The Politics of Financial Development: Evidence from Trade Liberalization

Authors

  • MATIAS BRAUN,

  • CLAUDIO RADDATZ

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    • Braun is from IM Trust and Universidad Adolfo Ibañez; Raddatz is from the World Bank. We are grateful to an anonymous referee and the Editor, whose suggestions greatly improved the paper. We also thank participants of seminars at the Federal Reserve Bank of Boston, University of California Los Angeles, University of California Santa Cruz, Latin American Finance Network, NBER Corporate Finance Meeting, University of Chicago, New York University, Emerging Markets Finance Conference, the World Bank, and Inter-American Development Bank for their comments. The following provided insightful comments: Ricardo Bebczuk, Thorsten Beck, Antonio Bernardo, Michael Brennan, Mark Germaise, Borja Larrain, Alejandro Micco, Enrico Perotti, Avanidhar Subrahmanyam, Aaron Tornell, and Luigi Zingales (NBER discussant). Braun thanks the Research Department of the Federal Reserve Bank of Boston and UCLA Anderson, where part of this research was conducted. We also thank Abdul Abiad and Ashoka Mody for generously sharing their data for an earlier version of the paper. The views expressed in this paper are the authors' only and do not necessarily represent those of the World Bank, its executive directors, or the countries they represent. This paper circulated previously under the title: Trade Liberalization and the Politics of Financial Development.


ABSTRACT

Incumbents in various industries have different incentives to promote or oppose financial development. Changes in the relative strength of promoter and opponent industries thus result in changes in the political equilibrium level of financial development. We conduct an event study using a sample of 41 countries that liberalized trade during 1970 to 2000, and show that the strengthening of promoter relative to opponent industries resulting from liberalization is a good predictor of subsequent financial development. The benefits of developing the financial system are insufficient for financial development, and rents in particular hands appear to be necessary to achieve it.

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