Lozinskaya
Y., Ozarina O.V.
Donetsk
National University of Economics and Trade named after
M.I. Tugan-Baranovskiy
The main trends in the development of financial
globalization
Financial globalization has been one of the most
important trends in the world economy in recent
decades. This process has involved sharply rising foreign asset and liability
positions, whether scaled by GDP or by domestic financial variables. In
addition to larger gross positions, financial globalization has also allowed a
greater dispersion in net foreign asset positions, with a significant number of
countries emerging as either large net creditors or net debtors.
The key target of this article is to define the
main trends and directions in the development of financial globalization, its
organizing principles, advantages and disadvantages, consequences and
perspectives.
The recent wave of
financial globalization got started in earnest in the mid-1980s, with rising cross-border
financial flows among industrial economies and between industrial and developing economies. This was spurred by
liberalization of capital controls in many of these countries, in
anticipation of the benefits that cross-border flows would bring in terms of
better global allocation of capital and improved international risk-sharing
possibilities. The main benefits from successful financial globalization are
probably catalytic and indirect, rather than consisting simply of enhanced
access to financing for domestic investment.
The major tendencies of financial globalization
are:
1. It
should lead to flows of capital from capital-rich economies to capital-poor
economies since the returns to capital
should be higher.
2. These flows should complement limited domestic saving
in capital-poor economies and, by reducing the cost of capital, allow for
increased investment.
3. There
are also a number of indirect channels through which financial globalization
could enhance growth. It could help promote
specialization by allowing for sharing of income risk, which could in turn
increase productivity and growth as well.
4. Financial
integration serves as an important catalyst for a number of indirect benefits,
which we term potential “collateral benefits” since they may not generally be
the primary motivations for countries to undertake financial integration. These
collateral benefits could include development of the domestic financial sector,
improvements in institutions (defined broadly to include governance, the rule
of law, etc.), better macroeconomic policies, etc. [1].
One cannot, of course, overstate the case that
financial integration leads to the collateral benefits. It is equally
plausible, for instance, that, all else being equal, more foreign capital tends
to flow to countries with better-developed financial markets and institutions.
Furthermore, the process of
globalization seems to proceed more smoothly when trade liberalization
precedes financial integration. Thus, it is the interaction between financial globalization and this set of initial conditions
that determines growth and volatility outcomes. Financial globalization leads to better macroeconomic outcomes when
certain threshold conditions are
met. This generates a deep tension as many of the threshold conditions
are also on the list of collateral benefits.
Note that most (but not
all) of the elements on the list of threshold conditions are
identical to the list of collateral benefits. In other words, financial globalization serves as a catalyst for a number
of important collateral benefits but can greatly elevate the risks to
benefits ratio if the initial conditions in these dimensions are inadequate
[5].
The effects of financial
integration on output volatility
are not obvious in theory. In principle, financial
integration allows capital-poor countries to diversify away from their narrow production bases that are often agricultural or
natural resource-dependent. This should reduce macroeconomic volatility.
At a more advanced stage of development, however, trade and financial
integration could simultaneously allow for enhanced specialization based on comparative advantage considerations. This could
make countries more vulnerable to industry-specific shocks.
The empirical implications of this perspective
are powerful. First of all, it suggests that the beneficial impact of financial
integration on growth may take a while to show up because it operates through
these indirect channels rather than just directly through financing of domestic investment. This
problem cannot be resolved simply by using a technique such as instrumental variables estimation; that would entirely miss
the logic of the scheme above since our interest is in how financial
integration affects growth through all channels, direct and indirect [3].
The perspective
acknowledges the relevance of the traditional channels, but argues that the
role of financial globalization as a catalyst for certain
collateral benefits may be more important in increasing GDP/total factor
productivity (TFP) growth and reducing consumption volatility.
Unfortunately, existing
papers have identified only the importance of threshold effects in specific
dimensions. There is as yet little work on the relative
importance of different thresholds and the trade-offs among different threshold
conditions. What would be most useful for a country contemplating
liberalization of its capital account would be a composite threshold measure
that would determine its preparedness to
undertake this policy change. In the absence of such a measure, it is hard to determine
when a country is ready for financial integration.
Although financial
globalization is, in theory, supposed to work its magic through increased capital
flows, indirect benefits to undertaking financial globalization that are
arguably of greater potential importance than the direct benefits.
There are some
consequences of financial globalization. One of them is that the international spillovers from
asset price and currency movements have
been enhanced. In addition to affecting the direction and magnitude of net
capital flows, asset price dynamics also generate changes in the valuation of existing
investment positions. For instance, the value of the net liability position of
the United States is quite sensitive to relative movements in the U.S. versus
non-U.S. equity markets and swings in the value of the dollar.
Besides, the U.S. current account deficit has
grown steadily since the early 1990s to the historically unprecedented level of $857 billion (6.5 percent
of GDP) in 2006 (Figure 1). Much attention has focused on the causes and
sustainability of the “global imbalances” – a euphemism for the large U.S.
deficit – and on the appropriate policy response. Observers are divided in two camps: those who think that this is a dangerous
situation which poses serious risks for global economic and financial
stability and those who believe it is a natural by-product of real and
financial globalization. At the risk
of oversimplifying, the first view as “the traditional
view” and to the second as “the new paradigm” view.
Figure 1.
