Financial Globalization

Financial globalization refers to the increasing interconnectedness of global financial markets through cross-border financial flows and investments. This phenomenon has evolved significantly since the late 20th century, marked by a notable shift from state-controlled economic activities to more liberalized, super-national financial networks. These networks facilitate access to development funds for emerging economies, potentially improving their quality of life by integrating them into the global market. However, financial globalization also presents challenges, such as the risk of economic instability, as evidenced by crises like the Asian financial crisis of 1997, which highlighted the dangers of insufficient regulatory oversight.

While financial globalization can lead to economic growth and foster international partnerships, it can also exacerbate inequalities within nations, with benefits often concentrated among specific groups. Emerging market economies, characterized by their potential for growth, are particularly sensitive to these dynamics, navigating a complicated landscape of investment opportunities and regulatory environments. As globalization continues to evolve, striking a balance between the benefits of capital mobility and the need for protective regulations remains a critical concern for policymakers and stakeholders worldwide. Understanding these complexities is essential for evaluating the ongoing implications of financial globalization for both developed and developing nations.

Published in: 2021

By: Auerbach, Michael P.

Subject Terms

Financial Globalization

Abstract

This paper reviews the central themes and concepts of one manifestation of the globalization trend: financial globalization. In addition to casting light on its fundamentals, this article also provides insight into the positive and negative implications of financial globalization on the international community.

Overview

Beginning in the last two decades of the twentieth century, there has been a worldwide trend of international commercial activities operating beyond borders and the confines of national government-imposed regulations. Enterprises increasingly began looking for and establishing links to business partners in other countries. To be sure, international commerce has been a staple of human history, although inter-governmental trade agreements were considerably different than the business contracts of today.

Globalization has undergone an evolution of sorts, accelerating in growth and volume, particularly with the evolution of technologies that serve its needs and effectively make the notion of globalization's indefinite continuation inevitable. As former UN Secretary General Kofi Annan once said, "It has been said that arguing against globalization is like arguing against the laws of gravity."

Indeed, the speed at which globalization has developed over a relatively short time corresponds with the suggestion that it is a powerful force of nature, one whose strength continues to build rather than subside. It is therefore important to understand the elements and trends that give it life. This paper reviews the central themes and concepts of one manifestation of this trend: financial globalization. In addition to casting light on its fundamentals, this article also provides insight into the positive and negative implications of financial globalization on the international community.

Understanding Financial Globalization. Financial globalization can be defined as the linkages created from cross-border financial flows. Globalization is closely linked to another trend, financial integration, in which myriad national and regional markets merge into one single international entity (Prasad, et al, 2003). As has occurred in other studies, these terms shall be used interchangeably in this paper in light of their close connections. Such trends are significant, as they present a shift away from commerce on a nation-state basis and toward a more private, super-national network.

Super-national networks serve several important purposes.

First, they make available and accessible the funds to be used for development loans (Arestis, Basu & Mallick, 2009). This is so because within such a large financial marketplace, greater opportunities exist for developing nations to tap into international development funds.
The second purpose is akin to the first, in that the quality of living of developing nations, having been influenced by the same financial systems that strengthened industrialized countries, stands to improve as a result of this manifestation of globalization.
The third of these purposes is one of global stability—by centralizing global financial systems, adverse systemic shocks may be mitigated (Federal Reserve Bank of New York, 2004).

This paper explores these three purposes in greater detail. However, it is first important to review the history of financial globalization in the modern world and how it led to the evolving system of financial integration prevalent in the twenty-first century.

A Brief History of Financial Globalization. Financial globalization is hardly a new concept in human history. During the latter 19th century, it was particularly commonplace because of the gold standard (the practice by which currencies were converted into gold at fixed prices per ounce), which was set by Great Britain and the United States. The fact that the British Empire was the dominant developer in the world also contributed to the centralization of various national financial systems: The Bank of England was the central lender in British development efforts in Australia, India, Africa, the Americas and other regions. As such, developing nations looked to the central, globalized British Empire to conduct any international financial business (Tobin, 1998).

