- Advances in Chinese Economic Studies series
7. External ﬁnancial liberalization in China INTRODUCTION The previous chapters have dealt almost exclusively with issues relating to domestic ﬁnancial reform in China. However, ﬁnancial reform also has an external element. External ﬁnancial liberalization (EFL), the topic of this chapter, can be deﬁned as the removal of barriers to the free ﬂow of capital between countries (Eichengreen et al., 1998, p. 2). At least in theory, economists have traditionally looked upon EFL as a means to promote economic development and maximize national wealth (Makin, 1994, p. 93). This is for two primary reasons. First, access to foreign capital can promote domestic growth by allowing a country to invest more than its saves, or import more than it exports. Second, it can increase the efﬁciency of investment by allowing funds to reach those projects that offer the highest rate of expected return on an international scale. However, the experience of numerous developing countries has shown that these beneﬁts do not come automatically. As once again evidenced by the Asian crisis in 1997, far from being growth inducing, EFL has frequently coincided with an unsustainable increase in foreign debt and domestic consumption, a rash of unproductive investment and sharp ﬂuctuations in exchange rates, equity indices and asset prices (Diaz-Alenjandro, 1985; McKinnon and Pill, 1996). A modeling exercise conducted by McKibbin and Tang (2000) sought to gauge the consequences of China undertaking rapid EFL. The model’s predictions depended crucially on the assumptions made regarding investor conﬁdence. When EFL coincided...
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