Consequences of Financial Globalization on the Economy

• Elena Chistyakova

Is financial globalization beneficial?

Consequences of financial globalization and its impact on the world economy.

Introduction

Nowadays, financial globalization as latest stage of financial internationalization process becomes to be the most discussed and controversial subject by contemporary economic scientists.

Globalization expresses the extension of economic activities, social and political across borders (national and regional). Increasing globalization of the world economy is a fundamental feature in the XXI century. It is characterized by emphasizing the trend of reduction and elimination of barriers between national economies and gaining bonds between these economies.

Globalization of the world economy and growing internationalization of national financial markets allow speculation on the process called “financial globalization”. Financial globalization concept aims to create a global money market, a global financial market, and integrated financial system, whose appearance and development is based on the phenomenon of deregulation of national financial markets, the emergence and development of new financial instruments and the expansion of banks and other international financial institutions.

The main objective of this paper is to answer the following key questions: Is financial globalization beneficial? What are its positive and negative effects and consequences? And how developing countries might benefit due to it?

Literature review

In the last decade financial globalization has attracted much attention from research teams, scientists and economists. In recent years much research on the topic of financial globalization and its consequences has been done. The literature on this subject shows a variety of approaches in assessing the effects of financial globalization.

Most authors point out that the process of financial globalization has both positive and negative aspects. Frederic S. Mishkin (2006) demonstrated that financial globalization can help encourage financial and economic development, but it may often leads to devastating financial crises. Peter B. Kenen analyzed benefits and risks of financial globalization and argued that it “is a source of strength but likewise a source of risk” (2007, p.183). Thus, financial globalization is a very contradictory process.

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On the one hand, there are many positive effects of financial globalization. It allows agents to diversify risks and significantly expand their investment opportunities. It also helps governments and businesses to reduce the cost of capital attracted from abroad by opening funds that would be difficult to obtain (Ceballos, Didier & Schmukler, 2012). Financial globalization promotes the development of world financial markets and becomes a source for acceleration of economic development in some countries (Lutsyshyn, 2008).

Results of the research conducted by Gianni De Nicolo and Luciana Juvenal (2010) suggest that financial integration and globalization are likely to yield the beneficial real effects resulting from a more efficient resource allocation.

Fetiniuc & Luchian argue that financial globalization “stimulates the activity of various participants on the global financial markets” (2014, p. 605). It simplifies access to foreign financial resources, technology, management experience and information. Moreover, it stimulates the concentration of capital and the creation of global transnational corporations, activating mergers and acquisitions. Thus financial globalization creates a new financial architecture in the interests of the global economy, contributes to a more effective functioning of global financial markets (Fetiniuc & Luchian, 2014).

On the other hand, financial globalization can have several potential negative consequences. Financial globalization increases the risks of international financial operations, considerably amplifies the impact of local financial crises. For example, crisis of state finance or stock exchange collapse, that happens in borders of one country, in conditions of a single global financial system may spread to whole regions, and, and can lead to world financial shocks. In other words, financial problems, pressures and mistakes of one country may easily spread outside of its borders and could lead to negative consequences globally. (Lutsyshyn, 2008).

Zoryana Lutsyshyn (2008) points out several negative effects of financial globalization. Globalization creates favorable conditions for financial speculators, which instead of influencing the intensity and efficiency of foreign direct investment, began to take away financial liquidity from the country. It leads to certain asymmetry in the flows of capital and to formation of debt problem, because speculation is not favorable for the development of the long-term borrowed capital market. Moreover, financial globalization exacerbates the problem of expansion of «financial bubbles» and self-sufficiency of financial markets, breeding a gap between financial assets and material (or physical) assets towards the first ones. Thus, financial globalization is not promoting the stability in the global capital market; on the contrary, it can act as a catalyst for the spread of the crisis.

Francisco Ceballos, Tatiana Didier and Sergio L. Schmukler argue that “One possible negative spillover suggested is the migration of activity to international markets, reducing the financing and trading activity at home” (2012, p.16).

There is also a fear that globalization is intensifying inequality between countries, and perhaps even worsening welfare of the poor by eroding their incomes, increasing their vulnerability, and adding to their disempowerment. (Bharadwaj, 2014). Some authors indicate the uneven distribution of its benefits between developed and developing countries as the negative consequences of financial globalization (Fetiniuc & Luchian, 2014; Lutsyshyn, 2008).

