Patterns of International Capital Flows and Productivity Growth: New Evidence

Recent evidence from developing and emerging economies shows a negative correlation between growth and net capital inflows, a contradiction to neoclassical growth theory. I provide updated and disaggregated evidence on the origins of this puzzle. An analysis of the components of capital flows and of gross portfolio positions shows that foreign direct investment is directed towards countries with the highest growth rates, but that portfolio investment outflows exceed these inflows. Liberalized capital accounts further exacerbate this pattern. My results suggest a desire for international portfolio diversification in liquid assets by fast‐growing countries lies at the heart of the puzzle.     

Taxi,Takeoff and Landing: Behavioural Patterns of Capital Flows to Emerging Markets

This paper analyses volatility, persistence, predictability, correlation, comovement (or contagion risk) and sudden stop (reversibility) of capital flows (foreign direct investment (FDI), foreign portfolio equity investment, long-term and short-term debt flows) using time series econometric techniques for 24 emerging economies over 1970–2014. This is informative on the pattern and relationship between capital inflows, with implications for accommodating macroeconomic policies in countries receiving inflows. The paper also addresses the predictions of conventional theory, that differences are associated with the maturity of the capital (long-term vs. short-term), with the information-based trade-off model of Goldstein and Razin [(2006). An information-based trade off between foreign direct investment and foreign portfolio investment. Journal of International Economics, 70(1), 271–295], that differences are associated with the structure of the capital (equity vs. debt). In line with the latter, equity flows (FDI and portfolio) are less volatile and persistent, more predictable and less susceptible to sudden stops than debt flows. Contrary to conventional theory, short-term flows are not more volatile, but there is evidence that correlations and risks of contagion are strong within all capital flow components.     

Decentralization and political institutions

Does fiscal decentralization lead to more efficient governance, better public goods, and higher economic growth? This paper tests Riker's [Riker, W. (1964) “Federalism: Origins, Operation, Significance,” Little, Brown and Co, Boston, MA.] theory that the results of fiscal decentralization depend on the level of countries' political centralization. We analyze cross-section and panel data from up to 75 developing and transition countries for 25 years. Two of Riker's predictions about the role of political institutions in disciplining fiscally-autonomous local politicians are confirmed by the data. 1) Strength of national political parties significantly improves outcomes of fiscal decentralization such as economic growth, quality of government, and public goods provision. 2) In contrast, administrative subordination (i.e., appointing local politicians rather than electing them) does not improve the results of fiscal decentralization.     

Surviving Asymmetry in Capital Flows and the Business Cycles: The Role of Prudential Capital Controls

Past literature of different strands has pointed to a potential asymmetry: while portfolio capital inflows are largely irrelevant to the economy, capital outflows can cause recession. In a model with a convex investment and portfolio balance adjustment cost, and endogenous credit‐in‐advance constraint, we find that investment is determined solely by opportunity cost of physical capital unrelated to portfolio capital inflows when the constraint is slack. However, once credit availability is tightened up by capital outflows, the negative liquidity constraint dominates the opportunity‐cost factor, causing an economic downturn. Financial fragility against capital outflows is an outcome of pecuniary externalities, which, however, can be moderated by prudential capital controls. Even when exchange rates float freely, capital controls ease the macro‐stabilizing burden of monetary policy, as they help shield the economy from financial instability. Prudential tax on foreign debt is most preferred, and works the best when the exchange rate float is managed.     

Adam Smith's “tolerable administration of justice” and the Wealth of Nations

Adam Smith argues that a country’s income depends on its labor productivity, which in turn hinges on the division of labor. But why are some countries able to take advantage of the division of labor and become rich, while others fail to do so and remain poor? Smith describes how the security of property rights, through a “tolerable administration of justice,” allows investment and exchange to take place, bringing about economic progress. Recent empirical work on economic development has supported Smith’s emphasis on a country’s political “institutions,” particularly the judiciary, in determining its national income.     

