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Financial Globalization, Fiscal Policies and the Distribution of Income

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Abstract

This paper provides evidence that financial globalization—liberalization of the capital account—makes income distribution more uneven by raising the share of income that goes to the richest income deciles. We also offer evidence that changes in domestic fiscal policies in the aftermath of financial globalization are one channel through which these distributional effects could occur. Specifically, we show that episodes of capital account liberalization are followed by greater fiscal consolidation and reduced fiscal redistribution, both of which lead to increased inequality.

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Notes

  1. Furceri et al. (2019) also find that the impact of capital account liberalization on output is, on average, small and statistically insignificant. The uncertain aggregate benefits associated with capital account liberalization have also been documented in the previous literature (Eichengreen 2001; Prasad et al. 2003; Edison et al. 2004; Kose et al. 2009), while the distributional impacts appear to be quite strong (Jayadev 2007; Larrain 2015; Furceri and Loungani 2018).

  2. See Chinn and Ito (2008) for details on the methodology.

  3. In addition to Furceri et al. (2019), a similar strategy has been followed in previous papers to identify episodes of stock market liberalizations (Henry 2007) and labor and product market reforms (Bernal-Verdugo et al. 2013; Bouis et al. 2012).

  4. Data on top income shares are taken from Atkinson, Piketty and Saez (2011).

  5. See Ostry et al. (2009) for a description of how the data are constructed.

  6. We use real debt rather than the debt-to-GDP ratio to isolate the effect of capital account liberalization on fiscal discipline from the effect on GDP. Data on income inequality are taken from the Standardized World Income Inequality Database (SWIID 5.1). The SWIID includes measures of net (post-tax, post-transfers) and market (pre-tax, pre-transfers) income.

  7. In this case, we look at the effect of capital account liberalization on net Gini.

  8. The main advantage of this approach relative to estimating SVARs for each regime is that it uses a larger number of observations to compute the impulse response functions of only the dependent variables of interest, improving the stability and precision of the estimates. This estimation strategy can also more easily handle the potential correlation of the standard errors within countries, by clustering at the country level.

  9. The specification also includes redistribution not interacted.

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Authors and Affiliations

  1. IMF’s Asia and Pacific Department, International Monetary Fund., Washington, USA

    Davide Furceri

  2. IMF’s Independent Evaluation Office, Washington, USA

    Prakash Loungani

  3. IMF’s Asia and Pacific Department and Research Fellow, CEPR, Washington, USA

    Jonathan Ostry

  4. Department of Economics, University of Palermo, Palermo, Italy

    Pietro Pizzuto

Authors
  1. Davide Furceri
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  2. Prakash Loungani
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  3. Jonathan Ostry
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  4. Pietro Pizzuto
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Correspondence to Prakash Loungani.

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Furceri, D., Loungani, P., Ostry, J. et al. Financial Globalization, Fiscal Policies and the Distribution of Income. Comp Econ Stud 62, 185–199 (2020). https://doi.org/10.1057/s41294-020-00113-4

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