Chapter 7:The International Financial Architecture and Emerging EconomiesI.Chapter OverviewChapter 7 begins with a discussion of recent developments in the global capital markets. One key development is the growth of foreign direct investment (FDI). Table 7-1 shows that growth of FDI flows greatly outpaced that of word exports, while Table 7-2 shows that more than 70 percent of these flows are among the developed economies. The section concludes with a presentation on capital flows to the emerging economies.The second section of the chapter considers the role of capital flows on economic growth and economic stability. There is a brief review of some of the problems described in chapter 6, which are pervasive to financial markets. The section concludes that there are benefits and risk to liberalized capital markets and that financial intermediaries are important to the efficient allocation of these capital flows. The third section of the chapter investigates the role of capital flows in recent financial crises. Capital controls are also discussed.The fourth section of the chapter explores the debate on the appropriate type of exchange rate regime for the emerging economies. Dollarization, described in Chapter 3, is revisited and the pros and cons of dollarization of the emerging economies are considered. The section then turns to the role of the International Monetary Fund (IMF) and the World Bank. The final section of the chapter addresses some of the criticisms of the IMF and World Bank and offers a table of various proposals for reforming these international institutions.II.Chapter OutlineA.International Capital Flows1.Explaining the Direction of Capital Flowsa. Foreign Direct Investment and Developed Nationsb. Cross-Border Mergers and Acquisitionsc. The Emerging Economies2.Capital Allocations and Economic Growtha. How Capital Inflows Can Smooth the Domestic Economyb. How Capital Inflows Can Contribute to Long-Term Development3.Capital Misallocations and Their Consequencesa. Markets Imperfectionsb. Policy-Created Distortionsc. Financial Instability and Financial Crises4.Maximizing Benefits and Minimizing Risks5.Where Do Financial Intermediaries Fit In?B.Capital Market Liberalization and International Financial Crises1.Are All Capital Flows Equal?a. Portfolio Capital Flowsb. Foreign Direct Investment2.The Role of Capital Flows in Recent Crisis Episodesa. Foreign Direct Investment as a Stabilizing Elementb. Is There a Role for Capital Controls?C.Exchange Rate Regimes and Financial Crises1.Schools of Thought on Exchange Rate Regimes2.The Corners Hypothesis3.Dollarizationa. The Benefits of Dollarizationb. The Costs of Dollarizationc. Dollarized Economies4.Peg, Take the Middle Road, or Float?5.Evaluating the Status Quoa. Ex Ante versus Ex Post Conditionality at the IMFb. Searching for a Mission at the World BankD.Does the International Financial Architecture Need a Redesign?1.Crisis Prediction and Early Warning Systems2.Rethinking Economic Institutions and Policiesa. Rethinking Long-Term Development Lendingb. Alternative Institutional Structures for Limiting Financial CrisesE.Chapter SummaryIII.Fundamental Issues1.What are the most important developments in the recent evolution of global capital markets?2.What is the relationship between capital allocations and economic growth, and what is the role of financial intermediaries in this relationship?3.What is the difference between portfolio capital flows and foreign direct investment, and what role did these types of capital flows play in recent crises?4.What type of exchange-rate regime is most appropriate for emerging economies?5.What aspects of IMF and World Bank policymaking have proved controversial in recent years?6.What changes in the international financial architecture have economists proposed in recent years?IV.Chapter Features1.Policy Notebook: “Free Trade Agreements and Capital Market Liberalization”This notebook describes the U.S. Treasurys attempts to include key agreement on investment as part of free trade agreements. Specifically, a sticking point was the Treasurys insistence that foreign policymakers sign an agreement that they would not impose capital controls in the future. This delayed considerable the signing of free trade agreements with Chile and Singapore.For Critical Analysis: U.S. manufacturing organizations had argued in the business press that the Treasury was representing the interest of investment organizations, who wanted the investment agreements-at the expense of manufacturing firms, who desired the passage of the FTAs.2.Policy Notebook: The Failure of Interest Rate ConvergenceThis notebook examines interest rate differentials as a function of exchan