The Order of Liberalization of the Current and Capital Accounts of the Balance of Payments

It has generally been considered that the opening of the economy to the rest of the world is an integral part of any economic reform aiming at increasing the role of markets in LDCs. Until recently, however, very little discussion has been devoted to the order in which the capital and current account should be liberalized. This paper deals with several aspects of the order of liberalization. First, the brief literature is critically reviewed. Second, a three goods-two factors model is used to analyze the effects of alternative orderings on production and income distribution. And third, a two periods model of a small economy is used to investigate the welfare effects of opening the capital account in the presence of distortions. While the discussion does not yield a theorem regarding the appropriate order of liberalization, there are strong presumptions that it is more prudent to liberalize the current account first.