Capital Account Liberalization and Income Inequality: A Panel Study of 28 European Countries

Abstract

Financial globalization has evolved from domestic policy to international scope policy. One of its form is capital account liberalization which can be observed from the declining number of restrictions among countries for cross-border financial transaction, and the increasing level of capital flow between countries. Europe crosscountry financial transaction has increased for the last three decades and this increase happened simultaneously together with that of income inequality as measured with Gini index. This condition indicates that there is a positive correlation between income inequality and capital account liberalization. This research aims to study whether income inequality corresponds to the increase of capital account liberalization in 28 European countries. Furthermore, this research seeks to understand the role of institutional quality and financial depth as threshold variables. By employing System GMM Estimator on balanced panel data, this study finds that capital account liberalization positively correlated with income inequality and institutional quality has proven to be an important threshold variable. These findings emphasize the urgency for policy makers to consider institutional quality before or during the implementation of capital account liberalization.

Keywords

• capital account liberalization
• gmm estimator
• income inequality
• institutional quality
• financial depth