DP12998 Financial Globalization and the Welfare State

Author(s): Assaf Razin, Efraim Sadka
Publication Date: June 2018
Date Revised: July 2018
Keyword(s):
JEL(s):
Programme Areas: International Macroeconomics and Finance
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12998

There is strong evidence from the launch of the single financial market in Europe on the interactions among financial globalization, international tax competition, and the fading generosity of the welfare state. Financial globalization triggers a race-to-the bottom tax competition. The tax race generates an international re-allocation of capital that further chips away at the domestic tax base, and drives a downscaling of scope and size of redistribution. To understand the working of key mechanism which links financial globalization to redistribution policy, this paper develops a stripped-down model, where easing the country access to the world capital markets induces political-economy based policy changes that impact income inequality. We demonstrate in the paper the crucial role of the welfare state in guaranteeing that the gains from trade from financial globalization spread out to all.