A basic policy question facing the leaders and economic ministers of emerging countries is the degree to which they should open their economies to the international financial system. By opening themselves to global capital markets, these countries can borrow development capital that would otherwise have to be squeezed as savings out of their domestic economies--economies in which average income is already low and severe poverty often widespread. On the other hand, by opening their economies to foreign capital, developing countries inevitably cede some control of their economic fate to the lenders of that capital.
The risks of doing so are both economic and political. While financial liberalization can bring in more development capital, that capital may surge away again, or become more expensive, due to shifts in the global financial climate. Rapid growth may promote a bubble psychology, producing wastful mis-investments and a sharp downturn when the bubble bursts. An economic downturn may then lead to a political crisis. So long as times are good, nationalist grumbling about foreign investment is likely to be muted, but if times turn bad--and particularly if leaders are compelled to impose austerity measures by the International Monetary Fund (IMF), resentments may turn explosive. In Latin America, for example, IMF-bashing is a persistant feature of regional politics (Maddison, 1985, p. 81).
Nevertheless, the question of financial liberalization is today largely one of degree. Autarkic development, as attempted by Communist and some other countries in the past generation, has proven a failure. Moreover, unlike the situation prior to the 1970s, when it was harder to borrow internationally, foreign capital is now readily available and eagerly lent (Haggard and Lee, 1993, p. 7).
The ready available of international capital, indeed, widens the range of options available to governments. Even without full liberalizat...