TAMING FINANCIERS: THE POLITICAL ECONOMY OF EXCHANGE RATE POLICY IN EASTERN EUROPE A Dissertation Presented to the Faculty of the Graduate School of Cornell University in Partial Fulfillment of the Requirements for the Degree of Doctor of Philosophy by Jana Grittersova August 2009 © 2009 Jana Grittersova TAMING FINANCIERS: THE POLITICAL ECONOMY OF EXCHANGE RATE POLICY IN EASTERN EUROPE Jana Grittersova, Ph.D. Cornell University 2009 Throughout the transition and developing world, the choice of exchange rate regime is one of the most important and controversial policy decisions. What are the main factors that determine the choices of governments in exchange rate policy? What are the structures and institutions that allow governments to credibly commit to and sustain a fixed exchange rate regime? These are the central questions for this study. To answer these questions, I examine the puzzling variation in exchange rate regime choices in Eastern Europe (EE) and changes in these choices over time. This study is an attempt to explore the determinants of the “de facto” exchange rate arrangements chosen by policymakers in EE. I combine the choice and the sustainability of fixed exchange rate regimes in a political-economic approach. The project’s central finding is that exchange rate regime choices depend on several factors: first, on the different interests and strategies of incumbent domestic (state-owned and private) and foreign banks in determining exchange rate policies; and second, on the bank ownership structure and institutional variation of national financial systems. The variation in national financial systems between EE countries is, in turn, a function of the variation in privatization strategies and openness to foreign investments in the banking sector. This research thus demonstrates how the connection between financial interests and exchange rate regime choices is mediated by domestic financial systems. This dissertation integrates theories of financial development into interest groups theories in the political economy of exchange rates. I evaluate this argument against two types of evidence. Statistical analysis of cross-national time-series data allows me to test the impact of financiers on exchange rate policies against a sample of twenty-five EE countries between 1990 and 2004. Statistical analysis is accompanied by in-depth examination of four theoretically important cases—Bulgaria, the Czech Republic, Poland, and Estonia—based on a thorough reading of the relevant secondary literature, the perusal of central bank, government and archival documents, and the conducting of 105 semi-structured interviews. The thesis develops a novel four-fold typology of financial systems in EE—capture, collusion, consensus, and competition—exemplified by the four countries. BIOGRAPHICAL SKETCH Jana Grittersova is an Assistant Professor at the Department of Political Science at the University of Riverside. Her research agenda focuses on the political economy of international finance, exchange rates and financial crises, central banking, institutions and development, globalization, European integration, and transition economies. She obtained her Ph.D. in Economics from the University of Economics in Bratislava, Slovakia, and her Master in Arts in International Relations from the University of Kent at Canterbury, United Kingdom. She has previously taught at the University of California, Berkeley and Stanford University. Furthermore, her professional experience also includes work for the European Commission in Brussels and the National Bank of Slovakia. She is the recipient of the British Chevening Award, a pre-doctoral fellowship from the University Ca’Foscari in Venice, Italy, and a fellowship from the Institute International d’Administration Publique in Paris, France. She was a visiting research fellow at the central banks of Bulgaria, the Czech Republic, and Poland. She has received additional training at the European School on New Institutional Economics and attended the summer MBA program at the Vienna University of Business Administration and Economics in Austria. Besides English and her native Slovak, she is fluent in French, Italian, and Czech and has a working knowledge of Russian and German. Her monograph, “The Redefinition of the Transatlantic Partnership,” was published by the Slovak Foreign Policy Association, and her other publications on independence of central banks, European monetary integration, European Union enlargement, and short pieces on U.S. foreign policy have appeared in peer-reviewed journals and policy magazines. Her economic analyses and legal decisions on the European competition law are published in the Official Journal of the European Communities. iii DEDICATION For my family iv ACKNOWLEDGMENTS