Concluding Remarks: Financial Openness, Economic growth and (In)Equalities in the World

Our study of the interdependencies between financial openness and economic growth, on the one hand, and global (in)equalities over the past twenty five years, but particularly the first fourteen years of this century, on the other, has shown how shaky the initial assumptions made in early works on this topic in the 1970s, in particular the assumption of a positive correlation between development of the financial system, innovation and the rate of economic growth, became during the first fourteen years of the current century. More precisely, the research presented in this book demonstrates that while financial liberalization may have been a very important element of economic policy in the 20 fastest- growing countries during this period, most of them, and the two most populous ones, China and India, in particular, approached it only gradually. Certainly, neither China nor India could have achieved such exceptional results in growth rates, poverty reduction, and increasing their absolute and relative stakes in world economic flows without attracting significant amounts of export-oriented FDI. This is particularly true of China. But it is not less true that both countries did take a gradual approach to financial liberalization and the financial strength of their major banks (again particularly China) shows that gradually opening up to (minority) ownership of banks and banking institutions allowed them to introduce mechanisms to improve corporate practice, while also maintaining state control over the management of financial and economic cycles. Their policy raises the issue of the insufficient deepening and © The Author(s) 2017

F. Causevic, A Study into Financial Globalization, Economic Growth and (Inequality, DOI 10.1007/978-3-319-51403-1_7

sophistication of financial and, more particularly, capital markets at times when developing countries have become a major destination for international financial investors.

The results of our investigation into financial theory’s fundamental assumptions regarding the impact of financial opening upon the practical aspects of managing financial stability, whether at national or global level, deserve attention, particularly with regard to the more financially sophisticated countries and generally speaking more-developed countries. The two financially most sophisticated environments - the United States and the United Kingdom - saw GDP per capita decline between 2005 and 2009, a fact that is not unconnected with the simultaneous major expansion in transactions on derivative markets and the major expansion of lending by internationally active banks. This directly contradicts the predictions of most papers published during the 1980s and 90s and even the first few years of this century.

A moderate relative decline, measured in percentage change in the growth coefficient, would not in itself be evidence of negative links between the degree of development of the financial system and the rate of economic growth. A relative decline accompanied by an absolute decline, however, does demonstrate that the problems which brought on the global financial crisis in 2008 and later the sovereign debt crisis in EU countries (and to a certain degree in the United States as well) have roots in fundamental aspects of the financial systems of the more-developed countries. The United Kingdom and the United States are the two countries most involved in transactions in financial derivatives from overall financial flows and, in contrast to Western Europe, their money and capital markets dominate the generation of real sector financing in them (arms-length financial systems). As a result, both the United States and the United Kingdom offered major opportunities for financial speculation based on the abuse of financial derivatives and regulatory arbitrage. Their recovery from the shocks in 2008 and 2009 required enormous financial packages, certainly in comparison to anything previously. Each individual percentage point of GDP per capita growth achieved between 2005 and 2014 was accompanied both by enormous growth in public debt and much more rapid growth in their negative net international financial positions (a steep increase in net foreign debt).

The preceding paragraph, with its brief statement of the fundamental paradox underlying the relationship between financial liberalization and economic growth in the two most financially sophisticated environments, does not mean financial liberalization in developed economies has to lead to economic stagnation and so lower or even negative growth rates over the longer-term. While it is a thankless task to project what relations between developed and developing countries will look like in the coming decade or two, it does appear from Germany’s performance, particularly between 2005 and 2014, that completely (de jure) financially liberalized economies with high and growing levels of de facto financial openness (Germany’s TOTAL is higher than the United States’s) can avoid the problems of secular stagnation and economic backsliding.

Whatever indicator one looks at, from the rate of economic growth to reducing unemployment to the budget surplus, the data presented in this study show that fully de jure and de facto financially liberalized and open Germany performed best of all the developed countries. On the other hand, the second most important founder country in the EU - France - was not quite so successful. Social costs, measured by the rise in public borrowing to combat the great recession, were particularly high in France, resulting in a considerably weaker impact of financial openness and degree of globalization than in Germany. By contrast, the Netherlands offers an example of a country which had managed to improve its economic standing vis-a-vis the world average up to 2009 under conditions of full financial openness, which might lead one to conclude that the correlation between financial openness and economic growth in this country is positive. It had, however, not just experienced a relative decline by 2014, with a growth rate below the world average, but had actually seen GDP per capita fall against 2009. In spite of converting a negative net international investment position (2009) into a strikingly positive one (2014), the Netherlands thus nonetheless experienced a fall in GDP per capita.

The countries of the Southern Eurozone experienced strongly negative correlations between full financial liberalization and growth rates. It is one of the fundamental assumptions of financial liberalization that private sector banking always targets resources better, more efficiently and towards more productive uses than publicly-owned or mixed forms ofbanking. It is worth noting in this regard that the steep expansion in lending between 2002 and 2008 in Spain, Greece, Italy, and Portugal was based on incentives to invest in the commercial property sector associated with tourism and financial services. Over the medium term (1995-2005), this investment did contribute to rapid economic growth (during the period of abundant credit), but it also led to the development of major structural imbalances within the economies of the southern Eurozone and equally severe imbalances on their labour markets, which have resulted in absolute economic backsliding and an already lengthy recession, whose economic and political consequences over the next decades are far from certain.

