connecting two views on financial globalization: can we make further progress?
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Connecting Two Views on Financial Globalization: Can We Make Further Progress?. Shang-Jin Wei IMF, NBER & CEPR Personal Views Only. What does Financial Globalization do? The gap between theories and empirics In theory, benefits through many channels - PowerPoint PPT PresentationTRANSCRIPT
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Connecting Two Views on Financial Globalization:
Can We Make Further Progress?
Shang-Jin Wei
IMF, NBER & CEPR
Personal Views Only
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• What does Financial Globalization do?• The gap between theories and empirics
– In theory, benefits through many channels• Direct: savings, cost of capital, and transfer of
technology,• Indirect: development of domestic financial market,
more specialization, and better policies
– In the data, evidence not strong
(Eichengreen, 2000; Prasad, Rogoff, Wei, and Kose, 2003; Kose, Prasad, Rogoff, and Wei, 2006)
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• Reconciling theories with empirical patterns:• Two independent proposals
– The composition effect: • Some capital flows are more beneficial than others
– The threshold effect:• Benefits of FG can be realized only if the recipient
countries meet some conditions
• Eichengreen (2000), Prasad, Rogoff, Wei, and Kose (2003)
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Roadmap for discussion
• How do the two effects work?
• My take on the two effects– The composition is a reflection of the threshold effect
• Challenges to this interpretation
• Response to the challenge
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The composition hypothesis
• Not all capital flows are equal
• FDI and maybe portfolio inflow are more beneficial to growth than debt– Desoto and Reisen 2001; Bekaert, Harvey, and
Lundblad, 2005, JFE
• FDI is also less volatile than international bank loans -> More reliance on bank loans increases vulnerability to currency crashes – Frankel and Rose, 1996; Frankel and Wei, 2005
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Volatility of (FDI/GDP) and (Loan/GDP) (1980-2003, Measured by Standard Deviation)
0.0
2.0
4.0
6.0
8S
tan
da
rd D
evia
tion
.
FDI/GDP Loan/GDP
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The Threshold Effect
• Certain minimum conditions have to be met before a country can benefit from FG
• Institutions– Low corruption / decent rule of law
• Otherwise, FG may exacerbate distortions
– Reasonable level of financial development• So international capital can be channeled into investment
– Human capital
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Are the Two Effects Connected?
• Yes!– Earlier: Wei (2000, 2001), Wei and Wu (2002)– Recently: Faria and Mauro (2005)
• Why? – Insight from the literature from corporate
finance– A built-in bias in the international financial
architecture
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Challenges
• Countries with worse financial institutions appear to attract more (not less) FDI
• Albuquerque (JIE 2003)• Also see Hausmann and Fernandez-Aris (2000)
• Even if public governance and composition of capital inflows are related as hypothesized, how do we know the relationship is causal?
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Answers to the Challenges
• Separate the effects of financial development and weak governance
• Find instrumental variables for government corruption and financial development
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Why would weaker financial development be
associated with more FDIs?• Caballero, Farhi and Gourinchas, 2005,
“An eqbm model of ‘global imbalances’ and low interest rates.”
• Ju and Wei, 2005, “A solution to two paradoxes on international capital flows”
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• Instrumental variable for government corruption:
• Initial cost to colonizers –mortality rate of European settlers before 1850
• Acemoglu, Johnson, and Robinson (AER 2001)
• Alternative: initial population density in 1500
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• Instrumental variables for financial development:
• Legal origins: La Porta, Lopez-de-silanes, Shleifer, and Vishny (JPE 1998)
• Settler mortality
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(History-based) instrumental variables
• Corruption is mostly affected by settler mortality but not by legal origin
• Financial development is affected by both legal origins and settler mortality.
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• The basic specification:
(1) Composition(j) = β1 Corruption(j)
+ β2 FinDev(j) + Z(j)Γ + e(j)
Zj is a vector of control variables,
β1, β2, and Γ are parameters
ej is a random error.
