Event Information

CNAPS and the Epoch Foundation organized this conference examining cross-strait relations and U.S. policy toward Asia at a time of political change in Taiwan and the United States. Three panels, featuring Brookings and CNAPS scholars as well as other experts, analyzed U.S. policy, cross-Strait relations, and the economy of mainland China. Brookings President Strobe Talbott and Vincent Siew, vice president of the Republic of China, provided keynote remarks.

Read the welcome remarks and morning keynote address »
Read the panel 1 transcript »
Read the afternoon keynote address »
Read the panel 2 transcript »
Read the panel 3 transcript » (forthcoming)

Transcript

• Transcript (.pdf)

Event Materials

• 1203_cross_strait_relations

      

 

 

Abstract

The literature on the benefits and costs of financial globalization for developing countries has exploded in recent years, but along many disparate channels and with a variety of apparently conflicting results. For instance, there is still little robust evidence of the growth benefits of broad capital account liberalization, but a number of recent papers in the finance literature report that equity market liberalizations do significantly boost growth. Similarly, evidence based on microeconomic (firm- or industry-level) data shows some benefits of financial integration and the distortionary effects of capital controls, while the macroeconomic evidence remains inconclusive. We attempt to provide a unified conceptual framework for organizing this vast and growing literature. This framework allows us to provide a fresh synthetic perspective on the macroeconomic effects of financial globalization, in terms of both growth and volatility. Overall, our critical reading of the recent empirical literature is that it lends some qualified support to the view that developing countries can benefit from financial globalization, but with many nuances. On the other hand, there is little systematic evidence to support widely cited claims that financial globalization by itself leads to deeper and more costly developing country growth crises.

Downloads

• Download

      

 

 

Abstract

The practice of sourcing service inputs from overseas suppliers has been growing in response to new technologies that have made it possible to trade in some business and computing services that were previously considered non-tradable. This paper estimates the effects of offshoring on productivity in US manufacturing industries between 1992 and 2000, using instrumental variables estimation to address the potential endogeneity and errors in measurement of offshoring. It finds that service offshoring has a significant positive effect on productivity in the US, accounting for around 11 percent of productivity growth during this period. Offshoring material inputs also has a positive effect on productivity, but the magnitude is smaller accounting for approximately 5 percent of productivity growth.

View full paper — (PDF - 581KB)

      

 

 

Introduction

The 2 percent revaluation of the Chinese exchange rate on July 21, 2005 has generated what appears to be a disproportionate amount of interest around the world. In many ways, this attention has to do with China's massive build-up of its foreign exchange reserve, its position as the world's largest destination for foreign direct investment, and as the third largest trading nation.

Given China's status as a global economic power, characterizing the nature and determinants of China's capital inflows is of considerable interest for analytical reasons as well as for understanding the implications for the regional and global allocation of capital. Our primary objective in this paper is to provide a detailed descriptive analysis of the main aspects of capital inflows into China. Given the degree of interest in China and the relative paucity of data, we aim to provide a benchmark reference tool for other researchers, including by providing some critical perspectives on the numbers that we report.

Section II presents a detailed picture of the evolution of China's capital flows. China has both large inflows and large outflows in absolute dollar terms. Its inflows have generally been dominated by FDI, which, for an emerging market, constitutes a preferred form of inflows since FDI tends to be stable and associated with other benefits such as transfers of technological and managerial expertise. An interesting aspect of these inflows is that, contrary to some popular perceptions, they come mainly from other advanced Asian countries that have net trade surpluses with China, rather than from the United States and Europe, which constitute China's main export markets. As for other types of inflows, China has limited its external debt to low levels, and non-FDI private capital inflows have typically been quite limited, until recently. Its outflows are dominated by official reserve assets and unrecorded private sector outflows (or capital flight).

In Section III, we examine the evolution of the balance of payments and dissect the recent surge in the pace of accumulation of international reserves. A key finding is that, while current account surpluses and FDI have remained important contributors to reserve accumulation, the dramatic surge in the pace of reserve accumulation since 2001 is largely attributable to non-FDI capital inflows. We provide some analytical perspectives on the costs and benefits of holding a stock of reserves that now amounts to nearly 40 percent of GDP. There has also been considerable international attention focused recently on the issue of the currency composition of China's massive stock of international reserves (which is now second only to that of Japan). Despite data constraints, we attempt to shed what little light we can on this issue, both by carefully examining a popular source of data for China's holding of U.S. securities and by calculating the potential balance of payments implications of reserve valuation effects associated with the depreciation of the U.S. dollar in recent years.

Section IV discusses the broader composition of China's capital inflows in the context of the burgeoning literature on financial globalization. Notwithstanding the recent surge of non-FDI inflows, FDI remains historically the dominant source of inflows into China. The literature on the benefits and risks of financial globalization suggests that China may have benefited greatly in terms of improving the risk-return trade-offs by having its inflows tilted so much toward FDI.

Whether this composition of inflows is a result of enlightened policies, the structure of institutions, or plain luck is an intriguing question. In Section V, we examine various hypotheses that have been put forward to explain why China has its inflows so heavily tilted toward FDI. In this context, we provide a detailed description of China's capital account restrictions and how these have evolved over time. While controls on non-FDI inflows as well as tax and other incentives appear to be proximate factors for explaining the FDI-heavy composition of inflows, other factors may also have contributed to this outcome. It is not straightforward to disentangle the quantitative relevance of alternative hypotheses. We argue, nonetheless, that at least a few of the hypotheses—including some mercantilist-type arguments that have been advanced recently—are not consistent with the facts.

Downloads

• Download

      

 

 

Abstract

State-owned financial institutions have been proposed as a way to address market failure, though the literature has also highlighted their pathological problems. This paper examines pitfalls of a statedominated financial system in the case of China, including possible segmentation of the internal capital market due to local government interference and mis-allocation of capital. Even without formal legal prohibition to capital movement across regions, we find that capital mobility within China is low. Furthermore, to the extent some capital moves around the country, the government (as opposed to the private sector) tends to reallocate capital systematically away from more productive regions towards less productive ones. In this context, a smaller role of the government in the financial sector might increase economic efficiency and the rate of economic growth.

Downloads

• Download

      

 

 

Abstract

Tax evasion, by its very nature, is difficult to observe. We quantify the effects of tax rates on tax evasion, by examining the relationship in China between the tariff schedule and the 'evasion gap' which we define as the difference between Hong Kong's reported exports to China at the product level and China's reported imports from Hong Kong. Our results imply that a one percentage point increase in the tax rate is associated with a 3 percent increase in evasion. Furthermore, the evasion gap is negatively correlated with tax rates on closely related products, suggesting that evasion takes place partly through mis-classification of imports from higher-taxed categories to lower-taxed ones, in addition to under-reporting the value of imports.

