Financial Openness and Growth: 2000-2010

By Kennedy, Amy | Pepperdine Policy Review, January 1, 2013 | Go to article overview

Financial Openness and Growth: 2000-2010


Kennedy, Amy, Pepperdine Policy Review


I. INTRODUCTION

In light of the globalized concern to improve world economies, policymakers are faced with the difficult task of whether to implement policies to benefit their nation's economy such as increasing tariffs, quotas, or transaction taxes. Many countries are looking to impose additional taxes on financial transactions in order to boost revenue lost with the slump of the global economy. In fact, the European Union recently backed a financial transaction tax (FTT) implementation for ten European Union (EU) states (BBC News Business, 2012). If implemented, the EU could tax cross-border transactions such as purchases of securities, bank investments, and loans: for each financial transaction, the government would receive a percentage through the tax. Policymakers theorize that these taxes will be small enough not to impact overall transactions, and that with so many transactions on a day-to-day basis, the government would receive large revenues (BBC News Business, 2012).

These taxes and other transaction taxes such as the securities transaction tax (STT) are brought up by Congresses often enough (Wang & Yau, 2012, p. 2). The idea originated with England's Stamp Duty and is currently in place in countries such as England where currency transactions are taxed (Wang, p. 2). Proponents argue that FTTs "would increase government revenues that could be used for various purposes, including funding regulatory agencies" (Wang & Yau, 2012, p. 2). The argument is that certain capital flow restrictions would not impact economic growth and much needed revenue will be raised. Those who oppose FTTs argue "increase[d] price volatility, reduce[d] market liquidity, and decrease[d] price efficiency" would result, causing increased costs of capital and lower security values (Wang & Yau, 2012, p. 2). Yet, this tax appeals to many countries that face high deficits, reduced tax revenue due to unemployment, and dissatisfied constituents who wish to reduce global competition.

Despite the global context, a key question is whether or not this is the best solution for countries to increase revenue. For example, revenue can also increase through economic growth. Thus, it is possible that reducing financial openness is a more painful way for countries to raise revenue - reducing consumer spending power and growth. An alternative to imposing a restriction, such as a tax, would be to increase openness. This could potentially lead to increased growth and may be less painful for consumers in a slumped global economy.

In the context of the recent global economic crisis and the increasing pursuance of trade barriers such as higher tariffs or FTTs, this study seeks to examine how financial openness impacts annual growth: whether or not there is a significant relationship between the two. If there is a relationship, that should direct future policy decisions related to increasing growth of the global economy. Therefore, it is important to examine the relationship between growth and financial openness in order to produce the best policy solution. The current analysis focuses on the impact of open globalized financial markets in developed countries, and the change in annual GDP growth in relation to changes in financial openness.

The key variable examined in the study is financial openness. Financial openness is defined as the extent of openness in cross-border financial transactions (Chinn & Ito, 2007, p. 4). The Openness variable is composed of four sub-variables which measure various aspects of restricting capital accounts. The higher the values, the more open a country is in terms of crossborder transactions. In theory, policymakers should expect that financial openness would lead to higher growth because it allows for investment through spread risk and increased liquidity.

Before additional restrictions are placed on global financial transactions in the form of taxes, assessing the impact of financial openness on economic growth is a priority. …

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