FDI and its Economic Impact on Brazil

International ECON

5/8/2013

Megan Betz

Kenny Halleran

Colleen Reeping

Adam Scherer

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Foreign direct investment (FDI) is modeled as the movement of capital between

countries. There are two types of FDI, Greenfield and Acquisition. Greenfield is when a

company builds a plant in a foreign country, while Acquisition is when a firm buys an existing

foreign plant. The U.S. Department of Commerce defines FDI as occurring if acquiring ten

percent or more of a firm, inflow or outflow. Brazil has the third largest amount of FDI in the

world.

We want to first examine why Brazil has been able to attract such a great amount of FDI,

including when and why investors chose and are choosing their country. From there, allude to

the theory behind how these FDI inflows to Brazil should impact their economy. This will be

based on Feenstra and Taylor’s textbook, International Trade. We then will review researched

past studies on the topic and relate what the studies have found to the theory from the textbook.

Then, through our own research and data collecting and analysis, we will compare the theory and

past studies to data, growth indicators, and trends in Brazil. From this, we will be able to draw

our own conclusions on the economic impact of FDI on Brazil.

In the 1980’s Brazil went through a debt crisis that took them off of the FDI map.

However, in the early 1990’s Brazil was able to make the shift from import substitution to

economic liberalization that enabled industrialization. Tariffs and non-tariff restrictions were

liberalized and FDI inflows began to pour back into the country. Because this was the time

period of such drastic inflows, we are going to focus our data analysis on this time period and

beyond. Brazil’s market size was another contributor to making it a destination for FDI, having

the fifth largest population in the world at just over 200 million people. Other contributing

factors include location, investors return for their capital, literacy rates, and a more developed

industrial base relative to other developing third world countries.

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We begin with the theory of what to expect from an increase in capital stock in the short

run, specific factors model. Manufacturing uses capital and labor, while agriculture uses land

and labor. As capital moves into the economy, it will be used in the capital intensive industry,

manufacturing. This will shift out the manufacturing curve. Equilibrium wage increases to W’,

and as more workers are drawn in to manufacturing, the labor in agriculture shrinks as the labor

is pulled from there. Since land has not changed, output of agriculture must fall. Since labor and

capital increase in manufacturing, their output must increase. The production possibilities

frontier increases and equilibrium shifts to point B. Both real rentals on land and capital will

fall.

For the long run, we will use the theory from the Hecksher-Ohlin model. An increase in

capital expands the graph upward, and because capital-labor ratios are unchanged, the wage and

the rental on capital are also unchanged. Change in output is from A to B in the graph. As the

Rybczynski Theorem states, the increase in capital through FDI has increased the output of the

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capital-intensive industry and reduced the output of the labor-intensive industry. The change in

output is achieved with no change in the capital labor ratios in either industry. This long run

result is what we are going to focus on in our data analysis.

The following figure then shows the gains from foreign direct investment on the world

market. As capital enters Foreign, the margianl product of capital will fall, as will its rental. As

capital leaves Home, the marginal product will rise, as will the rental. Equilibrium with full

capital flows is at B, where rentals are equal at R’. Gains to Home from capital outflow is then

triangle ABD. Gains to Foreign is the triangle A*BC. Thus, world gains are A*BA

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Over the past several years, Brazil’s economy has been growing with marked growth in

the sectors comprising the world market: crop, livestock and mineral extraction; industry; and

services. Brazil’s inflow of FDI exceeds that of several other South American and developing

countries with “a compound annual growth rate of 20%” throughout “the past seven years (a

period chosen to coincide with conditions of stability in both the economy and the currency)”

(“Cartesian”). Inflows of capital over the specified period led to results consistent with the

Rybczynski Theorem, which states that the output of the economic sector whose good uses

capital intensively will increase while the output of the other sectors that do not use capital

intensively will decrease. The article we cite entitled “The Evolution of FDI in Brazil” suggests

that not all aspects of Brazil’s inflow of FDI benefit its overall economy. A few problems

involved in foreign investment exist and may actually be impeding internal Brazilian growth in

the long run, according to the article; the author of the article, however, offers a practical

solution to this dilemma.

“Brazil’s growing net recipient position furthermore seems to indicate a path of continued

growth, with no plateau in sight, and

FDI seems to be positively

correlated with development”

(“Cartesian”). “On a per capita basis

Brazil surpasses all other BRIC

countries in terms of FDI flows over

the last four years” (“Cartesian”;

related graph also from

“Cartesian”).

