Lecture II

1. Lecture II Questions from last lecture Revisions to syllabus: will be shortened Review of data: discuss some characteristic facts before continuing discussion. Monterrey Statement – Discussion of the main points that it hits and how it relates to course and syllabus Stiglitz papers on capital market liberalization

2. International Capital: Important But Not Dependable Compares GDP of emerging market and developing countries including selected advanced economies and capital flows of Emerging market and developing countries including selected advanced economies.

3. International Capital: Important But Not Dependable

4. International Capital: Important But Not Dependable

5. International Capital: Important But Not Dependable Developing Asia for capital flows defined to also include Hong Kong SAR, Korea, Singapore, and Taiwan Province of China

6. Some types of flows are more volatile than others Latin America was chosen because of incomplete data for other areas.

7. Flows to some areas are more volatile than others Net private portfolio flows include the purchase of private equity shares (amounting to less than 10% of firm) and debt securities debt (e.g. bonds). Measured in US$ billions.

8. Some types of flows are too persistent Total foreign indebtedness in billions of US$

9. Persistent debt and its legacy Principle and interest payments on total foreign indebtedness in billions of US$

10. Capital flows are concentrated

11. Even FDI is concentrated

12. Lecture II Monterrey Statement Focus on Sections C, E and F: Trade, Debt and Systemic Issues Goals – to end poverty, sustainable growth and development, and equitable global economic system National efforts need t be supported by enabling international economic conditions Peace and development are mutually reinforcing Appropriate regulatory framework at national level Redefines macroeconomic policy – growth and full employment first Invest in social infrastructure and basic services

13. Lecture II Monterrey Statement -- continued Orderly development of local capital markets, i.e. “sequencing”, with sound banking systems Support microfinance and national development banks, and lower transactions costs of remittances

14. Lecture II Monterrey Statement B. Private Capital Flows The challenge is to promote FDI even to small, remote developing countries • Public-private partnerships • Structured finance • Measures to reduce short-term volatility in capital flows • Sequencing regulatory measures • Voluntary standards and codes • Trade Recognize managed trade measures as a means to development Recognize the role of regional development banks Need multilateral assistance to helped depressed export revenue Need to insurance against risk (see C. 37)

15. Lecture II Stiglitz papers on capital market liberalization Rogoff study comes in wake of policy failures. Intended to evaluate effects of policy and indicate some opening towards change in those policies IMF tried in 1993 to change its charter to require all member states to pursue policy of capital market liberalization. This effort was abandoned following the financial crises in the developing world. Stiglitz claims IMF policy based on hard-headed ideology – and in the interest of private financial markets – and not on economic science (economic theory based on facts).

16. Lecture II Stiglitz papers on capital market liberalization • EMPIRICAL PROBLEMS Empirical studies of the role of trade liberalization and capital market liberalization on growth rates is difficult because of model specification and simultaneity. That is, many factors are not or cannot be included, some factors that are associated with liberalization are highly correlated with other factors that are deemed ‘positive’ for growth, and there is the problem that higher growth rates might lead to liberalization (such as the recent experience with the developed world). Even faulty measures of liberalization and the IMF’s own data failed to demonstrate the economic benefits of liberalization by the end of the 1990s. The counterfactual remains that the two big success stories, China and India, both experienced rapid growth without liberalization. In contrast the Russian experience with it had ended in a great disaster.

17. Lecture II Stiglitz papers on capital market liberalization THEORETICAL PROBLEMS • Liberalization can lead to capital flight, not inflow (e.g. Russia) • Speculative flows does not necessarily create new or expand existing enterprises • Inflow leads to higher exchange rate and Dutch Disease type problems • Short-term inflows can also lead to speculative pressure on asset prices • Accumulation of foreign reserves as self-insurance

18. Lecture II Stiglitz papers on capital market liberalization RISK Liberalization has NOT led to better regulation • due to external pressure from IMF or the US • pressure precisely to deregulate financial markets • few trained and experienced people in financial market regulation (and those that exists are bought at higher salary by private sector) Crises occurred despite good fundamental • East Asian countries had good fundamentals such as fiscal policy • Largest source of instability was recent inflows themselves • IMF responses exacerbated risks – private markets feared consequences of IMF policy (contractionary macro policies to respond to crisis) • IMF opposed bankruptcy that would have cleared books

19. Lecture II Stiglitz papers on capital market liberalization Externalities and Capital Controls Externalities impose costs on many who do not share in upside Government intervention is one remedy – though it might raise costs of funds it might just be more efficient so that costs match benefits on a social level.

