Financial Globalization and Capital Flows

Financial Globalization and Capital Flows

• Financial globalization is not the same as trade globalization
• Measures of trade openness include (exports + imports)/GDP
• Measures of financial globalization analyze cross-border financial transactions
• De Jure measures examine restrictions on international capital movements
• De Facto measures quantify international financial asset transactions
• Financial assets are used to transfer purchasing power across time periods
• Portfolio investment includes equity and debt
• Foreign direct investment is ownership greater than 10%
• Other investments are bank loans and trade credit
• Derivatives include futures and options
• Reserves are held by central banks

Flows and Stocks

• Flows are the value of assets traded per year
• Stocks are the value of assets held per year
• Stocks are the cumulative total of flows
• Measures include international financial integration (domestic assets held by foreigners + foreign assets held by domestic agents) / GDP
• Inflows are net purchases of domestic assets by foreign investors
• Outflows are net purchases of foreign assets by domestic investors
• Negative capital flows mean people are selling more financial assets than buying

The First Financial Globalization

• World capital markets were highly integrated in the late 19th century
• British wealth invested overseas was significant (17% in 1870, 33% in 1913) surpassing most countries today.
• This was similar for France and Germany.
• Capital outflows from the UK were mainly to the "New World", driven mostly by portfolio investment in infrastructure and resources.
• This involved the purchase of equity and bonds in railroads, harbors etc.
• Factors driving this included increasing transportation and communication improvements (ie telegraph), and the rise of global banking.

Marginal Productivity of Capital (MPK)

• Capital falls when total capital (K) increases.
• MPK measures the additional output generated by adding one extra unit of capital, holding other factors like labor constant.
• MPK generally falls as more capital is added (diminishing marginal returns).
• MPK is a foundational concept in growth theory and production analysis.

The Case for Financial Globalization

• The Washington Consensus was a set of policy recommendations in the early 1990s focused on economic liberalization.
• This often included steps towards reforms, deregulation, and opening economies.
• Many emerging markets opened their capital markets in the early 1990s.
• Most developed markets were already open by the 1980s.

National Accounting and the Balance of Payments

• GDP (Gross Domestic Product) measures the value of final goods and services produced within a country's borders
• GNI (Gross National Income) measures the value of final goods and services produced by the country's factors of production
• GNI = GDP + net receipts of factor income from the rest of the world
• The current account identity relates the current account to saving and investment
• A current account surplus indicates saving exceeds investment
• A current account deficit reflects investment exceeding saving.

The Balance of Payments

• All transactions of a country with the rest of the world are recorded
• The balance of payments must balance (all credits equal debits)
• The BOP registers all transactions with foreign economic agents
• Three main types of transactions include: current account (exports/imports of goods, services), financial account (sale/purchase of financial assets), capital account (certain transfers of wealth).

Financial Globalization

• Financial globalization is the increasing integration of financial markets across countries and leads to certain intertemporal gains from both risk sharing and capital flows.
• It has also been important for enabling efficient allocation of capital
• However, financial globalization is also associated with the possibility of greater risks and vulnerabilities for individuals and countries
• Capital flows to countries with lower capital and vice versa