Optimal capital account liberalization in China

China maintains tight controls over its capital account. Its current policy regime also features financial repression, under which banks are required to extend funds to state-owned enterprises (SOEs) at favorable terms, despite their lower average productivity than private firms. We incorporate these features into a general equilibrium model. Our model illustrates a tradeoff between aggregate productivity and inter-temporal allocative efficiency from capital account liberalization under financial repression. As a result, along a transition path with a declining SOE share, welfare-maximizing policy calls for rapid removal of financial repression, but gradual liberalization of the capital account. (C) 2020 Elsevier B.V. All rights reserved.