The Macroeconomic The Macroeconomic Implications of Financial Implications of Financial

GlobalizationGlobalization

EswarEswar Prasad, Prasad, IMFIMF Research DepartmentResearch DepartmentNovember 10, 2006November 10, 2006

The views expressed in this paper are those of the The views expressed in this paper are those of the author(sauthor(s) only, and the presence of them, or of links to them, ) only, and the presence of them, or of links to them, on the on the IMFIMF website does not imply that the website does not imply that the IMFIMF, its Executive Board, or its management endorses or shares the , its Executive Board, or its management endorses or shares the

views expressed in the paper.views expressed in the paper.

Benefits of Financial Integration: Benefits of Financial Integration: TheoryTheory

Efficient international allocation of Efficient international allocation of capitalcapital

Consumption smoothing via Consumption smoothing via international risk sharinginternational risk sharing

Large welfare effects for developing Large welfare effects for developing economieseconomies

Figure 4. GDP (per capita, PPP weighted): 1970-2004

100

150

200

250

300

350

1970 1975 1980 1985 1990 1995 2000

Advanced Economies

Emerging Markets

Emerging (excluding China and India)

Other Developing Economies

Figure 5B. Change in Financial Openness and GDP Growth, 1985-2004Unconditional Relationship

FJIZMB

TUN

TGO

TZA

SEN

ZWE

NER

MUS

MWIKEN

GHA

CMR

DZA

THA

PHL

PAK NPL

MYS

KOR

IDNIND

LKA

BGDEGYISRIRN TTO

JAM

VEN

URY

PER

PRY

MEXHND

GTMSLV

ECU

DOMCRI

COL

CHL

BRABOL ARG

ZAF

NZL

AUSTURESP PRT

GRC FINJPNCAN SWE

NOR

ITA DEU FRADNKAUTUSA

-0.02

-0.01

0

0.01

0.02

0.03

0.04

0.05

0.06

-150 -50 50 150 250 350 450

Change in financial openness

Gro

wth

rate

of p

er c

apita

GD

P

Figure 5B. Change in Financial Openness and GDP Growth, 1985-2004Conditional Relationship

USA

AUTDNK FRADEUITA NOR SWECAN

JPN

FINGRCPRTESP

TUR AUS

NZL

ZAFARG

BOLBRA

CHL

COL

CRI DOM

ECU

SLVGTM

HNDMEXPRY

PER

URY

VEN

JAM

TTO

IRN

ISR

EGY

BGDLKA

IND

IDN

KORMYS

NPL

PAK

PHL

THA

DZACMR

GHA

KEN

MWI

MUS

NER

ZWE

SENTZA

TGO

TUN

ZMB

FJI

-0.03

-0.02

-0.01

0

0.01

0.02

0.03

0.04

0.05

0.06

-150 -50 50 150 250 350 450

Change in financial openness

Gro

wth

rate

of p

er c

apita

GD

P

Growth Benefits of Financial Integration: Growth Benefits of Financial Integration: EvidenceEvidence

About 25 studies of growth effectsAbout 25 studies of growth effects

No effect: No effect: 44Mixed:Mixed: 1818Positive:Positive: 33

Growth: Why Such Diverse Results?Growth: Why Such Diverse Results?

Finer measures of integration, de jure or Finer measures of integration, de jure or de facto, tend to yield more positive resultsde facto, tend to yield more positive results

Sample of countries: Effects much weaker Sample of countries: Effects much weaker in poor developing countriesin poor developing countries

Time span of sample: Longer datasets Time span of sample: Longer datasets yield more positive resultsyield more positive results

No robust macroeconomic evidence of No robust macroeconomic evidence of growth benefits growth benefits

Financial Integration and Volatility: Financial Integration and Volatility: EvidenceEvidence

Capital mobility does not increase Capital mobility does not increase probability of sudden stops or current probability of sudden stops or current account reversals (Edwards)account reversals (Edwards)

Banking crises are most disruptive and Banking crises are most disruptive and occur frequently in closed economiesoccur frequently in closed economies

No evidence that financial integration by No evidence that financial integration by itself is proximate determinant of itself is proximate determinant of

financial crisesfinancial crises

But Two Issues on Volatility But Two Issues on Volatility

Relative volatility of consumption Relative volatility of consumption growth increases at low and growth increases at low and intermediate levels of integration intermediate levels of integration

Developing economies, including Developing economies, including emerging markets, have not attained emerging markets, have not attained better risk sharing better risk sharing

Other Ways of Looking at the DataOther Ways of Looking at the Data

Effects of different types of private Effects of different types of private capital flows:capital flows:

> Equity flows> Equity flows> FDI> FDI> Debt> Debt

Macroeconomic vs. microeconomic Macroeconomic vs. microeconomic evidenceevidence

International Financial Integration:Distribution of Gross Inflows(% of Total)

Emerging Markets

0

20

40

60

80

100

FDI Equity Debt

80-84 90-94 00-04

Equity Market Liberalizations Boost Equity Market Liberalizations Boost GrowthGrowth

Bekaert, Harvey, Lundblad Bekaert, Harvey, Lundblad big big positive growth effectspositive growth effects

Henry Henry lower cost of capital, private lower cost of capital, private investment booms, productivity investment booms, productivity growthgrowth

Chari and Henry Chari and Henry allocative allocative efficiencyefficiency

Equity Market Liberalizations Boost Equity Market Liberalizations Boost Growth: Growth: RReally?eally?

