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Financial Liberalisation: Past, Present and Future

Thursday 31 March 2016
St Catharine's College, Cambridge, UK -
all sessions in the Senior Combination Room (SCR)

 

Introduction: We propose to concentrate on financial liberalisation in terms of its past performance, current and future developments. We have a paper on the past record of financial liberalisation, and one on future policies of regulation in terms of ‘de- financialisation and another on capital controls. There are also contributions on current policies in specific and group of countries, developed, developing and emerging ones. One paper on the impact of financial repression on current account completes the list of contributions. A main focal point of all eight papers is to analyse the emergence and implications of the financial liberalisation period and how to proceed in terms of the future.

 

PAPER 1
Author: Philip Arestis

Professional affiliation: University of Cambridge, UK and University of the Basque Country, Spain

Title of proposed paper: Financial Liberalisation, the Finance-Growth Nexus, Financial Crises and Policy Implications

The purpose of this chapter is to investigate the growth-finance nexus with reference to what has become known as ‘financial markets liberalization’. The `financial liberalization' thesis can be succinctly summarized as amounting to freeing financial markets from any intervention and letting the market determine the allocation of credit. The history of banking, however, since the policy makers in both developing and developed countries adopted the essentials of the financial liberalization thesis tells a rather sad story. It actually points to two striking findings: the first is that over the period of financial liberalisation (early 1970s and subsequently), banking crises have been unusually frequent and severe. The second finding is that beyond the financial costs of banking crises for the local economies involved, they have exacerbated downturns in economic activity. Even more recently, the origins of the international financial crisis of 2007/2008 and the emergence of the ‘great recession’ are assigned to the ‘financialization’, namely financial liberalisation and financial innovation, as one of the main features of it.  It is the case that ever since both developing and developed countries adopted the essentials of financial liberalisation thesis, banking crises have been unusually frequent and severe. In this contribution we discuss further the financial liberalisation aspect of crises, emphasising two examples that led to crises (the South East Asian crisis and the August 2007 international financial crisis that led to the ‘great Recession’), before we turn our attention to, and discuss, the economic policy implications, emphasising recent experience with the great recession.

 

PAPER 2
Author: Malcolm Sawyer

Professional affiliation: University of Leeds, UK

Title of proposed paper: Confronting Financialisation

The period since circa 1980 has been widely recognized as one of financialisation, which has involved the growth of the financial sector (size of banking and of financial markets), development of a wide range of financial instruments including derivatives and securitisation, de-regulation and liberalisation, the ownership of corporations by financial institutions and the pursuit of ‘shareholder value’, privatisation and de-mutualisation of the financial sector etc.. Financialisation has had global reach, but developed at different speeds and in different forms around the world. Many researchers come from a range of disciplines have pointed to deleterious effects on the economy and society of these processes of financialisation, in some contrast to previous mainstream economics research which had portrayed the growth of the financial sector as economically and socially beneficial. Three questions are addressed in this paper. First, what policies should be adopted towards the financial sector to construct a sector which better serves people and society? Measures such as re-mutualisation of the financial sector, development of State banks, financial transactions taxes directed at reducing the deleterious effects of financialisation through elements of de-financialisation are proposed. Second, as financialisation involves greater economic and political power of the financial sector, how politically feasible are policies of de-financialisation? Third, the period since circa 1980 has been perceived in terms of financialised capitalism as a further stage of capitalism, the question is posed on the advocacy of de-financialisation would relate with ideas of eras and stages of capitalism.

 

PAPER 3
Authors:  Jesús Ferreiro and Carmen Gómez

Professional affiliation: University of the Basque Country UPV/EHU, Spain

Title of proposed paper: Financialisation and Financial Balance Sheets of Economic Agents in the Euro Area

The process of financial liberalization has given rise to the phenomenon of the financialisation of most developed economies. One of the most striking features of the financialisation is the huge increase recorded in the financial balance sheets of the different (public and private, financial and non-financial agents) economic agents. However, despite the generalization of the process, significant differences remain among countries, and these differences could help to explain the different economic performances. Thus, for instance, it is commonly argued that the economies that have been most seriously affected by the economic and financial crisis have been, precisely, those with the highest size of the financial liabilities of the economy in the years previous to the crisis. The contribution will analyse the behavior of the balance sheets of the private (households, financial corporations and non-financial corporations) and public (general government) agents in the Euro area member states. The main objectives of the paper are, on the other hand, to detect the existence of significant differences among countries in the evolution of the size of the financial sheets of the different agents both before and after the burst of the Great Recession; and, on the other, to analyse whether the different evolution of the size of the balances sheets is associated to a different economic performance, again before and after the Great Recession.

 

PAPER 4
Author: Stephany Griffith-Jones

Professional affiliation: Columbia University, USA, and Sussex University, UK

Title of proposed paper: The Challenges of Financial Sector Development in Low-Income Countries: Lessons from Developed and Emerging Economies
 
The financial sectors in low-income countries have been significantly liberalized in recent decades. This paper will attempt to evaluate the extent to which these more liberalized financial systems perform the two key functions that financial sectors should perform - serve well the needs of the real economy, and specifically the needs of structural transformation to ensure sustained and inclusive growth - and ensure financial stability, to avoid developmentally costly crises, as have occurred so frequently in developed and emerging economies. One of the hypotheses of the paper will be that liberalization has not contributed significantly to either aim, as access  has not significantly increased, not has the cost of credit fallen significantly, especially for small and medium enterprises. Finally, vulnerability to future crises remains high, even though in the last decade LICs have not experienced many crises(the main crisis in a low income country has been in Nigeria). The paper will draw on a research project the author has directed looking at the financial sector in low income countries, including both in-depth case studies and analytical work.  It will also focus on the lessons to be learned from the experience of developed and emerging economies, particularly as regards recent crises; both domestic financial sector regulation (especially the need for good counter-cyclical policy) and structure, as well as management of capital flows, at a time when capital flows to low income countries have increased significantly will be discussed from this perspective.

