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As with all financial disasters -- whether it's your neighbor’s lost job or a macroeconomic shock -- the first thing people want to know is "will it hit me?" This question must be on the minds of ordinary people and macroeconomic policymakers across the world, including those in developing countries. The policymaker's answer will depend on two things: (1) how closely is her country integrated in the international financial markets; and (2) how vigilant have her country's regulators been in regulating and supervising its capital markets?

Greater financial and trade ties with the rest of the world usually bring positive results for a country's consumers, producers, and investors but also create vulnerability in times of financial shock. Weak capital quickly causes markets to seize up and a more integrated economy will seize up on multiple fronts. In this circumstance, the poorest countries may for once be spared the worst, since they are less dependent on external goods and financial flows. The second factor is the regulatory environment in a country. To encourage growth and efficiency in the financial sector, it needs to be flexible enough to allow funds to seek their highest and best use, but tight enough to ensure that capital is of sufficient quality and financial flows respond to real profit opportunities and not speculation and rumor.

The global regulatory environment has not kept up well with changing financial opportunities and instruments over the past 10 years, and even regulators in developed countries have trouble competing for technology and talent with the private markets. The developing countries most likely to suffer from being a part of this weakly regulated and hot money environment are the middle-income and emerging markets. Most are relatively open to trade, and deeply involved in financial markets -- from Indonesia to Argentina. We will soon see -- as we have in the past on a regional or unilateral basis -- which ones have protected themselves against the current shock.

Disclaimer

CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.