Anastasia Nesvetailova

Capital flows and crisis

D. Dasgupta, M. Uzan, D. Wilson, (eds), 2001, Capital Flows without Crisis? Reconciling Capital Mobility and Economic Stability, London: Routledge. £55.00 (hardback).

At the time when warnings about the looming world recession and endemic financial crises become commonplace, any scholarly study of financial crises and international capital flows should be highly welcome. Capital Flows Without Crisis, a collection of essays by academic economists as well as economic development practitioners, addresses the problem of increasing frequency of financial crises in developing and transition economies. As noted in the introduction, "virtually all thirty-one countries identified as emerging markets have experienced at least one incident of loss of external liquidity as a consequence of financial crises during the 1990s" (p.1). The experience of the last decade demonstrates that the integration of emerging markets into the global financial system poses much larger policy challenges than previously expected. Whereas the early 1990s will be remembered for the euphoria that emerged about the benefits of financial liberalisation, private capital flows and emerging markets; the late 1990s will be remembered as the era of inherent financial volatility and crises (p. 2).

In such era of turbulence, it is unsurprising that the challenge of reconciling international capital mobility with domestic economic stability has now emerged as the most pressing and controversial topic in international economics and policymaking. The central question that the book seeks to address is "whether policies can be designed that allow economies to reap the gains from greater access to international capital while minimising the risk that international capital flows will compromise domestic economic stability" (p. 3). In the volume, thirteen papers analyse the systemic issues of why crises occurrence and the ways to manage and prevent them. Another eleven essays provide detailed analysis of the experience of individual economies from around the world to understand how they have coped with policy dilemmas raised by increased capital mobility. One can agree with the editors who say that the key feature of the volume is the breath of its coverage (p.3).

The two opening parts of the book discuss the dynamics of financial crises in the era of mobile capital. They draw lessons from the recent outbreaks on what measures can possibly prevent crises in the future. In particular, the essay by U. Dadush and D. Dasgupta reveals the causes of developing countries’ vulnerability to liberalised capital flows and observe a distinctively pro-cyclical behaviour of international capital flows. The latter, authors note, makes the policy choices available to governments in developing world in times of financial strain, severely restricted (p.17). The article by Miller and Zhang, "Sequencing of capital account liberalisation" examines the challenge presented to the Washington Consensus by recent events, and how should it be modified as a consequence. Following P. Krugman, the authors argue that the reason behind the danger of the combination of market fundamentalism and poor regulation lies in the interaction between government guarantees given to bank deposits and the limited liability enjoyed by shareholders, which pose potentially serious problems of moral hazard (p.37).

On the theme of the management and prevention of crises, two contributions stand out. J. Dijiwandono’s "The muddling through of crisis management in Indonesia", analyses the challenges that the shifts in the international financial system present to traditional central banks. As he concludes, with innovations in financial instruments, new techniques of financial intermediation in global finance, and the changing nature of money itself, the concept of independent central banking needs to be redefined (p.52). The article by G. Irwin and D. Vines, "International policy advice in the East Asian crisis" sketches a critique of the IMF’s handling of the 1997 crisis. In Asia, they argue, the collapse of currency pegs was associated not as the Fund has fared, with a spiral of exchange rate falls and inflation. Instead, it was linked to a spiral of exchange rate falls, increases in indebtedness, output falls, and further exchange rate falls. Therefore, in order to speed up the recovery in East Asia, the authors propose a move towards a floating exchange rate with an inflation-targeting framework as the nominal anchor (pp. 64-70).

The other five parts of the volume provide detailed case studies of crisis outbreaks in Eastern Europe (chs. 7-9), Latin America (chs. 10,11) East Asia (chs. 12-14), as well as discussing China’s and Malaysia’s experiences with capital controls (chs. 15-16). Despite being thorough in terms of statistical details and quite strong in comparative outlook, the empirical cases typically trace the roots of the crises to individual government’s policy mistakes. There is a weak correlation between the empirical part of the book and the opening chapters, which seem to have recognised the dangers of systematic turbulence of the global financial system. If the breadth of illustration may indeed be a chief merit of the book, the depth of inquiry is by no means so.

In 2002, the authors’ reflections on the dangers of speculative and volatile nature of global finance by no means read like a novelty. (Although, considering that the book is largely written from the point of view of orthodox economics, such recognition deserves credit). However, readers familiar with more radical literature would inevitably want more in terms of disclosure of the inner mechanisms of the liberalised financial system, and their normative implications. Moreover, although many case studies are written by practising economists and advisers, they do not offer any concrete proposals for a plausible reform of international finance. While the option of Malaysian-type restrictions on capitals movements are criticised and ultimately rejected (ch. 15), no alternative measure to restore financial stability is discussed in sufficient detail. With the critique of New International Financial Architecture already available in the IPE literature and development economics, such omission is surprising. Overall, Capital Flows Without Crisis will certainly be a valuable addition to reading lists on international finance and development economics. Empirically sound and wide in coverage, this single volume clearly demonstrates the severity and pervasiveness of financial crises in emerging economies. On the other hand, readers seeking a more profound insight into systematic causes and dynamics of the modern financial capitalism are recommended to refer to more radical studies in the political economy of money and finance.