Proceedings of the 2009 Industrial Engineering Research Conference

A Multiple Criteria Decision Analysis for the FDI in Latin-

American Countries
Levis R. Cabrera, Germán E. Giraldo
Department of Industrial Engineering
University of Puerto Rico, Mayagüez, Puerto Rico 00680, USA

Abstract
The interest of Foreign Direct Investors in Latin American countries is growing rapidly; in the period of 1992-2006
the Foreign Direct Investment (FDI) has tripled, from US$27,500 to US$72,440 millions. Investors have the
challenge of deciding which country is better for their investments. The problem of selecting a country to invest in is
a common topic in the current economic environment. In this study, an analytical hierarchical process (AHP) is used
to help investors make a rational decision. The results show consistence with the ranking obtained by the World
Economic Forum, where Chile appears with an advantage of 34% as best option.

Keywords
Foreign Direct Investment, Analytical Hierarchical Process, Latin America, Country Selection

1. Introduction
The Foreign Direct Investment (FDI) on Latin American Countries has increased in the recent years. The Economic
commission for Latin America and Caribbean Countries (CEPAL) has informed that in the period from 1992-2006
the amount of Foreign Direct Investment (FDI) has tripled, from US$27,500 to US$72,440 millions [17] This
economic interest in the development on emerging economies and of several of our Latin American countries in
particular has triggered a new challenge for Company executives, entrepreneurs and investors. Facing the problem
of deciding what country is better to put their investments. It is important to recognize that each country is different
and each one has different factors FDI attractive. This is an important problem because FDI is deemed an engine
with respect to growth. This decision has several aspects to be analyzed in order to take a correct decision based on
different important factors.

Traditionally it would be desirable to have a criterion of decision based on experience, costs, and benefits, but in this
case it is not possible to measure the factors in those terms. These factors are called [2] “nonmonetary attributes”. A
more formal approach provides the decision maker with a rational method to evaluate the alternatives with respect to
a multiple nonmonetary attributes and assist them in their country selection problem. The Analytical Hierarchical
(AHP) Process developed by Saaty [11] involves a multiattribute, multiperiod and multiperson problem hierarchy
for the selection of the most desirable alternative. The method constructs a hierarchy based on pairwise comparisons
of the elements. In this case, these are factors that attract the investment (attributes) and the selection of the country
(Alternatives) and create a scale of the strength with the elements that dominates another. The result of the process is
a scale of alternatives that allows the decision maker to justify the selection of the country to the stockholders or
owners in a rational fashion, based on the strength of the alternative. Unfortunately for foreign investors interested in
Latin America, the countries’ attributes are not sufficiently organized in order to help investors to make decisions.

The main objective of this paper is to collect each country attribute and develop a scale of Latin American countries
as investment alternatives using the AHP methodology, so that it helps investors to resolve conflicting interests and
goals to make a decision. Other objectives that are involved in this research are: the identification of the most
attractive countries, the identification of important attributes common to all and the gathering of data for diverse
sources to fit the AHP model. For engineering, it is useful to develop new models that explain and help analyze
critical decisions that are involved in important economical factors. Given the resources that will be invested in a
host country and the risk involved for the stockholders, the analysis of factors, alternatives and their relation; it is an
important area of interest for research and development which is subsequently important to engineering and science.
Cabrera and Giraldo

2. Multicriteria FDI Analysis Methods Using Latin American Countries

Relevant studies in which FDI in Latin American countries are compared versus a set of important factors are
analyzed. To the best of our knowledge there is no a study performed with AHP model for Latin America, but some
authors have made specific approaches on Latin countries using other techniques. The following is a summary of
these studies.

Treviño and Mixon uses cross-country differences in macroeconomic and institutional environments to explain the
factors that affect the FDI inflows by Multinational Enterprises (MNE) to seven Latin American countries [5].
Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela where analyzed for the period of 1988-1999, while
Frenkel et. al. [6], examine the determinants of FDI flows to emerging economies by analyzing a compiled data set
of bilateral FDI flows the period of 1992-2000. Five countries of investment were selected: France, Germany, Japan,
UK and USA, and 21 countries from Asia, Latin America, and Central and Eastern European countries for FDI were
employed, were five are Latin American: Mexico, Chile, Brazil, Argentina and Venezuela. These authors employed
regression analysis technique. Galan and González [4] proposed three main hypothesis for potential growth,
manufacturing should be close to the customer, the cultural affinity. [3], presents the most close work to our study.
They used a Multiple Criteria Decision Analysis (MCDA) based on the use of fifteen factors and different index
(rank) for each one of them. A hierarchical process was made in order to compare pairs of alternatives. The result of
the study shows a rank of countries for selection in a “utility” percentage. The study is different in the way that the
analysis was made. Our analysis use the AHP developed by Saaty [12] and the present work is based on the work of
Nijkamp and van Delft [9].

