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Macroeconomics, Politics and Policy: The Determinants of Capital Flows to Latin America

Since the “lost decade” of the 1980’s Latin America has attracted several forms of capital from abroad. Extensive studies about the effects of capital have found mixed results, but have established that these emerging markets are still constantly seeking out foreign monies. Despite unresolved debates over the consequences, policy makers desire to understand the determinants of capital inflows—specifically foreign direct investment (FDI), portfolio investment (PI), and remittances. Although determinants of FDI have been extensively studied, portfolio investment and remittances, which make up a combined three-fourths of capital inflows for many of these nations, have been mostly ignored. In this study, I investigate the different factors and dynamics that determine these three different forms of capital inflow. I argue that the factors (macroeconomic, political, and domestic) that help determine each of these types of capital inflows are different across inflow type. I find that PI remains the most unpredictable form of capital to the region, but that remittances and FDI demonstrate important similarities that policy makers should consider. My findings about remittances also have substantial implications for future research of migrants’ decision to remit as well as the states ability to stimulate these flows with implications for capital control policy.

The economic performance of Latin America since the “lost decade” of the 1980’s has been on a gradual upwards climb, yet has not withstood startling setbacks (Boeker 1993). The Washington Consensus, presented as the economic reform package to end the market downturns, has largely been replaced by market driven economic policy and signaled a return to concerns about government infrastructure as well as effects on poverty and inequality levels due to these reforms. Foreign capital has had a sizable role in the economic recovery seen in Latin America. Although foreign direct investment (FDI) still makes up most of total foreign capital, faster-moving portfolio flows as well as less predictable worker remittances are increasing in importance for Latin American economies.

FDI has been cited as partially responsible for much of the economic recovery of the region and investment has recovered steadily since the loss of the petro-dollar recycling in the 70’s (Kentor and Boswell 2003). Increasingly more permanent forms of finance, such as direct investment after the privatization in the 1990’s, has led to a measurable economic growth in the region (Birch 1991; Bird 1996; Grosse 1997, 2001). Since the 1980’s there has also been an increase in the data quality and collection efforts from this region giving new insights into other forms of finance that are on the rise in the region. Steady increases in portfolio flows since the emerging-market crisis of the late 1990’s have contributed to a growing literature of their specific causes and effects (Alqhuist 2006; Haley, 1999; Little and Leblang 2004). Portfolio investment is less-studied with regard to the Latin American region, yet it is considered an important player in the development patterns of emerging markets (Reisen and Soto 2001; Levine 2001; Stiglitz 2001).

Remittances have recently been recognized as an enormous source of capital to many Latin American nations, though its emergence has not come without controversy. Worker remittances represent a very different form of capital than either portfolio investment or FDI. This capital is more consistent (Kapur and Singer 2006) and less prone to dramatic increases and decreases, as are FDI and PI (Aggarwal 2006; Blue 2004). Remitters’ monies represent the second largest form of capital for emerging market economies (Aggarwal, Demirguc-Kunt, and Martinez Peria 2006, 1; Ratha 2003; World Bank 2006). This makes the analysis provided in this paper ever important as policy makers are searching for proxies for garnering this type of investment. Furthermore, recent improvements in data gathering have not been followed by research subjecting this data to rigorous quantitative testing. Remittances have been analyzed as both a stimulus and retardant of development (Foster and Rosenzweig 2001; Kapur and Singer 2006; Kapur 2005) as well having both positive and negative influences on equitable income distributions (Blue 2004; Funkhouser 1995; Stark, Taylor and Yitzhaki 1986).

List Of Tables
I. Introduction
II. Literature Review

    Foreign Direct Investment
    Portfolio Investment

III. Research Design: Model And Hypotheses

    Dependent Variables
    Independent Variables
    Data And Model Specification

IV. Model Analysis And Discussion

    Foreign Direct Investment
    Portfolio Investment
    Joint Model Determinants

V. Conclusions: Limitations And Future Research Works Cited
Appendix A: Statistical Appendix
Appendix B: Correlation Matrices

Macroeconomics, Politics and Policy: The Determinants of Capital Flows to Latin America