Gobal Economics and Financial Systems - Research Paper Example

Global Economics and Financial Systems Analysis of the Field of International Finance International finance is a branch of international economics that seeks to study the dynamics of exchange rates and foreign direct investment and their impact on international trade (Brown & Stern, 2001; Greenberg, Kang & Brown, 2009). The field of international finance also studies areas such as international projects, international capital flows and international trade deficits (Greenberg, Kang & Brown, 2009). International finance is an important feature in explaining the issue of globalization and is characterized by features such as international financial law, global capital markets and international trade (Greenberg, Kang & Brown, 2009; Brown & Stern, 2001; Argitis & Pitelis, 2008). In recent times, international finance is characterized by issues that are both favorable and unfavorable which include international monetary policy, global economic governance, foreign direct investment, multinational corporations, capitalism, privatization, global capital markets and global financial crisis (Cornford, 1996; Charles, 2007; Argitis & Pitelis, 2008). Globalization and international finance are two inseparable concepts. The field of international finance affects the whole world and for this reason, it is an integral part of globalization. The world is rapidly becoming a global village (Krugman & Venables, 1995; Charles, 2007; Osland, 2003). The world has been reduced to a small village in terms of space and time. This has taken place in all sectors such as health, finance, telecommunication, information technology, transport, stock market among others. According to Charles (2007); Osland (2003) and Helleiner (2001), the origin of globalization is a controversial issue and a subject of an ongoing debate with some scholars citing its origin to modern times whereas others regard it as a phenomenon that has a long history. Globalization has its advantages which include, but are not limited to, benefit to developing countries; increased productivity due to increased options for manufacturers and entrepreneurs; wider global market with increased access; increased access to labor and money markets; reduction of cost of production in things like communication and transport (I Love India, 2010; Yale Center for the Study of Globalization, 2010; Helleiner, 2001; Osland, 2003). Much as globalization has been considered by many people as the savior of the world, it has its shortcomings such as increased inequality of nations; loss of jobs by most Europeans due to low labor cost in Asian countries; social stratification and degeneration; profit repatriation from developing countries (Osland, 2003; Krugman & Venables, 1995; Argitis & Pitelis, 2008; I Love India, 2010; Charles, 2007). Foreign direct investment is also an important aspect in the field of international finance. There exists a casual relationship between globalization and foreign direct investment. According to Kim, Hwang, & Burgers, (1993); Ottaviano & Puga, (1998), foreign direct investment is taking place in the world at a very fast rate with some scholars considering this as an economic wave that is seeping over the entire world (Ottaviano & Puga, 1998). Foreign direct investment is seeing the emergence of multinational corporations both in the developed and developing world. Multinational corporations such as Coca Cola, Microsoft Corporation, General Motors among others are taking advantage of investment opportunities in the world and this is as a result of Structural Adjustment Programs that were devised and introduced to debt-ridden countries by the International Monetary Fund (IMF) and International Finance Corporation (IFC) so as to respond to economic shocks and stress. The free market and privatization policies have made the conditions for foreign direct investment more than favorable (Cornford, 1996; Kim, Hwang, & Burgers, 1993). Much as foreign direct investment has brought with it benefits such as employment creation, full utilization of resources and economic growth, it has had negative impact on social and economic life such as death of traditional enterprises in developing countries, death of small scale establishments as a result of multinational corporations and low incomes as a result of low labor costs in a bid to minimize costs and maximize profits (Brown & Stern, 2001). As the world is being rapidly swept by the tidal wave of globalization, the need for global economic governance comes in handy. The concept of global economic governance is not new. It can be traced from the end of the Second World War with the formation of the United Nations and the Unilateral Declaration of Human Rights with a sole purpose of preventing another world war. The need for an international governance framework based on rules was much needed to restore sanity to the world (Brown & Stern, 2001). This gave birth to financial institutions such as World Bank, International Monetary Fund and World Trade Organization. The existing multilateral system was built and this has made considerable progress and economic growth to the entire world. Global governance structures and institutions have seen countries grow and develop. However, some scholarly circles argue that present challenges of globalization cannot be adequately addressed by these systems that were designed for a world of more than a century ago (Argitis & Pitelis, 2008; Foo, 2008). This is because the world has changed since then and yet there is no formal mechanism that addresses these challenges and there are institutional instruments that decide who does what (Argitis & Pitelis, 2008; Yale Center for the Study of Globalization, 2010). Sub prime financial crisis is another emerging