Economic and Institutional Determinants of FDI Flows to Latin America: A Panel Study

This paper estimates a pooled (fixed-effects) FDI investment function that seeks to identify some of the major economic and institutional determinants of FDI flows to nine major Latin American countries during the 1980-2001 period. First, it develops a conceptual framework of analysis that seeks to identify some of the major economic and institutional determinants of FDI. Second, the paper gives an overview of FDI flows to Latin America during the 1990-2006 period, with particular emphasis on their contribution to the financing of gross capital formation. Third, an empirical model for FDI flows to Latin America is outlined and an economic rationale is provided for the included variables and their expected signs. Fourth, the estimates from a panel regression designed to explain the variation in FDI flows to Latin America during the 1980-2001 period suggests that market size (proxied by real GDP), credit provided by the private banking sector, government expenditures on education, the real exchange rate, and the level of economic freedom have a positive and significant effect. On the other hand, public investment spending, the debt-service ratio, and the volatility of the real exchange rate have a negative and significant effect on FDI flows. The panel unit root tests on the residuals of the relevant panel regressions also suggest that there is a stable, long-term relationship among the included variables; i.e., the selected variables in the reported regressions are cointegrated over the relevant time period. Finally, the paper summarizes the major findings and offers some policy prescriptions for attracting FDI flows to the region and enhancing their positive direct and indirect effects