1.
International
Capital
Flows:
Remedy
or
Curse?
Keith
Mellott
Commonwealth
Honors
College
Isenberg
School
of
Management
May
4,
2015
Abstract
Capital
account
liberalization
has
increased
the
importance
and
prevalence
of
international
capital
flows.
There
is
much
debate
over
the
risks
and
benefits
of
freely
moving
capital,
especially
during
times
of
crisis
and
especially
for
developing
countries.
Capital
flow
“volatility”
is
often
blamed
for
worsening
the
effects
of
financial
crises
in
developing
countries.
In
an
attempt
to
control
the
behavior
of
capital
flows,
countries
have
implemented
different
types
of
capital
controls
to
varying
extents.
I
argue
that
capital
controls
have
a
relationship
with
capital
inflow
volume
both
during
crises
and
in
general.
Specifically,
I
determine
that
capital
account
restrictiveness
is
related
to
lower
volumes
of
capital
inflows
and
vice
versa.

2. 1.
Literature
Review
1.1
The
Growth
of
International
Capital
Flows
International
capital
flows
are
movements
of
money
across
country
borders
for
the
purpose
of
investment,
business
activities,
or
trade.
Gross
international
capital
flows
have
increased
drastically
over
the
past
half-­‐century
as
a
result
of
a
globalized
economy,
changes
in
the
international
political
landscape,
and
advances
in
technology.
As
gross
international
capital
flows
have
grown
in
volume,
they
have
also
grown
in
importance,
especially
for
developing
countries.
The
growth
in
international
capital
flows
became
markedly
more
rapid
in
the
mid
1990’s,
and
exploded
in
the
mid
2000’s,
as
indicated
in
Figure
1.
Although
the
majority
of
the
increases
in
capital
flows
are
attributable
to
advanced
countries,
Figure
1
indicates
that
developing
countries
are
starting
to
account
for
a
bigger
portion
of
the
gross
flows.
The
dissipation
of
the
Soviet
Union,
which
occurred
in
1991,
is
one
of
the
most
important
political
events
of
the
last
50
years.
The
collapse
of
the
USSR
Figure
1:
Global
Gross
Capital
Inflows,
Advanced
and
Developing
Countries,
1980-­‐2010
This
figure
shows
annual
changes
in
global
gross
capital
inflows
and
separates
the
flows
that
are
attributable
to
developing
and
advanced
countries.
Source:
Calculations
by
Adams-­‐Kane
&
Yueqing
Jia
(2013),
based
on
data
from
the
IMF
International
Financial
Statistics
(IFS)
database;
annual
basis.

3.
subsequently
created
15
states,
all
of
which
represented
new
opportunity
for
international
investors.
According
to
World
Bank
data,
these
newly
formed
countries
experienced
a
period
of
economic
depression
that
lasted
until
the
mid
1990’s,
with
GDP
declining
and
poverty
increasing.
Domestic
financial
liberalization
policies
allowed
these
countries
to
attract
outside
investors,
helping
to
satisfy
domestic
needs
for
financial
capital,
savvy
management,
and
advanced
technologies.
Levels
of
foreign
direct
investment
(FDI)
to
the
post-­‐Soviet
states
are
shown
in
Figure
2.
It
is
obvious
that,
in
the
5
years
following
the
collapse
of
the
USSR,
there
was
an
upward
trend
of
FDI
flows
to
these
countries.
1
Communism
not
only
stymied
the
economic
relationship
between
capitalist
nations
and
the
Soviet
Union.
The
influence
of
communism
had
spread
to
other
parts
of
the
globe,
such
as
Latin
America.
Once
the
Soviet
regime
collapsed,
other
countries
also
abandoned
their
communist
regimes.
Countries
such
as
Argentina,
1
Figure
2
depicts
the
mean
net
FDI
inflow
volume
as
a
%
of
GDP
for
the
15
post-­‐Soviet
states:
Armenia,
Azerbaijan,
Belarus,
Estonia,
Georgia,
Kazakhstan,
Kyrgyzstan,
Latvia,
Lithuania,
Moldova,
Russia,
Tajikistan,
Turkmenistan,
Ukraine
&
Uzbekistan.
There
are
no
country-­‐specific
weightings
for
FDI
as
a
%
of
GDP.
0
0.5
1
1.5
2
2.5
3
3.5
4
1992
1993
1994
1995
1996
FDI
Net
InHlows
(%
GDP)
Year
FDI
Net
Inglows
(%
of
GDP)
Figure
2:
Net
FDI
Inflows
to
Post-­‐Soviet
States
(%
of
GDP),
1992-­‐19961
This
figure
measures
the
average
annual
net
FDI
inflow
volume
to
post-­‐Soviet
States
from
1992
to
1996.
Source:
Author’s
calculations
based
on
World
Bank
data.

4.
Uruguay,
Chile
and
Brazil
all
instituted
democracy,
no
longer
viewing
the
democratic,
developed
countries
of
the
world
as
political
and
ideological
enemies.
These
countries
also
liberalized
their
international
trade
policies,
opening
their
borders
to
foreign
investors
and
capital.
Foreign
direct
investment
inflows
to
former
communist
Latin
America
nations
rose
quickly
throughout
the
1990’s,
which
is
evident
in
Figure
3.
2
China’s
emergence
as
a
global
economic
power
is
another
political
factor
that
has
contributed
to
the
vast
increases
in
global
gross
capital
flows.
During
the
1980’s,
China
became
a
member
of
the
International
Monetary
Fund,
the
World
Bank,
the
Asian
Development
Bank,
and
the
General
Agreement
on
Tariffs
and
2
Figure
3
depicts
the
mean
net
FDI
inflow
volume
as
a
%
of
GDP
for
selected
Latin
American
countries
with
a
history
of
domestic
communist
regimes:
Argentina,
Bolivia,
Brazil,
Chile,
Colombia,
Ecuador,
Paraguay,
Peru,
Uruguay,
Venezuela,
El
Salvador
&
Guatemala.
There
are
no
country-­‐
specific
weightings
for
FDI
as
a
%
of
GDP.
Figure
3:
Net
FDI
Inflows
to
Selected
Latin
American
Countries
(%
GDP),
1990-­‐19982
This
figure
illustrates
the
annual
changes
in
Net
FDI
inflows
to
Latin
American
countries
with
a
history
of
domestic
communist
regimes
from
1990-­‐1998.
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
1990
1991
1992
1993
1994
1995
1996
1997
1998
FDI
Net
InHlows
(%
GDP)
Year
FDI
Net
Inglows
(%
GDP)
Source:
Author’s
calculations
based
on
World
Bank
Data.

5.
Trade.
China
also
retooled
their
international
trade
policies,
becoming
more
receptive
to
foreign
sources
of
capital
and
even
allowing
foreign
banks
to
open
branches
within
the
country.
The
Chinese
government
implemented
policies
that
incentivized
foreign
investment,
a
stark
contrast
from
the
policies
that
were
in
place
prior
to
the
1980’s,
when
China
was
still
influenced
by
the
ideologies
of
Mao
Zedong’s
regime.
The
economic
changes
instituted
in
China
had
their
desired
effect.
According
to
data
from
the
World
Trade
Organization,
Chinese
trade
totaled
US
$27.7
billion
in
1979,
which
accounted
for
0.7%
of
worldwide
trade.
By
1985,
Chinese
trade
totaled
US
$70.8
billion,
which
accounted
for
2%
of
worldwide
trade.
Technological
advances
in
the
financial
industry
have
also
contributed
to
the
increase
in
global
gross
capital
flows.
New
computing
capabilities
have
enabled
financial
firms
to
cost-­‐effectively
create
index
funds
composed
of
assets
in
foreign
countries.
These
indices
have
reduced
the
necessary
amount
of
capital
to
invest
abroad,
making
it
feasible
for
individual
investors
to
include
foreign
assets
in
their
portfolios.
Developing
countries
have
experienced
the
largest
relative
increase
in
portfolio
inflows.
Mihaljek
(2008)
measured
changes
in
portfolio
flow
volume
to
emerging
market
economies
over
time.
2005,
global
portfolio
flows
to
emerging
market
economies
totaled
US
$127
billion.
By
2007,
this
number
had
increased
to
US
$432
billion.
1.2
Types
of
International
Capital
Flows
International
capital
flows
can
take
on
a
variety
of
forms,
one
of
which
is
foreign
direct
investment
(FDI).
FDI
is
defined
as
a
party
buying
controlling
ownership
in
a
business
enterprise
in
a
country
other
than
their
own.
The
IMF
defines
“controlling
ownership”
as
an
investment
that
equates
to
10%
or
more
of
voting
stock.
FDI
is
differentiated
from
other
types
of
capital
flows
because
it
generally
implies
that
the
investor
has
long-­‐term
confidence
in
both
the
investment
and
the
economic
outlook
of
the
country
where
the
capital
is
being
invested.
FDI
sometimes
brings
benefits
to
the
host
country
aside
from
the
capital
itself.
The
foreign
investor
often
provides
technology,
infrastructure,
and
managerial
skills
in
order
to
operate
the
business

