Observing an increasing financial liberalization and income inequality during the last decades, this study investigates how the opening of financial markets is influencing income inequality. Operationalizing the research question, it focuses on capital account liberalization (CAL).
The paper begins with an extensive literature review which recognizes the importance of a countries institutional quality and derives the following two hypotheses: CAL generally increases income inequality and CAL leads to an especially high increase in income inequality if the institutional quality is low. These hypotheses are empirically tested based on a panel data set covering 159 countries from 1996 – 2009.
In the last decades the economies and financial systems of many countries liberalized and integrated with each other in order to benefit economically. However, at the same time income inequality and the gap between the extreme poor and the rich increased. The European Union is one of the regions with the most remarkable development regarding financial liberalization and integration. Some countries have been transformed within the last 25 years from centrally planned economies with controlled financial markets to market economies with open financial markets, integrated within the European Monetary Union.
On the one hand this financial liberalization and integration is argued to be an important reason for economic growth. However, on the other hand it is strongly related to the Euro currency crises which is currently the main challenge facing the EU and is discussed daily on the news. The lower- and middle-classes in particular are protesting against immense financial supports for banks and investors on the one side and wage reductions, unemployment and social benefit cuts on the other. Can these inequalities be explained by the increasing liberalization of financial markets?
Are they logical consequences of international financial liberalization and integration? This paper approaches these questions on a meta-level by answering the research question: How is Financial Market Liberalization Influencing Income Inequality? Before elaborating on this research question and explaining the investigated hypotheses it is explained what exactly is meant by financial market liberalization.
Table of Contents
1. Introduction
1.a. What are Liberalized Financial Markets?
1.b. Hypotheses and Structure of the Paper
2. Literature Review and Hypotheses
2.a. Reasons for Financial Market Liberalization and Integration
2.b. Capital Account Liberalization and Economic Growth
2.c. Capital Account Liberalization and Economic Stability
2.d. Capital Account Liberalization and Poverty / Income Inequality
3. Quantitative Research
3.1 Model Design
3.2 Data
3.2.a. Response Variable: Income Inequality
3.2.b. Explanatory Variable: Capital Account Openness
3.2.c. Explanatory Variable: Institutional Quality
3.2.d. Explanatory Variable: Economic Development
3.2.e. Logarithms, Polynomials, Lags, Binaries and Interaction Variables
3.3 Regressions and Causality
3.3.a. Interpretation of Basic Regressions
3.3.b. Crises, CAL and Income Inequality
3.3.c. Endogeneity and Instruments
3.3.d. Endogeneity Calculations
3.4 Quantitative Answers for Hypotheses
3.4.a. Open Capital Accounts generally Increase Inequality
3.4.b. Capital Account Liberalization leads to an especially high increase in income inequality if the institutional quality is low.
3.5 Sensitivity Analysis
3.5.a. Adjustment for Outliers
3.5.b. Alternative Proxies
4. Discussion of the Results
5. Conclusion
5.a. Summary of Results
5.b. Limitations and Further Research
5.c. Implications
Research Objectives and Topics
This thesis examines the influence of capital account liberalization (CAL) on income inequality, aiming to determine whether the opening of financial markets exacerbates wealth gaps and whether this effect is dependent on a country's institutional quality. The research investigates two primary hypotheses: that capital account liberalization generally increases income inequality and that this effect is particularly pronounced in countries with low institutional quality.
- The relationship between capital account liberalization and income inequality.
- The mediating role of institutional quality in the context of financial openness.
- The impact of international financial crises on income inequality dynamics.
- Empirical analysis of 159 countries using panel data from 1996 to 2009.
Excerpt from the Book
1.a. What are Liberalized Financial Markets?
Financial market liberalization consists of the reduction of regulations of financial institutions, financial transactions and equity markets. In order to understand the effects of financial market liberalization, the terms financial market and financial liberalization as well as open and integrated financial markets are elaborated upon in this section.
