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THE GLOBAL CAPITAL MARKET: The Integration of Global Capital Markets

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Economic theory leaves no doubt about the potential advantages of global financial trading. International financial markets allow residents of different countries to pool various risks, achieving more effective insurance than purely domestic arrangements would allow. Furthermore, a country suffering a temporary recession or natural disaster can borrow abroad. Developing countries with little capital can borrow to finance investment, thereby promoting economic growth without sharp increases in saving rates. At the global level, the international capital market channels world savings to their most productive uses, irrespective of location. The resulting economic gains are difficult to quantify, as I discuss in a moment, and may work through subtle mechanisms. For example, producers who can diversify risks in financial markets may undertake more high-yield but risky investments, increasing average rates of economic growth. In that case the welfare gains can be enormous (Obstfeld, 1994).

The other main potential positive role of international capital markets is to discipline policymakers who might be tempted to exploit a captive domestic capital market. Unsound policies–for example, excessive government borrowing or inadequate bank regulation–would spark speculative capital outflows and higher domestic interest rates. In theory, a government’s fear of these effects should make rash behavior less attractive. Electronic Payday Loans Online

It is difficult to quantify the gains countries have realized from international capital mobility, since a rigorous attempt would require a fully-articulated model in which the counterfactual of no capital movements could be simulated. Historical evidence is suggestive of substantial benefits, however, notably for smaller countries, which are likely to gain the most from trade. Norway borrowed as much as 14 percent of gross domestic product in the 1970s to develop its North Sea oil reserves. Portugal borrowed as much as 17 percent in the early 1980s to modernize its economy; the country was chosen in May as a founder member of the European Union’s economic and monetary union (EMU). Preliminary forecasts by the Organization for Economic Cooperation and Development put Poland’s 1998 and 1999 foreign borrowing at around 6 percent of GDP. Strong foreign investment inflows have fueled falling unemployment and a high rate of capital accumulation. However, the non-negligible risk that the Polish economy will overheat and succumb to a financial crisis, despite restrictive domestic macro policies, illustrates a serious pitfall of access to the global capital market to which I return below. Borrowers may overextend themselves, sparking an investor panic in which foreign debts cannot be repaid on time.