Capital Openness and Income Inequality: A Cross-Country Study and the Role of CCTs in Latin America

Abstract

Recently, capital controls have made a comeback as both policymakers and academia have questioned the net benefits of liberalization and economic growth, especially after the 2008 Great Recession. While that literature has largely concluded that capital account liberalization may have detrimental effects on growth and accentuate financial instability in emerging markets, relatively little literature has examined the impacts of capital account liberalization on income inequality. Thus, this paper investigates the extent to which liberalization is beneficial for countries, conditional on institutional strength and financial depth. We specifically explore the differential impacts of capital account liberalization on income inequality during periods of economic expansion and contraction. The main findings suggest that the net impact of financial liberalization on income inequality is ambiguous during periods of economic expansion but detrimental during contractions. However, we also find that capital account openness needs not to be detrimental on income inequality if institutions are strong or - as it is the case in Latin America -if social safety nets are available.