Estimating the Effects of Financial Liberalisation on Governability and Social Stability
| Published date | 01 November 2024 |
| DOI | http://doi.org/10.1177/00157325231173209 |
| Author | Carlos Chavez |
| Date | 01 November 2024 |
Estimating the Effects of
Financial Liberalisation
on Governability and
Social Stability
Carlos Chavez1
Abstract
This article studies the effects of financial liberalisation on governability. The
dependent variables measure governability in terms of control of corruption,
government effectiveness, political stability, rule of law, regulatory quality and
free speech for 125 countries from 1996 to 2019. As a variable measuring
financial liberalisation, I use the Chinn-Ito index and Fernandez index as capital
control measure. I use fixed-effects panel data, quantile regression, system GMM
and event study to estimate these effects. The results I find show that the finan-
cial liberalisation has strong effects on those governability variables, especially
low-income countries tend to have a higher sensitivity to changes in capital con-
trols on governability and social stability, as well as countries in the 0.4–0.6 quan-
tiles of the governability. Finally, I find that these effects take at least one year to
become persistent over time. These findings imply that, in times of political tur-
bulence and instability, governments may pursue liberalising policies that increase
the dynamism of the economy to alleviate the climate of ungovernability.
JEL Codes: F38, D72, P16
Keywords
Financial liberalisation, capital controls, governability
Introduction
Montesquieu, in 1758, mentioned that trade brought peace because countries trad-
ing with each other, in case they went to war, would harm the bilateral income
Original Article
1 Faculty of Economics Sciences, Universidad Nacional Mayor de San Marcos, Lima, Peru
Corresponding author:
Carlos Chavez, Faculty of Economics Sciences, Universidad Nacional Mayor de San Marcos, Lima, Peru.
E-mail: carlos.chavez2@unmsm.edu.pe
Foreign Trade Review
59(4) 588–614, 2024
©2023 Indian Institute of
Foreign Trade
Article reuse guidelines:
in.sagepub.com/journals-permissions-india
DOI: 10.1177/00157325231173209
journals.sagepub.com/home/ftr
Chavez 589
they obtained from trading. Furthermore, this position on trade and peace has
been advocated by the liberal spectrum.
In the 1990s, a series of reforms called the ‘Washington Consensus’ were
implemented and adopted by several countries, especially emerging and devel-
oping countries. These reforms were intended to allow economies to integrate
with the world from a trade perspective; see Little et al. (1993), Sharer and Sorsa
(1998) and Subramanian (2000). There has also been a preference for right-wing
governments to apply these reforms, see Alesina and Roubini (1992); however,
there have also been left-wing governments that have applied these kinds of
reforms and that have been more credible to the electorate, see Cukierman and
Tommasi (1998).
From these processes of economic liberalisation, most studies have addressed
the relationship between trade liberalisation and peace in terms of democracy and
political stability. However, the literature that analyses the effects of financial liber-
alisation processes on governability and social stability is relatively scarce. As there
has yet to be a consensus on the effects of financial liberalisation on political stability
and governance, this article arises as a motivation to understand the link between
these two variables. Therefore, the objective of this article focuses on the other side
of openness, which is financial openness, understood as financial liberalisation.
This question is relevant from an empirical perspective since due to the great
financial crisis (GFC) and its adverse effects, the debate on capital controls as a
policy to protect itself gained strength. Moreover, these debates are not only found
at the academic level, see Eichengreen (2010), but also at the political level, see
Wade and Sigurgeirsdottir (2012), for the case of Iceland. Since this crisis, many
low- and middle-income countries started to become more restrictive with capital
controls. Something similar happened in the late 1990s with the Asian crisis.
Figure 1 shows the evolution of capital control across income country groups;
this variable is constructed in Chinn and Ito (2006) and fluctuates from 0 to 1,
where 1 is free capital mobility in each country, and 0 is fixed capital control.
It is observed that high-income countries have had an increasing trend towards
financial liberalisation, while low-income countries from the early 2000s began a
decline and are now relatively constant. Middle-income groups have been open to
the movement of capital until before the GFC, when they began to become more
restrictive and stagnated.
On the other hand, I measure governance and social stability based on six
measures control of corruption, government effectiveness, political stability and
absence of terrorism, rule of law, regulatory quality, and voice and accountability.
In section three, I further describe these variables. From Figure 2, governance
has had to fall significantly for these low-income countries in all the measures
mentioned; on the other hand, for middle-income countries, there is a relatively
stable trend, see Figure 2.
Now, studying the effects of capital account control/laxation on governance
and social stability is also important at a theoretical level, as we understand that a
measure such as capital accounts has an impact not only on economic activity, see
Ang and Mckibbin (2007), but also on the social stability of a country.
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