Money Power and Financial Capital in Emerging Markets

Facing the Liquidity Tsunami

Ilias Alami

• Publisher: Routledge
• Year: 2019
• Print ISBN: 9780367276478
• eBook ISBN: 9781000769005
• Edition: 1
• Topic: Business
• Subtopic: Finance
• Index: Business

This book provides a comprehensive investigation of the messy and crisis-ridden relationship between the operations of capitalist finance, global capital flows, and state power in emerging markets.

The politics, drivers of emergence, and diversity of these myriad forms of state power are explored in light of the positionality of emerging markets within the network of space and power relations that characterises contemporary global finance. The book develops a multi-disciplinary perspective and combines insights from Marxist political economy, post-Keynesian economics, economic geography, and postcolonial and feminist International Political Economy. Alami comprehensively reviews the theories, histories, and geographies of cross-border finance management, and develops a conceptual framework which allows unpacking the complex entanglement of constraint and opportunities, of growing integration and tight discipline, that cross-border finance represents for emerging markets. Extensive fieldwork research provides an in-depth comparative critical interrogation of the policies and regulations deployed in Brazil and South Africa.

This volume will be especially useful to those researching and working in the areas of international political economy, contemporary geographies of money and finance, and critical development studies. It should also prove of interest to policy makers, practitioners, and activists concerned with the relation between finance and development in emerging markets and beyond.

Part 1
Theory, history, and geography

1 Managing cross-border finance

Key theoretical debates and policy prescriptions

According to a prominent contemporary economic historian, ‘capital account liberalisation … remains one of the most controversial and least understood policies of our day. One reason is that different theoretical perspectives have very different implications for the desirability of liberalising capital flows’ (Eichengreen, 2004, p. 49, emphasis added). This observation raises a number of important questions. Why is capital account liberalisation so controversial? What is desirable, or not, about liberalising financial capital flows? Why are theoretical perspectives on the capital account and cross-border finance so different, and what policy prescriptions did these theoretical perspectives provide justification for? How and why did a certain form of ‘orthodoxy’ in both theory and practice in terms of cross-border finance emerge and consolidate? How did it evolve over time?

There are four main reasons why the analysis conducted in this book starts with an exploration of these fundamental questions. First, it is necessary to critically unpack the theoretical debates on the management of the capital account and cross-border finance in order to uncover how a number of economic theories and ideas have been instrumental in constructing the question of cross-border finance as a specific development problem. These economic theories and ideas, the chapter emphasises, must be understood in light of material developments in the world capitalist economy. In particular, various rounds of theory-making and adjustments have been profoundly shaped by the syncopated rhythms of global financial capital flows to developing economies and the multiple financial and monetary crises they catalysed. Second, the influence of these economic theories and ideas has been long lasting, and they still significantly frame the terms of the debates about managing cross-border finance in developing and emerging economies. As such, critically scrutinising these theories and ideas is essential to understanding the ideational context in which the recent policy choices regarding the management of cross-border finance were made, in Brazil, South Africa, and beyond. Indeed, as discussed at length in chapters 8 and 9, Brazilian and South African state managers extensively relied upon these theories and ideas as they attempted to justify and provide legitimacy to their policy choices in the post-crisis environment. Third, the theories and ideas discussed in this chapter have provided the ideological basis for a set of policy prescriptions regarding the management of cross-border finance. The emergence and diffusion of these policy prescriptions has profoundly shaped policy-making in developing and emerging economies over decades. The contemporary landscapes of state intervention in cross-border finance must be understood against the backdrop of these dominant policy prescriptions and located within the longer historical trajectory of capital account management in developing and emerging economies. As the book demonstrates, this is key to grasping the nature of the contemporary landscapes of cross-border finance management in emerging markets and the broader transformations of state power of which they are a part. Finally, carefully dissecting these theoretical and policy-oriented debates allows highlighting a number of political issues at the heart of the management of the capital account and cross-border finance. This is despite attempts by the international financial establishment to frame debates about cross-border finance management in highly technical and allegedly neutral terms.

The chapter proceeds as follows. It starts by charting the development of an ‘orthodox’ view on the management of the capital account within neoclassical economics in the 1970s, and how this view provided theoretical legitimacy for widespread capital account liberalisation across the global South in the 1980s and early 1990s. The chapter then discusses how this view – and the associated set of policy prescriptions – evolved in the 1990s and 2000s in reaction to a series of catastrophic financial crises in developing and emerging economies. Next, it provides a review of the critical arguments that were put forward by a variety of ‘heterodox’ schools, including neo-structuralism, post-Keynesianism, statist-developmentalism, neo-developmentalism, and Marxism. Finally, and in light of this analysis, the chapter examines the extent to which there has been a change in thinking and practice about cross-border finance management since the 2008 global financial crisis.