Unfair inequality,governance and individual beliefs

Unfair inequality arises when incentives are not fairly tied to effort or investment across the socio-economic spectrum. The actual limitations on economic activity from this failure may depend on whether people believe the system is unfair, and how well governing institutions safeguard fair-play. In this paper, I study whether unfair wealth inequality is correlated with beliefs about fairness, and whether good governance can be a substitute in belief formations for decreases in unfair inequality. I find a that people in countries with recent increases in unfair wealth inequality are less likely to believe that inequality is due to fair processes. This relationship holds when“fair” determinants of inequality include effort, as well as moral and meritocratic components. The relationship is strongest in countries with poor quality governance. In countries with high quality governance, people appear to be more tolerant of unfair inequality, as it is only weakly reflected in their beliefs about process fairness.     

The impact of sub‐national institutions

This paper assesses the effect of sub‐national institutions on the economic performance of Russia's regions (oblasts, republics, krais and okrugs) from 2001 to 2008, a period of rapid economic advancement and recentralization. Approximating sub‐national institutions with the RA Expert index of investment risk, we find that a reduction in investment risk by one standard deviation increases output by 1.4 percent in the short run and 11.9 percent in the long run, suggesting a substantial regional performance gap in government practices, despite intensive political recentralization. Assuming that the main components of effective governance are running satisfactory public health programmes aimed at decreasing overall mortality among the working‐age population, creating fair labour market conditions and improving the regional institutional climate to encourage investment in fixed assets, we argue that sub‐national institutions remain important for growth in post‐Soviet Russia after 2000. This paper contributes to the literature on institutional persistence.     

Political stability and growth: An application of dynamic GMM and quantile regression

This paper studies the effect of political stability on economic growth by taking 120 developing countries over the period of 1996–2014. We apply relatively advanced dynamic two step system-GMM and quantile regression. Political stability is found to be a key determinant of economic growth. More importantly, political instability (or risk) is found to be higher in the OIC countries and is a deterrent to economic growth. Also, for the lower and middle income OIC countries, political instability appears to affect economic growth more severely perhaps due to the absence of strong economic and political institutions. Moreover, political instability is also found to be significantly higher in the oil-dependent OIC countries. Notably, political instability is likely to affect growth through the channels of investment and human capital accumulation in the developing countries. Finally, the impact of political stability and political instability on growth is found to be equally distributed across the OIC countries with higher or lower growth level. Therefore, the development of political and economic institutions along with human capital development is recommended for all the developing countries in general and the OIC countries in particular.     

I (Could Have) Told You! Early warning indicators and crisis performance of the 12 “old” Euro-countries under the economic crisis 2008–09

The impact of the economic crisis 2008-09 was remarkably different in the 12 “old” member states in the Euro-zone. Five of them were hit especially badly; four of them even had to be bailed out by the rest in one way or another. This paper asks if one could have foretold, based solely on information available prior to 1999, which of the countries then about to enter the Euro-zone would run into economic trouble once a serious economic crisis occurred. The focus is on the (post)predictive power of three kinds of leading indicators: economic indicators, political indicators (indicating quality of governance), and indicators derived from the theory of optimal currency areas (OCA). Since there are more indicators than cases, PLS-regression is used to gauge the (post)predictive strength of the indicators examined. The results show that political indicators have quite some (post)predictive power in this case, whereas indicators derived from OCA-theory do not do too well. Economic indicators perform better than indicators derived from OCA-theory, but generally less well than the political indicators. Thus, the experience from the latest economic crisis in the Euro-zone suggests that more emphasis should be placed on the quality of governance record of a country when deciding if it should be deemed fit to become a member.     

Risky business: Institutions vs. social networks in FDI

Political economy scholarship on foreign direct investment (FDI) emphasizes variation in host country political risk but overlooks variation in investors' sensitivity to political risk. We show that relational contracting, relationship‐based contract enforcement, is more efficient for high‐risk, human capital‐intensive activities for which the costs of writing legally enforceable contracts are prohibitive. We disaggregate FDI into two distinct varieties: mergers and acquisitions (M&A) and venture capital (VC). We propose that VC flows are less sensitive to host institutions but correlate strongly with skilled migrant networks that monitor compliance and impose reputational costs. Our empirical analysis of dyadic VC and M&A flows covers over 100 countries during 1980–2009. We address other mechanisms through which migrant networks facilitate FDI and verify our results hold at the country‐industry level. These findings suggest that relational contracting facilitates global integration of dynamic, knowledge‐intensive industries even when formal institutions are weak.     

