- 25 Apr 2014
- Research & Ideas
To Pay or Not to Pay: Argentina and the International Debt Market
Argentina's escalating financial crisis seems rocketing toward disaster. The fix? Finance Professor Laura Alfaro, who served as Minister of National Planning and Economic Policy in Costa Rica, recommends a radical solution sure to anger banks and fund managers: absolute sovereign immunity, Open for comment; 0 Comments.
- 19 Mar 2013
- Working Paper Summaries
Carry Trade and Exchange-Rate Regimes
In emerging countries, carry-trade activity and foreign participation in local-currency bond markets have increased dramatically over the past decade. This study revisits the issue of choosing an exchange-rate regime under the assumption that emerging markets can borrow internationally in local currency. This hypothesis reflects a new trend in international capital flows: carry trade and relevant foreign participation in local-currency bond markets. Results show that, by means of international borrowing in domestic currency, emerging countries can partially offset foreign shocks. The authors argue that as emerging nations develop their local currency markets, a "pseudo-flexible regime," whereby a country accumulates reserves in conjunction with debt, is the best policy alternative under real external shocks. Key concepts include: This study reflects recent trends in the international flow of funds: the development of local currency bonds in emerging markets and increased foreign participation. It is well known that the choice of exchange-rate regime depends crucially on the type of shock to an economy. In this new framework, however, a flexible-exchange-rate regime is optimal for domestic shocks and a fixed-exchange-rate regime is optimal for external shocks. The traditional fixed-exchange-rate regime, albeit ideal in the presence of external shocks, is not sustainable. A flexible-exchange-rate regime can reduce exchange-rate volatility by issuing local-currency bonds, a policy the authors dub a "pseudo-flexible regime." Welfare levels are better if a pseudo-flexible regime is implemented in conjunction with reserve accumulation. Closed for comment; 0 Comments.
- 17 Jan 2013
- Working Paper Summaries
Deregulation, Misallocation, and Size: Evidence from India
India carried out wide-ranging deregulation policies in 1991. Significant sectors of the economy were opened up for private participation through de-licensing and allowing entry to industries previously reserved exclusively for the state-owned sector. This paper analyzes the efficiency impact of the removal of a specific distortion: compulsory industrial licensing that regulated firm entry and imposed output capacity constraints on Indian firms prior to 1991. Did industrial delicensing in India, which relaxed entry barriers and capacity constraints on firm size, lead to a change in firm size distributions within industries? Key concepts include: Pro-market reforms in the 1990s rapidly deregulated significant sectors of the Indian economy previously kept off-limits to private participation. Deregulation of entry and the end of industrial licensing (also known as the "License Raj") in all but a small subset of industries had the capacity to transform the competitive environment in which firms operated. Deregulation in India may have created a winner-take-all environment where the largest firms drive out any competition. While deregulation leads to more small firms in the sample, the size distribution that the authors observe—namely, a large number of small firms and a small number of large firms—can be characterized as the "missing middle" in Indian manufacturing. Small firms may continue to face constraints in their attempts to grow. Distortions have decreased over time with higher gains for deregulated industries. Closed for comment; 0 Comments.
- 16 Jul 2012
- Working Paper Summaries
Selection, Reallocation, and Spillover: Identifying the Sources of Gains from Multinational Production
Nations with greater openness to multinational production exhibit, on average, higher productivity and faster economic growth. This positive relationship, likely conditional on many factors, is often attributed to knowledge spillover, such as direct knowledge transfer through partnership, the possibility to learn from the innovation and experiences of foreign firms, and the interaction and movement in labor markets. However, another less stressed explanation centers on firm selection whereby competition from multinationals leads to market reallocation and survival of only the most productive domestic firms. Moreover, as only firms with greater productivity are able to overcome the fixed cost of foreign investment, countries with greater openness to multinational production are thus attracting foreign firms that are, by selection, more productive. The above mechanisms all imply a positive relationship between multinational production and host-country productivity but represent sharply different economic causalities and policy implications. The self-selection of multinational firms suggests that higher host-country productivity can reflect the productivity of self-selected multinational firms, instead of the causal effect of multinational production. In contrast, domestic firm selection and knowledge spillover imply multinational production causes higher aggregate, domestic productivity. How the latter two affect domestic production is countervailing: tougher domestic firm selection results in a contraction of domestic production while knowledge spillover creates positive externalities. In this paper the authors disentangle the roles of knowledge spillover and firm selection in determining the aggregate productivity and welfare impact of multinational production and quantify the relative importance of these distinct sources of gains. Results show that firm selection and market reallocation constitute an important source of productivity gains while its relative importance varies across nations. There are crucial implications for policy aimed at influencing foreign direct investment (FDI) flows. Key concepts include: If foreign firms have knowledge spillover effects for domestic firms, special policy treatment may be justified. If, however, as these results suggest, increases in productivity can also arise from tougher selection on domestic firms as a result of competition for scarce labor and capital, it is important to improve domestic conditions, including conditions of labor (in particular, skilled labor) supply and credit access, and to eliminate barriers in order to facilitate gains from competition and reallocation of resources. The entry of multinational firms raises the cutoff productivity of domestic firms, pushing the least productive domestic firms to exit the markets. New multinational production also leads to an increase in the minimum revenue of continuing domestic firms, indicating an increase in fixed production cost and capital price. The authors analyzed a 60-country dataset of financial, operation, and ownership information for over one million public and private manufacturing companies in 2002-2007. Closed for comment; 0 Comments.
