New Perspectives on Financial GlobalizationIMF Economic Forum, April 27, 2007Six points“Financial markets good or bad” is a straw man. To illustrate, let’s play a game:“…Market fundamentalists have a fundamentally flawed conception of how financial markets operate. … They attribute the fluctua“…Liberalization of foreign financial flowsis not regarded as a high priority.”“…International loan markets are prone to self-fulfilling crises, in which although individual creditors may act rationally, m“I remember -- when the Korean crisis first became serious -- calling people at a couple of the banks that had been extending“Left alone, market forces will direct too much effort into speculation and too little into the development of new products...“Financial trading activity has increased enormously...Short-term speculation activity makes the market less stable...A tax of“While there is no proof in the data that financial globalization has benefited growth, there is evidence that some countries“…The claims of enormous benefits from free capital mobility are not persuasive…[O]nly an untutored economist will argue that,“The capital market has vindicated its critics and embarrassed its would-be defenders too often of late. It has been responsIt is a sterile debate to accuse others of believing that international financial markets work perfectly – or, for that matterAdvantages of financial integrationInternational financial markets in practice may not work as claimed.Recurrent disruptions in international financial markets, cont.We are now in the 3rd big consecutive cycle ofcapital inflows to developing countriesThe cycles show up in capital flow quantitiesThey also show up in prices: sovereign spreads.EMBI was up in 1995 & 98; down in 2003-07Calvo, BIS, 2006Is “this time different”?Most large emerging markets are not usingthe capital inflows to finance CA deficitsas much as they did in the 1990sInstead, countries are using the inflows to build up forex reservesExport/GDP ratios 2000-04 > than in 1990sNew emerging market crises will come; butCan recent research give us a verdict?Effect on the cost of capital when countries open their stock marketsto foreign investors -- P.Henry, Nov. 2006LiberalizaEffect on investment when countries open their stock markets.P.Henry, NBER WP 12698, Nov. 2006Liberalization occurs in “YEffects on growthwhen countries open their stock markets.P.Henry, Nov. 2006Liberalization occurs in “Year 0”Some recent research, continuedRecent research, continuedRecent research, continuedRecent research, continuedRecent research, continuedRecent research, continuedRecent research, continued10 important policy lessons about emerging market crisescan be phrased in terms ofthe car crash analogyCar crash analogy, continuedCar crash analogy, concludedNew Perspectives on Financial GlobalizationIMF Economic Forum, April 27, 2007Jeffrey FrankelHarpel Professor of Capital Formation and GrowthKennedy School of GovernmentHarvard University2Six points• “Financial markets good or bad” = straw man.• Better approach to weigh pros & cons.• We are now in the boom phase of the 3rdconsecutive emerging-market cycle.• “Is this time different?”• Recent research: financial opening works best if countries have already achieved good institutions.• All wisdom resides in the car crash analogy.3“Financial markets good or bad”is a straw man. To illustrate, let’s play a game:We will match the following names with quotes pointing out the limitations to international financial markets.4• Jagdish Bhagwati, Pro-globalization free trader• George W. Bush, Republican president• The Economist magazine• Milton Friedman, Mr. Free Markets• Ken Rogoff, et al, IMF study (2003)• Robert Rubin, Secy. of the Treasury, 1996-1999• Jeff Sachs, Mr. Shock Therapy• George Soros, leading international speculator• Lawrence Summers, Treasury Secy., 1999-2000• James Tobin, Nobel-Prize winning economist• Paul Volcker, FRB chairman, 1979-87• Friederick von Hayek, libertarian• John Williamson,“Washington consensus” (1990)“…Market fundamentalists have a fundamentally flawed conception of how financial markets operate. … They attribute the fluctuations to external influences, so-called exogenous shocks… This view is plain wrong…There are times like the present when financial markets swing more like a wrecking ball than a pendulum, knocking over one economy after another.”George SorosThe Crisis of Global Capitalism (Public Affairs, NY) 1998“…Liberalization of foreign financial flowsis not regarded as a high priority.”John Williamson“What Washington Means by Policy Reform,” in Latin American Adjustment: How Much Has Happened, edited by Williamson (IIE, Washington DC, 1990) in his list of ten reforms that coined the phrase “Washington consensus.” (P.15)“…International loan markets are prone to self-fulfilling crises, in which although individual creditors may act rationally, market outcomes produce sharp, costly, and fundamentally unnecessary panicked reversals in capital flows.”Jeff SachsS. Radelet & J. Sachs "The East Asian Financial Crisis: Diagnosis, Remedies, Prospects," BPEA, 1:1998. p.6-7 of pp.1-74.Robert Rubinin Economic and Financial Crises in Emerging Market Economies, M.Feldstein, ed. (U. Chicago Press: Chicago) 2002.“I remember -- when the Korean crisis first became serious -- calling people at a couple of the banks that had been extending credit to Korea, and it was astounding to me how little they knew about the country to which they had extended credit….When times are good, people reach, and when they reach, sooner or later it leads to excesses, and excesses sooner or later lead to trouble.”“Left alone, market forces will direct too much effort into speculation and too little into the development of new products...Larry Summers“Financial trading activity has increased enormously...Short-term speculation activity makes the market less stable...A tax of a half percent on exchange of financial securities... would take much of the juice out of the short-term trading game…”Larry SummersL.& V. Summers, 1989, “When Financial Markets Work Too well: A Cautious Case for A Securities Transactions Tax,” J.Fin.Services Research, 3, 261-286.“While there is no proof in the data that financial globalization has