Before and After Financial Liberalization

Given all the ambiguities about the outcomes of the financial liberalization process, it is relevant to ask what the systematic, cross-country evidence reveals on several questions, including: What happens to key macroeconomic and variables following domestic and external financial liberalization? Are there significant differences in the outcomes between emerging and developed economies? Are there regional patterns in the response to financial sector reforms? Does a country’s level of development shape the outcome of financial sector reforms? These are the questions we focus on in this paper. With greater certainty, financial liberalization appears to deliver: higher real interest rates (possibly reflecting the allocation of capital toward more productive, higher return projects.); lower investment, but not lower growth (again, possibly owing to a shift to more productive uses of financial resources); a higher level of foreign direct investment; and high gross capital flows--the catch is that occurs only in the higher income countries. Liberalization appears to deliver financial deepening, as measured by the credit and monetary aggregates--but, again, low income countries do not appear to show clear signs of such a benefit As regards saving, anything goes. In some regions saving increased following financial sector reforms; but in the majority of cases saving declined following the reforms.