ESSAYS ON CAPITAL FLOWS IN DEVELOPING COUNTRIES

Abstract

In the first chapter, I develop a quantitative small-open-economy model to assess the optimal pace of foreign reserve accumulation by developing countries. The model features endogenous growth with foreign direct investment (FDI) entry and sudden stops of capital

inflows to incorporate benefits of reserve accumulation. Reserve accumulation depreciates the real exchange rate and attracts FDI, which endogenously promotes productivity growth. When a sudden stop happens, the government uses accumulated reserve to prevent a severe economic downturn. The calibrated model shows that two factors are the key determinants of the optimal pace of reserve accumulation: the elasticity of the foreign borrowing spread with respect to debt, and the entry cost for FDI. The model suggests that these two factors can explain a substantial amount of the cross-country variation in the observed pace of reserve accumulation.

The second chapter is a joint work with Felipe Saffie. In this chapter, we develop a small-open-economy model with endogenous firm and trade dynamics. Aggregate productivity of the economy increases through new firm entry and incumbent firms' innovation. Firms invest in two types of innovation: innovation to acquire new product lines, and innovation to start exporting their products. These innovation activities determine the extensive margins of imports and exports. The economy is also subject to sudden stops of capital inflows. The model can capture some of the empirical regularities of firm and trade dynamics during sudden stops: firms' innovation drops sharply, which causes a persistent decline in productivity and output; imports of goods decline substantially, while exports are almost unaffected; profits for exports increase due to a large real depreciation and lower production cost; the extensive margin of exports gradually expands after sudden stops. The model provides a tractable framework to study optimal capital policies in the context of endogenous firm and trade dynamics.