Capital Flows and Debt in Emerging Markets

April 11-12, 2016
Sebnem Kalemli-Ozcan, University of Maryland, and Carmen Reinhart, Harvard University, Organizers

Jaume Ventura, CREI and Universitat Pompeu Fabra and NBER, and Hans-Joachim Voth, University of Zurich

Debt into Growth: How Sovereign Debt Accelerated the First Industrial Revolution

Why did the country that borrowed the most industrialize first? Earlier research has viewed the explosion of debt in 18th century Britain as either detrimental, or as neutral for economic growth. In this paper, Ventura and Voth argue instead that Britain's borrowing boom was beneficial. The massive issuance of liquidly traded bonds allowed the nobility to switch out of low-return investments such as agricultural improvements. This switch lowered factor demand by old sectors and increased profits in new, rising ones such as textiles and iron. Because external financing contributed little to the Industrial Revolution, this boost in profits in new industries accelerated structural change, making Britain more industrial more quickly. The absence of an effective transfer of financial resources from old to new sectors also helps to explain why the Industrial Revolution led to massive social change — because the rich nobility did not lend to or invest in the revolutionizing industries, it failed to capture the high returns to capital in these sectors, leading to relative economic decline.

Jesse Schreger, Princeton University, and Benjamin Hebert, Stanford University

The Costs of Sovereign Default: Evidence from Argentina

Schreger and Hebert estimate the causal effect of sovereign default on the equity returns of Argentine firms. The researchers identify this effect by exploiting changes in the probability of Argentine sovereign default induced by legal rulings in the case of Republic of Argentina v. NML Capital. They find that a 1% increase in the probability of default causes a 0.55% decline in the value of Argentine equities. The authors construct tracking portfolios for the present value of output growth and estimate that an entirely unexpected sovereign default would cause a decline in this measure of between 5.9% and 10.9%.

Gita Gopinath, Harvard University and NBER; Sebnem Kalemli-Ozcan; Loukas Karabarbounis, University of Chicago and NBER; and Carolina Villegas-Sanchez, ESADE-Universitat Ramon Llull

Capital Allocation and Productivity in South Europe

Following the introduction of the euro in 1999, countries in the South experienced large capital inflows and low productivity. Kalemli-Ozcan, Gopinath, Karabarbounis, and Villegas-Sanchez use data for manufacturing firms in Spain to document a significant increase in the dispersion of the return to capital across firms, a stable dispersion of the return to labor across firms, and a significant increase in productivity losses from misallocation over time. They develop a model of heterogeneous firms facing financial frictions and investment adjustment costs. The model generates cross-sectional and time-series patterns in size, productivity, capital returns, investment, and debt consistent with those observed in production and balance sheet data. The authors illustrate how the decline in the real interest rate, often attributed to the euro convergence process, leads to a decline in sectoral total factor productivity as capital inflows are misallocated toward firms that have higher net worth but are not necessarily more productive. The researchers conclude by showing that similar trends in dispersion and productivity losses are observed in Italy and Portugal but not in Germany, France, and Norway.

Vladimir Asriyan, Universitat Pompeu Fabra; Luca Fornaro, CREI, Universitat Pompeu Fabra and Barcelona GSE; Alberto Martin, CREI; and Jaume Ventura

Monetary Policy for a Bubbly World

Serkan Arslanalp, International Monetary Fund, and Takahiro Tsuda, Ministry of Finance

Tracking Global Demand for Emerging Market Sovereign Debt

This paper proposes an approach to track US$1 trillion of emerging market government debt held by foreign investors in local and hard currency, based on a similar approach that was used for advanced economies (Arslanalp and Tsuda, 2012). The estimates are constructed on a quarterly basis from 2004 to mid-2013 and are available along with the paper in an online dataset. Arslanalp and Tsuda estimate that about half a trillion dollars of foreign flows went into emerging market government debt during 2010–12, mostly coming from foreign asset managers. Foreign central bank holdings have risen as well, but remain concentrated in a few countries: Brazil, China, Indonesia, Poland, Malaysia, Mexico, and South Africa. The researchers also find that foreign investor flows to emerging markets were less differentiated during 2010–12 against the background of near-zero interest rates in advanced economies. The paper extends some of the indicators proposed in the authors' earlier paper to show how the investor base data can be used to assess countries' sensitivity to external funding shocks and to track foreign investors' exposures to different markets within a global benchmark portfolio.

Laura Alfaro, Harvard University and NBER; Anusha Chari, University of North Carolina at Chapel Hill and NBER; and Ugo Panizza, The Graduate Institute, Geneva

Lessons Unlearned? Corporate Debt in Emerging Markets

For a sample of emerging markets, Alfaro, Chari, and Panizza examine and contrast various firm-level indicators related to corporate fragility and profitability prior to the East Asian Financial Crisis of 1997–1998 and the aftermath of the Global Financial Crisis of 2008–2009. The East Asian Financial Crisis serves as the benchmark that allows the authors to answer the following question: How do corporate debt vulnerability and profitability indicators in emerging markets post-GFC compare with these indicators on the eve of the East Asian Crisis? They compare the post-GFC indicators to three benchmarks: (i) a within-country comparison relative to 1992-1997 values for a given indicator; (ii) a crisis-country comparison relative to the 1992-1997 average of the five East Asian Crisis countries, and (iii) a within group comparison relative to the 1992-1997 average for all the emerging markets in their sample. The researchers observe substantial heterogeneity and degrees of vulnerability across emerging market countries and firms. The results suggest that while corporate vulnerability levels are not as severe as the run-up to the East Asian crisis, a broader spectrum of emerging markets display weaker liquidity and solvency indicators in the post-GFC period while corporate distress indicators have increased in the post-GFC period.

Carmen M. Reinhart; Vincent Reinhart, American Enterprise Institute; and Christoph Trebesch, University of Munich

Global Cycles: Capital Flows, Commodities, and Sovereign Defaults, 1815-2015 (NBER Working Paper No. 21958)

Capital flow and commodity cycles have long been connected with economic crises. Sparse historical data, however, has made it difficult to connect their timing. Reinhart, Reinhart, and Trebesch date turning points in global capital flows and commodity prices across two centuries and provide estimates from alternative data sources. The researchers then document a strong overlap between the ebb and flow of financial capital, the commodity price super-cycle, and sovereign defaults since 1815. The results have implications for today, as many emerging markets are facing a double bust in capital inflows and commodity prices, making them vulnerable to crises.

NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us