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Although there is now a general recognition that capital market liberalization failed to help developing countries achieve economic growth and stability, the important question remains of why the supporters of liberalization were so wrong. The chapter begins with the ‘debate in brief’, which presents the central arguments for and against CML. The next three sections look at the impact of capital market liberalization on stability, growth, and poverty. The chapter then discusses the impact of the international policy response to instability known as ‘bail-outs’. The sixth section presents a brief discussion on the interaction of capital market liberalization, political processes, and democracy.

This chapter examines some of the other outstanding debates on capital market liberalization (CML). In particular, it focuses on when a country is sufficiently developed to risk capital market liberalization, whether all countries should make liberalization their long-term goal, and whether capital market liberalization is reversible; even if it was a mistake in the first place, should countries that have already liberalized now stick with it? For example, proponents of liberalization often argue that the issue is not whether countries should liberalize their capital markets, but rather that liberalization should occur within the ‘proper’ sequence of reforms. Critics, however, argue that CML should not necessarily be the long run goal of all countries and that there are better ways for developing countries to integrate into the global economy. The chapter also contains a section that examines the appropriateness of different techniques of capital market liberalization for countries in various stages of development.

This chapter extends the analysis of the previous chapter to an open economy by introducing exchange rate policy; analyzing the complex relationships between exchange rate, fiscal, and monetary policies; and examining the ways in which capital flows complicate traditional analyses. Despite the greater complexities associated with open economy macroeconomics, the policy conclusions for a closed economy remain remarkably unaffected. While Keynesians and heterodox economists believe that government should actively intervene, conservatives remain skeptical about the desirability of such interventions. The objective of this chapter is to shed some light on how economists can come to such diverse views on economic policy. The first section examines the macroeconomic effects of exchange rates on employment, trade, inflation, aggregate demand, growth, and balance sheets. The second section examines the complex interactions between fiscal, monetary, and exchange rate policies in open economies with either fixed or flexible exchange rate regimes. This section also examines the effects of interest rates and exchange rates on capital flows in both crisis and non-crisis situations.

This chapter studies the relationship between international trade, capital mobility, and environmental quality in developing countries. Although the ‘pollution haven hypothesis’ has dominated much of the discussion of the composition effects of trade between rich and poor countries, this paper argues that it is not supported by empirical evidence. Regardless of environmental policy, trade liberalization may still shift the development path towards environmentally-intensive activity in countries with a comparative advantage in this area. This paper also considers the fundamental differences between environmental problems associated industrial pollution emissions, and those that affect stocks of natural capital, such as fisheries and forests. In addition, it examines the effects of linkage between trade policies and environmental concerns in developing countries. Section 1 discusses the role of the environmental policy process and institutions, and how they interact with the trade regime. Section 2 reviews the empirical evidence on the effects of environmental policy on trade patterns, and the evidence on the effect of trade on environmental quality. Section 3 considers policy issues.

The growing collection of literature on the rise of capital flows in several countries across Eastern Europe, Latin America, Asia, and even in the former Soviet Union during the 1990s mainly takes on issues on whether domestic factors like structural reforms and plans on stabilizing inflation or external factors like international interest rates have a significant role in bringing about increased financial flows in developing market economies. While the macroeconomic ‘countercyclical’ policies implemented to address the rising inflows are often analyzed, few studies have attempted to examine the link between the two matters and discuss how the form of capital flows are shaped by the financial sector and the domestic capital market. As such, this chapter aims to study the changing dynamics involved in cross-border capital movements while specifically evaluating the role of policy response through direct intervention and a monetary-foreign exchange ‘policy mix’.

This chapter provides an overview of the book and discusses the objectives and arguments set out in the following chapters. It starts by giving a brief history of international capital flows in the period of globalization before the First World War. This book attempts, as this chapter explains, to shed light on today's international financial environment by comparing it with that of 1870–1913. The overarching objective of the book is to enrich the current debate on the design and reform of the international financial system and architecture, by drawing on the evidence from an earlier period of globalization. The chapter finishes by outlining the chapters that follow.

Because of technological advances in terms of communications, and because of the liberalization of capital accounts, private capital flows experienced rapid growth at the end of the 20th century across developing economies. This final chapter looks into the differences between the capital flows to Asia and Latin America that seem to have gained much importance during the earlier years of this study rather than in 1990s. Analyzing the scale and the prominent characteristics of global private capital flows aids in identifying the key elements involved in managing capital flows and policy making procedures especially in developing countries. Also, this chapter attempts to provide a comparison of the various policy responses implemented by different developing countries in addressing such issues.

This introductory chapter presents the arguments of the book and provides a framework for the issues related to capital market liberalization (CML). The first section addresses an important set of market failures that are likely to be significant in developing countries, and shows how they provide a rationale for state intervention in capital markets. The second section analyses the effects of capital market liberalization on developing countries, showing how the pro-cyclical nature of short-term capital flows can lead to financial and macroeconomic volatility and undermine growth. The third section introduces alternative policy options for interventions in capital markets, including direct and indirect capital controls and international regulations. The last section concludes by arguing that CML has high economic and social costs in developing countries, whereas its assumed benefits in terms of both economic stability and growth are unlikely to materialize.

