The domestic politics of financial internationalization in the developing world

ABSTRACT

This paper examines the domestic politics of financial internationalization. Financial internationalization has two components, the liberalization of cross-border capital flows and the liberalization of foreign ownership restrictions, yet most research to date has concentrated exclusively on the former. Building on existing theoretical work, this paper argues that in the developing world, domestic finance favors the joint abolition of restrictions on the inflow of foreign capital alongside continued restrictions on the ability of foreigners to own and operate domestic financial institutions. I test the argument on a unique dataset of foreign entry restrictions in developing economies and by examining interest group pressures for financial internationalization in Indonesia and Mexico. The findings complement and extend recent work on financial internationalization in the developing world and suggest further areas for research in the role of domestic interest group preferences for global economic integration.

KEYWORDS:

• Financial politics
• capital controls
• interest groups and IPE
• globalization and domestic politics
• Indonesia
• Mexico

ACKNOWLEDGEMENTS

Thanks to Andy Baker, David Brown, Jerry Cohen, Gustavo Flores-Macías, Jeff Frieden, Jonathan Kirshner, David Leblang, Sonal Pandya, Grigore Pop-Eleches, David Waldner, participants at the 2009 IPES meeting in College Station, TX, and the 2010 Annual Meeting of the American Political Science Association in Washington, DC, and the editors of RIPE for valuable comments. All errors are my own.

Notes

1. By ‘relatively capital poor', I mean both that the marginal product of capital in the developing world is higher than that in the advanced industrial economies and that domestic banks are at a competitive disadvantage relative to foreign banks. I thank an anonymous reviewer for clarifying this point.

2. I base the narrative in this section primarily on Cole and Slade (1999), MacIntyre (1993), Pepinsky (2009), Sharma (2001), Soesastro (1989) and Winters (1996).

3. I base the narrative in this section on Adams (1997), Haber (2005), Hernández Trillo and Villagómez (2000), Maxfield (1990, 1992, 1997), Santín Quiroz (2001) and Valdés Ugalde (1994).

4. I thank an anonymous reviewer for suggesting this point.

5. This practice is also standard in the subnational and cross-national literatures on tariff policy. For other uses of national sector size as a proxy for sectoral political influence in the realm of international finance, see Blomberg et al. (2005), Brooks (2004), Chwieroth (2007), Frieden et al. (2001) and Shambaugh (2004).

6. Data on deposit money bank assets and central bank assets are widely available in the dataset, but data on the assets of other financial institutions are very sparse. Where these data are missing for a country or country-year, I calculate Total financial assets/GDP as the sum of deposit money bank assets and central bank assets only. Including central bank assets is useful for three reasons. First, central bank assets help to capture the relative market power of the financial sector because, as indicators of the depth of the domestic financial market, these assets are understood as comprising some of the funds to which private sector actors might have access in the event of a financial downturn. Second, they are also useful in countries where the accounts of state-owned financial and quasi-financial enterprises have unclear legal standing. Third, in liberalizing economies, central bankers may in fact operate as representatives or agents of private financial sector actors, meaning that central bank assets are another measure of the (indirect) political influence of the banking sector. I thank an anonymous review for suggesting this possibility.

7. These are countries whose IFS country code >200.

8. See, e.g., the findings in Mukherjee and Singer (2010) and Pepinsky (2012).