1. Introduction
The widespread progress on capital account liberalization, the massive increase in
financial flows across the borders, and the financial crises that hit emerging
economies in the ‘90s have stimulated a lively debate on the broad economic effects
of financial openness. This paper contributes to the debate by assessing whether
financial openness facilitates international trade in goods and services and per-capita
income catching-up across countries in Europe and the CIS. As the current wave of
globalization has generated widespread interest among national policymakers on the
factors and policies that best promote economic integration, the paper provides
empirical evidence on whether financial openness should be included among such
policies by focusing on two of the dimensions that most critically characterise the
process of economic integration, namely international trade and income convergence.
Several features characterise this paper relative to the existing literature. First, the
analysis specifically separates the concept of financial openness from that of
international financial integration. These two terms have often been used
interchangeably in the literature, but, in fact, they represent a mean-goal relationship1.
Financial openness is the process of lifting administrative or legal restrictions on
capital movements and hence creating the necessary conditions for the integration of
the domestic financial system into the global market. Thus, financial openness is
essential to achieve international financial integration, but the former does not
necessarily lead to the latter. Operationally, the analysis in this paper will employ
different empirical proxies: financial openness will be measured by an index of capital
account restrictions while international financial integration will be measured by
portfolio-based and equity-based capital flows.
Second, specific attention will be devoted to disentangling the effect of financial
openness from that of domestic financial development. As the two phenomena are
expected to be positively correlated, the variables used to proxy for financial openness
might also capture the effect of domestic financial development on the economic
performance. The consequence might be the overestimation of the actual impact of
financial openness. To address this problem, the econometric model will include
1 See, for instance, the discussions in De Brouwer (1999) and Le (2000).