Too Much Financial Integration: The Perils of Open Capital Accounts in Low and Middle Income Countries

Abstract

Over the past 3 decades, financial integration of lower income countries with global capital markets has in most cases been detrimental to development. Currency hierarchies determine investor perceptions and render capital flows to such countries more volatile and more demanding of higher returns. They also lead to significant spillover effects of macroeconomic policies in advanced economies. As a result, financial integration has not led to sustained increases in investment rates or economic growth, has generated greater financial instability and vulnerability, and been associated with high ‘seignorage costs’ because of differences in rates of return of capital inflows and outflows. Developing countries now suffer from ‘too much financial integration’, and cross-border capital flows should be more regulated.