Into the Great Wide Open, Or Why Institutions Matter in an Era of Globalized Finance

Previous research has shown that the same level of investment contributes more to growth in the presence of good institutions. This paper investigates how the role of institutions changes as a country removes its capital account restrictions. I run an OLS regression of growth in 70 countries over the sample period 1960-2000. My key explanatory variable is the interaction between an institution bonus term and an index of capital account openness developed by Quinn (1997). Controlling for standard growth determinants, I find that the magnitude of the institution bonus rises as countries globalize their financial systems. When financial markets operate smoothly, investment is allocated more efficiently and growth rises. Because more is asked of financial markets post-liberalization, the benefits for having good supporting institutions are greater. For my grandfather, Robert F. Sears Acknowledgements Throughout the years of education and months of research that culminate in the spring of 2005 with my submission of this thesis, I was aided and helped along by many people. Listing them all would not be possible in this limited space, but it would be amiss of me to not single out a few individuals whose roles, though perhaps small in their own eyes, were large in mine. First of all, thanks to my faculty advisor, Professor Adam Honig. My habit of coming into his office late on Friday afternoons with long lists of questions must surely have tried his patience, but I thank him for always taking the time to hear me out. His probing queries have forced me to refine my arguments, and his suggestions have pointed me in illuminating directions. This collaboration has been a learning experience for both of us, and I sincerely hope that he has found the project as rewarding as I have. I would also like to thank Professor Geoffrey Woglom, who taught my first course in economics. For better or for worse, he is the person most directly responsible for my decision to become a major. His oft-repeated credo has kept my eyes focused on the true goal of economics—happiness. Thanks to my fellow thesis writers in the economics department. If art is but suffering and toiling, then we have all of us created masterpieces this semester. Your camaraderie has made the long hours seem shorter and the late nights a little less dark. Several other individuals deserve recognition. Kevin Daly suggested the title to this paper. Kerry Harwin encouraged me to spend a year studying in France. Aaron Lee introduced me to the joy of hiking, and discovered alongside me the wonder of Belgian beer. In Paris as well as in Amherst, I had the opportunity to befriend many wonderful people—far too many to name individually. Thank you for the memories. Thanks as well to the many incredible professors whose classes have inspired and challenged me. My parents always believed that anything was possible—so much that I started believing it, too. And Alison, thank you for everything. I apologize to those whom I have left out or forgotten. This thesis would not have been possible without many people’s assistance. Its merits are, in large part, due to their help. Any faults are entirely my own.