Sudden stop and sudden flood of foreign direct investment: Inverse bank run, output, and welfare distribution

Abstract

In this paper, I focus on a phenomenon that has not received much attention in the literature, namely that the mere expectation of foreign direct investment (FDI) incentivizes long-maturity investment projects by domestic residents, and a Sudden Stop when expectations are frustrated. Long-maturity investment projects enhance productivity but increase the economy's vulnerability to Sudden Stop. The discussion is framed in a context in which a Sudden Stop follows a surge of capital inflows (Sudden Flood), and FDI is concentrated on ongoing projects. A Sudden Stop episode can trigger a fire sale of long-term assets, output collapse, and welfare redistribution, which is another ignored phenomenon. © The editors of The Scandinavian Journal of Economics 2013.