Madura (2011) defines a financial market as a “market in which financial assets (securities) such as stocks and bonds can be purchased or sold. … Financial markets facilitate the flow of funds and thereby allow financing and investing by households, firms, and government agencies” (p.3). It is thus the main task of financial markets to improve the allocation of funds by providing a framework allowing financing by the trading of financial securities.
According to Cobham (2002) financial liberalization is “the removal of perceived barriers to the freedom of financial markets – in particular, to the ability of deposit institutions to set their own interest rates and choose their own lending policy and recipients” (p.165). In addition, Kaminsky and Schmukler (2003) emphasize that financial liberalization is a multidimensional term. It consists out of the deregulation of the domestic financial sector, the foreign sector capital account and the equity market. The following paragraphs will shortly outline the links between these different parts before distinguishing between liberalized, open and integrated financial markets.
The domestic financial sector provides households, organizations and government agencies with capital, by granting credits or buying bonds. Whether it is additionally possible to acquire money from foreign investors or to invest in foreign companies depends on the degree of the country’s foreign sector capital account liberalization (CAL). The domestic financial sector and the foreign sector capital accounts are therefore closely related. Cobham (2002) explains that CAL “involves the removal of controls on domestic residents’ international financial transactions and on investments in the home country by foreigners” (p. 165).
Summary of Chapters
1. Introduction: Outlines the research focus on financial market liberalization and its potential link to rising income inequality, presenting the central research question and establishing the study's scope.
2. Literature Review and Hypotheses: Investigates theoretical perspectives and previous empirical studies regarding the impact of financial liberalization on economic growth, stability, and inequality, ultimately deriving two specific research hypotheses.
3. Quantitative Research: Details the empirical methodology, describes the dataset covering 159 countries, explains the model design, and presents the regression analyses used to test the hypotheses.
4. Discussion of the Results: Interprets the empirical findings, evaluates the validity of the hypotheses in the context of the gathered data, and discusses policy implications for managing the impacts of liberalization.
5. Conclusion: Summarizes the study’s central results, acknowledges limitations in operationalization and variable selection, and provides final recommendations for policy makers and future researchers.
Keywords
Financial Market Liberalization, Capital Account Liberalization, Income Inequality, Gini-coefficient, Institutional Quality, Economic Growth, Economic Stability, Volatility, Financial Crises, Policy Making, Panel Data Analysis, Developing Countries, Financial Openness, Global Finance, Wealth Gap.
Frequently Asked Questions
What is the central focus of this thesis?
The thesis investigates how the liberalization of capital accounts influences income inequality across 159 countries between 1996 and 2009, specifically testing whether this liberalization produces different outcomes based on a nation's institutional quality.
Which core thematic fields are addressed?
The work combines macroeconomic theory with empirical findings, focusing on capital account openness, income distribution, institutional infrastructure, and the role of economic volatility in generating inequality during crises.
What is the primary research question?
The central guiding question is: "How is Financial Market Liberalization Influencing Income Inequality?"
What scientific methods are applied?
The research employs an econometric panel data analysis, utilizing fixed effects models to explore the relationships between variables, and conducts sensitivity analyses to ensure the robustness of the results.
What is covered in the main body (Chapters 3-5)?
The main part of the work focuses on the quantitative testing of the hypotheses, the presentation of regression tables, the discussion of the results in light of economic theory, and the proposal of policy implications.
Which keywords best characterize this work?
Core themes are characterized by terms such as Capital Account Liberalization, Income Inequality, Institutional Quality, Economic Volatility, and Financial Crises.
Does the data support the hypothesis that low institutional quality makes CAL significantly worse?
The data did not support this specific hypothesis; the results indicated that capital account liberalization is generally associated with increased inequality, but it did not conclusively prove that low institutional quality acts as a significant amplifier of this effect.
Why are Latin American and Caribbean countries treated as a distinct group?
The empirical results revealed that the relationship between capital account liberalization and income inequality in Latin American and Caribbean countries significantly deviated from the global norm, warranting separate investigation and identification via interaction variables.
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- Daniel Jägers (Autor:in), 2012, How is Financial Market Liberalization Influencing Income Inequality?, München, GRIN Verlag, https://www.grin.com/document/1305803
