Assessing the Causes of Capital Account Liberalization: How Measurement Matters¹

Abstract

Why do countries open their economies to global capital markets? A number of recent articles have found that two types of factors encourage politicians to liberalize their capital accounts: strong macroeconomic fundamentals and political pressure from proponents of open capital markets. However, these conclusions need to be re-evaluated because the most commonly used measure of capital account openness, Chinn and Ito's (2002) Kaopen index, suffers from systematic measurement error. We modify the Chinn-Ito variable and replicate two studies (Brooks and Kurtz 2007;Chwieroth 2007) to demonstrate that our improved measure overturns some prior findings. Some political variables have stronger effects on capital account policy than previously recognized, while macroeconomic fundamentals are less important than previous research suggests.

Regulatory quality, financial integration and equity cost of capital

“…Therefore, some components of the variable would be endogenous to any independent variable lagged less than five periods. This has been pointed out in the literature as well (Karcher & Steinberg, ; Quinn, Schindler, & Toyoda, ). Some firms in the data are cross‐listed in other countries.…”

Measurements of Capital and Financial Current Account Openness

“…from t À 4 through t. 14 KAOPEN is the first standardized principle component of four AREAER table variables. Higher scores indicate greater financial openness as both a function of current and capital accounts. Ito (2002, 2007) make some simplifying assumptions to construct KAOPEN 15 (see Karcher and Steinberg, 2010, for a discussion of KAOPEN and its uses). We have three cautionary notes for investigators using measures derived from the AREAER table in both its past and current forms.…”

“…The Conservative Thatcher Government undertook a complete liberalization of UK capital and financial current account transactions in June, July, and October of 1979 (IMF, 1980, pp. Investigators using KAOPEN as a dependent variable in panel models with annual data should be aware that some of the information in KAOPEN for any given year has its origins in prior years (see Karcher and Steinberg, 2010, for a discussion of the implications of using KAOPEN as a dependent variable in econometric analysis). KAOPEN changed from a value of À 0.76 to a value of 1.46 from 1978 to 1979, reflecting these changes.…”

What We Talk About When We Talk About Foreign Direct Investment

“…This paper contributes not only to the empirical literature on FDI in political science, it also matters for the growing literature on construct validity in international political economy. For example, Quinn, Schindler, and Toyoda () and Karcher and Steinberg () illustrate both the diversity of plausible measures and the pitfalls of mismatching data to theory with respect to capital controls and financial integration. This paper makes a similar intervention with respect to FDI.…”

“…Distance is taken from the correlates of war data set. Capital account openness is taken from Karcher and Steinberg (). Descriptive statistics for all variables are included in the Table .…”