Balance of payments crisis in an external debt led growth regime

Yannick Kalantzis

Description

Balance of payments crisis in an external debt-led growth regime Yannick Kalantzis ? (CEPREMAP, ENPC) Version : May 7, 2004 Abstract We study the long-run effect of capital account liberalization us- ing the model of a small open economy with two sectors. In the case of a low technological level, the long-run evolution of the productive structure that follows the liberalization leads to financial fragility by creating the conditions under which balance of payments crises are possible. Higher capital inflows both have a stabilizing and a destabi- lizing effect, their overall effect depending on the relative technological level of each sector. 1 Introduction What are the effects of capital account liberalization on developing countries? The last twenty years have witnessed numerous balance of payments (BoP) crises, often coupled with banking crises, in developing countries that had previously opened their economy to foreign capital flows. The south cone crises at the beginning of the eighties, the Mexican crisis of 1994, the Asian ?CEPREMAP. 48, bd Jourdan 75014 Paris. France. E-mail: 1

• tradable sector


• open economy


• short time


• growth regime


• account liberalization


• developing countries


• capital account


• gdp ratio


• external debt

Sujets

• Open economy
• Short Time
• Developing country
• Capital account
• External debt

Informations

• Publié par: pefav
• Nombre de lectures: 15
• Langue: English

Extrait

Balanceofpaymentscrisisinanexternal
debt-ledgrowthregime

YannickKalantzis
∗
(CEPREMAP,ENPC)
Version:May7,2004

Abstract
Westudythelong-runeffectofcapitalaccountliberalizationus-
ingthemodelofasmallopeneconomywithtwosectors.Inthecase
ofalowtechnologicallevel,thelong-runevolutionoftheproductive
structurethatfollowstheliberalizationleadsto
financialfragility
by
creatingtheconditionsunderwhichbalanceofpaymentscrisesare
possible.Highercapitalinflowsbothhaveastabilizingandadestabi-
lizingeffect,theiroveralleffectdependingontherelativetechnological
levelofeachsector.

1Introduction
Whataretheeffectsofcapitalaccountliberalizationondevelopingcountries?
Thelasttwentyyearshavewitnessednumerousbalanceofpayments(BoP)
crises,oftencoupledwithbankingcrises,indevelopingcountriesthathad
previouslyopenedtheireconomytoforeigncapitalflows.Thesouthcone
crisesatthebeginningoftheeighties,theMexicancrisisof1994,theAsian
∗
CEPREMAP.48,bdJourdan75014Paris.France.
E-mail:
[e-mail]

1

crisesof1997andtheArgentinecrisisof2001wereallprecededbymassive
capitalinflows.Amongthehugeliteraturededicatedtotheempiricalanalysis
ofthoseevents,severalworkshaveshownthatcapitalinflowswerelikelyto
initiateaboom-bustcyclethatcoulddramaticallyendinaseveretwincrisis.
1
Eveniftheopeningofthecapitalaccountmaybeattheoriginofthecycle,
somepapersinsistontheamplifyingroleplayedbythedomesticfinancial
system,particularlythebankingsystem(Herna´ndez&Landerretche1999).
Boom-bustcyclesarethusassociatedwithacyclicalevolutionofbankcredit
andthecredit/GDPratiostronglyincreasesinthefewyearsprecedingthe
crisis.
Allthesepapersshowagrowingconsensusastothepossiblydestabilizing
short-runeffectofcapitalinflowstodevelopingcountries,butthequestion
oftheirlong-runeffectisstillsubjecttodebate.Amongthefactorsthat
areattheoriginofthecycles,pro-cyclicalrisk-takingofentrepreneursand
externalcreditorscouldeventuallybecomelesspronouncedasagentslearn
fromtheirerrors,andtheimperfectprudentialregulationofthebanking
systemmightbeimprovedaftersometimebythemonetaryauthorities.
Kaminsky&Schmukler(2003)givereasonsforoptimismastheyobservethat
financialliberalizationincreasestheamplitudeofboom-bustcyclesinthe
stockmarketintheshort-runbutdecreasesitinthelong-run.Theysuggest
financialliberalizationmightcreatethenecessaryincentivestoimplement
institutionalreformsthatwouldstabilizetheeconomyintheend.Onthe
contrary,fourhundredyearsoffinancialcrisesleadRodrik(1998)toconsider
thatboom-bustcycles“arethemainstory”.Distortionsandanomaliesare
theusuallotoffinancialmarketssothatthedebateshouldbeledina
worldofsecond-bestpolicy,wherecapitalaccountconvertibilitymightnot
beanadequatepolicyfordevelopingcountries.Theargument,asitgoes,
1
Forthepositivelinkbetweencapitalinflowsandlendingboomsindevelopingcoun-
tries,seeHerna´ndez&Landerretche(1999)andGourinchas,Valde´s&Landerretche
(2001).Lendingboomsaregoodpredictorsoftwincrises(Kaminsky&Reinhart1999,Tor-
nell&Westermann2002)althoughthetypicallendingboomusuallyendsupwithasoft
landing.

