Direct investment and welfare: an empirical investigaion of economic integration in less developed countries when foreign firms are present (Andean Case)

This study has two purposes. The first is to estimate traditional welfare effects of economic integration for the Andean Pact. The second purpose is to extend this analysis to take into account cost and benefit effects of direct foreign investment by foreign-owned firms. Estimates of trade creation and trade diversion are performed by using two different procedures (growth rate in imports and growth rate in import/ consumption ratios) and two different sets of normalizers.

Results indicate the traditional welfare effect in Andean Pact countries during the 1969-1977 period resulted in a welfare increase of $2200 million on the average for 1977. This finding is consistent with that of other studies. When effects of direct investment by foreign-owned firms are considered, welfare effects are reduced noticeably.

Conclusions reached in this study suggest two sets of policies aimed at raising welfare. First, the Andean Pact should attract new members and attempt to achieve an equitable distribution of benefits among members. Second, members should take a more favorable attitude toward direct foreign investment and should exercise control to obtain a fair share of foreign firms' gains. This could be achieved through regulations to preserve member benefits, by instituting specific performance requirements, by engaging in more joint domestic-foreign ventures, and through encouraging more usage of local inputs.