6.
venture
to
their
liking.
A
2002
report
from
the
Organization
for
Economic
Cooperation
and
Development
addressed
the
benefits
of
FDI.
“FDI
triggers
technology
spillovers,
assists
human
capital
formation,
contributes
to
international
trade
integration,
helps
create
a
more
competitive
business
environment
and
enhances
enterprise
development.
All
of
these
contribute
to
higher
economic
growth,
which
is
the
most
potent
tool
for
poverty
alleviation.”
As
with
the
other
types
of
capital
flows,
the
level
of
global
FDI
flows
has
grown
considerably
over
the
past
two
decades.
The
levels
of
net
global
FDI
inflows
from
1980
to
20012
are
depicted
in
Figure
4.
Global
net
FDI
inflow
volume
increased
rapidly
starting
in
the
early
1990’s
and
the
upward
trend
has
been
consistent
throughout
time.
The
figure
shows
decreases
in
global
FDI
inflow
volume
in
2000
and
2007,
which
are
attributable
to
global
crises
that
had
a
negative
impact
on
investor
confidence.
Figure
4:
Global
FDI
Net
Inflow
Volume
($US
Millions),
1980-­‐2012
This
figure
shows
annual
changes
in
global
FDI
Net
inflow
Volume
between
1980-­‐2012.
-­‐$500,000.00
$0.00
$500,000.00
$1,000,000.00
$1,500,000.00
$2,000,000.00
$2,500,000.00
$3,000,000.00
Global
FDI
Net
InHlow
Volume
($US
Millions)
Year
FDI
Net
Inglows
Source:
Author’s
calculations
based
on
World
Bank
data.
There
are
no
country-­‐specific
weightings
for
KAOPEN
values.

7.
A
2009
United
Nations
Conference
on
Trade
and
Development
report
noted
that
FDI
inflow
volume
to
developing
countries
has
grown
at
a
faster
rate
than
FDI
inflow
volume
to
developed
countries.
Prior
to
the
1990’s,
global
outward
FDI
from
developing
economies
was
very
minimal.
Over
the
past
20
years
however,
global
outward
FDI
from
developing
economies
has
grown
significantly
in
both
nominal
terms
and
relative
to
the
global
outward
FDI
from
developed
countries.
The
most
important
determinant
of
a
country’s
outward
FDI
level
is
economic
growth,
which
dictates
the
demand
side
of
investment
and
the
demand
for
goods
and
services
from
foreign
countries.
As
developing
economies
continue
to
grow,
their
demand
for
investment
and
foreign
goods
and
services
will
increase
and
their
levels
of
outward
FDI
are
expected
to
do
the
same.
Foreign
portfolio
investment
(FPI),
a
financial
transaction
in
which
an
individual
or
institution
purchases
foreign
bonds
or
equity,
is
another
type
of
capital
flow.
Portfolio
flows
are
more
liquid
than
FDI
flows,
as
they
can
be
transferred
to
other
parties
more
easily.
Portfolio
flows
are
generally
regarded
as
more
volatile
than
FDI
flows
and
liquidity
is
one
of
the
primary
reasons
for
this.
Another
reason
for
this
volatility
is
herding
behavior
in
financial
markets,
which
is
the
tendency
of
asset
managers
to
follow
the
behavior
of
other
asset
managers,
causing
them
to
take
action
in
ways
that
they
independently
would
not.
Hwang
&
Salmon
(2004)
find
that
herding
towards
the
market
is
significant,
both
when
the
market
is
falling
and
rising.
Another
reason
for
portfolio
flow
volatility
is
asymmetric
information
between
financial
markets.
Portes
&
Rey
(2005)
find
that
inter-­‐country
differences
in
informational
wealth,
proxied
by
variables
such
as
telephone
traffic
and
amount
of
bank
branches,
had
significant
effects
on
the
behavior
of
cross-­‐border
equity
flows.
Informational
advantages
incentivize
the
international
movement
of
capital
as
information
bearers
seize
opportunities
to
profit.
Figure
5
shows
how
global
FDI
and
portfolio
flows
have
changed
in
volume
between
1995
and
2009.
The
figure
indicates
that,
after
peaking
around
1997,
portfolio
flows
declined
until
around
2002.
A
2002
UNDP
Report
attributes
this
decrease
to
the
Asian
financial
crisis,
which
made
asset
managers
wary
of
investing
in
foreign
equities
and
bonds.
Portfolio
flows
had
an
even
more
pronounced

8.
reversal
in
response
to
the
2008
financial
crisis,
dropping
precipitously
before
rebounding
in
2009.
The
figure
indicates
that
FDI
flows
reversed
one
year
after
portfolio
flows.
This
reflects
the
difference
in
liquidity
between
the
two
types
of
flows.
When
the
crisis
began
in
2008,
asset
managers
could
immediately
sell
off
their
portfolio
investments,
whereas
investors
had
to
remain
committed
to
their
FDI
flows
in
the
short-­‐term.
Ananchotikul
&
Zhang
(2014)
discovered
that
portfolio
flows
to
emerging
markets
have
grown
in
volume
and
volatility
since
2003.
The
authors
found
that
portfolio
flows
to
emerging
markets
are
very
responsive
to
market
trends,
such
as
monetary
policies
in
advanced
economies
and
global
aversion
to
risk.
The
authors’
calculations
indicated
that
there
is
statistically
significant
correlation
between
the
behavior
of
portfolio
flows
to
emerging
markets
and
asset
prices
in
those
markets,
specifically
stock
market
indices,
10-­‐year
government
bond
yields
and
exchange
Figure
5:
Composition
of
Private
Capital
Flows,
1995-­‐2009
(US$
billions)
This
figure
measures
annual
changes
in
global
portfolio
investment
flows
and
FDI
flows
between
1995
and
2009.
Source:
Calculated
for
2002
UNDP
Report,
based
on
data
from
World
Bank,
Global
Finance
for
Development,
and
IMF,
Balance
of
Payment
Statistics
2009.