- 20 Sep 2011
- Working Paper Summaries
Sovereigns, Upstream Capital Flows and Global Imbalances
Uphill capital flows and global imbalances have been at central stage in debates among academics and policymakers for quite some time. Many have argued that capital has been owing upstream from fast-growing developing nations to stagnant countries in the last decade. At the same time, these emerging countries accumulate a vast amount of reserves. HBS Professor Laura Alfaro and coauthors dissect capital flows between 1970 and 2004 into private and public components for every type of capital, namely FDI, equity and debt. The authors show that upstream ows and global imbalances are manifestations of the same underlying phenomenon: the central role of official ows in determining the international allocation of capital. Private capital does not flow on average uphill from emerging market countries and total capital flows uphill only out of five Asian countries including China due to reserve accumulation which completely dwarfs the net inflows of private capital. Key concepts include: There is much more nuance to the direction of capital ows than is commonly appreciated. Current account decits of low-productivity developing countries have been driven by government debt/aid. Once aid ows are subtracted, there is capital ight out of these countries. Total capital does not ow uphill for an average emerging market economy, and the regional patterns for current account behavior in Asia are driven by few outliers who happen to be big players in reserve accumulation, such as China. This paper has important policy implications. Addressing systemic distortions in the international financial system that require international cooperation, such as intentional undervaluation of exchange rates, should come before fixing domestic distortions in fast-growing emerging markets. The paper sheds light on the relevant theories. The most common theoretical references in understanding the uphill flows and global imbalances are models in which domestic financial frictions and/or precautionary motives lead to over-saving in emerging markets. However, as the paper shows, any explanation for uphill flows and global imbalances must take into account the fact that private capital flows downhill. The failure to consider official flows as the main driver of uphill flows and global imbalances is an important shortcoming of the recent literature. Closed for comment; 0 Comments.
- 15 Jul 2010
- Working Paper Summaries
Trade Policy and Firm Boundaries
What is the impact of trade policies on firms' ownership structures? Drawing on analysis based on a unique database from Dun and Bradstreet that contains both listed and unlisted plant-level observations in more than 200 countries, HBS professor Laura Alfaro and coauthors describe a simple model in which firms' boundaries depend on the prices of the products they sell: The higher the prices, the more integrated firms will be. More generally, when equilibrium prices converge across economies, so do ownership structures. The reason behind these predictions is that integration, although more productive than non-integration because of its comparative advantage in the coordination of firms' operating decisions, also imposes higher private costs on enterprise managers. At low prices, the productivity gains from integrating have little value, and managers choose non-integration. As prices rise, the relative value of coordination increases, favoring integration. Key concepts include: Results lend empirical support to a simple model of the determination of firm boundaries in a global economy. There is systematic relationship between firm boundaries and the equilibrium price in the product market. Higher prices, as proxied by higher most-favored-nation tariffs, lead to more vertical integration at the firm level. The impact of tariffs on vertical integration is significant. Enterprises' integration choices affect not only their productivity, but also aggregate economic performance and consumer welfare. Closed for comment; 0 Comments.
