Financial Liberalization, How Far, How Fast? (original) (raw)

2004, Journal of Comparative Economics

Comparative economists interested in financial development in the formerly centrally planned economies of the Soviet Union and Eastern Europe can learn much from an examination of the process of financial liberalization in developing countries. With an examination of four or five decades of institutional and policy changes around the globe, this volume brings a broad overview of empirical analyses to the theoretical debate about the management and development of financial systems. The volume is divided into three sections: Analytics, Cross Country Evidence and Liberalization Experience. The first section contains two excellent chapters that provide the conceptual and analytical background essential to understanding financial liberalization. In the first chapter, Gerard Caprio, James Hanson and Patrick Honohan examine financial repression, the case for liberalization, and arguments for restraint. The short-run consequences of liberalization are sometimes disastrous; exposure of weak portfolios within the financial system may bring about financial and exchange rate crises. The benefits of liberalization include more rational allocation of financial capital, improved corporate governance, increased efficiency, and the elimination of rents within the financial and banking system, and an overall increase in the supply of capital. Although these benefits certainly justify liberalization, caution and restraint may be appropriate in the transition process. The authors turn to liberalization in practice and provide an overview of the cases presented in the third section of the book. The second chapter, by Honohan and Joseph Stiglitz, argues that while previous repressed systems often had regulations designed with sectoral objectives rather than prudence in mind, which may have become technologically obsolete, and may have masked financial insolvency of the banking system, complete liberalization is not appropriate. Rather they make the economic case for a more robust approach to financial restraint, i.e. policies that provide policy makers with the ability to cope with events and behaviors that may lead to system failures. These policies should be clear and transparent so that violations are easy to detect and they should embody sanctions that can be easily enforced. Agency and information problems in developing countries argue for robust policies, whereas liberalization with reliance on sophisticated indirect models of control require information processing beyond the capacity of policy makers in most developing economies. Moreover, fair and even-handed regulatory capacities often do not exist and independence of policy makers, including the subtle judgments of the systemic risk managers is not typically found in practice. Robust policies and cautious financial restraint that recognizes and preserves franchise values seems more appropriate than a 0147-5967/2004 Published by Elsevier Inc. on behalf of Association for Comparative Economic Studies.