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“A breakdown of FDI flows in Brazil indicates that the increase in net FDI is fueled

mostly by an increase in inflows – exhibiting a 25% compound annual growth rate since 2003. In

contrast, net FDI inflows expressed as a percentage of GDP have remained relatively stable over

the period, hovering between 2% and 2.5%. While FDI is not the sole fuel of the Brazilian

economy’s growth over the period, the above mentioned statistics seem to indicate a strong

correlation between inflow of foreign investment and Brazilian growth,” relating to development

and “income growth” (“Cartesian”). “Neoclassical growth literature, in which FDI inflows are

shown to exert a positive influence in developing countries by increasing capital, as well as

having the possibility of qualitatively improving the labor factor, and raising total factor

productivity by transferring new technologies” reinforces what has been concluded: that FDI is

very important in terms of Brazil’s economic growth (“Cartesian”).

After reaching this conclusion about FDI’s importance, the article dissects each of the

three main economic sectors of Brazil’s economy: crop, livestock and mineral extraction;

industry; and services. Each sector has a certain share of FDI, leading to a somewhat uneven

distribution in the economy. Out of the three competing sectors in Brazil’s economy, the industry

sector “has overtaken services as the dominant recipient of foreign direct investment inflows”

(“Cartesian”). To prove how narrow the investment stream in the industry sector is, the article

reports that only a small portion of FDI inflow recipients – “the top five” – receive “over 75% of

the total capital inflows to industry,” leading to an uneven distribution of growth from

investment (“Cartesian”).

On the opposite side of the coin and of particular interest are Brazil’s industries in metal,

oil, and chemicals. These industries have benefitted the most from “changes in capital

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distribution,” and they exemplify the Rybczynski theorem in that each is “principally export

oriented and capital intensive” (“Cartesian”).

Instead of adding to the boost in Brazil’s economy, insufficient “education, R&D

and infrastructure may prove an obstacle in fully reaping the benefits of foreign direct

investment” (“Cartesian”). Additional downfalls affecting the utility of Brazil’s FDI inflow are

the uses of FDI, as delegated by Brazil’s government, which are probably not being used

optimally, creating gaps in productivity. In hopes of providing some advice on the topic, the

article suggests that “to the extent that it is possible, the Brazilian government should introduce a

federally coordinated targeting plan for FDI,” which could lead to “the capture of positive

spillovers from FDI” (“Cartesian”).

The study Foreign Direct Investment and Home Country Political Risk: The Case of

Brazil published in the "Latin American Research Review" was conducted by the United Nations

Conference on Trade and Development (UNCTAD) and examines about 180 countries. The

authors point out that “Brazil clearly stands out in the spectrum of countries attracting large

amounts of [foreign direct investment] (FDI) in recent years, having consistently captured since

the mid- 1990s, more than 10 percent of the world’s FDI flow of emerging markets and

becoming the recipient of about half of Latin America’s FDI inflow” (Aguiar, 147). This further

supports our data about how FDI is continuing to be strong in Brazil. Also explains why Brazil is

one of the top countries in receiving FDI other than China. They go on to explain that this is

because countries are bringing the foreign direct investment into Brazil. “According to 1995 data

on FDI stock, the United States was Brazil’s leading investor over the years, accounting for 28

percent of the total FDI stock, followed by

German (10.8 percent), Japan (9.6 percent) and

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Figure 1

Switzerland (6.6 percent)… In 2001, a mere eleven countries accounted for about 90 percent of

foreign investment in Brazil” (Aguiar, 148). They highlight that in 2005 Netherland has gone

past the United States in being the top country to have foreign direct investment coming into

Brazil (see Figure 1).

Another study done by Organization for Economic Co-Operation and Development

(OECD) sheds light on incentives that have based competition for foreign direct investment in

the case of Brazil. The study points out that “A recent study prepared under the auspices of the

OECD Committee on International Investment and Multinational Enterprises concluded that FDI

generally supports growth in developing, emerging and transition economies, irrespective of

their initial state of development” (OECD, 02). This quote will further our data that we found in

the Data Analysis. The next quote “Where policies in the past aimed at using foreign investors as

a tool for import substitution or boosting exports, it is increasingly recognized that foreign

corporate presence tends to boost both imports and exports by giving the host location better

access to the investors’ global network” (OECD, 02). This further explains the benefits of

foreign direct investment on the increase number of exports coming into the country. ”Foreign

corporate presence is capable of producing significant spillovers to the local business sector. The

two areas where this channel seems to be particularly strong are technology transfer and human

capital formation” (OECD, 02). As was said above the spillovers are not as great so little

spillover means better outcomes.

