What do our indicators tell us?
Figure 1: Patterns in Capital Account Openness in 2005. Source: Chinn and Ito, “A New Measure of Financial Openness” (2007) [pdf].
Globalization is a phenomenon often documented by way of anecdote. It’s also often documented by way of referring to statistics.
For trade one can recount trends in the ratio of exports plus imports to GDP. For financial integration, one can look to how
large cross-border transactions are, either in flow or stock terms. The latter is the approach undertaken by Lane and Milesi-Ferretti (e.g., here and here), using the cross-country data base they compiled.
Another way of examining financial integration is by way of tabulating the restrictions on capital account transactions. There are a variety
of indicators that take the de jure restrictions and code them as either a continuous variable (Quinn) or as a binary variable (“on” or “off”).
I, along with Hiro Ito at PSU, have constructed a data set based upon a coding of the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions, hereafter AREAER.
Figure 1 depicts financial openness, as measured by our index, country by country in 2005. The top 25th percentile in openness are depicted in dark red, while the lowest 25th percentile in lightest pink.
This index is the first principal component of four categories of restrictions.
- The existence of multiple exchange rates (k1)
- Restrictions on current account transactions(k2)
- Restrictions on capital account transactions (k3)
- requirement of the surrender of export proceeds (k4)
While one’s primary interest in developing a measure of capital openness, the indicator variable on k3 is a very poor indicator on its own of the openness of the capital account. It’s a binary variable, which does not indicate on its own the stringency of restrictions of capital controls. Hence, we smooth k3 by using a 5 year trailing moving average. We then use k1-2 and k4 to provide additional information regarding capital account openness, using the presumption that the existence of other restrictions on international transactions will be correlated with how restrictive the capital
account regulations are.
We don’t argue that our measure is the best. As we discuss in the paper, there are several indicators in circulation. The greatest virtue of our mesure is its wide coverage — about 180 countries — and long sample period, starting in 1970.
The behavior of our index appears to conform to priors. Figure 2 indicates that capital account openness across the world has
increased over time, albeit slowly (green bars). However, the figure also highlights the variability in capital account
liberalization. Industrial countries started from a higher base and have liberalized throughout the past 35 years. Emerging market economies only began liberalization in the 1990s.
Figure 2: Average indices by period subsamples and country groupings. Source: Chinn and Ito, “A New Measure of Financial Openness” (2007) [pdf].
Figure 3 shows the regional variation in liberalization amongst LDCs. One observation is that capital account openness has not trended upward monotonically; Latin America experienced some retrenchment in the wake of the debt crises of the early 1980s. Another observation is that South Asia/Middle East/Africa has been the slowest to open up. In contrast, Eastern Europe has undertaken the most rapid dismantling of restrictions.
Figure 3: Average indices by period subsamples and LDC regional groupings. Source: Chinn and Ito, “A New Measure of Financial Openness” (2007) [pdf].
So when you hear the conclusions of a model that assumes that capital is mobile, check to see which countries look likely to fit that characterization.
The index has been used in the following papers. Chinn and Ito, JDE 2006 [pdf] on financial development; Cheung, Chinn and Fujii, JIMF f’coming [pdf] on the RMB; Chinn and Ito, JIMF f’coming [pdf] on the saving glut; Joyce and Noy, RIE f’coming [pdf] on the IMF and capital liberalization; Mendoza, Quadrini and Rios-Rull [pdf] on imbalances; di Giovanni and Shambaugh (2005) [pdf] on interest rate links; Eichengreen and Leblang (2007) [pdf] on democracy and globalization; Eichengreen and Razo-Garcia EP (2006) [pdf] on exchange rate regimes; Brooks, World Politics (2004) [pdf] on determinants of liberalization.