Financial Globalisation Essay

Financial Globalisation: Development or disaster? EC414 Lynne Howie 201144880 22nd March 2015 Word count: 2,200 Extensive literature documents the intensely debated topic of financial globalisation, desperately trying to answer the burning question; “is financial integration in an open economy beneficial to a country, or just the creation of a perfect storm?” It would appear that the rather persuasive, logical and rational theory is there but unfortunately for international economists the empirical data is not robust enough to substantiate it. Diagram 1 below outlines the conceptual framework from which this essay will form a structured discussion of financial globalisation before developing a simple model to apply to the Swiss scenario.

Conceptual Framework - Diagram 1

Theoretical Gains from trade Firstly lets distinguish between a ‘closed’ and an ‘open’ economy. Underpinning both types of economy and a key element of the conceptual framework is the existence of a ‘long run budget constraint’ (LRBC).1 A closed economy has no external trading with the rest of the world therefore is constrained by the extent of its own resources.2 As a consequence a closed economy must adhere to a budget constraint upon every quarter. In comparison financial openness and advanced financial systems characterise an open economy allowing it to relax it’s long run budget, only targeting a zero trade balance in the distant future.3 This is conducive to ‘consumption smoothing’, a fundamental theoretical gain from financial globalisation. The long run budget constraint requires the present value of future trade balances to be of an opposite and equal balance. [PV(GDP) + (Wt-1) = PV(GNE)]. Trade with the rest of the world is a defining characteristic of an open economy.

1

2

Investment is financed by domestic saving in a closed economy. A closed economy would be the benchmark for a conceptual framework looking to analyse the gains from financial globalisation. 3

Trade with the rest of the world is a defining characteristic of an open economy.

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Financial globalisation allows a country access to resources from abroad and enhances their ability to finance domestic investment.4 The additional financial capacity allows them to invest immediately, create jobs and reduce macroeconomic volatility. Reallocating future income to the present time period allows the domestic country to smooth consumption over time.5 This attribute can be invaluable to an economy vulnerable to frequent consumption fluctuations by mobilising savings and reallocating capital towards timed profitable projects.6 A linchpin benefit of financial globalisation, outlined by the Neoclassical framework, is the long term capital account liberalisation. (Kose et al. 2006) Investment is plausible reason for a country to engage in financial globalisation, creating new value income streams to improve economic welfare. Access to foreign capital markets could enhance opportunities for domestic growth as capital outflows are directed towards more lucrative foreign assets.7 In addition, the foreign presence often encourages better practises/policies in host country financial markets.8 Insurance is also a theoretical win from financial globalisation, this ultimately refers to the diversification of risk.9 Inter-temporal macroeconomics accounts for the systematic risk at country level. In order to reduce the risk of domestic investments country’s will diversify portfolio’s by investing in foreign assets with the hope of idiosyncrasy.10 The gains from financial globalisation come in the form of reduced macroeconomic volatility and an upswing if net factor income from abroad (NFIA) proves lucrative due to foreign investments.11 Financial globalisation can enhance the international diffusion of technology and access foreign knowledge which facilitates long run growth. Essentially financial globalisation opens the economy’s mind to bigger and better ideas which already exist abroad. With fewer barriers to entry, free movement of capital and trade, countries will imitate and innovate in an attempt to diverge the productivity gap with competitors.12 (Appendix 1) Whether that’s in the form of capital, labour or foreign direct investment these resources could be used to the advantage of domestic firms.Exploiting foreign bank interest rates to borrow affordable, sizeable loans may instigate economic growth for the host country 4

The importance of consumption smoothing is paramount given that in economics we measure welfare more accurately based on consumption volatility rather than output perse. 5

If we take the example of agriculture in Africa where they have great risk associated with external factors e.g. weather influencing crop growth rates. Exposing consumption levels to volatility is likely to reduce welfare and make it more difficult to meet any long run budget constraints. To ameliorate such fluctuations in consumption African farmers could borrow from abroad to ‘tide them over’ in times of drought and hardship. N.B this external finance comes at a price, known as the external finance premium. 6

7

Measured by (return on equity of foreign assets - exchange rate risk) compared to (return on equity from domestic assets).

