The Political Economy of Financial Liberalisation

Political economy theories of financial development argue that in countries where a narrow elite controls political decisions, financial development may be deliberately obstructed to deny access to finance to potential competitors. This paper empirically examines whether the level of liberalisation of the banking system, the stock market and capital account depend on regime characteristics, using panel data from 26 countries from 1973 – 1999. Our results show that it is predominantly fully democratic regimes that have liberalised financial systems. Countries that are not fully democratic have a lower probability of having liberal banking systems and capital accounts and this probability decreases with increasing democratisation. This suggests that the attractiveness of using financial levers to allocate funds in the economy increases with the amount of competition the government faces, although a fully competitive electoral system creates incentives to relinquish financial control.