Financial Globalization

Financial Globalization

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Introduction
Countries of the world depend on each other for various economic reasons. The differences in the levels of dependency are however relative to the status of development that the specific country is exhibiting. Developed nations seek to finance their trade deficits by venturing into developing countries for capital expansion rather than capital aiding the ailing economies of these countries. Capital investment in foreign countries therefore tends to feature a likelihood that will be moving to another developed nation or an emerging market than a poor nation. Financial globalization therefore refers to the flow of capital in its various forms across the different borders of countries in the economic world (Mishkin, 2008, p. 260). Financial experts and theorists believe that the flow of net capital should be from developed to developing countries. This paper seeks to establish the current forms of capital flow and the ideal causes of the differences between developed and developing countries. By way of trade and capital sharing supposed to be same or similar, the differences in the capital flow will be looked at in analytical manner. This will highlight the reason why despite the continuous trade engagements between countries, the level of capital flow has remained low and unpromising as far as the developing world is concerned.
The Status of Financial Globalization
Direct Foreign Investment Policies
Eswar Prasad et al (2007) present the expected view of capital relationship between poor and developed countries. The assertion that capital flow is expected to move from the rich to the poor countries in the investment of physical capital such as infrastructure, machinery and equipment is the expected case of trade. However, the modesty with which this capital is flowing presents a rather practice that is more theoretical than practical. There is a practical outlook at the reasons that may cause laxity in the direct foreign investment in the developing countries. This as stipulated by economic theorists is attributable to the general formation of the economic systems in the developing countries. Inadequacy in infrastructural formations, corruption, illiterate or semi-illiterate workforce, a tendency to a large extent default in the payment of debts borrowed from abroad are some of the causes of laxity in the way capital flows from developed to developing countries.
According to Gourinchas and Jeanne (2007) in their research and findings about the allocation puzzle, there was a conclusive argument that capital flow to the developed world has no direct relationship with the development experienced but contributes to the expected development. There has been however, a growth in the exported capital from the medium growing economies like China and India to the poor countries. Moreover, the developments in research of Eswar Prasad et al (2007) showed that there is a high capital flow to the medium economy states from the developed states because these offer better investment opportunities. As far as Foreign Direct Investment (FDI) is concerned, the financing to the developing countries is far more less than the reversed benefits that are gained by the developed nations. By reference to the current account balances between three groups of countries, there was a wide disparity in the level of balances as related to growth (Prasad, et al., 2007).
The three categories of countries were the emerging markets, the developed and the developing. The current account balances are important because they make an indication in the different between savings and investment. It is assumed that countries that are able to obtain more from borrowing abroad are able to develop more and have positive current account balances (Gourinchas & Jeanne, 2007). This is because they have fewer constraints as far as saving domestically is concerned. The results of the relationship between the amount of borrowing and the relative development showed some very large disparities in the countries future development prospects. The developing countries that heavily relied on foreign aid experienced less growth than those that relied less on the aid. So, is the reluctance in the amount of investments in developing countries a way of making them develop faster? The response to this challenge is all based on the psychological inability to think beyond the individual problems highlighted earlier on.
Countries that are above the average growth rate levels are positively able to attract foreign investment. Those that are above the average growth levels are the countries that are less reliant on foreign engagements in terms of finances. They are developing much faster as a result of self-reliance equally dependent on the ability to have more internal savings and less dependence on foreign aids. The negative savings are related to the weak financial systems in the country. As proof, the United States dollar and the British pound values have remained of high value and this limits the exchange rates of the lower class countries as well as their ability to grow (Prasad, et al., 2007, p. 54).
