How does financial integration today differ from that of a century ago? Martin Wolf, Chief Economics...

How does financial integration today differ from that of a century ago?Martin Wolf, Chief Economics Commentator, Financial Times

Leverhulme Centre for Research on Globalisation and Economic Policy, School of Economics, Nottingham University

April 30th, 2003

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Financial integration then and now

• Why is financial integration so controversial?

• How has financial integration evolved?

• What are the big differences between the financial globalisation of the late 19th century and today’s?

• What are the big issues, especially for developing countries?

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1. Why is financial globalisation so controversial?

• International capital flows are unstable and associated with crises

• They are also associated with constraints on policy makers

• This is the “trilemma”: one can have only two of capital mobility, a fixed exchange rate and domestic monetary autonomy

• Governments want all three. Since they cannot do so, the history of the past 120 years has been one of big shifts in the two they have chosen

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NET PRIVATE CAPITAL FLOW TO DEVELOPING COUNTRIES($bns)

$0.0

$50.0

$100.0

$150.0

$200.0

$250.0

$300.0

$350.0

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

f

2003

f

Source: IIF

5


THE UPS OF EQUITY INVESTMENT IN DEVELOPING COUNTRIES ($bns)

$0.0

$20.0

$40.0

$60.0

$80.0

$100.0

$120.0

$140.0

$160.0

$180.0

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002f

2003f

Source: IIF

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COMPOSITION OF EQUITY INVESTMENT IN DEVELOPING COUNTRIES ($bn)

-$20.0

$0.0

$20.0

$40.0

$60.0

$80.0

$100.0

$120.0

$140.0

$160.0

$180.0

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002f 2003f

Net direct investment Net portfolio investmentSource: IIF

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UPS AND DOWN OF NET LENDING ($bns)

-$50.0

$0.0

$50.0

$100.0

$150.0

$200.0

$250.0

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002f

2003f

Source: IIF

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COMPOSITION OF NET LENDING ($bns)

-$100.0

-$50.0

$0.0

$50.0

$100.0

$150.0

$200.0

$250.0

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002f

2003f

Net commercial banks Net nonbanksSource: IIF

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UPS AND DOWNS OF CURRENT ACCOUNT IN DEVELOPING COUNTRIES ($bns)

-$120.0

-$100.0

-$80.0

-$60.0

-$40.0

-$20.0

$0.0

$20.0

$40.0

$60.0

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002f

2003f

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THE IMPACT OF CRISES ON CURRENCIES(exchange rate to the dollar)

0.0

20.0

40.0

60.0

80.0

100.0

120.0

Jan-

95

May

-95

Sep-9

5

Jan-

96

May

-96

Sep-9

6

Jan-

97

May

-97

Sep-9

7

Jan-

98

May

-98

Sep-9

8

Jan-

99

May

-99

Sep-9

9

Jan-

00

May

-00

Sep-0

0

Jan-

01

May

-01

Sep-0

1

Jan-

02

May

-02

Sep-0

2

Jan-

03

Argentinian Peso Brazilian Real Indonesian Rupiah South Korean Won

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THE IMPACT OF CRISES(year-on-year growth, per cent)

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

1996 1997 1998 1999 2000 2001 2002 2003

Argentina Indonesia Korea

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• Extraordinary instability in capital flows

• Leads to many twin crises

• These crises are costly

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2. How has integration evolved?

• The three periods of international economic integration

• The rise, decline and rise of capital market integration

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PERFORMANCE IN THE THREE MOST SUCCESSFUL PHASES

IN THE CAPITALIST EPOCH

(annual average compound growth rate of GDP per head)

1950-73

Golden Age

1973-98

Neo-Liberal Order

1870-1913

Liberal Order

Western Europe 4.08 1.78 1.32

Western Offshoots 2.44 1.94 1.81

Japan 8.05 2.34 1.48

Resurgent Asia 2.61 4.18 0.38

Advanced capitalist

and resurgent Asia

2.93 1.91 1.36

Faltering Economies 2.94 -0.21 1.16

World 2.93 1.33 1.30

Source: Maddison (2001)

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FOREIGN ASSETS OVER WORLD GDP (per cent)

7.0%

19.0% 18.0%

8.0%11.0%

5.0% 6.0%

25.0%

36.0%

49.0%

62.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

1870 1900 1914 1930 1938 1945 1960 1980 1985 1990 1995

Source: Obstfeld and Taylor

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GROSS VALUE OF FOREIGN CAPITAL STOCK IN DEVELOPING COUNTRIES OF AFRICA, ASIA AND LATIN AMERICA, 1870-1998

$40.1

$235.4$63.2

$495.2

$3,030.7

$0.0

$500.0

$1,000.0

$1,500.0

$2,000.0

$2,500.0

$3,000.0

$3,500.0

1870 1914 1950 1973 1998

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Stock in 1990 prices ($bn) Stock as share of developing country GDP

Source: Maddison (2001)

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CORRELATION BETWEEN DOMESTIC INVESTMENT AND SAVINGS SINCE 1870

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1870-79

1880-89

1890-99

1900-09

1910-19

1920-29

1930-39

1940-49

1950-59

1960-69

1970-79

1980-89

Source: Taylor (1996)