9.
rates.
During
times
of
portfolio
outflows
from
emerging
markets,
there
also
were
drops
in
the
value
of
stock
market
indices
and
increases
in
10-­‐year
government
bond
yields.
Periods
of
portfolio
outflows
from
emerging
market
economies
also
were
concurrent
with
depreciation
in
those
markets.
The
authors
concluded
that
portfolio
flows
are
generally
more
volatile
than
other
types
of
capital
flows,
but
especially
so
during
times
of
financial
recession.
The
measured
effect
of
portfolio
flows
on
asset
prices
during
a
recession
was
5-­‐10
times
greater
than
the
magnitude
during
non-­‐recessionary
time
periods.
The
United
Nations
Development
Programme
published
a
report
in
2001
on
Millenial
Development
Goals,
acknowledging
the
risks
that
emerging
markets
face
as
a
result
of
portfolio
flow
volatility.
“The
consequences
of
such
volatility
for
growth
are
obvious,
especially
in
countries
highly
reliant
on
such
flows
for
investment.
When
investment
sources
are
unpredictable
and
volatile,
so
is
growth.
This
is
especially
the
case
for
the
smaller,
lower-­‐income
countries
where
many
FDI
projects
are
huge
in
relation
to
the
size
of
the
host
economy
and
because
these
countries
tend
to
be
much
less
diversified
and
depend
on
one
or
two
large
projects
or
sectors.”
Private
loans
are
another
type
of
capital
flow.
They
consist
of
every
type
of
bank
loan
as
well
as
loans
from
other
sectors,
such
as
trade
financing
loans,
mortgages
and
repurchase
agreements.
Private
loans
are
often
divided
into
two
categories:
short-­‐term
and
long-­‐term.
The
likelihood
of
short-­‐term
debt
to
expose
countries
to
risk
of
crisis
is
contested
in
economic
literature.
Stiglitz
(2000)
argues
that,
by
liberalizing
the
short-­‐term
capital
account,
a
country
opens
itself
to
the
risk
of
capital
flight,
which
occurs
when
assets
quickly
flow
out
of
a
country.
Capital
flight
decreases
the
level
of
domestic
wealth
and
is
almost
always
associated
with
depreciation
of
the
domestic
currency.
Diamond
&
Rajan
(2001)
assert
that
structural
flaws
are
to
blame
for
countries
being
exposed
to
such
risks.
“Short-­‐term
debt
mirrors
the
nature
of
the
investment
being
financed
and
the
institutional
environment
that
enables
investors
to
enforce
repayment.
It
is
no
surprise
that
illiquid
or
poor
quality
investment
when
a
bank
or
banking
system
is
close
to
its
debt
capacity
will
result
in
a
buildup
of
short-­‐term
debt.
The
higher
likelihood
of
crisis
stems,
not
from
the
short-­‐term
debt,
but
from
the
illiquidity
and
potentially

10.
low
creditworthiness
of
the
investment
being
financed.”
Conventional
economic
wisdom
dictates
that
countries,
especially
those
with
developing
economies,
should
be
wary
of
short-­‐term
loan
flows
because
they
are
more
liquid
and
volatile
than
long-­‐term
loan
flows.
1.3
Benefits
of
Capital
Flows
&
Recessionary
Trends
One
feature
of
the
globalized
economy
is
an
integrated
international
financial
market.
An
interconnected
financial
system
facilitates
the
uninhibited
movement
of
capital
across
countries.
In
theory,
international
financial
integration
should
allow
for
capital
to
be
allocated
in
the
most
efficient
ways.
Fischer
(1997)
elaborated
on
these
benefits.
“Free
capital
movements
facilitate
a
more
efficient
global
allocation
of
savings,
and
help
channel
resources
into
their
most
productive
uses,
thus
increasing
economic
growth
and
welfare.”
Bailliu
(2000)
agrees
with
Fischer’s
assertion
that
freely
moving
capital
does
indeed
have
the
potential
to
maximize
economic
growth
and
welfare,
but
argues
that,
in
developing
countries,
freely
moving
capital
can
only
maximize
economic
benefits
if
the
domestic
banking
sector
has
achieved
a
minimum
level
of
development
and
sophistication.
Bailliu
(2000)
suggested
that
there
are
three
ways
capital
flows
can
foster
domestic
growth:
increasing
domestic
investment
rates,
facilitating
investments
from
foreign
agents
with
positive
spillover
effects
(such
as
technology
transfers),
and
increasing
domestic
financial
intermediation.
Fischer
(1997)
points
out
that
free
capital
movement
benefits
capital-­‐seeking
agents
because
institutions,
firms
and
individual
investors
have
access
to
ever-­‐
increasing
sources
of
capital.
The
author
notes
that
foreign
capital
markets
have
grown
substantially
in
terms
of
the
volume
of
funds
being
distributed
on
an
annual
basis.
Enhanced
capital
access
can
also
reduce
the
cost
of
capital.
International
sources
of
capital
are
oftentimes
cheaper
than
those
available
in
the
domestic
market.
Stulz
(2005)
discovered
that
the
largest
reductions
in
capital
cost
are
enjoyed
by
developing
countries
that
are
gaining
access
to
international
capital
markets
for
the
first
time.
He
determined
that
developed
countries
with
a

11.
longstanding
presence
in
the
international
financial
market
can
also
reduce
their
capital
costs,
but
to
a
lesser
extent.
International
capital
account
liberalization
has
not
only
benefitted
recipients
of
capital,
but
also
distributors
of
capital.
The
interconnected
financial
system
has
created
new
opportunities
for
investors
to
diversify
their
portfolios
and
achieve
higher
returns.
Levey
and
Sarnat
(1970)
found
that
investment
portfolios
can
achieve
“material
improvements”
in
risk
reduction
by
diversifying
their
holdings,
specifically
by
purchasing
equities
in
developing
countries
to
complement
holdings
in
developed
countries.
As
Bailliu
(2000)
noted,
another
benefit
of
international
capital
flow
liberalization
is
the
transfer
of
technology,
infrastructure,
and
intellectual
capital
that
often
comes
with
FDI.
Acknowledging
that
multinational
corporations
account
for
a
large
portion
of
global
research
and
development
investment,
Borensztein,
Gregorio
&
Lee
(1998)
found
that
FDI
is
important
for
the
international
transfer
of
technology
and,
in
developing
countries,
leads
to
more
growth
than
domestic
investment
as
long
as
the
host
country’s
infrastructure
is
advanced
enough
to
absorb
the
technology
spillovers.
Despite
their
benefits,
freely
moving
international
capital
flows
have
not
always
created
positive
outcomes
for
emerging
market
economies.
One
of
the
most
important
drawbacks
of
capital
flows
is
the
pattern
of
reversals
in
periods
of
crises.
Capital
flight
occurs
when
a
large
volume
of
capital
flows
out
of
a
country.
Capital
flight
is
almost
always
a
symptom,
rather
than
a
cause,
of
a
financial
crisis.
Capital
flight
was
present
in
the
global
recession
of
2008.
Total
net
private
capital
flows
had
reached
a
historic
high
of
US
$1.2
trillion
in
2007,
only
to
fall
to
US
$649
billion
in
2008.
According
to
Suchanek
&
Vasishtha
(2009),
they
fell
even
further
in
2009,
to
US
$435
billion.
This
affirms
the
findings
of
Kaminsky,
Reinhart,
&
Vegh
(2005).
The
authors
calculated
that,
for
all
groups
of
countries,
capital
flows
are
pro-­‐cyclical,
with
higher
inflows
during
periods
of
growth
and
lower
inflows
during
periods
of
crisis.
Capital
flow
reversals
during
a
recession
can
worsen
a
crisis,
especially
in
emerging
market
economies.
Calvo
&
Reinhart
(1999)
discovered
that
during
a

