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Capital Controls and Financial Crises

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  • Joshua Aizenman

Abstract

The purpose of this paper is to explain the reluctance of developing countries to open up their capital market to foreigners, and the conditions inducing an emerging market economy to switch its policies. We consider an economy characterized initially by a one-sided openness to the capital market domestic agents can borrow internationally, but foreign agents cannot hold domestic equity. We identify conditions under which the emerging market's capitalists would oppose financial reform. This would be the case if 'green field' investment by multinationals would bid up real wages, reducing thereby the rents of domestic capitalists. A financial crisis that raises the domestic interest rate and causes a real exchange rate depreciation may induce the emerging market's capitalists to support opening up the economy to FDI. This attitude switch is more likely to occur the greater the debt overhang, the lower the borrowing constraint, and the weaker the market power of foreign entrepreneurs. Even in these circumstances, the emerging market's capitalists would prefer a partial reform to a comprehensive one -- they would prefer to maintain the restrictions on 'green field' FDI.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7398.

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Date of creation: Oct 1999
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Handle: RePEc:nbr:nberwo:7398

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  1. Feenstra, Robert C. & Hanson, Gordon H., 1997. "Foreign direct investment and relative wages: Evidence from Mexico's maquiladoras," Journal of International Economics, Elsevier, Elsevier, vol. 42(3-4), pages 371-393, May.
  2. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "Paper tigers? A model of the Asian crisis," Research Paper, Federal Reserve Bank of New York 9822, Federal Reserve Bank of New York.
  3. Dooley, Michael P, 2000. "A Model of Crises in Emerging Markets," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 110(460), pages 256-72, January.
  4. Chang, R. & Velasco, A., 1998. "Financial Crises in Emerging Markets: A Canonical Model," Working Papers, C.V. Starr Center for Applied Economics, New York University 98-21, C.V. Starr Center for Applied Economics, New York University.
  5. Ann E. Harrison & Brian J. Aitken, 1999. "Do Domestic Firms Benefit from Direct Foreign Investment? Evidence from Venezuela," American Economic Review, American Economic Association, American Economic Association, vol. 89(3), pages 605-618, June.
  6. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
  7. Paul Krugman, 2000. "Fire-Sale FDI," NBER Chapters, National Bureau of Economic Research, Inc, in: Capital Flows and the Emerging Economies: Theory, Evidence, and Controversies, pages 43-58 National Bureau of Economic Research, Inc.
  8. Joshua Aizenman & Nancy Marion, 1999. "Uncertainty and the disappearance of international credit," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Sep.
  9. Ricardo Caballero & Arvind Krishnamurthy, 1999. "Emerging Market Crises: An Asset Markets Perspective," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 99-23, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. Buffie, Edward F, 1993. "Direct Foreign Investment, Crowding Out, and Underemployment in the Dualistic Economy," Oxford Economic Papers, Oxford University Press, vol. 45(4), pages 639-67, October.
  11. Haddad, Mona & Harrison, Ann, 1993. "Are there positive spillovers from direct foreign investment? : Evidence from panel data for Morocco," Journal of Development Economics, Elsevier, Elsevier, vol. 42(1), pages 51-74, October.
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Cited by:
  1. Gabriella Montinola & Ramon Moreno, 2001. "The political economy of foreign bank entry and its impact: theory and a case study," Pacific Basin Working Paper Series, Federal Reserve Bank of San Francisco 2001-11, Federal Reserve Bank of San Francisco.

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