TY - JOUR AU - Tornell,Aaron AU - Westermann,Frank AU - Martinez,Lorenza TI - The Positive Link Between Financial Liberalization, Growth and Crises JF - National Bureau of Economic Research Working Paper Series VL - No. 10293 PY - 2004 Y2 - February 2004 UR - http://www.nber.org/papers/w10293 L1 - http://www.nber.org/papers/w10293.pdf N1 - Author contact info: Aaron Tornell Department of Economics UCLA 405 Hilgard Ave, Bunche Hall #8283 Los Angeles, CA 90095-1477 Tel: 310/794-1686 Fax: 310/825-9528 E-Mail: tornell@econ.ucla.edu Frank Westermann Department of Economics Rolandstr. 8 49069 Osnabrueck, Germany E-Mail: Frank.Westermann@uni-osnabrueck.de AB - There is no agreement regarding the growth-enhancing effects of financial liberalization, mainly because it is associated with risky international bank flows, lending booms, and crises. In this paper we make the case for liberalization despite the occurrence of crises. We show that in developing countries trade liberalization has typically been followed by financial liberalization, which has indeed led to financial fragility and a greater incidence of crises. However, financial liberalization also has led to higher GDP growth. In fact, the fastest-growing countries are typically those that have experienced boom-bust cycles. That is, there is a positive link between GDP growth and the bumpiness of credit, which is captured by the negative skewness --not by the variance-- of credit growth. To substantiate our interpretation of the data we present a model that shows why in countries with severe credit market imperfections, liberalization leads to higher growth and, as a by-product, to financial fragility. Thus, occasional crises need not forestall growth and may even be a necessary component of a developing country's growth experience. Finally, our analysis indicates that foreign direct investment does not obviate the need for risky international bank flows, as the latter are the only source of financing for most firms in the nontradables sector. ER -