The Global Capital Market: Benefactor or Menace?: Maurice Obstfeld

Journal of Economic Perspectives—Volume 12, Number 4—Fall 1998—Pages 9–30
The Global Capital Market: Benefactor

or Menace?
Maurice Obstfeld
T
he Asian financial turmoil of 1997 and 1998 started as a seemingly localized
tremor in far-off Thailand, but then swelled into a crisis with repercussions
in stock markets on every continent. Both international lending institu-
tions led by the International Monetary Fund and national governments including
those of the United States, Japan, and the European Union joined in the policy
response. The U.S. Federal Reserve, headed for monetary tightening in the fall of
1997, postponed its move for fear of destabilizing world markets further.
These turns of events would have been inconceivable during the 1950s. In that
inward-looking era, most countries’ domestic financial systems labored under ex-
tensive government restraint and were cut off from international influences by of-
ficial firewalls. Despite these restrictions, which were a legacy of the Great Depres-
sion and World War II, international financial crises occurred from time to time.
Between 1945 and 1970, however, their effects tended to be localized, with little
discernible impact on Wall Street, let alone Main Street.
Over the past 25 years or so this has all changed dramatically. Regional financial
crises seem to have become more frequent, and the domestic impact of global
financial developments has grown—to the alarm of many private citizens, elected
officials, and even economists. Further change will result from the December 1997
pact on trade in banking, insurance, and other financial services, signed by more
than 100 countries under the aegis of the World Trade Organization. Why has
global financial trading grown at such an explosive pace? Does the powerful global
market limit our government in the pursuit of legitimate economic and social ob-
jectives? Is there any way to prevent destabilizing disturbances that originate in
world asset markets, or to mitigate their effects? Does the cross-border mobility of
䊏 Maurice Obstfeld is the Class of 1958 Professor of Economics, University of California,

Berkeley, Berkeley, California. His e-mail address is »obstfeld@econ.berkeley.edu….
/ 300d 0007 Mp 9 Monday Oct 09 01:37 PM LP–JEP 0007

10 Journal of Economic Perspectives
firms threaten our living standards? What benefits could possibly justify exposing
ourselves to these risks?
Definitive answers to these questions remain elusive, but a review of the theo-
retical functions, history, and policy problems raised by the international capital
market offers some perspective on both the considerable advantages it offers and
the genuine hazards it poses. This duality of benefits and risks is inescapable in the
real world of asymmetric information and imperfect contract enforcement. I shall
argue, however, that in confronting the global capital market there is no reason to
depart from conventional economic wisdom. The best way to maximize net benefits
is to encourage economic integration while attacking concomitant distortions and
other unwanted side effects at, or close to, their sources.
The Integration of Global Capital Markets
Economic theory leaves no doubt about the potential advantages of global

financial trading. (See Obstfeld and Rogoff, 1996, for an exposition.) International
financial markets allow residents of different countries to pool various risks, achiev-
ing more effective insurance than purely domestic arrangements would allow. Fur-
thermore, a country suffering a temporary recession or natural disaster can borrow
abroad. Developing countries with little capital can borrow to finance investment,
thereby promoting economic growth without sharp increases in saving rates. At the
global level, the international capital market channels world savings to its most
productive uses, irrespective of location. The resulting economic gains are difficult
to quantify, as I discuss in a moment, and may work through subtle mechanisms.
For example, producers who can diversify risks in financial markets may undertake
more high-yield but risky investments, increasing average rates of economic growth.
In that case, the welfare gains can be enormous (Obstfeld, 1994).
The other main potential positive role of international capital markets is to
discipline policymakers who might be tempted to exploit a captive domestic capital
market. Unsound policies—for example, excessive government borrowing or in-
adequate bank regulation—would spark speculative capital outflows and higher
domestic interest rates. In theory, a government’s fear of these effects should make
rash behavior less attractive.
It is difficult to quantify the gains countries have realized from international
capital mobility, since a rigorous attempt would require a fully-articulated model
in which the counterfactual of no capital movements could be simulated. Historical
evidence is suggestive of substantial benefits, however, notably for smaller countries,
which are likely to profit most from trade. Norway borrowed as much as 14 percent
of gross domestic product in the 1970s to develop its North Sea oil reserves. Sin-
gapore attained double-digit ratios of foreign lending to GDP during the 1990s,
deploying its abundant domestic savings to support productive investment abroad.
Preliminary forecasts by the Organization for Economic Cooperation and Devel-
opment put Poland’s 1998 and 1999 foreign borrowing at around 6 percent of GDP.
Strong foreign investment inflows have fueled falling unemployment and a high

Maurice Obstfeld 11
rate of capital accumulation. However, the non-negligible risk that the Polish econ-
omy will overheat and succumb to a financial crisis, despite restrictive domestic
macro policies, illustrates a serious pitfall of access to the global capital market to
which I return below. Borrowers may overextend themselves, sparking an investor
panic in which foreign debts cannot be repaid on time.
Given the advantages of a global capital market, why was the market still so
fragmented and limited in scope a full generation after the end of War II? It had
not always been so. Before World War I, a vibrant, free-wheeling capital market
linked financial centers in Europe, the western hemisphere, Oceania, Africa, and
the Far East. A 19th-century reader of the Economist magazine could track invest-
ments in American railroads, South African gold mines, Egyptian government debt,
Peruvian guano, and much more. The laying of the trans-Atlantic cable in 1866
reduced the settlement time for intercontinental transactions from roughly ten days
(the duration of a steamship voyage between Liverpool and New York) to only hours
(Officer, 1996, p. 166). This enormous communications advance of the era was
perhaps more significant than anything that has been achieved since.
The international financial market broke up during World War I, made a brief
comeback between 1925 and 1931, and then withered in the Great Depression. At
that time, governments everywhere limited the scope of domestic financial markets
as well, imposing tighter regulations and prohibiting myriad activities outright.
World War II cemented the demise of the global capital market. As late as 1950,
the world’s major economies remained linked only by the most rudimentary, and
typically bilateral, trade and financial arrangements. However, private capital move-
ments began to return in the 1960s, grew rapidly in the 1970s, and then grew even
faster in the 1980s (though global capital largely bypassed the developing countries
mired in that decade’s debt crisis). The worldwide trend of financial opening in
the 1990s has restored a degree of international capital mobility not seen since this
century’s beginning.
These developments can be documented through data on international finan-
cial flows and asset prices.1 Table 1 shows data on one such measure, the current
account balance from 1870 through the present, for 12 countries, reported as the
absolute value of the current account divided by gross domestic product. The cur-
rent account balance, of course, is the difference between national saving and do-
mestic investment: if positive, it measures the portion of a country’s saving invested
abroad; if negative, the portion of domestic investment financed by foreigners’
savings. The final column of the table presents the unweighted average over the 12
countries for different time periods. While international investment flows com-
monly topped 3 percent of GDP before 1914, they slumped to less than half that
level in the 1930s and only after 1970 began to move decisively upward. The rela-
tively high imbalances during wars represent government rather than private bor-
rowing. Even today, the average level of current account balances has not quite
attained the magnitude that was common before World War I.
1
For discussions of similar data and their interpretation, see Frankel (1993), Mussa and Goldstein (1993),
and Obstfeld (1995).

