Title: The Trade Effects of Financial Flow Liberalization: A Focus on Africa
Abstract: ABSTRACT The purpose of this paper is to empirically test the impact of financial flow regulation on international trade. An extended gravity model for 74 countries is employed to test the impact of capital restrictions and investment barriers on trade for the years 1995-1999. The results indicate that a 10 percent reduction in capital flow regulation will enhance international trade by roughly 1.7 percent for the entire sample, and roughly 1.2 percent for the nine African country subsample. The empirical results indicate that national income, geographic location, and freedom of exchange in financial markets are the primary determinants of bilateral trade in Africa. INTRODUCTION During the last three decades, international investment has been growing at over twice the rate of international trade. Yet, as with trade, the general public does not perceive intertemporal investment and other forms of asset transactions with foreigners as being welfare enhancing. For example, a recent Associated Press poll revealed that three out of five Americans were in favor of restricting foreign capital flows, and over half of all respondents agreed that foreign investment in the U.S. was dangerous. (Scheve & Slaughter, 2001). This negative sentiment toward international investment is pervasive worldwide as indicated by the many financial barriers that remain on foreign direct investment, foreign asset flows, and multinational bank lending. Research on the relationship between international investment and macroeconomic factors like economic growth and international trade are still in the early stages. The main problem is that researchers are faced with a lack of historical data and evidence. It was not until the 1980's that many countries started to dismantle the barriers to international investment that were erected after World War II. Moreover, the deepening of international investment to include many more types of assets like foreign direct investment (FDI) and international equity (stocks) is a recent phenomenon; it was only twenty years ago when nearly all of the international financing was in the form of bonds or bank lending. With the return of greater international investment, the risks of default and sudden reversal of investment flows have also grown. For example, in the early 1990's capital flows to developing countries rose to new heights, but defaults and sharp reversals in capital flows to Mexico in 1994, a number of East Asian countries in 1997, Brazil in 1998, and Russia in 1999, have caused concern about the volatility of unregulated international investment markets. It is not surprising that despite the potential welfare gains from international capital flows, there are frequent calls to manage the international investment sector. Despite these challenges, economists have discovered several benefits from international investment. Several studies have documented the positive effects of international investment on technological progress (Romer, 1993; Moran, 1998; Aitken & Harrison, 1999), savings and investment allocation (Feldstein & Horioka, 1980), economic growth (De Long & Summers, 1991; King & Levine, 1993; Borensztein, De Gregorio & Lee, 1998; Temple, 1998), and asset diversification (French & Poterba, 1991; Obstfeld, 1994). But there is little empirical evidence on how international capital flows impact international trade. The purpose of this paper is to estimate the size and significance of this association. In order to test the relationship between financial freedom and international trade, the paper is organized as follows: First, gravitational underpinnings are used to develop hypotheses about the effects of asset regulation on bilateral trade flows. The next section presents the cross-sectional results for the 74 country global sample. Third, a subsample of African countries is analyzed. The final section concludes with a review of the findings and the resulting implications. …
Publication Year: 2003
Publication Date: 2003-01-01
Language: en
Type: article
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Cited By Count: 2
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