Structural change, productive development, and capital flows: does financial "bonanza" cause premature deindustrialization?

This article investigates the impact of large net capital inflows—specifically non-Foreign Direct Investment (non-FDI) flows such as portfolio investment and international credit—on premature deindustrialization and productive development in a sample of 36 developed and emerging/developing economies (EDEs) from 1980 to 2017. The study finds that periods of abundant non-FDI capital inflows are significantly associated with contractions in manufacturing's share of employment and GDP, as well as declines in the Economic Complexity Index (ECI), particularly in EDEs. These effects are linked to finance-led structural changes resembling Dutch disease, where capital inflows appreciate real exchange rates and shift resources away from tradable manufacturing sectors toward non-tradable sectors, thereby hindering technological upgrading and diversification. The article emphasizes that capital flow management (CFM) policies—including capital controls and sector-specific macroprudential measures—can mitigate these adverse effects by restraining volatile capital inflows and directing investment toward tradable, technology-intensive sectors, thus supporting long-run productive development and helping countries avoid the middle-income trap.