2004 Reports

Capital Market Liberalization, Poverty and Inequality

Cobham, Alex

Research has typically addressed capital account liberalisation in terms of its growth effects. While no systematic growth benefits have been identified, potentially damaging poverty and inequality impacts have been overlooked. This paper identifies a number of channels through which these may occur. For policymakers, these are: increased instability of government finances, restricted policy freedom through "market discipline" and the direct costs of managing inflows. Financial market and industrial structure effects include: greater volatility in access to finance for households and small businesses, increasing industrial concentration and shifts in taxation away from capital and towards labour and consumption. The paper makes a number of suggestions to address these potential dangers of liberalisation. These include measures to encourage the taking of longer-term positions in developing country markets by institutional investors in richer countries, and support for reserve requirements on capital inflows. The paper finally argues that requirements for equal treatment of investors (in WTO negotiations or elsewhere) should be resisted, where this is likely to prevent policymakers taking a selective approach to foreign direct investment.