Tuesday, February 10, 2009

Tuesday with Maurie

Long blogging hiatus due to family, teaching, and dissertation obligations...not to mention a general blogging malaise. But when I read this new abstract from international economist extraordinaire Maurice Obstfeld this morning, I just had to pass it along:

Despite an abundance of cross-section, panel, and event studies, there is strikingly little convincing documentation of direct positive impacts of financial opening on the economic welfare levels or growth rates of developing countries. The econometric difficulties are similar to those that bedevil the literature on trade openness and growth, though if anything, they are more severe in the context of finance. There is also little systematic evidence that financial opening raises welfare indirectly by promoting collateral reforms of economic institutions or policies. At the same time, opening the financial account does appear to raise the frequency and severity of economic crises. Nonetheless, developing countries have moved over time in the direction of further financial openness. A plausible explanation is that financial development is a concomitant of economic growth, and a growing financial sector in an economy open to trade cannot long be insulated from cross-border financial flows. This survey discusses the policy framework in which financial globalization is most likely to prove beneficial. The reforms developing countries need to institute to make their economies safe for international asset trade are the same ones they need so as to curtail the power of entrenched economic interests and liberate the economy's productive potential.

The puzzle Prof. Obstfeld presents us is this: if there is "little systematic evidence" international financial opening raises growth and welfare--and instead leads to more frequent and severe financial crises--why have so many countries undergone financial liberalization? Obstfeld responds with what he deems a "plausible" answer: financial development and growth go hand-in-hand.

How plausible is this? Not as plausible as Obstfeld implies, and Prof. Obstfeld should know better. First off, financial liberalization has been driven forward as a political agenda--globally, and in crisis-afflicted countries. Part of the reason the embrace has been so great is that for decades (a) many economists have been telling political leaders and technocrats that this kind of financial liberalization is the key to success, and (b) international financial institutions (public and private) have systematically pressured countries onto this path. Looking at the political economy of this process reveals a more "plausible" explanation of why so many countries have pursued liberalization despite the apparent risks and unapparnt rewards. Second, Obstfeld implies that growth and financial development are structurally related. They are not--and he himself has so observed the dearth of empirical evidence for such claims.

I think Prof. Obstfeld must know better than this. So why does he continue to frame the topic in this way? The free market pathology strikes again.