Unbalanced Privatization in Emerging Economies and Capital Flows

Abstract

This empirical study reveals that a higher credit distribution by State-Owned Banks (SOBs) to State-Owned Enterprises (SOEs), to the detriment of some highly productive private firms, has an effect on foreign investments in emerging countries experiencing an economic transition. A first approach relying on GMM, Bayesian techniques, and utilizing a sample of 40 emerging countries over the period 1987-2007, demonstrates that the capital misallocation created by SOBs during privatization hinders inward FDI and enhances the accumulation of foreign assets. Then, to specify the effect on FDI inflows, a sectoral approach is implemented for 1992-2012 and strengthens the results; the rise in the credit afforded to SOEs to the detriment of growing private firms is associated with a slowdown of inward FDI stocks by approximately 16% to 23% during privatization. This conclusion is valid in manufacturing but not in tertiary sectors, that is, in sectors with more private firms and external finance dependence. The literature on the Chinese case is partly extended to the main emerging privatizing countries. These results allow for improvement in policy actions to better allocate capital in transition economies and for international stability.