Financial Openness, Democracy, and Redistributive Policy

The debate about the relationship between democratic forms of government and the free movement of capital across borders dates to the 18th century. It has regained prominence as capital on a massive scale has become increasingly mobile and as free...

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Bibliographic Details
Main Author:	Dailami, Monsoor
Format:	Policy Research Working Paper
Language:	English en_US
Published:	World Bank, Washington, DC 2014
Subjects:	AGGREGATE DEMAND AGRICULTURE ASSET MANAGEMENT AUTONOMY BALANCE OF PAYMENTS BANK LOANS BANK RUN BANKING REGULATION BANKING SUPERVISION BENEFIT ANALYSIS BONDS BORROWING BORROWING COSTS CAPITAL ACCOUNT CAPITAL CONTROLS CAPITAL FLIGHT CAPITAL FLOWS CAPITAL MARKETS CAPITAL MOBILITY CAPITALIZATION CENTRAL BANK CENTRAL BANK GOVERNORS CHRONIC INFLATION CIVIL SOCIETY CONSOLIDATION CONSUMER PREFERENCES CORPORATE GOVERNANCE COST OF CAPITAL CRITICAL SOCIAL CURRENT ACCOUNT DEBT DEMOCRATIC INSTITUTIONS DEMOCRATIC SOCIETIES DEVELOPING COUNTRIES ECONOMIC ACTIVITY ECONOMIC CONDITIONS ECONOMIC EFFICIENCY ECONOMIC GROWTH ECONOMIC RESEARCH EMERGING MARKET ECONOMIES EMPIRICAL ANALYSIS EMPIRICAL EVIDENCE EMPIRICAL RESEARCH EXCHANGE RATE EXCHANGE RATE ARRANGEMENTS EXCHANGE RATE REGIME EXCHANGE RATES EXPORTS EXTERNAL DEBT FINANCIAL CRISES FINANCIAL CRISIS FINANCIAL ENVIRONMENT FINANCIAL INNOVATION FINANCIAL INSTITUTIONS FINANCIAL INTEGRATION FINANCIAL MARKET VOLATILITY FINANCIAL MARKETS FINANCIAL OPENNESS FINANCIAL REGULATION FINANCIAL RESOURCES FINANCIAL SECTOR FINANCIAL SERVICES FINANCIAL STABILITY FINANCIAL SYSTEM FINANCIAL TRANSACTIONS FINANCIAL VOLATILITY FISCAL DEFICITS FISCAL POLICY FOREIGN ASSETS FOREIGN EXCHANGE FOREIGN EXCHANGE MARKETS FREE MARKETS FULL EMPLOYMENT GDP GLOBALIZATION GOVERNMENT EXPENDITURES GOVERNMENT INTERVENTION HUMAN CAPITAL IMPORTS INCOME INDUSTRIAL COUNTRIES INFLATION INFLATION RATES INSURANCE INTEREST RATE INTEREST RATES INTERNATIONAL BANKING INTERNATIONAL FINANCIAL TRANSACTIONS INTERNATIONAL POLICY COORDINATION INTERNATIONAL TRADE INVESTMENT OPPORTUNITIES LIQUID ASSETS LIQUIDITY MACRO POLICY MACROECONOMIC MANAGEMENT MACROECONOMIC POLICY MACROECONOMIC STABILITY MACROECONOMIC STABILIZATION MACROECONOMIC VARIABLES MACROECONOMICS MARGINAL COST MARGINAL WELFARE COSTS MARKET INTEGRATION MARKET VALUE MATURITIES MONETARY AUTHORITIES MONETARY POLICY MORAL HAZARD NATIONAL ECONOMIES OIL OIL PRICES PAYMENT IMBALANCES PER CAPITA INCOME POLICY RESEARCH POLITICAL ECONOMY PORTFOLIO DIVERSIFICATION POVERTY ALLEVIATION POVERTY REDUCTION PRICE STABILITY PRIVATIZATION PROPERTY RIGHTS PUBLIC ENTERPRISES PUBLIC EXPENDITURES PUBLIC GOODS REDISTRIBUTIVE TAXATION REGULATORY RESPONSES RENT SEEKING RENT SEEKING BEHAVIOR RISK AVERSE RISK AVERSION RISK DIVERSIFICATION RISK PREMIA SAVINGS SECURITIES SHORT-TERM TRANSACTIONS SOCIAL COSTS SOCIAL SECURITY SOCIAL SERVICES STANDARD DEVIATION STOCK MARKETS TRADE LIBERALIZATION TRANSACTION COSTS TRANSFER PAYMENTS TRANSPARENCY UNEMPLOYMENT WEALTH WELFARE ECONOMICS WELFARE GAINS
Online Access:	http://documents.worldbank.org/curated/en/2000/06/437065/financial-openness-democracy-redistributive-policy http://hdl.handle.net/10986/19832

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Summary:	The debate about the relationship between democratic forms of government and the free movement of capital across borders dates to the 18th century. It has regained prominence as capital on a massive scale has become increasingly mobile and as free economies experience continuous pressure from rapidly changing technology, market integration, changing consumer preferences, and intensified competition. These changes imply greater uncertainty about citizens' future income positions, which could prompt them to seek insurance through the marketplace or through constitutionally arranged income redistribution. As more countries move toward democracy, the availability of such insurance mechanisms to citizens is key if political pressure for capital controls is to be averted and if public support for an open, liberal international financial order is to be maintained. The author briefly reviews how today's international financial system evolved from one of mostly closed capital accounts immediately after World War II to today's enormous, largely free-flowing market. Drawing on insights from the literature on public choice and constitutional political economy, the author develops an analytical framework for a welfare cost-benefit analysis of financial openness to international capital flows. The main welfare benefits of financial openness derive from greater economic efficiency and increased opportunities for risk diversification. The welfare costs relate to the cost of insurance used as a mechanism for coping with the risks of financial volatility. These insurance costs are the economic losses associated with redistribution, including moral hazard, rent-seeking, and rent-avoidance. A cross-sectional analysis of a large sample of developed and developing countries shows the positive correlation between democracy (as defined by political and civil liberty) and financial openness. More rigorous econometric investigation using logit analysis and controlling for level of income also shows that redistributive social policies are key in determining the likelihood that countries can successfully combine an openness to international capital mobility with democratic forms of government.

Financial Openness, Democracy, and Redistributive Policy

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