These crises have already imposed extremely high social and economic costs on the affected countries. Just for East Asia, the loss in aggregate domestic output, measured by deviation from historical trends, is estimated to be $500 billion (in 1996 prices and exchange rates) in 1997-1999.2 This is nearly 1.3 times those countries' external debt in 1996. With the memory of the debt crisis of the 1 980s and its prolonged resolution still alive, the international policy response was prompt, involving the extension of large stand-by and direct loans in order to refinance maturing foreign exchange obligations and restore confidence. The total volume of international financial assistance committed from August 1997 to December 1998 to Thailand, Korea, Indonesia, Russia, and Brazil amounted to $190 billion-1.4 times the total stock of foreign exchange reserves for these countries--and 30 percent of the foreign exchange reserves of all developing countries at the end of 1997.3 The crises have also catalyzed interest in the broader debate on the functioning, architecture, and regulation of international financial markets. Fifty-five years after the post-war institutional reconstruction that launched the Bretton Woods consensus, the international community must again contemplate how to design a new international financial architecture that would promote financial stability and long-term economic growth.

The underlying conditions, trends, and forces at play have changed substantially since 1944. Global financial markets have grown significantly in the size, complexity, and range of services and products that they offer. Private capital has emerged as the dominant source of development finance, surpassing official finance by a factor of _5_ to 1 in recent years. In addition, the Euro has been launched, which could potentially rival the US dollar in both the international payment system and international finance.

Even more important, the spread of democracy and increased political and civil liberty mean that for the first time in human history, electoral democracy is the world's predominant form of government. According to a recent survey by the Freedom House, 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>4</sup> Inherent in pursuing financial openness is the realization that there are benefits and risks, and much current debate probes how best to balance them.<sup>5</sup> The benefits to developing countries include access to a broader menu of investment sources, options, and instruments, enhanced efficiency of domestic financial institutions, and the disciplinary impact of capital markets in conducting domestic macroeconomic policy. At

> **2** See Note I in Annex for an explanation of the methodology used in this calculation.

> 3See Dailami (1998) and Eichengreen (1999) for further elaboration.

> **4** A majority of the world's population is run by democratically elected governments - thus, today, 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. See Karatnycky (1999).

In a survey paper, Williamson and Mahar (1998) reviewed empirical studies and experience of financial liberalization and its linkage with financial crises. Their conclusion is that financial liberalization offers economic gains but it carries many risks. In twenty-four countries that had experienced financial crises, thirteen of them had liberalized their capital account within five years prior to crises.

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