Foreign direct investment in Latin America
Good news for inequality and poverty?

Latin American countries began to open up to trade and foreign direct investment (FDI) in the mid 1980s. This led to a dramatic increase in FDI in the region until the late 1990s. Inequality in Latin America has remained consistently high and progress in poverty reduction has been slow in the last decade.

Recent research by the Overseas Development Institute has examined how FDI affects the distribution of income and wages of skilled and less skilled workers in particular. Poor people are more likely to gain when less skilled workers gain. FDI can affect product markets with consequences for income distribution, for example when foreign firms introduce new products favouring specific groups or when previously publicly-owned monopolies are taken over by foreign firms with fewer or no social objectives. Other – sometimes opposing – effects work through the labour market:

• FDI can lead to the introduction of new and skill-biased technologies (such as electronic firms in Costa Rica), which can increase wage inequality.
• FDI may affect skill-specific wage bargaining. While skilled workers possess key skills enabling them to negotiate higher wages, less-skilled workers – in the Central American garment industry, for example – frequently experience relatively poor industrial relations because foreign – Asian in particular – firms threaten to locate elsewhere.
• Foreign firms tend to locate in skill-intensive sectors or skill-intensive segments within sectors as was the case in the Mexican maquila industries which process imported goods for re-export. This improves the relative demand for and wages of skilled workers.
• While foreign firms generally offer more staff training than their local counterparts, after controlling for other factors such as size, much of this training benefits mostly skilled workers.

FDI and inequality

New empirical evidence shows that FDI did not have an inequality-reducing effect in Latin America. There are possible exceptions, such as Colombia, but even here FDI may have played a relatively minor role in reducing inequality. On the contrary, there are indications that FDI may have increased wage inequality in Bolivia and Chile.

Policy responses

Government and business policies can affect the link between FDI and income inequality. Policy responses are required to improve the developmental impact of FDI. These responses may be most effective when there are benefits for both business and host country development:

• Governments need to gear the quantity and quality of basic education towards areas of economic expansion and the needs of Transnational Corporations (TNCs) – those already established and those considering where to locate themselves. TNCs are more inclined to train their workers when workers have a good and appropriate basic education.
• Governments also need to consider providing incentives (such as public-private partnerships in training, subsidies, taxes and standardisation) to bolster the training of less-skilled workers.
• Both TNCs and local communities desire local infrastructure appropriate to their needs as well as the good health of the communities. While governments may have limited funds, it makes economic sense for TNCs to provide these social goods on a limited scale. Hence, joint action between TNCs and governments or donors may benefit the area as a whole, as occurred with the Inti Raymi gold mine in Bolivia.
• Governments may want to support linkages between TNCs and local firms in a market-led way through matching local suppliers with TNCs and upgrading the basic capabilities of local firms (for example, Costa Rica).

Dirk Willem te Velde
Overseas Development Institute
111 Westminster Bridge Road
London SE1 7JD
UK

T +44 (0)20 7922 0319

dw.tevelde@odi.org.uk

See also

‘Foreign Direct Investment and Income Inequality in Latin America: Experiences and Policy Implications’, International Economic Development Group, ODI, by D.W. Te Velde, 2003
www.odi.org.uk/iedg/Meetings/FDI_feb2003/FDI_Programme.html

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