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Capital Account Openness and the Losses from Financial Frictions

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  • Minsoo Han

    (Pennsylvania State University)

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    Abstract

    The goal of this paper is to isolate the role of openness to international financial markets (capital account openness) on the total factor productivity (TFP) effect of financial frictions. To do so, I formulate a model in which individual households are either workers or entrepreneurs, can only save in the form of capital, and entrepreneurs are subject to a collateral constraint. Using this structure, I compare two steady states of a calibrated model numerically: one in which the capital rental rate must clear a domestic capital rental market (closed economy), and one in which that rate is given by the world (small open economy). The model predicts that a small open economy is affected less by financial frictions than a closed economy: for the tightest collateral constraint, TFP in a small open economy is only about 1% lower than in the economy without a collateral constraint, while it is 15% lower in a closed economy. TFP losses in a small open economy reflect factor misallocation among incumbent entrepreneurs (intensive margin), not distortions along entry-exit margin, whereas for a tight financial frictions, there are distortions on both intensive and entry-exit margins in a closed economy. Using macro data, I find that a 1% rise in openness is associated with 0.196% decline in the effect of financial frictions on TFP. Running the same regression on subsamples, I also find that this empirical result mainly comes from a group of low income countries.

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    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 485.

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    Date of creation: 2013
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    Handle: RePEc:red:sed013:485

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    1. Chang-Tai Hsieh & Peter J Klenow, 2008. "Misallocation and Manufacturing TFP in China and India," 2008 Meeting Papers 121, Society for Economic Dynamics.
    2. Douglas Gollin, 2001. "Getting Income Shares Right," Department of Economics Working Papers 2001-11, Department of Economics, Williams College.
    3. Robert E. Hall & Charles I. Jones, 1999. "Why Do Some Countries Produce So Much More Output Per Worker Than Others?," The Quarterly Journal of Economics, MIT Press, vol. 114(1), pages 83-116, February.
    4. Vincenzo Quadrini, 1997. "Entrepreneurship, saving and social mobility," Discussion Paper / Institute for Empirical Macroeconomics 116, Federal Reserve Bank of Minneapolis.
    5. Francisco J. Buera & Joseph P. Kaboski & Yongseok Shin, 2011. "Finance and Development: A Tale of Two Sectors," American Economic Review, American Economic Association, vol. 101(5), pages 1964-2002, August.
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    7. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
    8. Nancy L. Stokey & Sergio Rebelo, 1993. "Growth Effects of Flat-Rate Taxes," NBER Working Papers 4426, National Bureau of Economic Research, Inc.
    9. Aoki, Kosuke & Benigno, Gianluca & Kiyotaki, Nobuhiro, 2010. "Adjusting to Capital Account Liberalization," CEPR Discussion Papers 8087, C.E.P.R. Discussion Papers.
    10. Joaquin Blaum, 2012. "Wealth Inequality and the Losses from Financial Frictions," 2012 Meeting Papers 1077, Society for Economic Dynamics.
    11. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
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