The phenomenon of the capital account liberalisation boom and bust is well established in development economics. In the late 1990s John Williamson – who coined the term, the 'Washington Consensus' – demonstrated that every liberalisation period in developing countries had been followed by a bust. In most cases – though not all – a boom occurred in between.
The broad strokes of a 'typical' episode are these. First, the liberalisation allows domestic banks and companies to borrow and to sell equity more freely. As foreign capital flows in, this greater access to finance triggers an economic boom. The second systematic feature is that these financial flows are not converted into productive investment, but overwhelmingly into consumption and unproductive assets. The latter typically results in major bubbles in the property market and the stock market.
Eventually, some trigger event – not necessarily with any clear relationship to the economy in question – leads investors to re-evaluate their exposure, and to reduce it.
The resulting reversal of flows means that banks are suddenly unable to roll over their foreign debts, and in turn call in their own loans to domestic businesses. Some banks go bust, further reducing credit. Listed companies also see their share value drop sharply. The combination causes a major squeeze on company finances, resulting in bankruptcies, falling investment and a steep rise in unemployment.
Domestic investors, meanwhile, have often been lulled into a sense that 'this time is different' and are highly exposed to the local stock markets – as well as to the property bubble. Many citizens lose both investment value and their jobs.
The economic and social costs are great indeed. Inequality is often exacerbated, both in the boom and in the bust. The reversal of the money tide often reveals business activity in its wake that was foolhardy at best, blatantly fraudulent at worst. Ratings agencies and auditors raise the alarm, if at all, only after the fact.
How much of the last four paragraphs sound familiar? Asset bubbles and a credit-fuelled consumption boom, giving way to a bust that brings social unrest and a sustained period of economic depression.