Foreign Direct Investment and its Determinants in the Chilean Case: An Error Correction Model Analysis, 1960-2002

Abstract

This paper examines the major economic and institutional factors underlying the surge in foreign direct investment (FDI) flows to Chile during the 1985-2002 periods. It presents econometric evidence which indicates that market-based economic reforms and major changes in the institutional-legal status of foreign capital are, in large measure, responsible for the rapid increase in FDI inflows to leading sectors of the Chilean economy. Cointegration analysis and error-correction modeling suggest that market size, the real exchange rate, the debt-service ratio, the secondary enrollment ratio, physical infrastructure, and institutional reforms such as the elimination of restrictions on profit and dividend remittances and the implementation of a selective debt conversion program are economically significant in explaining the variation in FDI inflows to the country. The paper also addresses the long-term negative effects which rapidly growing profit and dividend remittances may have on the financing of capital formation and the Chilean balance of payments.

Keywords: Akaike Information Criterion (AIC), Chilean economy, cointegration analysis, error correction model, FDI flows, Granger causality test, Johansen and Juselius test, remittances of profits and dividends, Schwartz Bayesian Criterion (SBC), Theil inequality coefficient, unit roots

JEL Classification: C22, O10, O40, O57