Beruflich Dokumente
Kultur Dokumente
1985- present
Unprecedented increases in the trade and financial integration
180
All Developing Economies
160
Bank lending
140
Portfolio flows
120
FDI
100
80
60
40
20
0
–20
1970 75 80 85 90 95
180 9
More Financially Integrated Economies Less Financially Integrated Economies
160 8
Bank lending Bank lending
140 7
Portfolio flows
Portfolio flows 6
120 FDI
FDI 5
100
4
80
3
60
2
40 1
20 0
0 –1
–20 –2
1970 75 80 85 90 95 1970 75 80 85 90 95
The big question: what can we learn from countries experience to reap the
benefits of financial integration while minimizing the costs?
FINANCIAL GLOBALIZATION AND GROWTH:
THEORY PERSPECTIVE
Growth theory: one of the key ingredients in economic growth is
domestic private investment It (contributes to capital stock)
Indirectly:
Financial integration ENCOURAGES SPECIALIZATION by allowing
better risk diversification options
Financial integration may constrain the country’s government to
pursue better policies (the cost of bad policy decisions is greatly
increased in financially integrated economies)
Signaling effect: liberalization of financial markets may signal
broader policy reforms favorable to foreign investment
EMPIRICAL EVIDENCE
At first glance there seems to be a positive correlation between financial openness
and economic growth.
BUT correlation does not imply causation
Could growth be caused by other factors unrelated to financial openness?
Could it be that economies which are fast growing to begin with also tend to
experience higher financial openness?
Most recent empirical studies: accounting for other factors, financial openness has at
best weak association with economic growth.
Financial openness is often accompanied by financial crises – currency, banking and twin
crises (all of them are damaging to output in the short run and some of them possibly
in the long run).
Financial openness promotes specialization, which can make the country more vulnerable
to output shocks.
This is not a problem if a country can borrow in bad times and repay in good times.
BUT:
Developing countries often experience SUDDEN STOPS - abrupt reversals of
capital flows from abroad during bad times. This amplifies the cost of financial crises
and output shocks.
national lev
Figure 4.1. Volatility of Income and economies,
Consumption Growth ternational c
(10-year rolling standard deviations; medians for each group of Consisten
countries) ture sugges
flows appea
sumption vo
manifestatio
0.10
Income non of “sud
0.09 and Reinhar
LFI countr ies
0.08 national cap
0.07
which tends
well as exc
0.06 MFI countr ies that of incom
0.05 that sovereig
0.04 spreads on
strongly infl
0.03 costs of bor
0.02 Industr ial countr ies
cyclical as w
0.01 sent more d
ior of capita
0
1970 74 78 82 86 90 94 98
Crises as
0.10 Crises ca
Total Consumption
0.09 episodes of
0.08 nancial crise
LFI countr ies aspects of th
0.07
over the last
0.06 recent crises
0.05 led to these
of the unequ
0.04
MFI countr ies and risks. T
0.03 about wheth
0.02 time, what f
Industr ial countr ies whether suc
0.01
globalization
0 Some as
1970 74 78 82 86 90 94 98
changed ove
vu all over a
Source: Kose, Prasad, and Terrones (2003a).
Note: MFI denotes more financially integrated, and LFI less episodes in
financially integrated, economies. capital acco
to as curren
EXPLAINING THE THEORY- EMPIRICS
DISCONNECT
Capital flows into developing countries depend on both external and internal factors:
External:
- macroeconomic conditions and shocks in industrialized countries. Example: low
US interest rates usually imply heavy investment flows to emerging markets (can
create credit bubbles).
(The most volatile types of capital: short-term portfolio investments and bank
lending. FDI is less sensitive to external conditions)
- contagion (when investors pull out capital from the country after a crises
happens in another developing country). Financial globalization increases the risk
of financial contagion.
- herding behavior on the financial markets
Internal: country’s own shocks and macroeconomic conditions
WHAT CAN THE COUNTRY DO TO MINIMIZE
RISK?
Structure of debt and strength of financial institutions is important:
although financial crises can happen even in the economy with more or less good
economic fundamentals, the severity of financial crises increases when
- country borrows in foreign currency
- country can only borrow short-term
- ratio of (bank borrowing + other debt) to FDI is high.
- high government spending (together with fixed exchange rate regime can
lead to currency crisis)
- opening financial markets when institutions (for example banking
regulations are weak).
- counter-cyclical fiscal policies
OTHER POLICY OPTIONS TO BENEFIT FROM
FINANCIAL INTEGRATION
The theoretical channels through which financial integration improves growth can
work only under certain conditions:
Empirical evidence:
- FDI improves growth, for countries with high level of human capital
- The level of FDI inflows is highly correlated with low corruption, higher
transparency of macroeconomic policies and corporate finance
- Higher levels of financial integration reduce volatility of output and
consumption but only beyond a certain threshold ( which has not been reached
by most developing countries).
- Having good financial supervision in place BEFORE the country opens up
to capital inflows from abroad is essential for minimizing the risk of devastating
financial crises.