Introduction

This paper studies the responsiveness of tax evasion to tax rates. Much of the work in the theory and empirics of taxation has taken tax collection as given and often costlessly executed. This simplification is unlikely to be realistic: even within the United States, where tax collection is considered to be relatively efficient, about 17 percent of income taxes are estimated as unpaid (Slemrod and Yitzhaki, 2000). One particularly important issue is understanding the relationship between tax rates and tax evasion. A number of models have evolved to incorporate tax evasion, but these models fail to provide any prediction regarding the uniform impact of tax rates on evasion. In the pioneering work of Allingham and Sandmo (1972), the relationship between tax rates and evasion is positive, but this depends on particular assumptions of risk aversion and the punishment for evasion. A broader review of the literature reports that, more generally, theoretical predictions of the effect of tax rates on evasion are highly sensitive to modeling assumptions (Slemrod and Yitzhaki, 2000).1 Furthermore, even if the effect of tax rates on evasion may be signed, there is still a need to assess the magnitude of this effect. Hence, empirically examining the effect of tax rates on evasion would be very useful from the perspectives of both theory and policy. This has proven to be a challenging task due to the difficulties in measuring evasion, which by definition is not directly observed.

Downloads

• Download

      

 

 

The General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade Organization (WTO), were set up to promote world trade. That trade increased courtesy of this institution may seem self-evident. To the doubters, Bhagwati (1991) has this succinct riposte:

"A common criticism is that the GATT in truth is the General Agreement to Talk and Talk: It has delivered nothing. This is nonsense."

However, in one of the first and very few empirical analyses of this question, Rose (2002a and 2002b), after an impressively meticulous and comprehensive scrutiny, has argued that there is no evidence that the World Trade Organization (WTO) has increased world trade. To quote Rose (2002a):

"My quantitative examination indicates that there is little reason to believe that the GATT/WTO has had a dramatic effect on trade. In particular, once standard gravity effects have been taken into account, bilateral trade cannot be strongly and dependably linked to membership in the WTO or its predecessor the GATT."

In this paper, we attempt to reconcile the apparent inconsistency between the well-entrenched belief in the benefits of the WTO and the conclusion of Rose's analysis. We will furnish evidence that Rose's analysis is incomplete and can be misread seriously. The incompleteness is on two grounds.

Downloads

• Download

      

 

 

At the beginning of 2002, Enron was the seventh largest company in the United States, with operations extending worldwide.

Telecommunications giant Global Crossing operated in twenty-seven countries and two hundred cities on five continents. But both companies collapsed last year under the weight of financial problems created by the self-dealing of a few corporate insiders and masked by nontransparent accounting.

These and other similar corporate failures deprived millions of company employees and shareholders of their lifetime savings and retirement benefits. Stock prices of other U.S. companies also took a beating, partly in response to the revelation of these scandals, and foreign markets have suffered enormous losses.

The practice of opaque self-dealing by a few insiders—as evidenced by insider trading and a lack of transparency in corporate and government operation—has contributed to the meltdown of the financial markets around the world. A crucial, invigorated reform effort is under way worldwide to stem the problem, which, if left unchecked, could lead to global financial ruin.

POLICY BRIEF #118

Roller Coaster Rides

Since January 2002, all major U.S. stock indexes have plummeted. NASDAQ fell almost a third in 2002, and the Dow Jones industrial average and S&P 500 tumbled for the third consecutive year, the longest downturn since 1939-41. Overseas, Japan's Nikkei 225 closed down 18.6 percent for the year; Britain's FTSE 100 was down 24.5 percent. Of course, the burst of the dot-com bubble, the uncertainty about a war in the Middle East, and a possible rise in oil prices may have all contributed to the stock price decline. However, it is only natural to suspect that "Enronitis? "opaque self-dealing by a few insiders" has contributed to the financial meltdown.

Insider trading—the buying and selling of stock by people who possess nonpublic information relevant for its price—is one of the primary indicators of self-dealing among an elite few within a corporation. Recent work by Julan Du of the Chinese University and Shang-Jin Wei has shown that insider trading can affect stock price volatility—and even more important, economic performance—around the world.

Stock markets are volatile. That is not news. But volatility varies significantly from one country to the next. Measured by the standard deviation of the monthly returns of a major market index, stock market volatility is almost twice as high in Italy as it is in the United States. Markets in developing countries are typically even more volatile. The Chinese market, for example, is three and a half times more volatile than the U.S. market; the Russian market, six and a half times more volatile.

Excessive volatility matters because it affects people's incentives to save and to invest. A certain degree of market volatility is unavoidable, even desirable. Ideally, changing stock prices signal changing values across economic activities and thereby improve the way resources are allocated. But volatility that is unrelated to market fundamentals results in confusing signals that hamper resource allocation. To the degree that insider trading affects the volatility of a country's stock market, it could also affect that country's economic performance.

Some think that because insider trading allows relevant information to be quickly reflected in the stock price, it should reduce market volatility and improve economic efficiency. However, this view fails to take into account the rational actions that a few insiders would take to maximize personal benefits. Access to inside information is most valuable when prices are either rising or falling dramatically, so people who are positioned to possess inside information love market volatility. They realize that the actual extent of volatility could be partly a consequence of their actions.

There are two channels through which insiders may generate increased volatility. First, they may choose riskier projects or riskier technology than they normally would. Second, insiders have an incentive to manipulate the timing and content of the information release in such a way as to increase the price volatility.

Laws and enforcement regarding insider trading differ widely around the world. The set of activities defined as illegal can vary, as can the diligence with which laws are enforced. In the United States, for example, insider trading is a criminal offense with penalties including jail terms. In Hong Kong, insider trading is considered a civil violation with a maximum penalty of a fine.

But Hong Kong compensates for that light penalty with tight antifraud regulation and rigorous and predictable law enforcement. Government regulators are well trained, professional, and relatively incorrupt. Corporate insiders in Hong Kong would think twice before releasing misleading information or committing financial fraud.

Because insider trading is an opaque practice, it is difficult to precisely measure and compare among countries. Consequently, few empirical studies have been done on the subject. But a recent survey conducted by Harvard University and the World Economic Forum for their annual Global Competitiveness Report (GCR) polled business executives in approximately 3000 firms in 53 countries and resulted in a new measure of the extent of insider trading. As mentioned, both the differences in the definition of insider trading along with the fact that it is illegal in many countries make it difficult to assess. However, business executives who are savvy about financial markets should have a sense of the extent of insider trading. Therefore, although the GCR insider trading index is derived from subjective responses, these responses should reflect the practices within firms as accurately as possible.

The executives were asked: "Do you agree that insider trading is not common in [your country's] domestic stock market?" The measure was adjusted by Du and Wei so that on a scale from 1 to 7, a higher number corresponds to more insider trading. The average of the answers for a particular country is used as a measure of that country's extent of insider trading. Using this formula empirically, insider trading is shown to correlate with higher market volatility (figure 1).

