Barcelona GSE Working Paper Series Working Paper nº 509 Rethinking The Effects of Financial Globalization Fernando Broner Jaume Ventura This version: October 2015 (October 2010)
RETHINKING THE EFFECTS OF FINANCIALGLOBALIZATION°Fernando BroneryJaume VenturazThis version: October 2015AbstractDuring the last few decades, many emerging markets lifted restrictions on cross-border °nan-cial transactions. In this paper, we present a simple model that can account for the observede/ects of °nancial globalization.The model emphasizes the role of imperfect enforcement ofdomestic debts and the interactions between domestic and foreign debts. Financial globaliza-tion can lead to a variety of outcomes: (i) domestic capital ±ight and ambiguous e/ects on netcapital ±ows, investment, and growth; (ii) capital in±ows and higher investment and growth;or (iii) volatile capital ±ows and unstable domestic °nancial markets.The model shows howthe e/ects of °nancial globalization depend on the level of development, productivity, domesticsavings, and the quality of institutions.JELCodes: F34, F36, F43, G15, O19, O43.°Previous versions of this paper circulated under the title ²Rethinking the E/ects of Financial Liberalization.³Wethank Francisco Queiros, Jagdish Tripathy, and Robert Zymek for excellent research assistance. We also thank theeditor, Elhanan Helpman, three anonymous referees, Fernando Alvarez, Yan Bai, Vasco Carvalho, Michael Devereux,Aitor Erce, Nicola Gennaioli, Giacomo Ponzetto, Romain Ranciere, and participants at various conferences andseminars for their valuable comments. We acknowledge °nancial support from the International Growth Centre, theSpanish Ministry of Science and Innovation (ECO2008-01666), and the European Research Council (ERC263846-KF&EM).yCREI, Universitat Pompeu Fabra, and Barcelona GSE. Address: Ramon Trias Fargas, 25-27, 08005-Barcelona.Telephone: (+34) 93 542 2601. E-mail: [email protected]zCREI, Universitat Pompeu Fabra, and Barcelona GSE. Address: Ramon Trias Fargas, 25-27, 08005-Barcelona.Telephone: (+34) 93 542 1765. E-mail: [email protected]
I.IntroductionDuring the last three decades, many countries have lifted restrictions on cross-border °nancialtransactions fueling a new wave of °nancial globalization.There is a strong and well-justi°edtheoretical presumption that increased trade opportunities should be welfare improving. And yetmany observers have noticed that the incidence of domestic °nancial crises has grown alongside°nancial globalization.1With historical perspective, this is not surprising. Figure I (which is takenfrom Reinhart and Rogo/´s seminal book on °nancial crises) shows that this relationship between°nancial globalization and the incidence of °nancial crises is also present in earlier periods.The goal of this paper is to improve our understanding of this relationship and its implications.