Composition Of Capital Inflows Research Articles

Targeted Liberalization: China's foreign investment regulation reform and its post‐WTO‐accession export surge

AbstractTo gain membership in the World Trade Organization (WTO) in 2001, China substantially modified its regulation of foreign direct investment. These reforms coincided with rapid changes in the composition of capital inflows, as the dominant entry mode shifted from joint venture to wholly foreign owned affiliate. Foreign‐invested enterprises contributed a rising share of China's rapidly growing exports. We investigate how much China's foreign ownership liberalization contributed to these observed trends in foreign investment flows and Chinese exports. Accounting for both the set of activities from which it removed foreign equity caps and those into which it newly encouraged investment, we estimate the impact of China's reforms on firm entry and exports using a difference‐in‐differences estimator. To eliminate bias resulting from heterogeneous and dynamic treatment effects, we also apply novel dynamic difference‐in‐differences estimators. We find that removal of foreign equity caps induced entry of wholly foreign owned firms, while having no significant effect on entry of new joint ventures. Concurrently, the designation of new activities for investment incentives induced foreign entry, particularly in the form of joint ventures. Reduced‐form calculations imply that FDI policy changes explain almost 9% of the increase in exports from foreign‐invested firms over the decade studied. The effect was larger in sectors identified as “high‐tech industries” by the Chinese government, as they contribute most of the estimated policy‐driven export growth from foreign‐invested firms. Thus, China's FDI regulation reform following WTO entry was targeted liberalization: elimination of equity share limits induced new foreign entry, while investment incentives encouraged formation of joint ventures.

The Effectiveness of Macroprudential Policies and Capital Controls Against Volatile Capital Inflows

This paper compares the effectiveness of macroprudential policies (MaPs) and capital controls (CCs) in influencing the volume and composition of capital inflows, and the probability of banking and currency crises. We distinguish between foreign exchange (FX)-based MaPs, which may be similar to some types of CCs, and non-FX-based MaPs. Using a panel of 83 countries over the period 2000-17, and a propensity score matching model to control for selection bias, we find that capital inflow volumes are lower where FX-based MaPs have been activated. The imposition of CCs does not have a significant effect on the volume or composition of capital inflows. Further, we find that the activation of MaPs is associated with a lower probability of banking crises and surges in capital inflows in the following three years.

The Impact of International Capital Flows on Jordan’s Economic Growth

The aim of this study is to examine the impact of international capital flows on the economic growth in Jordan during the period from 2005 to 2017, The study also examines trends and composition of capital inflows. The study used descriptive analytical research method which was appropriate for the purpose of research. By using time series data, the study found that Foreign Direct Investment (FDI), foreign portfolio investment (FPI), grants (Gr) and Worker remittances (WR) are positively affecting the economic growth direct contribution. Based on the research results, the study came with a several recommendations, the most important recommendation is; the government of Jordan should create and relax the rules and regulations to attract more investors, and also the government should work hand in hand with the developed countries to create economic and employment opportunities, improve the country’s competitiveness, and expand growth within the private sector so that everyone in Jordan has the opportunity to contribute to a brighter future.

Capital Inflows, Credit Growth, and Financial Systems

Exploiting a granular panel dataset that breaks down capital inflows into FDI, portfolio and other categories, and distinguishes between credit to the household sector and to the corporate sector, we investigate the association between capital inflows and credit growth. We find that non-FDI capital inflows boost credit growth and increase the likelihood of credit booms in both household and corporate sectors. For household credit growth, the composition of capital inflows appears to be more important than financial system characteristics. In contrast, for corporate credit growth, both the composition and the financial system matter. Regardless of sectors and financial systems, net other inflows are always linked to rapid credit growth. Firm-level data corroborate these findings and hint at a causal link: net other inflows are related to more rapid credit growth for firms that rely more heavily on external financing. Further explorations on how capital flows translate into more credit indicate that both demand and supply side factors play a role.

Does Foreign Capital Enhance Economic Growth In Emerging Countries: Flow Decomposition Approach?