To illustrate this comparatively, we look at what would happen to the market volatility if the extent of insider trading rises from a relatively low level, such as the U.S. rating of 2.62, to that of China, with a relatively high rating of 4.62 (see table 1). The statistical analysis shows that this rise in insider trading would increase the volatility of stock returns by 2.5 percentage points (e.g., stock volatility will go up from 5 percent to 7.5 percent). This is a substantial increase, considering that the average volatility of the entire sample of 56 countries is 9.8 percent.

In contrast, using the difference in the volatility of GDP growth rate for the two countries yields an increase of only one percentage point. In other words, China's higher stock market volatility is explained more by excessive insider trading than by the volatility of its economic fundamentals.

Correlation does not necessarily imply causality, but the research by Du and Wei employs a statistical approach designed to address the issue. Using these additional statistical methods, their findings show that the positive correlation between insider trading and market volatility likely implies a causal relationship where an increase in insider trading leads to a rise in stock market volatility. Furthermore, insider trading is associated with a higher market volatility even after one takes into account the impact from the volatility of the real output growth, volatility of macropolicies, and market liquidity and maturity on stock market volatility. To sum up, an economy where insider trading is rampant is likely to have a very volatile stock market, resulting in less savings and lower investment than otherwise.

Opacity

Another symptom of "Enronitis" is a lack of transparency in corporate and government operation. The recent wave of corporate scandals in the United States has thrown open some corporate curtains to reveal practices that were routine but secret until now. Other countries, however, have even more serious deficiencies in transparency that exist not only in the private sector but in the government as well. These practices have caused countries like China, Russia, and Venezuela to lag behind the rest of the world in the financial realm, as research by Gaston Gelos of the International Monetary Fund (IMF) and Shang-Jin Wei demonstrates (see "Additional Reading," p. 5).

Policymakers often cite lack of transparency as one cause of the financial crises in emerging markets over the past decade. A recent IMF report, for example, noted that a "lack of transparency was a feature of the buildup to the Mexican crisis of 1994-95 and of the emerging market crises of 1997-98."

The report concluded that "inadequate economic data, hidden weaknesses in financial systems, and a lack of clarity about government policies and policy formulation contributed to a loss of confidence that ultimately threatened to undermine global stability."

The international financial institutions have actively promoted increased transparency among their member countries and are aiming for more transparency in their own operations. The emphasis on greater transparency presupposes that destabilizing behavior by individual investors can be avoided or attenuated by making better information available. For example, international investment funds may be more likely to engage in herding—that is, to make investment decisions only because other funds are making them—in less transparent countries. As a result, investors may rush in and out of those countries even in the absence of substantial news about fundamentals. Greater transparency could discourage such behavior.

The term transparency denotes both the availability and the quality of information measured at the country level. In government, transparency refers to the availability of macroeconomic data (both timeliness and frequency) as well as to the conduct of macroeconomic policies. Corporate transparency refers to the availability of financial and other business information about firms.

In principle, for investment across countries, just as for investment across corporations within a country, greater transparency levels the playing field for all investors and increases the confidence of the investors collectively, and as a result, can encourage investment. While this is intuitive, it has not been demonstrated rigorously.

Advances have been made by Gelos and Wei, whose research tests this theory empirically. Before it can be concluded that international mutual funds invest less in less transparent countries, there must be a benchmark on how much international funds would have invested in various countries if they had the same degree of transparency. A natural benchmark is the index produced by Morgan Stanley Capital International (MSCI), which essentially documents the weight of a country's stock market assets in the global market. Finance theory predicts that the allocation of investment across different countries should be proportional to the importance of these countries in the world stock market.

It is common for asset managers to report their positions relative to this index and for investment banks to issue recommendations relative to it (e.g., "over-weight Singapore" means "advisable to invest more than Singapore's weight in the MSCI Emerging Markets Free index").

Looking at the difference between the actual share in the world market portfolio and the MSCI weight for opaque and transparent countries, we see that the more transparent countries actually attract a greater amount of foreign investment than predicted by MSCI, whereas the more opaque countries obtain less than predicted (see figure 2).

In this research by Gelos and Wei, transparency is measured for both government and corporate operations, independently and collectively. The variables used are referred to as opacity measures, as a higher rating is associated with a lack of transparency. The research examines two aspects of government transparency: the transparency and predictability of a government's monetary and fiscal policies (Macro policy opacity) and the frequency and timeliness of the official release of the important macroeconomic data (Macro data opacity).

In addition, the lack of transparency at the corporate level is gauged from a survey of firms worldwide on executives' own perception of the degree of mandatory disclosure requirement (corporate opacity).

The statistical analysis suggests that a lack of transparency on all levels is associated with a lower share of emerging market funds. For example, a country like Venezuela would quadruple its portfolio holdings if it increased its transparency to Singapore's level (see opacity measures, table 2).

This increase in portfolio holdings should be an important incentive for countries to increase their transparency levels. In addition, greater transparency could moderate the herding tendency of outside investors, which might reduce the country's vulnerability to financial contagion and crisis.

At least since the 1997-98 Asian financial crisis, herding behavior by international investors has been said to have contributed to the market volatility in the developing countries. Although in economic theory the relationship between transparency and herding is not clear, our research uncovers some evidence of a positive association between a country's opacity and the tendency for international investors to herd when investing in its assets (see figure 3). Thus, if herding by international investors contributes to a higher volatility or more frequent financial crises in emerging markets, it is related to these countries' transparency features.

Beyond herding, another important question is whether capital flight during a time of currency and financial crisis is related to a lack of transparency. Do differences in transparency, above and beyond macroeconomic indicators of a country's economic health, explain why some countries suffer greater confidence loss than others during turbulent times? Our research suggests that more opaque countries do suffer larger outflows during crises. For example, during the Asian and Russian financial crises, we observed that capital exodus was greater in less transparent countries.

Wanted: Fair Play

It is not easy to restore confidence in financial markets where fraudulent and illegal practices within corporations have run rampant, and where government operation is not transparently accountable to its citizens. Greater transparency and investor confidence will not happen overnight. Even the United States, once the world's unquestioned leader in attracting international funds, cannot bounce back immediately. More than a year after the onset of the 2002 corporate scandals, Wall Street is still trying to regain the trust of its many disillusioned investors, both at home and abroad.

In the United States, efforts have been made by both the government and its citizens to restore the credibility of the market and assure the public that the nation is serious about eliminating foul play within corporations. Shortly after the Enron scandal became public, several initiatives were put forth to improve the monitoring practices within corporations. Congress passed legislation to eliminate corporate fraud by requiring more careful governmental supervision from both outside and within a corporation and strengthening requirements on what companies must disclose to investors. In addition, the Securities and Exchange Commission has been more diligent in its efforts by adopting new regulations, such as one outlining the standard of conduct that must be followed by all attorneys representing corporate clients.

Corporate governance reform has gained momentum in other countries as well. The 1997 economic crisis played a major role in prompting corporate governance reforms throughout Asia and Latin America.

