Editor’s Note: As developing countries continue to move toward opening their financial markets, lessons from the Asian financial crisis prove even more relevant for assessing how best to manage capital account liberalization. Eswar Prasad, an expert on the global economy, and Raghuram Rajan, offer analysis and recommendations.
It was fashionable in the mid-1990s for mainstream economists of nearly all stripes to recommend capital account liberalisation as an essential step in the process of economic development. Indeed, in September 1997, the governing body of the International Monetary Fund sought to make “the liberalisation of capital movements one of the purposes of the IMF and extend, as needed, the IMF’s jurisdiction …regarding the liberalisation of such movements.” The East Asian financial crisis of the late 1990s, where even seemingly well-managed countries like South Korea were engulfed by massive capital outflows and tremendous currency volatility, raised questions about the wisdom of developing countries opening their capital accounts, and certainly ended all discussion about giving multilateral organisations more of a mandate to push for liberalisation.
I think blended finance, development finance, is what’s needed, is the future. The U.S. is using a model that was created 40 years ago and I think it’s way past time for modernizing our capabilities.