How Big are the Gains from International Financial Integration?

The literature has shown that the implied welfare gains from international financial integration are very small. We revisit the existing findings and document that welfare gains can be substantial under two scenarios: a) the costs of remaining in autarky are worse than the standard neo-classical model would predict, and b) financial integration has a direct affect on total factor productivity. By estimating the implied path of convergence of rates of return from the actual data and calibrating the welfare gains based on this path, we find that the benefits are nearly 4.3 times larger than the previous estimates. We also find welfare gains are at least 2 times larger than those estimated ignoring the productivity effect. The combined effect of realistic convergence and endogenous productivity as a result of financial integration is equivalent to a nearly 15% permanent increase in consumption.

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This paper was revised on April 10, 2009

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