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The Pros & Cons of Financial Globalization

October 10, 2010 4 comments
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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