The Unassuming Economist

After countries remove restrictions on capital flows, inequality often gets worse

In June 1979, shortly after winning a landmark election, Margaret Thatcher eliminated restrictions on “the ability to move money in and out” of the United Kingdom, which some of her supporters regard as “one of her best and most revolutionary acts” (Heath, 2015).

Thatcher’s critics [have] regarded this same liberalization as starting a global trend whose “downside . . . proved to be painful” (Schiffrin, 2016). In their view, while the free mobility of capital across national borders confers many benefits in theory, in practice liberalization has often led to economic volatility and financial crisis. This in turn has adverse consequences for many in the economy, particularly for those who are not well off. Liberalization also affects the relative bargaining power of companies and workers (that is, of capital and labor, respectively, in the jargon of economists) because capital is generally able to move across national boundaries with greater ease than labor. The threat of being able to move production abroad reduces labor’s bargaining power and the share of the income pie that goes to workers.­

In studying such distributional effects of capital account liberalization, Davide Furceri and I found that after countries take steps to open their capital account, an increase in inequality in incomes within countries follows (Furceri and Loungani, 2015). The impact is greater when liberalization is followed by a financial crisis and in countries where there is low financial development—that is, where financial institutions are small and access to these institutions is limited. We also find that the share of income going to labor declines in the aftermath of liberalization. Thus, like trade liberalization, capital account liberalization can lead to winners and losers. But while the distributional effects of trade have long been studied by economists, the distributional impacts of opening the capital account are just starting to be analyzed.­

Read the rest of this (non-technical) summary of our results here: http://www.imf.org/external/pubs/ft/fandd/2016/03/furceri.htm

Here’s a link to the IMF Working Paper: http://www.imf.org/external/pubs/ft/wp/2015/wp15243.pdf

Earlier versions of this research, based on data for advanced economies, were featured on Krugman’s blog and in VoxEU. These new results extend our results to developing economies as well as lay out possible channels through which capital account liberalization leads to inequality.

A new IMF paper by Sami Ben Naceur and RuiXin Zhang “(…) provides evidence on the link between financial development and income distribution. Several dimensions of financial development are considered: financial access, efficiency, stability, and liberalization. Each aspect is represented by two indicators: one related to financial institutions, and the other to financial markets. Using a sample of 143 countries from 1961 to 2011, the paper finds that four of the five dimensions of financial development can significantly reduce income inequality and poverty, except financial liberalization, which tends to exacerbate them. Also, banking sector development tends to provide a more significant impact on changing income distribution than stock market development. Together, these findings are consistent with the view that macroeconomic stability and reforms that strengthen creditor rights, contract enforcement, and financial institution regulation are needed to ensure that financial development and liberalization fully support the reduction of poverty and income equality.”

My presentation today at CIGI tries to provide a framework for the IMF’s various recent policy forays and some of the key changes in IMF advice.

Figure 1 provides a measure of the global unemployment rate based on data for 116 countries, of which 37 countries are classified as ‘advanced’ (i.e. high-income) countries and the remaining 79 as ‘emerging market and developing economies.’ (We refer to the second group using the acronym ‘EMDE’.)

Let’s begin with how the global unemployment picture looked before the IMF’s January 2016 WEO Update. Figure 1 provides a measure of the global unemployment rate based on data for 116 countries, of which 37 countries are classified as ‘advanced’ (i.e. high-income) countries and the remaining 79 as ‘emerging market and developing economies.’ (We refer to the second group using the acronym ‘EMDE’.) Focusing on the recent cycle, global unemployment rate peaked in 6.2 percent in 2009 and has since been returning slowly to its pre-crisis level. Over the coming year, the global unemployment rate is expected to go up slightly.

To understand where this increase is coming from, Figure 2 shows the unemployment rate for the two main groups of countries separately. This reveals that the increase comes from the emerging markets and developing countries (EMDE) group. Moreover, the increase in unemployment among this group occurs because of the expected increase in unemployment among fuelexporting countries (Figure 3).

How will the growth revisions affect the unemployment picture?

Now let’s consider how the revisions to the growth forecasts that the IMF announced in the January 2016 WEO Update could change the unemployment picture. At the global level, the forecast for GDP growth in 2016 was revised down by 0.2 percent, which would in turn increase the global unemployment rate only a little bit above the path projected in Figure 1. However, for some countries the revisions in growth forecasts are larger, as shown in Figure 4 below. The biggest change is in Brazil, followed by Saudi Arabia, South Africa and Russia.

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