Managing Financial Globalization: Insights from the Recent Literature

Abstract

This paper seeks to draw lessons for developing countries based on a survey of the recent literature on financial globalization. First, while capital account openness holds promises (by potentially lowering cost of capital, promoting risk sharing, and providing disciplines on policies), it does not always work out that way in the data. Distortions in the domestic financial market, international capital market, domestic labor market, and domestic public governance can all make financial globalization less beneficial for developing countries. Second, developing countries may seek to avoid the effects of foreign monetary policy shocks. The empirical pattern appears to be somewhere between a trilemma and a dilemma. While nominal exchange rate flexibility provides some policy autonomy but not consistently, capital flow management can confer additional insulation against foreign monetary shocks.