Financial "liberalization": Benefits less than expected

As Harvard economist Dani Rodrik explains in this essay, financial "liberalization", or "globalization", or whatever inocuously-sounding name neoliberal cheerleaders and elitist policymakers in our nation's capital like to call it, has not exactly produced the wonderful benefits proponents claimed it would almost two decades ago.

As Rodrik notes, financial globalization is relatively new phenomenon in global economics, with its real origins dating back to the early Nineties. Or, as the essay puts it: "[I]t was only around 1990 that most emerging markets threw caution to the wind and removed controls on private portfolio and bank flows. Private capital flows have exploded since, dwarfing trade in goods and services."

Freeing up capital flows had an inexorable logic – or so it seemed. Developing nations, the argument went, have plenty of investment opportunities, but are short of savings. Foreign capital inflows would allow them to draw on the savings of rich countries, increase their investment rates, and stimulate growth. In addition, financial globalization would allow poor nations to smooth out the boom-and-bust cycles associated with temporary terms-of-trade shocks and other bouts of bad luck. Finally, exposure to the discipline of financial markets would make it harder for profligate governments to misbehave.

But things have not worked out according to plan. Research at the IMF, of all places, as well as by independent scholars documents a number of puzzles and paradoxes. For example, it is difficult to find evidence that countries that freed up capital flows have experienced sustained economic growth as a result. In fact, many emerging markets experienced declines in investment rates. Nor, on balance, has liberalization of capital flows stabilized consumption.

Most intriguingly, the countries that have done the best in recent years are those that relied the least on foreign financing. China, the world’s growth superstar, has a huge current-account surplus, which means that it is a net lender to the rest of the world. Among other high-growth countries, Vietnam’s current account is essentially balanced, and India has only a small deficit. Latin America, Argentina and Brazil have been running comfortable external surpluses recently. In fact, their new-found resilience to capital-market shocks is due in no small part to their becoming net lenders to the rest of the world, after years as net borrowers.

Read the article to get an explanation as to what is really going in here. It's a complicated story, more complex in fact that Rodrik gives credit for. But he at least provides a basic outline - and a decent start to understanding the downside of globalization.