Does Financial Openness Pay for Emerging Markets? New Research Find No

For more than three decades, the Washington Consensus has promoted capital account liberalization as a cornerstone of economic development. The logic appeared unassailable: emerging markets, constrained by domestic savings, would benefit from access to global capital pools, which would finance investment, accelerate productivity growth, and raise living standards. While policymakers acknowledged the risks-sudden stops, currency crises, and financial instability-the prevailing view held that these were transitional challenges to be managed through sound institutions and prudent macroeconomic policies. The ultimate destination of full financial integration remained not only desirable but inevitable in an increasingly globalized world.

Recent research published in the American Economic Review, however, offers a fundamental challenge to this framework. In "The Global Financial Resource Curse," economists Gianluca Benigno, Luca Fornaro, and Martin Wolf construct a theoretical model that explains why financial openness may systematically undermine growth prospects for emerging markets-not through the familiar channel of financial crises, but through a more insidious mechanism involving sectoral reallocation and innovation dynamics in the world's technological leader . Their work forces a reconsideration of whether the promised benefits of capital account liberalization have been, for many countries, more mirage than reality.

Capital Flowing Uphill

The starting point for understanding the Global Financial Resource Curse is an empirical phenomenon that has puzzled economists for two decades: the "global saving glut." Standard economic theory predicts that capital should flow from capital-rich developed economies to capital-scarce emerging markets, where returns should be higher. Yet the period since the late 1990s has been characterized by precisely the opposite pattern. Emerging markets, particularly in Asia, have become massive net exporters of capital to the United States.

The scale of this reversal is striking. Between 2000 and 2014, China alone accumulated foreign exchange reserves exceeding $4 trillion, the vast majority invested in U.S. Treasury securities and other dollar-denominated assets. This was not an isolated case. Across emerging Asia, current account surpluses ballooned, reflecting a systematic pattern of capital flowing from poor to rich countries. The United States, meanwhile, ran persistent current account deficits, absorbing capital from the rest of the world to finance domestic consumption and investment.

The conventional interpretation of this phenomenon focused on precautionary savings motives following the Asian Financial Crisis of 1997-98, mercantilist exchange rate policies, and the safe-asset shortage in emerging markets. While these factors undoubtedly played a role, they left unanswered a deeper question: if emerging markets were exporting capital to finance U.S. growth, why did this arrangement fail to deliver the productivity gains that standard theory predicted? Why, instead, did the 2000s witness a dramatic slowdown in productivity growth both in the United States and globally?

From Capital Flows to Productivity Stagnation

The Benigno, Fornaro, and Wolf model provides an answer by focusing on the sectoral composition of economic activity and its relationship to innovation. The key insight is that not all sectors contribute equally to long-term productivity growth. The tradable sector-manufacturing, technology, and other industries that compete in global markets-is identified as the primary locus of innovation and technological progress. The non-tradable sector-services like healthcare, education, construction, and hospitality-while economically important, is generally less dynamic in terms of productivity-enhancing innovation.

The mechanism operates through four interconnected steps. First, large-scale capital inflows into the United States increase aggregate wealth and purchasing power. Much of this additional spending is directed toward non-tradable goods and services, which by definition cannot be imported. This surge in demand drives up prices and profit margins in the non-tradable sector relative to the tradable sector.

Second, responding to these price signals, resources-particularly labor and domestic investment capital-are reallocated from the tradable to the non-tradable sector. This is a textbook example of "Dutch Disease," where a boom in one part of the economy (in this case, fueled by foreign capital rather than natural resource exports) causes a contraction in another. The tradable sector shrinks or stagnates even as the non-tradable sector expands.

Third, as the tradable sector contracts, so do the profits that firms in this sector would reinvest into research and development. Innovation is a risky, long-term investment that requires sustained profitability to justify. When expected returns in the tradable sector fall, firms rationally cut back on R&D spending. The result is a slowdown in the rate of technological innovation.

