Openness and Inequality: Distributional Impacts of Capital Account Liberalization
IMF Blog, November 24, 2015
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Bibliographic details
- Authors: Davide Furceri, Prakash Loungani
- Published: November 24, 2015
Overview and dataset
- Authors: Davide Furceri, Prakash Loungani
- Publication date: November 24, 2015
- Dataset: nearly 150 countries from 1970 to 2010
- Measure of capital account openness: the Chinn-Ito index (based on restrictions on cross-border financial transactions reported by the IMF)
Main empirical findings
- Capital account liberalization is followed by increases in inequality, as measured by the Gini coefficient.
- Capital account openness increased across all income groups, with a significant rise at the beginning of the 1990s.
- Quantified impacts:
- Capital account liberalization has typically increased the Gini index by 1 percent within two years of the liberalization.
- Capital account liberalization has typically increased the Gini index by 1.5 percent within five years of the liberalization.
- Robustness: the qualitative result is said to be robust to various stress tests documented in the paper.
Channels and heterogeneity in effects
- Financial development and inclusion:
- The increase in inequality after liberalization is smaller in countries with higher levels of financial development and inclusion.
- The increase in inequality is higher in countries where financial inclusion is lower (as illustrated by Chart 2 referenced in the text).
- Crisis transmission:
- Liberalization that is not well managed or well sequenced increases the likelihood of financial crises.
- The impact of openness on inequality is sharply higher in cases where there is a financial crisis in the immediate aftermath of liberalization (as illustrated by Chart 3 referenced in the text).
Policy implications and recommendations
- The results do not imply that countries should not liberalize capital accounts; capital flows can provide substantial benefits, including enhancing efficiency, promoting financial sector competitiveness, and facilitating greater productive investment and consumption smoothing.
- Cautions and design considerations:
- Proceed with caution because capital flows can be volatile and—given their large size relative to domestic markets—pose risks to economic and financial stability.
- Where reducing inequality is an important policy goal, design liberalization to address its potential impact on inequality.
- Follow the IMF’s institutional view that capital flow liberalization is generally more beneficial and less risky if countries have reached certain levels or thresholds of financial and institutional development.
- Ensure liberalization is well managed and accompanied by higher financial inclusion to mute adverse distributional effects.
Source: Openness and Inequality: Distributional Impacts of Capital Account Liberalization (IMF blog post, November 24, 2015).
Content in this bundle
- Content unit 111412 — "The Liberalization and Management of Capital Flows"