The events of the early twentieth century turned this environment on its ear. The British central financial system was virtually destroyed during World War I, and never returned to its pre-twentieth century form following the Great Depression and World War II. Instead, in the absence of a central banking authority for other countries, the international community fractured into a vast tapestry of independent nations, each developing its own currencies and converting against a myriad of other currencies. During the latter twentieth century, several regional economic powers grew to prominence, centralizing currency and gold exchanges based on three currencies: The US dollar, the German mark and the Japanese yen.

Coinciding with the nationalization (and later regionalization) of currency and financial transactions during the early to mid-twentieth century was the development of regulatory protections that were designed to promote stability of a given country's economic interests. Such measures, however, limited expedient growth, often isolated economies, and even created regional crises when exchange rates faltered (as was the case in Mexico and Southeast Asia during the 1990s and Argentina in the early 2000s).

Meanwhile, the three major regional currencies (the dollar, the mark and yen) began liberalizing their own exchange protocols, allowing for floating exchange rates rather than fixed ones. Doing so created greater stability among these currencies and those countries that were linked to them. Continued liberalization of monetary regulatory schemes also proved enticing to those countries wishing to obtain development monies in order to build or rebuild their own economic infrastructures. As this paper next discusses, there are benefits as well as negative consequences to liberalized and globalized financial transactions—a trend that continues to grow in the twenty-first century economic regime.

Development. In 1944, the European theater was devastated by war; the infrastructures of virtually every major country were crippled. The International Bank for Reconstruction (more popularly known as the World Bank) was established at the Bretton Woods economic conference for the purposes of providing financing for those countries affected by this conflict. The Bank would also serve a long-term purpose: Provision of low-interest, long-term loans to developing countries around the world. Over time, the Bank grew in membership, whose dues helped finance these loans (along with the sale of its securities), to more than 180 countries ("The World Bank," 2009).

As its name would suggest, the World Bank has worked to provide its loans worldwide but under a set of member guidelines, subject to the Bank's governance. Under a condition of such strict infrastructure and economic system management, the World Bank's form of financial aid has proven very effective in aiding development since its introduction.

It is interesting to note that while the Bank enables developing countries to rebuild their financial institutions and systems, globalization has spurred similarly developing countries and the regions to do so on their own. In fact, some experts argue, the economic development that has occurred naturally in a number of regions was done more quickly than was the development of World Bank-sponsored development.

Financial globalization has fostered this dynamic environment for two important reasons. First, whereas the World Bank and International Monetary Fund (IMF) have strict boundaries and regulations governing development, regional financial globalization tends to liberalize lending and development spending policies. Such liberalization means fewer administrative expenses and a greater degree of competition among financial lenders (as opposed to the singularity of the Bank and IMF). This means that securing development funds from a regional, non-governmental organization equals less cost to the developing country in question.

The second reason for non-World Bank development is the fact that less regulation and restrictive policies have been shown to result in higher rates of regional integration and development. In one study, for example, the regions of East Asia and Latin America were analyzed in terms of their rates of development. Latin America, in its pursuit of regional development through integration, has engaged in formal intergovernmental treaties, established under strict rules and guidelines. East Asia, on the other hand, did not employ as many formal agreements, largely due to the fact that its integrative efforts began before such regional agreements were the norm for distributing development loan monies.

The degree of informality and liberal monetary policy in the East Asian region activities has in fact allowed for financial market integration to occur at a faster rate, according to the study, than was the case in Latin America. Development, naturally, also occurred at a faster rate among these countries, as did political relationships. This latter point is important—with market integration already in place, political relationships are formed more readily and with greater strength because of the preexisting relationships (Aminian, Fung & Ng, 2009).

Of course, less formalized and structured development relationships have their risks in an era of financial globalization. At the 1997 Annual Meetings of the IMF, an economist presented to the participants his observations of the successes of financial globalization based on liberalized capital movement policy. Another economist, who had previously advocated for financial controls in international relationship-building, commented on controls applied to capital transfers as "an idea whose time has passed," saying that the "correct answer to the question of capital mobility is that it ought to be unrestricted" (Rodrick & Subramanian, 2008).

