TWN Info Service on Finance and Development (Jun17/02)
28 June 2017
Third World Network
Globalisation risks need careful management, not backlash, says BIS
Published in SUNS #8485 dated 20 June 2017
Geneva, 19 Jun (Chakravarthi Raghavan*) -- Increased economic globalisation has
contributed to a remarkable increase in living standards across the world and
while its adjustment costs and financial risks need careful management they do
not justify a backlash against globalisation, according to the Basel-based Bank
for International Settlements (BIS).
In Chapter VI of its annual report for 2017, released for publication at 1800
hrs CEST on 18 June, the BIS, commonly known as the central bank for the
world's central banks, adds: "Tighter global economic integration has been
hugely beneficial. Globalisation has been instrumental in raising living
standards and has helped lift large parts of the world population out of
poverty. Trade openness has greatly enhanced productive efficiency and vastly
improved consumption opportunities. Financial openness, in addition to
supporting international trade, allows greater scope for diversifying risks and
earning higher returns. It also makes funding more readily available and
facilitates the transfer of knowledge and know-how across countries."
In a foreword, released along with Chapter VI, Jaime Caruana, General Manager
of the BIS, says: "Arguments that question the benefits of globalisation
have been receiving greater attention in the public debate. This shows that we
risk forgetting the lessons of the past and taking for granted the gains in
living standards, productivity and prosperity achieved over the last
"In this year's Annual Report, we recommend taking advantage of the
current tailwinds to growth to build economic resilience as a basis for sustained
growth. Preserving the benefits of globalisation is a key element of this
strategy. ... The focus we are putting on this issue reflects the importance of
maintaining and developing these links and the changing nature of the debate
about the global economy.
"Critics often blame globalisation for the rising inequality in some
industrialised countries. Empirical studies show that other factors, mainly
technology, have played a bigger role. It is true that the burden of adjustment
often weighs heavily on specific sectors or regions. But sound domestic
policies can help those who are negatively affected overcome these obstacles.
"Another criticism is that financial openness makes economies more
vulnerable to ebbs and flows in global finance, and allows spillovers from one
country to another. We should recognise that the global financial system is
subject to procyclicality and excesses, just as domestic financial systems are.
But the right answer is not to roll back financial openness. Rather, it is to
put in place the necessary safeguards, just as the policy community has done in
response to domestic financial liberalisation.
"This will allow us to reap the benefits while addressing the challenges
involved. The role of global currencies such as the US dollar, and of globally
active banks, calls for close international cooperation in this regard. Indeed,
as we show in the chapter, real globalisation entails financial globalisation -
the two are inseparable, in that it is not possible to reap the benefits of trade
and investment without international finance. One can think of globalisation as
consisting of three layers.
"That real and financial globalisation go hand in hand is obvious in the
first layer, where cross-border payments and credit are needed to facilitate
trade of commodities and finished goods. But it is also true for the second,
which involves more complex international trade. Financial openness allows the
financing of cross-border investments and whole global value chains that
distribute production across countries. It also allows hedging of the
corresponding financial risks. It is only in the third layer that financial
links are established solely for financial purposes.
"The analysis in the special chapter we release today should serve as a reminder
of how globalisation has boosted economic welfare. Instead of retreating from
the ties of global trade and finance, we should reinforce them. Instead of
loosening them, we should make them more resilient. We must work together to
create well designed policies, both domestically and internationally. Only then
can we make sure that globalisation will continue to lift economic growth and
living standards around the world for generations to come."
The BIS is to hold its annual meeting on Sunday (25 June) at Basel. It normally
releases its entire annual report on that day, but this year has released
Chapter VI of its report, a week in advance of the meeting. The remaining
chapters and data are due to be released on 25 June.
Only when all the remaining chapters are made public, and the report as well as
the arguments in it with supporting data can be read together would it be
possible to make an overall assessment.
However, the unusual release of only Chapter VI, titled "Understanding
globalisation", and its message reinforced by the BIS General Manager's
foreword, suggests that the BIS and its constituent central banks are worried
that in the current state of politics and public debates in the advanced
economies, there will be concerted efforts by some governments to rein in and
discipline financial institutions, and put the brakes on financial
Restraining these efforts may in fact though result in increasing public
mistrust in governments, and in particular central banks, several of whom appear
to have conflated their duty to safeguard public interest with their actions,
since the 2008 Great Financial Crisis (GFC), to shore up the positions of banks
and finance capital (at the expense of the tax-payer), rather than as
regulators act to punish those in charge of banking and financial institutions
who have misbehaved and indulged in financial shenanigans, bringing the system
to near collapse.