Table 1
Size of Net Capital Flows since 1870 (mean absolute value of current account as
percentage of GDP, annual data)
Period Argentina Australia Canada Denmark France Germany Italy
1870–89 18.7 8.2 7.0 1.9 2.4 1.7 1.2

1890–1913 6.2 4.1 7.0 2.9 1.3 1.5 1.8
1914–18 2.7 3.4 3.6 5.1 — — 11.6
1919–26 4.9 4.2 2.5 1.2 2.8 2.4 4.2
1927–31 3.7 5.9 2.7 0.7 1.4 2.0 1.5
1932–39 1.6 1.7 2.6 0.8 1.0 0.6 0.7
1940–46 4.8 3.5 3.3 2.3 — — 3.4
1947–59 3.1 3.4 2.3 1.4 1.5 2.0 1.4
1960–73 1.0 2.3 1.2 1.9 0.6 1.0 2.1
1974–89 1.9 3.6 1.7 3.2 0.8 2.1 1.3
1990–96 2.2 4.0 4.1 2.0 0.7 1.9 1.8
Period Japan Norway Sweden U.K. U.S. All
1870–89 0.6 1.6 3.2 4.6 0.7 3.7

1890–1913 2.4 4.2 2.3 4.6 1.0 3.3
1914–18 6.8 3.8 6.5 3.1 4.1 5.1a
1919–26 2.1 4.9 2.0 2.7 1.7 3.1
1927–31 0.6 2.0 1.8 1.9 0.7 2.1
1932–39 1.0 1.1 1.5 1.1 0.4 1.2
1940–46 1.0 4.9 2.0 7.2 1.1 3.2a
1947–59 1.3 3.1 1.1 1.2 0.6 1.9
1960–73 1.0 2.4 0.7 0.8 0.5 1.3
1974–89 1.8 5.2 1.5 1.5 1.4 2.2
1990–96 2.2 3.7 2.1 2.0 1.0 2.3
Source: Obstfeld and Taylor (1998) data.

a
Denotes average with some countries missing.
Figure 1 offers another indicator of capital mobility, the standard deviation of

the difference between one-year interest rates on sterling-denominated assets sold
in New York and those sold in London. (See Obstfeld and Taylor, 1998, for data
on levels of mean annual interest differentials.) The interest differential, as well as
its variability, should equal zero if capital mobility between the two centers is perfect,
but these measures can deviate from zero in the presence of transaction costs,
political risks, and other barriers to the free flow of money. In practice, differences
in the American and British financial instruments chosen for comparison also can
lead to interest differences. By focusing on return standard deviations, I down-
play such discrepancies, which are not necessarily evidence of financial
segmentation.
Under the pre-1914 gold standard, differentials show relatively small fluctua-
tions (and they do so around a declining trend average differential). Differentials
start to open up during World War I, become quite large in the early 1920s, and
decline briefly in the late 1920s before widening sharply in the early 1930s through

The Global Capital Market: Benefactor or Menace? 13
Figure 1
Covered Interest Rate Difference between New York and London
Standard deviation of return difference

(percent per year)
3.5
2.5
1.5
0.5
0
1880 1902 1916 1921 1928 1935 1946 1955 1963 1971 1976 1984 1994
Source: Data come from Obstfeld and Taylor (1998), updated from May 1996 through March 1998 with
information from Datastream. The data points shown are standard deviations of annual sterling rate of
return differences between New York and London, for the following periods: January 1870-December
1889, January 1890-July 1914, August 1914-November 1918, December 1918-March 1925, April 1925-
August 1931, September 1931-August 1939, September 1939-December 1951, January 1952-December
1958, January 1959-December 1967, January 1968-February 1973, March 1973-December 1979, January
1980-December 1989, and January 1990-March 1998. The horizontal axis plots years that are approximate
midpoints of these time periods.
the early 1950s. Some arbitrage gaps remain in the mid-1950s, but the variability of
return differentials is generally quite small after the early 1950s and through the
late 1960s. This degree of financial market cohesion in the 1950s and 1960s reflects
New York’s and London’s positions as world financial centers, and is not typical of
most other industrial country pairs (Marston, 1995). Interest gaps open up sharply
again in the late 1960s, but have become progressively steadier and smaller since
the early 1970s, once again reaching levels close to those of the later classical gold
standard years, 1890 to 1914.
What explains the long stretch of high capital mobility that prevailed before
1914, the subsequent breakdown in the interwar period, and the very slow postwar
reconstruction of the world financial system? The answer is tied up with one of the
central and visible areas in which openness to the world capital market constrains
government power: the choice of an exchange rate regime.

Capital Mobility, the Exchange Rate, and Monetary Policy
It is a trite but true assertion of international monetary economics that the

exchange rate is an open economy’s most important price. The United States has
become ever more open to trade since the end of World War II, as Robert Feenstra
documents in his article in this symposium. Exchange rate movements therefore
have increasingly become a cause for public and official concern.
A Fundamental Tradeoff
In most of the world’s economies, the exchange rate is a key instrument, target,
or indicator for monetary policy. An open capital market, however, deprives a coun-
try’s government of the ability simultaneously to target its exchange rate and to use
monetary policy in pursuit of other economic objectives. As an example, consider
Austria, which for more than two decades has pegged the exchange rate between
its currency, the schilling, and the German mark. Since market participants under-
stand that the exchange rate will not change by more than a few basis points,
nominal interest rates in Austria must closely match those in Germany. The rates
are kept in line by arbitrageurs who would massively borrow in the currency with
the lower interest rate and lend in the currency with the higher interest rate, con-
fident that their gains will not be erased by a movement of the exchange rate. But
equality of interest rates also means that Austria cannot conduct a monetary policy
independent of Germany’s; both Austria’s exchange rate and interest rate will be
determined exogenously. Since it is Austria (and not Germany) that is pegging the
exchange rate, the Austrian central bank has only one monetary role, to offset any
incipient change in the schilling’s exchange value against the mark.
Austria can regain an independent monetary policy in two ways. If it could
prohibit any cross-border financial transactions, Austria would cut off the arbitra-
geurs and decouple its interest rate from Germany’s, but could still maintain the
fixed exchange rate. In that case, Austria might unilaterally lower its interest rates,
for example, but investors no longer would have the right to move funds from
Vienna to Frankfurt in response to the resulting return differential. Pressures in
the foreign exchange market would be limited to demands from Austrian importers
for marks and from exporters to Austria wishing to convert their schilling earnings
into marks. Any exchange-rate effect of these trade-driven demands for marks,
which are orders of magnitude below the potential demands associated with inter-
national financial flows, could normally be offset by sales of Austrian official mark
reserves as necessary.
Alternatively, Austria could maintain freedom of private capital movement but
allow the schilling/mark rate to float. In that case, Austria would be free to lower
its interest rates, but the schilling would depreciate against the mark as a result.
Both developments would tend to spur aggregate demand for Austrian output.
The limitations that open capital markets place on exchange rates and mon-
etary policy often are summed up by the idea of the ‘‘inconsistent trinity’’ or, as
Alan Taylor and I have labeled it, the ‘‘open-economy trilemma’’ (Obstfeld and
Taylor, 1998): that is, a country cannot simultaneously maintain fixed exchange

