On the Welfare Implications of Financial Globalization without Financial Development
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.
This paper was prepared for the NBER's International Seminar on Macroeconomics (ISOM), Istanbul, June 15-16, 2007. We would like to thank Giancarlo Corsetti, Mehmet Yorokoglu and conference participants for insightful comments. Vincenzo Quadrini also acknowledges the Financial support of the National Science Foundation. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
On the Welfare Implications of Financial Globalization without Financial Development, Enrique G. Mendoza, Vincenzo Quadrini, José-Víctor Ríos-Rull. in NBER International Seminar on Macroeconomics 2007, Clarida and Giavazzi. 2008