Case Study 1 Mgt 328


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Transitions in the Political and Economic Environment in Latin America: Implications for International Business

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Case Study 1 Mgt 328

  1. 1. Justin Newberry MGT 328 – 001 Professor Flores 9/20/2008 Case Study 1 Transitions in the Political and Economic Environment in Latin America: Implications for International Business In this paper, I will evaluate the recent effect of changing economic and political trends in Latin America. I will discuss how such trends have seemingly bounced back and forth and have had profound economic and personal impacts on the countries’ respective constituents and prospective investors. Furthermore, I will relate these trends to the preferred business environment for international businesses entering these markets and the implications for foreign direct investment in these countries by analyzing the degree of: democratization; political stability; and economic openness. From this analysis, I will show that the claims of Latin American populist leaders such as Hugo Chávez that free market economic policies are the source of Latin American economic problems do not hold true. From here, I will go on to explain why certain countries have successfully been able to implement liberal economic reforms to better themselves and set the stage for future economic growth through open international trade and direct foreign investment. Finally, I will compile my analysis of the Latin American countries with the greatest and least amount of political risk for international businesses. Recently, Latin America has seen a return to the populist political movements (and the associated high levels of government intervention in economies) that were seen in the mid twentieth century and had seemed to fade by the 1990s (when participation in international trade and markets was high with the creation and passage of the North American Free Trade Agreement [NAFTA] and the World Trade Organization [WTO]). This has, in turn, brought back the high levels of government intervention in business and subsequently has had repelling effects on the
  2. 2. entrance of international businesses to these markets and the flow of direct foreign investment into businesses already established in these countries. Such is the case for Hugo Chávez’s populist totalitarian government in Venezuela that came to power in 1999 and has effectively promised egalitarianism to the poor of his country by means of confiscating properties and holdings of the country’s wealthy. Similarly in Bolivia and Argentina the rise to power of Evo Morales and Cristina Fernández de Kitchner, respectively, has translated into more centralized authority of their countries’ economies and decreased willingness to participate in international trade and welcome foreign investment. In Bolivia, like in Venezuela, Evo Morales has denounced the free market capitalist economy and confiscated vast natural gas reserves. In Argentina, a move away from privatization and foreign investment further signals this recent trend in Latin America. Though it seems quite clear the political and economic implications of this trend, an important contributing factor of the political and economic realm of this trend should also be mentioned since it is also always an important consideration in world markets: the cultural and societal implications. This trend exemplifies the workings of societies that in this current era (since societies are constantly changing) appear to be quite collective in nature. This holds true to the final example of Andres Manuel López Obrador’s failed run for the presidency in Mexico in 2006. Although he lost the race, Obrador embraced many of the same political ideas and goals as Chávez and Morales and wanted a collective, egalitarian society and to increase government involvement in the economy. As mentioned above, Obrador did not win the presidency in Mexico and, therefore, it is a good place to start here in stating the deviation from this recent trend in Latin America. The newly elected President Felipe Calderón is seen as quite business-friendly and does seem to provide hope for promising direct foreign investment to facilitate future economic growth. Other deviations
  3. 3. from this recent shift in Latin America are in Peru, El Salvador, Brazil, and Chile all in which free market economies are embraced and direct foreign investment and international free-trade agreements are increasingly being welcomed. (Peru, however, is a difficult country to judge in this trend as it has in recent years been highly conformant with the trends of Venezuela, Bolivia, and Argentina but with a new president that is looking for increased foreign loans and direct investment positive expectations toward a more free market economy can be postulated.) Ideally, international businesses or international investors in businesses will look for countries in which democracy is firmly in place and a free market economy is widely accepted as naturally the most effective economic growth mechanism due to an “invisible hand” that leads to efficiency as a result of abundant competition, as Adam Smith described it. The lack of this kind of competition throughout Latin America in the 1970s under the command economies of populist regimes (most notably in Mexico and Brazil) led to a perpetual cycle of inefficiency, low productivity, and low innovation. Ideally, then, to obtain steady growth contrastingly and successfully, the level of democracy must not only be thorough and firmly in place without threat of coup or overturn at any moment, it must also be free of corruption. This is necessary because without faith in the stability in the workings and durability of the nation itself, it is almost impossible to invest and embark in business ventures confidently. This is clearly evident in the cases of Venezuela and Bolivia and it is also exactly what had prospective investors and current stakeholders spooked in Mexico on the bridge of the 2006 elections. Secondly, the economic openness of the country must be thorough as well. This can be extended from a country’s acceptance and embracement of international trade agreements such as NAFTA to participation in the WTO to the protection of property rights in the country. Take, for example, the case of Venezuela compared to a country like Canada. Let’s say that an American entrepreneur wants to
