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The Pros & Cons of Financial Globalization

Kofi Annan, the seventh Secretary-General of the United Nations, once stated that “… arguing against globalization is like arguing against the laws of gravity”. “From a historical perspective … globalization is not a new phenomenon” (Schmukler, 2004); though given the technological advancements in the most recent decade or two, globalization has manifested itself in all fields, “flattening the world” (p.51)  as Thomas Friedman called it. Technological advancements facilitated cheaper means of communication and transportation, effectively bridging the distance disparities between nations. From a financials’ industry perspective, this brought good news to both investors and businesses alike; or so it appeared from first glance!

There is no denying the advantages that are brought upon by financial globalization. Due to the interconnectedness of the world markets, a given country’s market will gain a “deeper degree of financial integration” (Schmukler, 2004). This translates to further market stability and regulation, strengthening investors’ trust in a given country’s market. Thus, businesses seeking to raise funds, will have a larger pool of investors to chose from. Due to the access of a larger pool of investors, “increased competitiveness” (Moldovan, 2010) will drive down the cost of funds for businesses. So not only will businesses have access to more funds, but the cost of raising the funds will be lower. From a global perspective, this will lead to “better allocation of capital” (Moldovan, 2010). From a specific business perspective, this may lead to businesses raising their required capital at the very least; it might even accelerate the business’s growth plans and funding requirements. This is most notable in low income countries, where a study conducted by the International Monetary Fund shows that private flows have “grown more than fourfold since the 1980s” (Dorsey, 2008).

 

 

 

 

 

 

 

(Dorsey, 2008)

 

 

Financial globalization also bares benefits to investors.  For example, it does promote for a “better financial infrastructure” (Schmukler, 2004). As a result, lenders and borrowers operate in a financial system that is more “transparent, competitive, and efficient” (Schmukler, 2004). This leads, from the investor’s perspective, to more trust in the financial system. It also enables the investor to make varied investments; allowing for the spreading of risk via  diversification.

But just like falling to the ground due to gravity, globalization has its dark side. Kofi Annon continued elsewhere to say that although “… globalization is a fact of life … we have underestimated its fragility”.

As the financial markets of the world become ever connected due to globalization, if a problem occurred in one part of the globe, it would “cascade [and echo] uncontrollably” (Beinhocker et al., 2009) in other corners of the world. The latest of such crises is the housing bubble burst in the United States. Therefore, the risk of financial globalization is market disturbance due to factors beyond that of the domestic market. What this may mean for businesses seeking capital at such times, is that it will not find any; or if it does, it will be at a very high cost. This will always be true, even in the case if a given country’s government takes necessary precautionary measures to support its financial market in times of needs

For example, Saudi Arabia has been preparing its yearly budget with the assumption that the price of the oil barrel is USD 40; though in reality, the oil barrel was being sold for over USD 100.  This created a lot of surplus for the Saudi government. When the housing bubble burst in end of 2008, the Saudi government tried to inject a lot of liquidity in its market. And although, Saudi Arabia was able to recover much quicker than other countries, the truth of the matter is that liquidity dried up in the country, and businesses seeking capital at that time, had to pay a higher premium to obtain it.

One benefit that was cited in regards to financial globalization is that capital, on a global scale, is distributed in the most efficient manner. But this same benefit may be viewed in a negative light by some business owners whom are seeking capital, due to the emerging trend of “imbalances in trade and financial flows” (Wyss, 2009). To such business owners, financial globalization dried up their pool of potential investors; or increased substantially their cost of capital.

Looking at things from an investor’s point of view, it can be argued that globalization of financial markets aid in spreading their risk via diversification, but when a crisis does occur, no financial market or industry is shielded. Thus, the spreading of risk efforts would be dampened due to globalization of financial markets. Sort of a double edge sword.

Another aspect that must be analyzed, from an investor’s point of view, is that due to the globalization of financial markets, capital is allocated in the most efficient manner; irrespective of other non profit oriented criteria. Rarely is a criterion such as the likes of morality, humanitarianism and environmentalism are incorporated in the definition of efficiency. Thus globalization of financial markets will penalize investors who don’t regard profits as their only priority.

— Youssef Aboul-Naja
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  1. October 11, 2010 at 9:47 AM

    Very nicely raised points. But at one point it was a bit unclear. In the part where you were concluding what a “global financial risk” is for a business, the paragraph said:

    “Therefore, the risk of financial globalization is market disturbance due to factors beyond that of the domestic market.”

    I felt it would have been a bit clearer if you added “for a business”. It wasn’t clear if you had meant an investor, a business, or any other entity concerned with the risk. So it would become:

    “Therefore, the risk of financial globalization for a business is market disturbance due to factors beyond that of the domestic market.”

    In theory, I think you gave it a well clear and constructive perspective on the advantages and disadvantages of the matter. Any organization as a whole, to think about it, is a chain of multi-businesses supporting each other to deliver the service or product. It is a pyramid that taking part of it topples down what is build on it. However, it felt that the “risk umbrella” was build upon, and eventually affect, businesses whose financial foundation was supported by global investors only. This excludes business financed domestically, so to speak, if not personally. You could build your own pyramid, and you could get the neighbors to help you build it. In any case, rain will fall on it.

    I just feel the aspect of businesses whose financial basis are not globally supported, is missing from the formula.

    Otherwise, great article my friend. Always like the clarity you write with. Well done.

  2. October 11, 2010 at 10:25 AM

    Dear Tamam

    Thanks for your insightful comments, and glad that you enjoyed the post.

    One point that my post did not take into account, is how economies/businesses react to market disturbances [or information]; uniformity is not a must. As the old idiom goes, “One man’s loss is another man’s gain”. One example I can offer is where I currently work; a leasing company in Saudi Arabia. When the housing bubble burst at the end of 2008, most banks in Saudi stopped extending loans (or charged very high interest rates). Given that we are a leasing/financing company, and in general charge higher than usual finance rates (since we are willing to take higher levels of risk), we became the only option for companies looking for financing in the Kingdom. So as most companies in Saudi were registering huge losses; we were achieving record high sales [number of transactions and monetary value of deals]. So, although the financial markets are interconnected, the effects of information (events/disturbances) is not necessarily uniform across the board.

  3. May 11, 2014 at 5:38 AM

    Remarkable! Its really amazing paragraph, I have got
    much clear idea concerning from this paragraph.

  4. ray
    April 12, 2015 at 6:16 AM

    that was a very clear explanation on that matter,i really liked it, more especially when others critisize it and put in more credits to it which gives the reader a full insight about the issue.

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