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First Stage Regressions:Using Histories to Instrument Modern-day Institutions
Corruption(GCR/WDR) Financial development Institutional Quality (1) (2) (3) (4) (5) (6) (7) (8) (9)
Log(settler mortality)
0.46** 0.31** -0.21** -0.38** -0.29**
(0.08) (0.08) (0.03) (0.07) (0.07)
Log(Population 0.27** 0.10 -0.07** density in 1500) (0.07) (0.08) (0.03)
Legal origin 0.37 0.62** -0.18** -0.14* -0.18** -0.06 (French) (0.23) (0.22) (0.08) (0.08) (0.08) (0.17)
Legal origin 0.00 0.00 0.74* 0.00 0.00 0.00 (German) (0.00) (0.00) (0.38) (0.00) (0.00) (0.00)
Legal origin 0.00 0.00 0.70* 0.00 0.00 0.00 (Scandivanian) (0.00) (0.00) (0.38) (0.00) (0.00) (0.00)
Legal origin 0.71 0.79 -0.25** -0.29 -0.14 -0.98** (Socialist) (0.66) (0.72) (0.10) (0.21) (0.25) (0.45)
Observations 44 48 40 44 120 60 73 70 61 R-squared 0.44 0.24 0.36 0.20 0.14 0.47 0.14 0.33 0.29
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Explaining the Ratio of FDI/ Total Foreign Liabilities in 2003
IV regressions Corruption(GCR/WDR) -0.10** -0.65** -0.56** (0.04) (0.23) (0.24)
Financial development 0.17* -1.07** -0.88* (0.09) (0.44) (0.46)
Resource a 0.13 (0.13)
Openness a 0.12* (0.07)
Observations 40 34 34 34 R-squared 0.15 0.09 0.28 0.36
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Explaining Portfolio Equity/Total Foreign Liabilities in 2003
IV regressions Corruption(GCR/WDR) -0.07** 0.06 0.09 (0.01) (0.09) (0.09)
Financial development 0.14** 0.25 0.31* (0.03) (0.17) (0.18)
Resource a 0.04 (0.05)
Openness a 0.01 (0.03) Observations 40 34 34 34 R-squared 0.37 0.37 0.38 0.40
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Explaining Portfolio Debt/ Total Foreign Liabilities in 2003
IV regressions Corruption(GCR/WDR) -0.10** -0.34** -0.31** (0.03) (0.14) (0.14)
Financial development 0.19** -0.45* -0.40 (0.05) (0.26) (0.27)
Resource a 0.05 (0.08)
Openness a -0.08* (0.04)
Observations 40 34 34 34 R-squared 0.26 0.27 0.39 0.47
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Explaining Outstanding Foreign Loans/ Total Foreign Liabilities in 2003
IV regressions Corruption(GCR/WDR) 0.36** 0.87** 0.67* (0.06) (0.30) (0.33)
Financial development -0.57** 1.10* 0.65 (0.13) (0.60) (0.66)
Resource a -0.15 (0.18)
Openness a -0.23 (0.14)
Observations 38 33 33 33 R-squared 0.53 0.38 0.52 0.56
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Total Capital Inflows Per Capita in Logarithm (2003)
IV regression Corruption(GCR/WDR) -2.15** -6.48** 0.79 0.88 (0.36) (1.56) (1.69) (1.79)
Financial development 2.57** -9.74** 0.68 0.87 (0.71) (3.01) (2.80) (3.00)
Log(Human capital stock) 0.32 0.31 (0.38) (0.40)
Log(Capital stock per capita) 0.95** 0.92** (0.18) (0.19)
Resource a 0.33 (0.74)
Openness a 0.22 (0.39)
Observations 40 34 34 28 28 R-squared 0.48 0.29 0.54 0.82 0.82
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Table 6: Alternative Measure of Institutions – Average of Six World Bank Indicators
IV Regression FDI/total
foreign liability
Portolio equity /total foreign liability
Portolio debt /total foreign liability
Loan/total foreign liability
Institutional Quality 0.67** -0.11 0.38** -0.81* (0.29) (0.11) (0.17) (0.40)
Financial development
-0.88* 0.31* -0.40 0.65
(0.46) (0.18) (0.27) (0.66)
Resource a 0.13 0.04 0.05 -0.15 (0.13) (0.05) (0.08) (0.18)
Openness a 0.12* 0.01 -0.08* -0.23 (0.07) (0.03) (0.04) (0.14)
Observations 34 34 34 33 R-squared 0.36 0.40 0.47 0.56
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Table 7: Adding more control variables (IV Regressions)
FDI/total foreign liability
Portolio equity/total
foreign liability
Portolio debt /total foreign
liability
Loan/total foreign liability
(1) (2) (3) (4) (5) (6) (7) (8) Corruption(GCR/WDR) -0.55** -0.42* 0.09 0.17* -0.34** -0.27* 0.69* 0.29 (0.24) (0.25) (0.10) (0.09) (0.14) (0.13) (0.34) (0.28)
Financial development -0.87* -0.76 0.31* 0.38** -0.48* -0.42* 0.72 0.28 (0.48) (0.46) (0.19) (0.16) (0.26) (0.25) (0.68) (0.54)
Resource a 0.13 0.12 0.04 0.04 0.05 0.05 -0.15 -0.16 (0.13) (0.13) (0.05) (0.04) (0.07) (0.07) (0.18) (0.14)
Openness a 0.13* 0.17** 0.01 0.04 -0.09** -0.07* -0.22 -0.39** (0.07) (0.07) (0.03) (0.02) (0.04) (0.04) (0.15) (0.12)
FDI restrition Dummy -0.01 -0.06 -0.00 -0.03* 0.05* 0.02 -0.04 0.09 (0.05) (0.06) (0.02) (0.02) (0.03) (0.03) (0.07) (0.06)
Log(GDP) 0.04* 0.03** 0.02* -0.10** (0.02) (0.01) (0.01) (0.02) Observations 34 34 34 34 34 34 33 33 R-squared 0.36 0.43 0.40 0.58 0.53 0.59 0.57 0.74
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Summary (1)
• Corruption does not appear to have a strong effect on a country’s total foreign liabilities.
• It affects the composition significantly. As FDI and portfolio debt are strongly discouraged, foreign loans take their places.
• Corruption increases a country’s vulnerability to a balance-of-payments crisis by altering its composition of capital inflows in an unfavorable direction.
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Summary (2)
• Financial development does not appear to have a strong effect on total foreign liabilities.
• However, a weaker financial system appears to induce more FDIs.
• A weaker financial system is likely to discourage inflows of portfolio equity and portfolio debt.