2

isthatthereisnoevidencedevelopingcountrieswithoutcapitalcontrols
outperformothers,
2
whereasthedangersofcapitalaccountliberalizationare
clearlystated.AccordingtoWyplosz(2001),capitalaccountliberalization
shouldultimatelybeafirst-bestpolicy,althoughitsbenefitsmightbeof
secondorder,butitshouldonlybeimplementedonceapropereconomic
infrastructureisinplace(thatis,oncethedevelopingcountryhasbecomea
developedone),anevolutionwhichmighttakedecades.
Thispaperisatheoreticalcontributiontothedebate.Westudythe
long-runeffectofcapitalaccountliberalizationinasmallopendeveloping
economy.Todothis,weconsiderthefinancialopeningasinducingatransi-
tionfromastationarystatewithoutmovementsofcapitalandwithamoder-
ategrowthratetoanotherstationarystatewithcontinuouscapitalinflows,
ahighergrowthrateandnonzeroexternaldebtratios(aslongasnocrisis
occur).Wedubthelatter
externaldebt-ledgrowthregime
.Weshowthatbal-
anceofpaymentscrisesmayoccurinthisnewstationarystate,dependingon
thestructuralcharacteristicsoftheeconomy.Ourmainfindingistherefore
thatcapitalaccountliberalizationhasdifferenteffectsondifferenteconomies:
veryproductiveoneswillbenefitwithoutdangerfromexternalsavingsfu-
ellingasteadiercapitalaccumulation,whilelessproductiveeconomieswill
alsoexperiencehighergrowthratesduringtranquiltimes,butatthecost
ofpossibleBoPcrises.Wealsoshowthatadeeperintegrationintointerna-
tionalfinance(inthesenseoflargercapitalinflows)can,asthecasemaybe,
strengthenthisfragilityor,onthecontrary,reduceit.

Webuildthemodelofasmallopeneconomy,withtwosectors,produc-
ingstandardizedcommoditiesfortheworldmarketsandanon-tradedgood.
Becausethereisnointra-sectorialcapitalmobilityintheshortrun,foreign
capitalinflows(corporateexternaldebt)leadtoarealappreciationwhich
manifestsitselfbyariseintherelativepriceofnon-tradedgoodswithre-
2
Thereisnowawideempiricalliteratureonthecorrelationbetweencapitalcontrols
andlong-termgrowth.SeeArteta,Eichengreen&Wyplosz(2001)forarecentandcritical
workonthesubject.