Unlike trade liberalization, the impact of financial openness on growth is still mitigated. In fact, empirical studies focusing on effects of capital account liberalization are inconclusive, which could be due to the sample chosen, to the liberalization index or to the fact that studies take account of capital inflows as a whole which can mask substantial differences between different flow effects.Our purpose in this paper is on one hand to re-examine the impact of capital inflows on growth by dividing these inflows into portfolio equity flows, foreign direct investment flows and debt flows and on the other hand to study if the composition of capital inflows has an importance. This work will be done by estimating a standard growth model using dynamic panel data approach.Our main findings are first, that total capital inflows improve economic growth and so does every kind of flow taken apart; which supports the neoclassical wisdom and second, that capital inflows composition isn't important; which indicates that all inflows are substitutes in the short term.

Is FDI a Safer Form of Financing?

It has been common to attribute financial crises to short-term capital inflows, while foreign direct investment (FDI) is seen as a safer form of finance. The relationship between crises and the composition of capital flows is particularly relevant at present because the flow of capital to Latin America is becoming increasingly dominated by FDI. This paper asks whether the composition of capital inflows and of the stock of foreign liabilities is relevant for financial crises, be it their frequency, depth, or length. It explores the possible role of FDI as a benign form of external liability relative to other classes of liabilities, reviewing both analytical and empirical arguments.

The composition of capital inflows when emerging market firms face financing constraints

The composition of capital inflows to emerging market economies tends to follow a predictable dynamic pattern across the business cycle. In most emerging market economies, total inflows are pro-cyclical, with debt and portfolio equity flowing in first, followed later in the expansion by foreign direct investment (FDI). To understand the dynamic composition of these flows, we use a small open economy (SOE) framework to model the composition of capital inflows as the equilibrium outcome of emerging market firms' financing decisions. We show how costly external financing and FDI search costs generate a state contingent cost of financing such that the cheapest source of financing depends on the phase of the business cycle. In this manner, the financial frictions are able to explain the interaction between the types of flows and deliver a time-varying composition of flows, as well as other standard features of emerging market business cycles. If, as this work suggests, flows are an equilibrium outcome of firms' financing decisions, then volatility of capital inflows is not necessarily bad for an economy. Furthermore, using capital controls to shut down one type of flow and encourage another is certain to have both short- and long-run welfare implications.

The Composition of Capital Inflows when Emerging Market Firms Face Financing Constraints

The composition of capital inflows to emerging market economies tends to follow a predictable dynamic pattern across the business cycle. In most emerging market economies, total inflows are procyclical, with debt and portfolio equity flowing in first, followed later in the expansion by foreign direct investment (FDI). To understand the timing of these flows, we use a small open economy (SOE) framework to model the composition of capital inflows as the equilibrium outcome of emerging market firms' financing decisions. We show how costly external financing and foreign direct investment search costs generate a state contingent cost of financing, so that the cheapest source of financing depends on the phase of the business cycle. In this manner, the financial frictions are able to explain the interaction between the types of flows and deliver a time varying composition of flows, as well as other standard features of emerging market business cycles. If, as this work suggests, flows are an equilibrium outcome of firms' financing decisions then volatility of capital inflows is not necessarily bad for an economy. Furthermore, using capital controls to shut down one type of flow and encourage another is certain to have both long- and short-run welfare implications.

One-Size-Fits-One: Tailor-Made Fiscal Responses to Capital Flows

This paper surveys policy responses in recent years to capital inflows in a diverse group of countries that are represented by the Netherlands at the IMF Executive Board. Based on the findings from cross-country empirical literature, the paper distills some guiding principles for policy responses to excessive capital inflows, depending on country-specific circumstances and with a particular focus on fiscal policy. In addition to considering the conventional macroeconomic and structural policy tools, the paper also discusses the role of microfiscal policies in affecting the size and the composition of capital inflows. While conditions in these countries have changed very recently, the policy principles remain salient.

