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The Political Economy of Financial Fragility

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  • Erik Feijen
  • Enrico Perotti

Abstract

While financial liberalization has in general favorable effects, reforms in countries with poor regulation is often followed by financial crises. We explain this variation as the outcome of lobbying interests capturing the reform process. Even after liberalization, market investors must rely on enforcement of investor protection, which may be structured so as to block funding for new entrants, or limit their access to refinance after a shock. This forces inefficient default and exit by more leveraged entrepreneurs, protecting more established producers. As a result, lobbying may deliberately worsen financial fragility. After large external shocks, borrowers from the political elite in very corrupt countries may successfully lobby for weak enforcement, and retain control of collateral. We provide evidence that industry exit rates and profit margins after banking crises are higher in the most corrupt countries.

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Bibliographic Info

Paper provided by Institute of Economic Research, Hitotsubashi University in its series Hi-Stat Discussion Paper Series with number d05-160.

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Date of creation: Mar 2006
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Handle: RePEc:hst:hstdps:d05-160

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Cited by:
  1. Susan Schroeder, 2009. "Defining and detecting financial fragility: New Zealand's experience," International Journal of Social Economics, Emerald Group Publishing, vol. 36(3), pages 287-307, January.
  2. Feijen, Erik, 2005. "Do incumbents manipulate access to finance during banking crises?," Policy Research Working Paper Series 3660, The World Bank.
  3. Bonfiglioli, Alessandra, 2008. "Financial integration, productivity and capital accumulation," Journal of International Economics, Elsevier, vol. 76(2), pages 337-355, December.
  4. Enrico Perotti & Paolo Volpin, 2007. "Investor Protection and Entry," Tinbergen Institute Discussion Papers 07-006/2, Tinbergen Institute.
  5. Enrico Perotti & Paolo Volpin, 2007. "Investor Protection and Entry," Tinbergen Institute Discussion Papers 07-006/2, Tinbergen Institute.
  6. Stephen Haber & Enrico Perotti, 2008. "The Political Economy of Financial Systems," Tinbergen Institute Discussion Papers 08-045/2, Tinbergen Institute.

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