Session 8.1-Barbara Stallings

Session 8.1
Barbara Stallings, Globalization and liberalization: The impact on developing
countries, in A. Kohli et al. 2003, p.9-38
Main arguments with respect to the impact of financial globalization:
(1) Globalization (G) has increased the capital available to developing countries,
which can potentially allow them to grow more rapidly than if they relied
exclusively on own resources. However, the increased mobility of capital can also
lead to greater volatility, which is very costly for growth. Short-term capital flows
and the purchase of existing assets are less valuable than investment in new
(2) Capital flows are unequally distributed by region and country, thus skewing the
patterns of growth. There is also unequal distribution of capital within countries
by geographic area, sector, and social group.
(3) The source of many problems resulting from G is local rather than global and
experience shows that “heterodox” policies can be followed (i.e. governments
extracting the benefits of capital flows, while limiting the costs)
(4) Policy changes at the global, regional, and national levels could improve the
overall picture
Components and mechanisms of G – four sets of issues:
(1) Macroeconomics – trade and finance
International trade growth has been dramatic and much faster than GDP growth in the
post-war period. Growth rates of capital flows over the past two decades have outstripped
those of trade. Developing countries have become more integrated into these economic
flows in the past twenty years. Trade G is based on planning and negotiation and has
been closely related to the activites of the WTO.
Private capital flows increasingly dominate over official loans, bilateral and multilateral
loans are still the main type of international financing available to poor countries, and the
conditionality that accompanies them is an important channel for promoting particular
types of economic policies. The World Bank and the IMF have a strong impact on the
behavior and performance of developing countries, which, however, are not wellrepresented in the decision-making bodies of these organizations (thus, the legitimacy of
their decisions can be questioned).
Liberalization of trade and capital flows by developing countries has allowed G to take
place. With the G process under way, further pressures for liberalization have followed.
A key mechanism is that leaders in developing countries came to agree with the types of
policies advocated by the international financial institutions and democratic elections
frequently returned leaders favoring such policies.
(2) Microeconomics – the technological revolution and the production process
Increasing dominance of transnational corporations (TNCs) with access to the latest
advances in new technologies and access to world markets (both desirable features for
developing countries)
(3) Culture and the media – strongly stimulated by the expansion of TNCs, and
particularly the communications revolution
(4) Pressures for democracy and human rights
The multilateral institutions include political, as well as economic, conditions as
counterparts to loans and membership in regional organizations is often conditioned on a
minimal recognition of human rights and democratic forms of governance.
Developing Countries and Globalized Finance
Over the last two decades, there was an increased role for private finance in comparison
to public funds. FDI was considered the least desirable kind of foreign capital in the
1970s because of its negative impact on the balance of payments and the restrictions it
placed on internal decision-making in developing countries. This prompted a shift to
bank loans. Nowadays, however, as a result of changes in economic models, FDI is
considered the most valuable kind of foreign capital, because it is stable and brings
access to markets and technology. FDI accounted for 90% of total private flows in 1999.
A substantial share of FDI goes directly to increase investment in the recipient country
such as building new plants (so-called “greenfield” investment) and this is the most stable
and desirable form of foreign investment.
Short-term capital (“hot money”) has become more prevalent in the 1990s and is highly
volatile. Portfolio equity investments, bonds, and bank loans are also considered more
unstable forms of foreign capital.
Shifting patterns of borrowers: in the 1970-80s borrowers were mainly governments and
state-owned enterprises; in the 1990s they were increasingly large private-sector firms.
1980s: Latin America starved for private-sector funds, leading to an increased role for
multilateral agencies. East and SE Asia continued to have access to private funds.
1990s: Latin America regained access to private finance and Eastern Europe became an
active borrower, sharing the expansion with East and SE Asia; sub-Saharan Africa
continued to draw primarily on official sources and South Asia and the Middle East had
limited access to any type of external finance.
Capital Flows and Growth
(1) Patterns of trade in the 1990s:
Asian developing countries mainly trade among themselves and with Japan, and a
growing investment also came from within the region. In Latin America, trade and
investment weighted heavily towards the US. In Africa and Eastern Europe, economic
transactions focused on Western Europe. As a result, growth rates and policies by region
depended on developments in the main industrialized country trade partners.
