Mauricio Larrain

Capital Account Liberalization and Wage Inequality

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Abstract:
This paper analyzes the distributional consequences of capital account liberalization. Opening the capital account allows financially constrained firms to borrow capital from abroad. I argue that since capital is more substitutable for unskilled workers and more complementary to skilled workers, liberalization increases the relative demand for skilled labor, leading to higher wage inequality. Using aggregate data and exploiting the variation in the timing of capital account reforms across 23 industrialized countries, I find strong evidence that opening the capital account increases wage inequality. In order to identify the mechanism driving this effect, I use sectoral data and exploit the variation in external financial dependence and capital-skill complementarity across industries. My findings show that capital account liberalization increases wage inequality particularly in industries with both high financial needs and strong complementarity. Overall, the results suggest that liberalization is a relevant driving force behind wage inequality.

Exact Citation:
Larrain, Mauricio. "Capital Account Liberalization and Wage Inequality." Columbia Business School, August 2012.
Date: 8 2012