Dependencia Revisited: Financial Liberization and Inequality in Latin America

This study addresses a gap in current financial liberalization literature, which has heretofore focused on post-reform growth experiences. I shift focus to consider the effects of liberalization on income inequality, a prime determinant of standard of living in the developing world. Specifically, I look at Latin America due to its common historical experiences with respect to economic interactions with the developed world. I use pooled OLS, panel OLS with fixed effects, panel GLS with random effects, and finally a GMM technique derived from Arellano-Bond (1991), adding more and stronger assumptions at each step to analyze correlations between liberalization and changes in income inequality. Though the battery of tests, when viewed together, yields ambiguous results, the most compelling findings come with the inclusion of an interaction term between liberalization and institutional quality. In these specifications, liberalization, proxied by a measure called Financial Openness, enters positively and highly significantly. The negative and highly significant coefficients on the interaction terms indicate that liberalization can ameliorate or exacerbate inequality, depending upon the integrity of the institutions in place at the time of internationalization. This finding implies that weak institutions, rather than mere economic interaction with more developed economies, may be responsible for the inability of all groups in Latin America to reap the full benefits of integration into the global economy.