Financial Integration, Trade and Growth

Abstract

This study adds to vast literature on financial integration and its impact on growth by suggesting that trade level should be more carefully considered to assess the effect of reduction of capital restriction. The study argues that the impact of financial openness on growth varies among countries with different level of trade openness. Some previous studies using rule-based index of capital restriction argue that financial liberalization promotes growth, but this argument does not hold for countries with low trade openness. However, the degree of impact of financial liberalization on growth monotonically increases as countries level of trade openness increases. For low-level countries, insufficient commercial opening not preceded by financial market liberalization are exposed to greater external risk when capital restriction is reduced. Hence, capital restriction is indeed important to mitigate current account reversals. Countries with highly integrated trade sector are positively affected by opening financial sector possibly as they are relatively safe to sudden-stop and current account reversal risk. Sufficient degree of commercial opening seems to be a prerequisite for countries to reap benefit from financial liberalization. Thus one should be cautious that there is no one-size-fits-all policy of financial liberalization.