“Financial liberalisation and increased access to international capital markets brings benefits and disruption to developing countries.”With the above statement in mind, and based on a review of the literature, consider the evidence on the net benefit to developing countries from unfettered access to international markets.
Globalization is the process of worldwide integration that occurs as a result of the exchange of global views, goods, ideas, and other cultural elements (Fernando, 2021). Globalization has been fueled by advancements in transportation and telecommunications infrastructure, such as the Internet and mobile phones, which have increased the interconnectedness of economic and cultural activity in countries all over the world (Fernando, 2021).
Though some researchers identify the beginnings of globalization in modern times, others trace its history back to the third millennium BCE, well before Europeans began crossing the Atlantic in the 15th century (Fernando, 2021). Large-scale globalization began in the 19th century, and by the late 19th and early 20th centuries, the world’s economies and cultures had become extremely intertwined (Fernando, 2021).
Following World war ii, leaders worked together to organize the Bretton Woods Conference, which took place from July 1 to July 22, 1944 (Chen, 2021). The conference brought together 730 representatives from all 44 Allied states to oversee the post-World War II international monetary and financial system (Chen, 2021). The conference resulted in key states agreeing to establish the framework for international monetary policy, commerce, and finance, as well as the establishment of various international institutions aimed at facilitating economic growth by eliminating trade barriers (Chen, 2021).
The rapid rise of globalization has sparked a heated discussion among economists, with both supporters and critics. This paper outlines the benefits and risks that financial liberalization entails for developing countries. Financial liberalization is the elimination of government involvement from financial markets.
It involves removing limitations such as bank interest rate limits, mandatory reserve requirements, entrance hurdles, especially for foreign financial intermediaries, and credit allocation choices (Masci, n.d.). These policies limit government intervention in financial markets, resulting in the privatization of state-owned banks, the introduction of currency convertibility on the capital account, capital account liberalization, improved prudential regulation, and the promotion of local stock markets (Masci, n.d.).
Simply phrased, it refers to a country’s local financial system’s integration with international financial markets and institutions. Financial liberalization lets governments and private investors to do business with less constraints, while also allowing financial hosts to access the global market (Banton, 2021). However, because emerging countries or economies are compelled to compete in the same market as larger economies or nations, this might be detrimental to them (Banton, 2021).
The capital account in a country’s balance of payments covers a wide range of financial flows, including foreign direct investment, portfolio flows (including equity financing), and bank borrowing, all of which involve the acquisition of assets in one nation by citizens of another (Kose and Prasad, 2020). It is theoretically feasible to manage these flows by imposing limitations on those that pass via official channels. However, through increased capital inflows and outflows, capital account liberalization is likely to result in a greater degree of financial integration of that nation with the global economy (Kose and Prasad, 2020).
Any action taken by a government or other regulatory agency to restrict the movement of foreign capital into and out of the domestic economy is referred to as capital control (Barone, 2020). Taxes, tariffs, laws, and market forces are all examples of these types of regulations. Many asset types, including stocks, bonds, and foreign currency trading, can be affected by capital regulations.
It is a country’s attempt to protect itself against the dangers connected with international capital flow variations. Unrestricted capital flows might make maintaining a fixed exchange rate system more challenging. This is one of the reasons why, under the Bretton Woods system of fixed currency rates, even industrial countries maintained relatively restricted capital accounts during the second world war (Kose and Prasad, 2020).
One of the major roles of capital control is that it reduces the volatility of currency rates in the economy as well as provide support and stability by shielding it from sharp fluctuations (corporate finance institute, 2015). This is because unrestricted capital can produce inflows and outflows that easily affects the appreciation and depreciation of the nation’s currency (corporate finance institute, 2015). For instance, in the year 1933, President Franklin D.
Roosevelt compelled Americans to convert their gold for US currencies by Executive Order 6102 (Giambruno, n.d.). The official government exchange rate was negative, which comes as no surprise. Until 1974, the United States government prohibited individual possession of gold bullion (Giambruno, n.d.). According to Ballotpedia (n.d.) this major decision made by the late president lead to the revision of the Trading with the Enemy Act of 1917, allowing banks to reopen after a four-day banking holiday and requiring the Department of the Treasury to examine institutions.
The legislation increased the president’s regulatory powers over the banking system, provided the comptroller of the currency the right to restrict the activities of banks with impaired assets, and empowered the Federal Reserve Board to create emergency money backed by commercial bank assets.
Capital controls are also used to prohibit foreigners from acquiring local assets or to restrict domestic individuals’ access to foreign assets. Foreigners’ and residents’ capacity to exchange domestic money for foreign money, and vice versa, has historically been the most extensively employed capital control and it is known as exchange control (Coppola, n.d.).It can disrupt international trade by interfering with floating foreign exchange rates;
when a country’s official exchange rates diverge significantly from market prices and citizens are not permitted to get foreign money, foreign enterprises may find it difficult to conduct business there (Coppola, n.d.).