Maurice Obstfeld 15
rates and an open capital market while pursuing a monetary policy oriented toward
domestic goals. Governments may choose only two of the above. If monetary policy
is geared toward domestic considerations, either capital mobility or the exchange
rate target must go. If fixed exchange rates and integration into the global capital
market are the primary desiderata, monetary policy must be subjugated to those
ends.
The choice between fixed and floating exchange rates should not be viewed
as dichotomous. In reality, the degree of exchange-rate flexibility lies on a contin-
uum, with exchange-rate target zones, crawling pegs, crawling zones, and managed
floats of various other kinds residing between the extremes of floating and irrevo-
cably fixed. Indeed, the notion of a ‘‘free’’ float is an abstraction with little empirical
content, as few governments are willing to set monetary policy without some con-
sideration of its exchange rate effects. However, the greater the attention given to
the exchange rate, the more constrained monetary policy is in pursuing other
objectives.2
Understanding the Evolution of International Capital Mobility

The broad trends and cycles in the world capital market over the last century
reflect changing responses to the fundamental policy trilemma. Before 1914, each
of the world’s major economies pegged its currency’s price in terms of gold, and
thus, implicitly, maintained a fixed rate of exchange against the currency of every
other major country. Financial orthodoxy saw no alternative mode of sound fi-
nance. Latin American interludes of floating exchange rates were viewed from the
main financial centers with ‘‘fascinated disgust,’’ to use the words of Bacha and
Dı́az-Alejandro (1982).
The gold standard system met the trilemma by opting for fixed exchange rates
and capital mobility, sometimes at the expense of domestic macroeconomic health.
Between 1892 and 1897, for example, the U.S. Treasury allowed the domestic
money stock to stagnate in the face of persistent speculation that the dollar would
leave gold. This policy led to banking panics and a harsh deflation. A populist
movement led by William Jennings Bryan and others agitated forcefully against
gold, but lost. The balance of political power began to change only with World
War I, which brought a sea-change in the social contract governing the industrial
democracies (Temin, 1989). Organized labor emerged as a political power, a coun-
terweight to the interests of capital.
2
If exchange rates are subject to pure speculative shocks unrelated to economic fundamentals and if a
government wishes to counter these movements, then its monetary control will be compromised. This
possibility motivates James Tobin’s proposal for a tax on short-term capital flows—the Tobin tax. As
Tobin recognizes, a tax with teeth would have to apply to all foreign exchange transactions, lest it be
circumvented by arbitrageurs. Debate on Tobin’s proposal continues, but the major industrial countries
that maintain floating rates seem to view it as a costly route to highly uncertain gains, particularly in view
of the degree of international cooperation that would be needed to plug up loopholes. For analyses of
the Tobin tax, including an overview written by Tobin, see the essays collected in ul Haq, Kaul, and
Grunberg (1996). Dooley (1996) surveys evidence on the recent use of capital controls to attain a variety
of objectives. His conclusions, on the whole, are pessimistic.

Although Britain’s return to gold in 1925 led the way to a restored international
gold standard and a limited resurgence of international finance, the gold standard
helped propagate a worldwide depression after the 1929 New York stock market
crash. Many countries abandoned the gold standard in the early 1930s and depre-
ciated their currencies; many also resorted to trade and capital controls to manage
independently their exchange rates and domestic policies. However, countries in
the ‘‘gold bloc,’’ which stubbornly clung to gold through the mid-1930s, showed
the steepest output and price-level declines. Eventually in the 1930s, virtually all
countries jettisoned rigid exchange-rate targets, open capital markets, or both in
favor of domestic macroeconomic goals.3
In this way, the Great Depression discredited gold standard orthodoxy and made
financial markets and financial practitioners unpopular. Their supposed speculative
excesses and attachment to gold became identified in the public mind as causes of the
economic calamity. Financial products and markets were banned or more closely reg-
ulated. In the United States and elsewhere, central banks were brought under heavier
treasury influence. Worldwide, a new consensus developed in which preserving the
value of the currency ran a distant second to maintaining high employment.
These changed attitudes underlay the new postwar economic order negotiated
at Bretton Woods, New Hampshire, in July 1944, where 44 allied countries set up
a system based on fixed, but adjustable, exchange parities, in the belief that floating
exchange rates would exhibit instability that would damage international trade. At
the center of the system was the International Monetary Fund (IMF). The IMF’s
prime function was as a source of hard-currency loans to governments that might
otherwise have to put their economies into recession to maintain a fixed exchange
rate. Countries suffering protracted balance-of-payments problems had the option
of realigning their currencies, subject to IMF approval.
The IMF’s founders viewed its lending capability as primarily a substitute for
private capital inflows, not a complement to them. Interwar experience had given
private capital flows a reputation as unreliable at best and, at worst, a dangerous
source of disturbances. Encompassing controls over private capital movement, per-
fected in wartime, were expected to continue. The IMF’s Articles of Agreement
explicitly empowered countries to impose new capital controls, prohibited mem-
bers from using IMF resources ‘‘to meet a large or sustained outflow of capital,’’
and even gave the Fund the right to request that capital controls be imposed in
such cases (Horsefield, 1969, pp. 193–4). As Treasury Secretary Henry Morgenthau
proclaimed at Bretton Woods, the new IMF and its sister institution, the World
Bank, would ‘‘drive . . . the usurious money lenders from the temple of interna-
tional finance’’ (Gardner, 1980, p. xix). The maintenance and even extension of
capital account controls had the additional advantage of placating a U.S. Congress
worried that taxpayers’ money would disappear down foreign ‘‘rat holes,’’ as Re-
publican Senator Robert A. Taft of Ohio put it (as quoted in Gardner, 1980,
p. 130).
3
For more detailed discussion see Temin (1989), Eichengreen (1996), Obstfeld and Taylor (1998), and
the references therein.

