Financial openness and financial integration

Abstract

Until now, the economic literature has used the two terms ‘financial openness’ and ‘financial integration’ interchangeably. As a result, problems relating to the mobility of capital across borders, which is associated with financial openness, have been considered one of the costs of the financial integration. Therefore, unlike trade liberalisation, financial integration does not necessarily deliver welfare improvements. This paper, however, argues that financial integration always leads to welfare improvement, provided that financial integration is understood to be a distinctive concept from financial openness. A small modification to the Solow-Swan model for a small open economy is introduced to define the difference between the terms ‘openness’ and ‘integration’ formally. Two empirical tests are also employed using data from fifteen Asia-Pacific economies to verify the assumptions of the model.