Chilean-type capital controls: A building block of the new international financial architecture?

Taxes on short-term capital flows such as introduced in Chile and Slovenia during the 1990s in the form of unremunerated reserve requirements (URRs) on financial credits are under discussion as a remedy against adverse effects of volatile international capital flows. From a theoretical point of view, URRs find support from the fact that financial markets react faster to exogenous shocks than goods markets. A high volatility of capital flows, in turn, may reduce investment and exports, and thus negatively affect overall growth. A tax designed to reduce inflows of (short-term) capital and to enhance the autonomy of domestic monetary policy may therefore raise welfare. Yet, the effectiveness of URRs is limited because capital controls can at best delay but not prevent speculative attacks on misaligned currencies. Moreover, a temporary introduction of capital controls, as is often proposed in the case of an acute financial crisis, may have the adverse effect of increasing rather than lowering financial market volatility. The empirical evidence from Chile and Slovenia shows that URRs are no panacea and that the gain in monetary autonomy has been limited. While the composition of inflows has changed towards flows exempted from the URR, the overall inflow of capital has increased, and interest rate effects have been short-lived. There is no evidence that the volatility of capital flows has declined. Exchange rate volatility seems to have come down, albeit possibly as a result of exchange market intervention. Capital controls are often proposed as a tool to promote the stability of the financial sector. More specifically, it is often argued that external financial liberalization should proceed only after sufficient progress has been made in reforming the domestic banking system. Yet, the administrative capacity to enforce capital controls is typically weak precisely in those countries which have poorly supervised and thus potentially unstable banking systems. Also, foreign competition can enhance the efficiency of the domestic financial sector. Thus, progressing simultaneously on internal and external financial liberalization seems the preferable option. At the time of opening up for foreign capital, minimum prudential standards should be in place. Also, public deposit guarantees should have been abolished in order to limit the risk of overborrowing and moral hazard. The imposition of capital controls may even send negative signals to investors and thus affect investment negatively. Exposure to external shocks should rather be reduced by pursuing structural reforms, by following sound macroeconomic policies, by disseminating clear and transparent information, and by using market mechanisms to alter the structure of foreign debt. This also allows for a more efficient use of scarce administrative resources. In this context, international institutions have an important role to play in designing and enforcing an institutional framework in which such mechanisms can be implemented. --

Multinational Firms and New Protectionisms

Recent initiatives to hold back cross-border mergers and acquisitions for ‘strategic’ reasons have made headline news. We discuss whether the initiatives may mark the start of a new protectionist era. We argue that standard globalization indicators show no such signs. However, an increasing divergence of incomes and increased insecurity might raise resistance against the globalization process. We discuss the benefits of globalization benefits in terms of lower prices for consumers, a greater variety of available products, lower risks, and higher economic growth. But we also outline the risks in terms of greater inequalities and greater need for flexibility. Protectionism is a double-edged sword. Many historic episodes show that the return to protectionism did significantly more harm in terms of reduced growth than generating benefits in terms of greater stability and smaller income differentials.

Openness and Income Dispaities: Does Trade Explain the 'Mezzogiorno' Effect?

Many theoretical models show that trade openness has positive welfare implications. Yet, openness might affect different social groups and regions asymmetrically, even within a given country. We use Italian regional data to answer the question whether trade openness affects within-country income differentials. In Italy, the more affluent regions are internationally more open than poorer ones not only with respect to trade in goods, but also with respect to FDI and international migration. Prima facie, there is a positive correlation between openness and per capita income. Studying this relationship empirically requires taking into account the endogenous component of openness. We apply panel cointegration and instrumental variables techniques to account for the endogeneity of trade. Our results show a positive link between trade openness and the level of income per capita.Openness, growth, regional income disparities, Italian regions

Regional Origins of Employment Volatility: Evidence from German States

Openness for trade can have positive welfare effects in terms of higher growth. But increased openness may also increase uncertainty through a higher volatility of employment. We use regional data from Germany to test whether openness for trade has an impact on volatility. We find a downward trend in the unconditional volatility of employment, which has been interrupted by the re-unification period. Patterns are similar to those for output volatility. The conditional volatility of employment, measuring idiosyncratic developments across states, in contrast, has remained fairly unchanged. In contrast to evidence for the US, we do not find evidence for a significant link between employment volatility and trade openness.employment volatility, trade openness, regional labour markets

Exchange rates and FDI: Goods versus capital market frictions

Economic theory provides two main explanations why changes in exchange rates can affect foreign direct investment (FDI). According to a first explanation, FDI reacts to exchange rate changes if there are information frictions on capital markets and if the investment by firms depends on their net worth (capital market friction hypothesis). According to a second explanation, FDI reacts to exchange rate changes if output and factor markets are segmented, and if firm-specific assets are important (goods market friction hypothesis). We provide a unified theoretical framework of the two explanations and test the model using German sectoral data derived from detailed firm-level data. We find greater support for the goods market friction hypothesis. --FDI,exchange rates,net worth effects,multinational firms

Openness and Growth: The Long Shadow of the Berlin Wall

The question whether international openness causes higher domestic growth has been subject to intense discussions in the empirical growth literature. This paper addresses this issue using the fall of the Berlin wall in 1990 as a natural experiment. We analyze whether the slow-down in convergence in per capita income between East and West Germany since the mid-1990s and the lower international openness of East Germany are linked. We address the endogeneity of openness by adapting the methodology proposed by Frankel and Romer (1999) in a panel framework. We instrument openness with time-invariant exogenous geographic variables and time-varying exogenous policy variables. We also distinguish different channels of integration. Our paper has three main findings. First, geographic variables have a significant impact on regional openness. Second, controlling for geography, East German states are less integrated into international markets along all dimensions of integration considered. Third, the degree of openness for trade has a positive impact on regional income per capita.openness, growth, German re-unification

Volatile multinationals? Evidence from the labor demand of German firms

Does more FDI make the world a riskier place for workers? We analyze whether an increase in multinational firms' activities is associated with an increase in firm-level employment volatility. We use a firm-level dataset for Germany which allows us to distinguish between purely domestic firms, domestic multinationals, their foreign affiliates, and foreign firms that are active in Germany. We decompose the volatility of firms into their reaction and their exposure to aggregate developments. Generally, we find no above-average wage and output elasticities for multinational firms. --Employment volatility,labor demand,multinational firms