Global Capital Heads for the Frontier

So-called “frontier market economies" are the latest fad in investment circles. Whether surging capital inflows in these countries – including Bangladesh, Vietnam, Honduras, Bolivia, Kenya, and Ghana – should be cheered or lamented is a question that has become a kind of Rorschach test for economic analysts and policymakers.

PRINCETON – So-called “frontier market economies" are the latest fad in investment circles. Though these low-income countries – including Bangladesh and Vietnam in Asia, Honduras and Bolivia in Latin America, and Kenya and Ghana in Africa – have small, undeveloped financial markets, they are growing rapidly and are expected to become the emerging economies of the future. In the last four years, inflows of private capital into frontier economies have been nearly 50% higher (relative to GDP) than flows into emerging market economies. Whether that should be cheered or lamented is a question that has become a kind of Rorschach test for economic analysts and policymakers.

We now know that the promise of free capital mobility has not been redeemed. By and large, the surge in capital inflows has boosted consumption rather than investment in recipient countries, exacerbating economic volatility and making painful financial crises more frequent. Rather than exerting discipline, global financial markets have increased the availability of debt, thereby weakening profligate governments' budget constraints and over-extended banks' balance sheets.

The best argument for free capital mobility remains the one made nearly two decades ago by Stanley Fischer, then the International Monetary Fund's number two official and now Vice Chair of the US Federal Reserve. Though Fischer recognized the perils of free-flowing capital, he argued that the solution was not to maintain capital controls, but to undertake the reforms required to mitigate the dangers.

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