theme that explains the state of the field of international finance. Real estate crisis and financial crisis were triggered by rise in mortgage delinquencies in the United States that led adverse effects to banks and markets all over the world (Foo, 2008; McClintock, 1996; Blackburn, 2008; Eichengreen, 2009; Argitis & Pitelis, 2008 and Demyanyk and Hemert, 2008). The major causes of this were the boom and bust in the housing sector; homeowner speculation tendencies; high risk mortgage loans and lending/borrowing practices; practices of securitization; inaccurate credit ratings; failure of government financial practices; central bank tendencies to respond to rather than prevent economic shocks and stress; high debt levels and low incentives by financial institutions; credit default swaps; United States’ balance of payment; boom and bust of the shadow banking system (Vasudevan, 2009; McClintock, 1996; Eichengreen, 2009; Foo, 2008; Demyanyk and Hemert, 2008). The impact of this was far reaching and felt all over the world. National economies responded to this through economic stimulus; bank solvency and capital replenishment; financial bailouts to the intensively affected firms; regulatory proposals and long term solutions (Blackburn, 2008; Hall, 2008; Estevadeordal & Taylor, 2002 and Demyanyk and Hemert, 2008). Research Topic Global economics and financial systems are two fields that are interdependent in nature (Brown & Stern, 2001; Foo, 2008). They entail the field of international finance. Hence, they form a broader field under which the field of international finance falls. Due to the interdependence of these two fields, the foregoing discussion will look at them concurrently but first, it will be prudent to expound on each one of them for easier understanding. Global economics is the science that analyzes the world’s production, distribution and consumption of goods and services (Volker, 2008, Papadamaou & Tsopoglou, 2002). Precisely, global economics is concerned with the impact of economic activity of international differences in productive resources and consumer preferences and the institutions that affect them (Volker, 2008). It seeks to establish and explain the patterns and consequences of transactions and interactions between the inhabitants of different countries which include, but are not limited to, trade, investment and migration (Papadamaou & Tsopoglou, 2002; Campbell, 1998). The global financial systems comprise of structures and institutions that act at the international level with international rules and regulations. The main players in global economics and financial systems are global institutions, national agencies and government departments, private institutions and regional institutions (Foo, 2008; Kaplan, Martin & Campbell, 1998; Anonymous, 2008; Shrader, Oviatt & McDougall, 2000). The global institutions include the International Monetary Fund and Bank of International Settlements; the national agencies and government departments include central banks and finance ministries; the private institutions include those that act on a global scale and influence the global economy and good examples are banks and hedge funds; regional institutions include players like Eurozone (Shrader, Oviatt & McDougall, 2000; Anonymous, 2008); Wah, 1998; Kaplan, Martin & Campbell, 1998; Krugman, 1980). At this critical juncture, it is important to note that global economics and global financial systems are two inseparable fields. This is for the reason that the state of global economics is determined by the undertakings of global financial systems. And yet, the undertakings the global financial systems are informed and influenced by the state of affairs at the global economics. Various theories have come in the field of global economics and financial systems as advanced by various scholars, researchers and institutions in a bid to address issues affecting the field, the impacts and recommend ways to better the state of affairs. Global economics and financial systems is a source of controversy and for this reason it has attracted a lot of debate with a lot of theories being advanced to that effect. The most common theories include the global economy theory, dependency theory. International trade theories form the basis of other theories such as Mercantilism theory, comparative advantage theory, Ricardian model, Heckscher-Ohlin model, product life cycle theory, new trade theory, gravity model and Ricardian theory of international trade (modern development) under which other theories are explained such as contemporary theories, neo-Ricardian trade theories, traded intermediate goods and Ricardo-Straffa theory (Samuelson, 2004; Paul, 2001; Lionel, 1954; Ronald, 1961). Some of these theories date as old as 1600 but its important to note that they still influence trade policy to date which influences global economics and financial systems. The 16th and 17th centuries witnessed the mercantilism, a theory that stressed that national economies should simultaneously encourage exports and discourage imports in a bid to stimulate financial wealth (Paul, 2001; Lionel, 1954). This is a very old theory but despite this, many contemporary trade policies in present day national economies apply this theory and this has consequences on the international trade. This theory is entirely built on the belief that financial wealth of a certain country is solely important for its growth and development and for this reason; other measures of the countries’ living standards and human development are irrelevant. The sole tenet of mercantilism is that the world’s resources are scarce and as a result, countries can only increase their share in the world economy at the expense of their neighbors. This theory is problematic because countries engage in export but they