Reforms, Finance, and Current Accounts

We analyze the implications of labor market reforms for an open economy's human capital investment and future production. A stylized model shows that labor market deregulation can imply more positive current-account balances if financial markets are imperfect and labor market institutions not only distort labor allocation, but also smooth income. Empirically, in Organisation for Economic Co-operation and Development (OECD) country-level panel data, we find that labor market deregulation has been positively related to current-account surpluses on average and more strongly so when and where financial market access was more limited. These results are robust to inclusion of standard determinants of current-account imbalances, and do not appear to be driven by cyclical phenomena.