Financial liberalization and economic growth

Abstract

Purpose – The purpose of this paper is to ascertain whether countries benefit from capital account liberalization in more democratic contexts. Design/methodology/approach – The authors used the follow methodologies in this paper: Pooled OLS, panel data with fixed effects and generalized method of moments. The empirical exercises were conducted for both a large sample and a smaller group of developing countries. Given the characteristics of the variables used in the standard model, the main conclusions were obtained from an estimation that took into account the presence of fixed effects and endogeneity. Findings – Considering a sample of 77 countries, the authors were able to ascertain that capital account openness has a positive effect on economic growth only in highly democratic countries. When the same estimates are carried out with a more restricted sample, composed of 50 developing countries, the results are more pessimistic. In this case, capital account openness has a negative and significant effect, although being more democratic is not sufficient in itself to reap the benefits of financial integration. Research limitations/implications – The results obtained in this paper are limited to the number of observations and the period analysed. Furthermore, the conclusions need to be confirmed by a test of robustness, which should be conducted in future works; such works could make use of other democracy indicators and other instruments. Originality/value – The innovation of the work, in comparison to those the authors consulted, resides in its testing, through an interactive variable, whether the effect of capital openness on economic growth depends on level of democracy.