Endogenous Financial and Trade Openness

42 Pages Posted: 28 May 2004 Last revised: 7 Sep 2010

See all articles by Joshua Aizenman

Joshua Aizenman

National Bureau of Economic Research (NBER)

Ilan Noy

Victoria University of Wellington

Multiple version iconThere are 2 versions of this paper

Date Written: May 2004

Abstract

This paper studies the endogenous determination of financial and trade openness. First, we outline a theoretical framework 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. De-jure restrictions on capital mobility have only a weak impact on de-facto financial openness, while de-jure restrictions on the current account have large adverse effect on commercial openness. Having established (Granger) causality, we investigate the relative magnitudes of these directions of causality using Geweke's (1982) decomposition methodology. 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%). We conclude that in an era of rapidly growing trade integration countries cannot choose financial openness independently of their degree of openness to trade. Dealing with greater exposure to financial turbulence by imposing restrictions on financial flows will likely be ineffectual.

Suggested Citation

Aizenman, Joshua and Noy, Ilan, Endogenous Financial and Trade Openness (May 2004). NBER Working Paper No. w10496, Available at SSRN: https://ssrn.com/abstract=546293

Joshua Aizenman (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ilan Noy

Victoria University of Wellington ( email )

P.O. Box 600
Wellington, 6140
New Zealand

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