Many countries within Latin America have been plagued by a lack of corporate and government transparency largely as a result of the prominence of family-owned companies and the extent of government intervention. But Chile, for example, has passed legislation that gives increased protection and rights to minority shareholders, which can serve as an example for other lawmakers in the region.

In Korea, a minority shareholders' movement that began in 1998 continues to raise awareness about the importance of corporate governance. The movement has also recently created a research center devoted to this topic in order to investigate the issue more thoroughly.

In China, instead of enacting immediate reforms at the national level, the government has set up a special governance zone (SGZ) in Shenzhen to experiment with anti-corruption reforms. A successful reform program there can serve as a model for the rest of the country.

But the significance of the experiment goes beyond that. Anti-reform bureaucrats often resist international best practices by claiming differences in culture, history, or tradition. Once anti-corruption reform succeeds in one SGZ, it will leave officials resistant to reform with one less excuse. It will also help galvanize popular demand for country-wide reforms.

Along with these individual country efforts, the IMF, the World Bank, and other international institutions have become more aggressive in assessing the adequacy of the existing standards and codes of financial supervision as well as the conduct of fiscal and monetary policies in their member countries. They have also become more persistent in advocating the international best practices in these areas.

None of the reforms can so far claim complete success; perhaps they never will. But the revelation of corporate scandals and the financial crises in the developing countries have persuaded many people around the world that "Enronitis," in its various guises, can seriously damage people's confidence in a financial system and retard economic development. An invigorated, worldwide reform effort, which is already under way, will reduce the chance of future economic devastation that could result from poor public and corporate governance.

Downloads

• Download

      

 

 

A Summary of Remarks

Shang-Jin Wei, Advisor at the IMF and Senior Fellow at the Brookings Institution, began his presentation by noting that eliminating corruption in developing countries is becoming increasingly important due to the rise of globalization. He then focussed on two questions of particular interest to both academics and policy makers. First, how can we quantify how corrupt particular countries are? And second, can corruption be good for economic development? Dr. Wei described several indices of corruption that are useful in cross-country comparisons while arguing that the answer to the second question is "no." It is possible, he said, to find examples of places that have done well in spite of corruption, but hard to think of anywhere that has done well because of it!

Much more attention is now being paid to the problem of corruption than was the case in the past. In fact, until recently, only the US had a law (the Foreign Corrupt Practices Act of 1977) prohibiting companies from bribing foreign officials. So, for example, a German multinational could legally pay bribes and even get a tax deduction for these amounts (as long as it got a receipt)! This state of affairs only ended in 1999, when the OECD countries (as well as some non-OECD countries that participated voluntarily) signed a treaty banning bribery.

There are two main reasons for the new focus on corruption. With the end of the cold war, it has become less necessary to tolerate "governance challenged" regimes like those of Marcos and Mobutu. At the same time, increased economic interdependence means that a given level of corruption has become much more costly. It has been estimated that moving from a relatively "clean" government like that of Singapore to one as corrupt as Mexico's would have the same effect on foreign direct investment as an increase in the marginal corporate tax rate of 50%. This means that corrupt countries are also more vulnerable to financial crises because they are forced to rely on short-term offshore loans, which flow out much faster then FDI following a shock. Not surprisingly, portfolio investment is also adversely affected by corruption--a study (by two IMF staff members) of six hundred global and emerging market mutual funds found that fund managers tend to overweight less corrupt countries (relative to the Morgan Stanley Capital International indices).

Downloads

• Download

      

 

 

At the beginning of 2002, Enron was the seventh largest company in the United States, with operations extending worldwide. Telecommunications giant Global Crossing operated in 27 countries and 200 cities on five continents. But both fell last year under the weight of financial problems created by the self-dealing of a few corporate insiders and masked by nontransparent accounting. These and other similar corporate failures deprived millions of company employees and shareholders of their lifetime savings and retirement benefits. Stock prices of other U.S. companies also took a beating, partly in response to the revelation of these scandals.

Since January 2002, all major U.S. stock indexes have plummeted. NASDAQ fell almost a third in 2002, and the Dow and S&P 500 tumbled for the third consecutive year, the longest downturn since 1939-41. Foreign markets have also been hit with big losses. Japan's Nikkei 225 closed down 18.6 percent for the year; Britain's FTSE 100, down 24.5 percent.

Of course, the burst of the dot-com bubble, the uncertainty about a war in the Middle East, and a possible rise in oil prices may all have contributed to the stock price decline. It is only natural, however, to suspect that "Enronitis"—opaque self-dealing by a few insiders—has also contributed to this meltdown of the financial markets around the world. In this article, we provide some evidence to substantiate the suspicion.

Roller Coaster Rides

Enronitis has many symptoms. Here we discuss two. One is insider trading—the buying and selling of stock by people who possess nonpublic information relevant to its price. As recent work by Julan Du of the Chinese University and one of the authors (Wei) has shown, insider trading can affect stock prices—and even more important, economic performance—around the world.

Stock markets are volatile. That is not news. But volatility varies greatly from one country to the next. Measured by the standard deviation of the monthly returns of a major market index, stock market volatility is almost twice as high in Italy as it is in the United States. Markets in developing countries are typically even more volatile. The Chinese market is three and a half times more volatile than the U.S. market; the Russian market, six and a half times more volatile.

Excessive volatility matters because it affects people's incentive to save and to invest. In almost any economic model with a representative investor, the more volatile the asset market, holding the average return constant, the less the investor will save and hence invest. A certain degree of market volatility is unavoidable, even desirable. Ideally, changing stock prices signal changing values across economic activities and thereby improve the way resources are allocated. But volatility that is unrelated to market fundamentals results in confusing signals that hamper resource allocation. To the degree that insider trading affects the volatility of a country's stock market, it could thus also affect that country's economic performance.

Some analysts think that because insider trading allows relevant information to be reflected in the stock price faster than it otherwise would be, it should reduce market volatility and improve economic efficiency. That view, however, fails to take into account the ability of insiders to take actions to maximize personal benefits. Access to inside information is most valuable when prices are either rising or falling dramatically. So people in the position to possess inside information love market volatility, and they realize that their actions can increase volatility—through two channels. First, if insiders have a choice of projects or technologies, they may choose the riskier ones. Second, even holding the risk of the technology or project constant, insiders have an incentive to manipulate the timing and content of the information release in a way to maximize volatility.

National laws and enforcement regarding insider trading differ widely around the world. The set of activities defined as illegal can vary, as can the penalties and the diligence with which laws are enforced and lawbreaking punished. In the United States, for example, insider trading is a criminal offense with penalties including jail terms. In Hong Kong insider trading is a civil violation whose maximum penalty is a fine. But Hong Kong compensates for that light penalty with tight antifraud regulation and relatively rigorous and predictable law enforcement. Government regulators are well trained, professional, and relatively incorrupt. Despite the light penalty, corporate insiders in Hong Kong would think twice before releasing misleading information or committing financial fraud.