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CAPITAL FLOWS SINCE 1870

(average absolute value of current account as per cent of GDP)

UK USA Argentina Australia Canada France Germany Italy Japan

1870-1889

4.6 0.7 18.7 8.2 7.0 2.4 1.7 1.2 0.6

1890-1913

4.6 1.0 6.2 4.1 7.0 1.3 1.5 1.8 2.4

1919-1926

2.7 1.7 4.9 4.2 2.5 2.8 2.4 4.2 2.1

1927-1931

1.9 0.7 3.7 5.9 2.7 1.4 2.0 1.5 0.6

1932-1939

1.1` 0.4 1.6 1.7 2.6 1.0 0.6 0.7 1.0

1947-1959

1.2 0.6 2.3 3.4 2.3 1.5 2.0 1.4 1.3

1960-1973

0.8 0.5 1.0 2.3 1.2 0.6 1.0 2.1 1.0

1974-1989

1.5 1.4 1.9 3.6 1.7 0.8 2.1 1.3 1.8

1989-1996

2.6 1.2 2.0 4.5 4.0 0.7 2.7 1.6 2.1

Source: Taylor (1996)

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• The stock of foreign capital is now higher than ever before, in relation to world GDP

• Most of the foreign capital is short term

• Reliance on domestic capital also seems greater than before 1914

• Net capital flows across borders are relatively small

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3. What are the big differences?

• Shift from UK to US as hegemon and US move into deficit

• Marginalisation of developing countries

• Rise of multi-nationals

• Frequency of crises

• Move to floating exchange rates (and the meaning of the euro)

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3. What are the differences? The hegemon

SHARE OF UK AND US ASSETS IN WORLD FOREIGN ASSETS(per cent)

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

1825 1855 1870 1900 1914 1930 1938 1945 1960 1980 1985 1990 1995

UK assets US assets

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3. What are the differences? The hegemon

• The UK’s foreign assets were three times GDP in 1914

• The US’s net foreign liabilities are a quarter of GDP today

• The UK was the world’s largest creditor

• The US is the world’s largest debtor

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3. What are the differences? Emerging markets

THE MARGINALISATION OF DEVELOPING COUNTRIES(liabilities as a share of world liabilities)

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

1900 1914 1938 1960 1980 1990 1995

Source: Obstfeld & Taylor

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3. What are the differences? Emerging markets

DID CAPITAL FLOW TO POOR COUNTRIES?

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

less than 20 per cent 20-40 per cent 40-60 per cent 60-80 per cent more than 80 per cent

per capita income range of receiving regions (US = 100)

Sh

are

of

Wo

rld

Sto

ck o

f F

ore

ign

C

apit

al

1913 1997Source: Maurice Obstfeld & Alan Taylor

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3. What are the differences? The rise of MNCs

RISE AND RISE OF MULTI-NATIONAL COMPANIES(Selected Indicators of FDI and International Production –

billions of dollars and percentages)

1982 1990 1999

FDI inward stock 594 1,761 4,772

Sales of foreignaffiliates

2,462 5,503 13,564

Gross product offoreign affiliates

565 1,419 3,045

Exports of foreignaffiliates

637 1,165 3,167

GDP at factor cost 10,611 21,473 30,061

Exports of goodsand non-factorservices

2,041 4,173 6,892

Source: UN (2000)

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3. What are the differences? Crises

FREQUENCY OF CRISES IN INDUSTRIAL COUNTRIES

42 1

7

1113 12

36

0

21

0

21

9

29

6

44

0

5

10

15

20

25

30

35

40

45

50

Banking Crises Currency Crises Tw in Crises All Crises

1880-1913 1919-1939 1945-1971 1973-1997Source: Bordo & Eichenreen

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FREQUENCY OF CRISES IN EMERGING MARKET ECONOMIES

116 8

25

73 3

13

0

16

1

1717

57

21

95

0

10

20

30

40

50

60

70

80

90

100

Banking Crises Currency Crises Tw in Crises All Crises

1880-1913 1919-1939 1945-1971 1973-1997Source: Bordo & Eichengreen

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• Crises are more frequent, but not more severe

• They are more than twice as prevalent as before

• The chief reason, suggests Eichengreen and Bordo has been the fragility of soft currency pegs (NBER Working Paper 8716)

• Banking problems were rarer before 1914 – so there were fewer twin crises – because exchange rates did not collapse

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3. What are the differences? Exchange rates

Activist policies Capital mobility Fixed exchange rate NotesGold standard Most Few Few Broad consensusInterwar Few Several Most Capital controlsBretton Woods Few Most FewFloat Few Few ManySource: Obstfeld and Taylor

Resolution of trilemma - countries choose to sacrifice

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4. What are the big policy issues?

• Global macro-economics and the US deficit

• Exchange rate regimes - the law of the excluded middle

• “Original sin” and foreign currency borrowing

• Capital controls and prudential regulation of the financial system

• Sovereign bankruptcy and debt workouts

How does financial integration today differ from that of a century ago? Martin Wolf, Chief Economics...

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