Crisis, Conditions, and Capital: The Effect of International Monetary Fund Agreements on Foreign Direct Investment Inflows
Abstract
A selection model for 68 countries between 1970 and 1998 is used to test the impact of International Monetary Fund(IMF) programs on international capital markets and examine how agreements are perceived by multinational investors. Results reveal that even after controlling for the factors that lead countries to seek IMF support, IMF agreements lead to lower levels of foreign direct investment (FDI). Countries that sign IMF agreements, ceteris paribus, attract 25% less FDI inflows than countries not under IMF agreements.
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1.
1. One of the most important works on the subject of political institutions and economic performance is North (1990). For an examination of political institutions on domestic finance, see North and Weingast (1989); for international debt markets, see Schultz and Weingast (2003) and Sobel (1999); for foreign direct investment (FDI), see Jensen (2002b, 2003) and Li and Resnick (2003).
2.
2. For the link between FDI and growth, see Balasubramanyam, Salisu, and Sapsford (1996) and Borensztein, De Gregorio, and Lee (1998).
3.
3. Bird and Rowlands (1997) discuss the literature.
4.
4. De Gregorio et al. (1999) argue that with the availability of capital to most middle-income countries, the role of the World Bank has shrunk considerably in recent years.
5.
5. Throughout this article, I admittedly ignore the complex governance structure of the International Monetary Fund (IMF). See Kahler (2001) for leadership selection, Vaubel (1996) for bureaucratic politics, Dreher (forthcoming) and Dreher and Jensen (2003) for conditionality, and Gould (2003) for the IMF and private financers.
6.
6. IMF conditionality became part of the IMF’s lending scheme in 1952 (Sidell 1988) and was later codified in the charter in 1968. After the 1976 annual meeting, the concept of conditionality further evolved and was defined in the 1979 IMF Guidelines on Conditionality; it was called “strict conditionality” (James 1996, 322-23). These conditions became more detailed in the 1960s and 1970s. For an interesting set of discussions and models on IMF conditionality, see Vaubel (1991) and Dreher (forthcoming). For empirical tests of the number of conditions on IMF loans, see Dreher and Jensen (2003). For an empirical test of the influence of supplementary financiers on IMF conditions, see Gould (2003).
7.
7. Other scholars argue for a greater differentiation in the level of conditionality. See Dell (1982) and Williamson (1983). For a discussion of some of the recent critiques of IMF conditionality, see Vreeland (2003).
8.
8. The IMF has increased the transparency of conditionality in recent years. Although the IMF does not provide details on the process of setting conditions, detailed data on the composition of IMF conditions are available for IMF agreements signed since 1997.
9.
9. Stone (2002) reviews the literature.
10.
10. This model uses a version of a dynamic probit model to predict IMF participation. In this dynamic, bivariate probit, Vreeland (2003) controls for selection in both the types of countries that seek IMF support and the types of countries that receive support. In the real world, we only observe when a country is either under an IMF agreement (both condition 1 and condition 2 are satisfied) or when a country is not under an agreement (either one or both conditions have not been fulfilled).
11.
11. Even some IMF research showed that programs could have a negative impact on output (Khan, Montiel, and Haque 1986; Vines 1990).
12.
12. The political costs to reform can be extremely high in countries with a high debt overhang (Sachs 1989; Krugman 1988).
13.
13. Other recent contributions include Markusen (1984), Markusen and Venables (1999), Markusen and Maskus (1999), and Venables (1999).
14.
14. See Jensen (2003)and Li and Resnick (2003)for tests on the impact of democracy on FDI inflows. See Jensen (2002b) for a test of the impact of economic reform and corruption on FDI inflows in post communist transition economies. See Sobel (1999) for an empirical analysis of political institutions on sovereign debt.
15.
15. Bird and Rowlands (1997), Krueger (1998), and Rodrik (1996) are all critical of these catalytic effects.
16.
16. The selection of cases is based on data availability.
17.
17. This variable only measures the change in foreign firms’ investments and does not consider the reactions of domestic firms to IMF agreements.
18.
18. This is similar to the baseline FDI inflows models in Jensen (2002a, 2003). All other variables are from the World Bank (1999).
19.
19. Both ε and u are bivariate normal with mean zero.
20.
20. I use the Stata 7.0 maximum likelihood estimator for the treatment effects model.
21.
21. Vreeland (2003) uses a dynamic model, whereas I employ a static model.
22.
22. See Table 4 for the regression diagnostics.
23.
23. I also included controls in the FDI equation for the level of democracy and an international crisis dummy variable from the ICB Conflict Database (2004). My results remain unchanged.
24.
24. However, if governments were enacting market-enhancing reforms, we would expect FDI flows to increase. See Vreeland (2003).
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