International Finance and Growth in Developing Countries: What Have We Learned?
86 Pages Posted: 31 Jan 2009 Last revised: 24 Aug 2010
Date Written: February 2009
Despite an abundance of cross-section, panel, and event studies, there is strikingly little convincing documentation of direct positive impacts of financial opening on the economic welfare levels or growth rates of developing countries. The econometric difficulties are similar to those that bedevil the literature on trade openness and growth, though if anything, they are more severe in the context of finance. There is also little systematic evidence that financial opening raises welfare indirectly by promoting collateral reforms of economic institutions or policies. At the same time, opening the financial account does appear to raise the frequency and severity of economic crises. Nonetheless, developing countries have moved over time in the direction of further financial openness. A plausible explanation is that financial development is a concomitant of economic growth, and a growing financial sector in an economy open to trade cannot long be insulated from cross-border financial flows. This survey discusses the policy framework in which financial globalization is most likely to prove beneficial. The reforms developing countries need to institute to make their economies safe for international asset trade are the same ones they need so as to curtail the power of entrenched economic interests and liberate the economy's productive potential.
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