12.
crisis,
developing
countries
often
experience
decreased
access
to
sources
of
international
capital,
which
makes
recovery
more
difficult.
They
point
out
that
a
country
hoping
to
enact
expansionary
policies
to
recover
from
recession
will
find
this
increasingly
difficult
as
their
sources
of
international
capital
disappear.
Not
only
does
capital
decrease
in
availability,
but
it
also
increases
in
cost.
Bernanke
(2000)
discovered
that
reduced
access
and
increased
cost
of
capital
discourages
investment,
contributing
to
reduced
aggregate
demand
and
decreased
output
during
a
crisis.
During
recessions,
there
is
heightened
uncertainty
in
the
domestic
economy
and,
from
the
perspective
of
a
foreign
loaner,
risk.
Banks
become
reluctant
to
lend
as
liberally
as
they
did
during
the
pre-­‐crisis
period.
Bernanke
(2000)
discovered
that
banks’
unwillingness
to
lend
during
crises
has
gotten
more
severe
over
time.
Cyclical
decreases
in
bank
loans
contribute
to
decreases
in
private
loan
flows
during
a
recession.
Countries
cannot
expect
private
loan
flows
to
be
as
abundant
during
a
crisis
as
they
are
in
a
stabile
economic
environment.
Decreased
loan
flows
indicate
that
firms
are
not
undertaking
as
many
investment
projects
during
a
recession,
which
makes
it
difficult
to
recover
via
economic
growth
and
expansion.
Capital
flight
is
not
always
caused
by
a
financial
crisis
within
the
domestic
economy.
Capital
flow
reversals
can
also
be
triggered
by
exogenous
factors.
If
investment
opportunities
with
higher
returns
and
less
risk
are
available
in
foreign
entities,
investors
have
an
incentive
to
remove
their
money
from
the
domestic
economy
and
reallocate
it
to
the
more
attractive
investment.
When
this
occurs,
investors
demand
repayment
and
the
domestic
country
will
face
high
volumes
of
capital
outflows,
which
it
can
respond
to
in
two
ways.
First,
the
country
can
raise
the
domestic
interest
rate,
which
reduces
or
eliminates
the
opportunity
cost
that
the
investor
incurs
by
keeping
his
or
her
money
in
the
domestic
country.
This
will
be
effective
in
reducing
capital
outflows,
but
it
also
discourages
investment
because
interest
rate
hikes
increase
the
cost
of
borrowing.
Decreased
investment
contributes
to
a
growth
stall,
exasperating
the
effects
of
a
recession.
If
the
country
does
not
wish
to
raise
the
domestic
interest
rate,
it
can
opt
to
repay
the
investors.

13.
Since
many
foreign
investments
are
denominated
in
foreign
currency,
the
domestic
country
has
to
deplete
their
foreign
reserves
to
meet
their
repayment
obligations.
In
extreme
cases,
depleted
foreign
reserves
can
lead
a
country
to
insolvency.
According
to
World
Bank
data,
in
2008,
when
the
global
financial
crisis
was
starting
to
reach
its
apex,
Brazil
had
foreign
exchange
reserves
of
$205.5
billion,
which
was
12.9%
of
their
GDP.
According
to
The
Economist3,
these
foreign
reserves
gave
Brazil
the
ability
to
intervene
in
foreign
exchange
markets
and
stabilize
the
Brazilian
real.
They
also
were
able
to
provide
foreign
exchange
swaps
for
Brazilian
corporations
that
were
struggling
to
pay
back
US
dollar-­‐denominated
debt.
If
Brazil
hadn’t
possessed
substantial
pre-­‐crisis
amounts
of
foreign
reserves,
they
would
have
been
less
able
to
pay
back
their
short-­‐term
debts,
which
could
have
led
them
towards
insolvency.
Capital
flow
reversals
can
also
be
caused
by
the
exogenous
factor
of
quantitative
easing
(QE).
QE
is
the
process
of
a
central
bank
buying
securities
from
the
market
to
lower
global
interest
rates
and
increase
the
money
supply,
with
the
goals
of
promoting
more
lending
and
increasing
liquidity.
QE
is
most
effective
when
it
is
conducted
by
an
economy
of
large
scale,
such
as
that
of
the
US.
During
quantitative
easing,
countries
ideally
use
the
money
they
receive
from
selling
domestic
securities
in
ways
that
stimulate
growth
in
the
domestic
economy.
This
theoretically
increases
investor
confidence
in
the
domestic
economy,
promoting
a
resurgence
of
international
trade
and
investment.
In
response
to
the
2008
financial
crisis,
the
Federal
Reserve
instituted
aggressive
QE
policies,
eventually
purchasing
trillions
of
dollars
of
securities.
QE
creates
a
risk
of
capital
flow
reversals
when
the
policies
are
eventually
phased
out,
or
tapered.
In
May
2013,
Ben
Bernanke,
the
former
Chairman
of
the
Federal
Reserve,
provided
a
glimpse
of
the
chaos
that
can
ensue
when
quantitative
easing
policies
are
tapered.
According
an
article
published
by
Forbes4,
Bernanke
sparked
3
The
article
Just
in
Case
was
authored
by
multiple
writers
for
The
Economist
and
was
electronically
published
on
October
12,
2013.
4
The
article
Bernanke’s
QE
Dance:
Fed
Could
Taper
in
Next
Two
Meetings,
Tightening
Would
Collapse
the
Market
was
electronically
published
on
May
22,
2013.
The
article
was
authored
by
Agustino
Fontevecchia.

14.
wild
swings
in
the
market
when
he
hinted
at
the
possibility
of
tapering
QE
in
the
near
future.
The
Dow
Jones
Industrial
Average,
a
stock
market
index
composed
of
30
large
publically
owned
American
companies,
increased
and
decreased
by
over
100
points
at
various
points
throughout
Bernanke’s
speech.
It
is
inevitable
that
quantitative
easing
will
eventually
be
phased
out
and,
to
some
extent,
investors
will
probably
respond
by
withdrawing
their
capital
from
developing
countries.
The
degree
to
which
investors
respond
to
QE
tapering
by
withdrawing
their
capital
from
developing
countries
will
determine
how
severely
economic
growth
in
emerging
markets
will
be
hindered.
1.4
Capital
Controls:
History
&
Types
Most,
if
not
all,
of
countries
institute
at
least
some
capital
controls,
which
are
domestic
policies
that
regulate
flows
to
and
from
capital
markets.
Throughout
history,
capital
controls
have
been
used
for
varying
purposes
and
to
different
extents.
Eichengreen
(2008)
explains
that
capital
controls
initially
gained
popularity
in
mainstream
economics
during
the
time
period
between
World
War
I
and
World
War
II.
The
purpose
of
capital
controls
at
this
point
in
time
was
to
allow
countries
to
rebuild
their
economy
during
the
post-­‐World
War
I
period
without
the
fear
of
capital
flight.
Eichengreen
(2008)
mentions
that
during
the
three
decades
after
World
War
II,
capital
controls
became
less
prevalent
and
international
capital
flows
reached
record
highs.
Industrial
nations
led
the
way
in
liberalizing
international
capital
flow
policies,
while
encouraging
developing
countries
to
do
the
same.
Post-­‐World
War
II
financial
crises
started
to
highlight
the
risks
of
freely
moving
capital,
especially
in
developing
countries.
Economists
and
governments
have
tried
to
better
their
understanding
of
capital
flow
behavior
and
how
capital
controls
can
be
instituted
to
mitigate
the
risks
of
capital
volatility
during
crises.
(Chamon
&
Garcia,
2014)
examine
the
ways
that
Brazil
used
capital
controls
to
respond
to
the
2008
crisis.
Brazil
was
the
one
of
the
most
aggressive
emerging