One-Size-Fits-One: Tailor-Made Fiscal Responses to Capital Flows

This paper surveys policy responses in recent years to capital inflows in a diverse group of countries that are represented by the Netherlands at the IMF Executive Board. Based on the findings from cross-country empirical literature, the paper distills some guiding principles for policy responses to excessive capital inflows, depending on country-specific circumstances and with a particular focus on fiscal policy. In addition to considering the conventional macroeconomic and structural policy tools, the paper also discusses the role of microfiscal policies in affecting the size and the composition of capital inflows. While conditions in these countries have changed very recently, the policy principles remain salient.

International Capital Flows and Growth in India: The Recent Experience

Capital flows are most helpful when the magnitude of those flows is steady and stable. The international capital flow such as direct and portfolio flows has huge contribution to influence the economic behavior of the countries positively. Countries with well developed financial markets gain significantly from Foreign Direct Investment (FDI). The huge volume of capital flows and their influence on the domestic financial markets, understanding the behaviour of the flows becomes very important especially at time liberalizing the capital account. The study attempts to examine the impact of international capital flows on economic growth. The study also examines trends and composition of capital inflows, changing pattern capital flows in view of economic reform, ascertain the impact of domestic financial policy variables on international capital flows and suggest policy implication thereof. By using monthly time series data, we found that Foreign Direct Investment (FDI) is positively affecting the economic growth direct contribution, while Foreign Institutional Investment (FII) is negatively affecting the growth alb its, in a small way and make a preliminary attempt to test whether the international capital flows has positive impact on financial markets and economic growth. The empirical analysis using the time series data between April 1995 to April 2007 shows that FDI plays unambiguous role in contributing to economic growth.

The Composition of Capital Inflows When Emerging Market Firms Face Financing Constraints

The composition of capital inflows to emerging market economies tends to follow a predictable dynamic pattern across the business cycle. In most emerging market economies, total inflows are procyclical, with debt and portfolio equity flowing in first, followed later in the expansion by foreign direct investment (FDI). To understand the timing of these flows, we use a small open economy (SOE) framework to model the composition of capital inflows as the equilibrium outcome of emerging market firms' financing decisions. We show how costly external financing and foreign direct investment search costs generate a state contingent cost of financing, so that the cheapest source of financing depends on the phase of the business cycle. In this manner, the financial frictions are able to explain the interaction between the types of flows and deliver a time varying composition of flows, as well as other standard features of emerging market business cycles. If, as this work suggests, flows are an equilibrium outcome of firms' financing decisions then volatility of capital inflows is not necessarily bad for an economy. Furthermore, using capital controls to shut down one type of flow and encourage another is certain to have both long- and short-run welfare implications.

Is foreign direct investment a safer form of financing?

It has been common to attribute financial crises to short-term capital inflows, while foreign direct investment (FDI) is seen as a safer form of finance. The relationship between crises and the composition of capital flows is particularly relevant at present because the flow of capital to Latin America is becoming increasingly dominated by FDI. This paper asks whether the composition of capital inflows and of the stock of foreign liabilities is relevant for financial crises, be it their frequency, depth, or length. It explores the possible role of FDI as a benign form of external liability relative to other classes of liabilities, reviewing both analytical and empirical arguments.

Is FDI a Safer Form of Investment

It has been common to attribute financial crises to short-term capital inflows, while foreign direct investment (FDI) is seen as a safer form of finance. The relationship between crises and the composition of capital flows is particularly relevant at present because the flow of capital to Latin America is becoming increasingly dominated by FDI. This paper asks whether the composition of capital inflows and of the stock of foreign liabilities is relevant for financial crises, be it their frequency, depth, or length. It explores the possible role of FDI as a benign form of external liability relative to other classes of liabilities, reviewing both analytical and empirical arguments.

Controls on capital inflows: do they work?

This paper analyzes the effectiveness of controls on capital inflows. In particular, we analyze in great detail the Chilean experience with the use of the unremunerated reserve requirement. We examine the effects of the controls applied in Chile in 1991–1998 on interest rates, real exchange rate, and the volume and composition of capital inflows. The effects are elusive and it is difficult to pin down long-run effects. Although after the unremunerated reserve requirement was introduced there was an increase in the interest rate differential, the econometric evidence does not show it has a significant long-run effect. Also we detect very small effects on the real exchange rate. However, the more persistent and significant effect is on the composition of capital inflows, tilting composition toward longer maturity.