Portfolio equity flows relatively smallPortfolio equity flows relatively small

De jure measuresDe jure measures——not actual not actual flowsflows——used in these studiesused in these studies

Equity market liberalizations Equity market liberalizations coincident with other reformscoincident with other reforms

Foreign Direct InvestmentForeign Direct Investment

Should in principle be the bestShould in principle be the best> stable> stable> transfers of technology, expertise> transfers of technology, expertise> right sorts of incentives> right sorts of incentives

But difficult to detect growth effectsBut difficult to detect growth effects> macroeconomic evidence mixed> macroeconomic evidence mixed> microeconomic evidence also weak> microeconomic evidence also weak

Evidence of vertical spilloversEvidence of vertical spillovers

Additional Microeconomic EvidenceAdditional Microeconomic Evidence

Capital controls result in significant Capital controls result in significant efficiency losses efficiency losses

> distortions (e.g. Forbes, 2005)> distortions (e.g. Forbes, 2005)> reductions in discipline> reductions in discipline> administrative costs> administrative costs

Again use of de jure measures, but Again use of de jure measures, but less of a problem in these casesless of a problem in these cases

Summary of New EvidenceSummary of New Evidence

Equity market liberalization seems Equity market liberalization seems to workto work

FDI benefits becoming more FDI benefits becoming more apparentapparent

Benefits more evident in micro data? Benefits more evident in micro data?

The Traditional ViewThe Traditional View

Financial Globalization

More efficient international allocation of capital

Capital deepening

International risk-sharing

GDP growth

Consumption volatility

A Different Perspective A Different Perspective

Traditional Channels

Potential Collateral Benefits

Financial market developmentInstitutional development

Better governanceMacroeconomic discipline

Financial Globalization

GDP / TFP Growth

Consumption volatility

Figure 6A. Financial Openness and Financial Development: 1985-2004Private Credit/ GDP

PNG

FJI

ZMB

TUN

TGO

TZA

SENZWE

NER

MUS

MWI

KEN

GHA

CMRDZA

THA

PHLPAK

NPL

MYS

KOR

IDNIND

LKABGD

EGY

ISR

IRN

TTO

JAMVEN

URY

PERPRYMEXHND

GTM

SLV

ECUDOM CRICOL

CHL

BRABOL

ARG

ZAF

NZL

AUS

TUR

ESPPRT

GRC

FIN

JPN

CANSWE

NORITA

DEU

FRA

DNK

AUT

USA

0

0.2

0.4

0.6

0.8

1

1.2

0 50 100 150 200 250 300Mean financial openness

Priv

ate

Cre

dit/

GD

P

Figure 6A. Financial Openness and Financial Development: 1985-2004Stock Market Capitalization/ GDP

USA

AUT

DNKFRA

DEUITA NOR

SWECANJPN

FIN

GRCPRT

ESP

TUR

AUS

NZL

ZAF

ARG

BOL

BRA

CHL

COL CRI ECUSLV

GTMHND

MEX

PRY

PER

URYVEN

JAMTTO

IRN

ISR

EGY

BGDLKA

INDIDN

KOR

MYS

NPLPAK

PHLTHA

GHAKENMWI

MUSZWE

TZATUN ZMBFJI

CHN

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

0 50 100 150 200 250 300Mean financial openness

Stoc

k M

arke

t Cap

italiz

atio

n/ G

DP

.

FG and Financial DevelopmentFG and Financial Development

Foreign ownership of banksForeign ownership of banks

Inflows add to depth of equity Inflows add to depth of equity marketsmarkets

Financial sector FDI has benefitsFinancial sector FDI has benefits

FG and Quality of Institutions, FG and Quality of Institutions, GovernanceGovernance

Openness to foreign capital provides Openness to foreign capital provides incentives for improving corporate incentives for improving corporate governance (Stulz)governance (Stulz)

Corruption, lack of transparency Corruption, lack of transparency discourage FDI, portfolio flows (Wei)discourage FDI, portfolio flows (Wei)

Figure 6B. Financial Openness and Quality of Institutions: 1985-2004Institutional Quality

CHNPNG

FJI

ZMB

TUN

TGO

TZASEN

ZWE

NER

MUS

MWI

KEN

GHA

CMRDZA

THA

PHL

PAKNPL

MYSKOR

IDN

INDLKA

BGD

EGY

ISR

IRN

TTO

JAM

VEN

URY

PER

PRY

MEX

HNDGTM

SLV

ECU

DOM

CRI

COL

CHL

BRABOL

ARG

ZAF

NZLAUS

TUR

ESP PRT

GRC

FIN

JPN

CAN SWENOR

ITA

DEU

FRA

DNKAUT

USA

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

0 50 100 150 200 250 300

Mean financial openness

Inst

itutio

nal Q

ualit

y .

