Paper #1340

Title:

Financial reforms and capital flows: Insights from general equilibrium

Authors:

Alberto Martin and Jaume Ventura

Date:

September 2012

Abstract:

As a result of debt enforcement problems, many high-productivity firms in emerging economies are unable to pledge enough future profits to their creditors and this constrains the financing they can raise. Many have argued that, by relaxing these credit constraints, reforms that strengthen enforcement institutions would increase capital flows to emerging economies. This argument is based on a partial equilibrium intuition though, which does not take into account the origin of any additional resources that flow to high-productivity firms after the reforms. We show that some of these resources do not come from abroad, but instead from domestic low-productivity firms that are driven out of business as a result of the reforms. Indeed, the resources released by these low-productivity firms could exceed those absorbed by high-productivity ones so that capital flows to emerging economies might actually decrease following successful reforms. This result provides a new perspective on some recent patterns of capital flows in industrial and emerging economies.

Keywords:

capital flows, financial reforms, productivity, economic growth, financial globalization

JEL codes:

F34, F36, G15, O19, O43

Area of Research:

Macroeconomics and International Economics

Published in:

Caballero, R. and Hebel, K. (Eds.), Economc Policy in Emerging Economies, Central Bank of Chile, Forthcoming

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