Table 1 summarizes the studies of multicriteria analysis on Latin American countries. None was made on the basis
of the AHP process.

Table 1.Studies of multicr

Year Author
2004 Treviño and Mixon
3. Selection of Alternatives (Countries) and Attributes (Factors)

2004 Frenkel et al.

To determine main alternatives and factors two studies are used. Fist, Estrada [7] presented an analysis of the most
attractive countries for investment during the World Economic Forum on Latin American. The study takes in to
account eight important factors for evaluation of alternatives: Economic stability, business law, risk conditions, ease

2006 Galan and Benito

access to information, financial security, FDI and government stability as principal factors. They determine that
Chile, Brazil, Colombia and Peru lead the region over the level of attraction offered by the climate for private
investment. Second, World Bank [17] in the annual report of 2007 uses principally the FDI to classify the most
attractive countries. The countries with mayor FDI in % of the total investment are Mexico (26.14%), Brazil

2006 Beim and Lévesque

(25.93%), Chile (11.12%), Colombia (8.69%) and Peru (4.78). These countries add a sum 76.66% of the total FDI.
Then, the alternatives for this study are: Brazil, Chile, Colombia, Mexico and Peru. The analysis identifies the
important factors that impact the FDI as follows: time to start a business, tax rates, borrow rate, labor cost (salaries),

2008 Trevino et al.

inflation and population growth, given by the research in many countries and in the official data that they collect.
The selected factors for the present study are: financial security, growth rate, purchase power parity, business law,
lack of crime, labor regulations, risk conditions, bureaucracy, lack of corruption, government stability, time to start a

*The name of the country are Unknown

business, tax rates, borrow rate, labor cost (salaries), inflation and population growth. These factors are the most
important factors that affect the FDI in a Latin American country, then this are the factors that are used in the model.

3.1 Attributes ranking

Beim and Lévesque [3] and World Bank [17] evaluate ranking of the alternatives based on economic, political and
cultural criteria. Table 2 summarizes the ranks and the indexes used are recommended by the Foreign Investment
Advisory Service of the World Bank Group (World Bank and Foreign Investment Advisory Service) and other
Cabrera and Giraldo
important sources. In order to take a final decision we made calculations for the ranking index (shown in Table 3)
using the “Ordinal Scaling” or “method of paired comparisons” to Canada et.al. [2] where pairwise comparisons
were made by putting a letter "P" in the row factor that is preferred than the column factor. Table 4 summarizes the
results obtained which turned out to be consistent with the literature.

Tabl
Attribute Desc
percept
quality of governanc
Government stability enterprises, citizen
organisations, comme
and th
Business law laws in country that
Lack of crime law a
likelihood that changes i
Risk conditions adversely affects operating
in a spec
Corruption Perc
Lack of corruption reflects the degree
is pe
time in days when you dec
Time to start a business
new business
Financial security the legal right
per capita Gross Nati
Purchase power parity
purchas
Tax rates company taxes that are p
Cabrera and Giraldo

A
G Government Stability =
A Business Law
L Lack of Corruption
M Lack of Crime =
4. The Analytical Hierarchical Process P Risks Conditions =
The Analytical Hierarchical Process developed [11] is a hierarchy based on pairwise comparisons of two types of

C Bureaucracy
elements: attributes and alternatives. The principal objective of the process is to rank the alternatives using weights
on the attributes and sub-attributes that indicate the strength of each. This is a technique that has been improved over =
time. The AHP was improved principally by Saaty [8,10-15]. The mayor contributions of the author are in the fields
Q Time to star business
of Network, dependence and feedback Systems. Table 4 below presents the research of the authors for improvement
of the technique through the years, but the present study use principally the AHP process that was explained by
Canada et. al. [2] follows: Construction of a decision hierarchy by identifying the elements and decision alternatives,
D Financial Security
determination of the relative importance of attributes and sub-attributes (if any), determination of the relative
standing (weight) of each alternative with respect to each next-higher level of attribute or sub-attribute,
determination of the indicator(s) of consistency in making pairwise comparisons and determination of the overall
H
priority weight (score) of each alternative. Tax Rates
O Purchasing Power Parity
C ou n try S election

B Borrow Rates =
B u sin es s A ctive B u rea u cra Fin an cial G D P gro w Gov erm en t La b or L ab or L ack La ck o f Pop u lation T im e to
FD I T ax R ates In fla tion PPP R isk s
L aw L aw cy S ecu rity ra te stab . C os t R egu la ti. C o rru p ti. C rim e g row t h start

F GDP growth rate

C h ile B ra zil M exico C olo m b ia Peru

J Labor cost
E Foreign Direct Investment
Figure 1. Model for the AHP hierarchy process

K Labor Regulations
I Inflation
N Population growth
Author Ranking: G>A>L=M=P>C>Q>D>H=O>B>F=J>E=K>I>N

Saaty, T.L.
Cabrera and Giraldo

4.1 Assumptions
There are many types of investors depending on different factors such as nationality, language, culture, distance to
the host country and many others. The assumptions are that the analysts are consistent in their decisions and the
evaluation is subjective. Other investors could give different values according to their perception, analysis or
preferences and change the ranking. We have to make generalizations of the data that serves as reference for other
person based on average or common factors.