Local Corruption and Global Capital Flows

THE RESEARCH REPORTED in this paper was inspired by a plane ride I took from China to the United States in 1996. Browsing the newspapers and in-flight magazines, I came across one story about the high level of official corruption in China, and another that extolled the extraordinarily large flow of foreign direct investment (FDI) into China that year.(1) Later in the flight, I struck up a conversation with the passenger sitting next to me, an American business executive who had just visited his joint venture firm in China. I asked him whether the corruption problem in China affected him and his business. He said that it did and went on to explain the myriad problems that his firm had encountered in dealing with corruption and bureaucratic red tape. During and after that flight, I reflected on whether corruption has generally worked as a beneficial grease, a minor annoyance, or a major obstacle for international investors. In this paper I address three interrelated issues. First, does corruption reduce inward FDI? Second, is China an exceptional case in which corruption does not do much harm? Third, does corruption distort the composition of capital inflows in a way that might raise the likelihood of a currency crisis? International direct investment reached $3.5 trillion in 1997. A small number of countries in the industrial world account for the bulk--about 68 percent--of this investment.(2) Yet international direct investment is especially important for developing countries, for which it is not only a source of scarce capital but also an important conduit for the transfer of technological and managerial know-how.(3) The recent currency crises in East Asia, Russia, and Latin America have highlighted the importance of the composition of capital flows for developing countries. Before I attempt to explain the relationship between corruption and the composition of capital inflows, it is worth noting that there are at least two views on the causes of these crises. One increasingly widespread view is that so-called crony capitalism--the misallocation of financial resources to the friends and relatives of government officials--is partly responsible. However, there is so far virtually no systematic evidence to support or reject this hypothesis.(4) The other view is that the confidence of international creditors in developing economies is fragile, so that small changes in the outlook can give rise to self-fulfilling expectations of a crisis. These two explanations are typically presented as rivals, but there may be a link between them. The extent of corruption in a country may affect that country's composition of capital inflows in a way that makes it more vulnerable to shifts in international creditors' expectations. Corruption here refers to the extent to which firms or individuals need to pay bribes to government officials to obtain permits, licenses, loans, or other government services needed to conduct business in a country.(5) Several studies have shown that the composition of international capital inflows is correlated with the incidence of currency crises.(6) They have found that the lower the share of FDI in total capital inflows, or the higher the ratio of short-term debt to reserves, the more likely a currency crisis becomes. One possible reason is that bank lending or other portfolio investment may be driven more by sentiment than direct investment is. Hence a small, unfavorable change in the recipient country's fundamentals may cause a large swing in portfolio capital flows, from massive inflows to massive outflows. This can strain the country's currency or financial system sufficiently to cause or hasten its collapse.(7) To my knowledge, no studies have examined the connection between corruption (or the intrusiveness of national bureaucracy more generally) and the composition of capital inflows. This paper seeks to fill that void. A small number of previous papers have looked at the effect of corruption on FDI. …

