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Why Did Financial Globalization Disappoint?

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  • Dani Rodrik
  • Arvind Subramanian

Abstract

The stylized fact that there is no correlation between long-run economic growth and financial globalization has spawned a recent literature that purports to provide newer evidence and arguments in favor of financial globalization. We review this literature and find it unconvincing. The underlying assumptions in this literature are that developing countries are savings-constrained; that access to foreign finance alleviates this to boost investment and long-run growth; and that insofar as there are problems with financial globalization, these can be remedied through deep institutional reforms. In contrast, we argue that developing economies are as or more likely to be investment- than savings-constrained and that the effect of foreign finance is often to aggravate this investment constraint by appreciating the real exchange rate and reducing profitability and investment opportunities in the traded goods sector, which have adverse long-run growth consequences. It is time for a new paradigm on financial globalization, and one that recognizes that more is not necessarily better. Depending on context and country, the appropriate role of policy will be as often to stem the tide of capital inflows as to encourage them. Policymakers who view their challenges exclusively from the latter perspective risk getting it badly wrong. IMF Staff Papers (2009) 56, 112–138. doi:10.1057/imfsp.2008.29; published online 6 January 2009

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Bibliographic Info

Article provided by Palgrave Macmillan in its journal IMF Staff Papers.

Volume (Year): 56 (2009)
Issue (Month): 1 (April)
Pages: 112-138

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Handle: RePEc:pal:imfstp:v:56:y:2009:i:1:p:112-138

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References

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  1. Carmen M. Reinhart & Kenneth S. Rogoff, 2008. "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," CEMA Working Papers 595, China Economics and Management Academy, Central University of Finance and Economics.
  2. Pierre-Olivier & Olivier Jeanne, 2009. "Capital Flows to Developing Countries: The Allocation Puzzle," Working Paper Series WP09-12, Peterson Institute for International Economics.
  3. Luiz Carlos Bresser-Pereira & Paulo Gala, 2009. "Why Foreign Savings Fail to Cause Growth," International Journal of Political Economy, M.E. Sharpe, Inc., vol. 38(3), pages 58-76, September.
  4. Peter Henry, 2007. "Capital Account Liberalization: Theory, Evidence, and Speculation," Discussion Papers 07-004, Stanford Institute for Economic Policy Research.
  5. Peter Blair Henry, 2006. "Capital Account Liberalization: Theory, Evidence, and Speculation," NBER Working Papers 12698, National Bureau of Economic Research, Inc.
  6. Mihir A. Desai & C. Fritz Foley & James R. Hines, 2006. "Capital Controls, Liberalizations, and Foreign Direct Investment," Review of Financial Studies, Society for Financial Studies, vol. 19(4), pages 1433-1464.
  7. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1993. "Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 108-151, March.
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