It is a great pleasure for me to address this conference. Its title "The Global Economy: Three Worlds or One" is both timely and befitting. It takes place in the wake of the major events in Southeast Asia and its worldwide ramifications and at the threshold to the introduction of the euro as the currency of the Economic and Monetary Union.
In discussing the status of the global financial system, the main question I will address is whether the world’s financial system is developing in such a way as to serve an increasingly integrated global economy, or giving rise to such problems that it needs to be changed. I would argue the former but with the important caveat that economic policies are the Achilles heel. I will consider how the benefits of international financial integration in terms of growth and prosperity for the population can be maximized, and the costs and risks minimized, through policies both at the national and international level.
My presentation will first give a brief overview of the globalization of financial markets, how far it has gone and its potential benefits, and then turn to the policy requirements of financial globalization drawing on the lessons from the recent events in Southeast Asia. Finally, I will discuss the implications for international policy coordination and the way forward for the global financial system.
II. Globalization of financial markets
1. How far has globalization gone? The facts
During the last decade, the integration of financial markets has progressed significantly and has helped promote a better distribution of world savings. Let me describe the extent of integration of advanced, developing, and transition economies separately bearing in mind that these are not separate markets but an integrated market.
a. Advanced economies
From the beginning of the 1970s through the early 1990s, advanced countries went through a process of dismantling of exchange and capital controls. This occurred at the same time as the deregulation of domestic financial markets and financial innovations. Moreover, with the improvements in communications, transaction costs decreased significantly. The resulting increase in international capital movements was initially concentrated in off-shore markets and banks but from the mid-1980s in reformed domestic markets and security markets.
As an illustration, cross-border transactions in bonds and equities in the major advanced countries that were less than 10 percent of GDP in 1980 had generally risen to over 100 percent of GDP in 1995.The daily turnover in the foreign exchange market expanded from about $200 billion in the mid-1980s to around $1.2 trillion in 1995, equivalent to 85 percent of all countries’ foreign exchange reserves. Another indicator of the integration of international financial markets is the significant narrowing in the interest differentials between onshore and offshore investments.
b. Developing countries
Private capital flows picked up substantially in the more successful developing countries following the lifting of controls on cross-border flows, especially on inflows. This followed progress in convertibility of current account transactions, which the IMF had strongly encouraged. In fact, 70 percent of all trade flows of developing countries, including most recently that of China, is now conducted under current account convertibility in that these countries have accepted the obligations under Article VIII under the IMF’s Articles of Agreement. Their exchange systems are virtually free of restrictions on current transactions of goods and services and interest payments. The acceptance of the obligations under Article VIII obliges countries to refrain from introducing new restrictions on current payments without the approval of the IMF, thus giving private markets an important signal of the commitment of the governments concerned to maintain liberal payment systems. Indeed, by today 100 developing countries have Article VIII status, more than double the number in the mid-1980s.
Reflecting the liberalization of the economies and the high growth performance and relative macroeconomic stability, capital flows have expanded quickly. In the period from 1990 to 1996, for example, net private inflows to developing countries more than doubled from about $80 billion in 1990 to more than $200 billion in 1996 benefitting particularly equity and portfolio investments in emerging market economies. The share of Asia rose particularly fast from one third of total private flows in 1990 to as much as half those flows in 1996.
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