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

The significant restructuring of international capital flows to developingcountries – in particular to Latin American countries – observed in the last quartercentury has generated significant research in the area to examine its potential impact ondevelopment efforts. The resurgence of foreign direct investment (FDI) and theincreasing 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 significantrelationship between FDI and economic growth, an important fact that has been so faroverlooked in the literature is its impact on standards of living in host countries. Thisdissertation first establishes the strong complementary connection between FDI andeconomic growth in Latin America, measured by increases in GDP per capita growthrates, to then examine additional channels through which it could affect the welfare ofthe 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 showthat FDI has a positive and significant effect on the employment rates in these hostcountries, with female employment rate getting the largest impact – relative to males.Remittances are another capital flow that plays a large and important role incertain economies, exceeding 10% of GDP in some countries. The impact ofremittances on the main macroeconomic measures of a small open economy is analyzedin the last section using a stochastic limited participation model with cash in advanceconstraints and costly adjustment of cash holdings. After verifying that the model responds adequately to standard shocks, a remittances shock is introduced to examinethe dynamic response of the representative economy. The results show that a positiveremittances shock forces the exchange rate to depreciate and lowers both output andconsumption in the period of the shock. The positive shock lowers utility during theshock but raises it from the following period onwards, improving discounted utility after10 years when remittances are 10% of GDP and there are no adjustment costs.