Abstract
This paper investigates the impact of financial openness on financial sector development and income inequality. We use two approaches to capture financial openness for a panel dataset of 52 African countries from 1980–2019 and find that: (1) Principle-based financial openness policy negatively affects financial sector development and widens income inequality. In contrast, the outcome-based measures positively affect banking sector development and narrow income inequality. (2) Capital inflow to African countries is not merely pulled a vibrant macroeconomic fundamental. Only schooling and governance factors facilitate the impact of financial openness on financial sector development. (3) Adverse non-policy factors play an insignificant role in moderating the impact of financial openness. This implies that the impact of financial openness on financial sector development and income inequality is weak in countries experiencing a banking crisis or passing through a lengthy conflict. Our finding is consistent with the institutional quality theory, which claims robust institutions are needed. We underline that countries should take caution in implementing principle-based reforms. Particularly, there is an alternative policy path for African countries to optimize the benefit by pursuing outcome-based financial openness measures.
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Notes
Note.
(1) Principle based openness policy refers to the Chinn-Ito index which measures a country’s degree of capital account openness (Chinn and Ito 2006). These policies are implemented via capital account restrictions. We use de jure/Kaopen interchangeably to represent the principle-based financial openness measure.
(2) Outcome based openness policy is represented by de facto which is the sum of total assets and liabilities divided by GDP from (Lane and Milesi-Ferretti 2018).
(3) Throughout the paper the word finance and financial sector development are used interchangeably to represent the development in the banking and stock market.
(4) In the latter stage, the outcome-based openness measure is decomposed into foreign direct investment net inflow % of GDP (FDI net inflow) and de facto. While the former is interacted with the US adjusted real interest rate (FDI X Push), the latter interacted with extensive pull factors.
The French and English traditions in monetary theory and history have been different. The French tradition has stressed the passive nature of monetary policy and the importance of exchange stability with convertibility; stability has been achieved at the expense of institutional development and monetary experience. The British countries by opting for monetary independence have sacrificed stability, but gained monetary experience and better developed monetary institutions” (Mundell 1972).
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Ashenafi, B.B., Dong, Y. Decomposing the impact of financial openness on finance and income inequality: principle vs. outcome-based approaches from Africa. Econ Change Restruct 57, 35 (2024). https://doi.org/10.1007/s10644-024-09638-5
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DOI: https://doi.org/10.1007/s10644-024-09638-5