- 08 Jul 2010
- Working Paper Summaries
Surviving the Global Financial Crisis: Foreign Direct Investment and Establishment Performance
In 2008 and 2009 the world economy suffered the deepest global financial crisis since World War II. Countries around the globe witnessed major declines in output, employment, and trade, and world trade volume plummeted by more than 40 percent in the second half of 2008. Using a new dataset that reports operational activities of over 12 million establishments worldwide before and after 2008, HBS professor Laura Alfaro and George Washington University professor Maggie Chen study how multinationals around the world responded to the crisis relative to local firms, and the underlying mechanisms of those differential responses. By taking into account establishments both at the epicenter and on the periphery of the crisis, their analysis also considers multinationals' role as an international linkage in transmitting economic shocks. Key concepts include: Responses to the crisis differed sharply between multinational and local firms. On average, establishments with multinational ownership performed better than local competitors, but there was considerable differentiation in the role of foreign direct investment. Multinationals located in host countries that have experienced sharper declines in aggregate demand and credit conditions displayed a greater advantage over local firms in economic performance. Multinationals headquartered in countries with a greater incidence of the crisis, including lower demand and worse credit conditions, fared less satisfactorily overseas, suggesting a potential spillover of home-country shocks. Multinational corporation subsidiaries that share vertical production linkages with parent firms exhibited more resilient performance while horizontally linked subsidiaries responded less positively. The size of multinational networks matters. Being part of a larger multinational network, on average, was associated with superior economic performance during the crisis. But there was a negative interdependence across establishments with horizontal production linkages. Closed for comment; 0 Comments.
- 23 Dec 2009
- Working Paper Summaries
The Global Agglomeration of Multinational Firms
(Paper formerly titled "The Global Networks of Multinational Firms.") When and why do multinationals group together overseas? Do they agglomerate in the same fashion abroad as they do at home? An answer to these questions is central to the long-standing debate over the consequences of foreign direct investment (FDI). It is critical to understand interdependencies of multinational networks and how multinationals influence one another in their activities at home and overseas. HBS professor Laura Alfaro and George Washington University professor Maggie Chen examine the global network of multinationals and study the significance and causes of multinational agglomeration. Their results provide further evidence of the increasing separation of headquarters services and production activities within multinational firms. The differential specialization of headquarters and subsidiaries leads to distinct patterns of agglomeration. Key concepts include: Recent decades have witnessed an explosion in the activities of multinational corporations, but little is understood about global patterns of multinational agglomeration. Examples of this trend include firms that agglomerated in Silicon Valley and in Detroit now having subsidiaries clustered in Bangalore (termed "the Silicon Valley of India") and in Slovakia ("the Detroit of the East"). A new data set provides detailed location, ownership, and activity information for establishments in more than 100 countries. Multinational subsidiaries with knowledge spillovers, among other factors, tend to agglomerate to one another. The importance of these agglomeration economies is, however, different across headquarters, subsidiary, and employment networks. Many factors play a role in the location decisions of firms, so it may not be possible for a country to duplicate the circumstances that led to agglomeration in other nations. Policymakers need to consider the interdependence of multinational firms when making decisions about FDI. Closed for comment; 0 Comments.
- 18 Nov 2009
- Working Paper Summaries
India Transformed? Insights from the Firm Level 1988-2005
Between 1986 and 2005, Indian growth put to rest the concern that there was something about the "nature of India" that made rapid growth difficult. Following broad-ranging reforms in the mid-1980s and early 1990s, the state deregulated entry, both domestic and foreign, in many industries, and also hugely reduced barriers to trade. Laura Alfaro of Harvard Business School and Anusha Chari of the University of North Carolina at Chapel Hill analyze the evolution of India's industrial structure at the firm level following the reforms. Despite the substantial increase in the number of private and foreign firms, the overall pattern that emerges is one of continued incumbent dominance in terms of assets, sales, and profits in both state-owned and traditional private firms. Key concepts include: In sectors dominated by state-owned and traditional private firms before liberalization (with assets, sales, and profits representing 50 percent or higher shares), these firms remain the dominant ownership group following the reforms. Rates of return remain stable over time and show low dispersion across sectors and across ownership groups within sectors. The high levels of state ownership and ownership by traditional private firms in India raise the question of whether existing resources could be allocated more efficiently and whether remaining barriers to competition jeopardize the effectiveness of reform measures that have been put in place. Closed for comment; 0 Comments.
- 21 Sep 2007
- Working Paper Summaries
Intra-Industry Foreign Direct Investment
One of the enduring puzzles for researchers on FDI has been the role and importance of "horizontal" and "vertical" FDI. Horizontal FDI tends to mean locating production closer to customers and avoiding trade costs. Vertical FDI, on the other hand, represents firms' attempts to take advantage of cross-border factor cost differences. A central challenge for study has been the absence of firm-level data to distinguish properly among the types of and motivations for FDI. Alfaro and Charlton analyzed a new dataset, and in this paper present the first detailed characterization of the location, ownership, and activity of global multinational subsidiaries. Key concepts include: Most FDI occurs between rich countries. In contrast to previous research, it appears that the share of vertical FDI is larger than commonly thought, even within developed countries. Multinational firms have tended to embrace vertical FDI for highly skilled and later stages of production, and for arm's-length transactions for lower-skill inputs and processes. Closed for comment; 0 Comments.
