The new religion on financial (and trade) globalization

The IMF sounds a cautious note on financial globalization:

While, in principle, financial globalization should enhance international risk sharing, reduce macroeconomic volatility, and foster economic growth, in practice the empirical effects are less clear-cut. Risk sharing has increased somewhat in advanced countries—consistent with their greater levels of financial openness—but has not been noticeably affected in emerging market and developing countries. International financial integration has not increased macroeconomic volatility or crisis frequency in countries with well-developed domestic financial systems and a relatively high degree of institutional quality; it has, however, increased volatility for countries that have failed to meet these preconditions or thresholds. The link between financial globalization and economic growth is also complex. Although foreign direct investment and other non-debt creating flows are positively associated with long-run growth, the impact of debt seems to depend on the strength of a country’s policies and institutions.

The paper’s empirical results are broadly supportive of the IMF’s “integrated” approach, which envisages a gradual and orderly sequencing of external financial liberalization and emphasizes the desirability of complementary reforms in the macroeconomic policy framework and the domestic financial system as essential components of a successful liberalization strategy. For countries that do not yet meet the relevant thresholds, the focus of policy makers should lie squarely with improving the relevant economic fundamentals. In addition, opening up to foreign direct investment (FDI)—a type of flow that appears to be beneficial even for countries with relatively weak fundamentals—would seem desirable at an early stage. Liberalization to other types of flow should be delayed until country fundamentals are more in line with the relevant thresholds. For countries that are closer to meeting the thresholds, opening to debt flows is unlikely to have strong adverse effects on volatility, though, equally, growth benefits have not been identified as being particularly significant in this case.

This is a clear statement of the new conventional wisdom on financial globalization: reaping the benefits is by no means automatic, and you need to have the complementary institutions to make sure you do. This parallels a similar line on trade liberalization from across the street, which also takes the view that the gains are contingent on supporting institutions.

What I think about all this is here.

Comments

[Rich C]

But is it really true that financial openness hasn't increased volatility and fragility in rich countries (ie those with well developed financial regulatory institutions)? It certainly seems that the corporate stock, corporate bond, and housing markets in the US, the UK, and Australia have shown much greater swings around their long-term averages in the 30+ years that openness has been increasing. I haven't seen the paper, but I'm curious how they're coding liberal market economies like the US and the UK compared to the social market economies in western Europe: these two groups may look very similar with respect to certain measures of financial sophistication and openness, but the latter contain institutional roadblocks that impede the build-up of asset price bubbles.

[paine]

rich c

i deeply
share your skepticism
about trans border hi fi flows
even in north markets

why are bubbles in asset markets and commodity markets
worse then in
product and job markets ??

no one controls credit flows
for assets
regardless of sector inflation
because its real economy
effects are indirect

okay there's no analogue
no human capital markets
or are there

the household
credit market
has two pillars
lot value and earning power

the first is of course subject to notorious bubbles

rational irrationality
fueled by credit flows

but isn't also
the implicit capitalized value
of a job earnings stream ?????

human capital
isn't for sale
only lease
but its implied value
is in flux every time
the credit line
borrow max
standards change

[jonfernquest]

That nations have to worry about the political glue that holds them together as they "liberalise" really can't be stressed enough.

Your paper is a beacon, in a sea of potentially injurious economic theoretical simplification.

I was dumbfounded the day Thaksin sold his telecommunications concession to a sovereign investment fund, Singapore Temasek, after weeks of rumours and zero public consultations. In fact at the time you couldn't even refer to the company as being his, because it was in the name of his children registered in the Caribbean in a tax shelter. That was the beginning of the end and you can't say that sell-offs of large American corporations to foreign exchange reserve liquidations by heavy saving capital outflow constrain China hasn't been an issue.

Smaller, smarter, more humbler, more educational, FDI like Googles for profit charity idea, instead of gigantic controversial MNCs seems to be the way to go.

[Peter]

The great danger with the current wisdom is that, if one thinks one knows the "right" institutional enhancements that make liberalization work, it becomes a justification for ever deeper interventions into the affairs of other countries. Your approach, which recognizes the locally specific character of institutional quality, avoids this.

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I have just discovered this blog, and while I enjoy dani rodrik's analyses, it's the comments section that's caused me to spend all night exploring the blog. I am particularly fascinated by paine, and because this entry is the most recent one s/he has commented on I'm posting this inquiry: who is paine, and why is he or she almost never responded to? paine's perspective is, I think, consistently coming from a postcolonial perspective I tend to share. apologies for posting about a commenter, I'd be very interested to know if he or she has a blog or publications I could look over ...

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