Capital Flow and Global Differences
Lukas models and assertions on why capital does not flow to poor countries despite there being high levels of investment opportunities are more practical than theoretical. The international economic report (2006) about direct foreign investment showed a very big disparity between the world investment channels. The flow of trade in terms of investment had a very big concentration in Western Europe, the USA and Canada. Minor investments included japan and china and the range of the amount of money flow to these two countries was a paltry $500 billion. As compared to the developed world, the range of trade was able to hit a high of $1 trillion. The investment to poor countries in Africa was in some cases negligible although the biggest range was less than $500billion and this took a little concentration to South Africa Nigeria. This established an open fact that direct foreign investment is only happening in countries that are considered to be industrialized where the returns on the invested capital would be better. In the same year 2006, the development of the business in the world were all based in Europe and America and if an outside country was concerned, it had to from the emerging economies such as China and Korea. Emerging economies such as China on the lead, Brazil and Mexico are countries that are all considered for investment (Alfaro, et al., 2008, p. 347). The existence of vertical FDI and horizontal FDI was the hallmark of investment during that period. The proportionality in between the vertical and horizontal FDI was very sound. The report had a high value of horizontal FDI as compared to vertical FDI where the investment was in between the developed world and the developing world. The reason that was stated for the laxity in the low levels of investments was the low wages on the investments. The changes that occurred at this moment are therefore as a result of the volatility of the trading conditions in these countries, continuous cyclical changes in the consumer preferences largely to lower quality products because they cannot afford the products at their retailing prices in the market.
The Influence of the Crises
A World Bank report of 2005 reported several crises that have shaped the direction of the world market and investments. These crises range back to the times when there was the world war to the present time financial crisis and the bubbles that erupted in the USA and spread all over the world. However, fundamental crises that occurred from around the 1970s were significant in changing the flow of world capital. The risks can be classified as first generation crises of the 1970s, the second generation crises of the early 1990s and the third generation crises that happened in East Asia in the late 1990s. The first generation crises happened in America and were mainly in Argentina, Mexico and countries that neighbour these in terms of their economic abilities. It was all about the classical policies in exchange rate systems.
The second crisis happened with drastic effects in Europe and was associated with multiple equilibriums. The third crisis was about the integration of the exchange rate crises and the banking crises. An exchange rate crisis can be defined as depreciation. The depreciation mostly occurs in the stability of the currencies of the different parts of the world. However, there are very big differences in the rates of depreciation that would be considered as fatal (Ju & Wei, 2006, p. 8). This is because a depreciation that would be fair to a growing economy would be considered fatal in a developed economy. In recent years coming to the year 1992, there were drastic drops in the European currencies with the Finnish Markka dropping by 25% and the brutish pound dropping by about 10%. In analysing the effects of the crises to currency, the idea would be to evaluate the relational effects both to the developed world and the developing world. Maurice Obstfeld and Alan Taylor (2007), assert that the effects of the crises are going to affect developing markets by well over two to three percentage points higher than it does on the developed markets. In terms of the timespan, it also takes an extent of two to three years to mark the end of the effects in the developing countries. The developed world experiences an almost immediate increment in the levels of recovery and is able to pick to normalcy as soon as possible. The emerging markets are able to experience a percentage that is well between the developed and the developing world in terms of effects and recovery. Banking crises often affect developing markets and are able to cause insolvency of banks as well as closing down of the banks or being declared bankrupt. In the public sector, the government may default in paying debts to other countries and this would be referred to as a sovereign debt crisis (Reinhart & Rogoff, 2004, p. 53).
The differences that occur among the banks interest rates also vary depending on whether the economic cycle is to favour the developing, emerging or developed countries. In many cases, the rates are all of negative effects to the developing countries and are able to be considered a turn-off to the prospective entrepreneurs and the capital inflow from the developed countries. In developed and emerging markets, the risk premiums that occur are always compensated if they have any effect on the investor’s capital. This however is a stark contrast to the weaker economies since the banks are in fact left in dire situations that call on the investors to look for alternative means of trying to make amends to save them from insolvency or bankruptcy. Therefore, due to problems of credibility, there are greater shocks in the interest rates in the developing and emerging markets than there are in the developed world. Therefore, there is always fear of having to salvage situations in the developing markets as opposed to the developed markets. The investors are the owners of capital and the decision on where to invest are triggered by prevailing market conditions which mean that such unfavourable rates are all put to scale. It might be less risky to make investments in the developed markets where there will be little effects on the crises as opposed developing economies where the crises are very fatal. Argentina and Mexico are emerging markets.