Some systems allow beneficiaries of certain types of exchange to sell a part of their receipts on the free market. A managed exchange rate is frequently higher than a free-market rate, reducing exports while increasing imports. The control authority can limit imports by restricting the amount of foreign exchange a resident may buy (Britannica, n.d.). As a result, the country’s overall gold reserves and foreign balances will not drop.
Regardless of the many advantages of capital control, there are still a number of negative factors to be considered. For instance, the distribution of resources would be inefficient if credit was determined administratively rather than by market price. Because the most promising initiatives would not be supported and hence would not contribute to economic growth, this poor allocation would exacerbate the negative impact on growth (Masci, n.d.).
Also, Access to credit would be granted for developmental purposes to big state owned and private companies, while the rest of the economy will only have some access to consumer credit (Masci, n.d.). Moreover, Individuals would find methods to export capital internationally, runaway inflation, putting pressure on the exchange rate. Administrative interest rates would undervalue actual interest rates, give an incentive to reduce savings and investment and also have a negative influence on the pace of economic growth (Masci, n.d.).
According to Kose and Prasad (2020), Capital account liberalization should theoretically allow for more efficient global capital allocation from capital-rich industrial countries to capital-poor developing economies, with widespread benefits such as higher rates of return on people’s savings in industrial countries and increased growth, employment opportunities, and living standards in developing countries. It also allows for risk sharing opportunities by demonstrating that international financial integration should lead to a decrease in consumption volatility relative to output volatility (Masci, n.d.).
Finally, financial liberalization provides protection against national income fluctuations while also demonstrating a country’s commitment to sound economic policy (Kose and Prasad, 2020). A perceived deterioration in the policy environment for a nation with an open capital account might be penalized by local and international investors, who might rapidly withdraw money. This offers a powerful incentive for governments to adopt and sustain solid policies, with evident long-term growth advantages (Kose and Prasad, 2020).
Federico and Tena-junguito (2016) estimated that since the 1950s, the growth in the proportion of international commerce in GDP had added around 5% to global wealth. With a global GDP of $85 trillion in 2018, the incremental trade advantages since the 1950s amount to around $4.3 trillion in global revenue.
Financial liberalization has also boosted finance, technology, and talent flows, boosting earnings and increasing living standards (Petri and Banga, 2020 p.3). According to other research, the United States has profited from globalization even more than the rest of the globe. According to Petri and Banga (2016), advancements in globalization added $0.8 trillion–$1.5 trillion, or 11 percent–14 percent, to the US GDP of $11 trillion in 2003, between 1947 and 2003.
Extrapolating these figures to 2018 GDP, economic interconnectedness has contributed $2.2 trillion since 1947. Unfettered access to international market has brought about both net benefit as well as certain disruptions to developing countries for the past two and a half years. To developing countries, financial liberalization and integration has brought about abundant benefits that are verifiably both theoretically and through empirical evidence as well as a number of disruptions to their economy.
Firstly, liberalization has brought about the elimination of barriers to international investing whereby both the government and private organizations are allowed to business with minimal restrictions. Tax rules, foreign investment limitations, legal challenges, and accounting requirements are all examples of barriers that make it difficult or impossible to access the international market (Barone, 2020).
During the 1980s through to early 1990s, a great banking crisis occurred that is considered to be one of the worst global credit disasters in history. The crisis drove the United States’ state and federal regulatory and deposit banking insurance systems to their breaking points, resulting in broad regulatory revisions (Summa, 2014). The Depository Institutions Deregulation Committee and Monetary Control Act of 1980, which removed many restrictions on thrifts and credit unions, and The Tax Reform Act of 1986, which fundamentally altered the banking landscape and engendered conditions that contributed to the banking crisis, were both passed prior to the onset of the crisis (Summa, 2014).
This was considered to be the primary cause of the banking crisis of that time. In order to rescue the banking sector. The United States’ economic comeback has been aided by liberalization and economic contact with the rest of the globe. Their relatively open borders, which let most foreign goods to enter with no or modest tariffs, have helped keep inflation in control, allowing the Federal Reserve to ride out the good times without raising interest rates as swiftly as it could have otherwise (Summa, 2014).
Financial liberalization manifests its positive impact through the rather increase in demand for domestic goods internationally for both developed and developing countries. By increasing the involvement of developing countries into the international market, it becomes evident through an increasing export and import volumes, as well as expanding outflows of domestic savings into international investment projects and increasing inflows of foreign capital into local enterprises (Masci, n.d.).
According to a report made by the office of the unites states trade representative (n.d.), The United States was the world’s top goods and services trading nation in 2017, with $2.35 trillion in exports. The total value of goods and services traded in the United States in 2017 was $5.3 trillion, up 6.5 percent ($321 billion) from 2016 and up 31% from 2007. The value of US goods trade was $3.9 trillion, while the value of US services trade was $1.3 trillion.
Despite the large number of benefits that are associated with financial globalization, there are also disruptions that come with liberalization. One is the transitional risks that accompany it. Despite a significant rise in global gross capital flows, net capital flows to developing countries have typically been minimal, if not negative (Broner and Ventura, 2016).
