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Myth or Reality?

Myth or Reality?. The Diffusion of Financial Liberalization in Developing Countries IPES, Princeton November 17, 2006 Nancy Brune (nbrune@sas.upenn.edu ) Alexandra Guisinger (guisinger.1@nd.edu). Testing policy diffusion hypotheses. Countries as interdependent policy decision makers

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Myth or Reality?

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  1. Myth or Reality? The Diffusion of Financial Liberalization in Developing Countries IPES, Princeton November 17, 2006 Nancy Brune (nbrune@sas.upenn.edu ) Alexandra Guisinger (guisinger.1@nd.edu)

  2. Testing policy diffusion hypotheses • Countries as interdependent policy decision makers • Strang and Chang 1993; Guler et al 2002; Meseguer 2002; Heinsz et al 2005; Brooks 2002; Cunre and Garrrett 2000; Kogut and Macpherson 2005; Guisinger 2005; McNamara and Castro 2003; Coppedge 2005 • Specific to financial liberalization Simmons and Elkins 2004; Quinn and Toyoda 2005; Kobrin and Wu 2005 • Concerns • Is diffusion just capturing trend towards liberalization? • How can we be certain that diffusion mechanisms are at work? • Solution • Analysis of multiple distinct but similar policy decisions • Linking distinct diffusion causal mechanism to specific policy decisions

  3. Financial Liberalization Percentage of Developing Countries with Financial Openness Score>1 • “The economics profession knows a great deal about current account liberalization … It knows far less about capital account liberalization. It is time to bring order both to thinking and policy on the capital account.” Stanley Fischer, 1988

  4. Diffusion Mechanisms • Capital Controls suited to diffusion mechanism • Uncertainty of economic outcome • Low political saliency • Often technocratic decision-makers • Mechanisms • Competition for capital (defined by S&P Rankings) • Emulation of economic peers (defined by economic or export structure) • Emulation of trading partners (participation in RTAs)

  5. Inflows of Invisibles Inflows affecting Capital and Money Mrkt Securities Inflows affecting Credit Operations Inward Direct Investment Proceeds from Exports Exchange Rate Rules Outflows of Invisibles Outflows affecting Capital and Money Mrkt Securities Outflows affecting Credit Operations Outward Direct Investment Real Estate Transactions Commercial Banking Rules Data • 12 Capital Control Categories • 117 developing countries, from 1970-2002 • Generates 12 obs. for each country year in full dataset • Additionally, partition dataset according to whether controls affect Capital Market, Credit Market, FDI, or Current Account • Diffusion variables: Average policy of peer/partner in same capital control category

  6. Testing policy for policy adjustments Not Shown: Controls for type of capital control and time

  7. Testing Specific Causal Mechanisms

  8. Conclusions • Evidence of Diffusion • Trade-related networks positively linked to diffusion of financial liberalization • Lends support to argument that trade promotes financial liberalization • Diffusion much more evident on transparent policies (FDI vs. capital markets) • Difficult to distinguish between diffusion mechanisms

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