On balance, do you consider the free movement of capital across borders a good or bad idea for developing countries? Why?
Abstract
The effect of free movement of capital across borders in developing countries and emerging markets has been widely argued and disputed throughout the recent five decades. This paper is focused of the pros and cons of free movement of capital for developing countries in the context of market economy. It describes the potential risks, threats and merits of free capital movement across borders, analyzing empirical literature, observing reports of international institutions and studying academic materials on the issue.
Key Definitions
Capital – is the wealth in the form of money or other assets owned by a person, organization or country, which is available for maintaining and creating new assets or investing.
Free capital movement – is the movement of capital between countries as the result of investment practices of corporate and physical entities.
Capital inflow – is the amount of capital coming into a country, for example in the form of foreign investment.
Capital outflow – is the amount of capital which is flowing from a certain country because of the decrease of foreign investment into the country or because of the increased capital investment of this country into foreign economies.
Foreign direct investment (FDI) – are investments in the market (enterprise) share, provided abroad by the residents of a certain country or by non-residents in a certain country.
Introduction
Developing countries would likely to benefit from free trade, but they should use the structured approach before giving permission to foreign individuals and entities to operate in their financial system. Additionally, a developing country makes perfect sense including foreign direct investment to build facilities and run operations, pursuing international trade with an open economy. At the same time it must take into account that financial capital should be off the table during the initial process of liberalization. The point is that it is a risky practice to sell short-term government debt to outsiders, especially when you just started to open your economy. The same risk applies to giving permissions to outsiders to hold large amounts of currency, which may influence the annual government deficit.
Free capital movement, in its entire essence, is a heart of market economy (Free Movement of Capital) which enables efficient, competitive, open and integrated financial market conditions. It also creates the ability for residents and non-residents to do various operations abroad, such as: buying shares in foreign companies, opening accounts in non-domestic banks, investing and purchasing assets (Hindelang, 2009). However, these financial indulgences possess threats and risks for the state economy. They may cause a substantial outflow of the capital, enable appreciation of state currency (Forbes, 2006), unfair competition, bankruptcy of domestic manufacturers and the vulnerability of the economy.
For developing countries it is rather a hard issue to enter international markets, balancing between saving and investment, and open market and protectionism policy. As a matter of fact, saving has always been associated with growth and has become an empirical fact (Gourinchasy and Jeanne, …