For instance during the I.T boom of the early 2000’s the US was capital rich and exhausting the dynamics of financial globalisation to invest in foreign projects. The US spotted opportunities for growth out-with the domestic geographical parameters and set their sights on positive NPV projects abroad. This meant capital was flowing out of the country. Due to their financial openness the US was able to sustain a period of current account deficit without compromising their long term budget constraint. 8

Just like a firm, a country doesn’t want to keep all it’s eggs in the same basket,so will tend to diversify risk by investing in foreign countries. In theory we know that if you want to reduce risk and smooth consumption, a country should hold a large amount of idiosyncratic foreign assets. (For more information on risk sharing capabilities through financial globalisation, see Kose, Prasad and Terrones, 2009) 9

N.B there will always be an element of risk associated with labour given that you can’t buy labour. This highlights the limitations of diversification. 10

Apple for example are a highly diversified multinational company selling goods/services and owning assets all over the world. This would only be possible on a country level if they were financially globalised. N.B our focus is not on net factor flows but instead on gross income. 11

12

Economic growth occurs when a country gets better at converting inputs into outputs - imitate the advanced country or importing technology.

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The literature frequently reiterates the positive correlation between an underlying set of initial, favourable conditions and the extent to which a country benefits from financial globalisation.These conditions collectively act to benchmark a ‘threshold’ of macroeconomic fundamentals required to effectively enhance economic growth through financial globalisation. Capital account liberalisation, requires a country to be stabilised upon sound macroeconomic policies and a well developed financial sector. Capital deepening will encourage domestic output and foreign investment to foster economic growth in the long run. Good quality financial intermediaries are important to reducing the cost of capital, improving resource allocation and reduce asymmetric information.13 In order for financial globalisation to flourish, an economy must meet criteria related to ‘absorptive capacities’.14 A minimum threshold of human capital underpins the transmission of technology flows throughout the economy. FDI relies on attractive domestic financial regulations and policies to facilitate direct capital investment.15 Verified by empirical evidence, this requires a conditional level of governance quality in the form of Government transparency, trade enhancing policies and financial sector supervision.16 Limiting corruption, implementing rule of law and extending financial integration have been documented to attract increased flows of FDI.17 (Kose et.al 2003) Empirical literature shows “the main FDI partners of the United States in 2006 include the Netherlands, Bermuda, and Luxembourg, which offered particularly favourable fiscal regimes, although the final investment is likely to refer to an affiliate located in a third country.” (Contessi and Weinberger, 2009) (See Appendix 2, Table 1) On the one hand, economists like Fischer, (1998); Summers, (2000) see financial development as an integral tool for middle income countries to diverge with industrial economies and reduce inequality. On the other hand, papers by Rodrik, (1998); Stiglitz, (2002) would strenuously argue “that financial integration carries huge risks that far outweigh the potential benefits for most middleincome countries” (Kose et al., 2009) (See Appendix 2, Figure 1) Empirical evidence produced by Borensztein, De Gregorio, and Lee (1997) would support theoretical gains from FDI. They highlight FDI as an ‘important vehicle’ for the diffusion of technological innovation by sharing evidence that FDI transfer contribute more to growth levels than domestic investment. (See Appendix 2, Graph 1). The host country has to have absorptive capability and minimum threshold of human capital for diffusion of advanced technologies to have an impact. This evidence aligns with Levine and Renelt (1992) earlier findings of a robust relationship between FDI, human capital and economic growth. (Borensztein, De Gregorio, and Lee (1997).

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Financial intermediaries facilitate the flow of funds between sources and users.

For instance the transferal of advanced technology bares little impact on an economy with low skilled labour and restricted resourcesA certain threshold of human capital, often met by developed economies, helps to harness the effect of FDI inflows and transfers of technology which are a vital component of long run economic growth. 14

It is rational to assume that investors wish to place their money in transparent, law abiding countries with a reputation of good credit controls and a valuably high credit rating. For example an investor is more likely to direct capital inflows towards UK investments over Nigerian investments given the credibility of UK governance vastly outweighs the corrupt reputation of governance in Nigeria. 15

16

Financial sector supervision has tightened particularly in the UK following the banking crisis of RBS in 2008. (See BBC News, 2013)

