Financial Globalization and the Emerging Market Economy

Dilip K. Das

• Publisher: Routledge
• Year: 2004
• eBook ISBN: 9781134333165
• Topic: Negocios y empresa
• Subtopic: Negocios en general

The whirlwind of financial globalization has descended upon emerging market economies and rapid change has brought both benefits and problems upon a dynamic group of nations.This book examines the impact of ever increasing financial globalization on emerging market economies, both in the former communist countries of Eastern Europe and the developi

1 The emergence of emerging market economies

1 Financial globalization

Neither the concept nor the phenomenon of globalization, or financial globalization, can be considered novel. Although the contemporary era of globalization is around a quarter of a century old, during the last decade the concept of globalization has acquired a great deal of currency, relevance, acceptance, and emotive force. From an economic point of view, globalization represents a process of increasing international division of labor on the one hand and growing integration of national economies through trade in goods and services, cross-border corporate investment, and capital flows on the other. There is serendipity in globalization, and several emerging market economies discernibly and measurably benefited from it during the preceding quarter-century. According to Horst Kohler, Managing Director of the International Monetary Fund: “This process led average global per capita income to more than triple in the second half of the last century.”¹ That said, there is an imperative need for globalization to be handled in a pragmatic, knowledgeable, clairvoyant and sagacious manner, otherwise its negative effects can seriously destabilize an economy.

Within the neo-classical paradigm, capital flows where its marginal product is higher. As a result, the allocation of capital is more efficient and global welfare is higher when capital flows freely across national borders. As trans-border capital flows increase, economies are progressively integrating globally. The financial structures of economies as well as the world of finance are pari passu changing. This applies to both domestic and global financial markets. A quarter century ago, a businesswoman was restricted to borrowing from her domestic market. However, if she operates in an emerging market economy, several options are presently open to her. For instance, she can choose between issuing stocks and bonds in the domestic or foreign financial markets. She can reduce her cost of capital if foreign currency loans are available at more attractive terms than the domestic loans, and these loans can be hedged by using a variety of financial products. She can also consider selling equity at foreign Bourses, which are far more liquid than the domestic ones.

A functional definition of financial globalization is the integration of the domestic financial system of an economy with the global financial markets and institutions. The enabling framework of financial globalization essentially includes liberalization and deregulation of the domestic financial sector as well as liberalization of the capital account. In a globalized financial environment domestic lenders and borrowers participate in the global markets, and utilize global financial intermediaries for borrowing and lending. Trans-border capital flows tend to integrate the domestic and global financial markets and systems (Das, 2003a). One of the most significant aspects of financial globalization is the rapid expansion of international liquidity. There has been an enormous increase in liquid assets available to global market participants.

Section 2 of this chapter describes the characteristics of an emerging market economy, followed by definitional issues in Section 3. Section 4 focuses on what could be called an absolute pre-condition for the creation of an emerging market economy. Section 5 delves into the domestic and global economic and financial environment affecting the emergence of an economy. The next section explores the macroeconomic factors in the emerging market and industrial economies that shaped the global financial scenario of the 1990s, particularly the events after July 1997.² Section 7 pulls these strands together and is followed by the conclusion.

2 What are emerging market economies?

Although the term “emerging market” is of recent vintage, the phenomenon itself is centuries old. Were all the industrial economies of today not the emerging markets in one period of their economic history or the other? Countries like Argentina, Australia, Britain, Japan, and the United States (US) were all emerging market economies at one point in time. Each of these countries was also among the richest, in terms of per capita income. In the emerging market sense, the US emerged around two centuries ago. After that it did suffer some reversals, yet the US has stood as economic history's premier example of the successful emergence of a market economy to attain the status of a matured industrial economy, having highly developed economic and financial institutions. Argentina is a diametrically opposite case. Around a century ago, when Argentina, Australia, and Japan were emerging market economies, Argentina was the richest of the three by a good measure. However, unlike the other two economies, Argentina failed to complete its emergence process. Australia and Japan did so in the twentieth century. Of the two, Japan emerged as the second largest global economy and has maintained this status to the contemporary period.

First under the sponsorship of the General Agreement on Tariffs and Trade (GATT), and subsequently due to the concerted endeavors of the World Trade Organization (WTO), tariff and non-tariff barriers to global trade have fallen dramatically over the preceding half-century and global trade has expanded. A large number of developing economies launched into liberalizing and deregulating their economies of their own accord in the mid-1980s, during the Uruguay Round period (1986–1994). The Doha round of multilateral trade negotiations (MTNs) is presently (2001–2005) working toward the objective of further liberalizing world trade. Likewise, barriers to global financial flows fell under the direction of the International Monetary Fund (IMF) and the World Bank, as well as because of unilateral measures taken by several developing economies over the last quarter-century. Consequently global trade in goods and services has expanded many-fold, benefiting many new dynamic developing-country traders, and financial globalization has expanded to this sub-group of developing economies. In this macroeconomic and financial mise-en-scène a sub-group of developing economies was able to integrate with the global financial markets, and emerged to join the ranks of the so-called emerging market economies.