As insider trading is an opaque practice, difficult to measure and compare across countries in a precise way, few economists have studied it empirically. Recently, a new measure of insider trading was established in a survey of business executives by Harvard University and the World Economic Forum. Using this measure, Du and Wei have shown that more insider trading is related to a higher market volatility. Statistical analysis of the data in table 1 reveals that a rise in insider trading from a relatively low level, such as that in the United States (2.62 on a scale from 1 to 7), to a relatively high level, such as that in China (4.62), would increase the volatility of stock returns by 2.5 percentage points (that is, stock volatility would go up from 4 percent to 6.5 percent)—a sizable increase. In comparison, the difference in the volatility of GDP growth rates for the United States and China increases Chinese stock volatility by only 1 percentage point. In other words, China's higher stock market volatility is explained more by excessive insider trading than by the higher volatility of its economic fundamentals.

Correlation, of course, does not necessarily imply causality. But further statistical analysis by Du and Wei shows that the link between insider trading and market volatility most likely is causal—that is, an increase in insider trading leads to a rise in stock market volatility. And insider trading is associated with a higher market volatility even after other possible causes of market volatility—the volatility of the real output growth, volatility of monetary and fiscal policies, and maturity of the stock market—are taken into account.

The clear lesson here is that to rebuild confidence in their financial markets—and to encourage saving and investment by their citizens—countries with a high degree of insider trading must strengthen their regulation of insider trading and enforce existing regulations more rigorously.

Lack of Transparency

Another symptom of Enronitis is a lack of transparency in corporate and government operations. The recent wave of corporate scandals in the United States has thrown open some corporate curtains to reveal numerous once-secret activities. But many countries the world over have even more serious deficiencies in transparency—not only in their corporations but in their governments—that have retarded their ability to attract international portfolio investment, as research by Gaston Gelos of the International Monetary Fund and one of us (Wei) has shown.

In fact, policymakers often cite lack of transparency as one cause of the financial crises in emerging markets in Asia and Latin America over the past decade. A recent IMF report, for example, noted that a "lack of transparency was a feature of the buildup to the Mexican crisis of 1994-95 and of the emerging market crises of 1997-98." The report concluded that "inadequate economic data, hidden weaknesses in financial systems, and a lack of clarity about government policies and policy formulation contributed to a loss of confidence that ultimately threatened to undermine global stability." The international financial institutions have actively promoted more transparency among their member countries and are also aiming for more transparency in their own operations.

We use the term "transparency" to denote both availability and quality of information at the country level. In government, transparency refers not only to the availability (both timeliness and frequency) of macroeconomic data but also to the conduct of macroeconomic policies. Corporate transparency refers to the availability of financial and other business information about firms.

In principle, for investment across countries, just as for investment across corporations within a country, greater transparency levels the playing field for all investors, increasing their collective confidence and thus encouraging investment. Most technical studies, however, have not demonstrated rigorously this intuitive insight.

To be able to say whether international mutual funds invest less in less transparent countries, one needs to know how much these funds would have invested in various countries had all the countries been the same on the transparency dimension. A useful benchmark is the index produced by Morgan Stanley Capital International, which essentially documents the share of a country's stock market assets in the world stock market.

Table 2 shows measures of opacity—the opposite of transparency—for both government and corporate operations for 15 emerging market countries. (A higher rating is associated with more opacity.) Statistical analysis of the data in the table suggests that a lack of transparency, using any measure, is associated with less investment by international mutual funds. A country like Venezuela, for example, would quadruple its portfolio holdings if it increased its transparency to Singapore's level. The prospect of such an increase in portfolio holdings should strongly encourage countries to undertake reform to improve transparency.

Aside from the level of investment, trading patterns by foreign investors would affect the volatility of the market. At least since the Asian financial crisis, analysts have seen "herding"—international investors' tendency to mimic each other's behavior, sometimes ignoring useful information—as one contributor to market volatility in developing countries. Although in economic theory the relationship between transparency and herding is not clear-cut, our research has uncovered evidence of a positive association between a country's lack of transparency and international investors' tendency to herd when investing in its assets. Thus, if herding by international investors raises volatility or causes more frequent financial crises in emerging markets, it is related to these countries' transparency features.

Another key question is whether capital flight during a time of currency and financial crisis is related to lack of transparency. Do differences in transparency, above and beyond macroeconomic indicators of a country's economic health, explain why some countries suffer greater confidence loss than others during turbulent times?

The Gelos-Wei research suggests that more opaque countries do suffer larger outflows during crises. During the Asian and Russian crises, capital exodus was greater in less transparent countries. So, in a concrete sense, lack of transparency worsens the crises in some countries.

Wanted: Fair Play

It is not easy to restore confidence in financial markets where fraudulent and illegal practices within corporations have run rampant and where a government's operations are not transparently accountable to its citizens. And it will not happen overnight. Even the United States, once the world's unquestioned leader in attracting international funds, cannot bounce back immediately. More than a year after the onset of the 2002 corporate scandals Wall Street is still trying to regain its preeminence in the financial world—and to regain the trust of its many disillusioned investors, both at home and abroad.

In the United States, both individuals and the government have made efforts to restore the credibility of the market and assure the public that the nation is serious about eliminating foul play within corporations. Shortly after the Enron scandal became public, policymakers proposed many initiatives to improve monitoring practices within corporations. Congress has passed legislation designed to eliminate fraudulent behavior in corporations through more careful supervision and the release of greater information to investors. The Securities and Exchange Commission has renewed its efforts to reform existing regulations and create new ones.

The United States is not alone in sensing the need for corporate governance reform. The financial crises of the 1990s spurred such reforms throughout Asia and Latin America. Corporate and government opacity is a major issue in many countries in Latin America, largely owing to the prominence of family-owned companies and the extent of government intervention. Legislation that was passed recently in Chile to increase protection and give more rights to minority shareholders can serve as an example for other countries in the region.

In Asia, a minority shareholders' movement launched in Korea in 1998 has raised awareness of the importance of corporate governance. The shareholders' movement has also created a research center to investigate corporate misbehavior.

China's government has resisted making immediate national reforms, preferring instead to set up a special governance zone (SGZ) in Shenzhen to experiment with anticorruption reforms. A successful reform program in Shenzhen can serve as a model for the rest of the country, but the significance of the experiment goes beyond that. Antireform bureaucrats in China often resist international best practices by claiming to have "a different culture," "a different history," or "a different tradition." Once anticorruption reform succeeds in one SGZ, reform-resistant officials will have fewer excuses for refusing to push for reform. Successful anticorruption reform will also help galvanize popular demand for larger-scale administrative reform in China.

Alongside these individual country efforts, the International Monetary Fund, the World Bank, and other international institutions have become more aggressive in assessing the adequacy of existing standards and codes of financial supervision and the conduct of fiscal and monetary policies in their member countries. They have also become more insistent in advocating the international best practices in these areas.

