Rethinking the Effects of Financial Liberalization


During the last few decades, many emerging markets lifted restrictions on cross-border …financial transactions. In this paper, we present a simple model that can account for the observed effects of …financial globalization. The model emphasizes the role of imperfect enforcement of domestic debts and the interactions between domestic and foreign debts. Financial globalization can lead to a variety of outcomes: (i) domestic capital ‡flight and ambiguous effects on net capital ‡flows, investment, and growth; (ii) capital in‡flows and higher investment and growth; or (iii) volatile capital ‡flows and unstable domestic …financial markets. The model shows how the effects of …financial globalization depend on the level of development, productivity, domestic savings, and the quality of institutions.