Article VIII of the IMF agreement did demand that countries’ currencies even-
tually be made convertible—in effect, freely saleable to the issuing central bank, at
the official exchange parity, for dollars or gold. But this privilege was to be extended
only to nonresidents (not a country’s own citizens), and mainly if the country’s
currency had been earned through sales of goods and services. Convertibility for
currency acquired through financial trades was not viewed as mandatory, or even
as desirable. But even this limited convertibility took years to achieve, and in the
interim, countries resorted to bilateral trade deals that required balanced or nearly
balanced trade between every pair of trading partners. If France had an export
surplus with Britain, and Britain a surplus with Italy, Britain could not use its excess
lire earnings to obtain dollars with which to pay France. Italy had very few dollars
and guarded them jealously for critical imports from the Americas. Instead, each
country would try to divert import demand toward countries with high demand for
its goods, and to direct its exports toward countries whose goods were favored
domestically.
Convertibility gridlock in Europe and its dependencies was eventually ended
through a regional multilateral clearing scheme, the European Payments Union
(EPU). The clearing scheme was set up in 1950 and some countries reached de
facto convertibility by mid-decade. But it was not until December 27, 1958, that
Europe officially embraced convertibility and ended the EPU.
The return to convertibility was important in promoting growth in multi-
lateral trade. However, most European countries still chose to retain extensive
capital controls, with Germany being the main exception. As trade increased,
however, so did opportunities for disguised capital movements. These might take
the form, for example, of misinvoicing, or of accelerated or delayed merchan-
dise payments. Buoyant economic growth encouraged some countries to pur-
sue further financial liberalization, although the United States, worried about
its gold losses, raised progressively higher barriers to capital outflow over the
1960s.
Eventually, the very success of the Bretton Woods system in spurring inter-
national trade and the related capital movements brought about its own collapse
by resurrecting the ‘‘inconsistent trinity.’’ For the United States, maintaining
fixed exchange rates seemed to require high interest rates and slower growth;
for Germany, fixed exchange rates seemed to require giving up domestic control
over inflation. Even the relatively limited capital mobility that existed by the
early 1970s allowed furious speculative attacks on the major currencies. After
vain attempts to restore fixed dollar exchange rates, the industrial countries
moved to floating rates early in 1973. Although viewed at the time as a temporary
emergency measure, the floating-dollar-rate regime is still with us a quarter-
century later.
Capital Mobility and Exchange-Rate Flexibility

Floating exchange rates have allowed the explosion in international financial
markets experienced over that same quarter-century. Freed from one element of
the trinity—fixed exchange rates—countries have been able to open their capital

markets while still retaining the flexibility to deploy monetary policy in pursuit of
national objectives.4
Numerous countries have tried to fix their exchange rates for various reasons,
but few have been willing or able to do so for long. Sooner or later, exchange rate
stability tends to come into conflict with other policy objectives to which voters
attach greater priority. Once the capital markets catch on to the government’s
predicament, a crisis can add enough economic pain to make the authorities give
in.
In an earlier article in this journal, Kenneth Rogoff and I observed that only
a very few major countries had observed the discipline of fixed exchange rates
for at least five years, and that most of those were rather special cases (Obstfeld
and Rogoff, 1995). The case that most puzzled us, Thailand, has dropped off
the list—with a resounding crash. Even Hong Kong, which operates as a currency
board supposedly subordinated to maintaining the Hong Kong-U.S. dollar peg,
has suffered continuing speculative pressure in 1997–98, withstanding persist-
ently high interest rates with Beijing’s support.5 Another currency board coun-
try, Argentina, has now held to its 1:1 dollar exchange rate since April 1991, and
so joins the exclusive five-year club. To accomplish that feat, the country has
relied on IMF credit and has suffered unemployment rates higher than many
countries could tolerate (nearly 15 percent in 1997). The European Union mem-
bers that have recently maintained mutually fixed rates have been aided by mar-
ket confidence in their own planned solution to the policy trilemma, a full cur-
rency merger due to be consummated in January 1999. But they too have paid
a price in terms of joblessness. The trend toward greater financial openness in
developing countries has been accompanied—inevitably, I would argue—by a
declining reliance on pegged exchange rates in favor of exchange rate
flexibility.6
Fiscal Autonomy and Income Distribution
An open capital market immediately confronts national authorities with a de-

cision over controlling either interest rates or exchange rates. Over the medium
term, integration into the global capital market also makes it more difficult to tax
internationally footloose capital relative to less mobile factors of production, no-
4
Alesina, Grilli, and Milesi-Ferretti (1994) and Grilli and Milesi-Ferretti (1995) report on panel
studies of the incidence of capital controls for 20 industrial countries over the years 1950 to 1989,
and for 61 industrial and developing countries over the years 1966 to 1989. They find that more
flexible exchange rate regimes and greater central bank independence lower the probability of
capital controls.
5
In a currency board system, the high-powered money supply is backed entirely by hard-currency foreign
reserves. Some contend that this feature makes currency boards invulnerable to speculative attack, but
recent experience bears out the contrary argument in Obstfeld and Rogoff (1995).
6
Collins (1996) studies the determinants of exchange rate regime choice by developing countries.

Maurice Obstfeld 19
tably labor. This loss of fiscal options could be costly, but just how costly remains
unclear.
International Tax Competition

When capital can move freely across national borders, it will flee countries
where it is taxed heavily to production locations where taxes are lower. Indeed,
accounting practices allow the base for capital taxes to migrate even when capital
itself does not. Simply by altering the accounting value attached to intermediate
goods being shipped within the company, a multinational enterprise can arrange
to book relatively large shares of its worldwide profits in countries with low rates of
corporate tax (Tanzi, 1996). Such strategic bookkeeping adjustments can take place
even more quickly than capital itself can be transferred between countries.
If capital (or the capital tax base) can migrate very quickly, individual countries
lose some of their autonomy with respect to capital tax rates.7 Absent special fea-
tures making for an attractive investment locale—like a high level of public goods
or skilled but inexpensive labor—a country must lower its capital tax rates to match
those set by foreign authorities. Otherwise it suffers a diminished tax base and,
possibly, a lower domestic living standard. Moreover, individual countries have in-
centives to tailor their tax policies so as to lure business from abroad. There is
potentially a ‘‘race to the bottom’’ as countries competitively offer tax breaks in a
collectively self-defeating scramble for national advantage.
International ‘‘tax poaching’’ is indeed a well-established practice. European
Union countries are attempting to ban poaching internally, putting heavy pressure
on Ireland, for example, to end the preferential 10 percent corporate tax rate it
has offered to lure investment from abroad. OECD countries show a clear trend of
declining corporate tax rates over the last decade (Tanzi, 1996, p. 14), though it is
unclear how important tax competition (as opposed to ideological change, for ex-
ample) has been in this development. As for the noncorporate sector, it has become
increasingly hard these days to tax the income that residents earn on assets held
overseas. Scandinavian countries have already moved toward a ‘‘dual’’ income tax,
with lower taxation of income from capital than of labor earnings.
How Great is the Threat to National Autonomy?

