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Managing risks of capital mobility

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  • Dailami, Mansoor

Abstract

Inherent in pursuing openness to international capital flows is an awareness that it brings both benefits and risks. Much of the current debate is about how best to balance them. Major benefits for developing countries include access to a broader menu of investment sources, options, and instruments, as well as enhanced efficiency of domestic financial institutions and the discipline of capital markets in conducting domestic macroeconomic policy. By easing financing constraints, the greater availability of international finance can extend the period for implementing needed adjustments. From the perspective of emerging market economies, the author highlights two sources of risk: the host governments'policy of liberalizing capital controls before having established the macroeconomic, regulatory, and institutional foundations required for capital openness. A shift in foreign leaders'and investors'sentiments and confidence, not necessarily related to a particular country's long-term creditworthiness. Risk management demands judicious strategies for both corporate and financial institutions and national policy. At the institutional level, with the advances in technology and communications, financial risk management practice has improved significantly in recent years through the use of statistical models, such as value at risk, computer simulation, and stress testing. At the national level, with the worldwide trend toward democracy, the author argues that managing the risks of financial openness will require developing national mechanisms through which to provide insurance to citizens-through the marketplace or through redistributive policy-and thus to avert political pressure for capital controls. To succeed, open democratic societies have to balance the threat of capital exit, made easier by the opening of capital markets, with the political voice of citizens-demanding protection through redistribution, social safety nets, and other insurance-like measures. These insurance measures have been critical increasing the tension between politics and financial openness in OECD countries. Indeed, cross-country empirical analysis confirms that countries that spend a large share of their GDP on social needs (education, health, and transfer payments) are more open to free international capital flows, and also score high on measures of political and civil liberty.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2199.

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Date of creation: 31 Oct 1999
Date of revision:
Handle: RePEc:wbk:wbrwps:2199

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Related research

Keywords: Capital Markets and Capital Flows; Fiscal&Monetary Policy; Payment Systems&Infrastructure; Banks&Banking Reform; Economic Theory&Research; Financial Intermediation; Banks&Banking Reform; Economic Theory&Research; Financial Economics; Settlement of Investment Disputes;

References

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  1. Steven Radelet & Jeffrey D. Sachs, 1998. "The East Asian Financial Crisis: Diagnosis, Remedies, Prospects," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 1-90.
  2. Razeen Sally, 1998. "Classical Liberalism and International Economic Order: An Advance Sketch," Constitutional Political Economy, Springer, vol. 9(1), pages 19-44, March.
  3. Sebastian Edwards, 1998. "Capital Flows, Real Exchange Rates, and Capital Controls: Some Latin American Experiences," NBER Working Papers 6800, National Bureau of Economic Research, Inc.
  4. Alberto Alesina & Vittorio Grilli & Gian Maria Milesi-Ferrett, 1993. "The Political Economy of Capital Controls," NBER Working Papers 4353, National Bureau of Economic Research, Inc.
  5. John C. Harsanyi, 1953. "Cardinal Utility in Welfare Economics and in the Theory of Risk-taking," Journal of Political Economy, University of Chicago Press, vol. 61, pages 434.
  6. Dennis Mueller, 1998. "Constitutional Constraints on Governments in a Global Economy," Constitutional Political Economy, Springer, vol. 9(3), pages 171-186, September.
  7. Calvo, Guillermo A & Mendoza, Enrique G, 1996. "Petty Crime and Cruel Punishment: Lessons from the Mexican Debacle," American Economic Review, American Economic Association, vol. 86(2), pages 170-75, May.
  8. Garrett, Geoffrey, 1998. "Global Markets and National Politics: Collision Course or Virtuous Circle?," International Organization, Cambridge University Press, vol. 52(04), pages 787-824, September.
  9. Francisco Gallego & Leonardo Hernández & Klaus Schmidt-Hebbel, 1999. "Capital Controls in Chile: Effective? Efficient?," Working Papers Central Bank of Chile 59, Central Bank of Chile.
  10. Kapstein, Ethan B., 1989. "Resolving the regulator's dilemma: international coordination of banking regulations," International Organization, Cambridge University Press, vol. 43(02), pages 323-347, March.
  11. Assaf Razin & Andrew Rose, 1994. "Business Cycle Volatility and Openness: An Exploratory Cross-Section Analysis," NBER Working Papers 4208, National Bureau of Economic Research, Inc.
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Cited by:
  1. Carmignani, Fabrizio & Chowdhury, Abdur R., 2005. "Does Financial Openness Promote Economic Integration? Some Evidence from Europe and the CIS," Working Paper Series RP2005/74, World Institute for Development Economic Research (UNU-WIDER).
  2. Dailami, Monsoor, 2000. "Financial openness, democracy, and redistributive policy," Policy Research Working Paper Series 2372, The World Bank.
  3. Fabrizio Carmignani & Abdur Chowdhury, 2005. "The Impact of Financial Openness on Economic Integration: Evidence from the Europe and the Cis," Working Papers 88, University of Milano-Bicocca, Department of Economics, revised Apr 2005.
  4. Zsolt Szabó, 2012. "The Impact of Capital Market Players’ Exit, Voice and Loyalty on Economic Growth," Public Finance Quarterly, State Audit Office of Hungary, vol. 57(4), pages 474-489.

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