Thresholds in the Process of InternationalFinancial Integration

The financial crisis has re-ignited the fierce debate about the merits of financial globalizationand its implications for growth, especially for developing countries. The empirical literaturehas not been able to conclusively establish the presumed growth benefits of financialintegration. Indeed, a new literature proposes that the indirect benefits of financial integrationmay be more important than the traditional financing channel emphasized in previousanalyses. A major complication, however, is that there seem to be certain “threshold” levelsof financial and institutional development that an economy needs to attain before it can derivethe indirect benefits and reduce the risks of financial openness. In this paper, we develop aunified empirical framework for characterizing such threshold conditions. We find that thereare clearly identifiable thresholds in variables such as financial depth and institutional quality− the cost-benefit trade-off from financial openness improves significantly once thesethreshold conditions are satisfied. We also find that the thresholds are lower for foreign directinvestment and portfolio equity liabilities compared to those for debt liabilities....