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Endogenous Financial and Trade Openness: Political Economy Considerations

Joshua Aizenman () and Ilan Noy ()

No 72, Economics Study Area Working Papers from East-West Center, Economics Study Area

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.

JEL-codes: F15 F21 F36 H21 (search for similar items in EconPapers)
Date: 2004-04, Revised 2004-09
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