Unfortunately, these comments were made shortly before the Asian financial crisis of 1997. The lack of governance of financial markets, the free flow of unregulated development money and a lack of market evaluation and risk assessment created widespread destabilization of both regional currencies and markets. Ironically, in an era of liberalized capital flow preferences, it was the IMF, whose mission it is to safeguard the international monetary system from such crises, that was called in to infuse approximately $35 billion US into the hardest-hit countries, while at the same time imposing new regulations and infrastructure redevelopments, in an effort to mitigate the crisis (IMF, 1999).

As shown above, the liberal policies attached to financial globalization do present great potential for fostering development. There are risks involved, to be sure, with eschewing the regulatory oversight of national economic systems. Striking a balance between the two regimes is a challenge that the international economic community strives to overcome as the trend of globalization continues in the twenty-first century.

Improving Quality of Life. Part of the pursuit of economic development entails the quest for a better way of life. Market integration is largely seen as a great opportunity to improve the quality of living for the developing nation's people. Such a development helps both parties involved, a point that becomes evident when one looks at the emerging market economy as a potential target for inclusion in a financially integrated relationship.

An emerging market economy can be defined as a system (or collection thereof) that is less than fully developed but contains the qualities that are enticing to international investors. It has proven difficult for economists and policymakers to clearly identify such economies, as there are a great many factors that may play a role in enticing investment from foreign entities, such as natural resources, human capital, geography and market stability.

A potential investor may be enticed by such factors, and may in the same vein be turned away should any of these elements prove unsatisfactory or non-conducive to creating a palatable return. It is therefore optimal that the developing economic system (and the national system that supports it) demonstrates such systemic benefits. One study of the emerging market economy emphasizes two basic arenas.

The first is that of the economic infrastructure: A system that does not contain overly intrusive or dominating regulatory precepts, is less susceptible to corruption and/or has reasonable taxation laws and investment potential.
The second is the human factor: A national system that has a demonstrated lack of emphasis on human rights or is enmeshed in conflict is less enticing for foreign-based developed financial systems (Das, 2004).

In this vein, a developing country with the potential to become an emerging market economy will tend to adopt policies and infrastructural frameworks that are conducive to international market integration, allowing for more liberal regulatory systems as well as more emphasis on human rights, diplomacy and social improvements (such as care for the poor and disenfranchised populations). There may also be increased investment in such arenas as environmental cleanup and protection, health care, workforce development and modern technology (Watson, 2008).

Negative Implications & Perceptions. While it is clear that financial globalization is a trend of commerce that will likely continue to develop in the twenty-first century, there are aspects to its ongoing evolution that pose risks to those whose interests are merged with others. Additionally, there are perceptions of this trend that cite the negative aspects of globalization. It is to these issues that this paper next turns.

The first of these negative consequences is one that is quantifiable and finds its causes at the very foundation of globalization. In order to facilitate the linkage of systems beyond the parameters of national economic frameworks, financial globalization entails a more lax application of protocols than would be manifest in inter-state commercial activities. The absence of such regulations facilitates higher quantities of monies to transfer between systems, enables the establishment of corporate development at a quicker rate and even enables the companies themselves to operate with the potential to save on expenses (such as taxes, regulatory and licensing fees). On the other hand, such an absence of controls also means fewer market protections and safeguards should instability occur.

The case of the 1997 Asian financial crisis described earlier illustrates this issue. To be sure, Asian countries stood to benefit from the loosening of financial regulations, as integration and capital mobility (which can be defined as the degree to which investors may infuse or remove their money from a given system) more readily occurred as a result. Then again, the pressure to integrate in an expedited manner also raised risks based on the manner by which integration occurred. It is believed that institutional pressures for integration in East Asia led to disregard for the system-specific impacts such integration might have on the various developing and industrialized systems involved (Eichengreen, 1999). In fact, the crisis led to suggestions that financial globalization may undermine a country's ability to intervene during an economic downturn. At the very least, the issue underscored a perceived need for financial globalization to occur in such a way that allows the creation of safety nets to prevent market collapse.