Comment and Discussion

Local Corruption and Global Capital Flows Shang-Jin Wei The research reported in this paper was inspired by a plane ride I took from China to the United States in 1996. Browsing the newspapers and in-flight magazines, I came across one story about the high level of official corruption in China, and another that extolled the extraordinarily large flow of foreign direct investment (FDI) into China that year.1 Later in the flight, I struck up a conversation with the passenger sitting next to me, an American business executive who had just visited his joint venture firm in China. I asked him whether the corruption problem in China affected him and his business. He said that it did and went on to explain the myriad problems that his firm had encountered in dealing with corruption and bureaucratic red tape. During and after that flight, I reflected on whether corruption has generally worked as a beneficial “grease,” a minor annoyance, or a major obstacle for international investors. In this paper I address three interrelated issues. First, does corruption reduce inward FDI? Second, is China [End Page 303] an exceptional case in which corruption does not do much harm? Third, does corruption distort the composition of capital inflows in a way that might raise the likelihood of a currency crisis? International direct investment reached $3.5 trillion in 1997. A small number of countries in the industrial world account for the bulk—about 68 percent—of this investment.2 Yet international direct investment is especially important for developing countries, for which it is not only a source of scarce capital but also an important conduit for the transfer of technological and managerial know-how.3 The recent currency crises in East Asia, Russia, and Latin America have highlighted the importance of the composition of capital flows for developing countries. Before I attempt to explain the relationship between corruption and the composition of capital inflows, it is worth noting that there are at least two views on the causes of these crises. One increasingly widespread view is that so-called crony capitalism—the misallocation of financial resources to the friends and relatives of government officials—is partly responsible. However, there is so far virtually no systematic evidence to support or reject this hypothesis.4 The other view is that the confidence of international creditors in developing economies is fragile, so that small changes in the outlook can give rise to self-fulfilling expectations of a crisis. These two explanations are typically presented as rivals, but there may be a link between them. The extent of corruption in a country may affect that country’s composition of capital inflows in a way that makes it more vulnerable to shifts in international creditors’ expectations. Corruption here refers to the extent to which firms or individuals need to pay bribes to government officials to obtain permits, licenses, loans, or other government services needed to conduct business in a country.5 [End Page 304] Several studies have shown that the composition of international capital inflows is correlated with the incidence of currency crises.6 They have found that the lower the share of FDI in total capital inflows, or the higher the ratio of short-term debt to reserves, the more likely a currency crisis becomes. One possible reason is that bank lending or other portfolio investment may be driven more by sentiment than direct investment is. Hence a small, unfavorable change in the recipient country’s fundamentals may cause a large swing in portfolio capital flows, from massive inflows to massive outflows. This can strain the country’s currency or financial system sufficiently to cause or hasten its collapse.7 To my knowledge, no studies have examined the connection between corruption (or the intrusiveness of national bureaucracy more generally) and the composition of capital inflows. This paper seeks to fill that void. A small number of previous papers have looked at the effect of corruption on FDI. Combining corruption with twelve other variables to form a composite indicator, Ashoka Mody and David Wheeler failed to find a significant relation between corruption and foreign investment.8 However, this result may have been due to a...

Emerging stock markets, portfolio capital flows and long-term economie growth: Micro and macroeconomic perspectives

The paper examines two major components of financial liberalization, stock market development and portfolio capital flows in the context of less developed countries. The paper considers microeconomic and macroeconomic perspectives on their implications for long-term development and economic growth. It concentrates on: 1. (a) the role of stock markets in financing corporate growth; 2. (b) the implications of stock market volatility for resource allocation and productive efficiency; and 3. (c) the interactions between the foreign exchange and stock markets in the context of economic shocks. Its policy recommendations are that LDCs should promote bank-based systems, influence the scale and composition of capital inflows, and prevent a market for corporate control from emerging.

International Financial Markets and the U.S. External Imbalance

This paper analyzes movements in the U.S. external imbalance over the 1980s from the perspective of the capital account. It considers the empirical evidence on two competing hypotheses about the causes of the large and persistent net capital inflow during the decade: one that the capital inflow was induced by a substantial increase in the expected rate of return on real fixed investment in the United States relative to other countries, and the other that strong U.S. fiscal stimulus and a declining private savings rate boosted demand for credit in the United States.The empirical evidence that we review on this score include the pattern and composition of capital inflows, trends in the components of U.S. domestic saving and investment, and movements in U.S. relative to foreign rates of return across different types of real and financial assets. The evidence strongly supports the view that the net capital inflow resulted from an increase in demand for credit, and not to any significant degree from an increase in the relative rate of return on real fixed investment in the United States.We also consider the sustainability of the U.S. external imbalance. Available empirical evidence on this score suggests that over the short to medium term at least, continued large U.S. external deficits could be absorbed manageably into foreign portfolios. Nevertheless, if those deficits continue to finance U.S. government and private consumption rather than the increased rate of domestic investment that would be needed eventually to service the associated external debt, they are not sustainable in the long run.