The political economy of financial internationalization in the developing world

Abstract

In the last decade a growing number of developing countries have opened their financial systems by liberalizing capital flows and the rules governing the international operations of financial intermediaries. One explanation of this rush toward greater financial internationalization is that increasing interdependence generates domestic and foreign political pressures for capital account liberalization. While we find evidence for that hypothesis, we find that the proximate cause in developing countries more frequently is found in balance of payments crises. Politicians perceive that financial openness in the face of crisis can increase capital inflows by indicating to foreign investors that they will be able to liquidate their investments and by signaling government intentions to maintain fiscal and monetary discipline. The argument is explored through case studies of Chile, Indonesia, Mexico, and South Korea.