Figure 6B. Financial Openness and Quality of Institutions: 1985-2004Control of Corruption

CHN

PNG

FJI

ZMB

TUN

TGOTZA

SEN

ZWE NER

MUS

MWI

KEN

GHA

CMR

DZATHA

PHL

PAK

NPL

MYSKOR

IDN

IND LKA

BGD

EGY

ISR

IRN

TTO

JAM

VEN

URY

PER

PRY

MEX

HNDGTM

SLV

ECU

DOM

CRI

COL

CHL

BRA

BOL

ARG

ZAF

NZL

AUS

TUR

ESP PRT

GRC

FIN

JPN

CANSWE

NOR

ITA

DEU

FRA

DNK

AUTUSA

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

3

0 50 100 150 200 250 300Mean financial openness

Con

trol o

f Cor

rupt

ion

Macroeconomic Policy DisciplineMacroeconomic Policy Discipline

Capital account liberalization as Capital account liberalization as commitment device commitment device

Even Stiglitz is on board!Even Stiglitz is on board!

Sadly, limited evidenceSadly, limited evidence

Figure 6C. Financial Openness and Macroeconomic Policies: 1985-2004Monetary Policy

CHNPNG

FJI

ZMB

TUN

TGO

TZA

SEN

ZWE

NER

MUS

MWI

KEN

GHA

CMR

DZA

THA

PHLPAKNPL

MYS

KOR

IDNIND

LKA

BGD

EGY ISR

IRN

TTO

JAM

VENURY

PERPRYMEX

HNDGTM

SLV

ECU

DOM CRICOL

CHL

BRA

BOLARGZAF

NZLAUS

TUR

ESPPRT

GRC

FIN

JPN

CAN SWENOR

ITA

DEUFRA

DNKAUT

USA

-5

-4.5

-4

-3.5

-3

-2.5

-2

-1.5

-1

-0.5

0

0 50 100 150 200 250 300

Mean financial openness

Log

Infla

tion

Figure 6C. Financial Openness and Macroeconomic Policies: 1985-2004Fiscal Policy

CHN

PNGFJI

ZMB

TUN TGOTZA

SENZWE

NER

MUS

MWI

KENGHA

CMR

DZA

THA

PHL

PAK

NPL

MYS

KOR

IDN

IND

LKA

BGD

EGY

ISR

IRN TTOJAMVEN

URYPER

PRY

MEXHND

GTM SLVECUDOM

CRICOL

CHLBRA

BOLARG

ZAF

NZLAUS

TUR

ESP

PRT

GRC

FIN

JPN

CAN SWE

NOR

ITA

DEU

FRA

DNK

AUTUSA

-15

-10

-5

0

5

10

0 50 100 150 200 250 300

Mean financial openness

Gov

ernm

ent B

udge

t Bal

ance

(%G

DP)

.

Complication: Threshold Effects Complication: Threshold Effects

Threshold ConditionsFinancial market development

Institutional Quality, GovernanceMacroeconomic policies

Trade integration

Financial Globalization

GDP / TFP growth

Risks of Crises

GDP / TFP growth

Risks of Crises

Above Thresholds

Below Thresholds

X?

TENSION !!TENSION !!

Some evidence that financial Some evidence that financial integration catalyzes financial integration catalyzes financial development, improves governance, development, improves governance, imposes discipline on macro policies... imposes discipline on macro policies...

But, in the absence of a basic preBut, in the absence of a basic pre--existing level of these supporting existing level of these supporting conditions, financial integration can conditions, financial integration can wreak havocwreak havoc

Further Work Needed Further Work Needed

Identification of thresholdsIdentification of thresholds

Interactions/tradeInteractions/trade--offs among offs among thresholdsthresholds

Level of integration itself is a Level of integration itself is a thresholdthreshold

Collateral Benefits Collateral Benefits Perspective Useful?Perspective Useful?

Unified conceptual frameworkUnified conceptual framework

CountryCountry--specific requirements, initial specific requirements, initial conditions can be taken into accountconditions can be taken into account

Selective approach to liberalizationSelective approach to liberalization

Can manage risks during transition to Can manage risks during transition to thresholds, but can not eliminate themthresholds, but can not eliminate them