In crafting this dissertation I have inevitably accumulated many financial, professional and personal debts. First and foremost, I am grateful to my two superb advisors, Peter Katzenstein and Barry Eichengreen, who strongly influenced my intellectual development. They remain a source of inspiration, trenchant criticism, and high standards. Peter was an ideal adviser, for he guided me every step of the way with this project and indeed beyond, carefully reading and meticulously commenting on its multiple drafts. I am eternally grateful for his excellent guidance, patience, and above all, unwavering support through the years. Peter has always been “in my corner,” as he used to say, with his praise, criticism, and profound insight. For his part, Barry graciously took me under his intellectual wing at the University of California, Berkeley, at his resident Economics Department. He threw his support behind this project, listened to every idea I had, and steered me into the right direction at crucial moments. He deserves recognition for substantially improving the clarity of my ideas and the rigor of my argument. I am also grateful to Chris Way for extensive and penetrating comments on draft after draft of dissertation chapters, and for insightful advice about both the prose and the argument. Valerie Bunce and Jonathan Kirshner conveyed sound advice and suggestions for improving my dissertation. I can hardly imagine a more helpful set of people to teach, inspire, and guide me. This project was supported by several institutions. Cornell’s Einaudi Center for International Studies and its Institute for European Studies, Cornell’s Department of Government and the Graduate School helped to fund my field research. I appreciate the support for my conference and workshop participations by the Viessmann Research Centre at Wilfrid Laurier University, Leonard Davis Institute for International Relations at Hebrew University of Jerusalem, and the European School on New Institutional Economics. I spent time as a visiting scholar at central banks in v Bulgaria, the Czech Republic, and Poland while conducting this research. I owe all three central banks my warmest thanks and appreciation for opening their excellent facilities to me, providing me with office space, research material, and helping with interviews. I particularly appreciate the financial support of the Bulgarian National Bank for my field research in Sofia. I also thank the Bank of Estonia for access to its library, research and archival assistance, as well as the National Bank of Slovakia for access to its officials. I am grateful to more than one hundred policy makers, bankers, and scholars in Prague, Warsaw, Sofia, Tallinn, and Bratislava who spoke with me and shared their reflections and experiences. This dissertation greatly benefited from their generosity. I also benefited from my discussions with the European Commission’s officials during my work assignment there. I thank all who graciously dedicated their time to answer my questions about financiers and economic policies, and have offered useful suggestions and comments on different portions of this project. They all influenced this dissertation in profound ways. I thank Rawi Abdelal, Neal Abrams, Chris Anderson, Marcos Chamon, William Clark, Benjamin Cohen, Patrick Crowley, Rui Pedro Esteves, Steve Fish, Jesse Fried, Timothy Frye, Roy Gardner, Jordan Gans-Morse, John Gould, Alexandru Grigorescu, Anna Grzymala-Busse, Galina Hale, Mark Hallerberg, Juliet Johnson, Ethan Kaplan, Evžen Kočenda, George Krause, David Leblang, Yoonho Kim, Jay Lyall, Gerald McDermott, Nikolay Nenovsky, David Ost, Zalman Shiffer, Brian Scholl, Beate Sissenich, Jan Švejnar, Daniel Treisman, Ned Walker, Steve Weber, and Tom Willett. Gene Baker, David Freedman, Charles Franklin, Greg Wawro, and Chris Zorn all answered various technical questions. I thank Anita Taci, Rai Desai, and Omar Choudhry for generously sharing their data. Most of the writing took place at the University of California, Berkeley, where I was a visiting scholar at the Institute for Slavic, East European, and Eurasian Studies and the Institute of European Studies. I vi benefited greatly from the rich and vibrant academic community at Berkeley, and I am grateful to those who involved me in their seminars and gave me chance to present my work. Some of the most helpful comments I received came at various conferences, seminars, workshops, and presentations along the way. While I cannot hope to thank everyone who has influenced my work, I am especially grateful to participants in seminars at the Johns Hopkins University, University of Pittsburgh, University of Miami, University of California, Riverside, and Cornell University, as well as attendees of the annual meetings