Working Papers

Regional trade agreements and South-South FDI: potential benefits and challenges for SACU-MERCOSUR investment relations

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25 May 2010

Author(s): Nicolette Cattaneo

In December 2004, the countries of the Common Market of the South (MERCOSUR) and the Southern African Customs Union (SACU) signed an initial preferential trade agreement (PTA) as a step towards the eventual formation of a free trade area. The PTA was expanded and consolidated during subsequent negotiations that took place between 2004 and 2008, and the new agreement was signed by SACU ministers in April 2009 and MERCOSUR in December 2008. Trade between SACU and MERCOSUR is currently a small proportion of each bloc’s total trade, and the rationale for the PTA rests more on trade and investment potential, as well as on the growing trend towards intensifying South-South trade and investment cooperation.

The potential benefits of foreign direct investment (FDI) for middle-income developing countries are well-known, and include technology transfer, acquisition of managerial and other skills, as well as job creation, the provision of capital needed for investment and growth, foreign exchange and balance of payments benefits, increased competition and possible access to export markets and global production-sharing networks. FDI is particularly important in countries with low domestic savings rates, such as South Africa and Brazil. However it is recognised that the benefits of FDI for development depend on the type of investment and its motivation. Indeed, the purported developmental benefits of inward FDI have been widely questioned, as FDI flows may have inappropriate or negative effects on the host economy. Certain types FDI may encourage low value added activity, little spending on plant and equipment, and offer weak prospects for employment creation. Beneficial technological spillovers may be limited and large dividend remittances could offset potential balance of payments benefits. As opposed to encouraging competition in host country markets, multinationals may exert market power in commodity supply chains to the detriment of domestic producers and consumers.

South-South investment flows have grown significantly in the last two decades in response to greater financial integration, rising wealth and rapid industrialisation, reductions in foreign aid and the proliferation of developing country regional trade agreements, preferential trade and investment accords and bilateral investment treaties. This paper explores the potential development benefits of South-South FDI and considers how such investment is to be promoted to exploit these benefits. In particular, the paper considers whether RTAs and PTIAs could be useful vehicles for increased investment cooperation of this kind. Against this background, the paper goes on to explore the levels, growth and structure of FDI in South Africa and Brazil and, in the light of this, considers the implications of intensified South-South FDI between SACU and MERCOSUR for the development and diversification of the SACU region. The paper’s focus on South Africa and Brazil rests on these countries’ economic prominence in their respective blocs. Further, low domestic savings rates suggest that FDI is likely to be of particular importance in each country, and that the prospects for expanding bilateral FDI flows may be weak in the absence of appropriate accompanying policies.

The paper finds that there could be potential for the promotion of FDI related to production networks and other sectors that are important for manufacturing trade between South Africa and Brazil. Research is needed on the comparative industrial and manufacturing export structures of the two countries to identify sectors of importance for bilateral investment promotion, such as food processing, pharmaceuticals and autos. In this regard, information on the sectoral structure of current bilateral FDI flows between the two countries at the manufacturing subsector and firm level is necessary. In addition, some significant FDI flows have been related to the growth of the services sector, particularly in finance, insurance and business services, wholesale and retail trade, and transport and communications. A framework for investment cooperation between SACU and MERCOSUR should explore ways in which to harness the benefits for development from FDI flows related to the services sector. In this regard, SACU could draw on the experience of Latin American countries, where services provisions of South-South regional cooperation agreements have proliferated.

Regarding the role that regional integration has to play in the promotion of South-South investment flows, theory suggests that the trade provisions of a PTA between SACU and MERCOSUR could, on their own, potentially promote FDI between the two regions, depending on the motivation for existing and new flows between the blocs. In addition, the prospects for increased FDI flows could be improved in the presence of explicit investment provisions in a PTA, even if such provisions simply provide a framework for investment cooperation without major disciplines. Given the small size of current bilateral flows between South Africa and Brazil, it is likely that investment relations between SACU and MERCOSUR would benefit from the inclusion of an investment framework in the PTA in the future. The IBSA Trilateral Development Initiative could be an important platform from which such investment provisions could be formalised. The more extensive experience of Latin American countries in South-South PTIAs would be useful to investigate in this regard.


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