Rethinking the effects of financial liberalization

Fernando A. Broner

"During the last few decades, many emerging markets have lifted restrictions on cross-border financial transactions. The conventional view was that this would allow these countries to: (i) receive capital inflows from advanced countries that would finance higher investment and growth; (ii) insure against aggregate shocks and reduce consumption volatility; and (iii) accelerate the development of domestic financial markets and achieve a more efficient domestic allocation of capital and better sharing of individual risks. However, the evidence suggests that this conventional view was wrong. In this paper, we present a simple model that can account for the observed effects of financial liberalization. The model emphasizes the role of imperfect enforcement of domestic debts and the interactions between domestic and international financial transactions. In the model, financial...