Three essays on capital account liberalization and economic growth: New measures, new estimates and the experience of South Korea
This study examines the economic effects of capital account liberalization on economic growth. The format of this study is in three essays. The first essay examines the macroeconomic effects of liberalization on economic growth, using cross-country growth regressions and developing a new measure for capital account openness. We find no evidence that capital account liberalization encourages long-term growth in cross-country regressions, even under typically prescribed preconditions. Capital controls, however, do have a positive effect on growth in countries with more institutional development, more ethnic homogeneity and a higher corporate debt ratio. Panel data estimations report ambiguous results, except in fixed effects models, in which the short-term benefits of liberalization are clearer. The second essay studies whether financial opening and foreign capital inflows ease financing constraints and make investment more responsive to ‘fundamentals’. There is no strong evidence of such microeconomic benefits from capital account liberalization in Korea for the decade of the 1990s. Non-chaebol firms are more financially constrained compared to chaebol firms and this disparity became more pronounced following the crisis. Higher foreign ownership made investment more responsive to profitability for chaebol firms, but at the same time, has a negative impact on the level of investment. Industry-level regressions show the same results. In the last essay, the political economy of capital controls, liberalization and crisis in Korea is examined from institutional and historical perspectives. The experience with capital controls in Korea points to the importance of the developmental state for success. The myriad changes in the institutional framework and following liberalization led to the serious economic vulnerability faced by Korea and to the financial crisis. Following the crisis, the government further opened the financial market, which has led to concerns of foreign dominance, lower investment and higher instability. This study critically evaluates the mainstream support for capital account liberalization and emphasizes the possibility of an alternative development framework.