The end-result may be to unleash forces that may result in the second wave of
globalisation to come to an end just as the first did in the last century.
Globalisation, the BIS report says, has had a profoundly positive impact on
people's lives over the past half- century.
Nevertheless, despite its substantial benefits, it has been blamed for many
shortcomings in the modern economy and society. Indeed, globalisation has faced
more severe criticism than technological innovation and other secular trends
that have potentially had even more profound consequences.
This chapter outlines how increased economic globalisation - tighter trade and
financial integration - has contributed to a remarkable increase in living
"Adjustment costs and financial risks need to be carefully managed, but
they do not justify a backlash against globalisation."
Trade and financial openness are deeply symbiotic. Trade integration not only
relies on, but generates, financial linkages. Banks with international
operations underpin trade financing and follow their customers into foreign
Trade denominated in a foreign currency can require hedging, with
counterparties accumulating international positions. Firms may build capacity
in a foreign country with an attractive skill or resource base in order to
export from there. Managing the financial asset and liability positions built
up through trade induces still deeper financial linkages, including
international trade in financial services.
Tighter global economic integration has been hugely beneficial. Globalisation
has been instrumental in raising living standards and has helped lift large
parts of the world population out of poverty. Trade openness has greatly
enhanced productive efficiency and vastly improved consumption opportunities.
Financial openness, in addition to supporting international trade, allows
greater scope for diversifying risks and earning higher returns. It also makes
funding more readily available and facilitates the transfer of knowledge and
know-how across countries.
Globalisation has also posed well-known challenges. Gains from trade have not been
evenly distributed at the national level. Domestic policies have not always
succeeded in addressing the concerns of those left behind. The requisite
structural adjustment has taken longer, and been less complete, than expected.
Furthermore, unless properly managed, financial globalisation can contribute to
the risk of financial instability, much like domestic financial liberalisation
has. And, not least through financial instability, it can increase inequality.
But globalisation has also often been made a scapegoat. For instance, there is
ample evidence that globalisation has not been responsible for the majority of
the concurrent increase in within-country income inequality.
Attempts to roll back globalisation, BIS says, would be the wrong response to
these challenges. Globalisation, like technological innovation, has been an
integral part of economic development. As such, it should be properly governed
Countries can implement domestic policies that boost resilience. These include
flexible labour and product markets (the boiler-plate standard advice since the
1980s by tenured academics and economists at international institutions, none
of whom advocate application of such policies to their own employment) and
policies that enhance adaptability, such as retraining programmes.
Close cross-country linkages imply that policies and actions of individual
countries inevitably affect others. Hence, international cooperation must
supplement domestic policies. In particular, a global regulatory framework
should be the basis for a sound and resilient international financial system.
In outlining the deep interconnectedness of trade and financial openness, the
BIS report maps out the historical path of globalisation - from the "first
wave" leading up to World War I, through the "great reversal" of
the interwar years, to the revival and surge in globalisation post-World War II
in the "second wave."
Recent suggestions of "peak globalisation", BIS says, are misleading,
and it goes on to review how the structure of trade and financial integration
has evolved in the second wave: the impact of globalisation on welfare, its
contribution to the substantial growth in incomes and the dramatic decline in
poverty as well as the risks to financial stability linked with financial
In some concluding observations, BIS discusses policy measures that can further
enhance the benefits of globalisation and minimise the adjustment costs.
In advancing this line of argument, the BIS report appears to be crossing swords
with (or ignoring views of) economists like Prof. Dani Rodrik, with his
characterisation of developments as "hyper-globalisation" and mooting
policy changes running contrary to the BIS advocacy of trade and financial
integration of the global economy.
And in a post on 14 June at the New York Times blog under the title "A
Finger Exercise On Hyper-globalization," Nobel Laureate in economics Paul
Krugman, discussing the surge in trade from around 1990 to the eve of the Great
Recession, has argued that this has been the result of an even seemingly small
decline in transport costs having a large effect on the location of production,
since it drastically reduces the production cost advantage emerging markets
need to have.
And in turn this leads to an even more disproportionate effect on the volume of
trade, leading to a sharp increase in shipments of intermediate goods as well
as final goods, a lot of "value chain" trade.
In Krugman's view, this is what happened after 1990, partly because of
containerization, and partly because of trade liberalization in developing
countries. "But it's also looking more and more like a one-time
thing," he says.
International trade and financial openness, BIS says, go hand-in-hand. Trade is
facilitated by financial links, such as international payments and credit, and
in turn results in financial links, such as the accumulation of international
assets and liabilities.
