**Financial Openness, Democracy, and Redistributive Policy'**

# **I. Introduction**

The observation that all advanced democratic countries are also open to free capital mobility across their national borders invites renewed debate on the link between democracy and financial openness. This debate has a long and distinguished history that goes back to the 18t century, but it has gained prominence recently as capital has become increasingly mobile at a massive scale, and as free economies have come under continuous pressure from rapidly changing technology, market integration, changing consumer preferences, and intensified competition. Reflecting the influence of advances in communication and information technologies, financial innovations, and deliberate government policies to abolish barriers and controls on capital mobility, international financial markets have grown significantly in recent years. The volume in international lending in new medium and long-term bonds and bank loans reached $1.2 trillion in 1997, up from $0.5 in 1988 (BIS 1998). International financial transactions now dwarf world trade at more than five times the value of world GDP. The average daily turnover in foreign exchange markets reached $1.6 trillion in 1995 (up from $0.2 trillion in 1986), compared with the $6.7 trillion a year in trade in goods and services.<sup>2</sup> While free capital mobility has its antecedents in 17th and 18t century Europe, the worldwide triumphant spread of democracy as a desirable system of governance is a fairly recent phenomenon bolstered by several developments, including the rise of global civil society and the information age, and the collapse of state socialism. This expansion of democracy, coupled with the corresponding increase in political and civil liberty, means that for the first time in human history, electoral democracy is the world's predominant form of governnent, which represents an historic victory over alternative forms of government (Held, 1995). A recent survey conducted by the Freedom House found that 88 of the world's 191 countries (46 percent) - the largest number ever recorded - were rated as free, meaning that "they, maintain a high degree of political and economic freedom and respect for civil liberties."<sup>3</sup> What explains the spread of both democracy and financial openness at this juncture of history, given the constraining impact of financial market integration on national policy autonomy? To be sure, both the goals of a democratic polity and free capital mobility command I This paper was largely inspired by the author's earlier contributions to _The Qudity of Grwth,_ a research project led by Vinod Thomas of the World Bank Institute. In this work, contributors seek to propagate abroader conception of economic growth, embracing environmnental sustainability, governance, financial stabiliy, and human capital as the fundamental ingredients of quality growth and poverty alleviation. Inthis paper, we examine in greater detail the link between financial openness and democracy as two important aspects of the evolving global govemance structure.

2 The figure reflects the average of world imports and exports of goods and services in 1988 (WDI 2000).

3 Democratically elected govemrnments govem a majority of the world's population. As noted above, 2.354 billion people (40 percent of the world's population) now live in free societies, 1.57 billion (26.5 percent) live in countries that are partially free and 1.984 billion (33.5 percent) live in non-free countries. (Karatnycky, 1999).

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