Do Stock Market Liberalizations Cause Investment Booms?

Stock market liberalizations lead private investment booms. In a sample of 11 developing countries that liberalized, 9 experience growth rates of private investment above their non-liberalization median in the first year after liberalizing. In the second and third years after liberalization this number is 10 of 11 and 8 of 11 respectively. The mean growth rate of private investment in the three years immediately following stock market liberalization exceeds the sample mean by 22 percentage points. The evidence stands in sharp contrast with recent work that suggests capital account liberalization has no effect on investment. Assistant Professor of Economics, Graduate School of Business, Stanford University, Stanford, CA 94305-5015. This paper is a revised version of Chapter 2 of my Ph.D. thesis at the Massachusetts Institute of Technology. I am extremely grateful to Steve Buser, Paul Romer, Bill Schwert (the editor), Andrei Shleifer, and two anonymous referees whose detailed comments on an earlier draft substantially improved the paper. I would also like to thank, Olivier Blanchard, Rudi Dornbusch, Jerry Hausman, Jim Poterba, Robert Solow, Jeremy Stein, and René Stulz for helpful comments and conversations. The International Finance Corporation and the Research Foundation of Chartered Financial Analysts generously allowed me to use the Emerging Markets Data Base. Ross Levine generously shared his extensive list of capital control liberalization dates. Finally, I would like to thank the National Science Foundation, The Ford Foundation, and the Stanford Institute for Economic Policy Research (SIEPR) for financial support. All remaining errors are my own.