Globalization and Capital Markets

Written as the financial-globalization backlash of the late 1990s was at its height, this chapter asks whether the integration of world capital markets at the turn of the twenty-first century was unprecedented, and what governed its rise and fall. The received narrative is a U – high mobility under the classical gold standard, destruction between 1914 and 1945, slow reconstruction under Bretton Woods, and a renewed rise after the early 1970s – and the authors are explicit that this is a hypothesis to be tested rather than a result, labelling their own stylised figure of it “Conjecture?” with the source listed as “Introspection.” The explanation they propose is the open-economy policy trilemma: since a government can have at most two of free capital movement, a fixed exchange rate, and a monetary policy oriented to domestic goals, capital mobility survived wherever politics supported one of the corner solutions and was suppressed wherever governments tried to occupy the middle ground. Because no single measure of market integration is decisive – price convergence and flow volumes both fail as criteria, and “all such tests may be able to evaluate market integration, but only as a joint hypothesis test where some auxiliary assumptions are needed” – the paper runs a battery. On quantities, foreign assets were about 7 percent of world GDP in 1870, just under 20 percent at the 1900-14 zenith of the gold standard, 8 percent in 1930, 11 percent in 1938, 5 percent in 1945, 6 percent in 1960, 25 percent in 1980 and 62 percent in 1995 – so “the 1900-14 ratio of foreign investment to output in the world economy was not equaled again until 1980, but has now been approximately doubled,” with liabilities tracing the same path (21 percent in 1914, 11 percent in 1938, 2 percent in 1960, 30 percent in 1980, 79 percent in 1995). Measured against the GDP only of countries with data, however, the seven great creditors exceeded 50 percent from 1870 to 1914, a level “we only surpassed … as recently as 1990, and only narrowly even then.” On prices, long-term real interest differentials against the United States for Britain, France and Germany are stationary over the whole 1890-2000 span and in most subperiods, with the unit-root null rejected at 1 percent almost everywhere except the recent float; covered and quasi-covered nominal differentials since 1870 widen in exactly the periods the U predicts, and threshold estimates of the no-arbitrage band – roughly 19 basis points for New York-London and 35 for London-Berlin before 1914, against 60 and 91 in the interwar years and about 6 in the mid-1980s – put pre-1914 integration “truly impressive compared to conditions over the following half-century or more.” Cross-country dispersion of dollar equity returns follows the same U for the G7. The authors then argue that only policy can account for the mid-century collapse, since “technology is a poor candidate” – financial techniques were not forgotten in the 1930s, and some, such as foreign exchange futures, matured then. The political-economy section supplies supporting evidence from bond spreads: on a consistent 1870-1940 London panel, being on gold lowered spreads by about 57 basis points before 1914 and only peripheral countries were punished for public debt (7.2 basis points per 10 percentage points of debt to GDP), whereas for 1925-30 the gold dummy is insignificant or wrongly signed, core and periphery are no longer distinguished, debt sensitivity is roughly five times larger, and estimated reputational persistence falls from 0.68 to 0.30. Finally the paper insists on one large difference between the two globalizations. Pre-1914 flows were long-term and nearly one-way, so gross and net positions nearly coincided; today the same rich countries top both the asset and liability rankings, net positions have stayed very low since 1980, and the developing-country share of global liabilities has fallen from 33 percent in 1900 to 11 percent in the 1990s. Today’s integration is therefore “mostly a rich-rich affair, a process of ‘diversification finance’ rather than ‘development finance’,” and the Lucas paradox of capital failing to reach capital-poor countries is, if anything, sharper now than a century ago.

Globalization in Historical Perspective | Macro Paper Warehouse

Globalization and Capital Markets