Capital Account Liberalization, Political Stability, and Economic Growth

Abstract

Our main purpose in this paper is first to study the interaction between capital account liberalization and political stability in affecting financial stability and so economic growth. Second, our contribution consists in decomposing both the effect of capital account liberalization and political stability into a direct effect on growth and an indirect effect through affecting financial system efficiency and stability. We show that the aggregate positive effect of political stability outweighs the negative partial or temporary effect. However, the total effect of capital account liberalization is negative and economic repressing. Our economic approach is firstly based on a growth traditional model conducted through a simple panel data regression, and then we used a logit model to identify potential determinants of financial crisis including interaction term. This methodology permits us to augment the growth model by a crisis model obtaining treatment effect specification necessary to decompose the total effect of our variables of interests. We conclude that the impact of capital account liberalization on growth depends on the political stability and that political stability is more needed to stimulate economic growth in less-liberalized countries. Capital account increases economic growth rate only in politically unstable countries where needs for capital is high.