The recent wave of currency and financial crises that have rattled most of the emerging market economies from Asia, Europe, and South America is deeply related to the process of financial liberalization over the preceding decade. The human, economic, and political costs of the crisis are staggering. They must be set against the benefits of financial liberalization. Proponents of liberalization rest their case on the improved allocation of resources which is expected to follow, as well as on the erosion of the effectiveness of restrictions. But just how big are these gains, especially if the controls “do not work”? Ex ante, of course, one cannot offer estimates. Ex post, when the costs of crises are accounted for, the balance is doubtful. Yet, the proponents of financial liberalization feel that they do not have to offer the kind of cost and benefit analysis that is customary in other circumstances. Theory, it is claimed, is unambiguous and since the benefits accrue permanently they must outweigh whatever costs occur in the interim period.

Theory, unfortunately, is not as one-sided as it is often made to be. If financial markets were operating fully efficiently, the case for liberalization would indeed be clear cut. Financial markets, however, are known to suffer from serious defects associated with the phenomenon of asymmetric information. The tendency of financial markets to display extreme instability is well recognized. Indeed virtually all financial markets are subject to public interventions in the form of extensive regulations and careful overseeing.