Working Paper: NBER ID: w18454
Authors: Alberto Martin; Jaume Ventura
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: financial reforms; capital flows; general equilibrium; emerging economies; credit constraints
JEL Codes: F34; F36; G15; O19; O43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial reforms that relax credit constraints (G28) | High-productivity firms expand their investments (D25) |
| High-productivity firms expand their investments (D25) | Crowding out of low-productivity firms (D22) |
| Crowding out of low-productivity firms (D22) | Reduction in capital inflows (F32) |
| Financial reforms that relax credit constraints (G28) | Net effect on capital flows is ambiguous (F32) |
| Reduction in investment by low-productivity firms (D25) | Substantial reduction in capital inflows (F32) |
| Small pool of low-productivity firms (L19) | Capital inflows may increase (F21) |
| Large pool of low-productivity firms (L19) | Potential reduction in capital inflows or capital outflows (F32) |