Capital Controls, Liberalizations, and Foreign Direct Investment

Posted: 29 Feb 2008

See all articles by Mihir A. Desai

Mihir A. Desai

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

C. Fritz Foley

Harvard Business School; National Bureau of Economic Research (NBER)

James R. Hines Jr.

University of Michigan; NBER

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Abstract

This article evaluates the impact of capital controls and their liberalization on the activities of US multinational firms. These firms attempt to circumvent capital controls by reducing reported local profitability and increasing the frequency of dividend repatriations. As a result, the reported profit impact of local capital controls is comparable with the effect of 27% higher corporate tax rates, and affiliates located in countries imposing capital controls are 9.8% more likely than other affiliates to remit dividends to parent companies. Multinational affiliates located in countries with capital controls face 5.25% higher interest rates on local borrowing than do affiliates of the same parent borrowing locally in countries without capital controls. Capital control liberalizations are associated with significant increases in multinational activity-property, plant, and equipment grow at 6.9% faster annual rates following liberalizations. The combination of the costliness of avoidance and higher interest rates discourages investment in countries with capital controls, and this effect is reversed upon liberalization of controls. (JEL F21, F23, F36, F42, G15, G32, G34)

Suggested Citation

Desai, Mihir A. and Foley, C. Fritz and Hines, James Rodger, Capital Controls, Liberalizations, and Foreign Direct Investment. The Review of Financial Studies, Vol. 19, Issue 4, pp. 1433-1464, 2006. Available at SSRN: https://ssrn.com/abstract=1097954 or http://dx.doi.org/10.1093/rfs/hhj041

Mihir A. Desai (Contact Author)

Harvard Business School - Finance Unit ( email )

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C. Fritz Foley

Harvard Business School ( email )

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National Bureau of Economic Research (NBER)

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James Rodger Hines

University of Michigan ( email )

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United States

NBER

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