17

It is important to note that transparency and profound macroeconomic policies have been linked to reductions in the volatility of foreign capital inflows. For more information on the influences on the volatility of foreign capital inflows see (Kose, et. al 2003) paper p.g. 4328

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The literature explains the empirical data on financial globalisation is paralysed by the incompetency to measure ‘collateral benefits’18 - arguably the most important element of financial globalisation and where the benefits accumulate in mass for the economy. The standard regression analysis doesn’t pick up on these particularly indirect benefits. For example, technology and knowledge spillovers, improved managerial practises and export behaviour materialise into increased long run output levels. Findlay (1978) alludes to the ‘contagion effect’ to explain the progressive effect FDI has on the diffusion of technology into the host economy. (Borensztein, De Gregorio and Lee, 1997). Javorcik (2004) uses enterprise-level data from Lithuania in a panel data set to assess productivity spillovers from backward and forward linkages. Her results suggest that, although there are positive spillovers from FDI through vertical linkages, there are few spillovers through horizontal channels.(Javorcik, 2004) Empirical evidence highlights what the theory would rationally suggest. Foreign firms will impose spillovers to improve supply chain and inform customers whilst attempting to prevent horizontal spillovers to competitors.19 The empirical data brings into question the spillover theory so commonly talked about in the literature. Aitken and Harrison (1999) take on firm level productivity in Venezuela only to shine a light on the fact that foreign investment actually lowers the productivity of domestic owned plants. Papers by Borensztein et al. (1998) and Carkovic and Levine (2003) also find that at the macroeconomic level regressions fail to support positive exogenous growth theory stemming from FDI. Where the theoretical literature would suggest holding foreign equity is part of an optimal investor portfolio,20 empirical evidence once again returns disappointing data to highlight an unprecedented home equity bias.21 (See Appendix 2, Graph 2). Kose et al. (2009) examined the promotion of risk sharing through financial globalisation only to find that many of the coefficients (de facto measure) were positive for emerging markets, suggesting a deterioration in risk sharing. They also highlight debt stocks negatively impacted risk sharing whilst FDI and portfolio equity had a positive influence.(Kose et. al 2009) The literature openly associates financial globalisation with the initiation of the recent global crisis by enabling the scaling-up of the US securitisation boom, the apparent trigger for the crisis. These accusations are founded upon the belief that foreign investors were the catalyst of unprecedented growth in credit markets. In addition, financial globalisation also had a central role in the emergence of large and persistent credit growth and current account imbalances across countries. (Lane, P. 2012) The financial crash of 2007 was prolonged and one of the deepest in living history. Some would argue countries absorbed too much external debt, wrapped themselves in FDI flows and when capital assets prices fell, bubbles burst and investors pulled out, currency crises flared and Sovereign debt crises followed. Unsurprisingly this led to the total collapse of many European economies and left financial markets in irreversible turmoil.

18

Collateral benefits - the term given to those indirect gains from financial globalisation.

To prevent horizontal leakages to competitors firms could impose a confidentiality clause on their employees to protect technological developments and firm specific process advantages. Firms want to maintain first mover advantages and firm-specific USPs at all costs. 19

Theory highlights benefits of diversification to reduce the volatility of investor portfolios. Diversify away from risk, spread equity across idiosyncratic systems and achieve a mean return of roughly 11.5% (+0.5% higher than home equity bias.) 20

21

Investors tendency to favour domestic assets can be explained by lack of information or concerns about foreign regulatory regimes and corruption. This underpins the Lucas paradox: why Developed countries do not invest more in developing countries.See (Alfaro, Kalemli-Ozcan and Volosovych, 2003) for more on the Lucas paradox.

