Working Paper: NBER ID: w13412
Authors: Enrique G. Mendoza; Vincenzo Quadrini; José Victor Rosrull
Abstract: It is widely argued that countries can reap large gains from liberalizing their capital accounts if financial globalization is accompanied by the development of domestic institutions and financial markets. However, if liberalization does not lead to financial development, globalization can result in adverse effects on social welfare and the distribution of wealth. We use a multi-country model with non-insurable idiosyncratic risk to show that, if countries differ in the degree of asset market incompleteness, financial globalization hurts the poor in countries with less developed financial markets. This is because in these countries liberalization leads to an increase in the cost of borrowing, which is harmful for those heavily leveraged, i.e. the poor. Quantitative analysis shows that the welfare effects are sizable and may justify policy intervention.
Keywords: Financial Globalization; Welfare Implications; Financial Development; Wealth Distribution; Economic Policy
JEL Codes: E2; E44; F32; F36
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial globalization (F65) | adverse welfare effects (D69) |
| Financial globalization (F65) | harming poorer individuals (D63) |
| Increased borrowing costs (G21) | negatively impact heavily leveraged individuals (F65) |
| Financial globalization (F65) | increase wealth inequality (D31) |
| Financial globalization (F65) | positive aggregate welfare effects (D69) |
| Welfare losses in less developed countries (F63) | outweigh potential gains from financial globalization (F65) |
| Financial policy measures (E62) | social welfare outcomes (I38) |
| Asset market incompleteness (D52) | influences cost of borrowing (G21) |