Developing Countries and Financial Liberalization - Essay Example

Developing Countries and Financial Liberalization Should Developing Countries engage in Financial Liberalization? What role do you see for Capital Controls? Introduction Financial liberalization has several advantages and disadvantages which are directly connected with the needs of developing countries. While there may be examples of how some countries have seen economic booms with a liberal approach to the financial markets, others have experienced inflation, erosion of wealth and a dire need for assistance and loans (Craig, 2000). Developing countries in Asia, Africa and Latin America serve as good examples of what pros and cons financial liberalization brings to a country and why capital controls are necessary for the healthy development of an economy. Asia has long been home to world’s most dynamic economies. The last decade has shown us a broad flowering of entrepreneurship throughout Asia in the face of different challenges. Factors attributed to this trend include a huge wave of private equity and venture capital funding, but more importantly, regulatory laws for financing and capital acquisition were eased and the less stringent rules governing the listing of young companies at the various stock markets helped in many companies getting the money they need for business (Robinson, 2005). The Stars The ease of getting loans and the financial liberalization process helped the growth of Pacific Rim for countries such as China, India, Hong Kong, Taiwan and even Japan. In particular, after the Second World War, Japan came to represent a model of economic development. Of course the massive gains made by the economy were based on the manufacturing of electronics and automobiles but the financial liberation process certainly helped the country gain its footings after the destruction it experienced (Herring, 2006). Similarly, Hong Kong has always been rated as one of the more free economies and even though it went through a change of government i.e. from Britain to China, it has retained the financially liberal attitude of the British economy rather than the controlled system of the Chinese. Taiwan can also be put on the list of countries benefiting from financial freedom. Although it has had a share of political instability and outright threats of invasion from China, it has led the way in semiconductor and IC manufacturing (Bremmer & Zakaria, 2006). Perhaps the biggest surprises resulting from the process of financial liberation are the giants that started emerging in early 1990s, China and India (Hubbard, 2005). China changed from socialist economy to a mixed market and still faces a big challenge of balancing controlled economy with capitalistic economy while turning into the manufacturing unit of the world (Herring, 2006). India has developed into the back office of the world due to its human resource skilled in information technology and still faces the challenge of reducing its dependency on services (Hubbard, 2005). Therefore, it can be said that the capitalist world in particular and the western world at large have certainly gained benefits from the liberalization of financial markets but the same liberalization has produced its own problems. For example, many developing countries (particularly the poor nations in sub-Saharan Africa) are faced with massive economic problems like inflation, currency crises and international debt (Craig, 2000). While some economists think that bodies like the World Bank and the IMF serve the cause of global harmony by bringing development and growth for developing countries (IMF, 2006), others suggest that the situation is quite the opposite (Stiglitz, 2002). The Question Marks In fact, some developing countries attribute their economic problems directly to the policies of the World Bank and IMF as well as the policies resulting from the Washington Consensus which often recommend a financial liberation process. In extreme cases, even the rise of terrorism in recent years has been linked with the policies created by global entities who are supposed to work for the economic benefit of the developing world. In economic literature, the term ‘Washington Consensus’ is a name given to the policies of creation a liberalized financial market and these policies were suggested by Washington based institutes (World Bank, IMF, etc.) to several Latin American countries in order to bring up and improve their economic conditions. The term was crafted by Williamson and it has been a part of economic terminology ever since. The defenders of the liberalization policies of the Washington Consensus call it a boon and a path to economic independence for less developed and developing countries of the world. Those who oppose it call it a cruel implementation of neo-liberalism and a tool for the global domination of America (Williamson, 2000). Economists like Williamson are well aware of the detractions and say that people misunderstand the need to establish the policies of the World Bank and IMF. Williamson (2000) says that analysts around the world think that the policies are forced upon various weaker countries by international financial and economic organizations. This line of thought further suggests that it is the policies which have taken those countries towards a state of crisis and created misery for their people (Harvard University, 2003). Financial liberation is only a small set of the recommendations made by Williamson (2000) as the implementation of monetary regulations. The complete set of policies are not limited to financial liberation since other things such as fair trade, redirection of government spending towards development plans, alleviation of poverty, investing in things like healthcare, education etc., creating a wider tax base, having a free floating interest rate, liberalizing trade policies, creating foreign investment prospects, privatization of national companies, deregulation of the economy as well as the establishment of correct currency exchange rates are all part of the package. Therefore, simply taking financial liberalization to be the panacea for all that ails a country is unjustified and may even be economic suicide if the other problems are not fixed. For example, Held (2005) expanded on the concept of financial liberation and created a more pertinent definition for the policies by suggesting that the policies should advocate free trade, liberal markets, property rights, and deregulation. In present times, a country must qualify for certain conditions and certain policies need to be avoided. By qualification, the economic