Financial globalisation and crisis, institutional transformation and equity

The most profound transformation of policy strategies in recent decades has been the widespread movement toward financial and other forms of liberalisation. This, along with the repeal of the US 1933 Glass–Steagall Act in 1999, which created the ‘parallel’ subprime mortgage market, engineered the August 2007 financial crisis. A crisis that was promoted by the international financial imbalances and by the monetary policy adopted by most central banks around the globe with the single objective of price stability to be pursued by manipulating the rate of interest. A good deal of the literature has focused on issues surrounding the crises that have frequently ensued and the extent to which the efficiency of intermediation has been improved. Little analytical work has been done on the issue of the relationship between financial development, institutional transformation and its effect on equity. The papers included in this symposium analyse a variety of salient issues—and yet there is a common underlying theme, which is that they explore at length financial globalisation and its impact in distinct areas. The first paper discusses the effects of financial globalisation, which are analysed with respect to global value chains and to subprime mortgages, applying the Minskyian approach. A second contribution examines the impact of foreign ownership of banks (itself an aspect of financial globalisation) on developing countries. The third paper examines financialisation developments from the point of view of the USA offshoring. A fourth examines the effects of financial globalisation, in the form of free capital flows, on poverty in developing countries, and the fifth challenges the orthodox views on the effect of law on financial development and how the latter affects developing countries. This is an extended introduction that shows how the five papers link together to provide a coherent whole. It identifies and elaborates on the main theme of the symposium,. We examine in this introduction the issue of financial globalisation not only in relation to the specific papers collected here but also within a wider perspective linking it to the current turmoil in financial markets. We take up the policy question of how the interest of the poor in particular, and developing countries in general, could be safeguarded from the vagaries of financial globalisation. How much choice do communities and countries have and what can the international community do to enhance these choices? Gary Dymski's (2010) contribution uses Hyman Minsky's financial instability hypothesis to explore the question of why the 2007–08 subprime crisis has been so deep and persistent, and why it has triggered forces that have undermined the entire trajectory of global economic growth. Dymski poses a challenge: if so many contemporary observers have acknowledged the current crisis as a ‘Minsky crisis’, why then is it that this crisis has been so resistant to precisely the sort of ‘lender-of-last-resort’/’big government’ policy interventions that Minsky suggested should suffice to prevent worsened outcomes for economies gripped by financial instability? Resolving this conundrum requires appreciating that there were some assumptions about the economic role of banks that have been subsequently eroded by institutional changes. In effect, Minsky built up his ideas on the basis of the 1960s and 1970s experience; but after 1980 the role of banking and financial dynamics in the economy were transformed.1 Dymski (2010) identifies several key implicit assumptions in Minsky's model, and he argues that it is the successive undermining of these assumptions by historical developments that explains the unprecedented scale of the current financial crisis. The first involves racial/ethnic discrimination in the credit market. In putting his model together, Minsky paid no attention to the problem of racial exclusion in credit markets. For one thing, he focused on commercial and industrial loans; further, when he was writing, exclusion for minority applicants and areas prior to the 1990s took the form of higher rates of loan denial. This changed in the 1990s, when racial exclusion was embodied in various forms of predatory loans, most notably subprime loans. Dymski (2010) shows that subprime loans, that is, mortgage loans made at high interest rates, with large fees and penalty clauses, were pioneered in minority areas. What made these loans feasible was the development of securitisation for higher-risk loans, which permitted banks to move these loans off their balance sheets. This meant that the focus of banks’ revenue-generation shifted from lending margin to fee-based income. Second, Minsky did not trace out the implications of the USA being a global liquidity sink. From the 1980s onward, the USA has consistently run current-account deficits, and thus had capital-account surpluses. These surpluses have flooded the USA asset markets with funds seeking placement outlets. This has altered the USA's financial dynamics, by keeping interest rates lower than they otherwise would be; this, in turn, permitted subprime loans to be used systematically to finance home purchases when the gap between borrowers’ income and housing prices spiralled out of control. A third extension of Minsky's ideas involves identifying, and then generalising, another unacknowledged assumption: that banks (the lenders) are more highly leveraged than households or firms (the borrower units) and that they (banks) have the lowest ratio of capital to assets of any economic sector or subsector. This assumption is invisible, because Minsky, in defining robust, hedge and Ponzi units, focused solely on whether expected cash flows are positive or negative. Loan commitments become unsustainable because they generate negative cash flows. But while Minsky pays no attention to sectoral leverage or solvency, Dymski (2010) argues that these dimensions have become crucial in the current crisis. When Minsky formulated his ideas, banks’ sectoral balance sheets were more leveraged than those of