NCPA - National Center for Policy Analysis

CAPITAL ACCOUNT LIBERALIZATION

August 18, 2008

Capital account liberalization in developing countries is said to reduce the cost of capital, temporarily increase investment and permanently raise the level of gross domestic product (GDP) per capita.  But critics claim that liberalization brings few benefits and high costs, and since the restrictions on capital flows have been lifted, many countries are experiencing such financial crises that question the merits of liberalization.

A new study by the National Bureau of Economic Research (NBER) weighs the costs and benefits of liberalization by examining the labor market.  In a sample of 18 developing countries that opened their stock market to inflows of foreign capital between 1986 and 1993, they find that:

  • The average annual growth rate of the real wage in manufacturing jumped from 1.3 percent per year in non-liberalization periods to an average of 8.6 percent in the year liberalization occurred.
  • The temporary 7.3 percentage-point increase in the growth rate of the real wage permanently drove up the level of average annual compensation for each worker by about $752; an increase of more than a quarter of their annual pre-liberalization salary.
  • Opening the stock market to foreign investment drives up real wages in the manufacturing sector of developing countries without eroding profitability.

If workers gain and owners of capital do not lose, then why do countries wait so long to liberalize?  The authors are cautious in addressing this question because their evidence only applies to manufacturing.

Nevertheless, the evidence demonstrates that trade in capital has significant consequences for the real economy beyond its impact on prices and quantities of capital.  Centris paribus, capital account liberalization raises the average standard of living for a significant fraction of the workforce in developing countries.

Source: Peter Blair Henry and Diego Sasson, "Capital Account Liberalization, Real Wages, and Productivity," National Bureau of Economic Research, Working Paper No. 13880, March 2008.

For text:

http://papers.nber.org/papers/w13880  

 

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