The tequila crisis that occurred in 1994 had its own implications on the economies of this region. There were high interest rates, deficits in the banks budgets and adverse damages to the balance sheets of commercial banks. The countries were in a financial crisis. The national central bank reserves were drained, the currency premium was raised. The liquid assets in were then revalue in terms of dollars and they were then moved to locations that were offshore. To alleviate the crisis, there was assistance from the international; monetary fund (IMF) and the USA. This made the economy to recover, capital flows to resume and two years later in 1996, the whole economy was revived (Bartolini & Drazen, 1997, p. 140). This is according to economic theorist’s research which asserted that the economy takes at least two years to pick to normalcy and the effects are usually 2%-3% more severe than in the developed world. The general knowledge in the developed world is that problems i8n the developing world does occur because the authorities allow them to occur. The persistence of these problems is also related to the authorities’ complacency in trying to handle them effectively. The introduction of use of terms like myopic cases results in the inability to enact consistent economic policies that are supposed to alleviate situations.
Crises therefore do occur but from the cases above, it is quite noticeable that the ways of handling them as far as the different countries and economies are concerned are different. This has put a lot of insinuations in the way the devel0ped world portend their financial aid to the developing and emerging economies (Anon., 2001, p. 31). the ability of the developed world to make compensations to the investors at a time when there is a crisis in their countries further pushes more investment aid to the developed than developing countries. The real risks in the financial systems of the countries that are in the developing category are of sound importance when aid is given to the countries for their own development. It is therefore not easy to invest in a risky place knowing the grave consequences that are imminent. The debate is all about little investor shocks in the developed world in case of crises as opposed to the existence of the same in the developing world.
Influence of Capital Markets
The cobb-Douglas function initiates differences in the way a market is provided with enough, certified and qualified labour. There are comparable differences in the productivity level of citizens of different countries. Robert Lucas (1990) in an analytical review of the abilities of qualified workers in the different countries provides that a worker at the same level of qualification in a developed and a developing country do not have the same level of productivity. He asserted that the levels of qualification are all dependent on a high level of systematic training and the worker from the developed country is supposed to be more skilled than the other from the less developed country. To prevent issues to do with outsourcing, it becomes economical to invest in a country that already has enough and qualified human resource development so as to minimise on the costs of production. With a stable and available market, the ability to make management more productive is simpler in the developed world than the developing world (Lucas, 1990, p. 93).
Labour force and the unionized reforms is an issue that is supported by Taylor and Obstfield in their search for differences in creation of capital markets among different countries. They cite labour markets, trade (commodity markets) as having undergone changes in the current economic world in two phases after the year 1800. The first phase ended in 1914 at the onset of the first world war and the second rather revolutionary phase happened to 1945 during the second world wars. These phases started defining differences in the way different countries managed to start and manage their resources. There have been a lot of changes in the labour qualifications mostly favouring the developed world at the expense of the developing world. Creation of policies either based on sustenance of the market artificially or the leaving of the markets to take a super turn which would be natural is an issue of great concern. There are usually so many risks in the markets and the idea of effective capital markets is to alleviate this. Global capital markets are usually in place to make sure that the risks are insured against (Demetriades & Bassam, 1999, p. 781).
Countries that have income risks that are imperfectly correlated are allowed to trade them through the global capital markets. This is also meant to make a reduction in the high variability in cross sectional consumption levels per capita. Countries that are poor and economically unstable would always want to borrow from the capital markets so that they increase the efficiency of their market productions. This happens when the individual state income levels and also fluctuation levels are predictable. Moreover, the global capital markets instil discipline ion governments and make them compel their business expatriates to avoid issues of economical moral hazards. Such hazards may include the financial practices that are lax and carried out by the financial intermediaries domestically. This is where the problem of management comes in especially in the developing world. This is the practices are done through corruptible ways that tend to favour and be based on the mutual benefit to individuals.
