Home .Finance Which globalization are you afraid of?
Which globalization are you afraid of?
Wednesday, 26 November 2008 04:20

Many people are against globalization.  But this is too simplistic.  There are of course many types of globalization.

The globalization of international trade is good, we can exploit our comparative advantages.  How would the Chinese buy cognac, and how would the French buy uranium for their nuclear power without international trade.  Foreign direct investment is also a good thing, even if some multinational enterprises do not always behave with great responsibility.  It creates jobs and development, and transfers knowledge and technology.  The dramatic reduction in China's poverty these past 30 years would not have been possible without foreign direct investment.

But what about international finance?  At this moment of financial crisis, it may be worth looking into this question more deeply.  Once again, we draw on the work of the International Institute for Labour Studies in in its excellent World for Work Report 2008.

The best place to start is of course at the beginning.  Financial markets play a very important role in our economies.  They allow us to save for the future.  They also allow us to borrow when we need money and allow enterprises to borrow for investment.  Our lifetime's spending and investment decisions do not require the same timing as our stream of income.  This also means that all financial decisions can be more efficient because they can take place when we want them to.

Financial globalisation means that financial markets can operate on a global scale with individuals, enterprises and financial institutions borrowing and lending across borders. In principle, once again, this is a good thing.  We can borrow more cheaply, and lend and investment in projects with a higher return.  We can also manage risk better by diversiying our portfolios.  In theory, developing countries should attract foreign capital because they have lower savings and more attractive investment projects.

What has been happening?  Over the last 20 years, there has been an acceleration of financial globalisation.  Developed countries have removed restrictions to cross-border financial movements, and many emerging and developing economies have opened up too, though to a lesser extent in general.  Information technology has also faciliated financial transactions. 

Developed countries have since invested massively in international financial markets to the tune of several times their GDP!  Developed countries have invested in each other and also in emerging economies.  But financial flows from developed to developing countries have not in reality been very important.  On the contrary, finance flows more from developing countries to developed countries, the so-called Lucas paradox.  It may be due to the lack of well developed financial markets in developing countries, and also bad investment climates and bad governance in developing countries.  The US has become the world's biggest borrower, and to this very day the world's investors show no sign of scaling back their investments in the US.  The yankee dollar has increased substantially in value since the onset of the US driven global financial crisis.

What is more dramatic is the growing frequency of international financial and banking crises.  Worldwide, systemic banking crises were 10 times more frequent in the 1990s than during the late 1970s, which was hardly a period of financial peace.  And these financial crises can wreak havoc on the affected countries with large losses in GDP and employment, wiith immense social consequences.  These boom-bust cycles are particularly damaging for the world's poor -- in both the developed and developing world.

There are increasing calls for measures to slow down capital movements (so-called Tobin tax), inhibit the excesses of financial innovation, and to leave some controls on capital movements, particularly short-term movements.  The world's most vehement supporter of free trade, Jagdish Bhagwati, made public his views in a 1998 article in Foreign Affairs.  While freeing up trade is good, the claims of of enormous benefits from free capital movements are not persuasive.  Substantial gains have been asserted by many obsevers, but the reality is that free capital movements repeatedly generate crises.  Indeed, there is growing evidence that the countries that have grown the fastest have relied least on foreign capital.      

Does this mean that we should forget financial globalisation?  No, in fact it is very difficult to stop international financial flows as the Internet has opened markets in such a way that they can no longer perhaps be closed again.  However, a cautious approach to financial globalisation is especially important in countries where financial markets are not sufficiently developed and where supervision mechanisms are weak, as is the case in many developing countries.  Moreover, as the current financial crisis demonstrates only too vividly, it is crucial to to strengthen regulation and supervisory frameworks in all countries (buttressed by strong international co-operation) so as to reduce irresponsible risk-taking on the part of certain financial actors. 

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