Working Paper: NBER ID: w1245
Authors: Sebastian Edwards; Sweder van Wijnbergen
Abstract: This paper deals with the dynamics of trade and capital account liberalization in a developing country. The welfare consequences of trade and capital account liberalization under alternative sequencing scenarios are investigated. We draw on standard trade theory results to show that the opening of the capital account in the presence of trade distortions may be welfare reducing if foreign borrowing is used to increase investment. However we demonstrate that this welfare reducing effect of opening the capital account will not occur if shadow prices are used to guide investment decisions. It is then shown that if capital market restrictions fall disproportionally on investment (as opposed to consumption) a gradual reduction of import tariffs is superior to an abrupt trade liberalization.
Keywords: trade liberalization; capital market liberalization; welfare effects; sequencing scenarios
JEL Codes: F13; F21; O24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital account liberalization (F32) | lower welfare (I38) |
| improper investment guidance (G11) | lower welfare (I38) |
| shadow prices (P22) | negation of adverse welfare effects (D69) |
| capital market restrictions (G18) | higher welfare costs (I39) |
| method of tariff reduction (F13) | welfare outcomes (I38) |