Role of Financial Globalization

Topics: Investment, Economics, Finance Pages: 6 (1751 words) Published: June 19, 2013
The role of Financial and industrial globalization is increasing substantially. Its aim is to increase economic growth and aid in welfare of the country through an exchange of skills and technology, creating new opportunities for both industrialised and developing countries. The largest impact has been on developing countries, who now are able to attract foreign investors and foreign capital. Two channels through which globalization benefits countries: Direct channel

The benefits on development through financial globalization could in principle, help to raise the growth rate of developing countries through two channels, direct and indirect channels. Under the direct channel, the first role of globalization is the augmentation of direct savings; this foreign capital flow in principle benefits both groups, as they allow for increased investment in developing countries, while they provide a higher return on capital than is available in developed countries. This effectively reduces the risk free rate in developing countries. Secondly globalization helps lower the cost of capital due to better risk allocation. The international asset pricing models show that stock market liberalization improves the allocation of risk, which helps diversifying risk through international spread. In turn it encourages firms and more potential investors to take on additional investment thereby increasing growth and developing the respective countries. Thirdly developing countries benefit from the transfer of technological and managerial expertise. Where the country is more financially integrated, larger proportions of Foreign Direct Investment (FDI) inflows are attracted, which bring in advanced technology. These spillages have the channel for passing on better management practices. Lastly, the benefits from stimulation of the domestic financial sector are increased foreign ownership of domestic banks, access to international markets and most importantly they introduce a variety of new techniques that improve the domestic economy. This increases competition and this role of globalization helps to improve the quality of domestic financial services as well as efficiency. Indirect channel

The following are the theoretical benefits of financial globalization under the indirect channel. Firstly, it promotes the importance of production of specialisation. In principle, financial globalization could play a useful role by helping African countries to engage in international risk sharing and thereby reduce consumption volatility. The second benefit is the role of commitment to better economic policies. International financial integration could increase productivity in an economy through its impact on government’s ability to credibly commit to a future course of policies. More specifically it changes the dynamics of domestic investment in an economy to the extent that it leads to a reallocation of funds towards more productive activities, as government usually take on predatory policies which discourage investment and reduce growth.

Financial globalization in developing countries has been associated with measures that are designed to make the central bank more independent. This is achieved by reducing financial control, by freeing interest rates, allowing financial innovation, reducing directed and subsidized credit, as well as allowing greater freedom in terms of external flows of capital in various forms. There are two aspects that a country must consider to initiate financial globalization. There are internal aspects in which its policies focus on what the country could do internally to globalize their financial sectors. The other aspect is external aids which includes activities such as foreign direct investments in which foreign investors can invest in domestic firms.

Internal aspects
a. The decrease or removal of controls on the interest...
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