How integrated are international capital markets? This is the question posed by Research Associate Tamim Bayoumi and Ronald McDonald in Discussion Paper No. 1028. By allowing countries to borrow and lend money efficiently, international capital markets can provide the same services across countries as markets provide within a single economy, allowing more efficient use of funds for investment and improving the allocation of consumption over time. These gains, which are similar to those accruing to individuals from capital markets within a country, are the logic behind the general move towards international financial liberalization since the late 1970s.

Using consumption patterns across countries to measure capital market integration, the paper argues that earlier empirical tests of this type were potentially mis-specified and proposes a more robust specification. Country analysis indicates that Japan was the only industrialized country for which national consumption was fully integrated with the rest of the world over the period 1973–89. For the other countries the source of the failure varies. Within the EU it is generally associated with incomplete integration across capital markets. Greater integration of national capital markets caused by moves towards a single market and, possibly, a single currency, could therefore provide potentially significant gains in economic welfare by improving consumption patterns across the EU region.

Consumption, Income, and International Capital Market Integration
Tamim A Bayoumi and Ronald McDonald

Discussion Paper No. 1028, October 1994 (IM)