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How does capital control spur economic growth?

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  • Zongye Huang
  • Yu You

Abstract

This paper provides a conceptual and empirical framework for evaluating the effect of capital controls on long‐term economic growth. In a small open economy which relies on successful investment projects to provide capital goods, taking out short‐term loans has two contradictory impacts: (i) it reduces the interest costs of financing investment projects; and (ii) it also leads to larger asset losses in the scenario of short‐term debt run. In this work, we hypothesise that private financing decisions made by domestic investors are distorted towards excessive risk‐taking, leading to ineffective capital formation. Thus, capital control policies, particularly regulations on short‐term loans, can be socially beneficial as they alter the debt composition, promote capital formation and achieve a higher output level. Using a panel data set covering 77 countries from 1995 to 2009, we employ a system generalised method of moments (GMM) estimator to sequentially test three hypotheses and find strong empirical evidence that supports our theory.

Suggested Citation

  • Zongye Huang & Yu You, 2019. "How does capital control spur economic growth?," The World Economy, Wiley Blackwell, vol. 42(4), pages 1234-1258, April.
    • Handle: RePEc:bla:worlde:v:42:y:2019:i:4:p:1234-1258
    DOI: 10.1111/twec.12682
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    Cited by:

    1. John Nkwoma Inekwe, 2022. "Economic performance in Africa: The role of fragile financial system," The World Economy, Wiley Blackwell, vol. 45(6), pages 1910-1936, June.

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