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Corruption, composition of capital flows, and currency crises

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  • Shang-Jin Wei

Abstract

Crony capitalism and international creditors'self-fulfilling expectations are often suggested as rival explanations for currency crises. A possible link between the two has not been explored. The author shows one channel through which crony capitalism can increase the chance of a currency/financial crisis by altering the composition of capital inflows. Using data on bilateral foreign direct investment and bilateral bank loans, the author finds clear evidence that in corrupt countries the composition of capital inflows is relatively light in foreign direct investment. Earlier studies indicated that a country with a capital inflow structure is more likely to run into a currency crisis down the road (partly through international creditors'self-fulfilling expectations). Therefore, crony capitalism, through its effect on the composition of a country's capital inflows, makes the country more vulnerable to currency crises brought about by self-fulfilling expectations. Corruption may also weaken domestic financial supervision, with a subsequent deterioration in the quality in banks'and firms'balance sheets.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2429.

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Date of creation: 31 Aug 2000
Date of revision:
Handle: RePEc:wbk:wbrwps:2429

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Related research

Keywords: International Terrorism&Counterterrorism; Banks&Banking Reform; Decentralization; Payment Systems&Infrastructure; Economic Theory&Research; International Terrorism&Counterterrorism; Economic Theory&Research; Governance Indicators; Banks&Banking Reform; Foreign Direct Investment;

References

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  1. Daniel Kaufmann & Shang-Jin Wei, 1999. "Does "Grease Money" Speed Up the Wheels of Commerce?," NBER Working Papers 7093, National Bureau of Economic Research, Inc.
  2. Jeffrey A. Frankel & Andrew K. Rose, 1996. "Currency crashes in emerging markets: an empirical treatment," International Finance Discussion Papers 534, Board of Governors of the Federal Reserve System (U.S.).
  3. Razin, A & Sadka, E & Yuen, C-W, 1997. "A Pecking Order of Capital Inflows and International Tax Principles," Papers 12-97, Tel Aviv - the Sackler Institute of Economic Studies.
  4. Fukuda, Shin-ichi & Hoshi, Takeo & Ito, Takatoshi & Rose, Andrew, 2006. "International Finance," Journal of the Japanese and International Economies, Elsevier, vol. 20(4), pages 455-458, December.
  5. McKinnon, Ronald I & Pill, Huw, 1999. "Exchange-Rate Regimes for Emerging Markets: Moral Hazard and International Overborrowing," Oxford Review of Economic Policy, Oxford University Press, vol. 15(3), pages 19-38, Autumn.
  6. Ronald I. McKinnon & Huw Pill, 1996. "Credible Liberalizations and International Capital Flows: The “Overborrowing Syndrome”," NBER Chapters, in: Financial Deregulation and Integration in East Asia, NBER-EASE Volume 5, pages 7-50 National Bureau of Economic Research, Inc.
  7. Steven Radelet & Jeffrey D. Sachs, 1998. "The East Asian Financial Crisis: Diagnosis, Remedies, Prospects," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 1-90.
  8. Pranab Bardhan, 1997. "Corruption and Development: A Review of Issues," Journal of Economic Literature, American Economic Association, vol. 35(3), pages 1320-1346, September.
  9. Tornell, Aaron, 1990. "Real vs. financial investment can Tobin taxes eliminate the irreversibility distortion?," Journal of Development Economics, Elsevier, vol. 32(2), pages 419-444, April.
  10. Mauro, Paolo, 1995. "Corruption and Growth," The Quarterly Journal of Economics, MIT Press, vol. 110(3), pages 681-712, August.
  11. Dani Rodrik & Andres Velasco, 1999. "Short-Term Capital Flows," NBER Working Papers 7364, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Laura Alfaro & Sebnem Kalemli-Ozcan & Vadym Volosovych, 2008. "Why Doesn't Capital Flow from Rich to Poor Countries? An Empirical Investigation," The Review of Economics and Statistics, MIT Press, vol. 90(2), pages 347-368, May.
  2. repec:pdn:wpaper:79 is not listed on IDEAS
  3. Eugen Dimant, 2014. "The Nature of Corruption - An Interdisciplinary Perspective," Working Papers CIE 79, University of Paderborn, CIE Center for International Economics.
  4. Ayhan Kose & Eswar Prasad & Kenneth Rogoff & Shang-Jin Wei & Ann Harrison, . "Financial Globalization, Growth and Volatility In Developing Countries," Working Paper 14902, Harvard University OpenScholar.
  5. Margaret S. McMillan & Andrew R. Waxman, 2007. "Profit Sharing Between Governments and Multinationals in Natural Resource Extraction: Evidence From a Firm-Level Panel," NBER Working Papers 13332, National Bureau of Economic Research, Inc.
  6. Norbert Funke & Faisal Ahmed & Rabah Arezki, 2005. "The Composition of Capital Flows," IMF Working Papers 05/40, International Monetary Fund.
  7. 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.
  8. Farida, Mohamad & Ahmadi-Esfahani, Fredoun Z., 2006. "Corruption and economic development: A critical review of literature," 2006 Conference (50th), February 8-10, 2006, Sydney, Australia 139727, Australian Agricultural and Resource Economics Society.
  9. Aysun, Uluc & Honig, Adam, 2011. "Bankruptcy costs, liability dollarization, and vulnerability to sudden stops," Journal of Development Economics, Elsevier, vol. 95(2), pages 201-211, July.
  10. Jeffrey A. Frankel & Shang-Jin Wei, 2004. "Managing Macroeconomic Crises," NBER Working Papers 10907, National Bureau of Economic Research, Inc.
  11. Bai, Chong-en & Wei, Shang-Jin, 2001. "The quality of bureaucracy and capital account policies," Policy Research Working Paper Series 2575, The World Bank.
  12. Papaioannou, Elias, 2009. "What drives international financial flows? Politics, institutions and other determinants," Journal of Development Economics, Elsevier, vol. 88(2), pages 269-281, March.
  13. Wasseem Mina & Jorge Martinez-Vazquez, 2006. "Contract Enforcement, Institutional Stability, and the Level and Maturity of International Debt," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper0617, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.

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