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IS FINANCIAL GLOBALIZATION BENEFICIAL? Frederic S. Mishkin Working Paper 11891 http://www.nber.org/papers/w11891 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 December 2005

JMCB-FDIC Lecture presented at the FDIC, Washington, D.C. on September 22, 2005. This lecture draws heavily on material in chapters 1-7 of my forthcomingbook, The Next Great Globalization: How Disadvantaged Nations Can Harness Their Financial Systems to Get Rich. I thank for their helpful comments the following who have commented on this material: Christian Broda, Charlie Calomiris, Jose De Gregorio, Peter Dougherty, Bill Easterly, Barry Eichengreen, Reuven Glick, Steve Haber, Joon-Ho Hahm, Michael Klein, Ross Levine, Geraldo Licondro GeraldoLicondro, Dani Rodrick, Maury Obstfeld, Guido Sandleris, Sergio Schmukler, Alan Taylor, Jane Tufts and participants in seminars at the FDIC, Federal Reserve Bank of New York, New School, Purdue, University of Scranton, University of Delaware, Columbia, and Penn State. I also thank Emilia Simeonova for helpful research assistance. Any views expressed in this paper are those of the author only and notthose of Columbia University or the National Bureau of Economic Research. ©2005 by Frederic S. Mishkin. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

Is Financial Globalization Beneficial? Frederic S. Mishkin NBER Working Paper No. 11891 December 2005 JELNo. F02, O10, O16, G20 ABSTRACT This lecture examines whether financial globalization is beneficial to developing countries by first examining the evidence on financial development and economic growth and concludes that financial development is indeed a key element in promoting economic growth. It then asks why if financial development is so beneficial, it often doesn't occur. It then goes on toexamine whether globalization, particularly of the financial kind, can help encourage financial and economic development and argues that it can. However, financial globalization does not always work to encourage economic development because it often leads to devastating financial crises. The issue is thus not whether financial globalization is inherently good or bad, but whether it can be done right.Frederic S. Mishkin Graduate School of Business Uris Hall 817 Columbia University New York, NY 10027 and NBER fsm3@columbia.edu

I. INTRODUCTION The current Age of Globalization in the last fifty years is actually the second great wave of globalization of international trade and capital flows. The first occurred from 1870 to 1914, when international trade grew at a 4% rate annually, risingfrom 10% of GDP in 1870 to over 20% in 1914, while international flows of capital grew annually at 4.8% and increased from 7% of GDP in 1870 to close to 20% in 1914.1 With the coming of World War I, the first Age of Globalization came to an end, leading to what Rajan and Zingales (2003a) have referred to as the “Great Reversal.” Given the economic and political nightmares that followed the GreatReversal, in the fading days of World War II, the victorious allies decided to create a new international system to promote world trade and prosperity, which resulted in the establishment of two new international financial institutions, the International Monetary Fund (IMF) and the World Bank, and also the General Agreement on Tariffs and Trade (GATT) whose successor organization was the World TradeOrganization (WTO). These new institutions were created to promote globalization and in this they were extremely successful. Once world economy returned to normal by the end of the 1950s, globalization advanced at a rapid pace. From 1973 until today, world trade grew at pace of 11% annually, rising from just over 22% of world GDP to 42% today (Estevadeordal and Taylor, 2002) Since 1973, the flows...