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This book examines the role of financial globalization in economic growth and derives corresponding implications for economic policy. Although economists have debated the importance of openness to international trade, they generally agree that in the market for goods, international openness is more favorable to growth than a largely closed economy. In contrast, whether external financial openness boosts or curbs growth has long been a ...
This book examines the role of financial globalization in economic growth and derives corresponding implications for economic policy. Although economists have debated the importance of openness to international trade, they generally agree that in the market for goods, international openness is more favorable to growth than a largely closed economy. In contrast, whether external financial openness boosts or curbs growth has long been a controversial issue, and it has become even more so with the outbreak of the global financial crisis of 2007-09.
The East Asian financial crisis of the late 1990s raised doubts on this issue, and helped spur a wave of empirical research on it. Supporters of financial globalization—such as Stanley Fischer and Lawrence Summers—maintained that, with the right policies, open capital markets continued to be a powerful means for enhancing growth. Critics, including Jagdish Bhagwati and Joseph Stiglitz, argued that the crisis demonstrated that, unlike free trade in goods, free mobility for capital is counterproductive for growth. In the past decade a large empirical literature has emerged examining this question. Overall it has tended to find that financial globalization has "positive marginal effects on growth."
The US-led financial crisis of 2007-09 swept most of the developed and emerging-market economies into its vortex. The global crisis has set the stage for an intensification of the debate on financial openness. Some analysts and policymakers will be inclined to escalate calls for restrictions on capital flows. In the acute phase of the crisis that began in September 2008, major stock markets around the world plunged along with the US equity market, and many currencies fell sharply against the dollar (excluding the yen, which proved, like the dollar, to be a safe-haven currency). If countries had maintained closed capital markets, some may argue, they would not have been vulnerable to these shocks.
Cline asserts that financial globalization represents a significant factor in economic growth of emerging-market economies. Further, he argues that a significant portion of current-day GDP can be attributed to the cumulative influence of financial openness, especially in industrial countries.
This study surveys the extensive literature on this issue to arrive at a broad sense of the state of the evidence for and against the growth benefits of financial openness. The survey is critical in the sense that it seeks to evaluate strengths and weaknesses of the various studies in addition to summarizing their results. It then applies leading quantitative models from the literature to arrive at synthesis estimates of the contribution of financial openness to growth for major industrial and emerging-market economies over the past four decades. Finally, the book considers the preliminary evidence on whether the 2007-09 financial crisis constitutes grounds for a major change in the policy verdict on financial openness. As part of that reconsideration, the analysis reviews the causes of the global crisis, as well as its principal events and policy interventions.
1 Overview 1
Research Context 2
Key Analytical Issues 4
Theoretical Expectations 11
Empirical Literature 13
Synthesis Estimates 18
Quantifying Crisis Effects 25
Quantifying Debt versus Equity Effects 26
Implications of the 2007-09 Crisis 28
Appendix 1A Covered Interest Parity as a Measure of Financial Openness 37
Appendix 1B Analogy to Gains from Trade 39
Appendix 1C Tests for Compositional Differences in Growth Impact of Financial Openness 41
2 A Critical Survey of Literature 45
Cross-Country Growth Regressions 46
Theoretical and Calibreated Studies 116
Diversification Gains and Consumption Smoothing 119
Summary Surveys 131
Appendix 2A Weighting Cross-Country Regression Results in Meta-Analysis 145
Appendix 2B Gourinchas-Jeanne Model of Gains from Financial Integration 155
Appendix 2C Gemini: A Simple Model of International Risk Sharing 161
Appendix 2D Potential Circularity in the Knack-Keefer Government Reputation Variable 165
Appendix 2E Current Account Deficits and Growth 167
3 The Impact of Financial Globalization on Growth: Country-Specific Estimates 171
The Synthesis Approach 172
Trends in Financial Openness 173
Results for General Financial Openness 183
Weighting Nonsignificant Model Estimates 192
Results for Direct Investment Openness 201
Comparison with Theoretical Expectations 208
Appendix 3A Normalizing Model Coefficients for Synthesis Analysis 217
Appendix 3B Temporary versus Permanent Growth Acceleration in the Henry Model 223
Appendix 3C Degree of Correlation among Alternative Measures of Financial Openness 229
4 The Financial Crisis of 2007-09 and Financial Globalization 235
Status by Late 2009 240
Implications for Financial Openness in Emerging-Market Economies 255
Appendix 4A Key Events and Policy Responses 261
Appendix 4B Causes of the Crisis 279
Appendix 4C Contemporary Policy Diagnoses from September 2008 to February 2009 301
Appendix 4D Economics of the Geithner Plan 315
Appendix 4E Financing Gaps, Reserves, and Official Finance in the Global Financial Crisis 325