The Welfare Gains Of Financial Liberalization: Capital Accumulation And Idiosyncratic Risks

From a simple (theoretical) growth argument, financial integration enables capital scarce countries to raise capital inflows with positive effects on investment and on the speed of convergence. The authors first show that in a complete markets neoclassical growth model that although financial openness increases welfare, its quantitative effects are limited. However, they also show that when agents face uninsurable idiosyncratic risks on income and borrowing constraints the welfare implications of financial liberalization are sizeable. For instance, the average welfare of a typical emerging market economy that switches from financial autarky to perfect capital mobility would increase by roughly 7.5 percent of consumption equivalent.