To understand what is going on, we need a different explanation of what keeps investment and growth low in most poor nations. Whereas the standard story is that developing countries are saving-constrained, the fact that capital is moving outward rather than inward in the most successful developing countries suggests that the constraint lies elsewhere. Most likely, the real constraint lies on the investment side. The main problem seems to be the Paucity of entrepreneurship and low propensity to invest in plant and equipment - what Keynes called "low animal spirits" - especially to raise output of products that can be traded on world markets. Behind this shortcoming lay various institutional and market distortions associated with industrial and other modern-sector activities in low- income environments.
When countries suffer from low investment demand, freeing up capital inflows does not do much good. What businesses in these countries need is not necessarily more finance, but the expectation of larger profits for their owners. In fact, capital inflows can make things worse, because they tend to appreciate the domestic currency and make production in export activities less profitable, further weakening the incentive to invest.
Thus, the pattern in emerging market economies that liberalised capital inflows has been lower investment in the modern sectors of the economy, and eventually slower economic growth (once the consumption boom associated with the capital inflows plays out). By contrast, countries like China and India, which avoided a surge of capital inflows, managed to maintain highly competitive domestic currencies, and thereby kept profitability and investment high. The lesson for countries that have not yet made the leap to financial globalisation is clear: beware.
Nothing can kill growth more effectively than an uncompetitive currency, and there is no faster route to currency appreciation than a surge in capital inflows. For those countries that have already made the leap, the choices are more difficult. Managing the exchange rate becomes much more difficult when capital is free to come and go as it pleases. But it is not impossible-as long as policymakers understand the critical role played by the exchange rate and the need to subordinate capital flows to the needs of competitiveness.
Given all the effort that the world's emerging markets have devoted to shielding themselves from financial volatility, they have reason to ask: where in the world is the upside of financial liberalisation?
When countries suffer from low investment demand, freeing up capital inflows does not do much good. What businesses in these countries need is not necessarily more finance, but the expectation of larger profits for their owners. In fact, capital inflows can make things worse, because they tend to appreciate the domestic currency and make production in export activities less profitable, further weakening the incentive to invest.
Thus, the pattern in emerging market economies that liberalised capital inflows has been lower investment in the modern sectors of the economy, and eventually slower economic growth (once the consumption boom associated with the capital inflows plays out). By contrast, countries like China and India, which avoided a surge of capital inflows, managed to maintain highly competitive domestic currencies, and thereby kept profitability and investment high. The lesson for countries that have not yet made the leap to financial globalisation is clear: beware.
Nothing can kill growth more effectively than an uncompetitive currency, and there is no faster route to currency appreciation than a surge in capital inflows. For those countries that have already made the leap, the choices are more difficult. Managing the exchange rate becomes much more difficult when capital is free to come and go as it pleases. But it is not impossible-as long as policymakers understand the critical role played by the exchange rate and the need to subordinate capital flows to the needs of competitiveness.
Given all the effort that the world's emerging markets have devoted to shielding themselves from financial volatility, they have reason to ask: where in the world is the upside of financial liberalisation?
No comments:
Post a Comment