Fact of the Week: Financial Liberalization Increases Technology Diffusion Within a Country by 7–9 Percent

Source: Gabriela Cugat and Andrea Manera, "Do Capital Inflows Spur Technology Diffusion? Evidence from a New Technology Adoption Index," International Monetary Fund (IMF),IMF Working Papers, no. 2024/044 (March 2024).

Commentary: A recent working paper by Gabriela Cugat and Andrea Manera analyzed the effect of financial liberalization on technology diffusion, along with other indicators including per-capita GDP and capital inflows. Using data from the International Monetary Fund (IMF), the authors looked at 181 countries over the 1971-2020 period. They measured technology diffusion using the IMF's Embodied Technology Imports Indicator (ETI), which in turn utilizes data from the European Patent Office's PATSTAT database and the United Nations COMTRADE database. The ETI serves as a way to measure how technologically intensive a country's capital imports are. Additionally, the authors measured financial liberalization using the Chinn-Ito index (KAOPEN). KAOPEN measures capital account openness based on IMF's Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) and is used for the purpose of tracking the timing of financial liberalization events.

The study's findings indicate a positive impact of financial liberalization on capital inflows, technology diffusion, and economic growth. This is because foreign direct investment, which unsurprisingly increases after capital account liberalizations, plays an important role in the transfer and subsequent diffusion of new technologies. In the modern economy, such technology diffusion and adoption serve as important determinants for economic growth. When looking at the direct effect of financial liberalization on inward foreign investment, the authors found that capital account liberalizations were, on average, associated with a 28 percent increase in capital inflows after five years and a 33 percent increase in capital inflows after 10 years. When looking at the effect of financial liberalization on technological intensity, capital account liberalizations were associated with a 7 percent increase in the ETI indicator after five years and a 9 percent increase in the ETI indicator after 10 years. Finally, when looking at the effect of financial liberalization on output, capital account liberalizations were associated with a 9 percent increase in real GDP per capita after five years and a 12 percent increase in real GDP per capita after 10 years.