Capital Market Imperfections and Financialization of Real Sectors in Emerging Markets: Private Investment and Cash Flow Relationship Revisited

The paper analyzes the impacts of cash flow from multiple investments in real and financial sectors on the new fixed investment spending of real sector firms. The empirical results based on the Euler equation approach and semi-annual firm level data from two major emerging markets, Mexico and Turkey, suggest that profits and rates of returns from fixed and financial assets have differential effects on fixed investment spending of real sector firms. Accordingly, increasing availability and accessibility of alternative investment opportunities in financial markets can become instrumental in channeling real sector savings to short-term financial investments instead of long-term fixed capital formation and thus lead to deindustrialization. (C) 2008 Elsevier Ltd. All rights reserved.