Fourth, and most critically, this innovation slowdown has global ramifications. Because the United States sits at the world technology frontier, innovation by U.S. firms effectively determines the pace at which that frontier advances. When U.S. innovation slows, the global productivity frontier advances more slowly. Emerging markets, whose growth strategies typically involve adopting and adapting technologies from the frontier, find that the frontier itself is moving away more slowly. They are, in effect, victims of their own capital exports.

Timing and Magnitude

The model's predictions align remarkably well with observed patterns in the U.S. economy over the past two decades. U.S. labor productivity growth averaged 3.3 percent annually between 1998 and 2005, well above the long-term historical average of 2.1 percent . This productivity boom was widely attributed to the information technology revolution and convinced many observers that the United States had entered a new era of sustained high growth.

The slowdown, when it came, was both sudden and severe. Beginning in 2005, productivity growth fell sharply, averaging just 1.3 percent annually through 2018-significantly below the historical trend. The period from 2010 to 2018 was even worse, with productivity growth of only 0.8 percent per year. The cumulative impact has been staggering: the Bureau of Labor Statistics estimates that the productivity slowdown since 2005 represents a cumulative loss of $10.9 trillion in output, or $95,000 per worker.

The timing of this slowdown is particularly telling. It coincides almost exactly with the peak of the global saving glut. Capital inflows to the United States were largest in the mid-2000s, precisely when productivity growth began to falter. While correlation does not prove causation, the temporal alignment is consistent with the Global Financial Resource Curse mechanism.

Sectoral data provide additional support. The manufacturing sector-a key component of the tradable economy-experienced a particularly sharp productivity slowdown. Between 2000 and 2007, the United States lost 3.6 million manufacturing jobs, a decline that research attributes primarily to trade deficits rather than automation . This hollowing out of the manufacturing base occurred even as employment in non-tradable services expanded. The pattern of sectoral reallocation predicted by the model appears to have materialized in the data.

Rethinking the Benefits of Financial Openness

The Global Financial Resource Curse framework fundamentally challenges the conventional wisdom on capital account liberalization. The traditional view, articulated by institutions like the International Monetary Fund, acknowledges that liberalization carries risks of financial instability but maintains that these can be managed through sound policies and strong institutions. The long-run benefits-efficient capital allocation, technology transfer, and faster growth-are presumed to outweigh the short-run costs.

The IMF's own empirical assessments, however, have long been more equivocal than its policy recommendations suggest. Even before the Global Financial Resource Curse research, IMF economists acknowledged that "after controlling for the effects of other factors, the causal effect of capital account liberalization on growth has been weak, at best" . They noted that emerging markets had been unable to use international financial markets to smooth consumption, and that capital flows tended to be procyclical-amplifying rather than dampening economic fluctuations.

What the Global Financial Resource Curse adds to this picture is a mechanism that explains why the benefits have been so elusive. It is not simply that emerging markets have struggled to manage the volatility of capital flows, though that is certainly true. It is that the very structure of global capital flows-with emerging markets exporting capital to the United States-creates a drag on global productivity growth that harms both capital exporters and importers.

For emerging markets, the implications are particularly stark. They have opened their capital accounts, as advised, and the result has been capital outflows rather than inflows. These outflows have financed a sectoral reallocation in the United States that has slowed U.S. innovation. And because emerging market growth depends on absorbing knowledge from the technological frontier, the slowdown in frontier growth has directly harmed their own growth prospects. They face a double curse: they lose capital domestically and they suffer from slower productivity growth globally.

Managing Integration in a Second-Best World

The policy implications of this research are complex and uncomfortable. A return to comprehensive capital controls is neither feasible nor desirable in an integrated global economy. Trade openness creates natural channels for capital flow evasion, and financial market sophistication makes enforcement increasingly difficult. Moreover, capital controls carry their own costs in terms of reduced efficiency and opportunities for rent-seeking.