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In his paper Bonfiglioli uses de jure and de facto measure to assess financial integration and financial depth. His results show that 4 main findings interesting for this essay. (See Appendix 3, Table 2) The main empirical result of his paper focuses on strand of literature that is to say financial globalisation stemming from a channel of TFP has a more substantial impact than factor accumulation on economic growth. (Bonfiglioli, 2008) Foreign direct investment (FDI) refers to the long standing financial position and interest in a foreign country. FDI flows in the form of direct capital, technology spillovers and importantly the intangibles like managerial skills and production specific knowledge.22 FDI can be gauged against domestic investment. 23 It is an particularly important source of external finance for developing countries. The FDI stock is the capital held in a domestic country by non-residents at any given period; FDIt = Kt – Kt –1

(1)

Foreign direct investment contributes to direct capital resources (capital accumulation) which finances investment opportunities and spurs long run economic growth. FDI may also facilitate the cross-border transferal of valuable technology and knowledge. Applied appropriately, this can enhance total factor productivity.24 Output, often measured as gross domestic product (GDP) is a fundamental contributor to economic growth. The production function for output can be denoted; Y = Z f(Kd, Ki, Ld, Li, ℳ).25

(2)

(Output, composed of factor inputs such as land, labour, capital, technological innovation and entrepreneurship, scaled by total factor productivity.) Total factor productivity (TFP) is the residual factor explaining the divergence between inputs and outputs in production. Sweating inputs intensely and efficiently can exponentially increase factor output. This often stems from FDI, foreign companies impose their know-how and developments on the host country.26 There are various channels of technology diffusion but there is a particular focus on MNC’s. Companies like Apple, Google and IBM act as an imperative vehicles of

22

FDI appears in the balance of payment accounts of a country along with international debt and international portfolio flows.

FDI is knowingly difficult to exclusively define and measure given the cross border differences in statistical agencies. There is often incomplete data sets for developing countries and measurements of FDI may not calculate the full investment in foreign counterparts if part of the project is financed locally. 23

For example if Apple set up Argentina, the diffusion of technology would eventually leak out in domestic firms through vertical or horizontal integration. 24

25

Y - real output Kd - Domestic capital Ld - Domestic labour M - intermediate outputs

Z - scale of total factor productivity Ki - foreign capital Li - foreign labour f(.) - common technology used

To see more about the production function and the components see (Contessi, S and Weinberger, A, 2009 p.g. 67) 26

Vertical integration of technology and knowledge is relatively more common in practise as foreign firms actively pursue suppliers and customers to improve their complementary inputs and services. However horizontal linkages are understandably less common as foreign firms try to restrict the knowledge and development of their competitors. Inevitably a degree of horizontal spillovers will occur through labour turnover and learning - by - observing techniques.

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technological diffusion.27 The resulted growth in TFP pushes the production possibility frontier (PPF) outward.28

(3)

The TFP formula used by Bonfiglioli (2004)

Capital accumulation is the aggregation of human and physical capital. To increase the capital stock (above the level necessary to account depreciation) a country will need to increase savings rates, maintain stable financial systems, minimise corruption and develop strategic growth opportunities, this is where FDI comes in. External resources have been known to pressurise host countries to improve their financial institutions and macroeconomic policies to compete with foreign inflows.

The foundation of this simple model is taken from Bonfiglioli’s paper where she states the formula for capital accumulation; K𝑡 = (1 - 𝒹)K𝑡-1 + I𝑡

(4)

The simple model; Y = a + β₀ FDI + A𝑓(FDI ) + K𝑓(FDI x 𝓧) + ℰ

(5)

This simple model illustrates the statistical interdependence of capital accumulation and TFP on FDI, based on a set of assumptions to suppress the complexity. (See Appendix 3, Table 3) The Swiss Franc (CHF) January 15th 2015, The Swiss National Bank (SNB) removed a cap on the CHF29 and cut interest rates to -0.75% which sent the currency soaring against the Euro (€).This unpredictable move by SNB caught financial markets by surprise and led to huge loses for those bet against a slump, hedge funds and banks. (Inman,P. The Guardian, 2015) (See Appendix 4, Graph 3)

Two important methods of acquiring new technology; imitation and innovation. Imitation although costly, is notably less expensive compared to innovation. The productivity gap is negatively correlated to the cost of imitation and innovation thus developing countries (with a large productivity gap) will have a smaller initial cost to ‘catch-up’ with competing countries. 27

28

Theoretically an outward shift in a country’s PPF symbolises a growth in their output capacity due to technical innovations and process developments. 29

This exchange rate ceiling was imposed in September 2011 at a ceiling of 1Swiss Franc to €0.83 - this was to protect the Swiss exporters from this cripplingly high exchange rate against the Euro given that it exports nearly 50% of its goods to the Eurozone.

