Don’t miss the latest developments in business and finance.
Home / World News / Globalisation of finance in the recent era
Globalisation of finance in the recent era
A number of offshore financial centers are managing an increasing amount of world wealth as IT and financial innovation have made it simpler to move funds overseas
Financial globalisation has increased massively since the 1990s. The Great Financial crisis of 2008 has stopped that progression. A simple and widely used measure of de facto financial integration is the sum of all cross-border financial liabilities (or of cross-border financial assets), scaled by annual world GDP. As reported in Lane and Milesi-Ferretti (2017), financial integration has risen spectacularly from the 1990s to 2007: cross-border labilities increased from about 70 per cent of world GDP in 1995 to about 210 per cent of world GDP in 2007. The lion’s share of these liabilities (or assets) belong to advanced economies or financial centers. In contrast, emerging and developing economies which constituted about 30 per cent of world GDP in 2007 accounted for only 10 percent of crossborder financial assets. Their economic mass grew remarkably so that as of 2015, the world GDP share of emerging and developing economies was around 40 per cent.
Their share of external assets had however expanded only to 13 per cent. The menu of assets exchanged across borders has become broader with derivatives and asset-backed mortgage securities becoming internationally traded. The share of asset managers has also grown in recent years while global bank flows have decreased. Given these large amounts of cross-border asset positions, the scope for international capital flows to provide welfare gains or to do harm, has therefore, widened considerably since the 1990s.
A number of offshore financial centers are managing an increasing amount of world wealth as information technology and financial innovation have made it simpler to move funds overseas. The data show a massive over-representation of financial centers (compared to economic size) in cross-border asset holdings. As of 2007, financial centres accounted for around 10 per cent of world GDP but over 43 per cent of global financial assets. In 2015, their share in world GDP was down at 8 per cent but their global share of external assets remained at around 43 per cent. Many of the services provided by offshore centres are legal but some facilitate tax “optimisation”.
There is also ground to believe that they ease tax evasion and money laundering. Recent work summarised in Zucman (2018) suggests that wealth held in offshore centres is very concentrated. For example, in Scandinavia, the top 0.01 per cent of the wealth distribution appears to own about 50 per cent of the wealth hidden in offshore financial centres. The emergence of more decentralised means of payments (cryptocurrencies, digital money) may lead to an amplification of this trend, if regulation is not carefully crafted by the central banking community — keeping abreast with the latest technological innovations and monitor these new types of capital flows.
Some of the most widely cited benefits of financial globalisation, enshrined in the psyche of economists and policy makers alike are - risk diversification and better allocation of capital (without restrictions on mobility, capital should flow to places where the marginal product of capital is the highest). Ironically, may be, since they have been very influential in the policy world, those benefits had not until recently been evaluated in a quantitative version of the stochastic neoclassical growth model, which provides the theoretical foundations for them. In a recent paper, I show with my co-authors (see Coeurdacier et al. (2018)) that welfare gains of financial integration due to better risk sharing and better capital allocation are small even for capital scarce and risky emerging economies.
The intuition for these results can be summarised as follows. Relatively safe developed countries have small gains from reducing consumption volatility. They also have small gains due to a more efficient world allocation of capital after financial integration. Emerging countries face higher levels of uncertainty and could have potentially larger gains when they share risk. However, financial integration, by affecting the distribution of risk across countries, also leads to a change in the value of the steady state capital stocks. Unless riskier countries are also capital scarce, they will see capital flowing out as their precautionary savings are reallocated towards safer (developed) countries. When riskier countries are also significantly capital scarce (as emerging countries in the data), the standard efficiency gains driven by faster convergence are strongly dampened by the reallocation of precautionary savings.
Hence the welfare gains are small. This does not necessarily imply that the gains from financial integration are small overall, but it does challenge economists and policy makers to go beyond the classic justifications to open up the financial account which are risk diversification and optimal international allocation of capital. There may be mechanisms through which financial flows improve Total Factor Productivity, for example, in the recipient country. It would certainly be valuable to learn more about those mechanisms and how general they are, in particular, whether they pertain to all classes of capital flows.
(Excerpted from the sixteenth LK Jha Memorial Lecture delivered by Professor Hélène Rey from London Business School. The speech is titled, “National Monetary Authorities and the Global Financial Cycle”. The full version of the speech is available at https://rbidocs.rbi.org.in
To read the full story, Subscribe Now at just Rs 249 a month