As a result, it is not surprising that countries that are more open to trade
also tend to have higher financial openness.
It is not clear from the released chapter whether the BIS economists think that
financial openness involved openness to trade.
The report views Europe as the most integrated financially. However, while
within Europe trade is open, vis-a-vis the rest of the world, claims of EU's
"openness" to trade is questionable. Its agricultural markets and
trade, for example, are highly protected.
The relationship between real and financial openness, BIS says, however,
evolves with the degree of integration and development. Conceptually, it says,
one can think of three globalisation layers.
The first, most basic layer is trade of commodities and finished goods and the
corresponding simple international financial links, such as cross-border
The second layer involves more complex trade and financial connections. It
includes trade in intermediate goods and services associated with the
efficiency-driven fragmentation of production across countries and the
corresponding financing arrangements.
The third layer concerns the financial transactions increasingly used to
actively manage balance sheet positions.
These positions include the stocks of assets and liabilities, and exposures
more generally, created by the first two layers, as well as the allocation and
diversification of savings, not necessarily related to trade. The third layer
thus introduces some decoupling between real and financial openness.
The links between trade and financial openness are most immediate in the first
globalisation layer. In the second globalisation layer, international financial
linkages support a greater degree of specialisation in trade and production,
notably in the trade of intermediate goods.
The third globalisation layer is characterised by intricate financial links
established solely for financial purposes.
The three layers share some common elements. One is the use of global
currencies. As the dominant global currency, the US dollar is used to
denominate around half of trade, roughly half of global cross-border bank
claims, more than 60% of central banks' foreign exchange assets, and features
in 90% of foreign exchange transactions. Thus, the dollar plays a central role
in determining global financial conditions.
Globally active financial institutions operate in many countries across
multiple continents. Through their international presence and sophistication,
they facilitate the global transfer of funding and financial risks. Balance
sheets that are managed at a consolidated level create close international financial
The first globalisation wave, which died out with World War I and the Great
Depression, saw a substantial increase in both real and financial cross-border
linkages. Its collapse was as remarkable as its build-up: the "great
reversal" in the interwar period witnessed an almost complete unwinding.
The second globalisation wave, starting after World War II, has far outstripped
the first. Trade openness surged beyond its prewar peak as countries traded
more, and more countries traded.
For the world as a whole, trade openness has doubled since 1960. Trade growth
in the two decades up to the mid-2000s was particularly rapid: China and former
communist countries re-entered global trade and the second globalisation layer
The specialisation through the division of production stages across national
borders resulted in the unprecedented expansion of GVCs (global value chains).
Financial openness increased with trade openness in both waves, but its rise
has been much more marked in the second.
Available estimates, while highly imperfect, suggest that financial openness is
more than triple its prewar peak.
The rapid expansion in financial openness from the mid-1990s has been
concentrated in advanced economies.
Though the BIS has refrained from drawing any conclusions from this, it would
suggest, that perhaps the rapid expansion in financial openness in advanced
economies (compared to the modest ones in EMEs) accounts for the backlash
against globalisation in the advanced economies.
GVCs have been a key driver of trade growth, especially in manufactured goods,
facilitated by the improvements in market access, transport and technology:
with high- and low-skill tasks increasingly located in different countries,
trade in intermediate goods and services now accounts for almost two thirds of
total global trade.
EME (emerging market economy) participation in GVCs has increased dramatically.
In 2014, EMEs were involved in half of GVC trade. The share of GVC trade
between EMEs has more than doubled. China alone is now responsible for 19% of
GVC trade, up from 7%.
And in the process, intra-EME trade integration has increased at a faster rate
than that of advanced economies, alongside EMEs' greater heft in the world
Large TNCs dominate global trade. With operations in multiple countries, they
often play a prominent role in GVCs.
For example, in the United States around 90% of trade involves TNCs, and half
is between related entities within a TNC. Despite the expansion in EME trade, TNCs
remain more prevalent in advanced economies.
Just as TNCs play a key role in trade, large internationally active financial
institutions increasingly dominate global finance, particularly in advanced
Standard BoP (balance of payment)-based measures of financial openness tend to
underestimate the degree of global interconnectedness, just as they do for the
non-financial sector, where TNCs' subsidiaries produce for their local market.
For EMEs, overall financial openness has grown only slightly faster than trade
openness, but the composition of external liabilities has changed substantially
to support greater risk-sharing.
The rise in globalisation has been in check since the Great Financial Crisis
(GFC) of 2007-09.
International trade collapsed during the GFC and, despite a rapid rebound, has
remained relatively weak. In real terms, global trade has barely grown in line
with global GDP.
