Dani Rodrik and Arvind Subramanian want to stem financial globalization:
If the risk-taking behaviour of financial intermediaries cannot be regulated perfectly, we need to find ways of reducing the volume of transactions. Otherwise we commit the same fallacy as gun control opponents who argue that “guns do not kill people, people do”. As we are unable to regulate fully the behaviour of gun owners, we have no choice but to restrict the circulation of guns more directly.
What this means is that financial capital should be flowing across borders in smaller quantities, so that finance is “primarily national”, as John Maynard Keynes advised. If downhill and uphill flows are both problematic, capital flows should be more level.
But how is such a levelling-off of flows to be achieved? In the current context, the source of liquidity is large current account surpluses in the oil-exporting countries and east Asia, especially China. Reducing these should be a high policy priority for the international community. Two concrete actions – one for each source of liquidity – suggest themselves.
First, some variant of petrol tax in the main oil-importing countries (including the US, China and India) is essential to cut demand and reduce oil prices and hence the current account surpluses of oil exporters. That such measures should be taken for environmental reasons or that they would reduce the size of sovereign wealth funds only adds to their attractiveness. Second, some appreciation of east Asian currencies is necessary to reduce their surpluses. Even though undervaluation is a potent instrument for promoting growth in low-income countries in general, at this juncture self-interest on both sides calls for an orderly unwinding of current account imbalances…
Financial globalisation has not generated increased investment or higher growth in emerging markets. Countries that have grown most rapidly have been those that rely least on capital inflows. Nor has financial globalisation led to better smoothing of consumption or reduced volatility. If you want to make an evidence-based case for financial globalisation today, you are forced to resort to indirect and speculative arguments.
It is time for a new model of financial globalisation, one that recognises that more is not necessarily better. As long as the world economy remains politically divided among different sovereign and regulatory authorities, global finance is condemned to suffer deformations far worse than those of domestic finance. Depending on context, the appropriate role of policy will be as often to stem the tide of capital flows as to encourage them. Policymakers who view their challenges exclusively from the latter perspective will get it badly wrong.
Mark Thoma has Frederic Mishkin’s contrary view.
Addendum: See the discussion at Martin Wolf’s forum. William Easterly says “To say that there are crises because of international capital flows is not very meaningful; it is like saying there are recessions because of GDP.” Emmanuel argues that “the genie of freer capital flows escaped from the bottle after the collapse of the Bretton Woods system and cannot be put back.”