Capital account liberalisation drives up real wages

Capital account liberalisation in developing countries is said to reduce the cost of capital, temporarily increase investment and permanently raise the level of gross domestic product (GDP) per capita. But critics claim that liberalisation brings few benefits and high costs, and since the restrictions on capital flows have been lifted, many countries are experiencing such financial crises that they question the merits of liberalisation.

A new study by the National Bureau of Economic Research (NBER) weighs the costs and benefits of liberalisation by examining the labour market. In a sample of 18 developing countries that opened their stock market to inflows of foreign capital between 1986 and 1993, they find that:

  • The average annual growth rate of the real wage in manufacturing jumped from 1.3 per cent per year in non-liberalisation periods to an average of 8.6 per cent in the year liberalisation occurred.

  • The temporary 7.3 percentage-point increase in the growth rate of the real wage permanently drove up the level of average annual compensation for each worker by about $752; an increase of more than a quarter of their annual pre-liberalisation salary.

  • Opening the stock market to foreign investment drives up real wages in the manufacturing sector of developing countries without eroding profitability.

    If workers gain and owners of capital do not lose, then why do countries wait so long to liberalise? The authors are cautious in addressing this question because their evidence only applies to manufacturing.

    Nevertheless, the evidence demonstrates that trade in capital has significant consequences for the real economy beyond its impact on prices and quantities of capital. Ceteris paribus, capital account liberalisation raises the average standard of living for a significant fraction of the workforce in developing countries.

    Source: Peter Blair Henry and Diego Sasson, Capital Account Liberalization, Real Wages, and Productivity, National Bureau of Economic Research, Working Paper No. 13880, March 2008.

    For text: http://papers.nber.org/papers/w13880

    For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17

    FMF Policy Bulletin/ 26 August 2008
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