Development

The view taken in this paper is that in order to provide advice to developing countries on how to improve regulation and supervision of financial markets, it is first necessary to answer (1) whether commonly used regulatory tools have been effective in reducing the adverse effects of capital flow volatility on domestic financial markets; (2) whether appropriate regulatory and supervisory tools in developing countries need to be different from those that work in industrial countries and even differ between developing countries at different degrees of financial sector development.

This short article summarizes a recent IMF paper on the subject with the same title, which is a part of the IMF’s ongoing research program on globalization. The long version was published as IMF Occasional Paper 220. The main purpose of the paper is to provide an assessment of empirical evidence on the effects of financial globalization for developing economies. The paper focuses on three related questions: (i) does financial globalization promote economic growth in developing countries? (ii) what is its impact on macroeconomic volatility in these countries? (iii) what are the factors that appear to help harness the benefits of financial globalization?

This paper discusses the benefits and risks that financial globalization entails for developing countries. Financial globalization can lead to large benefits, particularly to the development of the financial system. But financial globalization can also come with crises and contagion. The net effect of financial globalization is likely positive in the long run, with risks being more prevalent right after countries liberalize. So far, only some countries, sectors, and firms have taken advantage of globalization. As financial systems turn global, governments lose policy instruments, so there is an increasing scope for some form of international financial policy cooperation.

The potential of a properly regulated financial system to dampen rather than exacerbate shocks to developing economies has too often been overlooked. This chapter explores the potential of prudential regulations to dampen international capital flows, limit certain kinds of risk taking and help guard against systemic failures and international contagion.