1. The theoretical case for capital account liberalisation in developing countries

The emergence of an ‘orthodox’ view on the management of the capital account can be traced back to a series of theoretical arguments formulated within neoclassical economics in the 1970s. Before outlining these arguments and associated policy prescriptions, it is important to first briefly introduce some key elements of the material context in which they were formulated.

Development strategies of Import-Substituting Industrialisation (ISI), widespread across the developing world since the 1940s, extensively relied on a range of policies of tight financial and monetary regulation and interventionist policies with respect to managing cross-border finance: pegged currencies, differential exchange rate regimes, tight capital controls on both inflows and outflows, administrative price and quantity controls on credit and interest rates, and functional specialisation of financial institutions. Theoretical and ideological justification for those policies, which would later be pejoratively termed ‘financial repression’ (as further discussed later), was provided by both Keynesian and development economics. For the former, these policies contributed to the ‘euthanasia of the rentier’ in order to favour productive capital accumulation and were key tools for the demand-led management of the economy; for the latter, those policies were instrumental for the purpose of carefully allocating scarce domestic savings and resources (Lapavitsas, 2013, pp. 308–309). However, between the late 1960s and early 1970s, a series of dynamics associated with uneven capitalist development on a world scale put those policies under growing pressure. First, the global reorganisation of production, accompanied by the unfolding of a new international division of labour, led to growing imbalances in international payments, which were financed by massive expansion of international credit (Charnock & Starosta, 2016; Clarke, 2001). Second, international credit creation was compounded by mounting global conditions of capital overaccumulation and by the collapse of the Bretton Woods system of fixed exchange rates, resulting in speculative movements of liquidity across the world market. In that context, growing volumes of overaccumulated financial capital flowed into developing countries under the form of syndicated bank loans and public bond issues on Euromarkets (Vasudevan, 2008).

This provided both a constraint and opportunity for national states in developing countries. On the one hand, this made some of the ‘financial repression’ policies previously mentioned, such as pegged exchange rates, more and more difficult to manage (Eichengreen, 1996/2008, pp. 178–179). On the other hand, as ISI growth strategies were increasingly reaching their limits (including a slowdown of economic growth, balance-of-payments problems, inflation, and intense social unrest), national states across the developing world increasingly resorted to large financial capital inflows in order to sustain productive capital accumulation and finance the brutal repression of working-class struggles (Clarke, 1988; Cleaver, 1989). In order to tap into abundant and cheap international liquidity, they started liberalising their financial markets and capital accounts (Eichengreen, 2004; Dunn, 2009). As is well known, this ‘bout of uncontrolled lending in the 1970s and early 1980s’ (Corbridge & Thrift, 1994, p. 13) catastrophically ended up with the Third World debt crisis after the huge hikes in interest rates triggered by the Volcker shock in 1979–1982.

Against this background, a burgeoning neoclassical economics literature set out to theoretically justify the policies of financial liberalisation in developing countries. The seminal contributions of McKinnon (1973), Shaw (1973), and Fry (1982) are particularly important in that regard. Drawing upon the ‘efficient market hypothesis’ (Fama, 1970),¹ they argued that financial repression policies distorted the optimal functioning of financial markets, resulting in the misalignment of financial prices such as interest and foreign exchange rates, the underdevelopment of domestic financial markets, and the inhibiting of domestic savings. While those arguments initially concerned state intervention in domestic financial systems, they were rapidly extended to the management of cross-border capital flows (Painceira, 2012) and would quickly become what can be termed the ‘orthodox’ view on capital account liberalisation.

