Rich countries and emerging markets alike have participated in a rapid integration into global capital markets over the last 25 years. Proponents of financial globalization believed this would bring a myriad of benefits via improved financial intermediation, with a more efficient allocation of capital to productive firms and increased access to finance to those outside the halls of political power.
But the recent financial crisis has given pause to the pro-globalization advocates. The marked increase in capital flows to emerging markets quickly reversed in the wake of the financial crisis, leaving these countries looking vulnerable. Might the globalizers have gotten their prescriptions wrong?
A recent paper entitled Does Financial Openness Lead to Deeper Domestic Financial Markets? finds that, in fact, developing countries have reaped a number of benefits from financial globalization. In particular, the authors of the paper have found that greater financial openness:
- Enlarges the size/activity of financial intermediaries;
- Improves the efficiency in the banking system;
- Contributes to the deepening of local stock markets and private bond markets.
César Calderón, one of the authors of the paper, presented these findings as part of the World Bank's FPD Academy event series. Video of the event appears below the jump. Calderón presents from the 4-minute to the 32-minute mark, and is followed by a discussant and a Q&A. Copies of Calderón's presentation and the discussant's presentation are also available.
I would note in particular the discussant's questions on slide 9, which point out that while the paper looks at the benefits of financial openness, it does not look closely at the impact of financial openness on the likelihood of financial crisis. The next step in the 'financial openness' debate will require reconciling the assets and the liabilities side of the ledger for emerging markets.
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