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In theory an increase in the price of Swiss exports (Xm) and a fall in the price of imports (Im) will negatively affect the country’s net trade balance (TB).30 Domestic markets are forced to compete against low priced foreign goods and domestic investors will be seeking to capitalise on foreign opportunity (higher capital outflows). As exports become more expensive foreigners are likely to divert spending away from Swiss goods to alternatives. The exchange rate fluctuations entice foreigners to rethink any investments projects, hold back on future investments and extract money from Switzerland in search of higher interest rates. (Herding behaviour) Applying the simple model, it would be rational to think that Swiss output (Y) could fall given the change in combination of factor inputs. The appreciation of CHF against the Single Currency may entice committed foreign investors to pull out of their Swiss projects and convert back to their dominant currency whilst the exchange rate is favourable.31 Having said that, it depends on the initial composition of FDI as to whether these investments are reversible. Capital accumulation (K) is likely to slow as capital inflows are diverted elsewhere given the expense in buying CHF and the unwelcome presence of a negative exchange rate. 32 This fluctuation in exchange rate will affect the variable (X) in the simple model.33 Our expectation would be for FDI to fall in sync with the appreciating exchange rate which would have a negative spillover effect on TFP (A). In conclusion, real output (Y) is likely fall in the medium term as FDI flows adjust, financial markets adsorb these shocks and the productivity gap increases slightly as Switzerland fall behind on the gains from financial globalisation. In conclusion, theory suggests there is more to financial globalisation than meets the eye namely collateral benefits. These include the diffusion of technology through foreign direct investment, enhancing labour productivity and capital accumulation, building up a network of sustainable macroeconomic policies. Induced benefits are not necessary encapsulated in regression frameworks and perhaps time lagged. It would appear TFP has more of an impact on economic growth than capital accumulation, although both important factors augmented by FDI. However the empirical data lacks robust results to support the theoretical benefits of financial globalisation. The research would suggest developed and developing countries react differently to financial globalisation and a set of conditions determines just how much they benefit, if at all.There are issues of endogeneity make it difficult to determine the causality flow and highlights an area of further empirical investigation.34 Moreover, further research could assess the relative importance of the different thresholds conditions and the tradeoffs between them. “Differences in speed and approach to financial globalisation have often been driven as much by philosophy, regional fads, and political circumstances as by economic factors.” (Kose et. al., 2009)

(Xm - Im) is the net factor income from abroad (NFIA). As this falls, gross national income (GNI) declines unless the country’s GDP increases to counterbalance the effect. Baring in mind Switzerland is an open economy, financial globalisation allows them to smooth consumption in the short term and still meet their long run budget constrain despite the blip in current account deficit. 30

For example, if ING invested €2 million in Switzerland in January 2014, their investment would have been worth roughly 2,460,000CHF (rate 1€/1.23CHF). One year later if they sold their Swiss assets the value of their investment would be worth roughly €2,240,000 (rate of 1CHF/€0.913). €240,000 return over one year and that’s without taking into account the profits made whilst the money was invested. ING would be happy to see the Swiss Franc appreciate so quickly and if rational they would pull out their investment. This could cause a ripple effect of other investors following suit and pulling their investments too. This would significantly reduce FDI inflows and cause imbalance in the current account. 31

32

Investors ideally want cheap currency investments for a healthy interest rate return.

33

X included non-FDI variables such as the level of inflation and the black market premium.

34

To determine the weighted average of FDI, TFP and capital accumulation on economic growth would give policymakers more of an understanding of the principal cause could help reallocate economic activity more efficiently and boost long run economic growth.

