Financial Openness and Growth: The Importance of Public and Private Sector Protections

Abstract

Do more open financial economies grow faster? The short answer is yes, as long as certain policies are in place. This paper extends previous studies by analyzing how different legal protections interact with each other and with initial wealth to allow financial openness to enhance growth. I identify three types of institutions that are most important for countries to establish prior to removing financial restrictions: government protections of private assets and contracts, corporate protections of shareholder rights and judicial protections of business interests. Although these protections are not mutually exclusive, strong private-sector protections of investor rights can substitute for weak public-sector protections and vice versa. Furthermore, a high-income country still needs to provide these protections to benefit from an open financial economy. The econometric methodology employed in this paper has the ability to substantially improve upon previous estimates by simultaneously controlling for endogeneity and unobserved country fixed effects.