Social capital and social economics

The “discovery” of social capital in the early 1990s led to an upsurge of research into the economic impact of social cohesion and governmental effectiveness. This paper outlines key developments in the social capital literature over the past 13 years. It then examines theory and evidence of the links between social cohesion, quality of governance, economic performance and human welfare. The literature indicates that social capital makes a measurable contribution to economic development and overall wellbeing, particularly in developing countries. Partly in response to this emerging body of evidence, there has been increased interest in the application of community development principles to economic development initiatives. This paper argues that the advent of social capital theory represents a partial convergence between social economics and mainstream economics, and signifies an increased acceptance that economic activity cannot be meaningfully “disembedded” from social and political context.     

The Volatility of Foreign Portfolio Investment and the Access to Finance of Small Listed Firms

This paper examines the impact of foreign portfolio investment (FPI) volatility on the access to capital of small listed firms. The volatility of FPI is significantly associated with decreased access to finance for small listed firms only in years when nations are considered less “creditworthy.” Even in these times, however, the benefits of FPI are not completely depleted. These results underscore the significance of both a good financial system that minimizes capital flow volatility and national creditworthiness in inspiring confidence in foreign investors.     

Public investment in developing countries: A blessing or a curse?

This paper analyzes the relationship between public and private investment in developing countries. We set up a simple theoretical model where two countervailing forces coexist. On the one hand, public investment raises the marginal productivity of private capital and leads to potential crowding-in of private investment. On the other hand, weak institutions and restricted access to financing could diminish the positive effects of public investment projects and crowd-out private investment. The empirical results - which exploit both the time series and cross sectional variation in the data using a panel of 116 developing countries with annual observations between 1980 and 2006 - suggest that on average the crowing-out effect dominates. Moreover, we find that this crowing-out effect is dampened (or even reversed) in countries with better institutions - where the marginal productivity of public investment is conceivably higher - and that are more open to international trade and financial flows, such that financing constraints are less binding.     

Growth in fragile states in Africa: Conflict and post‐conflict capital accumulation

This article analyses the pattern of capital accumulation in Africa and its interaction with political fragility. Political fragility, defined as armed conflict or civil war, retards or reverses gains with respect to capital accumulation, slowing long‐term economic growth. Many countries experience negative rates of capital accumulation, particularly during periods of acute political instability. In post‐war periods, countries generally continue to experience capital destruction, lending support to the “war ruin hypothesis.” This has implications for long‐term economic growth in view of the strong association between capital accumulation and economic performance. The main policy implication of the analysis is that African countries and their international partners should pay more attention to capital accumulation, including capital reconstruction after periods of political instability, to lay the foundations for sustainable economic growth.     

An Alternative Post-Keynesian Framework for Understanding Capital Flows to Emerging Markets

This article contributes to the establishment of a framework for the analysis of international capital flows, with a specific focus on emerging markets. It is based on a “monetary” analysis of the economy, as well as on the works of Hyman Minsky and Jan Toporowski in particular. The key aspects of such an approach are the following. First, in a monetary economy, capital flows need to be understood as “flows of funds” that pertain to the realm of financial choices, as opposed to the traditional understanding of capital flows as based on “real” variables, such as saving and investment. A consequence of this is the need to focus on gross flows rather than capital flows. Second, liquidity preference considerations also apply at the international level, particularly in relation to the liquidity of emerging-market currencies that, in turn, depends on context-specific “Keynesian fundamentals.” Third, the rise of institutional investors is the key historical development in the financial system, shaping the current reality of cross-border capital flows, including to emerging markets. I argue that institutional investors’ liabilities, in light of the theories of Minsky and Toporowski, are one of the most important variables in determining these investors’ portfolio choices. I synthesize these elements by defining capital flows to emerging markets as the demand for emerging-market assets by institutional investors. I propose a framework to categorize the various channels that guide this demand.     

