Legitimacy and the Political Sources of Financial Liberalisation

This paper seeks to clarify how domestic and international sources of legitimacy of economic globalization help explain financial liberalization across countries and time. It does so in reaction to the findings on a recent dataset by Abiad and Mody (2005) which suggest that such liberalization has little to do with standard notions of politics. The main findings of our own investigation, empirically focused on their dataset, are that both domestic and international factors influence financial liberalization by shaping what can be termed the “input” and “output” legitimacy of such liberalization. The former involves the involvement or representation of, and embrace by, stakeholders of financial openness in decisions to liberalize. And “output” legitimacy involves the actual distributional consequences, and management of such consequences, of such liberalization. First, we suggest that shifts to left partisanship, and the interaction of left partisanship and democracy, are important domestic sources of input legitimacy, while international voter support for free-market internationalism, as opposed to anti-capitalist closure, are important international sources of input legitimacy. Second, we suggest that some targeted social policy compensation – and not spending generally – might be important domestic sources of output legitimacy. And multilateral and bilateral aid might not only spur liberalization through the conditionality sometimes attached to such aid, but may also serve compensatory roles that constitute important international sources of output legitimacy. All these factors we see as relevant to input and output legitimacy turn out to significantly spur financial liberalization in the Abiad and Mody data, suggesting a realm of politics much broader and more important to financial openness than their study acknowledges