Regional integration and foreign direct investment: The case of Argentina's food sector

Lucio Alejandra Reca, Purdue University

Abstract

Unilateral trade reforms and establishment of Mercosur led to increasing foreign direct investment (FDI) into Argentina. These inflows financed acquisition of new capital and/or renovation of existing plants, resulting in significant expansion in Argentina's capital stock and more rapid economic growth. It is argued that effects from FDI exceed those from capital accumulation and include efficiency gains from improved resource allocation and higher factor productivity. This study examines interactions between trade reforms and FDI in Argentina using an applied general equilibrium (AGE) model. We allow allocation of FDI to be determined endogenously and account for the effects of capital accumulation. Efficiency gains are modeled through exogenous changes in factor productivity, and by alternative assumptions on the rules determining sectoral and regional allocation of FDI flows. Given these features, our empirical estimates of trade reform impacts are systematically higher than those obtained under more standard AGE specifications. These results resemble more closely the transformations actually observed in Argentina since Mercosur's inception. This parallel calls for both inclusion of long term effects and consideration of changes other than just relative prices when examining trade liberalization and regional integration in an AGE context. Contributions of this study are twofold. First, we provide empirical evidence showing that appropriate treatment of FDI in AGE models calls for its endogenous determination, long run specifications, and an allocation rule based on rates of return. Second, we provide empirical estimates of the effects of trade reforms, regional integration and resulting FDI on Argentina's economy, and on its agricultural and food processing sectors in particular. These sectors show the larger output and export increases from reductions in trade barriers and especially from elimination of export taxes. In the short run, establishment of Mercosur only leads to marginal gains over those attained from unilateral reforms, but in the long run additional gains resulting from higher investment inflows and capital accumulation are significant. The additional gains from productivity improvements outweigh those from the larger capital stock. This case shows that to realize the benefits from trade reforms and regional integration, government policy in developing countries should facilitate FDI inflows.

Degree

Ph.D.

Advisors

Abbott, Purdue University.

Subject Area

Agricultural economics|Finance

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