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Notes (1)

FDI - Foreign direct investment at time t Kt - Capital stock at time t Kt-1 - Capital stock in previous period

(2)

Y - real output Kd - Domestic capital Ld - Domestic labour M - intermediate outputs

(3)

H - average human capital ( as a function of the years of schooling, s) [H = eΩ(s)] L - labour HL - human capital augmented labour Y - real output (K/Y) -

(4)

K𝑡 - Capital stock

Z - scale of total factor productivity Ki - foreign capital Li - foreign labour f(.) - common technology used

𝒹 - depreciation K𝑡-1 - capital stock in previous period

(5)

𝜶 - is a constant over time β₀ - beta defining country specific risk FDI - foreign direct investment flows A - total factor productivity K - capital stock 𝓧 is a controlled variable ℰ is the standard error term

WORD COUNT: 2,200


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References Alfaro, L., Chanda, A., Kalemli-Ozcan, S. and Sayek, S. (2004). FDI and economic growth: the role of local financial markets. Journal of International Economics, 64(1), pp.89-112.[Accessed 18 Mar. 2015]. Alfaro, L., Kalemli-Ozcan, S. and Volosovych, V. (2003). Why doesn’t Capital Flow from Rich to Poor Countries? An Empirical Investigation. 1st ed. [ebook] Available at: https://www.ecb.europa.eu/events/pdf/ conferences/ecbimf/paper.volosovych.pdf [Accessed 18 Mar. 2015]. BBC News, (2013). Banking reform: What has changed since the crisis?. [online] Available at: http:// www.bbc.co.uk/news/business-20811289 [Accessed 20 Mar. 2015]. Bonfiglioli, A. (2008). Financial integration, productivity and capital accumulation. Journal of International Economics, [online] 76(2), pp.337-355. Available at: http://www.sciencedirect.com/science/article/pii/ S0022199608000895 [Accessed 21 Mar. 2015]. Borensztein, E., De Gregorio, J. and Lee, J. (1997). How Does Foreign Direct Investment Affect Economic Growth. IMF Working Papers, [online] 94(110), p.1. Available at: http://www.olemiss.edu/courses/inst310/ BorenszteinDeGLee98.pdf [Accessed 20 Mar. 2015]. Contessi, S. and Weinberger, A. (2009). Foreign Direct Investment, Productivity, and Country Growth: An Overview. 1st ed. [ebook] Federal Reserve Bank of St Louis. Available at: https://research.stlouisfed.org/ publications/review/09/03/Contessi.pdf [Accessed 20 Mar. 2015]. Fisher, J. (2014). FAIRER SHORES: TAX HAVENS, TAX AVOIDANCE, AND CORPORATE SOCIAL RESPONSIBILITY. 1st ed. [ebook] Boston: Boston University School of Law, p.353. Available at: http:// www.bu.edu/bulawreview/files/2014/03/FISHER.pdf [Accessed 18 Mar. 2015]. Inman, P. (2015). Swiss bank’s currency U-turn hurts watchmakers, skiers and traders. [online] the Guardian. Available at: http://www.theguardian.com/business/2015/jan/15/currency-markets-switzerland-franc [Accessed 22 Mar. 2015]. Javorcik, B. (2004). Does Foreign Direct Investment Increase the Productivity of Domestic Firms? In Search of Spillovers Through Backward Linkages. American Economic Review, 94(3), pp.605-627. [Accessed 20 Mar. 2015]. Kose, M., Prasad, E. and Terrones, M. (2009). Does financial globalization promote risk sharing?. Journal of Development Economics, 89(2), pp.258-270. [Accessed 20 Mar. 2015]. Kose, M., Prasad, E. and Terrones, M. (2009). Does openness to international financial flows raise productivity growth?. Journal of International Money and Finance, 28(4), pp.554-580. [Accessed 20 Mar. 2015]. Kose, M., Prasad, E., Rogoff, K. and Wei, S. (2003). Effects of Financial Globalisation on Developing Countries Some Empirical Evidence. Economics and Political Weekly, [online] 38(41). Available at: http:// www.jstor.org/stable/pdf/4414133.pdf?acceptTC=true [Accessed 21 Mar. 2015]. Kose, M., Prasad, E., Rogoff, K. and Wei, S. (2009). Financial Globalization: A Reappraisal. IMF Staff Pap, 56(1), pp.8-62. [Accessed 20 Mar. 2015]. Lane, P. (2012). Financial Globalisation and the Crisis. Open Economies Review, 24(3), pp.555-580. [Accessed 20 Mar. 2015]. Sjöholm, F. (1997). Technology gap, competition and spillovers from direct foreign investment: Evidence from establishment data. Journal of Development Studies, [online] 38(1). Available at: http://www2.hhs.se/eijswp/ 38.pdf [Accessed 20 Mar. 2015]. Stepek, J. (2015). Chart of the day: Swiss franc move stuns the market. [online] MoneyWeek. Available at: http://moneyweek.com/chart-of-the-day-swiss-franc-euro-peg/ [Accessed 20 Mar. 2015].


