RDP 2002-03: International Financial Liberalisation and Economic Growth 6. Concluding Remarks

The effect of international financial integration on economic growth has been the subject of ongoing debate in both academic and policy circles. Sceptics point to the financial and currency crises that have followed financial liberalisation in many countries. Proponents, on the other hand, argue that financial openness enhances investment and economic growth.

Theory suggests different channels through which financial integration can positively affect investment and growth. Despite the theoretical case for capital account liberalisation, attempts at establishing a robust empirical link between financial openness and growth have so far not been very successful. However, one should be cautious in interpreting the lack of a strong statistical link as evidence against liberalisation. As noted earlier, it may be that the measures of capital account liberalisation employed in most studies, including this one, do not adequately capture complex phenomena like financial liberalisation. Attempts at identifying the conditions under which liberalisation might be beneficial have also been hampered by the lack of satisfactory measures of financial market development and institutional strength. To complement the existing research, we examine this issue by using the available data on capital flows instead of the measures of capital account liberalisation. Consistent with conventional wisdom, we find that foreign direct investment and portfolio inflows enhance growth. By contrast, bank inflows appear to have a negative effect on growth, although this result is less robust to changes in equation specification than the results for FDI and portfolio inflows. Future work should attempt to more closely identify the different channels through which capital flows affect growth.