003 2004 FDI In 2005 Bavaria 2006 2007p 1,825 3,929

Figure 7. Inward Foreign Direct Investment Colombia Own Construction8

7 8

http://www.doingbusiness.org/ExploreEconomies/?economyid=201 With data from http://www.banrep.gov.co/estad/dsbb/sec_ext_004.xls

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Colombia - FDI/GDP 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 2000 2001 2002 2003 2004 2005 2006 2007

Figure 8. Inward Foreign Direct Investment/Gross Domestic Product Colombia Own Construction9

Colombias Ranking Doing Business General Ranking Starting a Business Dealing with Construction Permits Employing Workers Registering Property Getting Credit Protecting Investors Paying Taxes Trading Across Borders Enforcing Contracts Closing a Business
Figure 9. Colombias Ranking Doing Business
10

2009 2008 2007 53 79 54 80 78 59 24 141 96 149 30 66 91 62 88 74 51 19 169 112 150 28 83 91 58 85 50 80 32 175 141 149 27

Consistent growth in Inward Foreign Direct Investment and an increase in the ranking by Doing Business correspond to the efforts of the Colombian Government to work on the

With data from http://stats.unctad.org/FDI/TableViewer/download.aspx and http://www.doingbusiness.org/ExploreEconomies/?economyid=46

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http://www.banrep.gov.co/estad/dsbb/srea1_008.xls
10

issues listed in Figure 3, especially after year 2002 under Mr. lvaro URIBE VLEZ presidency:

Colombia - Inward FDI & Presidents

12,000.000 Csar Gaviria 10,000.000 Ernesto Samper Andrs Pastrana lvaro Uribe I & II Term

8,000.000 USD Million

6,000.000

4,000.000

2,000.000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Figure 10. FDI and Colombias Presidents Own Construction11

11

With data from http://stats.unctad.org/FDI/TableViewer/download.aspx

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Capital Markets and the importance to Foreign Direct Investment

International capital markets are usually referred to as places where securities, currencies and derivatives are transacted. The type of these markets could be grouped in: Stock Exchange: Trading of public company shares Money Market: Used for short term debt and investment Bond Market: Bond financial instruments are transacted Derivatives Market: Used for the transaction of instruments to cover financial risks Foreign Exchange: Facilitate trading of currencies The exchange of shares usually takes place in the capital markets, but the fact is that main corporate mergers and acquisitions happen outside of these markets, despite the fact they may be formalized within them, as was the case with de SAB-Miller Bavaria transaction in Colombia in year 2005. Through the research carried on, there was no clear relationship between Foreign Direct Investment and the main international capital markets. These act as facilitators of the transactions, but do not determine flow, especially to developing economies. It is important to note that international capital markets are important in determining the flows of Portfolio Investment. What is clear, though, is that countries have to provide policies that facilitate free capital movement. For an investor, the possibilities of equity capital and dividend repatriation are important when deciding on the appropriate jurisdiction to do the investment (CEPAL (2006)). The principal world financial markets can be observed in the following map:

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Figure 11. Principal Financial Places www.world-exchange.org

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Comparison of Foreign Direct Investment between Colombia and Philippines

The Philippines and Colombia have been both categorized under Developing Countries. Different economic, social and cultural conditions have been present in both countries. A comparison between both can be observed in the following table:

Philippines Colombia 2 Area of Territory 300,000 kms 1,138,910 kms2 Population 96,061,680 45,013,672 2 Population Density 3.12 hab/km 40 hab/km2 GDP (nominal 2007) USD 144.1 MM USD 171.6 MM GDP per Capita USD 1.500 USD 3.892 GDP (PPP) per Capita USD 3.200 USD 6.700 Unemployment 7.3% 11.2% Oil Production N/A 539.000 bbl/da
Figure 12. Comparative Statistics Colombia Philippines12

Inflation rates have been some what stable for the Philippines, while in constant reduction for Colombia:

