Foreign direct investment in Latin America's hydrocarbon sector: government efforts to increase attractiveness by reducing social risks.

• Author: Garcia, Percy
• Position: Report

1. INTRODUCTION

   The energy sector plays an important role in the economies of many Latin American countries such as Bolivia, Colombia, Ecuador and Peru. The energy sectors' importance to a country can be infired based on the overall contribution to the countries' exports. Between 1993 and 2003, oil crude accounted for an average of 36.4%, 25.6%, 3.9%, and 5.8% of exports for Ecuador, Columbia, Bolivia and Peru, respectively (Arriagada, 2006).

   In 1996, Bolivia modified the legal framework to attract FDI in the oil and gas industry that resulted in significant increments of proven oil and gas reserves. However, this law was later modified by the current President, Evo Morales, who changed the legal framework by adding new restrictions on investors. Ecuador experienced a similar situation when President Rafael Correa changed oil and gas contracts to increase government's royalties.

   The situations in Colombia and Peru are quite different. Important reforms on hydrocarbon laws have been made in both countries since 1990. These reforms have been undertaken to increase countries' competitiveness by providing greater benefits for higher risk investments. A major goal of these reforms was to ensure these investments did not turn to other countries in the Middle East, Eastern Europe, China, or Africa, where incentives for foreign investments were also provided. Since early 2000, both countries have experienced a decline in hydrocarbon reserves; making it necessary to modify the legal framework to attract more FDI. Most of the reforms implemented by these countries focus on the following four areas: a) regime contracts in exploration and exploitation (upstream), b) transportation, refining and commercialization (downstream), c) modernization of state oil and gas companies, and d) partial or total privatization of state oil and gas companies.

   On the other hand, the responses of rural/indigenous communities with regards to resource-based activities are different for different regions/countries. In some cases, communities like Copiapo in Chile and Talara in Peru have supported resource-extractive industries such as mining and oil and gas development. But in most cases, communities have been opposed to company operations and in some cases to the development of the resource itself. For example, in Choropampa district of Peru, the community and other surrounding communities have protested against the mismanagement of environmental damage caused by a mercury spill. In Tambogrande, the community located on the north coast of Lima (Peru) is against the development of mineral resources by the Canadian based Manhattan Mining Company.

   Most resource-based firms in Latin America are operating in close proximity to rural/indigenous communities. With the development of resource-extractive industries in Latin America, indigenous and rural communities have increasingly gained more influence not only affecting the firms' operations but also shaping governmental policies related to social and environmental issues. Countries like Bolivia, Ecuador and Peru have a significantly strong presence of rural/indigenous populations. This paper explores the government effort to mitigate the social risks for international business in Latin America and the influence of indigenous people on resource-extractive firms.

   The paper summarizes relevant literature for this research and analyses the indigenous/rural communities with respect to their influence on resource-extractive. The paper concludes with a discussion of results.

2. LITERATURE REVIEW

   2.1 Foreign Direct Investment

   The growth of multinational enterprise (MNE) activities in the form of FDI has grown at a faster rate than most other international transactions (Blonigen, 2005). This is because FDI benefits the host countries through transfers of technologies and managerial expertise (De Mello, 1997), and it is more stable with a reduced risks of a sudden stop of investments (Alguacil, Cuadros, & Orts, 2010).

   Three fundamental questions were addressed in Root and Kramer's study of FDI (Root & Kramer, 1973): (1) the motivations for MNEs to go abroad as direct investors; (2) the processes, mechanisms and determinants required for MNEs to compete with local firms, given the inherent advantages of local firms operating in a familiar business environment; (3) the reasons for MNEs to enter foreign countries as producers rather than as exporters or licensors.

   It was suggested by Blonigen (2005) that the most fundamental questions about FDI activity relate to the choices of firms to serve a foreign market by FDI instead of other forms of financial support and firms' chose of region/country. With a firm-level framework, a large body of literature has examined the determinants of FDI to better understand and analyse a firms' behaviours. For example, Froot and Stein (1991) and Blonigen (1997) suggest that the MNEs' decisions on location is based on the level of exchange rate between home countries and host countries. An empirical study by Bengoa and Sanchez-Robles (2003) examining the relationship between FDI and economic growth used panel data analysis for a sample of 18 Latin American countries over the years of 1970-1999. The study suggests that a positive relationship exists between FDI and host country's economic development. Three determinants were specifically identified to attract FDI to Latin American countries; (1) adequate human capital, (2) economic stability and (3) liberalized markets. The quality of institutions was identified as an important determinant of FDI activity (Blonigen, 2005), as higher quality of institutions tend to have better infrastructures, higher legal protection of their assets and better-functioning markets.

   Table 1 summarizes key literature determinants on FDI flow. A classification has been made to distinguish these determinants and to management capabilities, economic , political regulation and resource issues. As indicated in the table, the literature reviewed did not include social risks as one of determinants of FDI flow. However, a stable political environment and lower social risk would attract significantly more FDI.

   2.2 Political Environment for International Business in Latin America

   Democracy is considered important for international business. Work by Sunkel (1995) affirms that the process of democratization leads to demands for allocating greater financial and economic resources. The institutionalization of democracy in Latin America and the relationship with the United States and other developed countries has greatly affected the international business environment (Grosse, 2001). Stable democratic economies such as Colombia have managed to attract significant FDI. Between 2000 and 2001, Colombia has approved over 60 contracts for oil and gas exploration with foreign companies.

   However, militarization of the government due to economic crisis and lack of government capacity to deal with internal and external pressures (Dietz, 1995) brings failure and instability to democracies in Latin America. Diamond et al (1999) state that the failure or instability of democracy in Latin America is deeply rooted in cultural components. There is a suggested linked to the colonial period where rulers were unable to diversify economic activities and political power was based on land control (Diamond et al, 1999). Political instability continued to the 20th century, with revolutions occurring in in Bolivia in 1952, in Cuba in 1959, in Peru in 1968, in Chile in 1973, Nicaragua in 1979 and Mexico in 1991. In the late 1970s, civil war broke out in El Salvador between the right-wing military and left wing guerrillas. At the same time, Mexico, Costa Rica, Venezuela, and Colombia moved toward democratic governments. In the 1990 elections, Nicaragua's Marxist Sandinista regime was replaced by a coalition government. General Augusto Pinochet of Chile was the last military dictator in Latin America to be replaced by a democratically elected President.

   There have been numerous factors influencing the return from dictatorship to democracy in Latin America. In the case of Argentina, the severe recession and failed invasion of the Malvinas Islands led the public to elect Raul Alfonsin in 1983 (McComb & Zarazaga, 1997). According to Fishlow (1997), Latin America has made a new political commitment to democracy. However, the new democracies in Latin America are...