The Financial Crisis Was a Rich-Country Affair

I haven’t read the book (yet), so I probably shouldn’t comment, but I’m puzzled by Matt Yglesias’ review of The Globalization Paradox, and here’s why.

Matt says:

The third book, which I wish he’d just done as the whole book, is about “financial globalization” and how it went very bad. These aren’t the terms he uses, but I think the point he’s making about this is that total lack of capital controls makes it very difficult to do effective macroeconomic stabilization so you end up with large output gaps so even if you assume that there’s some microeconomic inefficiencies associated with capital controls you still end up with more robust, more stable growth if you have controls . . . This seems very persuasive to me.

It’s very persuasive to me – but, if we’re talking about globalization, developing countries and the danger of attracting “hot money” then this is the lesson of Malaysia’s performance during the Southeast Asian currency crises of the late 1990s, versus the performance of Indonesia and Thailand. Right? Because the financial crisis of the last decade was overwhelmingly a rich-country affair. The 2000s were a great decade for the developing world – for China and India, of course, but also for Brazil, Southeast Asia, even for certain parts of Africa.

If you want to make an analogous argument about the perils of free movement of capital with respect to the recent crisis, you’d need to focus on small countries that got caught up in the housing bubble mania. In other words, this becomes a story about countries like Ireland and Greece and, hence, really a story about the Euro and what the costs and benefits are to a small country handing over control of its currency to a larger entity. (Positive: much lower borrowing costs; negative: no ability to monetize debt or otherwise inflate one’s way out of a recession.) That’s an interesting story, and one Matt has talked a lot about, but it’s not really a story about development economics because the Euro was, is and always will be first and foremost a political project, not an economic one, and because while Ireland and Greece were relatively poorer than the average European country twenty years ago, they weren’t developing countries, not in the sense that we usually use that term.

And if you want to talk about capital controls and development economics, the whole story is about China, and what benefits China gets (if any) from operating such an enormous and rapidly growing economy behind the wall of an essentially non-convertible currency. Obviously, the regime gets significant benefits in terms of greater control, but a sophisticated estimate of the economic costs to China of the existing currency regime would be useful to see. Because if China isn’t going “too far” in these controls, then “too far” is not a meaningful concept to talk about.