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Myth or Reality?
The Diffusion of Financial Liberalization in
Developing Countries
IPES, Princeton November 17, 2006
Nancy Brune
([email protected] )
Alexandra Guisinger
([email protected])
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
Financial Liberalization
Percentage of Developing Countries with Financial Openness Score>1
100
80
60
40
20
0
1970
1974
1978
1982
1986
1990
1994
1998
2002
 “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
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)
Data
 12 Capital Control Categories

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

Inflows of Invisibles
Inflows affecting Capital and
Money Mrkt Securities
Inflows affecting Credit
Operations
Inward Direct Investment
Proceeds from Exports
Exchange Rate Rules




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
Outflows of Invisibles
Outflows affecting Capital and
Money Mrkt Securities
Outflows affecting Credit
Operations
Outward Direct Investment
Real Estate Transactions
Commercial Banking Rules
 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
Testing policy for policy adjustments
Capital Control Measures (12 per country)
Prior Years Policy (lagged dependent variable)
Currency Crisis
US World Real Interest Rates
GDP Growth
Savings
Current Account Balance (IMF and World Bank)
Reserves
Square Root of Inflation
Fixed Exchange Rate
GDP Per Capita logged
Trade
Private Capital
Central Bank Independence
Democracy - 1 if country democratic (ACLP)
Right Party In Power
Country under IMF Program
Diffusion Measure - Trade Weighted Average
Diffusion Measure - S&P Average
Diffusion Measure - Economic Type Average
Diffusion Measure - Export Type Average
Diffusion Measure - RTA Average
Controls on EXP
All Capital Control
Measures
Coef.
SE
(0.14)
7.14
0.08
(0.13)
(0.04)
-0.09
0.01
(0.01)
(0.01)
-0.03
0.00
(0.01)
(0.01)
-0.04
0.00
(0.01)
(0.15)
-0.48
(0.12)
0.28
(0.00)
0.01
0.01
(0.00)
0.26
(0.19)
-0.22
(0.18)
(0.15)
0.50
(0.13)
0.47
(0.35)
0.89
(0.56)
0.99
(0.58)
1.40
(0.60)
-1.76
(0.26)
1.62
1.38
(0.43)
***
**
***
***
***
**
***
***
***
***
*
**
***
***
***
Not Shown:
Controls for type
of capital control
and time
Testing Specific Causal Mechanisms
Capital Openess 1970-2004
Capital Market
Credit Market
FDI
Current Account
(Countries=117)
Coef. SE
Coef. SE
Coef. SE
Coef. SE
Economic Variables Not Shown
Central Bank Independence
-0.47 (0.46)
0.58 (0.45)
0.06 (0.34)
0.31 (0.33)
Democracy (1=Dem)
0.32 (0.44)
-0.98 (0.46) **
-0.61 (0.34) *
0.23 (0.33)
Right Party In Power
1.11 (0.39) ***
0.86 (0.37) **
0.77 (0.33) **
0.27 (0.28)
Country under IMF Program
0.94 (0.39) **
0.08 (0.35)
0.67 (0.32) **
0.83 (0.26) ***
Diff: RTA Average
1.73 (0.96) *
0.77 (0.85)
2.04 (0.74) *** 1.61 (0.55) ***
Diff: Trade Weighted Average
0.97 (1.08)
0.37 (0.92)
-0.47 (0.76)
1.26 (0.738 *
Diff: S&P Average
1.87 (2.01)
-1.38 (1.79)
0.87 (1.37)
0.04 (1.16)
Diff: Economic Type Average
1.31 (1.94)
1.33 (1.45)
3.00 (1.36) **
1.50 (0.95)
Diff: Export Type Average
-4.14 (2.11) *
-3.92 (1.56) **
-1.17 (1.47)
-1.34 (0.98)
time
0.01 (0.04)
0.11 (0.05) **
0.02 (0.04)
0.04 (0.03)
Constant
-10.86 (2.43) *** -12.59 (2.46) *** -5.45 (1.73) *** -8.87 (1.70) ***
Observations
3780
3780
3780
5670
Standard errors in parentheses
* significant at 10%; ** significant at 5%; *** significant at 1%
Sources: Central Bank Independence (Cukierman, McNamara); Democracy - 1 if country democratic (ACLP);
Right Party In Power;(Addonizio/Brune); Country under IMF Program (Vreeland, Brune 2000-2004)
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