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Why Do Emerging Economies Import Direct Investment and Export Savings? A Story of Financial Underdevelopment

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  • Diego Valderrama

    (Federal Reserve Bank of San Francisco)

  • Katherine Smith

    (U.S. Naval Academy)

Abstract

The net foreign asset positions (NFAP) of developing countries and emerging markets tend to be short equity and either short or long debt, while most industrial nations are long equity and short debt. This paper proposes that financial system inefficiencies associated with underdeveloped financial markets can explain this difference in the NFAPs. Financial system imperfections typically found in emerging markets and developing countries raise the cost of debt financing for domestic firms. This in turn leads to three distinct effects; a greater need for firms to precautionary save, increased vulnerability to foreign multinationals buy-outs, and a drastic limitation on the purchase of foreign firms. We extend a small open economy framework to study the financing decisions of firms operating under financial frictions. In equilibrium, we can obtain a large negative net equity position and a smaller negative net debt position as a result of incremental financing decisions of the firms, rationalizing the observed NFAP in most non-industrial economies.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 1160.

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Date of creation: 2009
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Handle: RePEc:red:sed009:1160

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  1. Durdu, Ceyhun Bora & Mendoza, Enrique G. & Terrones, Marco E., 2009. "Precautionary demand for foreign assets in Sudden Stop economies: An assessment of the New Mercantilism," Journal of Development Economics, Elsevier, vol. 89(2), pages 194-209, July.
  2. Mendoza, Enrique G. & Smith, Katherine A., 2006. "Quantitative implications of a debt-deflation theory of Sudden Stops and asset prices," Journal of International Economics, Elsevier, vol. 70(1), pages 82-114, September.
  3. Katherine A. Smith & Diego Valderrama, 2007. "The composition of capital inflows when emerging market firms face financing constraints," Working Paper Series 2007-13, Federal Reserve Bank of San Francisco.
  4. Choi, Horag & Mark, Nelson C. & Sul, Donggyu, 2008. "Endogenous discounting, the world saving glut and the U.S. current account," Journal of International Economics, Elsevier, vol. 75(1), pages 30-53, May.
  5. Laura Alfaro & Sebnem Kalemli-Ozcan & Vadym Volosovych, 2005. "Capital Flows in a Globalized World: The Role of Policies and Institutions," NBER Working Papers 11696, National Bureau of Economic Research, Inc.
  6. Backus, David K. & Gregory, Allan W. & Zin, Stanley E., 1989. "Risk premiums in the term structure : Evidence from artificial economies," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 371-399, November.
  7. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
  8. P. Marcelo Oviedo & Enrique Mendoza, 2004. "Public Debt, Fiscal Solvency, and Macroeconomic Uncertainty in Emerging Markets: The Tale of the Tormented Insurer," Econometric Society 2004 North American Summer Meetings 647, Econometric Society.
  9. Anusha Chari & Paige P. Ouimet & Linda L. Tesar, 2004. "Acquiring Control in Emerging Markets: Evidence from the Stock Market," NBER Working Papers 10872, National Bureau of Economic Research, Inc.
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Cited by:
  1. Juergen von Hagen & Haiping zhang, 2010. "International Capital Flows and Aggregate Output," Working Papers 10-2010, Singapore Management University, School of Economics.
  2. Jurgen von Hagen & Haiping Zhang, 2011. "Financial Development and the Patterns of International Capital Flows," Working Papers 21-2011, Singapore Management University, School of Economics.
  3. von Hagen, Jürgen & Zhang, Haiping, 2012. "International Capital Flows with Limited Commitment and Incomplete Markets," CEPR Discussion Papers 8750, C.E.P.R. Discussion Papers.

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