NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Capital Mobility in Emerging Market Countries

"Many emerging economies lack the institutions required to manage the dramatic inflows and outflows of investment that have become a matter of routine in today's markets."

If there is one aspect of a globalized, borderless economy that has the capacity to rankle everyone from street protestors in Prague to finance ministers in Santiago, it is the notion that investors and their money should be able to move around markets like ancient Bedouins and their camel, freely roaming their respective terrains in search of the next oasis. While supporters of open markets argue that unfettered "capital mobility" is essential to global economic growth, critics blame the unbridled investor for exacerbating or even precipitating the economic crises that roiled emerging market countries in the 1990s.

In Capital Mobility and Economic Performance: Are Emerging Economies Different? (NBER Working Paper No. 8076), NBER Research Associate Sebastian Edwards argues that this debate lacks a strong body of detailed empirical analysis on exactly what it means to have an unrestricted financial market and how this openness (or lack thereof) affects a country's economy.

"Although this analysis is preliminary," he writes, "the results reported in this paper suggest quite strongly that the positive relationship between capital account openness and productivity performance only manifests itself after the country in question has reached a certain degree of economic development...A plausible interpretation is that countries can only take advantage, in net, of a greater mobility of capital once they have developed a somewhat advanced domestic financial market." Furthermore, Edwards asserts that "at very low levels of local financial development a more open capital account may have a negative effect on performance."

Edwards argues that his paper could offer new insights because, unlike other studies, it examines advanced countries and emerging economies with data that ranks their liberalization on a broad scale, rather than simply classifying them as open or closed. Edwards argues that, given the many ways countries regulate investment--and the myriad of tricks available to circumvent such laws--assessing how capital flows affect growth requires data that can capture the "subtleties of actual capital restrictions."

It should be pointed out that his detailed probing, while raising questions about the affect of globalization on emerging economies, does offer some measure of comfort to those who advocate liberalization. Indeed, after looking at data from 20 advanced countries and 45 emerging markets, Edwards finds general support for the basic argument that, broadly speaking, "countries with a greater degree of integration with the rest of the world performed better than more isolated nations."

But as Edwards points out, "many intellectually prominent" critics of globalization would readily agree that "account liberalization is not bad, per se." For them, Edwards notes, this is not the issue. Rather, the core concern is that many emerging economies lack the institutions required to manage the dramatic inflows and outflows of investment that have become a matter of routine in today's markets.

Edwards lends credence to this position. In a simple statement that has complex implications, Edwards concludes that when it comes to the affects of capital mobility, "emerging markets are essentially different from advanced nations."

-- Matthew Davis


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