The sub-group of developing economies that was able to integrate with the global economy inter alia stood to benefit from well-managed financial integration with the global economy. Financial integration needs to be well managed, because poorly managed integration can result in myriad problems for the integrating emerging economies. The benefits of well-managed financial integration tend to accrue on both the production and consumption sides. Global financial integration provides possibilities for accelerating real GDP growth rate by creating opportunities for better diversification and shifting to riskier but more productive investments. Global financial integration also enables inflows of global capital, including that of foreign direct investment (FDI). FDI is known to augment the total volume of investment in the recipient economy.

Global financial integration successfully severs the bond between domestic saving and investment. Domestic saving no longer acts as a constraint on investment, and larger investment in more productive endeavors becomes feasible. Even when FDI merely substitutes for (rather than augments) capital, it may be more productive than the capital for which it substitutes. FDI has many spillover effects, one of which is to raise the productivity of existing domestic capital. It also allows creation of an improved global pool of risks, making it feasible to shift the investment mix to projects with higher ex ante returns. Global financial integration reduces volatility in consumption patterns by creating opportunities for borrowing from and lending to the global markets, as well as by enabling better diversification of portfolios (cf. Chapter 5).

For the emerging market economies to emerge, a rapid growth rate with an endogenous character is a vitally important condition. Emergence takes a conscious and calculated phased approach. By building the foundation of continued growth in the first phase for expansion in the second, an economy can engender the self-sustaining character of growth. The creation of the necessary institutional infrastructure and its subsequent attainment of maturity will pari passu develop with the sustainable growth endeavors. Second, it is indispensable for the economy to have a high propensity to save and invest for a sustained period. Together these factors ensure a reasonable level of capital accumulation and its efficient allocation. As these economies integrate globally, it will eventually be feasible for them to emerge and qualify for the epithet “emerging market economy.”

3 Challenge of defining

The emerging markets – a transitioning group of economies – are somewhat vaguely and imprecisely defined. That there is a degree of vagueness regarding the concept of emerging market economies has caused amusement in some scholars.³ The countries that coined this expression attach one set of meanings to the concept, while it has different implications in the set of countries for which the term was intended. The latter group thinks of the emerging market economies as a large, if heterogeneous, group with “a well-defined center but a hazy periphery.” These economies are seeking a firmer foothold in the global economy than they presently have. They are endeavoring to go down the matured economy path at a rapid clip, so that they are able to “emerge” as fully-fledged matured market economies in the foreseeable future. As opposed to this, the industrial economies think of the emerging market economies as a country group that is liberalizing its economies, and in the process creating opportunities for the investment of surplus capital from the industrial economies as well as markets for the export of goods and services. In their view, this country group represents the “emergence” of additional demand and new markets.

Kolodko (2002) believes that it is easier to determine which countries are not emerging market economies than it is to determine those that are. Accordingly, the industrial economies do not qualify for the emerging market status, because for them the emergence stage of growth has been crossed and now they are economies with matured market institutions. That excludes all the members of the Organization for Economic Cooperation and Development (OECD) – except for Korea and Turkey.⁴ These are highly developed market economies with matured institutions. The second country-group that is a candidate for exclusion comprises those economies that have not as yet developed as market economies. Should the residual economies be called the emerging market economies? Decidedly not. Of this residual group, the countries that can be classified as emerging market economies are those whose economies are gradually developing and approaching an advanced stage in structural reforms. These countries have been liberalizing their economies for so long that a qualitative transformation in their economies is either about to take place or has already taken place. This qualitative transformation in turn enables them to integrate with the global economy and to take advantage of global factors (particularly capital) and trade flows. Determining the emerging market status of an economy is a matter of establishing the openness and maturity of its institutions, as well as whether the economy in question adheres to the rules, laws and culture of an open-market economy. These considerations make a diverse group of developing and transition economies, with substantial differences in economic histories, candidates for the emerging market economy status.

