Martin Wolf
Why Globalization Works

If we regard choices as valuable in their own right, then there are few choices more important to people than those to travel and, if necessary, to escape from oppressive, exploitative or predatory regimes. This is self-evidently true in big ways. It is also true in smaller ones. In the 1960s, it was forbidden for British citizens to take more than tiny amounts out of the country. This was worse than humiliating and unpleasant. The policy was designed to allow the government to avoid the exchange rate effects of a policy of inflation designed to maintain full employment in the presence of trade union pressures. This was a predatory policy. It ended up by wiping out the savings of a sizeable portion of the British middle classes. If money could have been taken out of the country, these dangerous and ultimately unsustainable policies would have been halted far sooner. This is the sense in which, as discussed in the previous chapter, the possibility of capital mobility desirably constrains the state. That is one reason for welcoming capital account liberalization, notwithstanding all the difficulties.

Now consider a second reason for convertibility. It is clear that a well-run and regulated financial system is a tremendous economic asset. Its functions are central to the good performance of the economy and to the ability of the population to live their lives in a tolerable manner. The purpose of the financial system is to mobilize savings, allocate capital, monitor management and transform risk. This is not just for the elite. Think, for example, of poor farmers. Consider the benefit they can obtain from the ability to put money by safely, to obtain adequate insurance of their harvests, to sell their crops in advance in liquid and competitive markets, or to buy useful assets before they have saved up the money they need. By performing these functions, the financial system can transform the effectiveness of the economy. A great deal of empirical work, much of it summarized in a comprehensive evaluation published by the World Bank in 2001, has demonstrated that the size of the financial sector alone, regardless of its sophistication, has a strong causal effect on economic performance. As the study notes, 'there is now a solid body of research strongly suggesting that improvements in financial arrangements precede and contribute to economic performance.' In terms of its impact on growth, the most important effect seems to be on productivity, not on the accumulation of capital.

Yet how are developing countries with what are, in general, tiny financial markets to obtain the first-class financial sectors that they need? Among the developing countries, only China and Brazil have financial sectors with assets that amount to even 1 per cent of the global total. In about a third of all countries the total assets of the banking system are less than $1 billion, smaller than those of an insignificant local bank in the US. Another third have assets of less than $10 billion. Yet, in 2000, the world's fiftieth largest bank, KeyCorp of the US, had assets of $83 billion. It is impossible for such tiny markets to support competition among self-standing national players with realistic aspirations to world-class performance. Unless one believes the world's poor deserve only low-quality financial services, the answer has to include substantial inward foreign direct investment in the sector. Outsiders bring five benefits. The first is superior know-how and efficiency. The second is the ability to exploit the economies of scale generated in world markets. The third is the ability to piggy-back on the skills and experience of the home-country regulator of the new entrant into the financial market. The fourth is a desirable disruption of domestic insider connections that allow the monopolization of the financial system by groups of powerful people, at the expense of the taxpayer and small customers, as both providers and would-be users of funds. Last, countries with a higher proportion of foreign-owned banks and a smaller proportion of state-owned banks are also less prone to financial crises, perhaps because the foreign banks are better regulated, better managed or merely more immune to pressures for imprudent lending.

Moreover, many of the fears about the presence of foreign banks have proved misplaced. There is no hard evidence, notes the World Bank, that the local presence of foreign banks has destabilized the flow of credit or restricted access to small firms. Instead, the entry of these banks has been associated with significant improvements in the quality of regulation and disclosure. The very threat of entry has often been enough to galvanize the domestic banks into overhauling their cost structure and the range and quality of their services, with the result that foreign entry has often proved not to be as profitable for the entrants as they may have anticipated.

  The World was all before them, where to choose
Their place of rest, and Providence their guide:
They, hand in hand, with wand'ring steps and slow,

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Through Eden took their solitary way.