The process that widens and intensifies the global linkages of trade and finance is economic globalization, and the globalization is associated with the benefits on an international scale. The major source of economic growth is the international trade and with the availability of new capital, modern technology, to the developing countries, consumers around the globe are benefited from good qualities and lower prices. The international allocation of the resources became more efficient; morever globalization has led to the beneficial effects of competition that can increase production and efficiency. (Friedman, 2000; Micklethwait and Wooldridge,2000). There are equity problems in the distribution of gains from the globalization among individuals, organizations, and nations. Rich nations and individuals are gaining resulting in greater inequalities. The major driver for the acceleration of the global economic integration is the international capital movements, and there is a clear visibility of the market failures associated with it. Asymmetry of information and the tendency of higher risk and volatility are hidden in the capital markets and became more serious with the internationalization of markets. Globalization is prone to triggering of instability, currency crisis in the emerging economies in addition to the increasing dangers in the world deflation, recession and depression. (Bhagwati, 2002; Stiglitz, 2002; and Sullivan, 2002). The current study deals with the extent and implications of the current economic globalization and some of the adverse implications of the financial integration of the world that include an increased risk in the international markets as well as deflation in the world economy. In addition to this the study also discusses the crisis of the emergent economies and the crisis prevention measures that include new and careful approach to financial deregulation and the creation of new financial structure.(Bustelo and Olivie,1999).
Implications of the economic globalization
Globalization intensifies and widens the international linkages in trade and finance, and there is an increase in the international trade, foreign direct investment and capital flows. Even though there is a growth in the foreign capital inflows, major part of the world investment is financed domestically. International movements in terms labor and capital are more intense and the ratio between the international trade and the world output has increased. Technological changes, improvements in transport and telecommunications as well as the surge of the quickly moving capital and the rise on the third world exporters are the new phenomenon for the acceleration f the global economic integration. The process of globalization is asymmetrical and the rich countries and privileged sectors are more benefitted. (UNCTAD, 1997). The trade liberalization for the competitive products from the developing countries is slow and the capital movements in the advanced countries with advantages have increasing mobility. The divergence of the per capita income between the developed and developing economies has increased, and the growth is not enough to generate more jobs on a global scale which has reversed the tendency to poverty. There is a preeminence of financial activities over the productive industrial activities and the share of the returns from the capital has increased in the total income in all the countries. There is a growing inequality between the workers who qualified and non -qualified, and this has been followed by the reduction of the middle social classes. There is an increase in the income and job insecurity.
However, there are advantages with globalization as there is consolidation of the foreign trade as the major driver for growth in the developing and developed economies and the organizations have more export opportunities in the world market. Globalization has enabled the increasing availability of the external funds as well as the imported technologies to the developing countries, and the increase in the international trade benefited the consumers with lower prices and good quality. Awareness among the common people has increased regarding the domestic implications of the trends of the world economy.
Rodrik (1997 and 1998), states that globalization has some disadvantages for the developed industrial economies that include the shift of balance of power from the workers to the employer, undermining of the established social norms such as the rights of workers and the difficulty for the governments to increase the taxes for social spending as there is a large mobility of capital and skilled labor. Globalization is not the sole reason for an increase in unemployment, inequality and deindustrialization in the developed economies. Least importance has been given to the low cost imports from the developing countries combined with the relocation of manufacturing activities towards low wage economies to explain the increasing unemployment. The tendency of inequality is associated with the increasing gap between qualified and non-qualified workers which is the result of changes in technologies. Deindustrialization is attributed to the gains in productivity that has outpaced the growth of production in the manufacturing activities in contrast to that happened in the service sector. Globalisation has enhanced inequality in the developing economies and increased relative poverty in the developing economies that was used by the governments of industrialized economies as an evidence to close their markets for the exports of the developing countries in order to enable structural adjustment of the programs of the developing countries.
The net capital inflows to the developing countries has increased, however, they are not sustainable in nature and are prone to sharp reversals. (Lopez-Mejia,1999). The composition and the destination of these capital inflows have undergone a considerable change and the bank lending as a major source of finance has been replaced by the direct and portfolio investments. Major part of the cash flows that were received earlier by the public sectors in the developing countries has been replaced by the private agents. This is the major cause for the instability of the capital inflows to developing countries and there is a reduction in the official development assistance in real terms. The inherent instability in the flows of the international portfolio can be explained due to various reasons. To avert their individual risks, investors prefer high liquidity and rapid exits and they invest in quoted securities in order to roll over short term positions. The investors choose to reduce the risk and diversification rather than more information and control. Due to a high competition between the funds and clients, investors offer the clients a high risk and high yield placements. (FitzGerald, 1998 and 1999).
Negative effects of the economic liberalization
There are two adverse consequences of economic liberalization that include a risk and volatility problem associated with the asymmetric information, weak enforcement of contracts, increasing use of derivatives, as well as the leveraged operations by the institutional investors and the deflationary bias problem that is imposed on the real economies by the expectations of the financial agents.