Traditional models acknowledge that foreign sources of funding can be problematic, since the incentive for opportunistic default coupled with low-quality institutions can lead to recurring foreign debt crises. They also expect that domestic savings stay in the country and that new foreign sources of financing add to overall development funding (Broner and Ventura, 2016).
The chief concern in the US is that the economy is delivering a disproportionate share of gains to the wealthiest few. According to Census data, from 1970 to 2018 the median US household income rose from $50,545 to $63,179, or by 0.46% per year, while that of the top 5% of households rose from $192,603 to $416,520, or by 1.62% per year (Semega et al., 2019). In 1970, a high-income household earned 3.8 times as much as the median household, but this ratio had grown to 6.6 by 2018.
Still more extreme contrasts emerged between richer and poorer households, and amongst subgroups by levels of education. In turn, inequality may have contributed to other trends such as withdrawal from the labour force, increased mortality and morbidity, and political polarization (Broner and Ventura, 2016). These trends are not direct results of liberalization, but they are often attributed to trade in popular discussions.
Is it worth the risk of liberalization? It depends, as it would with most things. Capital account liberalization is definitely not a perfect solution, and it comes with significant dangers if it is implemented in poor conditions, especially without accompanying measures (Kose and Prasad, 2020). While data indicate that capital account liberalization is linked with transitory risks, fighting it for a lengthy length of time may be useless and harmful. Closed capital accounts are becoming more difficult to maintain as the forces of globalization progress (Kose and Prasad, 2020).
References of Financial liberalization
Ballotpedia, n.d. emergency banking act. [online] Available at: https://ballotpedia.org/Emergency_Banking_Act[Accessed June 5, 2021]
Banton, C., 2021. Trade liberalization. [online](Updated March 24, 2021) Available at: https://www.investopedia.com/terms/t/trade-liberalization.asp [Accessed June 5, 2021]
Barone, A., 2020. Capital control. [online](updated December30, 2020) Available at: https://www.investopedia.com/terms/c/capital_conrol.asp [Accessed June 4, 2021]
Britannica, n.d.. Exchange control. [online] Available at: https://www.britannica.com/topic/exchange-control [Accessed June 5, 2021]
Broner, F. and Ventura, J., 2016. Rethinking the Effects of Financial Globalization. Available at: https://academic.oup.com/qje/article/131/3/1497/2461106 [Accessed June 4, 2021]
Chen, J., 2021. Bretton woods agreement and system. [online](updated April 28, 2021) Available at: https://www.investopedia.com/terms/b/brettonwoodsagreement.asp [Accessed June 5, 2021]
Coppola, F., n.d.. How capital and exchange controls affect international trade. [online] Available at: https://www.americanexpress.com/us/foreign-exchange/articles/capital-controls-in-developing-economies-affect-international-trade/ [Accessed June 5, 2021]
Corporate finance institute, 2015. Capital controls.[online] Available at: https://corporatefinanceinstitute.com/resources/knowledge/economics/capital-controls/ [Accessed June 4, 2021]
Federico, G. and A. Tena-Junguito 2016. ‘A Tale of Two Globalizations: Gains from Trade and Openness 1800–2010’, CEPR Discussion Papers, No. 11128. London: Centre for Economic Policy Research.
Fernando, J., 2021.Globalization. [online](updated May 17, 2021) Available at: https://www.investopedia.com/terms/g/globalization.asp [Accessed June 5, 2021]
Giambruno, F., n.d. Capital controls are coming. [online] Available at: https://internationalman.com/articles/capital-controls-are-coming/ [Accessed June 5, 2021]
Kose, M.A and Prasad, E., 2020. Capital Accounts: Liberalize or Not? [online](updated February 24, 2020) Available at: https://www.imf.org/external/pubs/ft/fandd/basics/capital.htm [Accessed June 4, 2021]
Masci, P., n.d. Financial Liberalization, Economic Growth, Stability and Financial Market Development in Emerging Markets. [online] Available at: https://www.bpastudies.org/index.php/bpastudies/article/view/68/146 [Accessed June 4, 2021]
Office of the united states trade representative, n.d. Benefits of trade. [online] Available at: https://ustr.gov/about-us/benefits-trade [Accessed June 5, 2021]
Petri, P.A. and Banga, M., 2020. The economic consequences of globalization in the United States. [pdf] Available at: https://www.eria.org/uploads/media/discussion-papers/The-Economic-Consequences-of-Globalisation-in-the-United-States.pdf [Accessed June 5, 2021]
Semega, J., Kollar, M., Creamer, J., and Mohanty, A., 2019. Income and Poverty in the United States: 2018 – Current Population Reports. Washington, DC: United States Census Bureau.
Summa, J., 2014. From Booms To Bailouts: The Banking Crisis Of The 1980s. [online](Updated September 10, 2014) Available at: https://www.investopedia.com/articles/financial-theory/banking-crisis-1980s.asp [Accessed June 5, 2021]
References of Financial liberalization