1. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES ALICIA GARCIA HERRERO AND DANIEL SANTABARBARA Does China have an impact on Foreign Direct Investment to Latin America? Direct Investment to Latin America? LAEBA CONFERENCE Beijing 3-4 December 2004

2. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 2 ROADMAP TO PRESENTATION  Motivation  Determinants of FDI:  Competition versus substitution between countries  Variables and data issues  Empirical methodology  Results  Policy implications

3. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 3 1.MOTIVATION  Rapid emergence of China as global player has consequences for the rest of the world  Particularly true for FDI being China a major recipient  FDI is key for Latin America –Most important source of finance since mid 1990s –Contribution to modernizing the economic structure  PAPER OBJECTIVE: –Analyse empirically whether the emergence of China as a large recipient of FDI has affected the amount of FDI received by Latin American countries

4. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 4 1.MOTIVATION (cont’)  Whether FDI is diverted from Latin America to China may depend on: 1.Degree of integration of capital markets 2.Substitution between FDI and other capital flows 3.Objective of FDI to Latin American countries – exports or domestic demand 4.How much Chinese inward FDI increases imports – especially commodities  Therefore empirical question

5. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 5 1.MOTIVATION (cont’)  Existing evidence very scarce: –IADB (2004): Descriptive account of degree of coincidence in FDI home countries –Chantasasawat et al. (2004): Impact of Chinese inward FDI on Asia and Latin America No impact on the level of Latin American inward FDI... But negative impact on the share of FDI –However, regional analysis –Treatment of potential endogeneity can be improved

6. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 6 2. DETERMINANTS OF FDI  No clear consensus for most variables: –Generally, the higher size, the more macroeconomic/ political stability and human capital and the better the institutions, the more inward FDI However, Haussmann challenges this view: Good cholesterol –Non consensus on the relation between trade and FDI: Complements or subtitutes? –Also doubts on the role of push factors: Home and global –What about the impact of other FDI recipients?: Complementarity or substitution?

7. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 7 3. VARIABLES AND DATA  Dependent variable: –Annual bilateral FDI flows to six largest Latin American countries (column 1) –And for each of them using interacted dummies (column 3) Argentina, Brazil, Chile, Colombia, Mexico and Venezuela OECD International Direct Investment Statistics

8. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 8 3. VARIABLES AND DATA (cont’)  Objective variable: –Annual bilateral FDI flows to China OECD data: note that Hong Kong, Macao, Taiwan or Singapur excluded from home investor –Probably irrelevant for potential substitutability with Latam – Taking into account: FDI to Hong Kong (due to reinvesting) –Separately and jointly –Also check for role of similar economic structure with China Two-digit manufactured value added data from UNIDO

9. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 9 3. VARIABLES AND DATA (cont’)  Control variables: –(i ) capital flows: Lag of FDI to Latin America (persistence) Developments in portfolio and cross-border flows Influence of competitors: OECD FDI to Latam, to China and to Hong Kong Regional decisions: FDI to whole Latin America Other private capital flows –(ii) bilateral variables Bilateral nominal exchange rate Host home interest rate differential Bilateral exports Bilateral imports Similarity in productive structure

10. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 10 3. VARIABLES AND DATA (cont’)  Control variables (cont’): – (iii) host country factors Macroeconomic conditions Size and natural resources Institutional characteristics Occurrence of financial crises –(iv) home country variables economic growth GDP per capita –(v) global factors Oil factors

11. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 11 3. VARIABLES AND DATA (cont’)  TWO TIME SPANS – 1984-2001: After China started its “open door” policy Maximum number of years given data limitations –Max of 850 observations –1995-2001: Structural change in FDI Acceleration in negotiations for WTO membership –Max of 426 observations

12. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 12 3. VARIABLES AND DATA (cont’)  The model estimated could be expressed as follows: i =host country (Latin America) j = home country (OCDE)

13. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 13 4. METHODOLOGY  Main challenges 1.Endogeneity 2.Unobserved heterogeneity 3.Choice of regressors – Balance between degrees of freedom and problem of missing variables –To tackle 1 and 2: Generalized Method of Moments (GMM), following Arellano and Bover (1995) so that: Unobserved time-invariant country-specific effects are removed Potential endogeneity is tackled by instrumenting with lags (FDI and trade variables) Possible non stationarity of dependent variable is dealt with.

14. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 14 4. METHODOLOGY (Cont’) –To tackle 3: Recursive strategy 1. Estimate with all controls (column 1) 2. Test the joint hypothesis that coefficients of the variables that are not significant individually are equal to zero 3. If not rejected, we re-estimate the model only with the controls which were significant in the general regression 4. Otherwise, we test a less restrictive hypothesis until we reduce the number of regressors to the maximum extent possible. (column 2 and 3)

15. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 15 5. RESULTS  Longer time span (1995-2001): –No evidence of substitution from Latin American inward FDI to China With all controls (column 1) and only with jointly significant regressors (column 2) –Similarity in economic structure between Latin American countries and China significant and with negative sign in complete model Lost in restricted model –Argentina and Colombia negatively affected but parameters are small And we cannot reject the hypothesis that the coefficients of each Latin American country are the same and equal to zero  In sum, no “Chinese effect” on Latin America in this time span

16. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 16 5. RESULTS (cont’)  Some other results: –Maintained in the three model specifications: 1.Strong substitution effect between FDI and other private capital flows 2. Regional effect in Latin American FDI 3.Complementarities between FDI and bilateral trade 4.Occurrence of banking crises appears to foster FDI Due to opening up to foreign investors after crisis? –Other results are weaker: significant in general model but not in restricted one bilateral exchange rate the debt service Home GDP growth Host GDP growth

17. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 17 5. RESULTS (cont’)  More recent time span (1995-2001) –Negative effect of Chinese inward FDI on the Latin American one With all controls (column 1) and only with jointly significant ones (column 2) –Mexico and Colombia are the two countries for which Chinese inward FDI reduces FDI inflows in a significant way (at 99% confidence level for Mexico) When Chinese inward FDI increases by $100 million, Colombian and Mexican FDI is reduced by $84 and $29 million, respectively Still, we cannot reject hypothesis that both coefficients are equal, statistically –In sum, negative “Chinese effect” in a more recent time frame

18. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 18 5. RESULTS (cont’)  Results on control variables in more recent panel –Previous results maintained –In addition: Bilateral exchange depreciation now clearly significant in increasing FDI to Latin American countries, – Lower investment costs seems to weigh more than a reduction in the repatriated benefits Larger bilateral imports seem to imply a lower level of Latin American inward FDI. – Supports the hypothesis of substitution between imports and FDI »FDI is oriented towards domestic demand

19. DEPARTAMENTO DE ECONOMIA Y RELACIONES INTERNACIONALES 19 6. POLICY IMPLICATIONS  Evidence of substitution effect from Latin American inward FDI to China’s coinciding with acceleration of negotiations for WTO entry –Particularly significant for Mexico and, slightly less so, for Colombia  China will probably continue to be a magnet for FDI (liberalization and privatization as well as sustained growth  This may seem worrisome for Latin American countries, particularly those with a more similar productive structure to that of China  But also tremendous opportunities in the medium term. –Latin America in a worse position than Asia to reap some of these benefits, such as assembling and re-exporting of manufactured products. –But will clearly benefit from China’s demand for raw materials