Causes of Financial Globalisation and Its Consequences on Developing Countries - Essay Example

Causes of financial globalisation and its consequences on developing countries Financial globalization can be defined as the integration of a country’s local financial system with international financial markets and institutions. This integration typically requires that governments liberalize the domestic financial sector and the capital account. Integration takes place when liberalized economies experience an increase in cross-country capital movement, including an active participation of local borrowers and lenders in international markets and a widespread use of international financial intermediaries.1 Financial globalization is not a new phenomenon, but something that had existed even though not at the rate experienced today. According to Sergio (2004), in the last one hundred years, only a few countries and sectors participated in financial globalization by which capital flows tended to follow migration and was generally directed toward supporting trade flows. Capital flows took the form of bonds, and the flows were of a long-term nature. International investment was dominated by a small number of freestanding companies, and financial intermediation was concentrated in a few family groups. The international system was dominated by the gold standard, in which gold was used to backed national currencies. The turn around things came at the heals of the effects of the first world war and the great depression that saw governments reversed their position on financial globalization, and were now imposing capital controls in order to regain monetary policy autonomy with the 1950s and 1960s witnessing the lowest capital flows. This all happened because the Bretton Woods had dominated the international system and used a system of fixed but adjustable exchange rates, limited capital mobility, and autonomous monetary policies that seriously affected the developing counties. But the developing countries saw the light of day when the 1973 oil crisis shock the international community and at that time, the Bretton Woods system of fixed exchange rates break down giving the lee way for international banks with fresh funds to invest in developing countries mainly in the areas of financing public debt in the form of syndicated loans. Developing countries at that time were able to open up new avenues for capital mobility while at the same time maintaining their autonomous monetary systems.2 Even though financial globalization created some debt crisis due to capital inflows in the 1970s and early 1980s, that all started in Mexico in 1982, it also led to the creation of Brady bonds which led to the subsequent development of bond markets for emerging economies. This helped in developing capital markets and good financial systems for developing countries. Gains for developing countries from financial globalization Levine (2001) believes that financial globalization has led to a better-functioning financial system with more credit for developing economies that can be seen as a key factor in fostering economic growth.3 Financial globalisation has led to promoting financial development by bringing in new type of capital (e.g. technological development) and more capital made available to developing countries especially as privatization, deregulation, technology due to foreign direct investments (FDI) and increase equity investment opportunities have attracted households and firms to invest in developing countries and markets. With the coming of this new capital, developing countries are now open to better smooth consumption, deepen financial markets, and increase the degree of market discipline. Financial globalization has led to a better financial infrastructure for developing countries, which mitigates information asymmetries and, as a consequence, reduces problems such as adverse selection and moral hazard that were a norm of the past. Financial globalization has come as a challenge for management in developing countries so that everyone will be able to take full advantage of the success of it, especially as financial globalization has come to stay and it is inherent with risks. Problems posed to developing countries by financial globalization Risks associated with financial globalization that developing countries are likely to face are: Financial crisis: The crises in Asia and Russia in 1997–98, Brazil in 1999, Ecuador in 2000, Turkey in 2001, Argentina in 2001, and Uruguay in 2002 are some typical examples. Financial globalization came at a time when most developing countries did not have the right financial infrastructure in place or not previewed during the integration process. Liberalization was followed by capital inflows that normally will debilitate the health of the local financial system. If market fundamentals deteriorate, speculative attacks will occur with capital outflows from both domestic and foreign investors pushing the countries into crisis especially as the country are now exposed to foreign currency shocks. Financial globalization affects democracy: Financial globalization has inherently increased the relative power of capital holders, particularly mobile capital holders and trade-oriented business, at the detriment of other groups, such as labour or domestic-oriented businesses. Democracy is affected because those in the first group have a greater ability to threaten or actually to leave the country (taking