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A Pragmatic Approach to Capital Account Liberalization

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  • Eswar S. Prasad
  • Raghuram G. Rajan

Abstract

In the mid-1990s, mainstream economists of nearly all stripes commonly recommended capital account liberalization -- that is, allowing a free flow of funds in and out of a country's economy -- as an essential step in the process of economic development. But then came the East Asian financial crisis of 1997-98, in which even seemingly healthy and well-managed economies like those of South Korea were engulfed by massive capital outflows and tremendous currency volatility, and capital account liberalization became quite controversial in the economics profession. A decade later, now that time has quelled passions and intervening research can shed more light on the debate, it appears that both the costs and benefits of capital account liberalization may have been misunderstood in that earlier debate. Now it appears that the main benefits of capital account liberalization for emerging markets are indirect, more related to their role in building other institutions than to the increased financing provided by capital inflows. And these indirect benefits are important enough that countries should look for creative approaches to capital account liberalization that would help attain these benefits while reducing the risks. Countries don't have much choice but to plan for capital account liberalization because capital accounts are de facto becoming more open over time, whatever governments may do to try to control them.

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Bibliographic Info

Article provided by American Economic Association in its journal Journal of Economic Perspectives.

Volume (Year): 22 (2008)
Issue (Month): 3 (Summer)
Pages: 149-72

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Handle: RePEc:aea:jecper:v:22:y:2008:i:3:p:149-72

Note: DOI: 10.1257/jep.22.3.149
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