The Intergenerational and Dynamic Effects of Opening the Capital Account

Abstract

A basic theme in the theory of international trade has been to study welfare gains and income redistribution caused by trade liberalization. Using optimizing finite lives overlapping generations combined with long-term real assets and adjustment costs in accumulating capital, this paper establishes new current account and welfare redistribution results caused by financial liberalization.
After briefly describing the model for the closed economy case, we study the resulting evolution of the current account, the accumulation of capital, the real wage behavior and the adjustment of asset prices, when capital flows are allowed.
Under the mentioned framework, we are able to show that an unanticipated liberalization of the capital account can cause an overshooting or an undershooting in external debt behavior during the transition. Another consequence associated with the liberalization policy, is the creation of some transitional welfare losers, eventhough the welfare of steady state generations is improved.
By following appropriate compensatory policies, we can show that the country may achieve a Pareto welfare improvement for current alld future generations. As a wav of reducing the intergenerational redistributions induced bv the opening of the capital account, we discuss the alternative of adopting more gradual strategies of liberalization.