Thursday, December 20, 2012

FDI Undeterred: Argentina's Messy Investment Climate

. Thursday, December 20, 2012

Argentina's investment policies certainly have been in the news recently. In this past Monday's (Dec 17) WTO Dispute Settlement Body's meeting, the US, EU, and Japan requested an establishment of a dispute panel against Argentina. Concurrently, Argentina sought to establish dispute panels against the EU (Spain in particular) and the US. Australia and Turkey lodged a formal complaint that Argentina was trying to use the DSB for inappropriate purposes. (See more here)

For more context, the Kirshner government wrested control of YPL from Spanish energy giant Repsol this past May. In the ensuing fall out, Repsol sued the Argentine government in a U.S. court, President Obama revoked Argentina's preferential trade privileges, and Repsol filed arbitration paperwork at ICSID earlier this month. No one is too confident that Repsol is going to recoup any of its $10 billion investment, especially since Argentina probably hasn't paid out a single arbitorial award. Spain is also threatening to sanction Argentina and Repsol has publically stated it will seek damages from any corporation that subsequently enters production and exploration agreements with YPL.

Standard political theories of foreign direct investment rest on a central insight from obsolescing bargaining (OBM) - FDI is limited by the political risk that firms face when they sink investment in a foreign jurisdiction, thus becoming "captive" to a potentially predatory state that faces incentives to promise contract sanctity ex ante and then renege on these promises ex post. From this perspective, no multinational should want to invest in Argentina - the risk of expropriation is just too high. Tools designed to mitigate the problems associated with time inconsistency of preferences just are not working in the Argentinian case (i.e. - Argentina is not compensating firms for contract breach, despite rulings against it). Yet, my weekly update from the Economist Intelligence Unit includes a discussion about how large oil multinationals are rushing to invest in Patagonia's shale deposits. Multiple oil giants are in contract negotiations with the Argentine government to undertake production sharing agreements with the newly nationalized YPL. And, they are doing this despite Repsol's threat to go after these private corporations for damages associated with nationalization.

So, what is the standard OBM missing? Of course, firms have to care about many things besides political risk. Economic factors are the primary drivers of investment decisions; political considerations are largely secondary. In this context, big countries with large domestic markets and with rich endowments of lucrative natural resources typically can get away with a lot of things small countries without energy reserves cannot. This economic/geographic argument underpins Rachel Wellhausen's recent post on the permissive environment for Argentina's nationalistic investment policies. And, understanding the economic factors that provide governments' more bargaining power vis-a-vie investors certainly explains much of the deviation away from what OBM-based theories predict.

But, I think there is something else we need to consider - how firm and investment characteristics modify OBM dynamics. Some of my current research considers how firms are heterogenous in both the amount of political risk they will accept and how they define political risk. What do I mean by this? First, firm characteristics matter for how risk acceptant they will be. Some of the most interesting current work on FDI focuses on explaining these systematic variations. Daniel Blake argues multinationals view their subsidiaries as a portfolio of potential revenue streams, and within this holistic management conception, MNEs might be willing to sustain losses in one location as part of a larger strategy of gaining market share. Ben Graham argues that firms can learn how to manage political risk, and that some firms are uniquely positioned to manage such risks and therefore may specialize in locating in high risk countries. Together, both of these arguments fit nicely with EIU’s assertion that large oil companies are willing to take large bets in Argentina’s shale fields despite threats of nationalization. Indeed, such threats may benefit large energy multinationals because small firms are less able to manage these risks, depressing acquisition prices. This is an important point because it indicates that certain multinational firms will actually benefit from nationalistic policies!

While a bit further afield from the Argentine case, I also argue firms vary in how exposed they are to the threat of government interference. Firms that enter countries through privatization of utilities and infrastructure as well as firms that engage in resource extraction on government land are more vulnerable to government interference than are manufacturing firms. Right now, I'm working on a project that shows that bilateral investment treaties (treaties specifically designed to overcome OBM problems) have differential effects on different modes of entry for FDI. The point here is that BITs may help attract FDI for privatization much more than FDI for private sector M&As or greenfield investment. Since there is some evidence that mode of entry matters for contributions to economic growth, this insight has important investment and development policy implications.

2 comments:

Emmanuel said...

Methinks this CPS article I have used while teaching political risk analysis sheds light on the subject matter. In essence, the likes of Argentina expropriate anyway since they believe their natural resources are too attractive for foreign investors to stay away from for far too long:

There is a growing literature on how natural resources affect both economic performance and political regimes. In this article the authors add to this literature by focusing on how natural resource wealth affects the incentives of governments to uphold contracts with foreign investors across all sectors. They argue that although all states suffer reputation costs from reneging on contracts, governments in natural-resource-dependent economies are less sensitive to these costs, leading to a greater probability of expropriation and contract disputes. Specifically, leaders weigh the benefits of reneging on contracts with investors against the reputation costs of openly violating agreements with firms. The authors’ theoretical model predicts a positive association between resource wealth and expropriation. Using a data set from the political risk insurance industry, the authors show that resource dependent economies have much higher levels of political risk.

Sarah Bauerle said...

Emmanual,

Thanks, yes, there is a lot of work being done on FDI in natural resource dependent economies. The Jensen & Johnston piece you mention is a good example of work that probes government incentives in such environments. But, my point is more about firm behavior, which is not their analytical focus. Their central finding is that political risk in natural resource-rich countries is higher than in countries without such resources, but that doesn't say anything about what firms do with that information. (To be clear, I think their work is good, I'm just asking a slightly different question here.)

FDI Undeterred: Argentina's Messy Investment Climate
 

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