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Endogenous Financial and Trade Openness: Political Economy Considerations

Author

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  • Joshua Aizenman

    () (Economics, University of California, Santa Cruz)

  • Ilan Noy

    () (Economics, University of Hawaii-Manoa)

Abstract

This paper studies the endogenous determination of financial and trade openness. First, we outline channels 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. While de-jure restrictions on capital mobility do not impact de-facto financial openness, de-jure restrictions on the current account have large adverse effect on commercial openness, suggesting that it is much easier to overcome restrictions on capital account convertibility than restrictions on commercial trade. Having established (Granger) causality, we investigate the relative magnitudes of these directions of causality using the decomposition test developed in Geweke (1982). 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%). The residual is due to simultaneous correlation between the two measures.

Suggested Citation

  • Joshua Aizenman & Ilan Noy, 2004. "Endogenous Financial and Trade Openness: Political Economy Considerations," Economics Study Area Working Papers 72, East-West Center, Economics Study Area, revised Sep 2004.
  • Handle: RePEc:ewc:wpaper:wp72
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Matías Braun & Claudio Raddatz, 2004. "Trade liberalization and the politics of financial development," Working Papers 04-3, Federal Reserve Bank of Boston.
    2. Aizenman, Joshua & Noy, Ilan, 2006. "FDI and trade--Two-way linkages?," The Quarterly Review of Economics and Finance, Elsevier, vol. 46(3), pages 317-337, July.
    3. Mouna Gammoudi & Mondher Cherif, 2014. "Threshold Effects in the Capital Account Liberalization and Foreign Direct Investment Relationship," Working Papers 877, Economic Research Forum, revised Nov 2014.
    4. Rana Ejaz Ali Khan & Qazi Muhammad Adnan Hye, 2014. "Foreign direct investment and liberalization policies in Pakistan: An empirical analysis," Cogent Economics & Finance, Taylor & Francis Journals, vol. 2(1), pages 1-12, December.
    5. Braun, Matias, 2004. "Trade Liberalization and the Politics of Financial Development," Santa Cruz Department of Economics, Working Paper Series qt70v7f9ff, Department of Economics, UC Santa Cruz.

    More about this item

    JEL classification:

    • F15 - International Economics - - Trade - - - Economic Integration
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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