None of the reforms so far can claim complete success; perhaps they never will. But the revelations of corporate scandal in the United States and the financial crises in the developing countries have persuaded many people around the world that Enronitis, in its various guises, can seriously damage people's confidence in a financial system and slow economic development. If one positive thing has come out of the Enronitis epidemic, it is the reinvigorated reform effort worldwide to reduce the chance of a future economic devastation resulting from poor public and corporate governance.

      

 

 

The effect of openness on income inequality sometimes arouses emotion and blood pressure as well as academic curiosity. There exists an active empirical literature on economic growth and income inequality, and a related and equally active literature on openness and economic growth. Most of the papers in these two literatures employ cross-country regressions. Prominent examples include Forbes (2000), Dollar and Kraay (2001a and 2001b), Edwards (1992, 1998), Sachs and Warner (1995), Frankel and Romer (1999), Rodriguez and Rodrik (2000) and other papers cited therein. Useful insights have been gained from this literature.

However, analyses based on cross-country regressions have been criticized on two grounds. The first type of problems has to do with data comparability across countries. This issue is particularly acute for data on income inequality: the definitions and data collection methods can be different across countries. As an illustration, for OECD countries, Atkinson and Brandolini (2001) noted the pitfalls in making cross-country comparisons based on pooled data. For a few countries where multiple measures of income distribution are available (households versus individuals, income versus consumption, etc.), the different measures can give different, sometimes contradictory, patterns even for the same time periods. Since the data that crosscountry regressions have to rely on come from potentially different methodologies, they can produce misleading results when pooled together. Atkinson and Brandolini noted further that ?in cross-country analysis, use of a dummy variable adjustment for data differences is not appropriate.? Atkinson and Brandolini?s specific criticism is on pooling data across OECD countries. It is reasonable to assume that the data quality for developing countries is generally inferior to the OECD countries. Therefore, running cross-country regressions involving data from developing countries can only make the quality of inference worse.

Aside from the Atkinson-Brandolini criticism just mentioned, we should note another potential source of data incomparability. The validity of comparing living standards across countries depends on the validity of the so-called purchasing-power-parity adjustment, which in turn depends on the assumption that a common ?representative consumption basket? can be meaningfully constructed for all countries. The last assumption cannot always be taken for granted.

The second difficulty with cross-country studies has to do with the fact that differences in cultures, legal systems, or other institutions other than openness may also be relevant for the outcome variable under study (e.g., economic growth or income inequality). These factors are difficult to be quantified and therefore to be controlled for in cross-country regressions. Inclusion of fixed effects in panel regressions helps. However, the myriad of country-specific institutions may also interact with the key regressor under investigation (e.g., openness) to affect the outcome variable (e.g., income inequality). For example, in response to a terms-of-trade shock, some countries would let the poor to fend for themselves, while others would have a social safety net to moderate the negative impact on the poor but the exact size of the income transfer may not be proportional to the size of the shock depending both on the nature of the social safety net and on the size of the shock. In this case, the usual fixed effects are not sufficient to control for the influence of the country-specific institutions.

In an influential paper, T.N. Srinivasan and Jagdish Bhagwati (1999) asserted that crosscountry regressions are deficient and cannot be relied upon to understand the impact of globalization on economic growth and presumably nor on income inequality (see the quote at the beginning of the paper). One may not agree completely with the strong assertion by Srinivasan and Bhagwati (1999). Nonetheless, given these criticisms, a careful study of cross-regional experience within a single country can, at a minimum, provide a useful complement to the literature based on cross-country regressions. Within a given country and over a relatively short time period, culture, legal system or other institutions can more plausibly be held constant. So the researchers? ability to isolate the effect of openness is enhanced. Furthermore, the comparability of data definition and collection method is, in principle, also higher within a single country than across multiple countries.

This paper presents a case study of the impact of globalization on income disparity by pooling two unique data sets on Chinese regions. There are five reasons that make China a good case study. Some of them have to do with the fact that China is an important country per se. But, perhaps more importantly, other factors (or peculiar features of China) provide a methodological advantage relative to typical cross-country studies.

Downloads

• Download

     

 

 

In policy circles, lack of transparency has frequently been blamed for the recent financial crises in emerging markets. For example, the IMF (2001) notes that a "lack of transparency was a feature of the buildup to the Mexican crisis of 1994-95 and of the emerging market crises of 1997-98," stating that "inadequate economic data, hidden weaknesses in financial systems, and a lack of clarity about government policies and policy formulation contributed to a loss of confidence that ultimately threatened to undermine global stability." Consequently, the international financial institutions have actively promoted more transparency among their member countries as well as made strides to become more transparent in their own operations.

The strive for more transparency presupposes that destabilizing behavior by individual investors can be avoided or attenuated by improved provision of information. For example, international investment funds may be more likely to engage in herding in less transparent countries (where herding is defined as funds taking investment decisions which they would not take if they did not observe other funds taking them). As a result, investors may rush in and out of countries even in the absence of substantial news about fundamentals.

As far as we know, there has been no systematic examination on the relationship between transparency, especially the transparency of government policies, on the pattern of international investment. The objective of this paper is to provide an evaluation of this relationship. Specifically, we will first document whether transparency of a country has any effect on the level of international investment. We will then examine whether transparency affects the herding tendency of international investment funds.

Transparency could affect the level of international portfolio investment. In the corporate finance context, Diamond and Verrechia (1991), among others, have argued that a reduction in informational asymmetry can increase the investment from large investors and hence reduce the cost of capital for the firm (see Healy and Palepu, 2001, and Core, 2001, for reviews of the empirical literature on corporate disclosure). So far, there is no theoretical paper that has modeled explicitly the effect of a country's transparency on the level of international portfolio investment. However, it seems reasonable to extrapolate from the corporate finance literature that an improvement in a country's transparency can be expected to lead to an increase in the level of investment by international mutual funds.

In terms of the effect of transparency on herding behavior, the relationship in theory is more complex. On the one hand, one set of theoretical explanations of herding behavior relies on asymmetric information (e.g., Bikhchandani et al., 1992; Banerjee, 1992; Devenow and Welch, 1996; Bikhchandani and Sharma, 2000). We would note that there is a natural linkage between low transparency and asymmetry of information. Low transparency typically does not mean that no one knows anything. Rather, lower transparency means that less information is made publicly available, which in turn implies that the gap between those who know and those who do not becomes larger. Such higher informational asymmetry should therefore result in more herding.

On the other hand, herding by institutional investors can be rationalized without an appeal to informational asymmetry at all, but instead by the incentives faced by fund managers that result from the need to have their performances compared periodically with a common benchmark (Scharfstein and Stein, 1990; and Chevalier and Ellison, 1999). In this case, an improvement in a country's transparency would not imply a reduction in international investors' herding behavior.

