Capital flows to Latin American countries: effects of foreign direct investment and remittances on growth and development

Abstract

The significant restructuring of international capital flows to developing countries – in particular to Latin American countries – observed in the last quarter century has generated significant research in the area to examine its potential impact on development efforts. The resurgence of foreign direct investment (FDI) and the increasing significance of remittances, both as shares of gross domestic product (GDP), have made these types of capital flows the most analyzed. Despite the large fraction of empirical studies that find a positive and significant relationship between FDI and economic growth, an important fact that has been so far overlooked in the literature is its impact on standards of living in host countries. This dissertation first establishes the strong complementary connection between FDI and economic growth in Latin America, measured by increases in GDP per capita growth rates, to then examine additional channels through which it could affect the welfare of the region. I first show that FDI has a positive effect on central government tax revenues, which is mainly channeled through its effect on taxes on goods and services. I then show that FDI has a positive and significant effect on the employment rates in these host countries, with female employment rate getting the largest impact – relative to males. Remittances are another capital flow that plays a large and important role in certain economies, exceeding 10% of GDP in some countries. The impact of remittances on the main macroeconomic measures of a small open economy is analyzed in the last section using a stochastic limited participation model with cash in advance constraints and costly adjustment of cash holdings. After verifying that the model responds adequately to standard shocks, a remittances shock is introduced to examine the dynamic response of the representative economy. The results show that a positive remittances shock forces the exchange rate to depreciate and lowers both output and consumption in the period of the shock. The positive shock lowers utility during the shock but raises it from the following period onwards, improving discounted utility after 10 years when remittances are 10% of GDP and there are no adjustment costs.