Sudden Stop and Sudden Flood of Foreign Direct Investment: Inverse Bank Run, Output, and Welfare Distribution

Guillermo A. Calvo

Scandinavian Journal of Economics, 2014, vol. 116, issue 1, 5-19

Abstract: In this paper, I focus on a phenomenon that has not received much attention in the literature, namely that the mere expectation of foreign direct investment (FDI) incentivizes long‐maturity investment projects by domestic residents, and a Sudden Stop when expectations are frustrated. Long‐maturity investment projects enhance productivity but increase the economy's vulnerability to Sudden Stop. The discussion is framed in a context in which a Sudden Stop follows a surge of capital inflows (Sudden Flood), and FDI is concentrated on ongoing projects. A Sudden Stop episode can trigger a fire sale of long‐term assets, output collapse, and welfare redistribution, which is another ignored phenomenon.

Date: 2014
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