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 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.