^*M. Ayhan Kose is a senior economist with the IMF Research Department; Eswar Prasad is the Nandlal P. Tolani Senior Professor of Trade Policy at Cornell University and a Senior Fellow at the Brookings Institution; Kenneth Rogoff is the Thomas D. Cabot Professor of Public Policy and Professor of Economics at Harvard University; and Shang-Jin Wei is the N.T. Wang Professor of Chinese Business and Economy in the Graduate School of Business at Columbia University. The authors are grateful for helpful comments from numerous colleagues and participants at various seminars where earlier versions of this paper were presented. Lore Aguilar, Cigdem Akin, Dionysios Kaltis, and Ashley Taylor provided excellent research assistance.

Abstract

The literature on the benefits and costs of financial globalization for developing countries has exploded in recent years, but along many disparate channels with a variety of apparently conflicting results. There is still little robust evidence of the growth benefits of broad capital account liberalization, but a number of recent papers in the finance literature report that equity market liberalizations do significantly boost growth. Similarly, evidence based on microeconomic (firm- or industry-level) data shows some benefits of financial integration and the distortionary effects of capital controls, but the macroeconomic evidence remains inconclusive. At the same time, some studies argue that financial globalization enhances macroeconomic stability in developing countries, but others argue the opposite. This paper attempts to provide a unified conceptual framework for organizing this vast and growing literature, particularly emphasizing recent approaches to measuring the catalytic and indirect benefits to financial globalization. Indeed, it argues that the indirect effects of financial globalization on financial sector development, institutions, governance, and macroeconomic stability are likely to be far more important than any direct impact via capital accumulation or portfolio diversification. This perspective explains the failure of research based on cross-country growth regressions to find the expected positive effects of financial globalization and points to newer approaches that are potentially more useful and convincing.