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Foreign Direct Investment and Debt Financing in Emerging Economies
Author(s) -
LUK PAUL,
ZHENG TIANXIAO
Publication year - 2020
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/jmcb.12612
Subject(s) - foreign direct investment , emerging markets , monetary economics , business cycle , economics , valuation effects , valuation (finance) , debt , financial crisis , external financing , external debt , capital outflow , debt financing , capital (architecture) , finance , macroeconomics , financial capital , capital formation , market economy , human capital , history , archaeology
The rich dynamics of capital flows is an important characteristic of business cycles in emerging market economies. In the data external debt is always procyclical, while FDI is procyclical only in normal times. We provide a microfounded rationale for this pattern by linking financial shocks to capital flows. For this purpose, we build a small open economy model in which firms are subject to borrowing constraints, and are either owned domestically or by foreign investors who purchase firms through FDI. During a financial crisis, the valuation gap per unit net worth between foreign and domestic investors widens, which triggers more FDI inflow. Our model produces business cycle moments consistent with empirical observations.