15.
markets
in
terms
of
their
reactionary
capital
control
policies.
Beginning
in
2009,
the
Brazilian
government
imposed
controls
such
as
portfolio
flow
taxes,
loan
flows
taxes,
currency
exchange
taxes,
and
increased
reserve
requirements
for
domestic
banks.
The
authors
discovered
that
capital
controls
increased
the
price
of
Brazilian
assets
and,
to
a
certain
extent,
isolated
the
Brazilian
financial
market
from
the
international
financial
market.
The
authors
also
concluded
that
the
capital
controls
as
a
whole
successfully
contained
the
appreciation
of
the
real
(the
domestic
Brazilian
currency).
The
Brazilian
government
began
relaxing
their
capital
controls
in
2011.
The
authors
infer
that
the
controls
allowed
Brazil
to
avoid
a
bubble
and
out-­‐of-­‐control
domestic
credit
levels.
The
downside
of
the
capital
controls
was
the
reduced
access
to
foreign
financing,
possibly
contributing
to
the
low
investment
and
growth
performance
during
the
post-­‐crisis
period.
Brazil
is
but
one
example
of
a
country
that
has
had
success
with
capital
control
policies
during
a
crisis.
These
success
stories
have
caused
many
economists
believe
that
capital
controls
are
a
legitimate
way
to
shield
countries
from
some
of
the
effects
of
recessions.
There
are
a
wide
variety
of
capital
controls
that
can
be
instituted
by
a
country.
Capital
controls
can
target
short-­‐term
investments,
long-­‐term
investments,
or
both.
Wary
of
the
risks
that
come
with
the
volatility
of
short-­‐term
capital
flows,
some
countries
impose
capital
controls
with
the
goal
of
attracting
investment
projects
that
necessitate
long-­‐term
commitment
from
investors.
In
Vietnam,
the
government
requires
as
a
precondition
that
foreign
investors
set
up
a
Vietnamese
capital
bank
account,
which
enables
the
tracking
of
flows
in
and
out
of
the
country.
Also,
the
Vietnamese
government
requires
that
foreign
investors
fulfill
all
financial
obligations
to
the
State
of
Vietnam
before
distributing
any
profits
(KPMG).
Ostry,
Ghosh,
Habermeier,
Chamon,
Qureshi
&
Reinhardt
(2010)
provide
another
example
of
capital
controls
that
target
short-­‐term
flows.
From
2006-­‐2008,
Thailand
imposed
an
unremunerated
reserve
requirement
on
any
foreign
currencies
sold
or
exchanged
against
the
domestic
baht.
The
requirement
was
30%
and
was
effective
in
reducing
the
volume
of
net
flows
as
well
as
altering
the
composition
of
inflows
(there
was
a
greater
percentage
of
foreign
direct
investment
inflows
and
a
lower
percentage
of
short-­‐term
flows).

16.
Some
capital
controls
that
target
long-­‐term
capital
flows
are
due
to
domestic
aversion
to
foreign
ownership
of
domestic
assets.
In
Mexico,
for
example,
Article
27
of
the
constitution
limits
foreign
investment
in
domestic
real
estate
and
natural
resources.
Neely
(1999)
explains
that
this
is
a
protective
measure
Mexico
has
taken
to
prevent
foreign
companies
from
exploiting
Mexican
resources
for
short-­‐term
profits,
which
is
has
frequently
occurred
in
the
history
of
Mexico.
Another
reason
a
country
might
impose
capital
controls
specific
to
long-­‐term
flows
is
because
of
a
general
aversion
to
the
risks
of
taking
part
in
international
financial
markets.
South
Korea,
for
example,
restricted
long-­‐term
foreign
investment
inflows
before
they
radically
reformed
their
capital
account
starting
in
the
late
1990s.
Noland
(2007)
attributes
South
Korea’s
restrictions
on
FDI
inflows
to
the
country’s
unwillingness
to
have
the
foundation
of
their
economy
be
contingent
on
foreign
capital
and
uncontrollable
macroeconomic
factors.
South
Korea
is
exemplary
of
an
economy
that
rapidly
developed
without
relying
on
FDI
inflows.
The
country
instead
relied
on
technology
licensing
and
international
loans
to
spur
growth.
Capital
controls
can
also
be
categorized
by
whether
or
not
they
restrict
capital
account
transactions
via
price
mechanisms
or
quantity
controls.
Price
controls
usually
manifest
themselves
in
the
form
of
taxes.
A
popular
price
mechanism
is
the
“Tobin”
tax,
which
was
first
introduced
in
1972.
Tobin
taxes
impose
a
small
percentage
tax
on
all
foreign
exchange
transactions.
Frankel
(1996)
explains
that
the
purpose
of
the
Tobin
tax
was
to
reduce
the
incentive
to
switch
investment
positions
in
the
short-­‐term
in
the
foreign
exchange
market,
which
would
mitigate
market
volatility.
Another
price-­‐based
capital
control
is
the
mandatory
reserve
requirement,
which
requires
foreign
investors
to
deposit
a
percentage
of
their
investment
with
the
central
bank
(earning
no
interest).
Mandatory
reserve
requirements
are
meant
to
build
the
foreign
reserves
of
the
central
bank.
Chile
implemented
such
a
policy
from
1991
to
1998,
specifically
targeting
short-­‐term
inflows.
In
the
context
of
Chile,
their
mandatory
reserve
requirement
essentially
functioned
as
a
tax
on
short-­‐term
inflows.
Stiglitz
(2000)
praised
Chile’s
mandatory
reserve
requirement
because
it
reduced
the
volatility
of
short-­‐term
inflows
without
compromising
long-­‐term,
growth-­‐fostering
inflows
such
as
FDI.

17.
Quantity-­‐based
capital
controls
can
take
the
form
of
policies
that
set
a
ceiling
for
borrowing
from
foreign
residents.
According
to
Athukoralge
(2001),
Malaysia
set
such
ceilings
in
response
to
the
1998
Asian
crisis,
limiting
foreign
currency
borrowings
by
residents
and
domestic
borrowing
by
non-­‐residents.
Malaysia
implemented
another
quantity-­‐based
control
by
setting
a
ceiling
on
banks/
external
liabilities
not
related
to
trade
or
investment.
Other
times,
countries
may
require
that
governmental
approval
be
granted
before
transactions
are
made
on
certain
types
of
assets.
The
case
of
South
Korea
prohibiting
nearly
all
long-­‐term
flows
is
one
example
of
this
type
of
quantity-­‐based
control.

18.
2.
Data
2.1
Quantifying
Capital
Account
Restrictiveness
Due
to
the
variety
and
complexity
of
capital
controls,
quantifying
capital
account
openness
is
a
burdensome
task.
Different
countries
at
different
points
in
time
decide
to
impose
different
mixes
of
capital
controls.
Given
the
variety
of
available
capital
controls,
each
mix
tends
to
be
unique.
It
is
therefore
important
to
have
a
standard
measure
of
capital
control
restrictiveness.
Many
capital
account
openness
indices
have
been
constructed
using
the
IMF’s
Annual
Report
on
Exchange
Arrangements
and
Exchange
Restrictions
(AREAER).
The
AREAER
is
a
database
of
binary
variables
that
contains
information
about
the
types
of
capital
controls
are
employed
by
the
187
IMF
member
countries.
The
variables
in
the
AREAER
include
a
wide
variety
of
capital
controls,
such
as
restrictions
on
international
payments
and
transfers,
arrangements
for
payments
and
receipts,
regulations
on
residents’
and
nonresidents’
accounts,
exchange
rate
systems,
financial
sector
policies,
and
foreign
exchange
market
operations.
A
binary
variable
with
the
value
of
1
indicates
that
a
country
has
instituted
the
particular
capital
control
and
0
otherwise.
The
AREAR
is
effective
in
distinguishing
between
de
jure
and
de
facto
capital
controls.
De
jure
capital
controls
are
legally
instituted
policies.
De
facto
capital
controls
relate
to
how
robustly
the
controls
are
implemented,
and
how
effective
they
are
in
serving
their
purpose.
De
facto
capital
controls
are
harder
to
quantify
than
de
jure
capital
controls,
but
they
depict
reality
more
accurately,
which
makes
them
more
valuable
for
practical
perspective.
There
are
various
issues
that
arise
when
measuring
capital
account
openness
with
the
binary
variables
contained
in
the
AREAER.
Binary
measurements
indicate
whether
or
not
a
country
has
instituted
a
given
capital
control,
but
provide
no
information
on
the
degree
to
which
it
has
been
implemented.
Therefore,
there
is
no
way
to
measure
differences
in
intensity
of
a
given
capital
control
between
countries.
Another
issue
with
the
variables
in
the
AREAER
is
that
they
are
broadly
defined,
preventing
them
from
capturing
certain
details
and
distinguishing
features
of

