International Finance
March 1, 2001

The director of the Project on Corruption and Globalization at the Brookings Institute examines the connection between domestic crony capitalism and dependence on volatile international capital flows such as international bank loans.

Domestic crony capitalism and fickle international capital flows are often suggested as two rival explanations for currency crisis. This article examines a possible linkage between the two that has not been explored much in the literature: domestic crony capitalism may make a country more dependent on the more fickle type of international capital flows (e.g., international bank loans) rather than the less volatile type (e.g., foreign direct investment). It presents statistical evidence that the degree of domestic crony capitalism is indeed associated with a higher external loan-to-FDI ratio. Such a composition of capital flows has been identified as being associated with a higher incidence of a currency crisis. Therefore, even though crony capitalism does not forecast the exact timing of a crisis, it can nevertheless increase its likelihood.