ABSTRACT
This chapter discusses how the analysis of sequencing of liberalization and the arguments for limited convertibility depend either on market failures in the conventional sense, or policy failures in the sense that for political reasons authorities are unable to deal with an economic problem using the instrument with the least costs in terms of other policy objectives. It reviews the commonly discussed preconditions for liberalization of capital account transactions and relates them to policy and market failures. The chapter focuses on policy failure arguments for capital controls. It also discusses market failure arguments and external capital flow surges. The chapter describes the "success" of market-oriented policies as arguments for and against capital account liberalization. It examines the role of market failures and, finally, conditions in the external environment and their role in capital account liberalization. Capital flows are to a large extent driven by relative expected returns and risks on real and financial investments in various countries.