19.
capital
controls.
Some
of
the
problems
associated
with
a
lack
of
capital
control
specificity
were
addressed
in
1997,
when
the
IMF
revised
the
classification
of
the
variables
in
the
AREAER.
The
new
variable
categorizations
now
account
for
distinctions
between
restrictions
on
inflows
and
outflows
as
well
as
the
differences
between
different
types
of
capital
transactions.
However,
it
is
doubtful
that
any
categorization
of
the
variables
in
the
AREAR,
no
matter
how
specific,
could
ever
perfectly
encapsulate
the
complexity
and
variety
of
capital
controls.
Using
the
information
from
the
AREAER,
Chinn
and
Ito
(2008)
created
a
capital
account
openness
index
called
KAOPEN.
The
authors
reversed
the
values
of
the
binary
variables
in
the
AREAER
in
order
to
construct
KAOPEN
in
a
way
that
has
higher
index
values
corresponding
to
less
restrictive
current
account
policies.
Selected
binary
variables
in
the
AREAER
are
weighted
and
aggregated
into
individual
index
values
for
each
IMF
member
country.
The
aggregated
index
measurements
assume
values
between
0
to
1,
with
0
representing
complete
restriction
and
1
representing
complete
openness.
KAOPEN
values
are
measured
annually,
with
1970
being
the
earliest
year
that
data
is
available
for.
KAOPEN
is
the
most
appropriate
capital
account
openness
index
to
use
in
this
study
for
two
reasons.
KAOPEN
is
constructed
so
as
to
focus
on
de
jure
capital
controls,
making
it
effective
in
measuring
the
extent
of
regulatory
restrictions
on
capital
account
transactions.
Since
the
purpose
of
this
study
is
to
evaluate
the
effectiveness
of
a
country’s
legally
imposed
capital
controls
in
mitigating
the
negative
effects
of
a
financial
crisis,
KAOPEN’s
focus
on
de
jure
capital
controls
makes
it
a
logical
choice
of
index.
The
second
reason
KAOPEN
is
an
ideal
index
of
capital
account
restrictiveness
is
that
it
is
a
holistic,
robust
measure
of
capital
account
openness.
Countries
oftentimes
impose
capital
controls
in
a
variety
of
ways
to
increase
their
collective
effectiveness.
As
Edwards
(1999)
points
out,
the
private
sector
frequently
circumvents
capital
controls.
Countries
can
make
this
more
difficult
by
adopting
an
all-­‐inclusive
approach
to
their
capital
control
policies.
A
country
with
a
closed
capital
account
can
reinforce
these
policies
by
imposing
controls
on
the
current
account
or
by
changing
the
requirements
for
surrendering
export
proceeds.

20.
Malaysia
adopted
this
strategy
in
response
to
the
Asian
Crisis
of
1998.
KAOPEN
incorporates
variables
from
a
variety
of
categories
in
the
AREAR,
accounting
for
a
wide
range
of
capital
controls.
Therefore,
KAOPEN
values
are
strong
measures
of
the
entirety
of
countries’
approaches
to
capital
account
restrictiveness.
Here,
I
first
examine
KAOPEN
values
from
1970
to
2012
across
the
entirety
of
the
IMF
member
countries
to
investigate
if
there
is
a
global
trend
towards
capital
openness
or
restrictiveness.
I
then
focus
on
the
regions
of
Latin
America
and
Southeast
Asia,
to
investigate
if
there
are
region-­‐specific
capital
account
openness
trends.
I
evaluate
KAOPEN
for
these
regions
across
the
entirety
of
the
time
series
(1970
to
2012)
as
well
as
specifically
for
time
periods
leading
up
to,
during,
and
after
a
crisis.
For
Latin
America,
my
analysis
focuses
on
the
five
years
preceding
and
following
the
2002
South
American
recession.
For
Southeast
Asia,
my
analysis
focuses
on
the
five
years
preceding
and
following
the
1998
Asian
financial
crisis.
2.2
KAOPEN
Values
Figure
6
presents
the
average
of
annual
KAOPEN
values
for
the
187
IMF
member
countries
as
a
group
from
1970
to
2012.
The
change
in
global
KAOPEN
values
over
time
indicates
that,
in
general,
capital
account
openness
has
increased
since
1970.
However,
Figure
6
shows
that
the
trend
toward
global
capital
account
openness
slowed
and
even
reversed
in
the
late
1970’s
and
early
1980’s.
The
mean
global
KAOPEN
value
did
not
begin
to
increase
again
until
the
late
1980’s.
The
reduction
in
KAOPEN
values
during
the
late
1970’s
and
early
1980’s
is
attributable
to
the
global
recession
that
occurred
during
the
same
time
period.
The
recession
negatively
impacted
both
developed
economies
and
emerging
market
economies.
The
trend
is
particularly
evident
in
the
Latin
American
debt
crisis
during
that
period.
In
the
1960’s
and
1970’s,
Latin
American
countries
built
up
vast
quantities
of
foreign
debt
by
borrowing
from
international
creditors
to
fund
economic
development
projects.
Investors
were
initially
eager
to
finance
projects
in
developing
Latin
America
because
GDP
in
the
region
was
rapidly
growing.
By
the
late
1970’s,
however,
Latin
American
countries
were
struggling
to
repay
their
debts,

21.
partly
due
to
rising
oil
prices
and
increasing
interest
rates
in
the
United
States
and
Europe.
Investors
became
wary
of
Latin
America’s
ability
to
repay
their
debts.
They
withdrew
their
funds
from
the
region,
causing
a
large
outflow
of
capital
flight.
According
to
Pastor
(1989),
capital
flight
in
Latin
America
totaled
$151
billion
between
1973
and
1987.
This
equates
to
43%
of
their
total
external
debt
during
that
time
period.
The
rapid
outflow
of
capital
from
Latin
America
deprived
the
region
of
important
funding
that
was
expected
to
be
used
for
developing
projects
and
servicing
their
foreign
debt.
Latin
American
countries
came
to
identify
capital
flight
as
one
of
the
primary
causes
for
their
economic
woes.
As
a
result,
countries
in
the
region
became
more
restrictive
on
capital
account
transactions
and
even
the
IMF
made
stricter
capital
controls
a
precondition
for
Latin
American
countries
to
receive
debt-­‐relief
assistance
packages.
Figure
7
depicts
the
KAOPEN
value
for
Latin
American
countries
from
1970
to
1990.
The
figure
shows
a
strong
trend
towards
capital
account
restrictiveness
during
the
late
1970’s
and
early
1980’s
in
Latin
America.
The
figure
shows
that
0.3
0.35
0.4
0.45
0.5
0.55
0.6
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
KAOPEN
Year
Figure
6:
Mean
KAOPEN
Value
for
all
IMF
Member
Countries,
1970-­‐2012
The
figure
presents
the
mean
KAOPEN
value
for
all
IMF
member
countries
from
1970-­‐2012.
Source:
Author’s
calculations
based
on
World
Bank
data.
There
are
no
country-­‐specific
weightings
for
KAOPEN
values.

22.
0
0.1
0.2
0.3
0.4
0.5
0.6
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
KAOPEN
Year
Latin
American
countries
did
not
begin
liberalizing
their
capital
accounts
until
the
late
1980’s.
In
contrast,
this
trend
is
absent
for
developing
countries
during
the
same
period.
Figure
8
shows
the
KAOPEN
value
for
a
selected
group
of
countries
that
had
some
of
the
largest
economies
(in
terms
of
nominal
GDP)
in
the
world
in
1980.
The
figure
makes
it
evident
that
the
overall
trend
towards
capital
account
restrictiveness
was
not
present
in
developed
countries
with
prominent
economies.
Thus,
the
overall
trend
towards
stricter
capital
controls
in
the
late
1970’s
and
early
1980’s,
apparent
in
Figure
6,
did
not
apply
globally,
but
had
important
regional
distinctions.
5
5
Figure
7
depicts
the
mean
KAOPEN
value
from
1970
to
1990
for
selected
Latin
American
countries:
Argentina,
Bolivia,
Chile,
Colombia,
Ecuador,
Guatemala,
Mexico,
Paraguay,
Peru,
Uruguay
&
Venezuela.
There
are
no
country-­‐specific
weightings
applied
to
KAOPEN
values.
Figure
7:
Mean
KAOPEN
Value
for
Latin
American
Countries,
1970-­‐19905
The
figure
presents
the
mean
KAOPEN
value
for
selected
Latin
American
countries
for
1970-­‐1990.
Source:
Author’s
calculations
based
on
World
Bank
data.