The lawmakers are able to enter into malpractices that will be bent on favouring their business ventures and in the end the entire economy suffers risks that are based on moral hazards by individuals and economic financial intermediaries. The global capital markets put a check on such practices and make sure that the markets are effectively functional. However, market discipline through global capital markets is not sufficient enough to clean moral hazards in the market. This is very rife in the developing world that is packed with poorly instituted policy behaviours. When such malpractices occur, the global capital market is able to instil very severe punishments to the entire markets. With the rules of law in the developing world especially Africa favouring the political elite, there is bound to be changes in governance that will impact negatively on the way the economic issues will be run (Kose, 2009, p. 555).
The capital markets cannot therefore punish a new regime as a result of high moral hazards that was in a previous government. Moreover, when there is a bad regime history in a developing country, there is bound to be a referral from the developed world to that specific issue if it ever happens in that developed country. This is because there may be lack of historical facts to support or dispute the viability of the malpractices being done. So to solve the issue, there will be a reference to the developing country that experienced the same. Capital transactions these days seem to be a rich-rich affair. Instead of the rich countries developing the capital to expand to other bases of the economic cycle (the poor), all they do is diversify it so that it is in circulation among the poor countries. This diversification has been relevant from the early leaders in the different worlds. Taking labour market for instance, the global capital has always been chasing the labour in its migratory routes. The labour has always been an efficient one and it has to be sourced from its origins (Mishkin, 2008, p. 264).
The inflow and outflow of capital therefore to any place has to chase the available efficient labour that would use it effectively for efficient productions. The capital therefore follows the availability of effective integration of the world market of labour, its migration policies and the migration flows. Countries that are poorly instituted with the operation of the world capital markets are always in a position to find their domestic investments under constrain with the domestic savings and a poor coefficient near equity in the market would be realized. Therefore, the world financial globalization has been restricted by the rich countries, a small section by the emerging markets and the rest of the countries are totally left out of the scheme. It is therefore evident that capital markets include some countries and leave out others. For the reasons give3n, it would be very impossible for there to be capital globalization with inclusion of the poor countries since they are not able to cope up with the conditions of effective market economies. The economic opinions on the viability of capital markets in the development of international trade in which there is financial globalization have been purely varied. With the different notions about the development of the third world countries, their integration into the market is a tough issue and sending capital for their development is equally complex.
Servicing Debts
Hampering of financial globalization has been effective in the development of the lending and borrowing of capital for development projects. Countries are able to borrow in times when there is a lot of need is very relevant in the making of a relationship between trading countries. Long run budgets make countries to be forced to live within their means. There are several ways of servicing debts that have been incurred. One of them is by direct servicing and the second is by neither interest nor principal are paid back. In this regard, there are several possibilities of being considered a defaulter in the international community of traders. Such a case is not sustainable and would be called a roll over case. In such cases, there are countries that are very small economies and cannot therefore influence prices in the world market. For such a country to attract the collection of investors and states that are able to ascertain its credit worthiness may not give it hope in the financial. Such countries do not have future prospects in the creation of wealth. The leadership of such countries are also corrupt and accumulate all the wealth for their personal and elite gains. With such history, and with the monitoring units of the world economic experts, there is not bound to be one investor who would be willing to venture into such markets for investments. When a country borrows from any external source, the debt must be paid off at any cost (Mishkin, 2008, p. 262).
The country would run into a big deficit if it suffers a crisis and some of the conditions are that it must satisfy the annual increments in the rates of interest. At the end of some period into the future, the ability to pay may fail off and the country request for the debt to be written off. Such historical reasons do not auger well with the development of financial flow of income to the nation in later transactional sessions with the rest of the world, especially the developed world. Since economical laws indicate that a country’s expenditure is directly dependent on how much it produces, it is therefore inevitable that the country will resort to borrowing especially if the economic conditions are not supportive enough.
Rich countries like the USA are rich enough to be considered to have exorbitant privileges and are considered net debtors. With the tough laws in the internationalization, the net factor income from abroad in the United States has always been in the positive position for long enough to declare such an economy rife enough to be a safe haven for investors. Richer countries such as the United States borrow very low and lend very high and are able to be positively relevant in the market. The risks of investing in such countries are very low and will remain at a minimum as long as the United States remains as rich as it is. Lack of financial openness in the financial sector is also a source of problematic hiccups as far as levelling the size of the market is concerned (Gourinchas & Jeanne, 2007, p. 7).
