Front Matter

Front Matter

Ayhan Kose, Kenneth Rogoff, Eswar Prasad, and Shang-Jin Wei
Published Date:
September 2003
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    2003 International Monetary Fund

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    Effects of financial globalization on developing countries: some empirical evidence/Eswar S. Prasad. . . [et al.].—[Washington, D.C.: International Monetary Fund], 2003.

    p. cm.—(Occasional paper; no. 220)

    Includes bibliographical references.

    ISBN 1-58906-221-3

    1. Developing countries. 2. Globalization. I. Prasad, Eswar S. II. International Monetary Fund. III. Occasional paper (International Monetary Fund); no. 220.

    HC59.7.E43 2003

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    The following symbols have been used throughout this paper:

    • …to indicate that data are not available;

    • —to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist;

    • –between years or months (e.g., 1998–99 or January–June) to indicate the years or months covered, including the beginning and ending years or months;

    • /between years (e.g., 1998/99) to indicate a fiscal (financial) year.

    “n.a.” means not applicable.

    “Billion” means a thousand million.

    Minor discrepancies between constituent figures and totals are due to rounding.

    The term “country,” as used in this paper, does not in all cases refer to a territorial entity that is a state as understood by international law and practice; the term also covers some territorial entities that are not states, but for which statistical data are maintained and provided internationally on a separate and independent basis.


    Financial globalization is a vast and complex topic. Understanding the effects of financial globalization on developing countries, in particular, is of considerable importance. Although there has been a great deal of debate on this issue, the evidence on which the debate is based has not been uniform and unambiguous. This paper attempts to provide a systematic and critical review of recent empirical evidence, including some new research, on this subject. The main findings are the following:

    • In spite of an apparently strong theoretical presumption, it is difficult to detect a strong and robust causal relationship between financial integration and growth.

    • Contrary to theoretical predictions, financial integration sometimes appears to be associated with increases in consumption volatility in some developing countries, at least in the short run.

    • There appear to be threshold effects in both of these relationships that may be related to absorptive capacity. Some recent evidence suggests that governance is quantitatively, as well as qualitatively, important in affecting developing countries’ experiences with financial globalization.

    This paper was prepared by Eswar S. Prasad, Kenneth Rogoff, Shang-Jin Wei, and M. Ayhan Kose at the International Monetary Fund. Additional contributions came from Eduardo Borensztein, Robin Brooks, R. Gaston Gelos, Olivier Jeanne, Paolo Mauro, and Marco Terrones. The paper has also benefited from useful comments and suggestions from Tamim Bayoumi, Andrew Berg, Peter Clark, Hali Edison, Aasim Husain, Olivier Jeanne, Manmohan Kumar, Gian Maria Milesi-Ferretti, Ashoka Mody, James Morsink, Carmen Reinhart, David J. Robinson, Ratna Sahay, Miguel Savastano, and numerous other colleagues in the Research Department and other departments at the IMF. Priya Joshi, Young Kim, Pedro Rodriquez, and Yi Wu provided efficient research assistance. Hali Edison and Gian Maria Milesi-Ferretti generously shared their data with the team. Maria Orihuela and especially Marlene George and Dawn Heaney provided able assistance in the preparation of this paper. Paul Gleason edited the manuscript and coordinated production of the publication.

    An earlier version of the paper was presented at an informal seminar of the IMF’s Executive Board on March 3, 2003. This version has benefited from the comments made on that occasion. However, the views expressed are those of its authors and do not necessarily reflect the views of national authorities or IMF Executive Directors.

    Kenneth Rogoff

    Economic Counsellor and Director

    IMF Research Department


    This paper provides a review of recent empirical evidence, including some new research, on the effects of financial globalization for developing economies. The paper focuses on three questions:

    • (i) Does financial globalization promote economic growth in developing countries?;

    • (ii) What is its impact on macroeconomic volatility in these countries?; and

    • (iii) What factors can help to harness the benefits of financial globalization?

    Developing economies’ financial linkages with the global economy have risen significantly in recent decades. A relatively small group of these countries, however, has garnered the lion’s share of private capital flows from industrial to developing countries, which surged in the 1990s. Despite the recent sharp reversals in such “North-South” capital flows, various structural forces are likely to lead to a revival of these flows and continued financial globalization over the medium and long term.

    Theoretical models have identified a number of channels through which international financial integration can promote economic growth in developing countries. A systematic examination of the evidence, however, suggests that it is difficult to establish a strong causal relationship. In other words, if financial integration has a positive effect on growth, there is as yet no clear and robust empirical proof that the effect is quantitatively significant.

    There is some evidence of a “threshold effect” in the relationship between financial globalization and economic growth. The beneficial effects of financial globalization are more likely to be detected when the developing countries have a certain amount of absorptive capacity. Preliminary evidence also supports the view that, in addition to sound macroeconomic policies, improved governance and institutions have an important impact on a country’s ability to attract less volatile capital inflows and on its vulnerability to crises.

    International financial integration should, in principle, also help countries to reduce macroeconomic volatility. The available evidence suggests that developing countries have not fully attained this potential benefit. Indeed, the process of capital account liberalization appears to have been accompanied, in some cases, by increased vulnerability to crises. Globalization has heightened these risks, since cross-country financial linkages amplify the effects of various shocks and transmit them more quickly across national borders. A type of threshold effect appears here as well—reductions in volatility are observed only after countries have attained a particular level of financial integration.

    The evidence presented in this paper suggests that financial integration should be approached cautiously, with good institutions and macroeconomic frameworks viewed as important. The review of the available evidence does not, however, provide a clear road map for the optimal pace and sequencing of integration. For instance, there is an unresolved tension between having good institutions in place before undertaking capital market liberalization and the notion that such liberalization can, itself, help a country import best practices and provide an impetus to improve domestic institutions. Such questions can best be addressed only in the context of country-specific circumstances and institutional features.

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