Comments and Discussion

By now there is widespread agreement that trade liberalization enhances growth. No such agreement exists, however, on the growth-enhancing effects of financial liberalization, in large part because it is associated with risky capital flows, lending booms, and crises. The Mexican experience is often considered a prime example of what can go wrong with liberalization. Mexico liberalized its trade and finance and entered the North American Free Trade Agreement (NAFTA), yet despite these reforms, Mexico's growth performance has been unremarkable in comparison with that of its peers. A particularly worrisome development is that, since 2000, there has been a slowdown in Mexico's exports.

That financial liberalization is bad for growth because it leads to crises is the wrong lesson to draw. Our empirical analysis shows that, in countries with severe credit market imperfections, financial liberalization leads to more rapid growth, but also to a higher incidence of crises. In fact, most of the fastest-growing countries of the developing world have experienced boom-bust cycles. We argue that liberalization leads to faster growth because it eases financial constraints, but that this occurs only if agents take on credit risk, which makes the economy fragile and prone to crisis. An implication of our analysis is that the international bank flows that follow financial liberalization and increase financial fragility are an important component of a rapid-growth path.

We also find that asymmetries between the tradables (T) and nontradables (N) sectors are key to understanding the links among liberalization and growth, boom-bust cycles, and the Mexican experience. Asymmetric sectoral responses to liberalization and crisis are the norm.

At first glance, the experience of Mexico, a prominent liberalizer, challenges the argument that liberalization promotes growth. However, when we compare Mexico against an international norm, we find that the growth in Mexico's exports during the 1990s was outstanding. We also find that, although its pattern of boom and crisis is similar to that of the average liberalizing country, Mexico's credit crunch in the wake of its crisis has been atypically severe and long-lasting. This credit crunch, together with a lack of structural reform since 1995, has resulted in stagnation of the N-sector, generating bottlenecks that have contributed to Mexico's less-than-stellar growth performance and to the more recent fall in exports.

To document these points, we analyze the empirical relationship among liberalization, crises, and growth across the set of countries with active financial markets, and we characterize the typical boom-bust cycle. To substantiate our interpretation of the data and to explain the Mexican experience, we present a model that establishes a causal link from liberalization to growth, and in which the same forces that lead to faster growth also generate financial fragility. The model leads us to divide our data set into countries with high and intermediate degrees of contract enforceability (which we call high-enforceability and medium-enforceability countries, or HECs and MECs, respectively).

Our data analysis shows that, across MECs, trade liberalization has typically been followed by financial liberalization, which has led to financial fragility and to occasional crises. On average, however, both trade liberalization and financial liberalization have led to more rapid long-run growth in GDP per capita across the set of countries with active financial markets. Furthermore, we find that this positive link is not generated by a few fast-growing countries that experienced no crisis. Instead, it is typically the fastest-growing countries that have experienced crises. This suggests that the same mechanism that links liberalization with growth in MECs also generates, as a by-product, financial fragility and occasional crises.

These facts do not contradict the negative link between growth and the variance of several macroeconomic variables—the typical measure of volatility in the literature. A high variance reflects not only the uneven progress, or "bumpiness," associated with occasional crises, but also high-frequency shocks. Instead we measure the incidence of occasional crises by the (negative) skewness of real credit growth. Our findings show that fast-growing MECs tend to have...