Yet the Global Financial Resource Curse suggests that the standard prescription-ever-deeper financial integration-may be fundamentally flawed. If the problem is not just the volatility of capital flows but their direction and their impact on sectoral allocation, then managing that volatility is not enough. Policymakers need to think more carefully about the composition of capital flows and their ultimate economic effects.

Several policy directions emerge from this analysis. First, emerging markets should reconsider the accumulation of large foreign exchange reserves. While such reserves provide insurance against financial crises, they also represent a massive export of capital that contributes to the global productivity slowdown. Alternative forms of insurance-such as regional liquidity arrangements or contingent credit lines-may be preferable.

Second, policies that encourage domestic investment in tradable sectors deserve renewed attention. This might include targeted industrial policies, support for R&D and innovation, and measures to ensure that domestic savings are channeled into productive investment rather than capital flight. The goal is not autarky but a rebalancing that keeps more capital at home to finance productivity-enhancing activities.

Third, at the global level, there is a need for better coordination of macroeconomic policies to address the underlying imbalances that drive the saving glut. This includes fiscal policies in surplus countries that could boost domestic demand, structural reforms that reduce precautionary savings, and exchange rate adjustments that make emerging market currencies less undervalued.

The IMF has cautiously evolved its position on capital controls over the past decade, acknowledging in its Institutional View that capital flow management measures can be appropriate in certain circumstances . The Global Financial Resource Curse research provides a new and powerful theoretical foundation for such pragmatism. It suggests that the question is not whether to manage capital flows, but how to manage them in ways that support rather than undermine long-term productivity growth.

Toward a New Framework

The Global Financial Resource Curse does not provide all the answers. The model is necessarily stylized, and the empirical evidence, while suggestive, is not definitive. Other factors-including the slowdown in educational attainment, the aging of the population, the exhaustion of low-hanging technological fruit, and the rise of market concentration-have also been implicated in the productivity slowdown. Disentangling these various channels is an ongoing research challenge.

What the research does provide is a compelling reason to question the presumption that financial openness is always and everywhere beneficial for emerging markets. It shows that the direction of capital flows matters, that sectoral composition matters, and that the global interdependencies of innovation and productivity growth matter. In a world where capital flows from poor to rich countries and where those flows distort the sectoral allocation of the technological leader, the simple prescription of "more integration" may be wrong.

For policymakers in emerging markets, this research offers both a warning and an opportunity. The warning is that capital account liberalization, pursued without attention to its broader economic effects, may not deliver the promised benefits and may even be harmful. The opportunity is to develop a more sophisticated approach to financial integration-one that recognizes the importance of maintaining a strong tradable sector, supporting domestic innovation, and managing capital flows in ways that enhance rather than undermine long-term productivity growth.

The era of the Washington Consensus, with its one-size-fits-all prescriptions, is over. The Global Financial Resource Curse is part of a broader rethinking of development economics that takes seriously the diversity of country circumstances, the importance of structural transformation, and the complex ways in which global economic integration shapes national development trajectories. For emerging markets navigating the challenges of the twenty-first century, this more nuanced understanding may prove far more valuable than the simple certainties of the past.

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References

[1] Benigno, Gianluca, Luca Fornaro, and Martin Wolf. (2025). "The Global Financial Resource Curse." American Economic Review, 115 (1): 220–62.

[2] Sprague, Shawn. (2021). "The U.S. productivity slowdown: an economy-wide and industry-level analysis." Monthly Labor Review, U.S. Bureau of Labor Statistics.

[3] Scott, Robert E. (2015). "Manufacturing Job Loss: Trade, Not Productivity, Is the Culprit." Economic Policy Institute.

[4] Kose, M. Ayhan, and Eswar Prasad. (2006). "Capital Accounts: Liberalize or Not?" Finance & Development, International Monetary Fund.

[5] International Monetary Fund. (2022). "IMF Executive Board Endorses Updates to the Institutional View on Capital Flows." Press Release No. 22/95.