20. Lecture II Economics of Growth and Development • Low incomes lead to lower savings • Shortage of savings constrains investment that is needed for capital formation as well as investment in labor and public infrastructure • Lower or slower investment rates result in slower growth and development • Foreign investment can serve to augment domestic savings so that a rate of investment can lead to higher rates of growth and development • At the same time foreign investment can expose country to disruptions originating abroad or leave country more vulnerable to disturbances from within • Volatility reduces the incentives for investment and hampers the improvement in living standards

21. Lecture II Monterrey Statement Focus on Sections B, C, E and F: Trade, Debt and Systemic Issues Goals – to end poverty, sustainable growth and development, and equitable global economic system National efforts need to be supported by enabling international economic conditions Peace and development are mutually reinforcing Appropriate regulatory framework at national level Redefines macroeconomic policy – growth and full employment first Invest in social infrastructure and basic services

22. Lecture II Monterrey Statement -- continued Orderly development of local capital markets, i.e. “sequencing”, with sound banking systems Support microfinance and national development banks, and lower transactions costs of remittances

23. Lecture II Monterrey Statement B. Mobilizing Private Capital Flows The challenge is to promote FDI even to small, remote developing countries • Public-private partnerships • Structured finance • Measures to reduce short-term volatility in capital flows • Sequencing regulatory measures • Voluntary standards and codes • Trade Recognize managed trade measures as a means to development Recognize the role of regional development banks Need multilateral assistance to helped depressed export revenue Need to insurance against risk (see C. 37)

24. Lecture II Stiglitz papers on capital market liberalization Rogoff study comes in wake of policy failures. Intended to evaluate effects of policy and indicate some opening towards change in those policies IMF tried in 1993 to change its charter to require all member states to pursue policy of capital market liberalization. This effort was abandoned following the financial crises in the developing world. Stiglitz claims IMF policy based on hard-headed ideology – and in the interest of private financial markets – and not on economic science (economic theory based on facts).

25. Lecture II Stiglitz papers on capital market liberalization • EMPIRICAL PROBLEMS Empirical studies of the role of trade liberalization and capital market liberalization on growth rates is difficult because of model specification and simultaneity. That is, many factors are not or cannot be included, some factors that are associated with liberalization are highly correlated with other factors that are deemed ‘positive’ for growth, and there is the problem that higher growth rates might lead to liberalization (such as the recent experience with the developed world). Even faulty measures of liberalization and the IMF’s own data failed to demonstrate the economic benefits of liberalization by the end of the 1990s. The counterfactual remains that the two big success stories, China and India, both experienced rapid growth without liberalization. In contrast the Russian experience with it had ended in a great disaster.

26. Lecture II Stiglitz papers on capital market liberalization THEORETICAL PROBLEMS • Liberalization can lead to capital flight, not inflow (e.g. Russia) • Speculative flows does not necessarily create new or expand existing enterprises • Inflow leads to higher exchange rate and Dutch Disease type problems • Short-term inflows can also lead to speculative pressure on asset prices • Accumulation of foreign reserves as self-insurance

27. Lecture II Stiglitz papers on capital market liberalization RISK Liberalization has NOT led to better regulation • due to external pressure from IMF or the US • pressure precisely to deregulate financial markets • few trained and experienced people in financial market regulation (and those that exists are bought at higher salary by private sector) Crises occurred despite good fundamental • East Asian countries had good fundamentals such as fiscal policy • Largest source of instability was recent inflows themselves • IMF responses exacerbated risks – private markets feared consequences of IMF policy (contractionary macro policies to respond to crisis) • IMF opposed bankruptcy that would have cleared books

28. Lecture II Stiglitz papers on capital market liberalization Externalities and Capital Controls Externalities impose costs on many who do not share in upside Government intervention is one remedy – though it might raise costs of funds it might just be more efficient so that costs match benefits on a social level.