In nominal terms, trade appears even weaker, failing to keep up with GDP growth
owing to the fall in the relative prices of traded goods and services,
particularly commodities. The GFC also brought to a halt the rapid rise in
standard BoP-based measures of financial openness.
The interaction of real and financial factors within the first two
globalisation layers in part explains the easing in both trade and financial
openness. More generally, the pullback in trade and financial openness reflects
a desire to reduce risk, most obviously by financial institutions, but also by
non-financial companies, as seen in the decline in disruption-sensitive GVCs.
However, at least on the financial side, the apparent pause in globalisation
needs to be interpreted with caution.
First, conventional measures somewhat overstate the reduction in openness.
Second, the pullback in finance has been limited to some types of flows. It has
been concentrated in cross-border bank loans.
However, the contraction in bank lending is not as severe when measured using
alternative metrics of financial openness, based on the location of headquarters
of economic units, or on nationality basis that consolidates the corresponding
BIS international banking statistics (IBS) indicate that this transnational
component has been much more stable post-crisis. Furthermore, there is some evidence
that EME banks, many of which are not captured by the IBS, have substantially
increased their international presence through foreign offices. This trend is
especially pronounced at the regional level.
Globalisation, BIS says, has greatly contributed to higher living standards
worldwide and boosted income growth.
Over the past three decades, it has been an important factor driving the large
decline of the share of the world population living in significant poverty, and
of income inequality across countries. For example, poverty has fallen markedly
in China, where the development of export industries has been a key force
behind the rapid growth of GDP and incomes.
Over the same period, the income gains have not been evenly spread. The biggest
gains have accrued to the middle classes of fast-growing EMEs and the richest
citizens of advanced economies. In contrast, the global upper middle class has
experienced little income growth.
This has seen within-country income inequality increase in advanced economies
and even many EMEs. The share of income accruing to the top 1% of income
earners has increased substantially since the mid-1980s. High inequality
appears to be harmful to growth and has undermined public support for
There is strong empirical evidence that globalisation is not the main cause of
increased within-country income inequality; technology is.
[In discussing the benefits of trade and financial openness, the BIS report
uses differing language for trade and finance. This suggests that benefits of
trade openness is rooted in empirical evidence, while there is lack of adequate
empirical evidence for finance openness, with BIS using language like
"should", "could", "can" and the like terms.
Both trade and financial openness can be expected to increase the rate of
economic growth. Overall, trade has been found to boost growth in many
economies. Trade also directly benefits consumers, as they can choose from a
greater variety of higher-quality products.
Financial openness SHOULD (emphasis added) also boost growth, by enabling a
more efficient allocation of capital and facilitating the transfer of
technology and know-how. Empirical work has not universally identified
increases in income or growth from increased financial openness.
It has also been suggested that the benefits from capital account deregulation
may be less direct and take time to detect. Last but not least, many of the
existing empirical studies treat trade openness and financial openness as
independent variables, thus implicitly assuming that trade integration could
take place without financial integration.
Yet, argues BIS, trade and financial openness tend to go hand-in-hand.
While national income undoubtedly increases with trade, the gains are unevenly
distributed - a general feature of economic dynamism. The winners and losers
are unevenly distributed across skills, income levels and location. Trade
between advanced economies and EMEs generally increases the return to advanced
economy skilled labour, which is relatively scarce globally.
In contrast, the returns to unskilled labour in advanced economies may well
diminish because of the greater competition from the large pool of unskilled
EME labour. Conversely, unskilled labour in EMEs MAY (emphasis added) benefit.
At the same time, trade also leads to relative price falls for goods
disproportionately consumed by lower-income households, boosting their relative
purchasing power. Given these offsetting effects, the net effect on inequality
from trade openness is uncertain in economic models.
There are also opposing channels through which financial openness could affect
income inequality, enhancing opportunities for income generation of low-income
individuals. Indeed, there is evidence that greater access to (domestic)
finance can increase incomes of the poor.
Alternatively, if financial openness, and FDI (foreign direct investment) in
particular, increases capital intensity and the returns to skill, the benefits
could accrue to higher-income individuals or if domestic institutions are not
strong enough to prevent special interest groups from capturing the associated
Trade and financial openness can also increase inequality by favouring income
from capital sources, reduce labour's "pricing" power, putting downward
pressure on wages, and constrain the feasibility of taxing capital,
contributing to higher taxes on labour income.