Many observers fear that the constraint of financial openness poses a dilemma
for fiscal policy: either the burden of providing necessary social services must be
shifted toward labor, or those services must be scaled back. Rodrik (1997), for
example, argues that greater economic openness is associated with greater uncer-
tainty over consumption, especially for workers, who at best can insure very little of
their income in markets. Government expenditure and social support programs,
Rodrik contends, have evolved to provide substitute insurance against those risks
7
In an early expression of the concern that capital might flee a nation in favor of lower-tax jurisdictions,
David Ricardo (1817 [1951], pp. 247–9) argued that the expected future tax burden accompanying a
high public debt would induce the rich and their capital to emigrate. This is one reason why Ricardo
himself rejected the ‘‘Ricardian equivalence’’ of debt and tax finance!

and others. He presents regression evidence suggesting that greater openness leads
to lower taxes on capital and higher taxes on labor, and that capital-account re-
strictions have allowed heavier capital taxation. Rodrik foresees that the downward
leveling of capital taxes will either raise the tax burden on labor to politically un-
acceptable levels, or else compromise the social and worker protection programs
that, in his view, have allowed countries gradually to lower trade barriers over the
postwar period. A popular backlash against free trade might result.
Such alarming scenarios raise several natural questions. Does international tax
competition offer any benefits that might be set off against the costs? Is there evi-
dence that international tax competition has already harmed, or is near to harming,
crucial social programs? How far can we expect the process of capital-tax leveling
to go? Finally, if policy interventions are needed, what forms should they take?
A basic point to keep in mind is that there is a strong case to be made on pure
efficiency grounds that taxes on capital should be low, to encourage long-term
investment and higher living standards; Lucas (1990) reviews this result within a
dynamic Ramsey tax model. Even in a closed economy, the burden of high capital
taxes will be shifted toward labor as savings shrink. From this perspective, pressure
for lower capital taxes may be a good thing.
Looking at the effects of international tax competition so far, it is hard to argue
that we see anything close to equivalent overall capital tax rates across countries,
or equivalent levels of social spending. For example, Germany, which has long had
an open capital account, devoted 21.2 percent of its GDP to government social
security payments and transfers in 1995, compared to 13.9 percent in the United
States. The ratio for France was 25.7 percent in the same year. Sőrensen (1993)
observes that proceeds from the corporate income tax did not fall over the 1980s
in industrial countries, either as a share of GDP or of total revenues, despite gen-
erally lower statutory tax rates. The reason was a broadening of the corporate tax
base.
It is difficult to say how far global tax competition might go in the long run.
Eichengreen (1990) finds that the variability of state tax rates in the United States
(through the early 1980s) was 40 percent below that among European Union states,
but far from zero. It is hard to measure the differential levels of public goods that
states might provide (in the form of infrastructure and so on) or other special
locational incentives they might offer. However, the U.S. states have a much higher
degree of economic integration than do the nations of Europe. Thus, a cautious
conclusion would be that the global capital market will push countries at most part
way toward the predicament Rodrik (1997) fears.8
To the extent the problem does arise, however, how can countries best deal
with it? Overt restrictions on capital outflows seem an inefficient way to address the
issue; they would be difficult and costly to enforce, they imply resource misalloca-
tions, and there is no support in the business community for preventing capital
8
American states also show limited convergence in social benefits. Alan Krueger has pointed out to me
that even neighboring states have persistently maintained very different levels of worker protection.

outflows. For countries that face revenue shortfalls in financing necessary social
protection programs, it would be far better to shift from capital taxes to a con-
sumption tax rather than to a tax on labor incomes. There is already a trend in
industrialized countries toward heavier taxation of consumption (King, 1996). Fur-
thermore, many industrial countries’ social protection programs could offer ade-
quate insurance at lower cost. In Europe, for example, often open-ended and
largely unconditional social benefits, coupled with the employment disincentives
that firms face, lead to programs that expend large sums on long-term income
support rather than true insurance (Siebert, 1997).
If tax competition nonetheless emerged as a threat to social cohesion or to
free trade, formal international tax coordination might begin to appear attractive,
despite the daunting difficulties in reaching a deal geographically comprehensive
enough to be effective.
Capital Mobility and Income Distribution

Debate on the changing distribution of United States wages and rising Euro-
pean unemployment has focused on imports from low-wage countries (as discussed
in Feenstra’s contribution to this symposium). In principle, however, capital move-
ments and commodity imports can have identical effects on wages, as shown in a
classic analysis by Mundell (1957), which raises the possibility that the global capital
market, in addition to hindering governments’ provision of social insurance, might
increase inequality and raise the need for those same insurance services.
The Mundell (1957) story works as follows. According to the usual Heckscher-
Ohlin reasoning, increased trade between high-wage United States and low-wage
Mexico has a depressing effect on the wages of low-skilled American workers, who
must find new jobs in sectors that previously had employed relatively few of them.
Consider the effects, however, when a General Motors plant moves south of the
border to avail itself of cheaper Mexican labor. Since there is now less capital in
the United States relative to the supply of workers, wages will need to fall to restore
full employment in the United States, while wages will rise in Mexico. Bottom line:
low-wage Americans are threatened both by importing the goods low-wage foreign
workers produce, and also by equipping foreign workers with exported U.S. capital.
A vital corollary is that import restrictions cannot prevent factor-price conver-
gence when capital markets are open. Since capital seeks out its most remunerative
global use, trade restrictions provoke large-scale capital movements that equalize
factor prices directly, and simultaneously eliminate incentives for commodity trade.
While the ‘‘great sucking sound’’ of firms relocating in low-wage countries has
loomed prominently in the news media, aggregate investment patterns make it look
implausible that the mechanism has so far had much impact on U.S. or European
labor markets. The United States has been running substantial current account
deficits since the mid-1970s; thus, the net effect of capital-market integration has
been to allow the U.S. to invest more than it would have out of its own savings alone.
To show that low-skilled American workers have been injured through the capital-
flow channel, one would have to argue not that they have been hurt by U.S. capital
moving abroad, but rather that they have been hurt by foreign capital arriving here,

