Why Did Financial Globalization Disappoint?

As Fischer had prophesied, there has been an explosion in empirical studies on theconsequences of financial globalization. But far from clinching the case for capitalaccountliberalization, these studies paint quite a mixed and paradoxical picture.3 Kose, Prasad, Rogoff, and Wei (2006, hereafter KPRW), who provide perhaps the most detailedand careful review of the literature, conclude that the cross-country evidence on thegrowth benefits of capital-account openness is inconclusive and lacks robustness. Theyargue that one should look for the gains not in enhanced access to finance for domesticinvestment, but in indirect benefits that are hard to detect with macroeconomic data andtechniques (an argument which we will evaluate below). In another paper, Kose, Prasadand Terrones (2003) find that consumption volatility actually rose (relative to outputvolatility) in emerging market economies during the current era of financialglobalization—a finding that flatly contradicts theoretical expectations. Perhaps mostparadoxical of all are the findings of Prasad, Rajan, and Subramanian (2007, hereafterPRS) and Gourinchas and Jeanne (2007), which throw cold water on the presumedcomplementarity between foreign capital and economic growth: it appears that countriesthat grow more rapidly are those that rely less and not more on foreign capital; and inturn foreign capital tends to go to countries that experience not high, but low productivitygrowth.