HELMUT REISEN / MARCELO SOTO Why Foreign Capital Is Good for Post-Crisis Asia M uch of Asia has long been characterised by high domestic savings. East Asia saved, before the Asian crisis in 1997 , a third of its GDP , more than any other region in the world. High savings financed rapid capital accumulation that accompa­nied remarkable economic growth. A question often raised is therefore: why should Asia incur risky foreign savings when it can finance develop­ment from local savings? After all, even distinguish­ed economists such as Joe Stiglitz have argued that countries with such enviable savings rates as often found in Asia do not need foreign funds for invest­ment and growth. Foreign savings, of course, are net capital inflows, the counterpart of current account deficits (if there is no change in reserves). In particular, the Asian crisis has reminded us of the risks of capital flows – that is, the unsettling effects of irrational exuberance, investor panic and financial conta­gion. As the(mostly temporary) withdrawal of for­eign savings caused and accompanied the great Asian slump in 1997 and thereafter, policy-makers have got used to terms such as moral hazard, asymmetric information and adverse selection, as far as global capital flows are concerned. There have been innumerable conferences and papers on the prevention and resolution of financial crises and their cross-border contagion, sharpening the awareness of policy-makers to the risks of volatile capital flows. This paper wants to take a respite from the cur­rent focus on the risks of capital flows. It rather intends to explore the benefits of foreign savings, both by reviewing the analytical arguments and by building fresh empirical evidence on the growth impact of private capital(in)flows. Some Asian countries have been blamed(also by the OECD ; see Poret, 1998 ) for discouraging long-term equity inflows and encouraging short-term inflows in the past. Thus, a particular effort will be made to pro­vide evidence on the independent growth impact that the various broad categories of flows are likely to exert. We proceed in three steps before drawing con­clusions. First, we review the economic arguments that have been advanced to presume economic benefits from overall capital inflows, even if domestic savings are plenty. Second, we concen­trate on collecting arguments which have been advanced in favour of(or against) benefits of four broad categories of inflows – foreign direct invest­ment( FDI ), portfolio equity investment, portfolio bond flows, and bank lending. This enables hypo­theses to be formulated on the potential growth impact of these four categories. Third, we present evidence for the recent period of strong private flows to the emerging markets. Fourth, we draw conclusions: First, why is it important to encour­age foreign savings in order to stimulate growth; second, which forms of private flows should be encouraged to maximise the benefits of financial integration? The insights should provide valuable inputs for the appropriate macro-economic and institutional approach towards capital flows; this paper also warns against relying solely on national savings for financing development. The Benefits of Foreign Savings The literature has emphasized the potential of foreign capital flows to enhance growth ̈ through higher investment in physical and human capital, ̈ through higher efficiency with which these factors of production are used and ̈ through consumption smoothing as a result of cross-border risk sharing. The earlier two-gap literature(Chenery and Bruno, 1962 ), assuming fixed prices and exchange rates and no capital-good production in develop­ing countries, had postulated that growth was not IPG 4/2000 Helmut Reisen/Marcelo Soto, Why Foreign Capital Is Good for Post-Crisis Asia 399