Working Paper: NBER ID: w14916
Authors: Ayhan Kose; Eswar Prasad; Ashley D. Taylor
Abstract: The financial crisis has re-ignited the fierce debate about the merits of financial globalization and its implications for growth, especially for developing countries. The empirical literature has not been able to conclusively establish the presumed growth benefits of financial integration. Indeed, a new literature proposes that the indirect benefits of financial integration may be more important than the traditional financing channel emphasized in previous analyses. A major complication, however, is that there seem to be certain "threshold" levels of financial and institutional development that an economy needs to attain before it can derive the indirect benefits and reduce the risks of financial openness. In this paper, we develop a unified empirical framework for characterizing such threshold conditions. We find that there are clearly identifiable thresholds in variables such as financial depth and institutional quality -- the cost-benefit trade-off from financial openness improves significantly once these threshold conditions are satisfied. We also find that the thresholds are lower for foreign direct investment and portfolio equity liabilities compared to those for debt liabilities.
Keywords: financial globalization; financial integration; threshold conditions; developing countries; capital account liberalization
JEL Codes: F3; F4; O4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial depth (O16) | benefits of financial openness (F30) |
| institutional quality (L15) | benefits of financial openness (F30) |
| financial depth (O16) | growth (O40) |
| threshold for financial depth (O16) | negative effects on growth (F62) |
| FDI and portfolio equity liabilities (F21) | benefits of financial openness (F30) |
| debt liabilities (F34) | benefits of financial openness (F30) |