their investment capital with them) if governments adopt policies that undermine their interest at the detriment of those in the second group. In this case therefore, democracy is undermined since it has open the way for the few privileged to have a greater voice in policy choices.4 A simple example here is the Structural Adjustment Programme (SAP) of the World Bank and IMF that has seriously put many Sub-Saharan African countries and their economies under their control leaving these countries with relative no power to act when it concern issues of their economies. How globalisation has caused financial fragility Globalisation has in effect had some serious consequences on currencies around the world. The ever increasing capital mobility caused some countries to loss autonomy of their monetary policies especially as capital flow to emerging markets had to follow an international exchange rate system. Developing countries saw their currencies pegged to some major stronger world currencies that made it difficult for these countries to manage their monetary policies especially as some lacked the efficient infrastructure for banking regulation and supervision. In most cases, some of these countries banks receive short term maturity capital that leaves them with liabilities or debts in strong foreign currency denomination. Globalisation and market integration can be said to have helped in the improvement and allocation of resources, but at the same time has been at the fore front of financial instability and volatility in market based changes of prices of assets, bond markets, and market activity. The crises of 1990, 1992-1993, the bond crash of 1994 or the bursting of the technological bubble in 20004 constitute many striking examples of this financial instability caused by globalization.5 This financial instability that has been within markets and individuals risks has now been transferred within the economies and financial spheres, whereas integration of financial sphere as actors has seen systematic risk being transferred with the markets.6 Therefore, globalization that was thought to bring about economic growth instead led to financial instability around the world especially with the developing countries. Globalisation has led to increase bank crisis over the years and with a lot of currency mismatch problems with credit concentrating in certain sectors (for example, oil or real estate) or companies; when interest rates are high during periods of lower economic growth; when there are high leverage levels resulting from rapid privatization or takeovers; or where there is a combination of these factors. (Correa, 1994; Girón, 1998; Girón and Correa, 2002). These have led to bank crisis due in part because of deregulation and liberalization of the financial sectors and increase in competition. Most recently is the Northern Rock of England that was bailed out by the Bank of England in February 2008 as a result of credit crunch that originated from the mortgage sector in the USA. In most countries, there is that problem of the trying to maintain interest rates differential in order to achieve a degree of currency stability. Most often than not, this has tend to an increase in foreign-exchange component of bank liabilities, and even the liabilities of non-bank enterprises. The local markets are now abandoned due to an influx of short term capital attracted by interest rate differentials and relative currency stability quickly produces a monetary imbalance in the banks and inability to pay their debts owed to non-bank corporations.7 Many countries have still not been able to reconcile between managing the country exchange rate as to maintain stability in their currency, or how to integrate policies and decisions into capital market integration decisions and how to be able to manage all of the above two factors as to achieve an autonomous monetary regime. The difficulty here is that all three cannot be combined at once and it is not possible to combine two factors without forgoing the third. For example, integrating an exchange stability and capital market can be done by adopting a fixed exchange rate but at the detriment of giving up monetary autonomy that will even see them lose the power to able to vary the home interest rate independently of the foreign interest rate especially as foreign interest rates are dictated by the market forces. At the same time, the country may choose to combine their monetary autonomy and capital market integration by floating the exchange rate but requires giving up exchange stability meaning they will be able to choose the home interest rate but they must in consequence accept any exchange rate that the market dictates. Or, the monetary authorities may choose to combine exchange stability with monetary autonomy but this will require that they give up capital market integration but with a consequence of breaking the interest rate - exchange rate link. Therefore with the large amount of capital flow into such countries, they finally see the monetary system weak and fragile as they are exposed to international shocks. Globalization and poverty in developing countries Globalization in actual sense is perceived as bringing improvements in the technological advances and increase output for industries along side with new investment opportunities which such countries can utilize to boost economic growth and poverty alleviation. But at the same time, globalization can cause many hardships