either the household or firm sectors. Thus, the banking sector was more exposed to the risks of asset losses and income downturns than non-bank sectors. Central bank interventions focused on the banking sector on the assumption that they could restore financial stability before other sectors’ balance sheets were systematically thrown into disarray. But in the past several years, structured investment vehicles (SIVs), even more leveraged than banks, became an important provider of credit for mortgage (and other forms of) finance. In this situation, central-bank interventions, aimed as they are at stabilising banks’ cash flows and balance sheets, have not succeeded in stabilising the economy. Injections of liquidity, and eventually equity, into the banking system could not prevent the spread of insolvencies and failures among household and non-financial business units. So, contrary to Minsky's model, lender-of-last-resort interventions could not forestall the meltdown. Howard Stein (2010) also focuses on the recent financial crisis but is concerned in particular with the role of the World Bank. Stein (2010) argues that in the wake of two decades of financial crises following exercises of orthodox financial reform, the World Bank in their reports focused not on critically analysing problems with the strategy itself but instead on a series of extraneous explanations. These included the incorrect order of financial liberalisation, incomplete liberalisation including too much state ownership of banks, inadequate liberalisation in other markets, state cronyism, inadequate prudential regulations, poor corporate governance and too much industrial policy. While there were some in the liberalisation strategies as attention to the order of financial crises after the in the wake of liberalisation frequently by the Bank. in 1999, the the Bank to by the off of the banking sector to foreign which they would efficiency and The World Bank that the of foreign banks is to have the effect of banks into and markets, they have a The question of to credit for the the is central to the issue of and poverty in developing countries the of are created by these the of foreign banking in the past or so in paper the development of the World on foreign ownership by World Bank in the 1980s and In the 1980s the key was which did not foreign and banks, which to after The of to the risks of lending to the Bank. Bank out to this in to the in countries and as in the they do not on lending to in but on loan and and which they as a for But this is a large have either or loan to which would highly to loans. in do they on lending to on the of the the is to the which is what is expected to be the The that in countries and foreign ownership is with and lower of lending to This is a would but is not with the take it a to explore foreign bank lending by and that the foreign banks have a higher and of lending than banks to The paper also from and other countries that had off of their banks to foreign The is and poor financial development, of financial lending to the sector and capital as foreign banks more of their assets This is a in the wake of financial which could foreign banks at In the paper discusses the in and other and Central countries, for foreign banks to in foreign In the wake of this is the of financial instability of that have foreign loans, which could to financial crisis and for the and (2010) their attention to corporate strategy in the with the in the 1980s and in the 1990s, corporate strategy in the USA more on the of value and on growth. and to this as the from and to and The transformation a in investment out of and an in the of financial most a by of their aimed at This of the non-financial corporate in the USA has been by and and some recent have financialisation to capital including and In their and focus on the of this corporate strategy and in particular on its international The that the on value and with those of around the that to the of corporate to focus on and to other and (2010) that the of global has a in the corporate from the globalisation of have a they have the for of those has up for the of financial assets and the of higher the past US corporate and the of income a the US price in markets prices at and firms shifted their corporate strategy to of in by their global for up to of purchases in some US or more of US and of are to higher and firm and the from of with the of these higher and (2010) that financialisation and globalisation have other for US non-financial the corporate contribution to the past the off the of non-financial to as a of the from the economic crisis that in to in the 1990s as of the financialisation US non-financial are to and focus on and of and (2010) the firms in of and and that firms with global chains in the and and and and firms which on global value were among those the of and The has important implications for the of international and finance. on international has the effects of liberalisation on the of and In their and the of for the in turn, investment and These are as the of a from the literature on which the relation between and the with its implications for capital and economic and in of this paper financialisation should be as and (2010) with the that the of poor in the is to the there are more than poor in the the recent in are also in poverty among developing countries. more is the recent by the that the current financial crisis poverty in countries in The paper by and focuses on the financial of poverty in developing countries and whether capital liberalisation can to lower poverty in developing countries. This to the literature by and the relationship between capital liberalisation and poverty for the first focus on developing countries and countries from their for two the and the extent of poverty in developing countries requires more attention the dynamics of poverty are in these countries than in countries. This is when is a the relationship between capital liberalisation and poverty the one by and and more to capital liberalisation the of a positive impact on the the extent that financial following capital liberalisation, financial