Question

Why might financial liberalization and globalization lead to financial crises in emerging market economies?

Answer 1

Financial liberation and globalisation is the removal of restrictions on flow of capital. Capital is free to move in and out of the country.

The financial and security markets in the emerging countries is not well developed. There exists the problems of moral hazard and adverse selection. They do not have the expertise to screen between good and bad investments, and to monitor the projects for which money is lent.

The problems of adverse selection and moral hazard become worse as there is no restriction on financial market and domestic market cannot control the market. This might lead to financial crises in emerging market economies.