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Frederic Mishkin (2006) indicates that financial globalization, the liberalization of the financial system to open it up to inflows of foreign capital, has several important positive effects and benefits in emerging market economies. First, globalization lowers the cost of capital, thus encouraging investment which promotes economic growth. Second, it improves the allocation of capital in the economy. Third, it helps promote the development of better institutions and property rights that make the domestic (national) financial sector better get capital to productive uses.

The main gains from financial globalization do not derive directly from the transfer of capital from rich to poor countries; they are the result of the contribution of financial integration to the quality of institutions in the capital-importing countries, including improvements in quality of banking supervision, corporate governance and financial deepening (Kenen, 2007).

However, financial globalization for developing countries does not always bring gains; it can also lead to negative consequences. Opening up the financial system to foreign capital flows can and has led to financial instability and disastrous financial crises, which have a devastating impact on the economy. This is why financial globalization is so controversial process (Mishkin, 2006).

Richard Kozul-Wright (2012) explains the essence of the paradox of finance-driven globalization: why some countries take profits and others do not. His research showed that there is no evidence of a positive correlation between financial globalization and economic growth in developing countries. Among developing countries can be identified: countries-losers from financial globalization, countries-winners that embraced financial globalization, as well as countries-winners that resisted financial globalization. Kozul-Wright concludes that “productivity-enhancing structural change does not emerge spontaneously from unleashing (financial) market forces, but rather is the result of concerted government policies to raise capital formation, strengthen productive capacities and diversify the economy”(2012, p.4) .

Conclusion

Financial globalization is a process which is an essential part of the overall process of globalization, aimed at creating a single financial market and increasing international movement of financial capital.

As the conducted analysis shows, financial globalization is difficult and contradictory process that is a source of strength but likewise a source of risk. It can have positive as well as negative effects. On the one hand, it can help encourage economic development and stimulate the activity of various participants on the global financial markets and expand their opportunities. On the other hand, it may often leads to devastating financial crises, but it also creates possibilities for mitigating them.

In general financial globalization creates a new financial architecture in the interests of the global economy, contributes to a more effective functioning of global financial markets. It provides new real opportunities for the development to all countries, through more effective use of their potential.

But financial globalization raises the acute problem of regulation of world financial markets. As the problems associated with financial globalization of the world economy cannot be solved by individual countries, it needs international measures adequate to the scale of the process.

References:

• Bharadwaj A. (2014). Reviving the globalization and poverty debate: effects of real and financial integration on the developing world. Advances in Economics and Business, 2(1), 42-57.
• Ceballos F., Didier T. & Schmukler S. L. (2012). Financial globalization in emerging countries: diversification vs. offshoring. ADBI Working Paper 389. Tokyo: Asian Development Bank Institute. Available at: http://www.adbi.org/working-paper/2012/10/18/5267.financial.globalization.emerging.countries/
• De Nicolo G. & Juvenal L. (2010). Financial integration, globalization, growth and systemic real risk. Federal Reserve Bank of St. Louis Working Paper, 2010-012D. Available at: http://research.stlouisfed.org/wp/2010/2010-012.pdf
• Fetiniuc V. & Luchian I. (2014). Financial globalization: concepts and main trends. 6th international multidisciplinary scientific symposium universitaria Simpro 2014.
• Kenen P.B. (2007). The Benefits and Risks of Financial Globalization. CATO Journal, 27, 179-183. Available at: http://www.cato.org/pubs/journal/cj27n2/cj27n2-7.pdf
• Kozul-Wright R. (2012). The Paradox of Finance-Driven Globalization. UNCTAD, 1. Available at: http://unctad.org/en/Docs/uxiiipb2012d1_en.pdf
• Lutsyshyn Z. (2008). Asymmetry and paradox of financial globalization. The Journal of International Economic Policy, 8-9 (1-2), 70-93.
• Mishkin F.S. (2006). Financial stability and globalization: getting it right. Paper presented at the Bank of Spain Conference, Central Banks in the 21st Century, June 8-9, Madrid. Available at: http://www.bde.es/webbde/Agenda/Eventos/06/Jun/Fic/Mishkin_BdE.pdf