Political Economy Aspects of Trade and Financial Liberalization: Implications for Sequencing

Abstract

This paper integrates a two-period overlapping generations model with a standard two-sector Hecksher-Ohlin trade model and analyzes the impact of uncertainty on domestic investment in the exportable and importable sectors, the political economy linkages between trade and financial liberalization, and the implications for sequencing. Under certain assumptions financial liberalization leads to a movement of resources in the opposite direction to that implied by trade liberalization, thus defeating one of the objectives of tariff reform. When political economy linkages are taken into account, however, the indirect effects of financial liberalization may offset the direct effects and encourage a movement of resources in the desired direction.

Keywords: Investment, Uncertainity, Political Economy, Financial Liberalization, Trade Liberalization

JEL Classification: E21, E22, E25, F1, F21