Managing Risks of Capital Mobility

30 Pages Posted: 20 Apr 2016

Date Written: October 1999


Countries need suitable mechanisms for balancing the risks and benefits of financial openness, including mechanisms through which to provide insurance to citizens - through the marketplace or through redistributive policy - and thus to avert political pressure for capital controls. Capital mobility as a policy objective gained currency and support only after significant trade liberalization and only in democratic countries that had established the ability to respond to citizens' demands for national economic security.

Inherent in pursuing openness to international capital flows is an awareness that it brings both benefits and risks. Much of the current debate is about how best to balance them.

Major benefits for developing countries include access to a broader menu of investment sources, options, and instruments, as well as enhanced efficiency of domestic financial institutions and the discipline of capital markets in conducting domestic macroeconomic policy. By easing financing constraints, the greater availability of international finance can extend the period for implementing needed adjustments.

From the perspective of emerging market economies, Dailami highlights two sources of risk: - The host governments' policy of liberalizing capital controls before having established the macroeconomic, regulatory, and institutional foundations required for capital account openness. - A shift in foreign lenders' and investors' sentiments and confidence, not necessarily related to a particular country's long-term creditworthiness.

Risk management demands judicious strategies for both corporate and financial institutions and national policy. At the institutional level, with the advances in technology and communications, financial risk management practice has improved significantly in recent years through the use of statistical models, such as value at risk, computer simulation, and stress testing.

At the national level, with the worldwide trend toward democracy, Dailami argues that managing the risks of financial openness will require developing national mechanisms through which to provide insurance to citizens - through the marketplace or through redistributive policy - and thus to avert political pressure for capital controls.

To succeed, open democratic societies have to balance the threat of capital exit, made easier by the opening of capital markets, with the political voice of citizens-demanding protection through redistribution, social safety nets, and other insurance-like measures. These insurance mechanisms have been critical in easing the tension between politics and financial openness in OECD countries. Indeed, cross-country empirical analysis confirms that countries that spend a large share of their GDP on social needs (education, health, and transfer payments) are more open to free international capital flows and also score high on measures of political and civil liberty.

This paper - a product of Governance, Regulation, and Finance, World Bank Institute - is part of a larger study, The Challenge of Development in the 21st Century (RPO 683-14). The author may be contacted at

Suggested Citation

Dailami, Mansoor, Managing Risks of Capital Mobility (October 1999). Available at SSRN:

Mansoor Dailami (Contact Author)

World Bank ( email )

1818 H Street, N.W.
Washington, DC 20433
United States


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