Ranks for different factors differ among themselves. We have changed the ranks of the factors that appear to be
common to all ranks, so that they can be compared between each other; the assumption is that all factors are moving
in the same range for easy comparisons. An implicit assumption that affects factor rank is that the factors can be
affected by each other; this is that the factors cannot be completely independent of each other. For example labor
cost is affected by inflation, or the lack of crime affects the risk conditions of the country, but for the study purpose
of this study we assume that are independent of each other.

5. Results
The final results obtained by the AHP process are given in form of a ranking of evaluation of the alternatives. This is
a model that gives to the investor a useful tool for making a decision about the country for investment; the model
developed is useful for any kind of entrepreneur, investor or company executive, but the aim of the ranking is not to
take an “optimal” decision, they try only to give a rational base of reference for the decision, that can change with
the perception of the analyst, the country or with some factors that are changing constantly with time (political,
cultural or social phenomenon).

Consistency ratio is the value that expresses the internal consistency of the judgments that have been entered in the
model [2]. All results in the model are consistent with CR with a value of 0.09738 which is acceptable (a value < 0.1
are acceptable [11]). Table 5 presents the ranking of the attributes. The results show that the principal factor in the
selection are Government Stability with a 14.4% followed by Business law, Risk conditions and Lack of Crime with
values between 11.3 and 11.8% as the four most important factors. The other weights are showing below.

Figure 2 shows the ranking of countries. The first option is Chile with a 34.37% of importance; this is a logical
result because Chile is the strongest economy right now in Latin America given its last reforms to the economic and
political system. Chile is the most attractive country by the World Forum Economics. The second place is for
Mexico with a 21.36%, who receives mayor part of the FDI compared to other Latin Countries; Mexico has a
competitive advance given its important relation with the US market. The third place is for Brazil with a 16.97%, the
fourth for Peru with a 14.16% and the fifth for Colombia with a 13.14% of the importance in the ranking. The
difference between the last three countries is in the order of a 1.02% and 2.8%. There is a close decision, a little
change on the variables can make that the order of alternatives change in these results, the analyst has to consider
that limitation for further analysis.

Table 5. W
Attribute Wei
Government Stability 0.1
Business Law 0.1
Risks Conditions 0.1
Lack of Crime 0.1
Lack of Corruption 0.1
Cabrera and Giraldo

Ranking of Alternatives

Colombia

Peru

Counrties
Brasil

Mexico

Chile

0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00%

Percent (%)
Chile Mexico Brasil Peru Colombia
Ranking of Alternatives 34.37% 21.36% 16.97% 14.16% 13.14%

Figure 2. Ranking of Alternatives

6. Conclusions
We developed a model for the Analytical Hierarchical Analysis of the factors that influence the selection of a host
country. The model was shown to be consistent with the data collected and preferences evaluated. A ranking of
Alternatives for investment and factors was presented as a tool that helps Company executives, entrepreneurs and
investors to make a more rational choice. Other authors establish that a minimum market size below a country can
be eliminated [3]. We propose a modification of the factor “size of the country” because the factor growth is more
important than size, which is not a significant argument to eliminate a country and can be the case for other criteria.

6.1 Practical Contributions of the Technique

We first establish two important matters. First, we see in the actual economic environment a remarkable interest of
investors to move their investment to more advantageous (profitable) economies. We call that movement as “capital
flow” and it is strongly correlated with the FDI. Second, the use of AHP is helpful to analyze complex problems
with multiple attributes to aid decision making. The problem of country selection involves many factors in which the
investor (as a decision-maker) have to choose an alternative that represents the interest of their stockholders. The
contributions of this research are basically the use of the technique in a multiattribute decision problem that are
practically unexplored under AHP process, and that is concerned to an actual economic problem. The process gives
the investor a different point of view of this matter for making decision in a real world situation.

6.2 Limitations of the Technique

One limitation of this technique is that it is based on personal judgment (subjective), so if two people are evaluating
the same problem they could reach two different solutions. This limits the application up to the evaluator. The
AHP's ranking of attributes is subjective and therefore depends on the evaluations that have been made previously.
Another limitation is the confidence of the sources used to gather data. Not always is possible to access information
sources (garbage in, garbage out). Finally, the calculations are made based on mathematical operations with
matrixes, but there is no statistical theory that allows us to endorse the results obtained under this technique.

Acknowledgements
We would like to thank Alexandra Medina-Borja, Ph.D. for her support in the realization of this research as well as
her commitment to us as her students from the graduate class of ININ 6030 and for the subsequent revisions. We
also extend our thanks to Ernesto Aponte.

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