So far there is little agreement on the country count. In the industrial economies the emerging market economies are thought of as the newly industrialized economies⁵ (NIEs) and some middle-income developing countries. The latter group includes those countries in which governments and firms are creditworthy enough, from the perspective of global investors, to borrow successfully from the global capital markets and/or attract institutional portfolio investment.⁶ Different international institutions include slightly different sets of countries in this category. For example, the Institute of International Finance (IIF) includes 29 countries; five from Africa and the Middle East, seven from the Asia-Pacific region, eight from Europe, and nine from Latin America.⁷

The IMF defines emerging markets as the developing countries' financial markets that are less than fully developed, but are nonetheless broadly accessible to foreign investors. According to the IMF, the term “emerging market economies” refers to “a group of countries comprising developing economies, countries in transition and the advanced economies.”⁸ Since 1997, the following five countries have been classified as advanced economies: Hong Kong SAR, Israel, Korea (the Republic of), Singapore, and Taiwan. Thus, this is a significantly broad interpretation of the term emerging market economies. A glance at various statistical appendices and tables of the IMF publications reveals that 20 countries are generally included in these tables as the emerging market economies. Their geographical division is as follows: one in Africa, ten in Asia, three in Europe, five in the Western hemisphere, and one in the Middle East.⁹

The Economist (2003a) is much more precise, and has classified 25 developing and transitional economies as emerging market economies for reporting its standard weekly tables of emerging market indicators. This classification includes ten Asian economies, seven in the Western hemisphere, four in the Middle East and Africa, and four in Eastern Europe.¹⁰ Only 18 countries are common to The Economist and the IIF categorizations, implying a good deal of diversity in their concepts.

4 The sine qua non for an emerging market

Other than the rapid endogenous growth endeavors noted in Section 2, Sylla (1999) identified respect of property rights and respect of human rights as the basic prerequisites for becoming an emerging market economy. The national government should offer protection to property and human rights of both the citizens of the country and the non-residents alike. An indispensable condition for an emerging market economy is its sustained ability to attract global capital inflows, and only an assurance of protection of property rights will attract global investors. Thus, protection of property rights is a fundamental, non-negotiable condition that an economy must meet before embarking on the road to becoming an emerging market economy.

When an economy has the required quantity and quality of human and natural resources but lacks the third vital ingredient for economic growth, namely capital, it can wait until capital is domestically generated and accu-mulated with advancing growth. The alternative course is to convince global investors of its dormant economic potential. If it succeeds in doing so, the global capital infusion will help to realize the economic potential of the country in a shorter time span than it would take by striking out on its own. Thus, the concept of an emerging market is basically tied up with “arbitraging the difference between a country's current economic reality and its future economic potential” (see Sylla, 1999). However, the recipient economy needs to ensure that global capital infusion results in the mutual benefit of the global investors and the recipient economy. Global investors are rational economic agents and market participants. Only a reasonable certainty of a regular (if not handsome) rate of return on their investment would attract global investors to the potential emerging market economy.

First and foremost, to fulfill the above-mentioned pre-condition, a country needs to have political stability, a structure of credible legal institutions that protect property rights and human rights, and a progressively open and liberal economic system. Statist economic systems are anathema to emerging market economies. Second, a stable currency and a credible public finance system are the basic infrastructure for an emerging market economy. Together they provide a trustworthy means of servicing public debt and make these economies attractive to domestic and global investors, resulting in higher investment rates in the economy. Third, the government should assist its private sector to develop attractive financial asset markets and secondary markets where public and private securities can be traded at market value. Determining and maintaining high regulatory and supervisory norms is also the task of the financial authorities.

When an economy embarks on its goal to be an emerging market economy, in the initial phases assistance from the financial and monetary authorities may also be required in the development of banking and financial institutions. Initiatives by the central banks are generally needed in developing a system of supervision and regulation. Experiences of the preceding quarter-century reveal that once these financial, regulatory, and legal objectives have been achieved and a basic financial infrastructure established, governments should leave the arena for the private sector to get on with the development of the financial sector and, in turn, the economy. Markets should be allowed free play, although on specific occasions governments may take a corrective measure or two. This needs to be done when market failure becomes obvious. Governments must be cautious in not pursuing their own objectives that are incompatible with economic growth. If the market perception of the role of the government is that of an unwarranted interventionist, it will be highly detrimental to the ca...

Table of contents

• Cover
• Half Title
• Routledge Studies in the Modern World Economy
• Full Title
• Copyright
• Dedication
• Contents
• List of illustrations
• Preface
• Acknowledgments
• 1 The emergence of emerging market economies
• 2 Global capital flows to emerging market economies
• 3 Financial liberalization in the emerging market economies: growth, volatility, or both?
• 4 Evolving financial market structure in the emerging market economies
• 5 Financial and macroeconomic instability in the emerging market economies
• 6 Financial globalization and the contagion effect
• 7 Global financial architecture and financial and regulatory infrastructure
• Notes
• References and bibliography
• Index