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In 2010, Chile placed for the first time amongst the 20 leading recipients of foreign direct investment (FDI) in the world. According to the World Investment Report 2011, released by the UN Conference on Trade and Development (UNCTAD), Chile ranked 19th and third in Latin America behind Brazil and Mexico, both much larger economies than Chile.

And 2011 was another good year for FDI. Through October, FDI inflows to Chile totaled US$13.88 billion, up from US$13.73 billion in the same period of 2010, which was a record year.

“It has been a very good year for Chile in terms of foreign investment,” says Matías Mori, executive vice-president of Chile’s Foreign Investment Committee.

For the many multinational firms that have established their regional headquarters in Chile, this is no surprise. According to numerous international rankings of economic freedom, transparency and business environment, Chile has one of the best climates for investment in the region. Crucially, it also offers a network of free trade agreements that give exporters access to 62.5% of the world's population.

Meanwhile, foreign investment has brought important benefits for Chile including employment, innovation, technology transfer, training and the development of service industries.

“Foreign investment has played a decisive role in the economic development of Chile and is fundamental to achieving the government’s [economic] growth objectives,” says Mori.                                                                                                                                                      

Since 1974, when Chile’s economy started opening up, the United States has been by far its largest foreign investor, accounting for around a quarter of total inflows under the D.L. 600 Foreign Investment Statute. It is followed by Spain (18.7%) and Canada (17.7%).

However, with the exception of 2009 when retail giant Walmart acquired a controlling stake in Chile’s D&S supermarket chain for US$2.7 billion, FDI by US companies has fallen from an average of around US$1 billion in the 1990s to half that amount or less.

Meanwhile, Asian investment in Chile is rising. Japan was the origin of 48.2% of the FDI that entered Chile in the first nine months of the year mainly due to imports of raw materials needed for reconstruction after the earthquake and tsunami in March 2011.

Korea placed fifth with 3.7% of FDI, which is significant considering its negligible historical investment in Chile. The Foreign Investment Committee also received, through the D.L. 600 mechanism, investment requests from two Chinese firms totaling US$205 million.

“Considering that from 1974 to 2010 China’s investment only reached US$85 million, we are talking about growth of 141%,” says Mori.

But Chinese investment remains a pittance of US FDI. This can be attributed to a combination of factors, says Francisco Garces, a member of Banco de Chile’s board and president of Chile’s Asia-Pacific Chamber of Commerce,

Part of the reason is that China prefers to invest in countries like Peru and Brazil with less environmental restrictions and lower labor costs than Chile.

“There will be more investment from Asia in the future but Chile has to cut red tape and reduce costs for investors,” says Garces.

Improving productivity is especially important for value-added exports. The capital-intensive mining sector continues to attract about a third of Chile’s total FDI, but other sectors including services and manufacturing are growing.

The services sector, which includes financial services and software development, represents 22% of FDI.

“Chile’s professional services are increasingly well evaluated and recognized internationally, which has contributed to the diversification of our exports,” says Mori.

The manufacturing sector, which receives 11.3% of FDI, is also expanding. Investment in agro-industry has been important for diversifying Chile’s food export basket by incorporating new technologies that increase efficiency.

Moreover, this sector has high potential for growth as foreign companies are becoming established in Chile to supply quality food products to their own countries, says Mori.

But there are important legal and regulatory issues that Chile must address if it aims to attract more FDI in these sectors and accelerate the diversification of its export base.

Chile has made some progress in fighting piracy but in 2011 it remained, for a fifth straight year, on the USTR Priority Watch List of countries that have failed to adequately protect intellectual property.

This is mainly due to the widespread piracy of US copyrighted music and films in DVD format. “We have a weak spot in this area but the government has taken some measures to address the problem,” says Esteban Elias, legal counsel for Microsoft Chile and a law professor at the Central University in Santiago.

A law passed in 2010 increased penalties for intellectual property infringements but so far its impact has been limited and enforcement needs to improve, says Elias.

Another area Chile should address is taxation. Chile signed a Double Taxation Avoidance Agreement with the United States in 2010 that was supposed to reduce the tax burden on companies and individuals required to file returns in both countries, but the deal has yet to be ratified.

The main hold up is related to the lack of economic incentives for companies located in both countries. “US companies in Chile already receive tax benefits in the U.S. and vice versa for Chilean companies,” says Elias.

Moreover, while the agreement has the potential to make Chile more attractive to US investors, some US companies in Chile may prefer it not to be ratified since it would generate more competition, adds Elias.

Another stumbling block is the lack of implementation of norms and regulations to allow the exchange of information between tax authorities. A law passed in 2009 as a condition of Chile’s accession to the OECD granted the tax authority, SII, access to personal banking information to share with authorities in other countries, but other reforms are still pending.

Meanwhile, other tax incentives could be used to attract FDI, especially in the IT sector. “Uruguay has done a great job offering tax incentives for IT exporters, Chile could so something similar,” says Elias.

But tax incentives alone are insufficient without a pool of qualified graduates who speak English. “Chile has many talented professionals but not enough of them speak English,” says Elias. “It’s a big problem.”

Clearly, the current economic situation in North America and Europe is an opportunity for Chile, which is seen by investors as a safe haven in times of uncertainty, to attract more FDI in sectors such as IT, renewable energy, tourism and agro-industry.

“We have to take this opportunity, especially to attract Asian investment,” says Mori.

But the window of opportunity will not stay open forever and Chile must act quickly – how well it succeeds in this endeavor could make the difference between achieving the government’s development goals and falling short.