for the poor and poorer countries, as it opens up opportunities within a country which some countries can utilize to cut down on employees of a company. The inherent problems that developing countries are facing are lack of the necessary infrastructure and the technical know how to be able to operate in the new technological world. In the past two decades, income distribution between the entire world’s populations has become more equal and the number of people living in extreme poverty has fallen.8 This can be largely attributed to economic integration between countries that has seen an upsurge in efficient resource use and countries taking advantage of their competitive advantage in production. According to Robert H. (2004), “globalization has thus confirmed the neo-liberal economic theory of that more open economies are more prosperous, economies that liberalize more experience a more faster rate of progress, and people who resist further economic liberalization must be acting out of vested or ‘‘rent-seeking’’ interests.” China and India after the 1990s had been able to reform their policies, change their institutions and infrastructure to enter the new era of “new globalizers” to take advantage of the transfer of technology and came out of the 20 poorest countries on earth. Some other, smaller countries have remained poor especially as they are encumbered by internal conflict, poor governance, anti-business policies and low participation in international trade. Many of the newly formed states have weak institutions and have been impoverished by the conflicts that led to their formation, to become new entrants to the ranks of the world’s poorest countries. Most often that not, these countries have excluded themselves from the process of globalisation, sometimes even producing declining incomes and rising poverty.9 With the advent of globalization, the gap between the rich and poor is gradually being eroded away as the World Trade Organisation (WTO), the World Bank and IMF and other multilateral organizations are acting to erode state imposed restrictions of markets as to provide a level play ground for all. Even though the world population has been growing by 1 per cent a year over the past decade, and the population of low income countries growing by 2 per cent a year, the number of people still living in extreme poverty or below the poverty line of less than US$1 a day has stopped rising since 1980 and trends show that it appears to have fallen in recent years with the greatest improvement in the East Asia and the Pacific, where the proportion of people living on less than US$1 a day fell from 27 per cent in 1987 to around 15 per cent in 1998. The proportion of people living below the internationally accepted poverty line has fallen from around 28 per cent in the late 1980s to an estimated 24 per cent. Globalization can be said to be the main reason why so much progress has been made against poverty and global inequality over recent decades. Globalization has throughout this paper been considered as a form of increased economic integration through trade and investments, has contributed largely to bridge the gap by opening trade and investment thereby lifting the economic growth. The developing countries who have integrated the world markets have seen their average incomes rise while at the same time, international trade has contributed to double their annual growth rate. At the same time, developing countries that put in place good national policies such as good governance, sound institutions and domestic political stability have been able to generate national income growth and reduced poverty. This is a prime condition for attracting Foreign Direct Investment (FDI) as most international investors prefer to invest in stable political countries where their business run no risks. In conclusion, globalization is widely seen as an important factor for poverty reduction if and if the country concerned can provide a safe and secured environment for investors. But on the other hand, it may be a deterrent for economic growth if the country has not put in place the required infrastructures to handle investment and trade. Such infrastructure concerns a sound and efficient banking sector. References Giron , Correa: (2002): Emerging markets and fragility. Levine, Ross (2001): International financial liberalization and economic growth. Review of International Economics 9 (November): 688–702. Ljiljana Jeremic (2005): An overview of the consequences of financial mutation. South-East Europe Review. S131 – 136 Minushkin Susan (2004): Financial Globalization, democracy and Economic reform in Latin America. Latin American politics and society. Retrieved at http://findarticles.com/p/articles/mi_qa4000/is_200407/ai_n9453970 on 18-04-2008 at 14,30pm Mundell, Robert A. (2000): A reconsideration of the twentieth century. American Economic Review 90 (June): 327–40. Robert Hunter Wade (2004): Is globalization reducing poverty and inequality? Retrieved at http://www.lse.ac.uk/collections/DESTIN/pdf/Isglobreducing.pdf, on 19-04-2008 at 16,00pm Sergio L. Schmukler (2004): Financial Globalization: Gain and Pain for Developing Countries. Federal Reserve Bank of Atlanta Economic review Second Quarter 2004 Stiglitz, J (2002): Globalization and its discontents W.W. Norton & Company. Trad. La grande desillusion Fayard. http://www.ausaid.gov.au/publications/pdf/globalisation_report.pdf, Retrieved at 17,05pm on 19-04-2008 Read More