Consumption, Income, and International Capital Market Integration

Integration by Tamim Bayoumi and Ronald MacDonald

By allowing countries to borrow and lend money efficiently, capital
markets can provide the same services across countries that they provide
within a single economy, allowing more efficient use of funds for investment
and improving the allocation of consumption over time. While the potential
gains from open international capital markets are clear, measuring the
actual level of international capital mobility has proved to be more
difficult. Among the main measures used in the literature are comparisons
of onshore-offshore nominal interest rates and the correlation of saving and
investment rates across countries. Tests involving nominal interest
comparisons generally indicate a high degree of capital mobility, while
those involving real rates and savings-investment relationships show
relatively low levels.

This uncertainty has revived interest in alternative measures of the
openness of international capital markets. One promising avenue involves
using consumption patterns across countries as a measure of capital
mobility. The logic behind the test is that, if capital markets are
integrated, consumers will be able to insulate themselves against
idiosyncratic disturbances. Hence consumption across individual countries
should be highly correlated with the path of the aggregate across all
countries. This paper extends this work on international consumption
patterns. As well as looking at a larger set of countries, a somewhat
different estimating equation is derived that takes explicit account of the
possibility that part of local consumption depends upon local income.

The paper finds that Japan is the only industrial country in the sample
for which national consumption appears to be fully integrated with the rest
of the world. For the other countries considered, however, the source of
the failure varies. Within the EC, with the notable exception of the United
Kingdom, the failure is almost universally associated with incomplete
integration across individual national capital markets. Greater integration
of national capital markets caused by moves toward a single market and,
possibly, a single currency, could therefore provide potentially significant
gains in economic welfare by improving consumption patterns across the
region. In the rest of the sample, national capital markets appear to be
integrated. However, except in the case of Japan, consumption is disrupted
from its optimum path by incomplete access of individuals to these national
capital markets.