Related to this discussion, the theoretical link between availability of information and market volatility is ambiguous, as pointed out, among others, by Furman and Stiglitz (1998). While their argument is not specifically about herding behavior, it is about investors' trading behavior in different information environments. In particular, they suggest that if more transparency means a higher frequency of information release (holding the true value of the fundamental constant), price volatility could increase rather than decline. The notion that transparency may not necessarily reduce volatility is reflected in the recent literature on corporate transparency. In particular, Bushee and Noe (2000) report a positive association between corporate transparency and the volatility of the firm's stock price. Firms with higher levels of disclosure tend to attract certain types of institutional investors which use aggressive, short-term trading strategies which in turn can raise the volatility of the firm's stock price. It is not clear whether this investor self-selection story can be generalized to international context. Ultimately, the effect of transparency on the behavior of international investors is an empirical question.

International evidence on this question, however, is still lacking. To be sure, there are several empirical studies that measure the degree of herding among funds, including Lakonishok, Shleifer and Vishny (1992), Grinblatt, Titman and Wermers (1995), and Wermers (1999) for the U.S., Choe, Kho and Stulz (1999) and Kim and Wei (2002) for Korea, and Borensztein and Gelos (forthcoming) for emerging markets worldwide. However, as far as we know, there is no paper that studies the connection between a country's level of transparency and the degree of herding by international investors.

We aim to accomplish two main objectives in this paper. First, we investigate the effect of transparency in developing countries on the level of investment by international institutional investors. Second, we examine the effect of transparency on the degree of herding among funds (as well as related issues). Apart from the novelty of the questions examined, two important features of the paper are the construction of transparency measures and the use of a unique micro investment data set containing the country allocation of over 300 emerging market funds at a monthly frequency over 1996-2000. The investment information at the individual fund level allows us to measure herding behavior, which is not possible with aggregate data.

We distinguish between government and corporate transparency. Within the category of government transparency, we further differentiate between macroeconomic data availability (timeliness and frequency) and transparency in the conduct of macroeconomic policies. Corporate transparency refers to availability of financial and other business information about firms in a country on average. It turns out that each measure contains information not captured by the other ones. For example, the correlation between corporate transparency and government data transparency is 0.02, and the correlation between corporate and government macropolicy transparency is 0.54.

The main findings of the paper can be summarized here. First, there is relatively clear evidence that low transparency—or high opacity—tends to depress the level of international investment. Government opacity and corporate opacity have separate, depressing effects on investment. Second, there is a moderate amount of evidence that low transparency in a developing country leads to an increase in the herding behavior by international investors. Thus, if herding by international investors contributes to a higher volatility or more frequent financial crises in emerging markets, it is not unrelated to the transparency features of the countries. Third, funds seem to react less strongly to news about country fundamentals in less transparent countries. Fourth, there is some evidence that during crises, funds flee non-transparent countries and invest in more transparent ones.

Downloads

• Download

     

 

 

Most developing countries and former centrally planned economies are eager to attract foreign direct investment (FDI). Hence, understanding the determinants of FDI is important in practice as well as in theory. Moreover, for many countries, a primary benefit of FDI is the inflow of technological knowhow of the foreign investor. As the technological content of a given FDI is closely related to the ownership mode of the investor (e.g., joint venture vs. sole ownership), it is also useful to understand the determinants of the ownership mode. In this paper, we study a particular determinant of FDI, namely host country corruption, that has received relatively less attention in the literature on FDI but is crucial in practice. While it is difficult to quantify precisely, casual empiricism would suggest that the cross-country variation in corruption level is probably as large as the variations in corporate tax rate or labor cost, two commonly emphasized determinants of FDI.

The issue of corruption has become a prominent item on the agenda of international institutions and national governments. The OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions, which was signed in 1997 and went into effect in February 1999, criminalizes bribery of foreign officials by firms from member countries. Yet indices produced by organizations such as Transparency International suggest that corruption is still a widely spread phenomenon. In this paper, we examine the consequences of corruption on cross-border direct investment. More specifically, we look into two separate effects of corruption simultaneously: a possible reduction in the volume of foreign investment and a possible shift in the ownership structure.

The literature on FDI is too vast to be comprehensively referenced here (see Caves, 1982, Froot, 1993, Balasubramanyam et al. 1996). A subset of the literature uses firm-level data to examine the choice of entry mode (for example, Kogut and Singh, 1988; Blomström and Zejan, 1991; Asiedu and Esfahani, 1998; Smarzynska, 2000). A few papers have investigated the impact of corruption on FDI. This is a relatively new area of interest, with principal contributions from Hines (1995), Henisz (2000) and Wei (2000a and b). Hines (1995) was the first paper that reported a negative effect of corruption on foreign investment. His sample was, however, restricted to U.S. multinational firms. As Hines (1995) pointed out, because U.S. had been until recently the only major source country criminalizing bribery to foreign government officials, the effect of corruption on U.S. multinational firms may not be representative of the effect on the universe of foreign investors. Henisz (2000) was the first to study both the FDI market entry and ownership mode (e.g., joint venture vs. wholly owned firms). His sample was also restricted to U.S. multinational firms, and hence could also be non-representative of the universe of multinational firms. Furthermore, Henisz examined market entry and ownership mode separately rather than simultaneously. These two decisions could potentially be inter-related. In terms of statistical results, the estimated coefficients on corruption in Henisz?s paper were mostly not significantly different from zero or with a paradoxical sign in the sense that higher corruption appeared to be associated with more FDI. Wei (2000a and b) used a data set on FDI that went beyond U.S. multinationals, but the data were aggregated at a bilateral national level rather than at a firm level. As a consequence, it could not study ownership mode and entry decisions of the multinational firms.

We believe that it is time to revisit this important question by putting various ingredients together. We use a unique firm-level data set encompassing multinational firms from both the U.S. and other countries, which will allow us to examine whether host country corruption discourages investment by foreign firms for reasons beyond investors? fear of legal penalty in the home country. In fact, we will check explicitly whether U.S. investment behaved systematically differently from firms from other source countries. In this regard, the paper will examine issues that could not be examined in Hines (1995) and Henisz (2000).

Downloads

• Download

     

 

 

Recent studies of the effect of currency arrangements on goods market integration (starting with Rose, 2000) employ a methodology based on volumes of trade. However, the connection between market integration and trade flows can be loose. In this paper, we adopt a different methodology that uses a 3-dimensional panel of prices of 95 very disaggregated goods (e.g., light bulbs) in 83 cities around the world from 1990 to 2000. We find that the impact of an institutionalized stabilization of the exchange rate, i.e., a currency board or a currency union, generally provides a stimulus to goods market integration that goes far beyond reducing exchange rate volatility to zero. However, there are important exceptions. Among the institutional arrangements, long-term currency unions demonstrate greater integration than more recent currency boards. All of them can improve their integration further relative to a U.S. benchmark.

The consequences of exchange rate volatility, and more generally, currency arrangements, are at the heart of open economy macroeconomics; yet professional opinion on their impact on goods market integration is divided. Witness the debate (and accompanying fanfare) surrounding the launching of the single European currency. Prominent among the skeptics, Feldstein (1997) argued that the euro would impose large costs upon its member countries without providing substantial economic benefits. This conclusion is based partly on his reading of the empirical literature up to 1997 that generally reported a small effect of exchange rate stabilization on trade volumes.