perhaps because such workers’ services are highly substitutable for those of capital.
In contrast, the European Union has on average run current account surpluses
since the mid-1970s, but these have typically been 0.4 percent of GDP or less—
much too small to explain the substantial rise in European unemployment over
that time.
Market Failures and the Policy Response
I have argued that the international capital market has the potential to yield
great benefits, but that it also constrains national choices over monetary and fiscal
policies, and may facilitate excessive borrowing. To what extent is the positive po-
tential of the international capital market outweighed by a potentially disruptive
role? Are there policy reforms or institutional changes that might improve the
balance of benefits and costs? Here, I discuss three facets of the debate: the very
low degree of international diversification of equity portfolios; the problem of in-
ternational capital-market crises, much in the news recently; and the role of the
IMF as an international emergency lender.
The International Diversification Puzzle

The opportunities for global risk sharing that the international capital market
offers should lead investors to diversify their portfolios over investments in many
countries. In practice, however, little of the sort seems to have happened. The
majority of investors apparently remain parochial in outlook, choosing to retain
most of their wealth at home.
In an article that drew attention to the extent of the international diversifica-
tion puzzle, French and Poterba (1991) pointed out that at the end of the 1980s,
U.S. investors held 94 percent of their equity wealth in U.S. equities and Japanese
investors held 98 percent of theirs in Japanese equities, while French, German, and
even Canadian investors held only around 1 percent of their equity wealth in U.S.
or Japanese equities. Such wildly unbalanced allocations are hard to reconcile with
any intuitive notion of a well-diversified portfolio. As a first pass, one might expect
people to diversify by ‘‘holding the market,’’ that is, by demanding a country’s
stocks in rough proportion to its share in global market capitalization. International
diversification has accelerated in the 1990s, but even the much publicized growth
of U.S.-based global equity mutual funds has not nearly erased the basic puzzle
raised by the French-Poterba data.9
What explains the apparent failure of people to take full advantage of such an
obvious opportunity for mutual gain? Nobody knows. Part of the puzzle could re-
flect that increasingly the profit streams associated with ‘‘domestic’’ companies do
9
Golub (1990) made a related point, that the gross foreign asset positions of OECD countries—including
equities as well as other securities—are small relative to total domestic financial wealth. But the numbers
are greater than for equity alone. In the mid-1990s, U.S. gross foreign assets (of all kinds) were about
10 percent of household net wealth and gross foreign liabilities were about 14 percent.

Maurice Obstfeld 23
in fact come from production operations abroad. Foreign direct investment is in-
deed substantial. People can and do diversify abroad by holding foreign non-equity
assets. In addition, estimates of supposedly optimal portfolios are quite imprecise,
and can encompass wealth allocations heavily skewed toward home-based indus-
tries. Nonetheless, the weight of the evidence suggests that significant unexploited
opportunities for diversification remain (Lewis, 1997).
Unfamiliarity with foreign products, firms, business practices, accounting stan-
dards, political trends, and regulatory environments surely plays some role. An
American investor, for example, may feel disadvantaged in assessing the future
prospects of a French firm, and may find the cost of becoming informed excessive.
Obstfeld and Rogoff (1996, pp. 401–7) show how asymmetric information can ra-
tionalize the dominance of noncontingent international contracts. Many industrial-
country stock exchanges now have substantial listings of foreign firms, but outside
of London, that development hasn’t led to substantial domestic trade in their
shares. For example, the Amsterdam market’s listings in 1996 were divided about
equally between domestic and foreign companies, yet more than 99 percent of its
turnover that year was in domestic shares (Folkerts-Landau et al., 1997, p. 198).
The puzzle therefore remains. At present the global capital market enforces
rather tight arbitrage among the returns on standardized securities that are subject
to risks along only a few well-understood (and easily hedged) dimensions. But such
trades go only a small way toward realizing the potential gains from risk sharing.
International trade in less homogeneous and riskier assets is growing all the time,
but remains less developed.10
Crises in the Capital Markets

The year 1982 marked the start of a global developing-country debt crisis.
Private lending to the affected developing countries, many of them in Latin Amer-
ica, slowed to a reluctant trickle, while sovereign debtors and their creditors tee-
tered on the edge of generalized default. But in the 1990s, the debt crisis gave way
to renewed capital inflows, as a combined result of workouts of the old debt prob-
lems, widespread economic reforms, and low American interest rates (Calvo, Lei-
derman, and Reinhart, 1996).
In the 1990s, foreign exchange crises have disrupted exchange markets in Eu-
rope, Latin America, and Asia. Outside of Europe, the crises have spilled into stock
markets, raised the specter of state default, and sometimes led to deep recessions.
Most of the east Asian countries avoided debt problems in the 1980s, but several
have been hit hard in the 1990s. The crises have sharpened debate over two op-
posing views. One claim is that otherwise successful economies have been victims
10
A related phenomenon, first highlighted by Feldstein and Horioka (1980), is the small average size
of current account balances for industrial countries over the early postwar period. It is tempting to infer
from the Feldstein-Horioka observation that the international capital market indeed has not succeeded
in channeling funds out of relatively high-saving countries. However, large foreign imbalances are more
evident for smaller countries, and even for bigger countries the Feldstein-Horioka regularity has been
attenuated in recent decades.