There are two contradictory views on the risk and volatility problem, the conventional theory argues that there will be a reduction in the risk and volatility with the liberalization and internationalization of capital movements. The risk is measured by the risk premium and there should be a fall in the effective interest rates following the liberalization of the capital markets. (Stulz, 1999).Liberalization enables the capital suppliers to access a large number of possible investments and by means of diversifying the investments, risks can be reduced on each one of their projects and the overall volatility. The internationalization of capital inflows is another thought that argues that internationalization of the capital flow results in high risk and volatility. With the globalization of the financial markets, the inherent distortions in the financial markets will be intense. Hermalin and Rose (1999) argue that there are two distortions that include asymmetric information and the enforcement of contracts. The asymmetry of information emphasizes that information available in the financial markets is not perfect and it is unevenly distributed among the agents as in any lending contract the borrower is better informed of the expected return of the project that the borrower intends to borrow than the lender. This lack of information implies a cost of the lender. The problem associated with the enforcement of contract is the institutional and legal environment in which the financial contract is signed and the cost associated with this problem is higher in the weaker institutional and legal framework. In both the situations the lender has two options; the lender can spend an additional amount of money to get the information on expected returns on the borrower’s project as well as the institutional framework in which the lender operates. The lender can also simply run on a higher risk. However, in both the cases, the result is a higher interest rate and this increase in the interest rate will be higher in the case of more asymmetry of information and the weaker institutional framework. These two problems become more pronounced when the domestic financial market becomes internationalized. The asymmetry of the information will be wider when the lender and borrower belong to two different economies and the lender gets lesser information about the borrower from the international market than the borrower from the local markets. In the enforcement of contracts, the transaction cost increases when the lender collects the information in a different legal framework and the risk and volatility associated with the financial operations will be higher in the global markets than in the financial domestic markets. As per the argument of the conventional theory, there will be a reduction in the risk only when a certain amount of resources are spent to keep the asymmetry at the same level as it was before and the amount of resources required to maintain the same level of asymmetry will be higher in the global markets. In addition to this, there are unknown borrowers that operate in unknown institutional and legal contexts in the global markets. Investor generally prefers to spend a small amount of resources in getting the additional information and choose for short term placements in such a way that they will be able to withdraw their investment in case of trouble. In industrialized countries, volatility in exchange rate, bond yields and stock markets has featured a little change and there is a higher volatility in stock prices in the emerging markets. (Eatwell,1996). The increasing risk of volatility in the global financial markets is due to the role played by the institutional investors such as in creating hedge funds, pension funds, mutual funds and so on. Leverage operations are displayed by some institutional investors which are highly risky and add high volatility to the financial system. (Das, 1998; Reisen, 1999).
Another most important negative effect of the globalization of the financial markets includes the deflationary bias that can be imposed by the financial markets on the real economies. The international financial agents set certain behavior on the government, if there is a benefit to the economy due to its higher activity, the financial agents expect a future rise in interest rates and this will result in a rise in the long term interest rates of the government. The consequence of this is the rise in the fiscal deficit with no appreciation to the currency and this leads to a decrease in the economic activity.
Prevention of the crisis
After analyzing the facts, it is important to lay emphasis on the measures to put the economies particularly the developing economies from the volatility of the international capital. (Dieter, 1999: 17). The economic liberalization in the developing countries should be processed slowly, carefully and gradually. The financial liberalization that includes domestic deregulation and external opening should be attempted only when the macroeconomic stability, a considerable openness of trade, along with the establishment of a solid and well regulated financial sector is achieved. The deregulation should proceed in a framework of adequate governmental oversight, as well as the careful supervision. In order to avoid the large vulnerabilities, it is important to open capital accounts before having a sound and solid financial system. A radical reform in the international financial architecture is required in an effort to prevent the recurrence of the financial crisis. Financial specialists have proposed several measures to improve the international financial structure.
There is a need to reorganize the international monetary fund to increase the transparency as well as its control by the national governments and its regionalization. In the situations of crisis, the IMF should intervene with its rescue operations in such a way that features attached conditions that are appropriate to the national development strategy as well as with the reasonable standards across the nations.
The international community should be more responsive and permissive to the requirement in the developing countries in order to maintain or impose capital controls. Taxes on the borrowings from the foreign countries, ceilings on the short term external debt by the local banks, restrictions in the use of foreign loans, controls over the foreign exchange deposits and loans made by the private or corporate bodies have already been used in several countries. This suggests that if the capital controls are used in an effective way, there is a possibility of increase in the proportion of the long term investment in total capital inflows without decreasing the capital inflows. The autonomy in the domestic monetary policy may help to avoid the adverse currency appreciations.
There is a need to improve the standards of the international financial regulations by establishing the far reaching Financial Stability Forum or the World Financial Organization.
There is a need to create a real international lender of last resort through the credit lines or through the contingency funds in the IMF. This may be possible through the establishment of new regional institutions or through a brand new international organization.
In order to improve the crisis management, the private sector should involve in rescue and the key insolvency principles should be accepted in dealing with the debt rescheduling in the financially distressed economies. (UNCTAD, 1998: 91).
The economic globalization not only creates asymmetry but also creates the global financial instability but also increases the risk of deflation and recession in the world economy. In an effort to reduce such adverse effects, it is necessary to adopt several measures at the national and international levels. However, most of the international initiatives such as the complete revamp of the IMF, the creation of the World Financial Organization may appear ideal and it is necessary to strengthen the institutional framework both at the national and international levels. It is also necessary to discourage the short-term and easily reversible capital inflows. The use of capital controls by the developing countries as a device has gained support. The practical way to contain the pace of international financial integration is to control the capital as the realistic alternative to improve the international regulation and the supervision of financial inflows that may be completely insufficient. The developing economies should be allowed to maintain their national sovereignty in the financial matters, and the financial proposals of the rich countries should be directed towards restructuring emerging economies in order to enable a larger international mobility of the capital rather than protecting them from the dangers associated with the capital flows.