Guillermo A. Calvo, Leonardo Leiderman, and Carmen M. Reinhart
alf a decade has passedsince the resurgenceof international capitalflows
to many developing countries. About $670 billion of foreign capital has flowed to developing countries in Asia and Latin America in the five years from 1990-94, as measured by the totalbalance on the capital account of these countries. This is about five times the $133 billion total of the previous five years, when there was a debt crisis and many of these countries had little or no access to international capital markets. Although there was a substantial decline in capital flows to developing countries in the immediate aftermath of Mexico's currency crisis in December 1994, in mostcases capital inflows have resumed and by mid1995 have been sustained at relatively high levels. The recent surge in capital inflows was initially attributed to domestic developments, such as the sound policies and stronger economic performance of a handful of countries. Eventually, it became clear that the phenomenon was widespread, affecting countries with very diverse characteristics. Thispattern suggested that global factors, like cyclical movements in interest rates, were especially important. Moreover, the pattern reflected a growing trend toward integration of world capital markets and globalization of investments. Capital flows from rich to poor countries are worth studying for a number of reasons. Foreign capital can finance investment and stimulate economic growth, thus helpingincrease the standard of living in the developing world. Capital flows can increase welfare by enabling households to smooth out their consumption over
* Guillermo Calvois Professor Economics,University Maryland,College A. Park,Maryof of land. LeonardoLeidermanis Professor Economics,Tel Aviv University,Tel Aviv, Israel. of InternationalMonetaryFund, CarmenM. Reinhart isEconomist,ResearchDepantment, D. Washington, C.
124 Journal of EconomicPerspectives
Figure 1 Asia and Latin America: Balance on the Capital Account, 1985-1994 (billionsof U.S. dollars) 80 70 6050403020 -
Latin America 4
10 0 l l l ll
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
Note:This comprehensive measure of the balance on the capital account includes errors and omissions. Source:WorldEconomicOutlook,International Monetary Fund, various issues.
time and achieve higher levels of consumption. Capital flows can help developed countries achieve a better international diversification of their portfolios and also provide support for pension funds and retirement accounts into the twenty-first century. However, large capital inflows can also have less desirable macroeconomiceffects, including rapid monetary expansion, inflationary pressures, real exchange rate appreciation and widening current account deficits. Hence, a surge in inflows of the magnitudes seen in recent years may pose serious dilemmas and tradeoffs for economic policy, especially in the present environment of high capital mobility. History has also shown that the global factors affecting foreign investmenttend to have an important cyclical component, which has given rise to repeated booms and busts in capital inflows.' For example, in Latin America, marked episodes of capital inflows during the 1920s and 1978-1981 were followed by major economic crises and capital outflows, such as in the 1930s and in the mid-1980s. The Mexican balance-of-payments crisis of December 1994 is but a recent example ofthis phenomenon and highlights the vulnerability of developing capital-importing countries to abrupt reversals; thus, an aim of policy is to reduce that vulnerability. This paper discusses the principal facts, developments and policies that characterize the current episode of capital inflows to Asia and Latin America. Figure 1 presents evidence on the patterns and magnitude of the flows to these...