of greedy market operators, usually foreign ones. This view is especially popular
with government ministers in the afflicted countries. In the 1960s, anonymous
‘‘gnomes of Zurich’’ were blamed for Britain’s chronic balance of payments prob-
lems; in the 1990s, ministers name gnomes, like George Soros. The opposing view
is that such crises are largely homegrown, and that the global capital market is
simply performing a needed role in disciplining imprudent government policies.
Recent thinking on crises would argue that neither view is entirely correct.
There may be extensive ‘‘grey areas’’ in which unwise policies make countries vul-
nerable to crises, but in which a crisis is not inevitable and might in fact not occur
without the impetus of international capital outflows, typically carried out by do-
mestic as well as foreign investors (Detragiache, 1996; Obstfeld, 1996). For example,
a country with extensive short-term dollar-denominated government debts and few
dollar reserves—Mexico’s position in December 1994—might find itself in a crisis
if previous lenders all suddenly demand repayment of their dollars, and if no new
lenders of dollars can be found. Thus, crises may contain a self-fulfilling element,
just as bank runs do, which can generate multiple equilibria in international asset
markets, and render the timing of crises somewhat indeterminate. What we see in
these cases is a sharp break from an essentially tranquil equilibrium to a crisis state,
rather than a gradual deterioration in domestic interest rates and other market-
based indicators. This view helps explain why capital markets can appear to impose
too little discipline before the crisis arrives, and too harsh a discipline afterwards.
The attempt to assure fixed exchange rates (or a preannounced ceiling on
exchange depreciation) can lead to the very vulnerabilities that raise the possibility
of an international credit crisis. When domestic banks and corporate borrowers are
(over)confident in an exchange rate, they may borrow dollars or yen without ade-
quately hedging against the risk that the domestic currency will be devalued, sharply
raising the ratio of their domestic-currency liabilities to their assets. They may be-
lieve that even if a crisis occurs, the government’s promise to peg the exchange
rate represents an implicit promise that they will be bailed out in one way or an-
other. Borrowers may face little risk of personal loss even if a bailout does not
materialize, because they have little or no capital at stake.
This problem has been especially severe in developing countries, where pru-
dential regulation is looser, financial institutions are weaker, and even the govern-
ment’s credit may be questionable. When market sentiment turns against the
exchange rate peg, the government is effectively forced to assume the short foreign-
currency positions in some way—or else to allow a cascade of domestic bankrupt-
cies. Since the government at the same time has used its foreign exchange reserves
(in a vain attempt to peg the exchange rate) and cannot borrow more in world
credit markets, national default becomes imminent.11 Dı́az-Alejandro (1985), de-
scribing Chile’s experience in the early 1980s, gave a classic account of this process.
The exchange crises of the 1990s have underlined the problem anew. In Mex-
11
Of course, there are other mechanisms driving such crises, as well. Because domestic interest rates
rise, entities that finance long-term domestic lending with short-term domestic borrowing—for example,
bank deposits—come under immediate pressure.

ico, domestic financial institutions in the early 1990s borrowed at low interest rates
in U.S. dollars so as to profit from higher Mexican interest rates. In many cases they
did this through special instruments designed to circumvent Mexican prudential
regulations (Garber and Lall, 1998). When the peso crisis struck at the end of 1994,
Mexico’s government found itself facing both a private-sector financial crisis along
with the problems arising from the government’s own dollar-linked foreign bor-
rowing. It saw no choice but to provide foreign reserves and liquidity to banks, thus
fueling the peso’s further depreciation.
Similar patterns can be seen in east Asia. As the IMF observes concerning
Thailand (Folkerts-Landau et al., 1997, p. 46):
While banks are believed to have hedged most of their net foreign liabilities,
the opposite is believed to be true for the corporate sector. The combination
of a stable exchange rate and a wide differential between foreign and (much
higher) domestic interest rates provided a strong incentive for firms to take
on foreign currency liabilities. . . . Hence, in addition to their own foreign
exchange exposure, banks may have a large indirect exposure in the form of
credit risk to firms that have borrowed in foreign currencies.
The Thai authorities intervened extensively in exchange markets after the crisis
started in May 1997, by committing to contracts under which the government would
assure future trades of dollars for baht (the Thai currency) near current spot prices.
This policy allowed many of those short on dollars to cover their liabilities relatively
cheaply. As a result, the Thai government was stuck with billions in foreign
exchange liabilities after the baht was floated in July, and these additional debts
fueled the crisis further.12
When currency crises struck Europe in 1992, its governments’ credit did not
come seriously into question. Europe’s exchange-rate crises therefore did not bal-
loon into more damaging default crises as in Mexico and Asia, capital market access
was not interrupted, and there was no need to seek emergency support from foreign
governments or the IMF.
The recent east Asian episodes again underline the need for more effective
monitoring and regulation of the asset and liability structures of financial institu-
tions. The recent episodes also underline the often weak political will to carry out
such supervision, the lack of local expertise, and the difficulty in discerning the
true risk characteristics of institutions’ assets and liabilities.13 Particularly when bor-
12
Note that Thai baht nominal interest rates will exceed U.S. dollar rates when there is some possibility
of baht depreciation and the marginal lender of baht does not expect to be fully protected from losses
in the event of an exchange-rate change. That configuration is consistent with a higher level of expected
government protection on average for capital flows from dollars into baht.
13
An inherent problem facing all countries, industrial and developing alike, is the great difficulty in
supervising financial institutions that can deal abroad, beyond the reach of their home supervisors. Since
the early 1970s, the Bank for International Settlements has been working to promote international
regulatory cooperation and allocate supervisory responsibility in areas that potentially fall under multiple
jurisdictions.

rowing is short-term, capital inflows may quickly reverse course and turn into out-
flows, squeezing liquidity and ultimately draining official reserves. This is what hap-
pened, on a global scale, in 1982. Such events are familiar from the record of bank
failure in a purely domestic context, but the emerging-market setting combines an
additional risk—currency risk—with the lack of a well-defined lender of last resort,
transparent accounting practices and legal systems, and (often) adequate pruden-
tial supervision. (Even in many industrial countries financial deregulation in the
1980s led to massive banking problems in the early 1990s.)
If more effective supervision proves impossible for a country, then there is a
second-best case for limiting foreign capital inflows through taxes on capital im-
ports, foreign deposit requirements, or similar measures. The possible moral hazard
problem raised by fixed exchange rates suggests an argument for exchange rate
flexibility (Mishkin, 1996). By purposely leaving some scope for unexpected
exchange rate movements and avoiding implicit exchange rate guarantees, the au-
thorities can induce domestic borrowers to internalize at least some of the costs of
failing to hedge appropriately. Other steps that would reduce the scope for crises
would be more foreign equity ownership in developing countries, and particularly
ownership of financial institutions in these countries, coupled with greater repre-
sentation in financial sectors of foreign-based intermediaries. These developments
would have the side benefit of reducing the perceived chance of government
bailouts.
While private financial mismanagement and inadequate supervision bear
much of the blame for recent capital-market crises in developing economies, one
should not conclude that international capital movements are necessarily stabilizing
in the absence of underlying vulnerabilities. Calvo and Mendoza (1997) show that
when international investors can allocate their wealth over many risky foreign in-
vestments and face a fixed cost of information about each country, it may pay for
individuals to diversify widely without bothering to become informed. In this situ-
ation, capital flows can be volatile and subject to herding effects. Any mechanism
for providing low-cost information to markets—for example, credible data on of-
ficial foreign reserves, the maturity of foreign borrowing, and the quality of do-
mestic investments—is a public good in this kind of model. In line with that con-
clusion, the IMF has been pressing countries to accelerate and broaden their dis-
closure of key economic data (although it is hard to verify the data that are
disclosed, and harder still to believe that a government in difficulty would release
damning figures). I conclude by taking up the Fund’s other major initiatives on
capital markets, which have placed the organization at center stage as an advocate
of open financial markets and as an international lender of last resort.
The IMF as an Emergency Lender