Conclusion
To the extent the world economy has come, there are several ways in which the third world countries are disadvantaged. There is a long way to go in trying to alleviate the huge disparities in the financial disparities as well as reducing the gap between the developed and the developing countries. This paper has analysed the causes of the existence of large differences between the developed and the developing countries. It has looked at the influence on investment as described in the Lukas paradox, the exchange rate crises and the risks involved between the developed and the developing countries. The influence and ability of a country to depend on itself is as a result of being self-sufficient in production. The production is all dependent on borrowing if it cannot fully satisfy its own populations. Therefore, global savings are important in making such ends meet as discussed in the paper. The paper has also discussed the influence of capital markets in influencing financial globalization. Internal moral hazards are all important in making sure that the Country is positively attributable in the world capital markets.

References
Alfaro, L., Kalemli-Ozcan & Volosovych, S., 2008. ‘Why Doesn 't Capital Flow from Rich to Poor Countries?. Review of Economics and Statistics, 90(2), pp. 347-368.
Anon., 2001. chang; Velcasso. Quarterly Journal of Economics , 45(7), pp. 23-40.
Bartolini, L. & Drazen, A., 1997. Capital Account Liberalization as a Signal. American Economic Review, 87(1), pp. 137-154.
Demetriades, P. & Bassam, A., 1999. ‘The South Korean Financial Crisis. International Affairs, 75(4), pp. 779-792.
Gourinchas, P.-O. & Jeanne, O., 2007. Capital Flows to Developing Countries, Washington: IMF.
Ju, J. & Wei, S., 2006. A Solution to Two Paradoxes of International Capital Flows. IMF Working Paper, 06(178), pp. 06-13.
Kose, M., 2009. Does openness to International Financial Flows Raise. Journal of International Money and Finance, 28(4), pp. 554-580.
Lucas, R., 1990. Why Doesn 't Capital Flow from Rich to Poor Countries?. American Economic Review, 80(May), p. 92–96.
Mishkin, F. S., 2008. ‘Is Financial Globalization Beneficial?. Journal of Money, Credit and Banking,, 39(2-3), pp. 259-294.
Prasad, E., Rajan, R. & Subramanian, A., 2007. The Paradox of Capital. Financial Globalization, 44(1), pp. 54-65.
Reinhart, C. & Rogoff, K., 2004. Serial Default and the “Paradox” of RichPoor Capital Flows. American Economic Review, 94(2), pp. 53-58.

References: Alfaro, L., Kalemli-Ozcan & Volosovych, S., 2008. ‘Why Doesn 't Capital Flow from Rich to Poor Countries?. Review of Economics and Statistics, 90(2), pp. 347-368. Anon., 2001. chang; Velcasso. Quarterly Journal of Economics , 45(7), pp. 23-40. Bartolini, L. & Drazen, A., 1997. Capital Account Liberalization as a Signal. American Economic Review, 87(1), pp. 137-154. Demetriades, P. & Bassam, A., 1999. ‘The South Korean Financial Crisis. International Affairs, 75(4), pp. 779-792. Gourinchas, P.-O. & Jeanne, O., 2007. Capital Flows to Developing Countries, Washington: IMF. Ju, J. & Wei, S., 2006. A Solution to Two Paradoxes of International Capital Flows. IMF Working Paper, 06(178), pp. 06-13. Kose, M., 2009. Does openness to International Financial Flows Raise. Journal of International Money and Finance, 28(4), pp. 554-580. Lucas, R., 1990. Why Doesn 't Capital Flow from Rich to Poor Countries?. American Economic Review, 80(May), p. 92–96. Mishkin, F. S., 2008. ‘Is Financial Globalization Beneficial?. Journal of Money, Credit and Banking,, 39(2-3), pp. 259-294. Prasad, E., Rajan, R. & Subramanian, A., 2007. The Paradox of Capital. Financial Globalization, 44(1), pp. 54-65. Reinhart, C. & Rogoff, K., 2004. Serial Default and the “Paradox” of RichPoor Capital Flows. American Economic Review, 94(2), pp. 53-58.