In 1995, Brazil began to experience significant Foreign Direct Investment (FDI) inflows.

The increase in FDI has improved economic conditions in the country since then, as can be seen

by examining several different economic indicators and their correlation with the inflows of

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capital that Brazil receives. Brazil’s Gross Domestic Product (GDP) has mirrored the trends that

can be seen in FDI inflows. The following graphs show this comparison:

There have been peaks and valleys in the amount of FDI that Brazil has received since

1995, but the overall trend has been a steady increase. This same trend can be seen in the graph

of Brazil’s GDP. Especially noticeable is the steep upward slope that occurs in both graphs from

2003 onward. Around 2008, there is a steep decline in FDI inflows, and this is reflected in the

less drastic decline in the GDP graph during the same time period. This temporary decrease was

most likely the result of the financial crisis that affected most of the world, including countries

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that significantly invest in Brazil, such as the United States. Excluding this period, both graphs

show steady increases from 2003 until 2012.

The increase in FDI inflows leads to an increase in exports, which theoretically explains

at least some of the GDP growth that has occurred. The graph below compares FDI inflows, as a

percentage of GDP, to Brazil’s exports, also as a percentage of total GDP:

19931995

19971999

20012003

20052007

20092011

0

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4

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Brazil BRA Foreign direct in-vestment, net inflows (% of GDP) BX.KLT.DINV.WD.GD.ZSBrazil BRA Exports of goods and services (% of GDP) NE.EXP.GN-FS.ZS

The reason that there is a correlation between FDI inflows and exports is that the inflow

of capital allows companies to produce goods more efficiently, therefore leading to an increase

in comparative advantage since the opportunity cost of producing any good will decrease as it

can be produced more efficiently. When analyzing this graph, it is important to notice the lag

that occurs between an increase in FDI inflows and an increase in exports. This is most likely a

factor of production delays since there can’t be instantaneous increases in efficiency as soon as a

firm begins receiving more capital. There will be a period of time, such as when factories are

being constructed, that exports will not be affected because increased productivity has not

occurred yet. When FDI inflows increase year-over-year, there is usually a corresponding

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increase in exports within a couple of years. The same trend occurs when inflows decrease in

comparison to previous years.

Another economic indicator that appears to be correlated with FDI inflows is the

education of the workforce. As the workforce becomes more educated, it will become more

skilled. This leads to increased productivity among workers. The following graph shows the

change in the education levels of the Brazilian workforce from 1992 until 2007:

During the time period from 1995 until 2007, coinciding with the significant increase in

FDI inflows, the percentage of the total workforce with a primary education nearly tripled,

increasing from 14 percent to 41 percent. The percentage of the total workforce with a

secondary education more than doubled, increasing from 14 percent to 31 percent. Along with

increased efficiency from worker productivity, a more skilled workforce also allows for an

increase in technology among domestic firms, as they become capable of implementing the types

of technology that are used by companies from more developed countries. This leads to

additional efficiency gains from the increased use of technology.

It is important to note, at this point, that not only did FDI inflows in Brazil increase

beginning in 1995, but most of the investments were targeted at the industrial and services

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sectors. For example, in 2010, the petroleum sub-sector received FDI inflows of 11,041,900,000

U.S. dollars. The mining and quarrying sub-sector received FDI inflows of 6,590,700,000 U.S.

dollars. The hotels and restaurants sub-sector received FDI inflows of 128,300,000 U.S. dollars.

All three of these sectors are considered industrial or service-based, and are considered capital-

intensive industries. By comparison, the textile/clothing/leather sub-sector, which is labor-

intensive, received negative inflows totaling 122,800,000 U.S. dollars. This trend holds true for

most other sub-sectors as well, as those that are relatively labor-intensive have been targeted less

than those that are capital-intensive.i

As was previously discussed, according to the Rybczynski Theorem, an increase in

capital inflows should lead to a shift in the workforce from labor-intensive industries to capital-

intensive industries. It should also lead to increased productivity in the capital-intensive

industries compared to the labor-intensive industries. As the graphs on the following page will

demonstrate, both of these effects were evident in Brazil. Over the time period that FDI inflows

increased, the percentage of the total workforce employed in the agricultural sector decreased

from 26 percent, in 1995, to 17 percent, in 2009. Industrial employment during this time period

increased from 20 percent to 22 percent, and employment in the services industry increased from

54 percent to 61 percent. As the first graph shows, jobs shifted directly from the labor-intensive

agricultural sector to the capital-intensive industrial and services sectors.

