In recent years, many emerging economies have embarked on the road to financial reform. As indicated in the previous chapter, an important component of such reform has been the liberalization of the capital account of the balance of payments. And indeed, restrictions on capital movements have been removed or greatly weakened in many of these economies, in a process that gathered force around the world during the late 1980s and early 1990s. This process of financial reform and capital account liberalization was part of a much broader reorientation of economic policies among emerging economies toward a much more market-friendly disposition. In the international financial arena, this switch in policy regimes marked the transition from the debt crisis conditions that we reviewed in Chapter 8 to a situation in which many emerging economies became the recipients of substantial amounts of private capital from the rest of the world, surpassing in magnitude the inflows that preceded the international debt crisis of the early 1980s.

Ironically, just as the scarcity of external funding posed serious macroeconomic problems for the heavily indebted emerging economies during the 1980s, the large inflows of private capital that many of these economies began to receive during the first half of the 1990s was also viewed as a policy problem. Indeed, the capital inflow “problem” became a serious concern for economists and emerging-economy policymakers during the first half of the decade. This chapter will analyze the factors driving such capital flows.