3

gardtotradedgoods.Inthelongrun,therelativesizeofthenon-tradable
sectorincreases,sothattherealexchangerateisbroughtbacktoitslong-
runequilibriumvalue.
3
Thus,therearetwodifferenttime-scales:theshort
time-scaleofpricemovements,capitalinflowsandoutflowsandinvestment
decisions,contrastingwiththelongertime-scaleofcapitalaccumulationand
changesinitssectorialcomposition.Astheadjustmentsoftheproductive
structureareslow,suddenvariationsofpricesandinvestmentarelikelyto
occurintheshortrun,therebymakingcrisespossible.
Theprecisemechanismofthecrisisinvolvesmultipleequilibria.Onthe
onehand,astopintheinvestmentofthenon-tradablesectorreversesthe
capitalflowstothatsectorandprovokesarealdepreciation.Ontheother
hand,arealdepreciationdiminishestheprofitabilityofthenon-tradablesec-
torandleadstoastopintheinvestmentofthissector
4
ifitissufficientlylarge.
DuringaBoPcrisis,thestopintheinvestmentofthenon-tradablesector
andtherealdepreciationoccursimultaneouslyandvalidateeachother.
5
The
momentatwhichthechangeofequilibriumwilloccurisofcourseimpossible
topredict;butwecanneverthelessexaminetheconditionunderwhichmul-
tipleequilibriaarise.Thisconditiondependsonstructuralfeaturesofthe
economy,mainlythesectorialcompositionofcapitalwhichevolvesinthe
longrun.Thus,themodelallowsustodeterminewhethertheendogenous
long-runevolutionoftheeconomyeventuallycreates,ornot,theconditions
underwhichacrisisbecomespossible.
Asouraimistodiscussthepossibilityofcrisesinthenewgrowthregime
ledbyexternaldebt,independentlyofshort-runcyclicalfluctuations,the
modelexcludesfactorsthatcouldoriginateacreditcycle.
6
Forinstance,to
3
Thismechanismissimilartotheonestudiedbytheso-called
Dutchdisease
literature.
SeeforinstanceBruno&Sachs(1982).
4
Thismechanismrequirestheinvestmentdecisionstobetakenwithashorttimehori-
.noz5
Thepaperdoesnotdealwithsuddenstopsincapitalinflows,althoughtheframework
developedherecouldeasilybeusedtoassessthevulnerabilityofadevelopingeconomyto
suchanexogenousshock.
6
Wedonotdenytheexistenceandrelevanceofthesecycles,butourpointistoconstruct

4

avoidover-indebtednessandover-investment,theexternaldebtisentirely
collateralizedandrisk-less,andacreditconstraintlimitstheinvestment.

Thestylizedfactsreproducedbythemodelarequalitativelyconsistent
withtheempiricalevidencethathasbeendocumentedinseveralpapers.The
realexchangerateappreciationwhichoccursinthephaseofrapidgrowthpre-
cedingthecrisesisawell-establishedfact(Kaminsky&Reinhart1999,Gour-
inchasetal.2001,Tornell&Westermann2002).Thisrealappreciationis
verylikelytobepartlytheresultfromthemassivecapitalinflows,although
thismightbetruerofLatinAmericathanofAsiancountries(Calvo,Leider-
mann&Reinhart1996,Athukorala&Rajapatirana2003).Theasymmetrical
evolutionofthetwosectorswasempiricallyobservedbyTornell&Wester-
mann(2002).Inaneventstudyoftwincrises,theyobservethattherelative
sizeofthenon-tradablesectorwithregardtothetradablesectorincreases
beforethecrisesanddecreasesafter.Thissectorialasymmetrymaybethe
consequenceofdifferencesinprofitability.Ros&Lustig(2000)providedata
onarelativeprofitsqueezeintheMexicantradablesectorwithregardto
thenon-tradablesectorbetween1987and1994.Themodelalsoempha-
sizesthecentralroleplayedbyinvestmentinthecrisismechanism.Thisis
consistentwiththefactthatinvestmentisthecomponentofGDPdisplay-
ingthelargestvariabilityinthecrisesepisodes,growingrapidlybeforeand
fallingabruptlyduringthecrisis,contrarytoconsumptionwhichremains
rathersmooth(Gourinchasetal.2001,Tornell&Westermann2002).At
last,thecrisesareoftenunpredictedandsurprising,afactaccountedforby
ourmultipleequilibriastory.

Thispaperisrelatedtothetheoreticalliteraturethattriestomodel
theinstabilityofemergingmarketsandtheBoPcrisesfollowingperiodsof
atheoreticalframeworkfromwhichtheyare
apriori
excluded.Thecriseswedescribedo
notendaphase