Benefits and Costs of International Financial Integration: Theory and Facts

57 Pages Posted: 20 Apr 2016

See all articles by Pierre-Richard Agenor

Pierre-Richard Agenor

University of Manchester - School of Social Sciences

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Date Written: October 2001

Abstract

This literature review joins with recent studies in arguing that financial integration must be carefully prepared and managed to ensure that the benefits outweigh the short-run risks. But in contrast with some other studies, it adopts a more skeptical view of the benefits of capital flows other than foreign direct investment.

Agénor provides a selective review of the recent analytical and empirical literature on the benefits and costs of international financial integration. He discusses the impact of financial openness on consumption, investment, and growth, and the impact of foreign bank entry on the domestic financial system.

Consistent with some recent studies, the author argues that financial integration must be carefully prepared and managed to ensure that the benefits outweigh the short-run risks. Prudent macroeconomic management, adequate supervision and prudential regulation of the financial system, greater transparency, and improved capacity to manage risk in the private sector are important requirements for coping with potentially abrupt reversals in pro-cyclical, short-term capital flows.

The author adopts a more skeptical view than some assessments in two areas, however. First, only foreign direct investment appears to provide dynamic gains and improved prospects for growth; the evidence on the benefits of other types of capital flows remains weak. Second, empirical research on the net benefits associated with foreign bank penetration is far from conclusive; in particular, the possibility that such penetration may lead to adverse changes in the allocation of credit among domestic firms cannot be dismissed on the basis of the existing evidence.

This paper - a product of the Economic Policy and Poverty Reduction Division, World Bank Institute - is part of a larger effort in the institute to analyze the impact of macroeconomic adjustment on poverty. The author may be contacted at pagenor@worldbank.org.

Suggested Citation

Agenor, Pierre-Richard, Benefits and Costs of International Financial Integration: Theory and Facts (October 2001). World Bank Policy Research Working Paper No. 2699. Available at SSRN: https://ssrn.com/abstract=632768

Pierre-Richard Agenor (Contact Author)

University of Manchester - School of Social Sciences ( email )

Oxford Road
Manchester, M13 9PL
United Kingdom

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