The Welfare Implications of Global Financial Flows

Any discussion of whether the global financial system has served the world well requires us to think about what it is that capital flows could achieve in the best of circumstances. The basic neoclassical model suggests that, with rising financial globalization, capital should flow from rich to poor countries, making people in both sets of countries better off by enabling a more efficient international allocation of capital from countries where capital is less productive to those where it ought to be more productive. In addition, financial flows should allow for more efficient sharing of risk across countries, thereby facilitating the smoothing of national consumption against country-specific shocks to national output. These benefits are likely to be greater for developing countries as they have less capital and more volatile growth, implying that both the growth and risk sharing benefits would be larger for them.