- 01 Jun 2007
- Working Paper Summaries
Firm-Size Distribution and Cross-Country Income Differences
Country-to-country differences in per-worker income are known to be enormous. Per capita income in the richest countries exceeds that in the poorest countries by more than a factor of 50. The consensus view in scholarly literature on development accounting is that two-thirds of these variations can be attributed to differences in efficiency or total factor productivity (TFP). Emerging research, however, suggests other possibilities. Alfaro and coauthors, applied a monopolistic competitive firm model to a new dataset of more than 20 million firms in nearly 80 developing and industrialized countries. They then calculated the extent to which differences in the misallocation of resources (as well as differences in the amount of physical and human capital resources) explain dispersion in income per worker. Their results suggest that misallocation of resources is a crucial determinant of income dispersion. Key concepts include: Particular sources of inefficiency, such as credit market imperfections, macroeconomic volatility, defective bankruptcy procedures, or a malfunctioning regulatory environment, drive country-to-country differences in firm size distribution. Misallocation of resources is a crucial determinant of income dispersion. Closed for comment; 0 Comments.
- 17 May 2007
- Working Paper Summaries
The Price of Capital: Evidence from Trade Data
Is the price of capital higher across different countries? Motivated by the fact that most countries import the bulk of machinery and equipment, Alfaro and Ahmed used an alternative trade data to capture differences in the price of capital goods across countries. On this basis they found evidence that capital goods are more expensive in poor countries. Key concepts include: Findings were consistent with conventional wisdom: The price and cost of capital in poor countries is high. Given that most countries import the bulk of their machinery equipment from a small number of industrialized countries, investment distortions might be a factor in the observed differences in physical capital intensity across countries. Higher prices might inhibit the diffusion of technologies from rich to poor countries. Closed for comment; 0 Comments.
- 16 May 2007
- Working Paper Summaries
Growth and the Quality of Foreign Direct Investment: Is All FDI Equal?
Understanding the effect of foreign direct investment is important for two main reasons: It informs foreign investment policy, and it has implications for the effect of rapidly growing investment flows on the process of economic development. While academics tend to treat foreign direct investment as a homogenous capital flow, policymakers maintain that some FDI projects are better than others. In fact, national policies toward FDI seek to attract some types of FDI while regulating other types, reflecting a belief among policymakers that FDI projects differ greatly in terms of the national benefits to be derived from them. Policymakers from Dublin to Beijing, for instance, have implemented complex FDI regimes in order to influence the nature of FDI projects attracted to their shores. Using a dataset on 29 countries, Alfaro and Charlton distinguished different qualities of FDI in order to examine the various links between types of FDI and growth. Key concepts include: FDI at the industry level is associated with higher growth in value added. The relation is stronger for industries with higher skill requirements and for industries more reliant on external capital. FDI quality is associated with positive and economically significant growth. More research on the consequences of FDI is needed before promoting FDI. Closed for comment; 0 Comments.
- 30 Apr 2007
- Research & Ideas
All Eyes on Slovakia’s Flat Tax
The flat tax is an idea that's burst to life in post-communist Eastern and Central Europe, especially in Slovakia. But is the rest of the world ready? A new Harvard Business School case on Slovakia's complex experience highlights many hurdles elsewhere, as HBS professor Laura Alfaro, Europe Research Center Director Vincent Dessain, and Research Assistant Ane Damgaard Jensen explain in this Q&A. Key concepts include: Despite successful examples of tax reduction, introducing a flat tax in the U.S. or Western Europe is a long way off. Slovak reforms have clearly been attractive to foreign investors. Neighboring Austria, for instance, has lowered its corporate tax rate from 34 percent to 25 percent. One lesson to be learned from Slovakia is that any changes to fundamental tax habits need to be thoroughly explained to all individuals and groups affected by it. Flat taxes were relatively easier to introduce in Central and Eastern Europe because tax collection was limited under the communist regimes. With a flat tax, tax revenues were likely to increase. Closed for comment; 0 Comments.
