Argument: Free trade risks rapid capital flight from developing countries

Issue Report: Free trade


  • Martin Wolf, Why Globalization Works?. Yale University Press. 2004. ISBN 0-300-10777-3. pp 85. – Difficulties exist within any financial system, because of asymmetric behaviour. But when funds cross borders, these vulnerabilities become still greater.
In emerging market economies, difficulties over the design of the exchange rate and montetary regimes interact with the fragility of financial arrangements, to create a host of obstacles to stable and sizeable capital flows. First, ignorance of financial and economic conditions in foreign countries is greater than at home. This applies particularly to emerging-market economies. Second, confidence in the probity of the governments and legal systems of countries abroad is low. Third, important elements of the legal and regulatory systems malfunction or do not exist. Fourth, banking institutions often have comprehensive guarantees, while being used by governments or owners for their own purposes, which makes them fundamentally unsound. Fifth, financial and accounting information is often lacking altogether, or is totally unreliable. Sixth, foreigners may expect to be discriminated against during a financial crisis, especially when the state or well-connected domestic interest is insolvent. Seventh, the government may have a long history of financial profligacy and default and so a poor reputation. Finally, when there is cross-border lending in a currency other than the borrower’s, which is normal in lending to emerging markets, there is the additional foreign currency risk. All these problems are relatively small if, say, American banks lend in the United Kingdom. They are large if they lend to, say, Argentina. Their net effect is to make finance expensive, small in size and, worst of all, unstable.”


See also