The influence of capital controls on long run growth: Where and how much?

Abstract

The financial crisis in East Asia generated a revival of interest in the merits of financial openness. The ensuing debate on the benefits of openness has focused more on short and medium run issues than on the long run effects. Within the empirical literature on economic growth, little or no attention has been paid to the effects of financial openness. Contrary to the orthodox position, the few results that exist suggest that capital controls have no effect on economic growth. This paper argues that this conclusion emerges from a failure to account for underlying differences across countries with similar degrees of capital controls. I show that the degree of ethnic and linguistic heterogeneity in a country plays a significant role in explaining the effects of controls on economic growth. For countries with relatively higher degrees of ethnic heterogeneity, the effects are particularly adverse whereas for countries with high degrees of homogeneity, capital controls actually have a net positive effect on economic growth. On balance, more developing countries suffered due to controls than not. Within the sample of 57 non OECD countries that did implement controls for the period 1975-95, as many as 39 saw a reduction in their growth rates. This result is robust to a number of variables commonly used in the economic growth regressions.

Financial Development and Economic Activity in Advanced and Developing Open Economies: Evidence from Panel Cointegration

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Capital flows to Asia and Latin America: Does institutional quality matter?

“…In contrast, non-FDI flows are considered more susceptible to reversal during crises (Sula & Willett, 2009). Based on capital controls and the performance of the financial markets, bank flows and other flows can affect economic growth (Chanda, 2005). For instance, Bekaert et al (2005) find that after controlling for broader capital account and trade liberalisation, there is significant growth effect of portfolio flows on long-run GDP growth.…”

Globalization, Economic Growth and Institutional Development in China

“…This finding is consistent with that of Alesina et al (1994) who find FDI shows evidence of a positive growth effect in countries which are sufficiently rich (Dreher, 2006;) and a negative one in lower income countries. Chanda (2001) even points out that developing countries are more likely to suffer from globalization than not. How does globalization adversely affect growth within a developing country?…”