Working Paper: CEPR ID: DP5317
Authors: Erik Feijen; Enrico C. Perotti
Abstract: While financial liberalization has in general favourable effects, reforms in countries with poor regulation is often followed by financial crises. We explain this variation as the outcome of lobbying interests capturing the reform process. Even after liberalization, market investors must rely on enforcement of investor protection, which may be structured so as to block funding for new entrants, or limit their access to refinance after a shock. This forces inefficient default and exit by more leveraged entrepreneurs, protecting more established producers. As a result, lobbying may deliberately worsen financial fragility. After large external shocks, borrowers from the political elite in very corrupt countries may successfully lobby for weak enforcement, and retain control of collateral. We provide evidence that industry exit rates and profit margins after banking crises are higher in the most corrupt countries.
Keywords: Entry; Exit; Financial Crises; Inequality; Political Economy; Refinancing; Strategic Default
JEL Codes: G36
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial liberalization (F30) | increased financial fragility (F65) |
| poor regulatory frameworks (L59) | lobbying interests capturing the reform process (D72) |
| lobbying (D72) | financial crises (G01) |
| higher corruption (H57) | worse outcomes post-crisis (H12) |
| lobbying (D72) | weaker enforcement of investor protection laws (G38) |
| corruption (D73) | higher industry exit rates (L19) |
| corruption (D73) | higher profit margins in banking crises (F65) |
| lobbying (D72) | financial outcomes (G39) |
| corruption (D73) | worse exit after crises (H12) |
| lobbying, investor protection (G24) | financial fragility (G51) |