Endogenous Financial and Trade Openness
This paper studies the endogenous determination of financial and trade openness. First, we outline a theoretical framework leading to two-way feedbacks between the different modes of openness; next, we identify these feedbacks empirically. We find that one standard deviation increase in commercial openness is associated with a 9.5 percent increase in de-facto financial openness (% of GDP), controlling for political economy and macroeconomic factors. Similarly, increase in de-facto financial openness has powerful effects on future trade openness. De-jure restrictions on capital mobility have only a weak impact on de-facto financial openness, while de-jure restrictions on the current account have large adverse effect on commercial openness. Having established (Granger) causality, we investigate the relative magnitudes of these directions of causality using Geweke's (1982) decomposition methodology. We find that almost all of the linear feedback between trade and financial openness can be accounted for by G-causality from financial openness to trade openness (53%) and from trade to financial openness (34%). We conclude that in an era of rapidly growing trade integration countries cannot choose financial openness independently of their degree of openness to trade. Dealing with greater exposure to financial turbulence by imposing restrictions on financial flows will likely be ineffectual.
We would like to thank Michael Hutchison, Hiro Ito, Nancy Marion and Shang-Jin Wei for sharing their data. We are grateful for the suggestions of two anonymous referees. We would also like to thank for useful comments we received from Micha Ben-Gad, Benny Bental, Carl Bonham, Mike Dooley, Hadi Salehi Esfahani, Doireann Fitzgerald, Byron Gangnes, Charles Kahn, Ken Kletzer, Xenia Matschke, Richard Portes, Aaron Tornell, Donald Wittman, Ari van Asche and seminar participants at the Hebrew University of Jerusalem, UCSC, UCLA, University of Haifa, University of Illinois (Urbana-Champaign), University of Hawaii, Tel Aviv University, University of Washington and the LACEA 2004 meeting in San José, Costa Rica. Any errors are ours. This paper integrates and updates results reported previously in NBER Working papers # 10144 and 10496. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
Joshua Aizenman & Ilan Noy, 2009. "Endogenous Financial and Trade Openness," Review of Development Economics, Blackwell Publishing, vol. 13(2), pages 175-189, 05. citation courtesy of