The Diffusion of Financial Liberalization in Developing Countries

Over the past three decades, many developing countries have liberalized their capital accounts. Recent studies suggest that these policy changes were interdependent and diffused through networks of peers. This article strengthens the literature on the diffusion of financial liberalization in several ways. Theoretically, we distinguish between concrete and more amorphous causal processes by which policies are diffused. We argue that networks vary by degree of interdependence, structure, and self-selection and hypothesize that diffusion of liberalization policies is more likely across networks that are more structured, interdependent, and self-selected, such as regional integration agreements (RIAs). Empirically, we employ both an aggregate measure of openness as well as a policy-to-policy measure of capital control transmission. Based on panel data for 114 emerging economies over 1973-2002, we replicate the finding of multiple diffusion processes using the aggregate measure, but find these results are substantially weaker using the policy-to-policy measure. Of all the networks tested, RIA networks were the most robust to different models and measurement.