In contrast, a recent influential paper by Rose (2000), argues that adopting a common currency provides a substantial expansion of the volume of trade; an effect that goes beyond the impact of reducing exchange rate volatility to zero. Indeed, Rose estimates that the presence of a common currency increases bilateral trade among members by as much as 300% over what would be expected between otherwise identical countries. Frankel and Rose (2002), Engel and Rose (2001), Glick and Rose (2002), and Rose and van Wincoop (2001) have provided further extensions and support to this claim. Building on results in Frankel and Romer (1999), Frankel and Rose (2002) have gone on to argue that having a common currency provides a substantial boost to the member countries' output growth. For example, they estimate that dollarization would raise an average country's income by 4 percent over twenty years. On the other hand, this line of research has also attracted criticism. Persson (2001) and Tenreyro (2002) have suggested that the trade promotion effect of a common currency is greatly exaggerated due to the possibility of endogeneity of existing common currency areas, and Klein (2002) has argued that the basic results in Rose (2000) are not robust when the sample is restricted to certain sub-samples.

Downloads

• Download

     

 

 

Abstract

This paper studies the role of insider trading in explaining cross-country differences in stock market volatility. It introduces a new measure of insider trading for 50 or so countries. The central finding is that countries with more prevalent insider trading do have more volatile stock markets, even after one controls for liquidity/maturity of the market, and the volatility of the underlying fundamentals (volatility of real output and monetary and fiscal policies). Moreover, the effect of insider trading is quantitatively significant when compared with the effect of economic fundamentals.

Downloads

• Download

     

 

 

Abstract

Using a unique data set, we study the trading behavior of foreign portfolio investors in Korea before and during the currency crisis. The central message is that investors in different categories have different trading patterns. For example, foreign investors outside Korea are more likely to engage in positive feedback trading strategies and are more likely to engage in herding than the branches/subsidiaries of foreign institutions in Korea or foreign individuals living in Korea. This difference in trading behavior is possibly related to the difference in their information. This paper suggests that it may be worth exploring policies that can encourage foreign investors to acquire more information (e.g. by setting up a branch or a subsidiary in the emerging country).

JEL Codes: F21; F3; G15

Single copies of the article can be downloaded and printed for the reader's personal research and study. Reprinted from the Journal of International Economics, vol.56, no.1, Woochan Kim and Shang-Jin Wei, "Foreign Portfolio Investors Before and During a Crisis," Pages 77-96, Copyright (2002), with permission from Elsevier Science.

Downloads

• Download

     

 

 

Abstract

This paper examines the evidence for nonlinear price behavior in retail goods prices across U.S. cities. First, a simple continuous-time model is used to explore the types of price behavior that can arise in the presence of market frictions. These frictions could be interpreted as transport costs, but we prefer a broader interpretation in which they operate at the level of technology and preferences. Second, we gather price data from 24 U.S. cities on individual goods like orange juice and toothpaste. The empirical analysis reveals that price discrepancies between U.S. cities are stationary and nonlinearly mean-reverting to price parity.

JEL Codes: F31; C32

Single copies of the article can be downloaded and printed for the reader's personal research and study. Reprinted from the Journal of International Economics, vol.56, no.1, Paul G. J. O'Connell and Shang-Jin Wei, "'The Bigger They Are, the Harder They Fall': Retail Price Differences Across U.S. Cities," Pages 21-53, Copyright (2002), with permission from Elsevier Science.

Downloads

• Download

     

 

 

Abstract

The level of corruption varies widely across countries. This paper examines the consequence of corruption for the design of monetary policy. We employ an extended Barro-Gordon framework a la Alesina and Tabellini (1987) and model corruption as a leakage of tax revenue. There are several important implications from the model. First, the optimal inflation targeting for a high-corruption country is generally different from that for a low-corruption country. A mechanical inflation target (i.e., the 1-3% range typically advocated to most countries in the world) could reduce social welfare. Second, corruption can be viewed as one source of lack of commitment. Fixed exchange rates or currency boards are more difficult to sustain for high-corruption countries as the inflation rate (in the anchor country) may be too low from the viewpoint of the countries that adopt the exchange rate arrangements. Third, while inflation rate generally rises with the level of corruption under a commitment regime, it may fall or rise with corruption under a discretionary regime, depending on the initial level of corruption. Despite of this, a commitment regime generally generates a higher level of welfare than an ordinary discretionary regime. Fourth, a Rogoff-style conservative central banker can outperform a fixed exchange rate regime, a mechanical inflation target, currency board or dollarization. However, the optimal degree of conservatism is an inverse function of the corruption level. In the extreme case in which corruption is so severe that the tax system breaks down completely, the optimal degree of conservatism is zero.

Downloads

• Download

     

 

 

Abstract
In this paper, we provide a case study of the impact of globalization on income inequality using data across Chinese regions. The literature on cross-country studies has been criticized because differences in legal systems and other institutions across countries are difficult to control for, and the inequality data across countries may not be compatible. An in-depth case study of a particular country's experience can provide a useful complement to cross-country regressions. We construct a measure of urban-rural income ratio for a hundred or so Chinese cities (urban areas and adjacent rural counties) over the period 1988-1993. The central finding is that cities that experience a greater degree of openness in trade also tend to demonstrate a greater decline in urban-rural income inequality. Thus, globalization has helped to reduce, rather than increase, the urban-rural income inequality. This pattern in the data suggests that inferences based solely on China's national aggregate figures (overall openness and overall inequality) can be misleading. The negative association between openness and inequality holds up when we apply a geography-based instrumental variable approach to correct for possible endogeneity of a region's trade openness.

JEL Codes: F1 and O1

Downloads

• Download

     

 

 

Abstract

This paper exploits a three-dimensional panel data set of prices on 27 traded goods, over 88 quarters, across 96 cities in the US and Japan. We show that a simple average of good-level real exchange rates tracks the nominal exchange rate well, suggesting strong evidence of sticky prices. Focusing on dispersion in prices between city-pairs, we find that crossing the US-Japan "Border" is equivalent to adding as much as 43,000 trillion miles to the cross-country volatility of relative prices. We turn next to economic explanations for this so-called border effect and to its dynamics. Distance, unit-shipping costs, and exchange rate variability, collectively explain a substantial portion of the observed international market segmentation. Relative wage variability, on the other hand, has little independent impact on segmentation.

JEL classification : F30; F40; F15


Single copies of the article can be downloaded and printed for the reader's personal research and study. Reprinted from the Journal of International Economics, vol.55, no.1, David C. Parsley and Shang-Jin Wei, "Explaining the Border Effect: the Role of Exchange Rate," Pages 87-105, Copyright (2001), with permission from Elsevier Science.

Downloads

• Download