Working Paper: CEPR ID: DP6343
Authors: Jiandong Ju; Shangjin Wei
Abstract: This paper proposes a simple model to study the relationship between domestic institutions - financial system, corporate governance, and property rights protection - and patterns of international capital flows. It studies conditions under which financial globalization can be a substitute for reforms of domestic financial system. Inefficient financial system and poor corporate governance in a country may be completely bypassed by two-way capital flows in which domestic savings leave the country in the form of financial capital outflows but domestic investment takes place via inward foreign direct investment. While financial globalization always improves the welfare of a developed country with a good financial system, its effect is ambiguous for a developing country with an inefficient financial sector/poor corporate governance. However, the net effect for a developing country is more likely to be positive, the stronger its property rights protection. This is consistent with the observation that developed countries are often more enthusiastic about capital account liberalization around the world than many developing countries. A noteworthy feature of this theory is that financial and property rights institutions can have different effects on capital flows.
Keywords: financial development; international capital flows; corporate governance; property rights protection
JEL Codes: F2; F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial globalization (F30) | two-way capital flows (F32) |
| two-way capital flows (F32) | domestic savings exit (D14) |
| two-way capital flows (F32) | foreign direct investment enters (F21) |
| financial globalization (F30) | bypass inefficient domestic financial systems (F65) |
| quality of domestic institutions (O17) | benefits from capital mobility (F20) |
| property rights protection (P14) | benefits from capital mobility (F20) |
| capital mobility (F20) | ambiguous welfare effects for countries with poor governance (O17) |
| institutional quality (L15) | net effects of capital mobility for developing countries (F20) |