Sudden stops in a currency union – some lessons from the euro area

During the Great Financial Crisis several euro area Member States with current account deficits were subject to sharp reversals of private capital flows. We examine how the specific policy rules of the euro area's payments system TARGET2 affects the macroeconomic adjustments to sudden stops. We find that – in the short run – public capital flows in form of TARGET2 help euro area‐deficit countries to stabilize output, consumption, and investment after a sudden stop of private capital inflows. In the long run, however, euro area countries suffer under a prolonged economic recovery and accumulated large public debt as well as higher welfare losses relative to euro peggers.     

Sovereign Wealth Funds and National Security: The Dog that Will Refuse to Bark

Concerns have been raised that Sovereign Wealth Funds (SWFs) might be used by governments to advance international political goals, raising red flags about their possible economic and national security consequences. These concerns are overstated. Warnings about national security threats related to foreign investment have been sounded repeatedly throughout history, but they have invariably been false alarms. Although there are novel attributes about SWFs in contemporary world politics, establishing their national security consequences is much more difficult than it might seem. And in those instances where theoretical connections between SWFs and “high politics” can be established, on closer inspection the SWFs appear to be intervening variables – manifestations of other pathologies – rather than the root cause of the postulated problem. The potential geopolitical problems caused by SWFs are the result of shifts in wealth in the international system, and not by the establishment or functioning of wealth funds.     

European influence and economic development

The development accounting literature identifies political institutions as fundamental development determinants. Forms of government or executive constraints are thought to shape economic institutions (e.g., property rights) that provide necessary incentives for economic growth. One strand of the literature suggests that European influence is a crucial economic development determinant, presumably through the adoption of European institutions. But how exactly did European influence in the distant past induce positive economic outcomes today? Previous approaches rely on “language,” “settler mortality,” “legal origins” or the “number of European settlers” as indirect proxies of European influence. We propose a direct and quantifiable mechanism: the adoption of European constitutional features. We construct a dataset of all constitutional dimensions from 1800–2008 for all countries and find that nations experience growth accelerations after adopting features of European constitutions. The growth effects are influenced (negatively) by periods of political turmoil, but they are independent of colonial backgrounds. These results show how European influence may have fostered growth, and they imply that countries were able to overcome adverse initial conditions over the last 200 years by adopting European constitutional features. Our constitutional dataset is sufficiently detailed to identify the specific dimensions of European constitutions that matter most for development: legislative rules and specific provisions that curtail executive powers.     

The Trans-Political Nature of Southwest China’s Energy Conduit,Yunnan Province

Transboundary flows of energy across Yunnan Province in China and to Southeast Asian states provide insight into the changing nature of borders and border areas. Rather than monolithic symbols of state sovereignty, China’s southwest borders in Yunnan can be more accurately characterised as zones of connectivity and exchange, serving a range of local, national and regional objectives. Energy production and distribution in and across Yunnan can be understood as functioning in a set of dynamic transnational processes that serve as economic and political bridges – increasing interaction and deepening regional integration – while also working to mitigate risk to China’s energy demands. In this article, energy projects in Yunnan and Southeast Asia demonstrate the ways border regions can respond to increasing globalisation, simultaneously strengthening national energy security while promoting regional interconnection and diplomacy. Thus, connections to and through a once peripheral region present an apparent contradiction: once rigid territorial borders are increasingly characterised by transboundary infrastructure development and exchanges of energy, capital and diplomacy, while promoting broader, diversified national energy security objectives – essentially strengthening national security through transnational energy projects. This article investigates how energy development works to shape Yunnan’s role as an “energy conduit,” while advancing both transnational and national geopolitical objectives, and thus, suggesting that these projects can be understood as trans-political in nature.     

Political turnover and the accumulation of democratic capital

Certain democratic institutions tend to persist in some countries whereas they are frequently reversed in others. Focusing on strong constraints on executive power as one such institution, this paper theoretically studies the cross-country differences in the costs of relaxing these constraints. The model features two political parties that stochastically alternate in office according to a political uncertainty parameter. In each period, the incumbent can make reversible investments into the future government's ability to reform executive constraints. The main results indicate that more competitive elections and higher degrees of policy polarization between the political parties lead to high and persistent levels of investment into the society's stock of “democratic capital”. These higher costs of institutional reform in turn result in durable strong executive constraint-regimes.