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Capital Controls and Financial Crises


  • Joshua Aizenman


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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  • Joshua Aizenman, 1999. "Capital Controls and Financial Crises," NBER Working Papers 7398, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:7398
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    References listed on IDEAS

    1. Roberto Chang & Andres Velasco, 1998. "Financial crises in emerging markets: a canonical model," FRB Atlanta Working Paper 98-10, Federal Reserve Bank of Atlanta.
    2. Ricardo Caballero & Arvind Krishnamurthy, 1998. "Emerging Market Crises: An Asset Markets Perspective," Working papers 98-18, Massachusetts Institute of Technology (MIT), Department of Economics.
    3. Paul Krugman, 2000. "Fire-Sale FDI," NBER Chapters,in: Capital Flows and the Emerging Economies: Theory, Evidence, and Controversies, pages 43-58 National Bureau of Economic Research, Inc.
    4. Dooley, Michael P, 2000. "A Model of Crises in Emerging Markets," Economic Journal, Royal Economic Society, vol. 110(460), pages 256-272, January.
    5. 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 639-667, October.
    6. Ann E. Harrison & Brian J. Aitken, 1999. "Do Domestic Firms Benefit from Direct Foreign Investment? Evidence from Venezuela," American Economic Review, American Economic Association, vol. 89(3), pages 605-618, June.
    7. Joshua Aizenman & Nancy P. Marion, 1999. "Uncertainty and the disappearance of international credit," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
    8. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel, 1999. "Paper tigers?: A model of the Asian crisis," European Economic Review, Elsevier, vol. 43(7), pages 1211-1236, June.
    9. Feenstra, Robert C. & Hanson, Gordon H., 1997. "Foreign direct investment and relative wages: Evidence from Mexico's maquiladoras," Journal of International Economics, Elsevier, vol. 42(3-4), pages 371-393, May.
    10. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
    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, 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 2001-11, Federal Reserve Bank of San Francisco.

    More about this item

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business

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