Reputational Constraints on Capital Account Policy in Emerging Markets

• In Event: The Political Economy of Finance in Developing Countries

Abstract

When do international reputational concerns constrain governments’ economic policy choices? We assess this question by analyzing decisions to tighten restrictions on capital outflows among a group of emerging markets. While policymakers should be more likely to tighten restrictions to protect their economies as capital flow volatility (CFV) increases, financial markets also view outflow controls with derision as they violate norms of capital freedom and property rights protection. We argue that the effect of CFV on outflow controls should be contingent on the use of capital controls in peer markets. When market peers are open, governments should anticipate that the use of outflow controls will come at high cost to their market reputations as norm violators stand out from a crowd of liberal substitutes. Conversely, when peer markets are closed and noncompliant with market norms, the use of outflow controls should be far less costly to an economy’s reputation. Focusing on 25 emerging markets from 1995 to 2015, we show that CFV is associated with outflow controls, but only when market peers are already closed. Our results suggest that reputational concerns and attendant fears of market punishment constrain economic policy choices.

Authors

• Steven Liao, University of California, Riverside

• Daniel McDowell, Syracuse University