"Capital Account Liberalization and Wage Inequality"
Publication type: Working paper
Research Archive Topic: Corporate Finance
This paper analyzes the distributional consequences of capital account liberalization. Liberalization leads to an inflow of foreign capital. I argue that since capital is more substitutable for unskilled workers and more complementary to skilled workers, this inflow of capital increases the relative demand for skilled labor, leading to higher wage inequality. I conduct a two-fold empirical strategy. First, I exploit the variation in the timing of capital account reforms across 23 industrialized countries. I find strong evidence that capital market integration increases wage inequality. Next, in order to pin down the mechanism driving this effect, I use sectoral data and exploit the variation in external financial dependence and capital-skill complementarity across industries. I find that capital account liberalization increases wage inequality particularly in industries with both high financial needs and strong complementarity. Overall, the findings suggest that capital market liberalization is a relevant driving force behind wage inequality.
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