Opposition to capital market opening

Abstract

We employ a neoclassical growth model to assess the impact of financial liberalization in a developing country on capital owners’ and workers’ consumption and welfare. We find for an average non-OECD country that capital owners suffer a 42% reduction in permanent consumption because capital inflows reduce their return to capital while workers gain 8% of permanent consumption because capital inflows increase wages. These huge gross impacts contrast with the small positive net effect found in a neoclassical representative agent model by Gourinchas and Jeanne (2006). Our findings provide an estimate of the amount of redistribution needed to overcome capitalists’ opposition to capital inflows.

Keywords:

• capital flows
• international financial integration
• distributional effects

JEL Classification:

• F21
• E25
• F36
• F43
• O11

Notes

¹ In addition, this assumption assures that the capitalist’s normalized consumption and asset holdings are constant in the steady state (see Barro and Sala-i-Martin, 2004).

² Furthermore, the capitalist respects appropriate transversality conditions. Workers, facing an exogenous real wage and supplying labour inelastically, cannot optimize their allocations.

³ The properties of the production function ensure this interior condition.

⁴ For t = 0, we have and , with and given.

⁵ η is not mentioned, as it does not affect relative consumption losses.

⁶

⁷ In the working paper version, we show that a productivity catch-up process associated with financial integration does not reduce domestic capital owners’ welfare losses because the capital income effects are unaffected.