are restricted from imports which is a major barrier to international trade development. The Scottish neoclassical economist, Adam Smith developed the absolute advantage theory as a reaction to mercantilism. The absolute advantage theory states that trade barriers such as tariffs and quotas should be eliminated for goods and services to flow according to market forces of demand and supply. Adam Smith opposed the mercantilism theory by maintaining that the invisible hand of market mechanism rather than government policy should determine each country’s imports and exports. The theory of absolute advantage further argues that each country should only concentrate on producing goods and services in which it holds an absolute advantage. Contrary to mercantilism’s idea of zero-sum game, the absolute advantage theory states that international trade is a positive-sum game which is justified by the reason that there are gains to be made by the countries involved (Lionel, 1954). But the absolute advantage theory has been criticized. The problem of this theory comes in a situation whereby a country does not have an absolute advantage in the production of any product (Paul, 2001). The theory of comparative advantage comes to give the solution. The English neoclassical economist, David Ricardo developed the comparative advantage theory in 1817 (Samuelson, 2004). This theory influences the global economy up to date. Basically, the theory is built on the concept of comparative advantage which states that a country should specialize in the production and export of goods and services in which it has a comparative advantage or relative cost as compared to other countries and it should import goods and services in which it has a comparative disadvantage (Samuelson, 2004). This theory remains a major influence on national economies and thus an influence on international trade and thus it comes in handy in explaining and understanding the modern global economy (Ronald, 1961). The theory of comparative advantage has various assumptions that put its practicability in question. One of the assumptions is that countries are driven by production and consumption maximization and not issues stemming out of consumers’ and workers’ concern. Because of this, Heckscher-Ohlin theory emerged as a reaction to comparative advantage theory. Heckscher-Ohlin theory is also called factors proportions theory and was advanced by two Swedish economists, Eli Heckscher and Bertil Ohlin in early 1900s (Ronald, 1961). The theory reacts to the comparative advantage theory that countries should produce and export goods and services that needs factors of production that are abundant and import goods and services that need factors of production that are in short supply (Ronald, 1961). In essence, this theory states that a country should concentrate on producing and exporting goods and services using the abundant resources at its disposal and thus cheapest and not producing and exporting goods and services that it can produce most efficiently as advocated by earlier theories. In the late 1950s, Raul Prebisch, the director of United Nations Economic Commission for Latin America and a group of other scholars came up with the dependency theory. They were motivated by the fact that there was unprecedented economic growth and development of the industrialized countries (developed countries/ the North) and this did not necessarily lead to economic growth and development of the least industrialized nations (developing countries/ the South) (Toye & Toye, 2003; Krugman & Venables, 1995). Raul and his colleagues maintain go on to argue that economic growth and development such as industrialization of the North often lead to serious problems such as environmental degradation of the South. The dependency theory is opposed to neoclassical models of laissez faire which assumed that economic growth as a result of trade would benefit all. According to this theory, poor countries of the South export primary products to the North and the latter add value to these products and export them to poor countries. The theory gives the solution to this as import substitution and export promotion and this is one of the tenets of mercantilism. This theory in itself is controversial as debates loom across the intellectual divide among liberalists such as Raul Prebisch, Marxists like Andre Gunder Frank and the world systems theorists such as Wallerstein (Krugman, 1980; Toye & Toye, 2003). There are many other theories that characterize the debate on global economics and financial systems. Some compliment each other and others challenge others in a bid to explain the state of global economics and financial systems. The above discussion looks at some of the theories and the debate on this topic. The debate is wide and heated and it is ongoing. Future Directions Specific areas of further research in this topic that would prove beneficial include: The impact of foreign direct investment. The global economic crisis: Am impact of global economics and financial systems. The effects of international trade on the South. The theory of global economy and globalization. The North-South divide: A direct consequence of globalization. Global economics and financial systems have large implications on the global economy and the future of research on this field. Firstly, Global financial systems have undertakings that influence the state of the global economy. These undertakings include international financial policy design, planning, formulation, implementation and analysis. Such actions have consequences on the global economy such as opening up borders for international trade, foreign direct investment, technological transfers, and free flow of financial, physical and human capital. 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