The shaky stability of financial globalisation

The process of financial globalisation has come under intense scrutiny following the economic crises in emerging market economies (EMEs) in the last decade. A fairly substantial body of theoretical and empirical literature exists on the subject.

The scope of the debate ranges from the pace and sequence of financial integration to the larger issue of the capabilities of EMEs to adapt to globalisation, and the benefits likely to result from such integration.

At the same time, the role of multilateral institutions, principally the International Monetary Fund (IMF), in guiding the EMEs through the crises, has also been reviewed closely. Padma Desai explores all these issues and more.

Desai studies the undercurrents of the dynamics dominating the global economic scenario in the 1990s by analysing the economic performances of the G-3 (US, Euro Zone and Japan) during the period.

The analytical framework relies on a basic "core-periphery" relationship, through which the author aims to assess the nature of forces emanating from the "developed centre" and casting their influence on the relatively less developed "periphery", comprising the EMEs.

In the course of the theoretical substantiation, Desai moves from the G-3 to the Asian meltdown, and the Russian, Turkish, and Argentinean crises respectively. The final focus of the author is on the role of the IMF in crisis resolution and the future agenda for global financial reforms.

One of the main conclusions that Desai reached relates to the differences in the abilities between the G-3 itself in mitigating recessionary conditions and associated economic difficulties.

The US economy, according to Desai, is superior to its developed counterparts in fighting both exogenous and endogenous disturbances on account of its more efficient institutions, well-reformed factor markets, and the proven ability to increase productivity through innovations.

Similar conditions necessary for sustaining high rates of growth, or mobilising the impetus for overhauling depressed economic fundamentals, are missing from large parts of the Euro area and Japan, the author says.

The US economy has for long been regarded as the main driver of global economic activity. Its significance in determining the buoyancy of global trade and output growth became well established during the 1990s, when the US economy enjoyed an unprecedented phase of economic expansion.

This was also the period, when integration of global financial markets occurred at a rapid pace, enabling the peripheral economies to obtain the benefits of a robust US economy and enhance their own economic progress.

The high growth of the US economy had much to do with the intrinsic strengths to which Desai refers. Nevertheless, in more recent years, the widening trade and budget deficits of the US have raised questions regarding its medium-term macroeconomic management.

Besides, there are serious concerns over the likely impact of these imbalances on the financial markets of a highly integrated world economy. Desai appears to have devoted relatively less attention to this issue.

The author has analysed in detail the issues and policies, that led to the outbreak of the financial crises in East Asia. Desai attributes the difficulties that these economies faced to short-sighted economic policies.

Foremost among these, according to the author, are the aggressive exposures to volatile short-term capital flows. Banks and financial institutions in the crisis-affected East Asian economies, after mobilising large volumes of short-term portfolio funds, were noted to have lent out long in dubious investments.

The inevitable result was a collapse of the domestic financial architecture once the flows reversed direction.

The author narrates the course of events in careful detail and also analyses the fundamentals in various crisis-affected economies. Despite there being a vast body of literature on the subject, Desai's elaborate analysis offers several fresh insights.

The author discusses in detail the policy issues that have gained prominence in the context of global financial instability and focuses on the future agenda for crisis prevention.

In this regard, she expresses doubts over the ability of the emerging market economies to adapt to floating exchange rates and independent monetary policies, given the relatively limited success of their more advanced counterparts (the Euro economies and Japan, for example) in doing so.

Desai is also critical of the IMF's management of the economic crises and the policy prescriptions provided by the Fund for bailing out crisis-affected economies.

Pointing to the IMF's insistence on fast removal of capital controls as the main reason behind the financial instabilities in many countries, the author mentions that even after the crises, the IMF hasn't been able to inject new inputs into its diagnoses or prescriptions.

A fluent style, firm narrative, and the author's commitment to a macroeconomic perspective of the issues involved in crisis outbreak and management, make the book not only interesting, but also a significant addition to the existing literature on financial crisis.

In spite of there being occasions where one might differ from the author, her clarity and grasp of the issues make the book a recommended read.

FINANCIAL CRISIS, CONTAGION, AND CONTAINMENT
From Asia to Argentina

Padma Desai
Oxford University Press
Price: Rs 695