When Don’t Developing Countries Benefit from Capital Account Liberalization? The Role of Labor Market Institutions

45 Pages Posted: 2 Dec 2019

See all articles by Qingyuang Du

Qingyuang Du

Monash University

Jun Nie

Federal Reserve Bank of Kansas City

Shang-Jin Wei

Columbia University - Columbia Business School, Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: November 27, 2019

Abstract

Many developing countries do not seem to benefit from capital account liberalizations. We find that labor market frictions can be an important reason for this and develop a model to explain the relationship between unemployment and capital account openness. In our model, a developing country with a flexible labor market tends to attract more capital inflow after capital account liberalization and hence, employment and output go up. On the other hand, when a developing country has a rigid labor market, opening the capital account leads to greater capital outflow and both employment and output fall. Such a pattern becomes less obvious in advanced economies. Using cross-country data from 1980 to 2004, we provide empirical evidence to support the theoretical predictions. When calibrating our model to Peru, which has a rigid labor market and opened its capital account in the 1990s, we find that 40% of the increase in the unemployment rate in Peru in that period is due to the capital account liberalization. One policy insight from our analysis is that for developing countries labor market reforms and capital account liberalization are complements.

Keywords: Unemployment, Labor Market Rigidity, Capital Account Liberalization, Developing Countries, Financial Openness

JEL Classification: E24; J08; F41; F44

Suggested Citation

Du, Qingyuang and Nie, Jun and Wei, Shang-Jin, When Don’t Developing Countries Benefit from Capital Account Liberalization? The Role of Labor Market Institutions (November 27, 2019). Federal Reserve Bank of Kansas City Working Paper RWP 19-11, November 2019, Available at SSRN: https://ssrn.com/abstract=3494416 or http://dx.doi.org/10.2139/ssrn.3494416

Qingyuang Du (Contact Author)

Monash University ( email )

23 Innovation Walk
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Clayton, Victoria 3800
Australia

Jun Nie

Federal Reserve Bank of Kansas City ( email )

1 Memorial Drive
Kansas City, MO 64198
United States
(816) 881-2255 (Phone)
(816) 881-2199 (Fax)

HOME PAGE: http://homepages.nyu.edu/~jn461/research.htm

Shang-Jin Wei

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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