International Financial Liberalisation and Economic Growth

This paper investigates the link between international financial integration and economic growth. In particular, we ask the following questions. What are the theoretical links between financial integration and growth? Is there any empirical evidence that an increase in financial integration is associated with higher economic growth at a cross-country level? Do different types of capital flows have different implications for growth? Existing empirical evidence suggests that the link between financial openness and economic growth is weak at best. While there is some evidence that financial liberalisation positively affects growth, this relationship is not robust. There is also some evidence that the positive impact of foreign investment on growth is conditional upon the existence of relatively developed domestic institutions and sound macroeconomic policy. This result is also not very robust and is sensitive to the measures employed to capture institutional development and the policy environment. To complement the existing research, we examine this issue with a particular emphasis on the composition of capital flows. Consistent with conventional wisdom, we find that both foreign direct investment and portfolio inflows enhance economic growth. By contrast, the effect of bank inflows is found to be mostly negative.