Three Essays on Financial Liberalization, Country Risk and Low Growth Traps in Argentina, Mexico and Turkey

The three essays analyze the effects of uncontrolled domestic and external financial liberalization on country risk, private investment and political instability in Argentina, Mexico and Turkey. The first essay explores the dynamic relationship among country risk, short and long term international capital flows, domestic investment and growth by suggesting that the relationship between external capital flows and country risk is not a linear one where one exogenously determines the other. The empirical results by employing a simultaneous-equation approach using annual and quarterly data provide support for self-fulfilling prophecy arguments by uncovering an endogenous relationship between country risk and short-term capital inflows such that they generate a self-reinforcing equilibria depending on the direction of change in either of them. The results also provide some support for the firesale FDI argument. The second essay, by employing micro level company panel data, analyzes the impacts of domestic and external financial liberalization on real investment behavior of private sector firms under capital market imperfections, volatile macro-prices and changing country risk levels. The empirical results confirm that under increasing risk and uncertainty combined with credit bottlenecks and/or profitability squeeze the real sector firms choose to invest not on fixed assets but on financial assets. Availability of higher rates of return in the financial markets further encourages this type of investment behavior. In addition, availability of internal funds is found to be a necessary but not sufficient condition for financing real investment projects even in the presence of capital market imperfections. Depending on the opportunity cost of fixed investments, profits from financial assets may as well be used for financing new financial investments. The third essay examines the effects of short-term capital inflows by exploring the relationship between their volatility and socio-political instability. The empirical analysis by employing a simultaneous-equation approach and Granger causality tests uncovers the presence of a dynamic and contemporaneous relationship between the volatility of short-term capital inflows and socio-political risk.