RDP 9602: Consumption and Liquidity Constraints in Australia and East Asia: Does Financial Integration Matter? 5. Implications for Welfare and Policy

In terms of the neo-classical model outlined in Section 2, eliminating financial repression whatever the stage of development must improve household welfare, and so the policy implication would seem to be straight-forward. Things are probably not that simple since the analysis is partial in that it ignores capital accumulation and growth. In Barro, Mankiw and Sala-i-Martin's (1995) neo-classical model of economic convergence, for example, financial openness is not the decisive factor in growth since the bulk of the capital stock is human capital and only real capital can be financed externally. Ideally, in this framework, a saving-deficit country would borrow on foreign markets to finance investment in real capital and would borrow on local markets to finance investment in human capital. In the earlier stages of development, however, the mobilisation of domestic saving may be necessary to finance real capital accumulation in order to build up the physical capital which secures acceptance of the country by foreign lenders, and so initially limiting access by households to domestic financial markets may be required. But once some productive capital is in place, maintenance of controls on household borrowing is difficult to justify because there is a welfare loss in preventing households from smoothing consumption. Moreover, access to consumer credit augments the accumulation of human capital since households have access to funds for better education, better accommodation and higher living standards. The maintenance of controls on household credit in countries like Korea or Taiwan would seem difficult to justify from the welfare perspective.

The results also suggest a loose hierarchy of countries in terms of constraint – very roughly from least to highest, Australia, Hong Kong, Singapore, Japan, Korea, Thailand and Taiwan – and it is interesting to ask how this fits with the structure of their macroeconomies. Table 5 below sets out the profile of saving, investment and current account balance for these countries over the past 15 years. It would seem that there is no correspondence between this hierarchy and current account balance, which is not surprising since the current account balance reflects not just private consumption decisions but also public consumption and private and public investment. Financial openness has no discernible impact on current account performance. It would also seem that there is no clear correspondence between this hierarchy and saving performance: the constraint is not less binding for countries with higher saving rates. Nor is it generally apparent that countries with forced saving occupy a clearly identifiable place in the hierarchy. On the other hand, it may be instructive that for the three most financially open economies in the region, liquidity constraints appear more binding for Singapore, which has a long-established compulsory saving system, than Australia or Hong Kong.