The Case for Open Capital Markets

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Recent financial problems in emerging economies have led tocalls for a new international financial architecture. Proposalsinclude restricting short-term capital flows and extending theInternational Monetary Fund's role to that of an internationallender of last resort. Both "reforms" would be mistakes.

International capital flows should not be restricted; theybenefit entrepreneurs and savers alike, with lower borrowing costsand greater returns. The international flow of capital improvesrisk management, allows consumption smoothing, improvesfinancial-sector efficiency, and leads to greater overall marketdiscipline. Furthermore, capital flows have a stabilizing effect onfinancial markets. Restricting international investment denies acountry those benefits; the result is slower growth and reducedstandards of living.

Expanding the IMF is a bad idea. It would increase the power ofan institution that has promoted ineffective macroeconomicadjustment programs. The IMF's lending programs do not providestrong incentives for fundamental market reforms. Instead ofhelping to create sustainable economic growth, IMF interventionspromote a debilitating dependence on further IMF loans.

Repeated IMF bailouts encourage excessive risk taking by bothlenders and borrowers. The result is more frequent and severefinancial crises. Expanding the role of the IMF will just lead tomore of the same. A better strategy would be to reduce the power ofthe IMF, ending its role as the global guarantor for internationalinvestors.

Without IMF intervention, global investors will increase theirscrutiny of the economic policies of emerging market economies.Countries that want access to world capital will face strongincentives to adopt market reforms. As a result, global capitalwill be used more prudently and efficiently. There will be fewerand less-severe financial problems. An open global capital marketcan thus serve as an important engine for worldwide economic growthin the 21st century.

Robert Krol

Robert Krol is a professor of economics at California State University, Northridge.