According to this view, the opening of the capital account and the liberalisation of cross-border finance would bring a series of economic welfare benefits (see Studart, 1995; Eatwell, 1996; Nissanke & Aryeetey, 1998; Singh, 2003; Eichengreen, 2004 for useful summaries of such arguments). First, it would facilitate the efficient allocation of savings across the world economy. Savings, driven by highest returns, would go to those regions, states, sectors, and companies most able to use them productively, which would maximise social and economic welfare. Accordingly, it was assumed that developing countries with high productivity growth would receive large flows, enhancing economic development. This would also increase competitive pressures and allow individuals and firms in developing countries to raise capital at lower costs on global capital markets, diversify their portfolio, and increase risk-adjusted returns. Second, it would lead to the development and ‘deepening’ of domestic financial systems in developing countries, which would provide better funding to the ‘real’ economy. Third, capital account liberalisation and global financial integration would enforce a ‘healthy discipline’ on profligate states in developing countries, because the ‘threat of exit’ would ensure that they implement ‘sound and transparent’ policies. By rewarding ‘good’ policies and punishing ‘bad’ ones, global capital markets would enhance long-term growth and reduce the likelihood of crises.

2. Policy prescriptions about cross-border finance in the 1980s–2000s

These theoretical arguments were then used to justify sweeping financial opening and deregulation in developing countries throughout the 1980s and 1990s, despite early signs of their detrimental effects, as evidenced by repeated financial crises (see for instance Díaz-Alejandro, 1985; Akyüz, 1993/2012 for discussions of crises that happened in Uruguay, Argentina, and Chile). A series of policy prescriptions were pushed by the Bretton Woods institutions (the IMF and the World Bank) in the context of the structural adjustment plans associated with the Third World debt crisis resolution and often welcomed by local ruling elites (Soederberg, 2005). These policies included full convertibility of the current account, a unified exchange rate system, the lifting of capital controls on both inflows and outflows, non-discrimination between local and foreign investors, the opening of banking systems to foreign banks, and domestic financial liberalisation.²

While capital flows to developing countries recovered in the early 1990s – net capital flows reached more than 4% of GDP in 1994 (IMF WEO, 2016, p. 64) – two features of the flows did not fit with what the aforementioned theory predicted, generating puzzlement in orthodox academic and policy-making circles. First, why did so little capital flow from advanced capitalist to developing countries? This question, termed the ‘Lucas paradox’, became the object of intense debates in the neoclassical economics literature (e.g. Lucas, 1990; Alfaro, Kalemli-Ozcan, & Volosovych, 2008; Gourinchas & Jeanne, 2013; see also introductory chapter). Second, why did dramatic financial crises keep happening?³ Those questions did not challenge much the dominant thinking about the benefits of capital account liberalisation, but they did trigger some adaptation of the orthodox policy prescriptions regarding cross-border finance in the mid-1990s. If capital account liberalisation did not yield the expected results, it was claimed, this was due to high corruption levels, the lack of political stability and robust institutions for the protection of property rights, and poor monetary and fiscal management in developing countries. Those views were epitomised by a World Bank report, which argued that for capital account liberalisation to be successful it needed to be accompanied by appropriate supervision and regulation, institution building, and ‘stabilisation and adjustment’ policies (Cottani & Cavallo, 1993).

Capital account liberalisation went apace in the aftermath of the late 1990s crises in East Asia, Russia, Brazil, Argentina, and Turkey, but orthodox prescriptions were further amended. According to the new policy orthodoxy, exchange rates must be allowed to freely float to adapt to economic fundamentals and ‘absorb shocks’, independent central banks must adopt ‘transparent’ inflation-targeting frameworks to maintain price stability and enhance ‘credibility’ and ‘confidence’, and foreign exchange reserves must be accumulated to ‘self-insure’ against sudden capital flight. Nonetheless, some voices within the mainstream increasingly started to challenge the case for capital account liberalisation, especially after the speculative attacks against the European Monetary System in 1992, the Tequila crisis in 1994, and the late 1990s’ emerging market crises. These voices included high-profile economists like Stiglitz (2000), Rodrik (1998), and free-trade apologist Bhagwati (1998). They pointed out that the case for capital account liberalisation was shaky on both theoretical and empirical grounds. There was little evidence that unregulated capital flows contributed to economic growth. Besides, short-term capital flows were destabilising and often triggered financial crises, even when the ‘right’ institutions and policies were in place, because they were ‘subject to asymmetric information, agency problems, adverse selection, and moral hazard’ (arguments summarised in Singh, 2003, p. 196). A series of large-N cross-country studies by other influential neoclassical economists also showed that there was no correlation between net capital inflows and prod...

Table of contents

• Cover
• Half Title
• Series
• Title
• Copyright
• Dedication
• Contents
• List of figures
• List of tables
• Acknowledgements
• List of abbreviations
• Introduction: Emerging markets in a world awash with liquidity
• Part 1 Theory, history, and geography
• Part 2 Case studies
• Part 3 Towards a unified theory
• Appendix
• Index