The second of these issues is less tangible but nonetheless considered a viable risk posed by financial globalization. As stated earlier, market integration and capital mobility may be facilitated when the merging systems demonstrate a desire for social justice, environmental protection and civil stability. However, the efforts of a given country to make such adjustments may seem, on the surface, innocuous, but can have a significant impact on the society. For example, in the course of facilitating financial integration, countries may be selective in terms of the changes they make relative to human rights. Additionally, the benefits of financial globalization may be localized among a select social segment or geographic location rather than widespread.

The example of the Asian crisis again provides an illustration of this point. When the crisis occurred, unemployment surged, as did suicide rates and poverty. However, concurrent with these social issues was a diminished investment in social welfare programs (Ji, 2007). Such social services might have been in place if given a higher priority in the government modifications enacted prior to the crisis.

These two issues demonstrate that financial globalization and market integration, while clearly beneficial on a number of levels, also introduce risks, particularly for those systems that are ill-equipped to adjust accordingly.

Conclusion

Then-UN Secretary General Kofi Annan made a valid point when he suggested that the trend of globalization was akin to a force of nature. Indeed, globalization developed out of commercial interest, and has continued to spread and evolve at a speed that even a series of financial crises could not halt.

Globalization has occurred in a number of areas, drawing together participants to address a wide range of issues in a forum that is framed outside of the governmental setting. As a result of this non-governmental atmosphere, political and regulatory interference is less likely, thereby streamlining the efforts at hand. Because of this condition, information, ideas and even money are more expeditiously (and sometimes in greater quantities) transferred between participants.

As demonstrated in this paper, financial globalization is no exception to this trend. With the absence of a number of inter-state commercial controls, many relationships built under such a regime see strong economic returns at a faster rate. The notion of such returns is enticing for any participating country, from industrialized nations looking to develop resources and assets in systems with rich resources but onerous operating conditions, to developing nations seeking aid monies to build their own market economies. The promise of market and economic integration, which is an important part of financial globalization, and the potential returns it represents, only makes globalization more of the seemingly "unstoppable" force suggested by Annan.

To be sure, there are risks involved with pursuing the transfer of capital across non-governmental lines via liberalized protocols. As this paper has demonstrated, the East Asian financial crisis of 1997 provided an example of how a lack of regulatory oversight could create a market free-fall. On the heels of that incident, a number of experts and leaders called for government bailouts and Keynesian policies designed to allow the government and/or the IMF to impose safeguards and regulatory measures so that such crises can be avoided in the future.

Financial globalization has reached a critical stage in its evolution. Few involved parties wish to see a return to the application of burdensome regulations, taxes and policies, but situations like the Mexican peso crisis of the late 1990s and even the worldwide recession that began in 2008 have given rise to talk of revisiting financial globalization in its current form. Liang (2012) argues that financial globalization has been a major factor in both global imbalances and financial fragility. The ability of borrowers and lenders to shop among both foreign and domestic projects and funding sources resulted in the accumulation of cross-border debt, which Lane (2012) asserts was one of the major concerns in the run-up to the 2008 financial crisis.

Terms & Concepts

Capital mobility: The degree to which investors may infuse or remove their money from a given system.

Emerging market economy: A system (or collection thereof) that is less than fully developed but contains the qualities that are enticing to international investors.

Financial globalization: The linkages created from cross-border financial flows.

Gold standard: The practice by which currencies were converted into gold at fixed prices per ounce.

International Monetary Fund: Government member-based organization designed to protect the global economy from crisis.

World Bank: Global financial institution funded by IMF members with the purpose of lending and managing development grants and other economic programs.

Bibliography

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Financial Globalization

On this Page

Subject Terms

Financial Globalization

Abstract

Overview

Conclusion

Terms & Concepts

Bibliography

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