The long-run effects of portfolio capital inflow booms in developing countries: permanent structural hangovers after short-term financial euphoria

Most of the literature about the effects of portfolio capital inflows to developing countries focuses on how macroeconomic stability is affected. Very little has been said on the long-run consequences that temporary booms in portfolio capital flows may bear by affecting the productive structure, particularly manufacturing development, of developing countries. The present paper tries to partially fill this gap. We first build a simple theoretical model to show how booming portfolio inflows may interact with domestic speculation at home, giving rise to a climate of financial euphoria featuring an appreciating exchange rate and rising prices of domestic speculative assets. We also discuss that such euphoria hardly lasts forever, but rather ends up in a phase of heightened financial turmoil and volatility. As for the long run, we maintain the Kaldorian perspective according to which manufacturing plays a crucial role for the development process of backward economies.