Financial globalisation has not generated increased investment or higher growth in emerging markets. Countries that have grown most rapidly have been those that rely least on capital inflows. Nor has financial globalisation led to better smoothing of consumption or reduced volatility. If you want to make an evidence-based case for financial globalisation today, you are forced to resort to indirect and speculative arguments.William Easterly responds to this by noting,
It is time for a new model of financial globalisation, one that recognises that more is not necessarily better. As long as the world economy remains politically divided among different sovereign and regulatory authorities, global finance is condemned to suffer deformations far worse than those of domestic finance. Depending on context, the appropriate role of policy will be as often to stem the tide of capital flows as to encourage them. Policymakers who view their challenges exclusively from the latter perspective will get it badly wrong.
To say that there are crises because of international capital flows is not very meaningful; it is like saying there are recessions because of GDP. Dani and Arvind do not adequately address two big issues on capital flows:Martin Wolf states his view, in part, as
(1) what are the benefits of capital flows? Usually, a voluntary movement of capital signifies a reallocation from a low-return investment to a high-return investment. This raises the rate of return to investment overall, which is usually considered to be a good thing.
(2) To what extent are international capital flow crises the symptom or the disease? They are oftentimes the symptom, so trying to control them to treat macroeconomic imbalances is like treating fevers with ice-baths. Better to confront the underlying imbalances, as Dani and Arvind sensibly recommend in the second half of their column.
I am certainly closer to the Rodrik-Subramanian position now than five years ago. But I remain of the view that free capital flows have some desirable consequences, including a degree of autonomy vis a vis the overweening or predatory state and a stimulus to institutional development.(HT: Bayesian Heresy)
The big question, however, is: what is to be done? I do not agree with the idea of handing over exchange-rate issues to the World Trade Organisation. That would grossly overload it, so risking its destruction. Nor do I think the IMF can do much about "global imbalances" either. But it would be desirable if the IMF staff were at least allowed to declare openly and clearly that particular countries have grossly undervalued exchange rates or that their intervention policies are indefensible. This would be the power of moral suasion.
Apart from this I have three comments.
First, this is a matter for individual countries to decide. Capital account liberalisation should neither be forced on countries nor should they be prevented by others. Outside advisers, including official advisers, should analyse the pros and cons against the particular circumstance of the country concerned and offer advice on the feasibility of the set of policies proposed.
Second, capital inflows are not a substitute for an adequate level of domestic savings. Promoting the latter is an important policy priority (though not to the excessive levels now seen in China).
Third, countries should normally discourage domestic borrowing in foreign currency, unless they adopt the foreign currency for domestic monetary use. Otherwise, countries should restrict capital inflow to direct investment, portfolio equity and domestic-currency-denominated lending. The fact that the US borrows in dollars makes the consequences of the crisis smaller and the ease of dealing with it far greater.