Over the past decade, increased trade with China has helped fuel Latin America's economic growth. The country's demand for commodities has made Beijing the main trade partner of some of Latin America's biggest economies, including Brazil, Chile and Peru. China's growing presence in the region, particularly in South America, has raised alarms in Washington, which historically has considered Latin America its backyard. But to look at international trade alone would be to misrepresent the situation. When trying to understand Latin America's complex economic structures and international relations, foreign direct investment (FDI) is one of the most important indicators to consider.
Last month the United Nations Economic Commission for Latin America and the Caribbean released its annual report on FDI in Latin America. The report's data show that more than 53 percent of the total FDI in the region in 2016 came from the European Union, while 20 percent came from the United States. China, on the other hand, contributed only 1 percent. Total FDI in the region dropped 7.9 percent in 2016 compared with 2015, to $167 billion. And though at first glance, the drop may appear linked to the dip in global commodity prices that has hurt the region's economic growth, it doesn't fully explain the region's FDI performance. In Brazil, for example, FDI increased almost 6 percent in 2016, despite a 3 percent decline in the country's gross domestic product. Commodities play an important role in most Latin American economies, but they are not the main attraction for the many foreign companies and individuals investing in the region.
Brazil and Mexico Dominate
Two-thirds of the total FDI in Latin America in 2016 went to Brazil and Mexico, the countries with the largest economies in the region. Brazil drew more than twice the amount of FDI that Mexico pulled in last year, at $78.9 billion, an impressive achievement considering that its economy was in the second year of a recession and its government in the throes of an impeachment.
Brazil, home to one of the world's 10 largest economies, has a large domestic market of more than 200 million people. Exports, in fact, make up less than one-tenth of its total GDP. Most of the foreign companies investing in Brazil are interested not in the country's exports of raw materials such as iron ore, soybeans, sugar and coffee but in its domestic potential. Of the money foreign entities poured into the South American nation in 2016, 46 percent went to the services sector and 38 percent to the manufacturing industry. Mining and hydrocarbon production accounted for most of the rest. Brazil's large domestic market will continue to attract FDI in the country, not its export potential. And its burgeoning trade ties with China notwithstanding, Brazil received more than 70 percent of its total FDI in 2016 from the European Union.
Mexico, by contrast, relies more heavily on exports, which represent more than 20 percent of its GDP. Nearly half of the $32.1 billion in FDI that Mexico brought in last year went to its manufacturing sector. The automotive industry traditionally has been one of the leading industries in the country, since foreign automakers can efficiently move their products onto the U.S. market from assembly plants in Mexico while avoiding import tariffs. (Should U.S. President Donald Trump push for stricter rules of origin or higher tariffs during negotiations to update the North American Free Trade Agreement, the interest in Mexico's auto industry could wane.) Given its proximity to and close trade ties with the United States — the destination for 83 percent of Mexican exports — Mexico is a magnet for U.S. investment. The country's northern neighbor topped the list of its foreign investors in 2016, kicking in 38 percent of all FDI. The European Union was only a few points behind, however, at 31 percent.
The Cost of Commodities
Compared with Brazil and Mexico, Chile's ability to attract FDI is tied more closely to commodity prices. Exports are a vital component in the Chilean economy, making up nearly one-quarter of the country's GDP. Because of Chile's reliance on exports, and its small domestic market, FDI in the South American state is volatile. Foreign investment in the country fell by more than 40 percent in 2016, a bad year for prices on commodities such as copper, one of Chile's economic mainstays. The drop cost the country its title as Latin America's third-largest recipient of FDI.
To compensate for its reduced commodity revenues, Chile has been trying to diversify its economy and is pushing to attract investment in renewable energy projects. Its efforts seem to be paying off; alternative energy initiatives drew 33 percent of FDI in the country last year. Still, between Chile's small market, its distance from the region's major economies and its economic dependence on copper, FDI in the country will continue to fluctuate.
Paying the Price for Politics
Argentina, meanwhile, offers a classic example of how politics can ward off investors. The country boasts Latin America's third-largest economy, but it came in behind Chile and Colombia in total FDI in 2016. Despite high hopes that President Mauricio Macri would improve the business climate, Argentina still struggles to attract levels of FDI commensurate with its economic clout because of the previous administration's policies. Restrictions on foreign currency, for example, proved a significant barrier to FDI because investors had a tough time sending profits back home. The economic problems in Brazil, Argentina's main trade partner, have only compounded its plight.
Since taking office in December 2015, Macri has fulfilled some of his promises to make the country more attractive for investors by lifting foreign currency restrictions, cutting red tape on imports and moving away from nationalization plans. Nonetheless, foreign investors will be wary of investing in Argentina until its government enacts measures to reduce labor costs and tax rates. The country attracted only $4.2 billion in FDI last year, less than one-third of the amount Chile pulled in.
China Faces a Learning Curve
Regardless of their economic and political differences, these countries have at least one thing in common when it comes to last year's FDI performance: China's investments in each state still pale in comparison with those of the European Union and United States. Unlike their European and U.S. counterparts, which have a long history in Latin America, Chinese companies have only recently started to establish operations in the region. But China is starting to spend more money in Latin America, and in the next couple of years, its investments in the region will significantly increase. Brazil's need to attract investments for its infrastructure projects, for example, will give Beijing an opportunity to increase its presence there; already China has invested heavily in electricity assets in the country, as well as in Argentina. Chinese investments in Brazil may exceed $20 billion this year.
Even so, European and U.S. companies such as Volkswagen AG, Nestle, General Motors Co. and Ford Motor Co. have been established in most of Latin America for decades and have consolidated their brands in the region. As a result, they will have little trouble expanding their activities in Latin America, while Chinese companies still face a learning curve ahead of them before they can strengthen their hold on the region's main domestic markets. In addition, the European Union's advanced trade negotiations with the Common Market of the South, or Mercosur, could facilitate greater investment between the blocs. Though China's investments in Latin America are likely to grow, it will be a long time before Beijing can edge out the European Union and the United States as the region's top investors.