Private Capital Flows in the 1970s and 1990s: Is there any evidence of Contagion?

The wave of private capital flows toward developing countries in the early 1990s resembles to a great extent the earlier episode of the late 1970s. Despite some important differences in inflow composition, both episodes were characterized by a high concentration of flows in a relatively small number of countries, mainly in Latin America and East Asia. Also, both episodes ended in a major financial crisis which tended to be regional, the first one –the debt crisis– in Latin America and the most recent one in Asia. Moreover, both crises started in one country, Mexico and Thailand, respectively, and spread quickly to the rest. These similarities across regions suggests the possibility of contagion in capital inflows. This paper studies the determinants of private capital flows to developing countries during these two episodes, and analyzes the possibility of contagion effects among countries during the different phases of the flow cycle—the surge and the ebb. Similar to the recent literature that studies contagion during specific crisis episodes, in this paper we attempt to identify specific channels through which the shocks were transmitted across countries. In particular, we test for discriminating contagion, which occurs because of herd behavior based on countries’ observable similarities. We find no evidence of the latter neither during the 1970s nor during the 1990s. However, consistent with related studies we do find evidence of regional contagion during the 1990s. † Corresponding author. International Monetary Fund. Email address: [email protected] ‡ Central Bank of Chile and Ministry of Finance, Chile, respectively. Email addresses: [email protected] and [email protected], respectively. This research was initiated when the three authors worked at the Economic Research Division of the Central Bank of Chile. This paper is part of a broader research project that was partially funded by FONDECYT, project number 1990338.