Domestic Policy Variables and Foreign Direct Investment Inflows in Latin America

The recent upsurge in foreign direct investment (FDI) inflows in Latin America is generally credited to the renewed confidence inspired by improved macro-policies and market-oriented reforms which were implemented by a majority of Latin American countries in the latter part of the 1980’s. Although foreign investment decisions must ultimately rest on micro-calculations comparing expected rates of return to the opportunity cost of capital, an improved investment climate created by a favorable macro-economic policy environment is likely to positively influence growth and profit expectations, and thus the level of capital inflows2. This chapter reports on an empirical test of this hypothesis using a pooled regression technique for the seven largest Latin American economies during the period 1970–1992. The results show a significant impact of import liberalization, of depreciation of the real effective exchange rate and of deficit reduction of FDI. Finally, there would seem to be country-specific factors exerting a significant influence, independent of the macro-economic performance or -policies.