Foreign Capital
Eswar Prasad, Ken Rogoff, Shang-Jin Wei and Ayhan Kose are offering another reappraisal of financial globalization (”Financial Globalization: A Reappraisal“).
Prasad and his colleagues reckon that the direct benefit of foreign capital — the extra money it provides — is “arguably” worth less than a number of indirect ones; namely a deeper financial system, better-run companies and a more disciplined macroeconomic policy.
Thanks to the first of these indirect benefits, open countries enjoy bigger, more liquid stockmarkets and a lower cost of equity. They also benefit from more sophisticated banking. Foreign lenders are often stronger and better run than their local rivals. They introduce new products and know-how and they give dissatisfied depositors somewhere else to take their custom, forcing local banks to improve.
However, overseas investors show little mercy to countries where public spending gets out of hand, the currency gets out of line, the banks are poorly supervised or companies rip off outside owners. Prasad thus lays out several “thresholds” that emerging economies should cross before they open up: A country’s financial system should be quite sophisticated, its companies fairly well run, and its macroeconomic policies reasonably disciplined.
Prasad’s checklist of “thresholds” echoes his catalogue of “indirect benefits”; the things financial globalization strengthens are also the things a country needs to have in place in order to benefit from it.