NBER Working paper #14636, with Indrit Hoxha and Sebnem Kalemli-Ozcan

Abstract

We compare welfare in a calibrated neoclassical model of consumption under autarky to welfare under financial integration. The estimated welfare gains of integration depend intimately on the assumed speed of convergence between domestic and world rates of return. Using observed data from 1960--2000 to derive the initial fundamental characteristics for each of 92 countries, we parameterize the convergence process and calculate welfare under different assumptions regarding rates of convergence. Allowing for realistic rates, we calculate that welfare is nearly six times larger than previously found. Expanding our analysis to include the productivity gains from the inflow of FDI implies welfare gains twelve times larger than found before. Our results indicate substantial gains from international financial integration arising from persistent differences in fundamentals across nations.