become to a of the and to the the other capital liberalisation and in the financial system the and those are at the of capital liberalisation, financial and credit in particular, are to the and A of capital liberalisation, only in more capital to the but not to the the effect is and (2010) and for developing countries to whether capital liberalisation that capital liberalisation to it is the of high and to a much extent economic that poverty that capital liberalisation is not with a in the poverty rate or an in the income of the In liberalisation of the capital poverty to some is that there is no effect of liberalisation. in their they for the of of the capital liberalisation as as for the other These are in not when about the of the poor in developing countries. These are on their or as or in or The main they are and and be expected to be by foreign if the of these are not capital liberalisation their by to from the The financial crisis of August 2007 and the spread of it in the of the economy and the not at for the so in the developing The of this contribution become even more and also the view to which is even more in the of this and (2010) the relationship between finance and In the hypothesis it is that between countries can be and The of the hypothesis have up with that countries to the and other have higher for and for than do countries to the and other The not only with respect to for but also with respect to and among other It is that common law than law and is more to economic development for the following the law in common law countries in law countries are by and with This of the between the two law and law has the and has to development of to the The policy implications of this hypothesis are their is that the model on common law is most to the of more to and of a common law firms have to are to and have corporate growth. These in generate of income. that basis it is suggested that the model of corporate law the of as there is that the main corporate should be to of markets. The hypothesis is much by the of corporate For current the law have than before in view of the in as the The are also to by to the law of From this perspective an on finance and development has been on at the for of The involves and It has on of as as on and a for countries and the and and (2010) are concerned in their contribution with the question of for in countries and its impact on The and by the to two of The first is the that the hypothesis and development is not by the of the in the and (2010) The second which from the policy. The of the out by the of the hypothesis have been used by as the World Bank to that developing countries should their to the common and to the model to economic The of to the of markets has been as a The of the and paper on the of the of the and This is more with the of which that has its form of and its and and that there is no single development model that can their The of the and paper is, that the of the hypothesis in its form are not with respect to the issues of financial globalisation and growth. This symposium a of into its main The of racial and to finance for and their relationship to underlying the subprime mortgage the of foreign ownership of banking on to the impact of financialisation among firms in global value chains on the income of in developing the of capital liberalisation for poverty and the question of the relationship between finance and development from a of The symposium has to these The in papers is by an institutional to the relationship between finance and equity. it a coherent to of financial globalisation, institutional transformation and equity. It would be to a on how paper of the issues that have been in this We with the financial globalisation and crisis Dymski's (2010) of Minsky and the US current that flooded the asset markets, the of the subprime mortgage market, and of loan and the has created a crisis on the as as on the banking Stein (2010) the that foreign ownership of the banking sector has to the globalisation of for this can be from foreign banks, even in poor developing countries, are capital to assets This the for The and (2010) paper an link between the globalisation of and the financialisation of It to crisis in view of of funds to prices and the extent to which are in other forms of global This to in the of crisis to an of from and being to the of In the and (2010) capital liberalisation and economies to the of capital flows and the financial are In the and (2010) the of the model the role of the market. This can to financial instability by from markets economic downturns financial This can of because capital are to and are also to a in the of to the impact of to the institutional transformation the and of institutional transformation is highly to of the of international finance. (2010) shows how the of institutional the securitisation of subprime loans and the of non-bank financial Stein (2010) is concerned with the of banking and how they into the of global strategies of and (2010) how in can deal with the of and any that be with and (2010) examine the of capital and their as a poverty and (2010) on which are an important of in developing countries, that by a the World which is a global institutional is In of equity, (2010) with forms of of the poor subprime markets to be the first in for Stein (2010) at the of lending to in view of the foreign ownership of banks’ of capital from poor to countries by This is as which can to problems in in developing countries with for and (2010) point toward the of and on from of purchases for in with implications for and (2010) focus on poverty with implications for equity. and (2010) deal with the for economic and crisis for in an system of The has how the included in this symposium to various of financial globalisation. In this and the following explore other important dimensions of financial globalisation, particular attention to its and also how it has to the current financial In the issue of financial globalisation in relation to and as as policy. there has been some of the For an orthodox of free financial globalisation as a between and the