need for the policy must be established first before World Bank or the IMF lends support for the policies. Rodrik (2001) is in complete agreement with Held and further adds that the IMF and World Bank policies for creating financial liberation in many developing countries of the world should be expanded. Financial liberation must come with the demand to have other things such as corporate and company accountability, social and personal responsibility, corruption mitigation, WTO agreements, control of quality standards, a free banking system, welfare systems and a focus on social security as well as poverty reduction measures for the country. It can be difficult if not impossible to suggest that these are bad policies in economic terms; however, the detractors show that just being financially liberal is a rather dangerous idea. For example, the financial liberalization of the Russian breakaway states began when the countries were completely debt free and within a few years of their independence they have become some of the most indebted nations of the world. The Role of Control It would seems that the policies recommended by the international bodies which recommend liberalization as well as control are sometimes at odds with each other which leads Akbar (2005) to ask if a consensus can even exist. This was answered quite nicely by outlining the present strategy of the IMF concerning low-income states as given by Rodrigo de Rato, who is the Managing Director of the Fund. As per the dictates of Rodrigo de Rato, the IMF has set the change of guidelines and social bodies of poor economies as a priority. This would enable these economies to come out of the debt and the poverty cycle on their own rather than with help from outside. The focus of the IMF appears to be on creating relationships with other countries rather than using the dictate of financial liberalization alone. However, the IMF does want to take control of the areas where it has the expertise i.e. macroeconomic growth, debt control, policy advisement and creating financial stability (IMF, 2006). A large part of the policies have to do with debt relief and the IMF has already given a total write off to the 19 poorest countries on the planet of which 13 were in sub-Saharan regions. Plans are being made to reduce or let go of the debts owned by many other poor nations. Policy recommendations from the IMF prevent or restrict additional loans for certain nations until pre-established conditions are met so that the economy has the chance to grow (IMF, 2006). Such policies certainly would have worked in the case of the Central Asian Republics which came into being after the collapse of the former Soviet Union. When they gained their independence, these countries were without any loan payments but after a few years they had heavy debts that caused their economies to slow down and lose the promise of growth and development which the public hoped for (IMF, 2006). Akbar (2005) suggest that aid management and handling large sums of money can be problematic for countries who have no experience with a liberal financial policy. Aid can be given for specific causes or programs such as hunger elimination, poverty reduction, education and disease control. Aid can also come with attached conditions since the goals of improving the lot of the people are also a part of the UN millennium goals (UN, 2005). Clearly, the international monetary agencies wish to show developing countries how money can be used in the country without causing a false appreciation in the currency or rising inflation (IMF, 2006). For the citizens, the IMF creates programs to improve their condition with micro-lending programs and soft loans for small businesses (IMF, 2006). This can be seen as a liberalization of economic policy from an international perspective rather than a local government approach. It must be noted however, that such a plan can have negative influences since financial control and independence might have to be given up to some extent (Stiglitz, 2002). Conclusion In the final analysis, financial liberalization can certainly help a country and the business in the country to gain the capital they need for investment, creation of services and improving the economy of the country. However, financial liberalization alone is nothing more than a disaster since it can lead to heavy inflation that can considerably weaken an economy. In effect, financial liberalization must be coupled with stringent application of other policies which work towards the benefit of the people within the country and in the case of developing countries; it might be a good idea to have an established system which governs how these policies are to be enacted. Finally, internal or external controls with regard to capital are also important because it is clear that whoever has the money can make the rules which are to be followed before that money can be shared with others. Works Cited Akbar, N. 2005, ‘Scoring the Millennium Goals: Economic Growth Versus the Washington Consensus’, Journal of International Affairs, vol. 58, no. 2, p233-244. Craig, B. 2000, ‘Aid, Policies and Growth’, American Economic Review, vol. 90, no.9, p847-68. Bremmer, I. and Zakaria, F. 2006, ‘Hedging Political Risk in China’ Harvard Business Review, Nov 2006, Vol. 84, Issue 11 Harvard University. 2003, ‘Washington Consensus’, Global Trade Negotiations, [Online] Available at: http://www.cid.harvard.edu/cidtrade/issues/washington.html Held, D. 2005, ‘Washington gets it wrong’, Global Agenda, no. 3, p100-101. Herring, S. 2006, ‘How you should structure investment in China and SE Asia’ International Tax Review, Vol 17 Issue 2, p 13 – 15 Hubbard, G. 2005, ‘Keep your eye on Japan’ Business Week, Issue 3851, p146 IMF (International Monetary Fund). 2006, ‘The IMF's Medium-Term Strategy for Low-Income Countries’, Remarks by Rodrigo de Rato: Managing Director of the International Monetary Fund, [Online] Available at: http://www.imf.org/external/np/speeches/2006/031606.htm Robinson, W. 2005, ‘Global Capitalism: The New Transnationalism and the Folly of Conventional Thinking.’ Science & Society, vol. 69 no. 3, pp316-328. Rodrik, D. 2001, The Global Governance of Trade as if Development Really Mattered, UNDP: New York. Stiglitz, J. 2002, Globalization and Its Discontents, Norton, New York. UN (United Nations). 2005, ‘What are the Millennium Development Goals?’ UN.org, [Online] Available at: http://www.un.org/millenniumgoals/ Williamson, J. 2000, ‘What Should the World Bank Think About the Washington Consensus?’, World Bank Research Observer, vol. 15, no. 2, pp. 251-264. Read More