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.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
13412.
Length: Date of creation: Sep 2007 Date of revision: Handle: RePEc:nbr:nberwo:13412
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Find related papers by JEL classification: E2 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
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