 

PAPER 5
Author: Ilene Grabel

Professional affiliation: University of Denver, USA

Title of proposed paper: Capital Controls in a Time of Crisis

The re-branding of capital controls during the global crisis reflects the increased policy space that many developing countries enjoy. Controls widen the space for other policy innovations, and may protect developing economies from the volatility likely to be associated with the end of quantitative easing by the US Fed, events on the periphery of Europe, and emergent financial fragility in China. The legitimation of capital controls raises many questions.  Chief among them is how are we to account for this extraordinary ideational and policy evolution around controls during the crisis? The paper highlights five factors that contribute to the evolving re-branding of capital controls. These include: (1) the rise of increasingly autonomous developing states, largely as a consequence of their successful response to the Asian crisis; (2) the increasing assertiveness of their policymakers in part as a consequence of their relative success in responding to the global crisis; (3) a pragmatic adjustment by the IMF to an altered global economy in which the geography of its influence has been severely restricted, and in which it has become financially dependent on former clients; (4) the need for capital controls by countries at the extremes, i.e. those that faced implosion, and also and more importantly by those that have fared “too well”; and (5) the evolution in the ideas of academic economists and IMF staff.  The paper also explores tensions around the re-branding of capital controls as exemplified by efforts to ‘domesticate’ their use via a code of conduct.

 

PAPER 6
Authors: Nigel Allington and John McCombie and Marta Spreafico

Professional affiliation: University of Cambridge, UK

Title of proposed paper: Capital Controls in the Wake of the 2007 Financial Crisis: Some Evidence from Euro Area Countries and a Comparison with Iceland

The 2007 financial crisis in the US impacted on the Euro Area where it exacerbated a combined sovereign debt and banking crisis, both of which were ultimately made worse by a growth crisis. This paper explores the nexus between these three crises and how they evolved in two case studies, Cyprus and Greece. A comparison is also made with reference to an earlier case of Iceland (a member of the European Economic Area). The crisis in Cyprus led to the temporary introduction of capital controls in March 2013 as an alternative to exiting the Euro Area. The controls were a method of defending its banks against a classic bank run and they remained in place until April 2015. In the case of Iceland, capital controls had been a method of containing a deficiency of foreign currency reserves after the collapse of its banking system. The foreign financing of Icelandic banks amounted to more than 900% of its GDP by 2007. The most recent example is likely to be Greece. In June 2015 Greece stands on the precipice of exiting the euro (and in the view of the Central Bank of Greece the European Union too), and this would necessarily be accompanied by the introduction of capital controls. At present there are limits on individual cash withdrawals from its banks. All of these developments are assessed in the light of recent research on the benefits and costs of capital controls.

 

PAPER 7
Author: Annina Kaltenbrunner

Professional affiliation: University of Leeds, UK

Title of proposed paper: Stemming the Tide: Capital Account Regulations in Developing and Emerging Countries

This paper presents a comparative analysis of the capital account regulations imposed in developing and emerging countries (DECs) before and after the 2008 international financial crisis. Over the years, the deleterious effects of financial liberalisation and international financial integration have prompted DECs to re-regulate and restrict the freedom of capital movements. An extensive literature shows the varying success of these measures, depending on the type and objective of the regulation, the country under consideration, the macroeconomic regime in place, and the capital flows involved. This paper aims to build on this literature and analyses the set of capital account regulations introduced by DECs in the wake of the most recent waves of capital flows. It will first present a detailed mapping of these measures across a wide range of DECs. This will include both capital account and macro-prudential regulations, taking account not only of foreign investors but also the destabilising international operations of domestic financial agents. It will then set out how these measures differed both with respect to previous capital account regulations and across the countries analysed. This approach will also give insights into the changing nature of DECs’ financial integration and its common features and differences across a broad range of DECs. Finally, the paper will attempt to present some insights into the relative effectiveness of these regulations measured against various criteria, including external vulnerability, exchange rate volatility, monetary independence and financial instability.

 

PAPER 8
Authors: Sergi Lanau and Tomasz Wieladek

Professional affiliation: International Monetary Fund and Bank of England

Title of proposed paper: Does Financial Repression Affect Current Account Adjustment?

The size and persistence of current account imbalances, together with a trend towards financial liberalisation globally, are typically referred to as two distinct causes of the global financial crisis of 2008. In this paper we explore whether these two trends are related. In this paper, we study the effect of financial liberalisation on current account adjustment. Following an extensive body of previous work, we introduce liquidity constraints as a way to model the consequences of financial repression and liberalisation into the intertemporal model of the current account. This theory predicts that liquidity constraints affect the size and dynamics of the current account response to a domestic net output shock. This prediction is tested in a sample of 79 countries with an interacted Bayesian panel VAR model, which allows for cross-sectional dependence, dynamic heterogeneity. Importantly, this empirical model allows the current account response to vary with the degree of financial liberalisation, to test the predictions of the theory. Our results suggest that the reaction of the current account balance to a net output shock is approximately 50% larger in the average financially liberalized than in the average financially repressed, country. This finding is robust to allowing the VAR coefficients to vary with other determinants of current account adjustment, such as the degree of capital account openness, trade openness, financial development and the exchange rate regime. Overall our results therefore suggest that the global rise in current account imbalances is likely to be a consequence of domestic financial liberalisation.



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