  4. 4. set up a revolutionary kind of manufacturing plant and has narrowed down his or her options to Canada and Venezuela. Whether or not the deal is enticing and there could be a once in a lifetime market niche waiting to be exposed in Venezuela, based solely on what the entrepreneur has been hearing lately about how Hugo Chávez has been confiscating private property for the collective good in Venezuela and assuming that the entrepreneur is pretty familiar with Canada’s economic openness and outlook on the protection of property rights, it should be without doubt or hesitation that the entrepreneur chooses Canada over Venezuela because of the very likely risk of having everything taken away without warning or compensation in Venezuela. An example like this effectively demonstrates the importance of the protection of property rights in determination of international markets. The elementary breakdown of the economic problems in Latin America can be traced to two partly related factors: the lack of long-term commitment to the free market system; and the historical high risk of Latin American investment. The former was very evident throughout this case study as Latin American countries at the beginning of the century seemed to be very open to international markets and seemed to follow the Heckscher-Ohlin Theory of international trade in that they naturally began to focus on and export according to the factor endowments that locally were abundant (beef, coffee, copper, oil, and rubber). This international participation, however, was short lived and fluctuations back and forth between free market and command economies drove foreign investment and economic progress away never giving a long enough chance for the “invisible hand” of the free market to bring productivity, efficiency, and growth. This is not irrational to assume considering that the United States did not become an economic superpower with its free market economy overnight after it won its independence. Actually, to the contrary was true. It took years of commitment to its free market economy and dedication to its firm
  5. 5. democracy to gain international economic relevance. The latter factor, which is partly influenced by the former and also influenced by the accompanying factors of the former (the political turmoil counter conducive to economic growth) led to increasingly higher rate of cost to invest in Latin American countries and businesses. Eventually, the point was reached where not enough direct foreign investment was coming in and growth could no longer be achieved simply because it was too risky of an investment in the Latin American countries. Therefore, such claims by populist leaders such as Hugo Chávez that free market economic policies are the source of Latin America’s economic problems are irrational and don’t pay due respect and chance to the fact that sustainable long-term economic growth cannot come overnight. A second question that has been asked is why have some Latin American countries comparatively done so well in implementing liberal economic reforms (such as Chile)? The answer lies in a few factors. Firstly, out of all the countries in the study Chile ranked second in GNI per capita with PPP Atlas. This translates into more purchasing power for Chileans and therefore a higher demand for a free market economy where they as consumers can drive market forces with their demand. Secondly, Chile is ranked highest in political rights and civil liberties. This obviously shows the presence of a firm democracy and furthermore, as it was shown in the case study, this firm democracy as a whole seems to agree quite well on the direction of the country and the economy. This is seen in the fact that the Chilean people democratically chose to elect President Michelle Bachelet and her party as the majority in both the Senate and the Chamber of Deputies, thereby reducing political friction and facilitating the progress of the nation. Based on all the factors that have been presented in this case, therefore, clearly two Latin American countries stand out as having the highest and lowest political risks for international businesses. The highest political risk country in Latin America is Venezuela. With the highly
  6. 6. centralized populist totalitarian government of Hugo Chávez that has increasingly stepped away from international markets and pushed foreign investors and businesses away it comes as no surprise that it has become the riskiest country in which to invest. Contrastingly, the Latin American country with the least political risk is Chile. With high levels of firm and stable democratization and effective economic policies that allow the free market to rule, it is evident that it is currently the most attractive Latin American country in which to invest.