1 Reforms, Finance, and Current Accounts

ABSTRACT: Reforms of institutions that shape labor’s productivity and labor income risk affect current accounts through consumption smoothing (in anticipation of future income growth) and precautionary savings (reflecting the intensity of uninsurable income risk). We propose a simple model to illustrate how these two theoretical channels interact with financing constraints, and confront theoretical results with empirical evidence from a standard sample of OECD countries. In nonlinear regression estimates, the association between deregulation trends and current accounts surpluses is statistically significant, robust to a variety of specification details, and stronger where financial markets are less developed. The labor market regulation and financial indicators that appear relevant to current-account patterns are empirically associated not only with lower consumption, faster production growth, and more investment, but also with higher wage dispersion. JEL Classification: E44, F32, J0