Transcript Slide 1

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
• 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)
• 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)
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
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
0
.02
.04
.06
.08
Volatility of (FDI/GDP) and (Loan/GDP)
(1980-2003, Measured by Standard Deviation)
.
FDI/GDP
Loan/GDP
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
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
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?
Answers to the Challenges
• Separate the effects of financial
development and weak governance
• Find instrumental variables for government
corruption and financial development
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”
• 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
• Instrumental variables for financial
development:
• Legal origins: La Porta, Lopez-de-silanes,
Shleifer, and Vishny (JPE 1998)
• Settler mortality
(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.
•
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.
First Stage Regressions:
Using Histories to Instrument Modern-day Institutions
(1)
Log(settler
mortality)
Corruption(GCR/WDR)
(2)
(3)
(4)
Financial development
(5)
(6)
(7)
Institutional Quality
(8)
(9)
0.46**
0.31**
-0.21**
-0.38**
-0.29**
(0.08)
(0.08)
(0.03)
(0.07)
(0.07)
Log(Population
density in 1500)
0.27**
(0.07)
0.10
(0.08)
-0.07**
(0.03)
Legal origin
(French)
0.37
(0.23)
0.62**
(0.22)
-0.18**
(0.08)
-0.14*
(0.08)
-0.18**
(0.08)
-0.06
(0.17)
Legal origin
(German)
0.00
(0.00)
0.00
(0.00)
0.74*
(0.38)
0.00
(0.00)
0.00
(0.00)
0.00
(0.00)
Legal origin
(Scandivanian)
0.00
(0.00)
0.00
(0.00)
0.70*
(0.38)
0.00
(0.00)
0.00
(0.00)
0.00
(0.00)
Legal origin
(Socialist)
0.71
(0.66)
0.79
(0.72)
-0.25**
(0.10)
-0.29
(0.21)
-0.14
(0.25)
-0.98**
(0.45)
40
0.36
44
0.20
120
0.14
60
0.47
73
0.14
Observations
R-squared
44
0.44
48
0.24
70
0.33
61
0.29
Explaining the Ratio of FDI/ Total Foreign Liabilities in 2003
Corruption(GCR/WDR)
-0.10**
(0.04)
Financial development
IV regressions
-0.65**
(0.23)
0.17*
(0.09)
-1.07**
(0.44)
-0.56**
(0.24)
-0.88*
(0.46)
Resource a
0.13
(0.13)
Openness a
0.12*
(0.07)
Observations
R-squared
40
0.15
34
0.09
34
0.28
34
0.36
Explaining Portfolio Equity/Total Foreign Liabilities in 2003
Corruption(GCR/WDR)
-0.07**
(0.01)
Financial development
IV regressions
0.06
(0.09)
0.14**
(0.03)
0.25
(0.17)
0.09
(0.09)
0.31*
(0.18)
Resource a
0.04
(0.05)
Openness a
0.01
(0.03)
34
0.40
Observations
R-squared
40
0.37
34
0.37
34
0.38
Explaining Portfolio Debt/ Total Foreign Liabilities in 2003
Corruption(GCR/WDR)
-0.10**
(0.03)
Financial development
IV regressions
-0.34**
(0.14)
0.19**
(0.05)
-0.45*
(0.26)
-0.31**
(0.14)
-0.40
(0.27)
Resource a
0.05
(0.08)
Openness a
-0.08*
(0.04)
Observations
R-squared
40
0.26
34
0.27
34
0.39
34
0.47
Explaining Outstanding Foreign Loans/ Total Foreign Liabilities in
2003
Corruption(GCR/WDR)
0.36**
(0.06)
Financial development
IV regressions
0.87**
(0.30)
-0.57**
(0.13)
1.10*
(0.60)
0.67*
(0.33)
0.65
(0.66)
Resource a
-0.15
(0.18)
Openness a
-0.23
(0.14)
Observations
R-squared
38
0.53
33
0.38
33
0.52
33
0.56
Total Capital Inflows Per Capita in Logarithm (2003)
Corruption(GCR/WDR)
IV regression
-6.48** 0.79
(1.56)
(1.69)
-2.15**
(0.36)
Financial development
2.57**
(0.71)
-9.74**
(3.01)
0.88
(1.79)
0.68
(2.80)
0.87
(3.00)
Log(Human capital stock)
0.32
(0.38)
0.31
(0.40)
Log(Capital stock per capita)
0.95**
(0.18)
0.92**
(0.19)
Resource a
0.33
(0.74)
Openness a
0.22
(0.39)
Observations
R-squared
40
0.48
34
0.29
34
0.54
28
0.82
28
0.82
Table 6: Alternative Measure of Institutions – Average of Six World
Bank Indicators
FDI/total
foreign
liability
IV Regression
Portolio equity
Portolio debt
/total foreign
/total foreign
liability
liability
Loan/total
foreign liability
Institutional Quality
0.67**
(0.29)
-0.11
(0.11)
0.38**
(0.17)
-0.81*
(0.40)
Financial
development
-0.88*
0.31*
-0.40
0.65
(0.46)
(0.18)
(0.27)
(0.66)
Resource a
0.13
(0.13)
0.04
(0.05)
0.05
(0.08)
-0.15
(0.18)
Openness a
0.12*
(0.07)
0.01
(0.03)
-0.08*
(0.04)
-0.23
(0.14)
Observations
R-squared
34
0.36
34
0.40
34
0.47
33
0.56
Table 7: Adding more control variables (IV Regressions)
FDI/total foreign
liability
(1)
-0.55**
(0.24)
(2)
-0.42*
(0.25)
Portolio
equity/total
foreign liability
(3)
(4)
0.09
0.17*
(0.10)
(0.09)
Financial development
-0.87*
(0.48)
-0.76
(0.46)
0.31*
(0.19)
0.38**
(0.16)
-0.48*
(0.26)
-0.42*
(0.25)
0.72
(0.68)
0.28
(0.54)
Resource a
0.13
(0.13)
0.12
(0.13)
0.04
(0.05)
0.04
(0.04)
0.05
(0.07)
0.05
(0.07)
-0.15
(0.18)
-0.16
(0.14)
Openness a
0.13*
(0.07)
0.17**
(0.07)
0.01
(0.03)
0.04
(0.02)
-0.09**
(0.04)
-0.07*
(0.04)
-0.22
(0.15)
-0.39**
(0.12)
FDI restrition Dummy
-0.01
(0.05)
-0.06
(0.06)
-0.00
(0.02)
-0.03*
(0.02)
0.05*
(0.03)
0.02
(0.03)
-0.04
(0.07)
0.09
(0.06)
34
0.36
0.04*
(0.02)
34
0.43
34
0.40
0.03**
(0.01)
34
0.58
34
0.53
0.02*
(0.01)
34
0.59
33
0.57
-0.10**
(0.02)
33
0.74
Corruption(GCR/WDR)
Log(GDP)
Observations
R-squared
Portolio debt
/total foreign
liability
(5)
(6)
-0.34** -0.27*
(0.14)
(0.13)
Loan/total
foreign liability
(7)
0.69*
(0.34)
(8)
0.29
(0.28)
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.
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.