Friday, January 12, 2007

Financial Liberalisation

Financial liberalisation is always a hot topic, particularly capital account liberalisation. In the '80s and early '90s, it was heralded as a prerequisite to development. How could countries such as Bangladesh, Ghana, and Bolivia ever develop if they did not have the finances needed to sustain economic growth and investment? Solution: open the economy up like an Eastend hooker, and let the cash flow in and out as it pleases. After all, according to neoclassical logic, markets will solve everything: finances will naturally flow from capital-rich areas to capital-poor areas, and everyone wins. Unfortunately, this makes about as much sense as legalising prostitution so that the ugly prostitutes don't feel "left out"...but I digress.

In theory, this makes sense: capital account liberalisation encourages foreign direct investment, which in turn means more money flows into the economy, thereby creating growth. The reality of the situation is that many financial systems in developing countries were simply not developed enough to handle this fast-paced flow of large sums of money to and from the country, which resulted in financial volatility, and in some cases, financial "crises" or "crashes". With speculators betting against a weak currency, sooner or later the state will have no choice but to devalue said currency; international investors get the hell out of the country, and the economy is left in a deep pile of poo-poo.

Now I will resist the urge to go all hippie by talking about the Asian Financial Crisis, the Peso crisis, and the Crises in South America. If you want to know more, google it. Point is: bad things happened man, like...totally. What we learn from these crises is what matters to me; they illustrate a number of things: (i) although they may provide much needed financing to increase investment, the inappropriate management of capital flows overwhelms weak financial systems; and (ii) the structure of the financial system needs to be addressed from a political economy perspective.

Let's begin with the first point; management of capital flows is straight-forward enough: if the government is able to channel capital into growth-enhancing sectors such as industry or agriculture, the economy would see substantial growth that would lead to development (as opposed to capital flows into 'rent-seeking' sectors such as real estate and the stock market, which only create a bubble that will eventually burst, ala the Peso crisis of '94). However, how much power does the government have? East Asian countries were able to control capital flows because they already have high-savings rate, which meant low interest rates. However, high savings rates are difficult to achieve if you're a country like Zimbabwe. In that case, you have little choice but to succumb to "the powers that be" and let the evver-so-efficient 'market' decide what is worth investing.

This brings us to part (ii); the mainstream understanding of financial systems has been deeply depoliticised. Like all social and economic systems, the financial system inherently contains power structures that influence the rules (and obviously, the structure) of the game. For this, I will only list questions that will hopefully leave you with some incentive to research more about this topic: who benefits from the current nature of global finance? Who carries the risk, and who is immune from the risk? Who has the power and why do they have it?

...and finally:

What are the implications of the increasing power of global finance for development?

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