Putting Financial globalization to Work
| Author | Paolo Mauro/Jonathan D. Ostry |
| Position | IMF Research Department |
| Pages | 166-167 |
Page 166
Capital flows to emerging market and developing countries are expected to top $1 trillion in the near future.
New IMF research finds that while most countries stand to benefit from foreign direct investment (FDI), they should liberalize other flows only as part of a broader package of reforms.
Financial globalization is here to stay, and all countries, essentially, are affected by it to varying degrees. Advanced countries have seen the most rapid increases in financial flows over the past two decades, but emerging markets and developing countries have also become financially more integrated (see chart).
Even those countries that have sought to "lean against the wind" of financial globalization by maintaining extensive capital controls have seen some increase in the size of their external assets and liabilities.
Should financial globalization, defined as the extent to which countries are linked through cross-border holdings, be viewed primarily as an opportunity for countries to finance investment projects that are good for growth or as a source of possible volatility and crisis? What have we learned from research on these topics over the past few years? A paper prepared by IMF staff in the Research Department, entitled "Reaping the Benefits of Financial Globalization," takes stock of what we know about the effects of financial globalization.
Data from the past 30 years reveal two main lessons. First, the findings support the view that countries need to carefully weigh the risks and benefits of unfettered capital flows. Whereas advanced economies largely benefit from the free movement of capital, emerging market and developing countries should make sure they meet certain thresholds-which include the quality of their institutions and policymaking and their level of domestic financial development-before they open up their capital account. If they do not meet such thresholds, financial liberalization can lead to macroeconomic volatility.
Second, there are also costs associated with being overly cautious about capital flows. Opening up the economy to outside investment may in itself encourage changes that are good for efficiency and growth, for instance by stimulating development of the domestic financial sector.
In theory, opening up the economy to investment from abroad should have largely positive...
To continue reading
Request your trial