On balance, is financial liberalization good or bad? In truth, we may not yet have the tools to do a definitive cost-benefit analysis, Aizenman suggested. There is "solid evidence," he said, that the fragility induced by financial opening increases the chance of a financial crisis. The proof that there is a positive correlation between financial opening and long-run growth-as Ross Levine and others have argued- was more tenuous, although financial opening could lead to higher growth, in part by encouraging a more efficient allocation of investment. Moreover, empirical studies provide little guidance on how to weigh potential costs against potential benefits. Any estimate of this balance would depend critically on an appropriate time horizon and an evaluation of the counter- factual. For example, what would have happened to the Korean economy had the country not liberalized financial flows during the 1990s?
The key challenge for policymakers is to figure out how to supplement financial opening with policies that could diminish short-term volatility without undercutting prospects for higher growth over the long term, Aizenman said. Numerous reforms have been proposed to reduce the incidence or alleviate the costs of financial crises. Among those that have focused on crisis prevention, Aizenman cited the Meltzer Commission recommendation that the IMF limit its lending to those countries that have been pursuing "appropriate" policies and have satisfied predetermined criteria; the Basel II Accord, which strengthens capital adequacy standards; Chilean-style capital controls (taxes on short-term inflows); varied efforts to design "crisis insurance"; incentives to move from debt financing to equity financing; and attempts to design a crisis warning system based on statistical indicators of vulnerability. Among the reforms that seek to strengthen crisis management and mitigate its costs, Aizenman mentioned proposals to develop international bankruptcy-style procedures or work- out mechanisms and the addition of collective action clauses and/or rollover options to loan agreements.
Which types of proposals hold the most promise? According to Aizenman, reforms must address the fundamental forces that lead to excessive exposure and crisis. He warned that changes in policies can affect...