US the financial of the and the leverage economic policy in developing countries. point is that liberalisation is a of to liberalisation of finance This perspective has been by a of the and by the at a financial globalisation in the form of capital liberalisation would to global economic of to those are to most and would of countries with free capital would be to their and their rates of It would in these countries to capital in international markets at a lower It is that liberalisation to development of a financial which in is to enhance in the economy by and by of that free capital another from and lower rates of in countries to and higher rates of in be as and poor countries would up the point of the orthodox perspective as the for a financial system the for markets in as in has so too and that risks have The the view that capital are for the from and economic has been made by a of from of within the argues that the of free of capital is from that of free in flows are to and incomplete capital markets. problems also in in and they are to financial flows and are more Thus, it is suggested that liberalisation in the for is than the free movement of financial between countries. it is from that the of the of international to the of free movement of finance. of the that financial markets are to failures and generate some some In the of by the or international an economy in a and The take a more and in of that rates and free international capital are with global and economic in an of free These also the orthodox that and of more would the financial markets to crisis. point out that the crises are to the that the is and have about the orthodox that financial liberalisation to global economic efficiency on the with free is on several the it is the of financial which a for the latter from that of in international The and the is on about the on and the failures at the and international to which financial markets are orthodox which that financial liberalisation and financial should to than has been the of many of financial liberalisation in developing countries in recent have been several financial and economic crises in markets the and and and These crises have capital The for the between and in the of financial liberalisation are The more important the of capital flows to or on the of among banks following liberalisation, to and bank the in the global financial system and the of the international and for on the effects of capital liberalisation on economic an that capital liberalisation or not but it the of which has a negative effect on These at with the policy were much in with those of many The do not Thus, that the used in that and their was of the positive effects of capital liberalisation on the suggested that there was a impact on some of including corporate and also on economic These been and by the crisis of the 1990s, many developing countries in and are with the of another crisis. The of the financial system in countries is the economies in and developing countries and It be that the economy had been the five prior to the August 2007 global crisis. from and which have many other developing countries have also notably in the economy has also been to financial These imbalances the US current which from of in to from which be as is the that among the countries has been in countries with current the and in those with current surpluses In other financial markets were and another was the that funds have been from poor to countries to the for contrary to the of economic In the wake of the most developing countries did not capital so as to international financial flows. they to a strategy of up large foreign to financial In view of the of the and the international financial expected that not only would these countries be to from financial turmoil in countries but also to to of of for the as the changed What the of the banking there was another transformation in the of the financial system the past the of financial with in large in other countries this was to because US had much of their they were exposed to a in and because foreign much of their in the they were exposed to a But a large of the in financial from the of highly leveraged financial which were various of when in the US these as what a a crisis that with the US housing to of crises prevent the global crisis it is for to in and to the of the This the of the economy have and to in and developing countries. have to the global financial system from a meltdown. For the first developing countries as and are to off has that the effect of and a of of in A It to be whether this and policy be to restore in the financial system and a deep global and of poverty an to the in the US housing in which provide a to and In that there is a that economic not by more than if that were to it would be the first of in any in the World past historical a can be in the the to in in the economies from around in the USA and and in and in the crisis were to by only before this should be as a not only for but also for the economic that the for the The financial markets are they a It that the economy when international financial markets that free international flows of financial capital do not the of developing countries. This was also by the of on the basis of their of economies the and This was the when the of were at they to prevent capital liberalisation. the two the of and the have done their to the of these in a to the of the so as to the of capital liberalisation one of the important of the In the this was in view of the economic crisis. this has not the from or capital liberalisation. It is following the foreign of the several developing countries the by of their to their economies and by that those developing countries that orthodox economic for and did not so as the countries in the that and capital can be for economic between and developing countries on international financial is to institutional to the effects of financial globalisation. of this are for the recent of and developing countries. be to the the to development first and to have institutional developing countries a role policy issues and with their and their