The U.S. government drew the IMF into the 1994 Mexican rescue. The orga-
nization then took the lead role in helping Argentina stave off the subsequent
‘‘tequila’’ crisis—an emerging-market headache blamed by many on Mexico’s elec-
tion-year binge. By 1997, the Fund was orchestrating international rescue efforts

Maurice Obstfeld 27
for Thailand, Indonesia, and Korea, putting up tens of billions of dollars itself and
imposing stiff conditions on the borrowers.
In reality, the IMF has been seeking a new permanent role ever since the
demise of the Bretton Woods system it was designed to oversee. It has eagerly em-
braced the role of international lender of last resort, and has requested extra re-
sources for that purpose. (At the IMF’s 1997 annual meeting in Hong Kong, share-
holder nations agreed to increase its $200 billion capital by 45 percent although
the U.S. Congress has balked at approving America’s contribution.) The IMF is also
seeking an amendment to its Articles of Agreement, which would codify the Fund’s
role in promoting open capital markets, as well as member countries’ obligation to
work, gradually if need be, toward that same goal (Fischer, 1997). Article VIII of
the original IMF agreement pushed countries to establish currency convertibility as
necessary to facilitate trade, and the Fund stood ready with resources should this
obligation lead to pressures on their fixed exchange rates. The proposed article
amendments in effect would oblige the Fund to stand ready with backstop finance
should private capital flows prove troublesome. After all, the IMF can hardly let
countries that have followed its advice twist slowly in the wind if things go awry.
The Fund clearly is right, it seems to me, to advocate an orderly process of
progressive integration into world capital markets. Convertibility for current ac-
count transactions seemed risky as well in the 1940s, but it proved an unprece-
dented engine for global growth. International finance likewise can be an engine
of growth, as it has been in the past. For this to occur, however, adequate prudential
safeguards must be in place first; capital markets must be competitive and free of
government-sponsored favoritism; and investors and capital recipients alike must
be motivated to avoid excessive risks and make use of new avenues for diversifica-
tion.14 These are tall, but not hopeless, orders. The Fund’s official espousal of fi-
nancial openness represents a break with the attitudes of its founders, but one that
seems entirely realistic after a half-century of financial market recovery.
While the IMF’s expanded lending role certainly offers potential benefits, it
once again raises the moral hazard problem that market agents may take on riskier
behavior, in the expectation that in a crisis, an IMF-arranged bailout is at least
possible, if not probable. To some degree, the IMF can reduce this risk by moni-
toring the behavior of potential claimants on its resources. But it is much harder
for the Fund to monitor and regulate sovereign countries—who are, remember,
the shareholders in the IMF—than it is for a nation’s bank regulators to monitor
its home financial system (Goldstein and Calvo, 1996).
Furthermore, the Fund’s credibility in foreswearing such bailouts is suspect
from the start. Strategic considerations and contagious threats to healthier econo-
mies might promote intervention. Moreover, is it plausible that the Fund would
deny resources in a pinch, possibly condemning millions of innocent people to
avoidable suffering? In discussing the 1995 Mexican support package, the IMF’s
14
McKinnon (1991), in particular, has stressed the need for properly sequencing the policy steps leading
to an open capital market.

First Deputy Managing Director, Stanley Fischer (1996, p. 323), observed, ‘‘It would
no doubt have been salutary for the Mexican policymakers and for the investors to
pay the right price for their sins. But the problem is that ordinary Mexicans would
have borne much larger costs. That’s justification enough for the international
action.’’ It remains to be seen how an institution with an essentially humanitarian
mission can square this circle. The Fund has faced this dilemma since its inception,
but the game is a new one, with higher stakes than ever before.
Summary
Postwar experience has been characterized by a growing acceptance of eco-

nomic openness. Compared to the world of the late nineteenth century gold stan-
dard, however, we increasingly reside in broadly democratic societies in which vot-
ers hold their governments accountable for providing economic stability and social
safety nets. These imperatives sometimes seem to clash with the reality of openness.
Despite periodic crises, global financial integration holds significant benefits and
probably is, in any case, impossible to stop—short of a second great depression or
third world war. The challenge for national and international policymakers is to
maintain an economic and political milieu in which the trend of increasing eco-
nomic integration can continue.
䊏 I thank Alan M. Taylor for ongoing discussions and for permission to draw on our joint
work. The paper benefited greatly from careful readings by Brad De Long, Alan Krueger, Dani
Rodrik, and Timothy Taylor. Stefan Palmqvist provided expert research assistance. Support
from a National Science Foundation grant to the National Bureau of Economic Research is
acknowledged with thanks.
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The Global Capital Market: Benefactor or Menace?: Maurice Obstfeld

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The Global Capital Market: Benefactor or Menace?: Maurice Obstfeld

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Journal of Economic Perspectives—Volume 12, Number 4—Fall 1998—Pages 9–30

The Global Capital Market: Benefactor

䊏 Maurice Obstfeld is the Class of 1958 Professor of Economics, University of California,

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The Integration of Global Capital Markets

Economic theory leaves no doubt about the potential advantages of global

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Period Argentina Australia Canada Denmark France Germany Italy

1870–89 18.7 8.2 7.0 1.9 2.4 1.7 1.2

Period Japan Norway Sweden U.K. U.S. All

1870–89 0.6 1.6 3.2 4.6 0.7 3.7

Source: Obstfeld and Taylor (1998) data.

Figure 1 offers another indicator of capital mobility, the standard deviation of

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Standard deviation of return difference

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Capital Mobility, the Exchange Rate, and Monetary Policy

It is a trite but true assertion of international monetary economics that the

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Understanding the Evolution of International Capital Mobility

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Capital Mobility and Exchange-Rate Flexibility

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Fiscal Autonomy and Income Distribution

An open capital market immediately confronts national authorities with a de-

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International Tax Competition

How Great is the Threat to National Autonomy?

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Capital Mobility and Income Distribution

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Market Failures and the Policy Response

The International Diversification Puzzle

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Crises in the Capital Markets

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The IMF as an Emergency Lender

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Postwar experience has been characterized by a growing acceptance of eco-

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dations of International Macroeconomics. Cam- Siebert, Horst, ‘‘Labor Market Rigidities: At

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