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RWP 19-11, November 2019; updated September 2020

We propose a new explanation for why developing countries may fail to benefit from financial globalization, based on labor market institutions. In our model, a combiation of a rigid labor market and a low economywide productivity generates a low domestic interest rate in financial autarky. With financial openness, there is a net capital outflow and a worsening of domestic unemployment rate. In comparison, financial opening in a developing country with labor market flexbility produces improved employment. Similarly, financial opening in a developed country need not produce a worsening unemployment even with labor market rigidity. We show such predictions are broadly consistent with the patterns in the data.

JEL Classification: E24; J08; F41; F44

Article Citation

  • Du, Qingyuan, Jun Nie, and Shang-Jin Wei. "On the Perverse Effect of Capital Account Liberalization: the Role of Labor Market Rigidity." Federal Reserve Bank of Kansas City, Research Working Paper no. 19-11, November. Available at External Link