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Faculty of Economics

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Antunes, A. and Cavalcanti, T. V. D.

The welfare gains of financial liberalization: capital accumulation and heterogeneity

Journal of the European Economic Association

Vol. 11(6) pp. 1348-1381 (2013)

Abstract: Research has shown that, absent individual heterogeneity and under complete markets, the welfare impact of financial openness is quantitatively limited. Not only are inequalities in wealth and labor productivity a feature of most societies, but also financial markets suffer from many well-known frictions. This paper demonstrates that, when households face borrowing constraints and uninsurable idiosyncratic shocks to income, the welfare implications of financial liberalization are considerable. For instance, the average increase in welfare of a typical emerging market economy that switches from a closed capital market to perfect capital mobility is equivalent to a permanent increase in average consumption of roughly 5.4%. This is about 3.9 times more than the welfare gains of the same policy under a complete markets environment without any individual heterogeneity. We show that individual heterogeneity accounts for two thirds of this additional increase in the average welfare gain; market incompleteness accounts for the remaining third. In our calibration, the median household in capital-scarce countries is in favor of international financial integration. However, if the pivotal voter is wealthy enough then such reform might not be implemented, since richer households have a vested interest in capital market closedness.

JEL Codes: E21, E60, F40

Author links: Tiago Cavalcanti  

Publisher's Link: http://onlinelibrary.wiley.com/doi/10.1111/jeea.12053/abstract



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