In addressing the question of why Germany has been so successful, particularly over a period in which most other developed countries have been stagnating or have had to spend far more financial resources to bring about recovery, especially within the EU context, one finds at least part of the answer in the structure of their financial systems and real sectors, including the composition of FDI into them. Over the past five years, the five largest banks in Germany accounted for approximately 25-30% of the banking sector. By contrast, banking sector concentration in France was such that the five largest banks accounted for more than 50%, while in Spain it was more than 60% and in the Netherlands more than 80%. Even if the number of lending institutions in Germany has gone down over the past five years from 1900 to approximately 1700 (according to data published by the ECB), it is still four times greater than in France and three times greater than in Italy, even though Germany’s population is only 23% more than France’s and 33% more than Italy’s.

As to FDI, investment in export-oriented manufacturing between 2000 and 2011 was twice as high in Germany as in the United Kingdom. Consequently, we find ourselves unable to confirm for the first fifteen years of the current century the answer given in the final two decades of the past century to one of the major research questions posed in academic works from the 1960s and 70s regarding the importance of financial structures and their impact on economic growth. The answer then was negative, i.e. that in and of themselves financial structures neither contribute to the acceleration of growth nor cause slower growth. We can no longer claim this, as financial structures in which financial innovation dominates (because of the major role of financial derivatives) and which have seen considerable deepening of arm’s-length markets or banking systems with high degrees of concentration within five major banks (resulting in an inflexible financial system) have given rise to significantly higher social costs related to combating recession, as represented by the major growth in public debt and/or net foreign borrowing and significantly lower or even negative growth rates, than financial systems with a far lower degree of market concentration in the banking sector (Germany).

The 20 fastest-growing economies during the first fourteen years of the century were mostly developing or poor countries (18 of 20). Their financial systems and the degree of financial liberalization and financial openness differed considerably. Most of them, however, achieved rapid economic growth by attracting capital from abroad through FDI. For some, FDI growth was linked to a sharp increase in foreign borrowing, while a number of small open fast-growing countries managed to reduce their foreign debt. This is particularly true of oil and gas producing countries, whose rapid economic growth was largely based on a combination of more intensive exploitation of energy resources and rising prices for them (up until 2013), as well as an increase in FDI in those sectors. As regards de facto measures of financial openness, most of these countries saw a major increase in overall capital flows as a proportion of GDP. With regard to de jure measures of financial liberalization, however, most developing countries were more or less financially repressed, with de jure financial opening-up primarily targeted at attracting FDI into manufacturing.

The two most populous countries in the world, China and India, placed consistently among the ten fastest-growing economies of the last twenty five years and China was one of the five fastest-growing economies for all five of the five-year sub-periods between 1990 and 2014. Both these economies approached financial liberalization gradually. As one of the fastest-growing economies and the first developing country to have its currency included into the basket of currencies used to calculate Special Drawing Rights (since December 2015, and effective from October 2016), China did not achieve higher growth rates through financial repression. Its economic success was due to targeted financial opening-up to investment in export-oriented manufacturing, with a coordinated attempt to integrate itself into international chains of production and added value. This was what allowed it to achieve such spectacular economic growth over the first ten years of this century. The significantly higher amounts of FDI over the past five years, compared to earlier periods, have been correlated with falling rates of growth, reflecting the fact that, during the higher phases of economic development, investment in the real sector requires more units of cash for each unit of output. This has happened just as loan- approval procedures in the megabanks, whose assets have grown even more rapidly than the rate ofeconomic growth, are becoming less efficient, suggesting probable problems down the line with cleaning bank balance sheets.

Even though the 20 fastest-growing economies included 18 developing countries, data on changes in gross national income, measured in US$ purchasing power parity, suggests that the differences between countries generally, particularly the top 10% and the lowest 10%, have not in fact been reducing, but have continued increasing over the past twenty five years. The most striking reduction in differences between countries within a given continent over the first fourteen years of the century has taken place in Europe. Here the differences between the richest and poorest countries have practically halved. The differences in GDP per capita between countries within Asia, by contrast, increased during the final decade of the last century, to shrink during the first fourteen years of this one, but nonetheless remain practically twice those in Europe. The correlation between radically implemented financial liberalization and economic growth was most direct precisely in Europe and particularly Central and South-eastern Europe and the Baltic. The rapid implementation of financial liberalization, including full opening- up to FDI in the banking sector and privatization of that sector in these European regions led to a direct spill-over effect of the steep expansion in lending in the core countries (Western Europe) to easier credit by subsidiary banks in the peripheral regions (for the period from 2000 to 2008). The subsequent decline in lending also led to a decline in investment and economic stagnation in the post-crisis period in the regions except of the Baltic.