In practice, BIS says, trade and financial openness appear to have made only a
fairly small contribution to the increase in income inequality. For financial
globalisation, this effect is likely to have been somewhat larger in low-income
countries. While declining labour shares have been linked to globalisation, the
evidence indicates that it is not the only driver. Importantly, the impact of
trade on inequality depends on obstacles to adjustment. These effects can be
persistent if labour is immobile across regions and industries.
Globalisation, BIS concedes, can affect economic growth, poverty and inequality
by its impact on financial stability. Financial crises can result in a
permanent loss of income, have a devastating effect on poverty and increase
inequality. Unfettered financial openness can contribute to financial
instability unless sufficient safeguards are in place.
Highly mobile international capital can behave in a very procyclical manner,
amplifying financial upswings and reversals. Foreign currency exposure, in
particular in dollars, transmits tighter global financial conditions and
exposes countries to foreign exchange losses. And, close financial linkages
between globally active financial institutions can spread financial stress,
although they may also act as a buffer when problems have a domestic origin.
This global currency channel is especially powerful in the case of the US
dollar - the dominant international currency. The outstanding stock of US
dollar-denominated credit to non-bank borrowers outside the United States, a
key indicator of global liquidity conditions, stood at $10.5 trillion as of
This outsize external role means that changes in the US monetary policy stance
have a substantial influence on financial conditions elsewhere.
And since monetary policymakers, including those in control of major
international currencies, are focussed on domestic conditions, they could
unintentionally end up contributing to financial imbalances well beyond their
The globalisation surge over the past half-century has brought many benefits to
the world economy. Openness to trade has enhanced competition and spread
technology, driving efficiency gains and aggregate productivity. The resulting
stronger income growth has supported a remarkable decline in global poverty and
cross-country income inequality.
Financial openness, properly managed, CAN (emphasis added) also independently
enhance living standards through a more efficient allocation of capital and
know-how transfers. (The BIS chapter does not say whether in fact it does.)
While globalisation increases living standards, the gains are not equally
The distributional implications of trade and financial openness need to be
addressed to ensure fair outcomes within societies and continued support for
growth-enhancing policies and economic frameworks, including global commerce.
Other factors - most notably technology - have played a dominant role in the
increase in income inequality. Just as there is no suggestion to wind back
technology, reversing globalisation would be greatly detrimental to living
Financial openness exposes economies to potentially destabilising external
forces, but this risk can be managed by designing appropriate safeguards. Since
international trade and finance are inextricably intertwined, particularly in
the first two globalisation layers, reaping the benefits of trade would be
impossible without international finance.
That is why the policy solution is not to reduce financial openness, but rather
to carefully address the associated risks, BIS argues.
The challenges of managing economic change are not unique to globalisation. As
with other secular trends, well designed policies can offset the adjustment
costs associated with globalisation and enhance the gains from it.
On the domestic front, countries can implement policies that boost resilience,
including well-articulated macroprudential frameworks on a firm microprudential
base, and the capacity to address directly any debt overhang and asset quality
problems that might arise during financial busts, in order to repair balance
sheets and improve overall creditworthiness.
Indeed, EMEs have been taking important steps in this direction since the
mid-1990s. And this has gone hand-in-hand with a better external balance sheet
structure, helping to reduce their vulnerability to external factors, including
through considerably stronger net international investment positions,
substantial increases in their foreign exchange reserves and a higher FDI
International cooperation that addresses global linkages must supplement
domestic policies. The special roles of global financial institutions and
global currencies transcend international trade and the financial interactions
directly linked to it in the first two layers.
An internationally agreed joint regulatory approach is needed to ensure that
policymakers properly manage global financial risks, not least those associated
with the highly procyclical third layer. Because policies and actions of
individual countries affect others, multilateralism is key for delivering the
best outcomes for all.
The first priority for global financial institutions is to complete the
international financial reforms already under way, which will go a long way to
boosting the resilience of the global financial system.
An agreed global regulatory framework is the basis for effective supervision of
internationally active banks, including mechanisms for cross-border
information-sharing, and fostering a level playing field, a precondition for
efficiency and soundness at the global level.
As regards global currencies, effective crisis management mechanisms remain
important, and naturally require international cooperation. A greater emphasis
on preventing the build-up of financial imbalances appears desirable. At a
minimum, this would mean taking more systematic account of spillovers and
spill-backs when setting policies.
International cooperation is also needed beyond finance to ensure a level
playing field in trade and areas such as tax.
Multilateral trade agreements provide the largest common markets to maximise
efficiency. Such well-designed domestic and international actions can ensure
that globalisation continues to be a greatly beneficial force for the world
economy and people's living standards, BIS concludes.
[* Chakravarthi Raghavan is the Editor Emeritus of the SUNS.] +