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We have benefited from comments and suggestions by Ayhan Kose, Alessandro Prati and Antonio Spilimbergo at the IMF, and participants at the 2009 JIMF-SCCIE conference, especially Joshua Aizenman, Michael Dooley, Eric Fisher, and our discussant, Clas Wihlborg.
As discussed in the following section in more detail, while a number of individual country studies exist, there is relatively little cross-country research on this topic.
Magud and Reinhart (2007) review more than 30 studies, only five of which are multi-country studies.
Edison and Reinhart (2001) consider the linkages between controls and financial stability (i.e., interest rate and exchange rate stability) and policy autonomy in a panel dataset with daily observations for Brazil, Malaysia and Thailand (and with South Korea and the Philippines as a control group). Using a variety of time series methodologies, they find that capital controls are ineffective for Brazil and Thailand and partly effective in Malaysia. Mody and Murshid (2005) consider the link between capital controls and domestic investment. In a panel data set consisting of 60 developing economies, they find that the surge in capital flows during the 1990s associated with financial liberalization (based on de jure measures from AREAER) was driven largely by diversification motives and did not lead to an increase in domestic investment. However, stronger policy environments appear to strengthen the link between capital inflows and domestic investment.
The IMF’s AREAER started to systematically differentiate between inflow and outflow controls only in 1995.
Although there are clear conceptual differences between portfolio equity and FDI flows, in practice, the difference is less clear-cut. Typically, equity ownership in excess of a 10 percent share in a company is considered FDI, but it is not obvious that this cutoff also corresponds to a conceptually different kind of investment. However, we also provide estimates separately for portfolio equity and FDI flows (see footnote 8).
These distinctions are clearly essential to our research question, but have also been used in other recent research. For example, Prati, Schindler, and Valenzuela (2009) exploit the inflow/outflow distinction in combination with firm-level credit ratings data to identify one of the channels through which capital account restrictions affect an economy.
Throughout the paper, we combine FDI and equity flows, rather than considering them separately. The reason is that while conceptually distinct, in practice, the difference is less clear: countries typically classify as FDI equity investments that exceed a certain threshold (e.g., a greater than 10 percent share). Separate regressions may therefore not be particularly meaningful. Indeed, as reported in Appendix Table 3, running separate regressions yields qualitatively unchanged results, and the fact that the estimated coefficients between portfolio equity and FDI are virtually identical supports the notion that the two measures may not capture truly distinct capital flows.
Country fixed effects are designed to capture systematic capital flows associated with idiosyncratic country-specific factors. In addition, over our data sample period (1995–2005) there was a noticeable trend decrease in de jure capital market restrictions. This trend was broken, temporarily, by the 1997–98 Asian financial crises that led many emerging economies to re-impose capital account restrictions. Including time fixed effects in the panel regressions would help to account for such broad movements over time, but as shown in Appendix Table A4, results are virtually identical when country and time fixed effects are included.
A possible explanation is the different sample, both in terms of time and country coverage.
Regression estimates for this and subsequent extensions in this section are not reported for brevity. They are available from the authors upon request.