Foreign Direct Investment and Its Determinants in the ChileCase: An Error Correction Model Analysis, 1960-2002

This paper examines the major economic and institutional factors underlying the surge in foreign direct investment (FDI) flows to Chile during the 1985-2002 period. 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.