23.
6
Excluding
the
reversal
in
the
late
1970’s
and
early
1980’s,
there
is
clearly
an
overall
trend
towards
global
capital
account
openness.
This
has
made
international
capital
reallocation
and
international
trade
easier,
prominent
features
of
the
present-­‐day
integrated
global
economy.
Figures
9
graphs
the
KAOPEN
values
in
Latin
America
and
Southeast
Asia
from
1970
to
2012,
illustrated
the
regional
differences
in
capital
account
openness.
In
general,
Latin
American
countries
have
liberalized
their
capital
accounts
more
so
than
Southeast
Asian
countries.
The
next
section
of
this
paper
relates
KAOPEN
values
to
FDI
inflow
volume
on
a
regional
basis,
which
should
indicate
whether
or
not
the
dichotomy
of
the
approaches
taken
by
Southeast
Asian
countries
and
Latin
6
Figure
8
depicts
the
mean
KAOPEN
value
from
1970
to
1990
for
a
selected
group
of
developed
countries
that
were
global
leaders
in
terms
of
GDP
in
1980:
Canada,
France,
Germany,
Italy,
Japan,
Spain,
the
United
Kingdom
&
the
United
States.
There
are
no
country-­‐specific
weightings
applied
to
KAOPEN
values.
0.4
0.45
0.5
0.55
0.6
0.65
0.7
0.75
0.8
0.85
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
KAOPEN
Year
Figure
8:
Mean
KAOPEN
Values
for
Developed
Countries,
1970-­‐19906
The
figure
shows
the
mean
KAOPEN
values
for
a
selected
group
of
developed
countries
from
1970-­‐1990.
Source:
Author’s
calculations
based
on
World
Bank
data.

24.
American
countries
towards
capital
account
restrictiveness
has
yielded
different
outcomes
for
the
countries
in
those
regions.
7
2.3
KAOPEN
&
FDI
Inflows;
Time-­‐Series
Data
Selection
I
examine
the
relationship
between
KAOPEN
values
and
net
FDI
inflow
volume
for
my
focus
countries
over
an
eleven-­‐year
period
centered
around
the
year
of
the
financial
crisis:
1998
for
Southeast
Asia
and
2002
for
Latin
America.
Figures
10
and
11
show
the
%
GDP
change
for
my
countries
of
focus
in
each
region
over
an
11-­‐year
period.
In
Latin
America,
the
crisis
was
deepest
in
2002
as
evidenced
by
the
GDP
7
Figure
9
depicts
the
mean
KAOPEN
value
from
1970
to
1990
for
a
selected
group
of
Latin
American
and
Southeast
Asian
countries.
The
Latin
American
countries
included
are
Argentina,
Bolivia,
Chile,
Colombia,
Ecuador,
Guatemala,
Mexico,
Paraguay,
Peru,
Uruguay
&
Venezuela.
The
Southeast
Asian
countries
included
are
Cambodia,
Indonesia,
South
Korea,
Lao
PDR,
Malaysia,
Myanmar,
Philippines,
Singapore,
Thailand
&
Vietnam.
There
are
no
country-­‐specific
weightings
applied
to
KAOPEN
values.
Figure
9:
Mean
KAOPEN
Values
for
Latin
American
and
Southeast
Asian
Countries,
1970-­‐20127
This
figure
shows
the
mean
KAOPEN
value
for
Latin
American
and
Southeast
Asian
Countries
between
1970
and
2012.
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
KAOPEN
Year
LA
KAOPEN
values
SE
Asia
KAOPEN
Values
Source:
Author’s
calculations
based
on
World
Bank
data.

25.
contraction
seen
in
figure
10.
In
Southeast
Asia,
the
crisis
was
deepest
in
1998
as
evidenced
by
the
GDP
contraction
seen
in
Figure
11.
Thus,
I
recognize
2002
as
the
start
of
the
financial
crisis
in
Latin
America
and
1998
as
the
start
of
the
financial
crisis
in
Southeast
Asia.
8
9
8
Figure
10
shows
the
mean
annual
%
GDP
change
from
1997
to
2007
for
my
focus
countries
in
Latin
America:
Argentina,
Chile
&
Venezuela.
There
are
no
country-­‐specific
weightings
applied
to
GDP
change
values.
Figure
11:
Mean
Annual
%
GDP
Change
for
Southeast
Asian
Countries,
1993-­‐20039
This
figure
shows
the
annual
%
GDP
Change
for
my
focus
Southeast
Asian
Countries
from
1993-­‐2003.
-­‐8
-­‐6
-­‐4
-­‐2
0
2
4
6
8
10
12
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
%
GDP
Change
Year
%
GDP
Figure
10:
Mean
Annual
%
GDP
Change
for
Latin
American
Countries,
1997-­‐20078
This
figure
shows
the
annual
%
GDP
Change
for
my
focus
Southeast
Asian
Countries
from
1991-­‐2001.
-­‐6
-­‐4
-­‐2
0
2
4
6
8
10
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
%
GDP
Change
Year
%
GDP
Source:
Author’s
calculations
based
on
World
Bank
data.
Source:
Author’s
calculations
based
on
World
Bank
data.

26.
The
KAOPEN
values
for
the
five
years
preceding
the
crisis
indicate
the
intensity
of
a
given
country’s
capital
controls
before
the
beginning
of
the
recession.
The
KAOPEN
values
in
the
years
after
the
start
of
the
crisis
reveal
if
a
given
country
responds
by
opening
or
closing
their
capital
account
and
to
what
extent.
The
FDI
inflow
levels
during
the
five
years
after
the
start
of
the
crisis
are
of
particular
interest,
because
they
show
how
effective
a
given
country’s
reactionary
capital
control
alterations
relate
to
actual
capital
flow
volume.
I
find
that
FDI
inflows
are
sensitive
to
capital
controls
imposed
in
response
to
a
crisis.
Figures
12
and
13
show
how
the
mean
KAOPEN
value
in
Latin
America
and
Southeast
Asia
changed
during
the
11-­‐year
periods
centered
around
the
year
in
which
their
respective
crises
began.
Figure
12
indicates
that
in
general,
Latin
American
countries
responded
to
the
2002
crisis
by
loosening
capital
controls.
Figure
13
shows
that
countries
in
Southeast
Asia
also
opened
their
capital
accounts,
but
less
drastically
than
Latin
American
countries.
In
2001,
one
year
before
the
start
of
2002
crisis,
the
average
KAOPEN
value
in
Latin
America
was
.655.
The
average
KAOPEN
value
in
Southeast
Asia
in
1997,
one
year
before
the
start
of
the
1998
crisis,
was
.371.
Before
the
start
of
the
crisis,
Southeast
Asian
countries
had
much
less
open
capital
accounts
than
countries
in
Latin
America.
This
is
consistent
with
the
broader
trend
of
Southeast
Asian
countries
being
more
averse
to
capital
account
liberalization
than
Latin
American
countries,
which
is
shown
in
Figure
9.
9
Figure
11
shows
the
mean
annual
%
GDP
change
from
1992
to
2002
for
my
focus
countries
in
Southeast
Asia:
Vietnam,
Singapore,
Indonesia
&
Malaysia.
There
are
no
country-­‐specific
weightings
applied
to
GDP
change
values.