- 27 Sep 2006
- Working Paper Summaries
How Does Foreign Direct Investment Promote Economic Growth? Exploring the Effects of Financial Markets on Linkages
Does FDI help developing countries as much as we think? While theoretical models imply that FDI is beneficial for a host country's development—a belief widely shared among policymakers—the empirical evidence does not support this view. This paper bridges the gap between theoretical and empirical literature with a model and calibration exercises that examine the role of local financial markets. Ultimately, Alfaro and colleagues contribute to existing research that emphasizes how local policies and institutions may actually limit the potential benefits that FDI could provide to a host country. Key concepts include: Research shows that an increase in FDI leads to higher growth rates in financially developed countries compared to rates observed in financially poor countries. Local conditions, such as the development of financial markets and the educational level of a country, affect the impact of FDI on economic growth. Policymakers should exercise caution when trying to attract FDI that is complementary to local production. The best connections are between final and intermediate industry sectors, not necessarily between domestic and foreign final goods producers. Human capital plays a critical role in achieving growth benefits from FDI. Closed for comment; 0 Comments.
- 05 Sep 2006
- Working Paper Summaries
Optimal Reserve Management and Sovereign Debt
One of the puzzles in the study of emerging markets is understanding why developing countries accumulate reserves as a means to avoid a financial crisis, rather than work to reduce their sovereign debt. In 2005, for example, reserve accumulation totaled 20 percent of gross domestic product in low- and middle-income countries but only about 5 percent in high-income countries. The costs and benefits of reserve accumulation still aren't clear, nor do economists agree on the optimal level of foreign reserves that sovereign countries should hold. By testing a model of a small, open economy with non-contingent debt and reserve assets, Alfaro and Kanczuk explored the issue in depth. Key concepts include: For economists to better understand high levels of foreign reserves holdings, future research should model additional constraints on a sovereign country's ability to reduce its debt. Political economy explanations may better address reserve accumulation in emerging markets. Closed for comment; 0 Comments.
- 05 Sep 2006
- Working Paper Summaries
International Financial Integration and Entrepreneurship
Why does entrepreneurship flourish in some countries and struggle in others? Economists and policymakers are divided on whether the rapid rate of global financial integration, specifically the explosive growth of foreign direct investment, helps or hurts local entrepreneurs and domestic economies. To see the differential effects of restrictions on capital mobility on entrepreneurship, Alfaro of HBS and Charlton of the London School of Economics analyzed data on 24 million firms—listed and unlisted—in nearly 100 countries in 1999 and 2004. Key concepts include: Contrary to the fears of many, capital mobility has not hindered entrepreneurship: Instead, international financial integration is related to greater firm activity. Countries with fewer barriers to international capital have a higher proportion of small firms. By the same token, firms tend to be older in less financially integrated countries. International financial integration might increase the total amount of capital in the economy and improve the availability of capital and credit. Thanks to FDI, local firms could benefit from linkages with foreign firms. This work did not look at growth or the overall welfare effects of capital liberalization on individual countries, an important area for future research. Closed for comment; 0 Comments.
- 17 Nov 2003
- Research & Ideas
Lessons from a Nasty Trade Dispute
Even if the World Trade Organization rules in favor of your country’s government, it may not mean the end of a business dispute. HBS professors Rawi Abdelal and Laura Alfaro explain why. Closed for comment; 0 Comments.
- 24 Feb 2003
- Research & Ideas
In Troubled Africa, Botswana Flowers
Quick, name the country with the highest sustained growth in real output over the last forty years. The surprising answer: Botswana. Harvard Business School professor Debora L. Spar discusses the dynamics behind this little-reported story. Closed for comment; 0 Comments.
The Real Effects of Capital Controls: Financial Constraints, Exporters, and Firm Investment
The massive surge of foreign capital to emerging markets in the aftermath of the global financial crisis of 2008-2009 has led to a renewed debate about the merits of international capital mobility. To stem the flow of capital and manage the attendant risks, several emerging markets have recently imposed taxes or controls to curb inflows of foreign capital. The case for capital controls usually rests on measures designed to mitigate the volatility of foreign capital inflows. However, controls also have an implicitly protectionist aspect aimed at maintaining persistent currency undervaluation. In this paper the authors investigate the effects of capital controls on firm-level stock returns and real investment using data from Brazil. Brazil is important because it has taken center stage as a country that has implemented extensive controls on capital flows between 2008 and 2012. Among the authors' key findings, real investment at the firm level falls significantly in the aftermath of controls. Overall, capital controls can increase market uncertainty and reduce the availability of external finance, which in turn can lower investment at the firm level. Capital controls disproportionately affect small, non-exporting firms, especially those more dependent on external finance. Key concepts include: Capital controls policy measures range from large-scale efforts to reduce the volatility of foreign capital inflows to a protectionist stance on maintaining the competitiveness of the external sector. The intended purpose of controls notwithstanding, evidence in this paper suggests that capital controls can increase market uncertainty and reduce the availability of external finance, which in turn can lower investment at the firm level. Controls affect small, non-exporting firms most, especially those more dependent on external finance. Closed for comment; 0 Comments.