Financial Liberalization: Stable Autocracies and Constrained Democracies

Abstract

Why do autocratic rulers liberalize financial markets? This article shows how autocrats use financial liberalization for two distinct purposes. First, autocrats may use liberalization to bolster the economy, making revolution less attractive to the political opposition and stabilizing the autocracy. Second, when stabilization of the autocracy is too costly, autocrats may use liberalization to make assets more mobile. Mobility provides elite asset owners with external investment options, which limit redistribution. When redistribution is the main fear associated with democratization, the mobility associated with liberalization makes direct control of political institutions through dictatorship unnecessary. Thus, autocrats use liberalization to stimulate the economy and stabilize their rule or to reduce redistribution in anticipation of democratization. Suharto’s policies in Indonesia and Pinochet’s policies in Chile illustrate these two objectives of financial liberalization.

IMF conditionality and central bank independence

“…To gauge the influence of these foreign financial interests, we construct a measure of foreign bank exposure to the G-5 countries. 15 Furthermore, we expect autocratic regimes to be less inclined to adopt CBI because they are less willing to give up a powerful tool for meddling with financial and macroeconomic outcomes Keefer and Stasavage, 2003;Pond, 2018). For instance, it is well documented that the Central Bank of Iran operates several special refinancing windows and credit subsidy schemes for important political constituents (Zahedi and Azadi, 2018).…”

Political Risk Insurance: A New Firm-level Data Set

“…Capital account openness could also reduce firm losses indirectly. Because capital account openness facilitates capital flight, the costs of expropriation are higher when markets are open (Strange 1996; Garrett 1998; Pond 2018). Capital account openness should reduce claims due to expropriation and inconvertibility.…”

No better time than now: Future uncertainty and private investment under dictatorship

“…Elites that are allied to the autocrat may invest because they think that any expropriatory policies selected by the unconstrained autocrat will help rather hurt them (Sonin, 2003). Indeed, this dynamics undergirds the common assumption in the literature that the economic elite are aligned with the ruler (Acemoglu & Robinson, 2006;Pond, 2018). There is ample evidence, from Putin's Russia to Erdogan's Turkey, that some considerable portion of private investment in autocracies can derive from the politically connected elite.…”