Changing financial landscapes and their policy implications

Journal of Interamerican Studies and World Affairs, Fall 2000 by McQuerry, Elizabeth

Armijo, Leslie Elliot, ed. Financial Globalization and Democracy in Emerging Markets. New York: St. Martin's Press, 1999. Tables, figures, notes, bibliography, index, 348 pp.; hardcover $79.95.

Coleman, William D. Financial Services, Globalization, and Domestic Policy Change. New York: St. Martin's Press, 1996. Tables, figures, notes, bibliography, index, 297 pp.; hardcover $75.

Kahler, Miles, ed. Capital Flows and Financial Crises. Ithaca: Cornell University Press, 1998. Tables, figures, bibliography, index, 268 pp.; hardcover $49.95, paperback $19.95.

Pempel, T. J., ed. The Politics of the Asian Economic Crisis. Ithaca: Cornell University Press, 1999. Tables, figures, notes, bibliography, index, 284 pp.; hardcover $49.95, paperback $19.95.

Many studies of Latin America over the last 15 years have noted the dual transitions under way as efforts to open up political systems have largely occurred simultaneously with the promotion of economic liberalization policies. In some ways, however, the dual transition metaphor is misleading, because economic liberalization-or policies such as the reduction of tariffs and subsidies designed to open up the economy to greater competition-is often a separate process from financial sector liberalization. Financial liberalization is also primarily an economic process, but it involves a different subset of policies, such as removing government controls on exchange and interest rates, credit allocation, foreign investment, and capital movements, along with the privatization of state-owned financial service institutions. Reforming the financial system, furthermore, may represent an even more delicate endeavor for policymakers than reforming the general economy, because the financial system is the very core of the economy.

Many countries have experienced financial sector instability to one degree or another during liberalization. Banking crises have occurred in several countries, including Mexico, where the December 1994 peso crisis led to a multiyear bailout of the banking sector costing over 21 percent of the gross domestic product (Christie 2000). Spillover from the so-called tequila crisis into other Latin American countries resulted in bank bailouts in Argentina and Brazil. Earlier, Chile experienced an extreme banking crisis-estimated to have cost a staggering 33 percent of GDP-after it liberalized its economy in the early 1980s (Amieva and Urriza 2000).

Yet banking crises are only one highly visible and costly manifestation of financial sector instability. Exchange rate volatility and balanceof-payments problems have also accompanied Latin America's transition to more open markets. A study of banking and currency crises in both industrial and developing countries by Kaminsky and Reinhart (1999) found that these two types of crises were more likely to occur when liberalization of the financial sector had recently taken place: "the twin crises may have common origins in the deregulation of the financial system and the boom-and-bust cycles and asset bubbles that, all too often, accompany financial liberalization" (480).

These findings bear humbling implications for policymakers as they map out country strategies to make their financial markets more efficient and attractive to foreign investment. Indeed, most policymakers in Latin America are eager to extend the logic of economic liberalization into the financial sector, largely because foreign capital inflows bring investment dollars that would otherwise not be available and help finance current account deficits. On the other hand, the behavior of these flows is generally not predictable, and the swift, sometimes large flow of funds out of currency and equity markets can bring about balance-of-payments problems and currency crises.

Recent scholarship on financial sector liberalization examines both the political implications of the sector's changing landscape and the economic consequences that often accompany these transformations. The four books reviewed here share a common perspective that primarily addresses domestic responses to global economic change, particularly efforts to open up the financial sector and the local impact of increasing foreign capital inflows. These works do not limit themselves to these areas, though; they acknowledge that change in the real economy occurs simultaneously with financial change, and developments in one sphere often influence the trajectory of reform in the other.

Each book has a different entry point to the subject, a variety that illustrates the broad, often cross-cutting economic and political implications of financial sector liberalization. Miles Kahler's Capital Flows and Financial Crises maps out the changing nature of capital flows to developing countries, how such infusions have affected domestic economies, and varying government policy responses. The political dimension of these flows is explicitly explored in Financial Globalization and Democracy in Emerging Markets through a series of thematic and country studies. Contributors to The Politics of the Asian Economic Crisis similarly examine the series of financial crises that began in 1997, for both the economic policy responses and the effects on the particular historical, institutional, and political framework in developing Asia. Financial Services, Globalization, and Domestic Policy Change looks at the political determinants and policy networks supporting the establishment of financial liberalization efforts in industrial countries.