Current account deficit and real effective exchange rate of the dollar for the
period of 1990-2004,% [7,4]
The traditional view focuses on the decline in
the U.S. national saving rate since the beginning
of this decade, reflecting the swing from fiscal surplus to deficit and the
decline in household savings – the result of asset bubbles in the equity
and housing markets. In this view, the widening of the U.S. current account
deficit is the result of fiscal and monetary policy decisions in the United
States that need to be urgently reversed to avoid a possible loss of market
confidence. A “sudden stop” of capital flows to the United States would trigger an adjustment process involving a massive
sell-off of dollar assets, a sharp increase in U.S. interest rates, and
a “hard landing” of the U.S. and global economy. It is another negative impact of financial
globalization. To avoid the possibility
of such an abrupt unwinding of imbalances, policymakers have called for joint
action to rebalance demand across regions, with the United States reducing its
fiscal deficit, the European Union
implementing growth-enhancing structural reforms, and Asian countries boosting
domestic demand and letting their currencies appreciate. Multilateral consultations involving the main players (U.S., EU,
Japan, China and Saudi Arabia), launched by the IMF in the spring of
2006, were aimed at discussing the policies
needed to rebalance demand while maintaining robust global growth. These
consultations resulted in a joint communiqué in April 2007 spelling out
the policy commitments of the countries/regions involved. Market
reaction to the joint communiqué was
muted, presumably because the announced policy commitments represented “old
news”.
Far from being deterred by the absence of joint
policy action during 2000-2006, foreign investors displayed an ever-growing
appetite for U.S. securities (Figure 2). By 2006, net foreign purchases of U.S. securities had reached $1,142 billion, of
which $956 billion were from private investors and only $185 billion from
official sources. Subtracting net U.S. purchases of foreign securities of $249
billion, the net inflow of $893 billion still exceeded the record-high
current account deficit of $857 billion.
Figure 2. U.S. Current account
deficit and net foreign purchases of U.S. securities for 2000-2006, billion
dol. [4]
A puzzling aspect of the imbalances is that the
counterpart of the growing U.S. current account
deficit is no longer surpluses mainly in Germany and Japan, as was the case a
decade ago, but also in the emerging market countries as a group, whose
external position shifted from a deficit of
$74 billion in 1996 to a surplus estimated at $587 billion in 2006 (or from a
$63 billion deficit to $305 billion surplus excluding the oil-producing Middle
East). The shift of emerging market countries to a surplus position goes
against the textbook view that they should be capital importers.
Although company executives perceived a rather
high degree of potential risk in all three categories, geopolitical risks were
considered the most significant, followed by those linked to financial
instability and changes in investment regimes. These concerns, however, seemed
unlikely to dissuade them from increasing their investment efforts, but could
lead them to focus more on risk management strategies. Many economists, such as
Lane, Milesi-Ferretti, Bordo,
Taylor and Williamson highlight the following points:
•
There appears to be a high level of awareness regarding a wide range of risks
that could potentially hinder companies’ investments and business: all the risk
factors were considered “important” or “very important” by a large majority of
companies (figure 3).
•
On the other hand, a sense of emergency was relatively limited among the
respondents. In the majority of responses, risks were qualified as only
“important” rather than “very important”. The only exception was “war and
political risks”, rated “very important” by over 50% of respondents [2].
FDI in labour-intensive manufacturing activities
is generally concentrated in low-wage developing countries and transition
economies, while Western Europe and North America remain attractive for
market-oriented activities, knowledge-intensive manufacturing industries and
high-value-added service activities. In Europe, for instance, Western European
countries host a large proportion of projects in biotechnology, software,
health products.
Figure 3. Importance of risk factors for FDI
decisions for 2007, % [5]
Similarly, indicators are not uniform for North
America and the EU-15, despite an overall increase in preference for the
region. For instance, a relatively large percentage of respondents reporting
they propose to increase their investments in these two regions is accompanied
by a somewhat larger than average share of companies that are considering
reducing their investments there (figure 4).
Figure 4. FDI prospects by host
region for 2007-2009, % [5,7]
Finally, the increase in both preferences and
actual investments in other developed countries and regions such as North Africa
and sub-Saharan Africa are below average. Those regions might thus remain
marginal in terms of FDI inflows[8].
Conclusions:
A central conclusion is gradually
tilting toward supporting a significant positive role for financial
globalization, there are many unanswered questions about how a country
should organize and pace its move. There is a strong presumption in theory that
financial integration is good for growth
and, although its effects on output volatility are unclear, it should
unambiguously lead to reductions in the relative volatility of consumption.
The composition of capital inflows has a
substantial influence on the growth benefits of financial globalization for
developing countries, although the evidence is far from decisive. Interestingly,
despite the general consensus that FDI is the form of capital inflow most
likely to spin off positive growth
benefits, these benefits are harder to detect in aggregate data than is the
case for equity flows.
In addition to the traditional channels such as efficient allocation of
capital and expanded international risk-sharing opportunities, the growth and
stability benefits of financial globalization
are also realized through a broad set of “collateral benefits”—financial market
development, better institutions and governance, and macroeconomic
discipline. These collateral benefits affect growth and stability dynamics
indirectly, implying that the associated macroeconomic gains may not be fully
evident in the short run and may be difficult to uncover in cross-country
regressions.
Gloomy predictions about the unsustainability of the U.S. current
account deficit and its dismal consequences for the dollar and interest rates,
repeated year after year, have failed to materialize and are unconvincing. The rise in the U.S. current account deficit, the
shift to surplus of emerging market countries, and the low long-term real
interest rates appear as anomalies in the traditional view.
References:
1.
Financial
Globalization and Exchange Rates // www.imf.org/ working papers
2.
Financial Globalization and the Governance of Domestic Financial Intermediaries
// www.imf.org/
working papers
3.
Financial
Globalization: A Reappraisal // www.imf.org/ working papers
4.
Global
Imbalances and Financial Stability // www.imf.org/ working papers
5. World investment prospects. Survey 2007-2009 // www.imf.org/ working papers