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RFS Advance Access published online on March 15, 2006
Review of Financial Studies, doi:10.1093/rfs/hhj041
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

Article

Capital Controls, Liberalizations, and Foreign Direct Investment

Mihir A. Desai 1 *, C. Fritz Foley 1, and James R. Hines Jr. 2
1 Harvard University and NBER
2 University of Michigan and NBER

* To whom correspondence should be addressed.
Mihir A. Desai, E-mail: mdesai{at}hbs.edu


  Abstract

This paper evaluates the impact of capital controls and their liberalization on the activities of U.S. multinational firms. These firms attempt to circumvent capital controls by reducing reported local profitability and increasing the frequency of dividend repatriations. As a result, the reported profit impact of local capital controls is comparable to the effect of 27 percent higher corporate tax rates, and affiliates located in countries imposing capital controls are 9.8 percent more likely than other affiliates to remit dividends to parent companies. Multinational affiliates located in countries with capital controls face 5.25 percent higher interest rates on local borrowing than do affiliates of the same parent borrowing locally in countries without capital controls. Capital control liberalizations are associated with significant increases in multinational activity - property, plant and equipment grows at 6.9% faster annual rates following liberalizations. The combination of the costliness of avoidance and higher interest rates discourages investment in countries with capital controls, and this effect is reversed upon liberalization of controls.


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