Catching Up by Deglobalization: Capital Account Policy and Economic Growth

Abstract

We examine the role of capital account policy pertaining to productivity growth and labor allocation at the sectoral level. Using panel data from 45 countries from 1985–2012, we find that capital controls combined with reserve accumulation — strategic capital account policy — contribute to the real GDP (TFP) growth through the enhancement of labor productivity in the manufacturing sector. While conventional wisdom shows a mixed result of capital account restriction on economic growth, we claim that the effect of closed capital account is positive if accompanied with large reserve hoardings. Second, we show that the policy is strongly associated with a larger scale with regard to the manufacturing sector. Our work is consistent with the hypothesis of growth through reallocation, as in Rodrik (2008); reserve accumulation combined with capital controls devalues real exchange rates and reallocates the labor to the manufacturing sector. As learning-by-doing externality comes with the scale of the manufacturing sector, the combined policy facilitates long-running productivity growth.

Keywords: foreign exchange reserves, capital control, emerging economies, resource reallocation, dynamic panel estimation

JEL Classification: C23, E58, F21, F31, F41