Financial Repression and Liberalization: A Survey of the Literature

The literature on financial repression and financial liberalization in developing countries commenced with the seminal work of Mckinnon and Shaw in 1973 which focused on financial repression and the need for developing economies to allow real interests rates to be determined by market forces. With the adverse effects of financial repression on economic growth emerging, financial liberalization was advocated as a key to financial development and growth-enhancing economic policies. These arguments have been challenged by experiences of many developing countries which implemented liberalization policies and underwent devastating financial crisis. Financial liberalization is intended to promote market efficiency and economic welfare. However, the experiences in many countries revealed that deregulation and liberalization without the requisite regulation resulted in excessive risk-taking and encouraged an over-accumulation of short-term external liabilities by both financial and corporate sector. Costly lessons learned from the experiences should not lead to a return to financial repression. Rather institutional framework, including regulatory reform and infrastructure reform, should be established for the enhancement of the economic benefits from the financial liberalization.