Inflation Rates
25.0%

20.0%

15.0%

10.0%

5.0%

0.0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Colombia

Philippines

12

With data from https://www.cia.gov/library/publications/the-world-factbook/geos/rp.html and

https://www.cia.gov/library/publications/the-world-factbook/geos/co.html
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Figure 13. Inflation Rates Colombia & Philippines Own Construction13

Both countries have had negative trade balances as percentage of their GDP:

Trade Balance / GDP (%)

10.00%

5.00%

0.00% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

-5.00%

-10.00%

-15.00%

-20.00% Philippines Colombia

Figure 14. Trade Balance/GDP (%) for Colombia and the Philippines Own Construction14

With regards to GDP growth and Foreign Direct Investment, Colombia has had a consistent growth for the past seven years, whilst for the Philippines, it has had a cyclical behavior:

13

With data from http://www.census.gov.ph/data/sectordata/tscpiyr.htm & Banco de la Repblica de With date from http://www.census.gov.ph/data/sectordata/tsft.html,

Colombia
14

http://www.banrep.gov.co/estad/dsbb/srea1_008.xls and http://www.banrep.gov.co/estad/dsbb/sec_ext_004.xls

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10% 8% 6% 4% 2% 0% 1995 -2% -4% -6% GDP Growt h Philippines GDP Growt h Colombia FDI/GDP Philippines FDI/GDP Colombia 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Figure 15. GDP Growth and FDI/GDP comparisons Colombia & Philippines Own Construction15

15

With data from http://www.aseansec.org/stat/Table5.pdf,

http://stats.unctad.org/FDI/TableViewer/tableView.aspx, http://stats.unctad.org/FDI/TableViewer/download.aspx, and http://www.banrep.gov.co/estad/dsbb/srea1_008.xls

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The ranking of Doing Business for the Philippines shows a deterioration of its ranking:

Philippines Ranking Doing Business Starting a Business Dealing with Construction Permits Employing Workers Registering Property Getting Credit Protecting Investors Paying Taxes Trading Across Borders Enforcing Contracts Closing a Business

2009 2008 2006* 140 155 105 126 97 123 126 129 58 114 151 136 151 102 123 88 116 125 132 58 113 150 126 108 113 118 98 101 151 106 63 59 147

Figure 16. Colombias Ranking Doing Business16

16

http://www.doingbusiness.org/ExploreEconomies/?economyid=153, Data for 2007 was unavailable at

time of search
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Conclusions
In terms of development, there is a general agreement of the potential benefits of Foreign Direct Investment. The relationship between GDP Growth and the increase of the relationship between FDI and GDP (FDI/GDP (%)) can be clearly established. These benefits though, depend on the alignment of a countrys strategies with those of Transnational Corporations. A country may design Passive as well as Active Policies. The later are ones that may align the needs of both parties. A country competitiveness which may attract Foreign Direct Investment from Transnational Corporations is determined by Comparative Factors, Economic Stability and Strong Institutions, the later taking in more importance year on year. For these reasons, countries have to implement active policies that can bring Economic Stability and that can build an appropriate investment environment for the country. Comparative reports for competitiveness are being published by institutions such as the The World Bank and the International Finance Corporation (IFC), where different areas are measured year on year and may form a quite good image of the conditions for investment in over one hundred and eighty one countries. Colombias position has been better over the past years in the comparative report Doing Buisness, as well as a clear increase in Foreign Direct Investment. On the other hand, Venezuela has deteriorated its ranking, as well as the Foreign Direct Investment figures, similarly for the case of Philippines.