During the period between the late 1980s and the early 1990s, Latin America’s economic concerns experienced a turning point since various leaders, policy makers, and multilateral institutions agreed upon the need to privatize projects implemented by the state, balance government budgets, and liberalize trade. Because of the Mexican peso crisis in 1994, economists and finance ministers in Washington replaced Chile and Mexico with Brazil and Argentina as models for the new regime since macroeconomic developments in these countries were affected significantly by capital flows. Environments that are free from crisis may be subject to the following exchange rate regimes: the target exchange rate that evades real appreciation and the floating exchange rate that transfers risks to private portfolios. Since Brazil has neither, this chapter attempts to point out how the current macroeconomic strategy imposed by Brazil is costly.

This chapter discusses the general principles of direct taxation when the economy is open to capital flows. Two basic principles of direct taxation are the residence principle and the source principle. The resident principle states that the government taxes the income of its residents regardless of source. The source principle tells that the government taxes income generated within the country. Also, this chapter studies the effects of opening up the economy to international capital flows. Opening up the economy allows capital to be mobile but it does not necessarily mean consumption tax is preferred to income tax. Governments will most likely find it optimal to tax capital, to impose a tax on it, or to sign tax treaties enabling them to impose a tax on it.

Developing countries have access to international savings that would enable the raising of the rate of investment. As such, the effects brought about by exogenous shocks could be lessened while efficiency gains from competitive technology and financial skills transfers are also realized. However, these ‘middle-income’ countries that are currently undergoing transitions to industrialization have to deal with the destabilizing effects that are brought on by short-term capital flows that could result in changes in exchange and interest rates, domestic credit levels, and asset values. To address such matters, international institutions resort to modifying certain policies and lending schemes while national authorities implement changes to monetary and fiscal policies. This chapter identifies the often negative effects on the real economy that are caused by short-term capital flows and how these affects the income distribution and sustainable growth of developing countries.

The literature on capital flows in the world economy is reviewed, along with that on the utilization of capital controls and the broader issues of international business risks associated with debt and equity capital flows for both firms and financial institutions, active internationally. The chapter concludes with a brief discussion of some of the research topics facing the field of international business in these areas.

This chapter reviews the recent analytical and empirical literature on the benefits and costs of international financial integration and the policy challenges that it creates. The chapter also discusses the impact of financial openness and capital flows on consumption, investment, and growth, as well as the impact of foreign bank entry on the domestic financial system. The argument is made that, for small open developing countries, the benefits of financial integration are mostly long term in nature, whereas risks can be significant in the short run. Careful preparation and management—notably by strengthening bank regulation and supervision and by adopting a more flexible monetary policy framework, possibly supplemented by countercyclical regulatory rules and temporary controls on short-term capital flows—are therefore essential. Cross-border regulation of systemically important financial institutions is also required to mitigate the impact of destabilizing capital flows, but care is needed in imposing micro-based prudential rules to avoid unintended general equilibrium consequences.

A great many features of the current international financial system have a significant bearing on international capital flows. Thus, proposed reforms of this system can generally be expected to affect the scale and character of these flows. The survey in this chapter concerns policies which have been at the centre of discussion since the East Asian crisis of 1997 but even so it is not comprehensive. This chapter reviews major features of developing countries' experience of external financing since the 1960s, paying special attention to shifts in the relative importance of private capital inflows and to their volatility. It contains a schematic account of the features of financial instability and crises, which is intended to serve as a backdrop for the policy discussion which follows and covers a selection of the policies. The policies in question include actions to be taken at both national and international levels as well as combinations of the two.

This chapter seeks to reassert the importance of Britain's formal empire in the ‘unofficial mind’ of the late 19th-century City of London, suggesting that even if they did not initially see independent gold standard countries as more risky than colonies, investors learned through experience that they were. The reality was that membership of the British Empire was a more reliable ‘no default’ guarantee than adherence to the gold standard by itself. The political upheavals of the period before, during, and after the First World War revealed the limits of commitments to gold in the face of war and revolution. By the 1920s, bitter experience combined with a new regulatory environment to increase substantially the proportion of overseas investment going to the Empire.

This chapter examines the implications of the liberalization of capital outflows in China, India, Brazil, and South Africa (CIBS) for other developing countries. It focuses on their prospects of attracting not only foreign direct investment (FDI), but also portfolio capital flows from CIBS. To inform the discussion, two steps are taken: first, in order to identify the type of capital flows that might come from CIBS, the chapter briefly describes capital account liberalization measures undertaken by CIBS to date and future intended liberalization. Second, it maps geographic distribution of outward FDI and foreign portfolio investment in the recent past, which are taken as possible predictors of future flows. The chapter shows that portfolio investment goes mainly to OECD countries and offshore financial centres, and only a small share to developing countries. But, within developing countries, CIBS' neighbouring countries have shown a greater ability to attract this type of investment, compared with other developing countries.