YALE DEPARTMENT OF ECONOMICS
WORKING PAPER NO. 62

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

Miguel D. Ramirez

June 2009

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.

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 codes:  C22, O10, O40, O57.