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Appendix 1 Additional theoretical gains from financial globalisation A theoretical gain from financial globalisation is trade in factor services.35 If British workers repatriate money back to the UK having worked for foreign firms or from investments made abroad, this is accounted as an additional financial resource for the UK. Often understated, net unilateral transfers are an important part of a country’s gross national disposable income (GNDI).36 These non repayable transfers could be philanthropy or foreign aid. Either way they are an additional financial resources, invested wisely by a country they could highlight further gains from financial globalisation. Financial globalisation also opens multinational firms up to an opportunity of arbitrage, on the grounds of tax minimisation. By exploitation of differing fiscal regimes across counties, they use FDI outflows to minimise their corporate tax burden. Take for example the case of Starbucks, Apple and Google.37 These global players are constantly under media scrutiny for apparently ‘rigging’ the cross border fiscal inconsistencies to their advantage - others would simply argue this is a legitimate benefit of financial globalisation.


35

Trade in factor services are effectively compensation for domestic labour, capital or land based in foreign countries.

36

In accounting terms, GNDI minus GNE is known as the current account. (CA) This is simply a balance between savings (S) and investment (I). The current account portrays how much the country is spending relative to receiving in income. N.B gross income streams are important when assessing the current account, not net factors inflows. 37

For more information on Starbucks cross-border tax avoidance regimes see (Fisher, 2014. p.g. 353)

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Appendix 2

Source; (Contessi and Weinberger, 2009, p.g.64) This table shows the largest proportion of US FDI outflows in 2006 to have directed towards the Netherlands and Luxembourg where there was particularly favourable FDI policies.

Figure 1.

This figure empirically confirms that financial integration is particularly important for middle income countries to diverge towards industrial economies. A strong correlation between savings and investments (r=0.61) could identify the welcome effects of capital accumulation. FDI flows allowing saving ratio to increase whilst still benefitting from the economic growth enhancing effects of investment. This approach is termed ‘Feldstein-Horioka approach’

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Graph 1

Source; (Borensztein, De Gregorio and Lee, 1997) Graph 1 shows “countries in the group with the highest levels of FDI and human capital grew, on average, by 4.3% a year compared to those with the lowest levels of FDI and human capital grew only by 0.64% per year on average. The figure also shows that, for a given level of human capital, an increase in FDI raises the growth rates of per capita income, except for the economies with the lowest level of schooling.”

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Graph 2

(Taken from Lecture 6) The actual U.S data in this graph (B) emphasises the stress of the Lucas Paradox. A favourable home bias of investors equity portfolio helps explain why there is a lack of capital flowing from rich to poor countries. There are several factors potentially causing this home bias such as poor information of foreign stocks, poor institutional quality, exchange rate risk, lack of financial stability, transparency and governance.


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Appendix 3 Table 2 Bonfiglioli, 2008

THE MAIN FINDINGS 1

International financial liberalisation has a positive direct effect on TFP especially in developed countries.

2

The direct effect on capital accumulation is insignificant

3

Banking and currency crises generally harm both capital accumulation and productivity.

4

Financial liberalisation raises only the probability that developed countries experience minor banking crises and has virtually no effect on the likelihood of currency crises

5

There is weak support for the hypothesis that financial integration affects productivity and investment by promoting financial depth.

MAIN EMPIRICAL RESULT

Financial globalisation seems more likely to impact long-run growth if it affects TFP, rather than factor accumulation

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Appendix 3 Table 3 Simple model assumptions Produces a single consumption good

𝜶 is a constant across all countries NO cost of technological implementation (machinery, technology, labour training) H (human capital) is a given endowment

𝓧 is a set of variables including income per capita, government size, openness to trade, financial integration, black market premium.

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Appendix 4 Graph 3

Source; Money Week (Stepek, 2015)

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