27.
10
11
2.4
KAOPEN
&
FDI
Inflows;
Latin
America
The
Latin
American
crisis
of
2002
was
sparked
by
the
devaluation
of
the
Brazilian
real.
After
the
devaluation
of
the
real,
Argentine
export
competitive
was
damaged
because
the
Argentine
peso
was
pegged
to
the
US
dollar,
preventing
the
country
from
devaluing
in
order
to
restore
their
export
competitiveness.
What
started
out
as
a
currency
crisis
in
Argentina
turned
into
a
sovereign
debt
crisis
when
the
country’s
economy
started
contracting
because
decreased
tax
receipts
could
no
longer
finance
the
country’s
outstanding
interest
payments.
Despite
assistance
from
the
IMF,
the
market’s
confidence
in
Argentina
and
the
peso
continued
to
deteriorate.
10
Figure
12
shows
the
mean
annual
KAOPEN
value
from
1997
to
2007
for
selected
countries
in
Latin
America:
Argentina,
Bolivia,
Chile,
Colombia,
Ecuador,
Guatemala,
Mexico,
Paraguay,
Peru,
Uruguay
&
Venezuela.
There
are
no
country-­‐specific
weightings
applied
to
KAOPEN
values.
11
Figure
13
shows
the
mean
annual
KAOPEN
value
from
1993
to
2003
for
selected
countries
in
Southeast
Asia:
Cambodia,
Indonesia,
South
Korea,
Lao
PDR,
Malaysia,
Myanmar,
Philippines,
Singapore,
Thailand
&
Vietnam.
There
are
no
country-­‐specific
weightings
applied
to
KAOPEN
values.
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
KAOPEN
Year
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
KAOPEN
Year
Figure
12:
Mean
Annual
KAOPEN
value
for
Latin
American
Countries,
1997-­‐200710
This
figure
shows
the
average
annual
KAOPEN
value
in
Latin
America
from
1997-­‐2007.
Figure
13:
Mean
Annual
KAOPEN
value
for
Southeast
Asian
Countries,
1993-­‐200311
This
figure
shows
the
average
annual
KAOPEN
value
in
Latin
America
from
1993-­‐2003.
Source:
Author’s
calculations
based
on
World
Bank
data.
Source:
Author’s
calculations
based
on
World
Bank
data.

28.
Argentina
gradually
phased
out
the
peso’s
peg
to
the
dollar,
but
action
did
not
come
swiftly
enough.
The
crisis
reached
an
apex
near
the
end
of
2001,
when
confidence
in
the
peso
was
so
compromised
that
Argentina
experienced
a
bank
run.
Arellano
(2008)
notes
that
Argentina
eventually
decided
to
default
on
over
$100
billion
of
their
debt
in
December
of
2001.
This
should
have
worsened
the
situation
in
Argentina
because
a
default
would
theoretically
block
Argentina’s
access
to
international
capital
markets.
Towards
the
end
of
2002,
however,
World
Bank
data
shows
that
the
global
price
of
soy,
which
is
one
of
the
most
prominent
Argentine
exports,
soared
to
their
highest
level
since
mid-­‐2000.
Argentina
enjoyed
an
export-­‐
driven
recovery;
GDP
contracted
by
10.89%
in
2002
then
grew
by
8.84%
in
2003.
Argentina’s
economy
began
to
slow
down
in
1998
when
the
Brazilian
Real
was
devalued.
The
recession
was
by
no
means
mild;
World
Bank
data
indicates
that,
from
1998
to
2002,
the
Argentine
economy
shrank
by
over
25%.
Figure
14
indicates
that
Argentina
responded
to
the
crisis
by
increasing
capital
account
restrictiveness.
Net
FDI
inflow
volume
in
Argentina
follows
a
trend
similar
to
KAOPEN
values
in
Argentina.
Similar
year-­‐to-­‐year
relative
changes
in
KAOPEN
and
FDI
inflows
indicate
that
the
extent
of
Argentina’s
capital
controls
have
a
relationship
with
capital
flow
volume.
Although
Argentina’s
economy
began
to
recover
in
2003,
net
FDI
inflows
did
not
begin
to
increase
until
2004,
one
year
after
Argentina
began
to
reopen
their
capital
account.
This
indicates
that
FDI
inflows
are
more
responsive
to
capital
controls
than
macroeconomic
trends.

29.
Figure
14:
FDI
Net
Inflows
&
KAOPEN
Values
in
Argentina,
1997-­‐2007
This
figure
shows
the
KAOPEN
values
and
FDI
net
inflow
volumes
for
Argentina
from
1997
to
2007.
FDI
Net
Inflows
are
measured
in
$US
Millions.
Figure
15:
FDI
Net
Inflows
&
KAOPEN
Values
in
Chile,
1997-­‐2007
This
figure
shows
annual
FDI
Net
Inflows
and
KAOPEN
Values
in
Chile
from
1997-­‐2007.
FDI
Net
Inflows
are
measured
in
$US
Millions.
0
0.2
0.4
0.6
0.8
1
1.2
$0.00
$2,000.00
$4,000.00
$6,000.00
$8,000.00
$10,000.00
$12,000.00
$14,000.00
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
KAOPEN
FDI
Net
InHlows,
$US
MIllions
Year
FDI
Net
Inglows
KAOPEN
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
$0.00
$5,000.00
$10,000.00
$15,000.00
$20,000.00
$25,000.00
$30,000.00
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
KAOPEN
FDI
Net
InHlows,
$US
Millions
Year
FDI
Net
Inglows
KAOPEN
Source:
Author’s
calculations
based
on
World
Bank
data.
Source:
Author’s
calculations
based
on
World
Bank
data.

30.
The
2002
crisis
did
not
affect
Chile
as
much
as
it
did
Argentina.
According
to
the
World
Bank,
Chile
only
had
GDP
contraction
in
1999,
while
Argentina’s
economy
shrank
for
four
consecutive
years.
Calvo
(2005)
attributes
Chile’s
relatively
strong
performance
during
the
recession
to
the
fact
that
Chile
did
not
have
as
severe
of
a
pre-­‐crisis
currency-­‐denomination
mismatch.
Figure
15
indicates
that
Chile
responded
to
the
crisis
by
opening
their
capital
account,
which
is
the
opposite
of
what
Argentina
did.
Chile
experienced
a
drop
in
FDI
inflows
from
1999
to
2002,
but
had
a
strong
resurgence
afterwards.
Again
the
relationship
between
capital
account
restrictiveness
and
net
FDI
inflows
appears
to
be
significant,
even
in
the
case
of
a
country
that
was
not
affected
by
the
crisis
to
the
same
degree
as
Argentina.
This
enforces
the
argument
that
net
FDI
inflows
are
more
sensitive
to
towards
short-­‐
term
variations
in
capital
controls
than
macroeconomic
trends.
Venezuela
also
experienced
adverse
effects
from
the
crisis
of
2002;
their
economy
shrank
by
9%
in
2002
and
by
8%
in
2003
according
to
the
World
Bank.
Adding
to
the
economic
problems
the
country
was
facing,
political
instability
led
to
a
strike
in
December
2002.
The
strike
caused
a
crisis
in
the
Venezuelan
oil
industry,
greatly
reducing
the
country’s
crude
oil
output
for
much
of
2003.
Venezuela
started
experiencing
capital
flight
as
confidence
in
their
economy
deteriorated.
In
order
to
curb
the
capital
flight
and
prevent
further
depletion
of
foreign
reserves,
Venezuela
increased
the
intensity
of
their
capital
controls
as
indicated
in
Figure
16.
FDI
inflow
volume
rose
during
2000
and
then
steeply
declined,
coinciding
with
the
time
that
Venezuela’s
KAOPEN
value
decreased.
Even
in
the
case
of
a
country
that
experienced
a
crisis
due
to
internal
rather
than
exogenous
factors,
there
appears
to
be
a
significant
relationship
between
capital
account
restrictiveness
and
capital
flow
volume.
It
is
difficult
to
ascertain
causality;
some
of
the
FDI
inflow
reductions
are
likely
due
to
a
general
lack
of
investor
confidence
in
the
region.
It
seems
probable,
however,
that
the
heightened
capital
account
restrictions
also
played
a
part
in
the
reduction
of
FDI
inflow
volume
during
and
after
the
crisis.