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The second graph shows the output of the three sectors. While each sector’s output

increases as a whole, the capital-intensive sectors should increase more than the labor-intensive

sector, which can be seen by comparing the slopes of the lines in the graph. The graph clearly

shows that Brazil is consistent with the Rybczynski Theorem because output does increase more

rapidly in the capital-intensive sectors that are being targeted more heavily by foreign

investment.

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Also of interest when analyzing the effects of FDI are indicators that attempt to measure

the well-being of the population as a whole. The following graphs demonstrate improving

standard-of-living conditions that coincide with the increase of FDI:

The first graph above suggests that the middle class has grown significantly since

substantial FDI began. The percentage of total income held by the top 20 percent of earners

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decreased from 64 percent in 1995 to about 59 percent in 2009. The middle 60 percent of

earners gained about 4 percent over the same period, and the lowest 20 percent gained close to 1

percent. Although there are many factors that must be considered when analyzing people’s

overall well-being, the fact that the middle and lower classes are making gains relative to the

upper class suggests that the inflow of FDI could be having a positive impact on the population

as a whole, and not just those who earn the most money, since a healthy middle-class is generally

considered important to a strong economy. Although it is not included in a graph, a Forbes

article from March 2012 stated that real wages in Brazil from February 2011 to February 2012

increased by 6.5 percent, while the unemployment rate remained at record lows. This

information also suggests that the people of Brazil are becoming increasingly better off.ii

The second graph above shows the Human Development Index. The Human

Development Index is another way of attempting to measure the well-being of a population and

takes into account education, health, and income. Brazil’s HDI has increased at a faster rate

since 1995 than the world average and the regional average. This also suggests that the inflow of

capital to the economy could be positively affecting the standards of living in the country.

A final factor important to FDI is whether foreign investment crowds out domestic

investment. If foreign investment is simply replacing domestic investment, it will not be as

effective as if there is a balance between the two. The following graph measures foreign

investment in Brazil versus domestic investment (Gross capital formation), as a percentage of

total GDP:

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So far, the increase in FDI does not seem to have crowded out too much domestic

investment. While domestic investment has decreased, and appears negatively correlated with

FDI because domestic investment decreases more in the years that FDI increases, it has remained

in the same range that it was in prior to 1995 so there does not appear to be too much crowding

out of domestic investment yet. This is an important issue to monitor in the future, however, as

increasing FDI could eventually cause domestic investment to be crowded out. It will be an

interesting indicator to reevaluate after the World Cup brings increased foreign investment to the

country.

Analyzing current indicators in Brazil, along with theory of FDI, leads to the conclusions

that FDI inflows are positively correlated with GDP, and there is a possible positive correlation

between FDI and standards of living. So far, there has been a relatively small crowding out

effect, although this could become a problem in the future assuming significant FDI inflows

continue. Also, it is important to notice that Brazil has experienced shifts in employment and

output that are consistent with the Rybczynski Theorem for the long run effects of increased

capital inflows.

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Notes

i International Trade Centre. (2010). Investment Map- International Trade Statistics. Retrieved

from http://www.investmentmap.org/prioritySector.aspx?

selCtry=BRA&selInds=&selOpt=inward&selYear/

ii Rapoza, K. (2012, March 22). Real Wages Rising in Brazil; Demand on the Upswing. Retrieved

from Forbes: http://www.forbes.com/sites/kenrapoza/2012/03/22/real-wages-rising-in-brazil-

demand-on-the-upswing/

Bibliography

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Aguiar, SandraAguiar-Conraria, LuísGulamhussen, Mohamed AzzimMagalhães, Pedro C.

"Foreign Direct Investment And Home-Country Political Risk." Latin American Research

Review 47.2 (2012): 144-165. Military & Government Collection. Web. 7 May 2013.

OECD. "Incentives-based Competition for Foreign Direct Investment: The Case of Brazil."

OECD. Organisation for Economic Co-operation and Development, Mar. 2003. Web. 7 May

2013.

International Trade Centre. (2010). Investment Map- International Trade Statistics. Retrieved

from http://www.investmentmap.org/prioritySector.aspx

Rapoza, K. (2012, March 22). Real Wages Rising in Brazil; Demand on the Upswing. Retrieved

from Forbes: http://www.forbes.com/sites/kenrapoza/2012/03/22/real-wages-rising-in-brazil-

demand-on-the-upswing/

"The Evolution of FDI in Brazil." The Cartesian. The Cartesian, 10 Jul 2012. Web. 25 Apr 2013.

<http://thecartesian.com/?p=468

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