(2) Two links between capital flows and growth: through the impact of capital flows on
investment (the crucial determinant of growth in the long run) and through the cycles and
sustainability (volatile capital flows lead to volatile growth and difficulties for stable
macroeconomic policies).
(3) Classic “two-gap” model:
- lack of adequate savings in developing countries to finance the investment required to
attain a desired growth rate – can happen either through large fiscal deficits (that absorb
available credit and “crowd out” private sector investor borrowers) or through
insufficient savings by households and/or businesses.
- lack of foreign exchange to pay for imports of equipment needed for investment in
developing countries; foreign exchange can come from a trade surplus but with low
exports, foreign capital is necessary to fill the gap.
(4) Volatility of capital flows is harmful to growth
In the 1970s, foreign capital often financed government budget deficits and with capital
being rapidly pulled out of a country, deficits had to be promptly cut, leading to a fall in
growth. More recent problem: capital inflows lead to overvaluation of exchange rates and
thus to large current-account deficits that require measures to cool down the economy.
(5) Empirical evidence
There is a positive link between access to foreign capital and higher growth rates.
However, when capital markets close to certain countries/regions (such as Latin America
after the 1980s debt crisis) growth slows down.
(6) Crises – despite the differences between the two cases below, short-term capital flows
were generally seen to be an important causal factor in both (because investors, as a result
of some events/policies, were unwilling to roll over short-term debt when it became due
and followed herd behavior).
Mexico- 1994
In 1992-94 Mexico was running a very large current account deficit, partly caused by a
pegged exchange rate to lower inflation. Much of the deficit was due to imports of capital
goods (which eventually result in higher growth and more exports). A series of political
shocks during the 1994 elections undermined investor confidence and when the
government tried a controlled devaluation of the peso, investors became nervous and
withdrew capital (because the large short-term debt was primarily government
obligations converted from peso debt). A full-blown crisis was averted by a large rescue
package from the IMF and US Treasury. GDP contracted sharply in 1995 and real wages
fell. Argentina, also having a fixed exchange rate, was affected by the Mexican crisis as
investors expected that it may devalue too.
East Asia – 1997
Devaluation in Thailand in 1997 led to extensive capital flight. The crisis spread quickly
across the region to Indonesia, the Philippines, and Korea and necessitated IMF-led
rescue packages. Much of the short-term debt in EA was held by the private non-financial
sector that took advantage of liberalized regulations to borrow abroad.
Capital Flows and Equity
In some cases the link between growth and equity indicators is positive, in others it is
more ambiguous. So capital flows, as far as they may stimulate growth, have uncertain
effects on the distribution of the fruits of that growth. Across regions: nearly 80% of FDI
in 1990s went to East Asia and Latin America, while South Asia and sub-Saharan Africa
received only 5%. There is also evidence of concentration at the country level: in 199097 the top ten emerging market economies accounted for over three-quarters of all FDI to
developing countries (China, Brazil, and Mexico received almost half of FDI).
Calculating FDI per capita also shows great inequality across these regions.
Private capital markets (banks, mutual and pension funds) have an even stronger
preference than direct (FDI) investors for the most advanced developing countries,
commonly referred to as “emerging markets”. To less-developed countries advantage is
the fact that they have been much less afflicted by the international financial crises of the
1990s. Poor countries then have to rely mainly on official capital flows (official
development assistance or ODA) but the volume of these has lagged behind that of
private flows.
Empirical evidence shows that GDP growth is necessary for employment creation and, as
far as financial G promotes growth, this is good for employment (which in turn is
positively related to equity). However, as employment creation has shifted from
relatively well-paid jobs in industry and the public sector to low-productivity services,
the quality of jobs may be negatively affected. A study of nine countries in LA in the
1990s showed that investment was concentrated in capital-intensive sectors with longterm growth potential where not many jobs were produced. Policies that promote both
growth and greater equality are support for small firms, labor-intensive growth strategies,
and investment in education. Regional integration is also positive for growth rates and
can give developing countries a greater say in international negotiations (e.g. trade talks).
Capital Flows and Government Policy Autonomy
Deficits – current and fiscal – are what the markets and IFIs most object to and this is
sound from macroeconomic point of view. Capital controls were used in the past to
prevent capital from leaving a country and enable loose macro policies. More recently,
they have been aimed at restricting the entry of speculative flows and there is now more
openness to some type of controls as a complement to sound macro policy.