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List of Figures
Figure 1. Foreign Direct Investment and types of Policies Own Construction ............... 9 Figure 2. Public Policies. Comisin Econmica para Amrica Latina (CEPAL (2006)), page 92 Own Translation ............................................................................................... 10 Figure 3.What makes a country attractive to FDI? Own Construction.......................... 12 Figure 4. Inward Foreign Direct Investment Venezuela Own Construction .............. 13 Figure 5. Inward Foreign Direct Investment/Gross Domestic Product Venezuela Own Construction ...................................................................................................................... 14 Figure 6. Venezuelas Ranking Doing Business............................................................ 15 Figure 7. Inward Foreign Direct Investment Colombia Own Construction ............... 15 Figure 8. Inward Foreign Direct Investment/Gross Domestic Product Colombia Own Construction ...................................................................................................................... 16 Figure 9. Colombias Ranking Doing Business ............................................................. 16 Figure 10. FDI and Colombias Presidents Own Construction ..................................... 17 Figure 11. Principal Financial Places www.world-exchange.org .................................. 19 Figure 12. Comparative Statistics Colombia Philippines .............................................. 20 Figure 13. Inflation Rates Colombia & Philippines Own Construction ..................... 21 Figure 14. Trade Balance/GDP (%) for Colombia and the Philippines Own Construction ...................................................................................................................... 21 Figure 15. GDP Growth and FDI/GDP comparisons Colombia & Philippines Own Construction ...................................................................................................................... 22 Figure 16. Colombias Ranking Doing Business ........................................................... 23

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Bibliography
1. RAMREZ, Carlos Enrique FLREZ, Laura (2006). Apuntes de Inversin Extranjera Directa: Definiciones, Tipologa y Casos de Aplicacin Colombianos. En: Apuntes de Economa, Universidad ICESI, Colombia, No. 8 (ISSN 1794 029X) 2. DUCE, Maitena (2003). Definitions of Foreign Direct Investment (FDI): a methodological note. Banco de Espaa. 3. BARACALDO, Diego GARZN, Paola VSQUEZ, Hernando (2005). Crecimiento Econmico y Flujos de Inversin Extranjera Directa. Departamento de Economa de la Universidad de Antioquia y Universidad Externado de Colombia. 4. CASTILLA, Luis Miguel (2005). Reporte de Economa y Desarrollo 2004-05. Corporacin Andina de Fomento (CAF). 5. Comisin Econmica para Amrica Latina y el Caribe (CEPAL) (2006). Polticas activas para atraer inversin extranjera directa: experiencia internacional y situacin de Amrica Latina y el Caribe. Captulo II. Pginas 89 122. 6. World Investment Report 2007: Transnational Corporations, Extractive Industries and development. Document symbol: UNCTAD/WIR/2007. Sales No. E.07.II.D.9 7. MONTOYA CORRALES, Carlos Alberto (2007). La economa poltica en la inversin extranjera directa en Amrica Latina (1995 2004) caso Brasil, Chile, Colombia y Venezuela. En: Revista Ciencias Estratgicas. Vol 15 No. 17, pginas 19 38; ISSN 1794 8347 8. COPELAND, Thomas. E., WESTON, J. Fred (1988): Financial Theory and Corporate Policy. Prentice Hall (ISBN 978- 0201106480)
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Curriculum Vitae
scar Eduardo MEDINA ARANGO
Educational Background Undergraduate: o Business Administrator EAFIT University o Public Accountant EAFIT University Graduate: o MBA in International Business European University, Antwerp, Belgium, graduated summa cum laude o Master in Information Systems European University, Antwerp, Belgium, graduated summa cum laude o Certificate program in Political Studies EAFIT University Professional Experience Presently: o Assistant Professor EAFIT University Department of International Business o General Manager of the EAFIT Employees Savings Fund FOMUNE o Member of the Intellectual Property Committee of EAFIT University o Business Consultant in the areas of: Strategy Business Internationalization Finance Financial Strategy Value Added Financial Structuring Merger & Acquisitions o Member of several Board of Directors for companies in Colombia and Venezuela Corporate Experience: o Finance Director of I&SP Latin America BOC Gases o Finance & Administrative Director BOC Gases de Venezuela, C.A. o Controller Director CRYOGAS S.A. Colombia
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