Global Capital Flows: A Historical Perspective
Earlier this year, Charles Calomiris, academic director of the Chazen Institute and the Henry Kaufman Professor of Financial Institutions at Columbia Business School, explored changes in global capital flows at a panel discussion sponsored by the institute. The event showcased a new book, Globalization: What’s New?, which features essays by Calomiris and nine other experts on economic policy issues relating to globalization. Other panelists included the book’s editor, Michael Weinstein, the Paul A. Volcker Chair in international economics at the Council on Foreign Relations; contributing author William Easterly, professor of economics at New York University and codirector of NYU’s Development Research Institute; and Richard Clarida, the C. Lowell Harris Professor of Economics and professor of international affairs at Columbia University.
In his chapter, Calomiris provides historical context for his own and subsequent answers to the title question: What’s new about globalization? The current period of globalization covers roughly the last decade, he explained, and its capital flows — large relative to worldwide GDP and to previous periods of globalization — are the culmination of decades of rebuilding the global economic system from its collapse just before World War I. “We started picking up the pieces at the end of World War II,” Calomiris said. “And that process of picking up the pieces to put back global trade and global capital flows really is just now being completed.”
Before World War I, the global capital market consisted of a few key countries. Great Britain, the most important player at the time, exported nearly half its domestic savings, but only to countries that most profitably exploited that capital. Those countries — the United States, Canada, Australia, New Zealand and Argentina — were able to do so because of high levels of immigration. So while these countries experienced huge inflows of both capital and labor, most other countries were left out of the global capital system entirely.
Throughout the 20th century, global capital flows have primarily existed only among developed countries. Because these flows depend on trade, which depends on borrowing and promising to repay debt with future net exports, developing countries were excluded from global capital markets through the 1980s. But with new technology enabling new forms of capital, such as foreign direct investment, portfolio equity flows and short-term private debt flows, the global financial system has become more inclusive. “It’s a very different picture,” Calomiris said. “In the last decade or so, we’ve seen much bigger capital flows in developing countries.”
But is that a good thing? Today’s emerging market economies are considerably less resilient against financial system shocks than those of a hundred years ago. During late-19th/early-20th century financial crises, Russia and Mexico remained stable because their governments had credibility and were on the gold standard — and could therefore access international capital markets, albeit less than developed economies.
“We see a very different pattern today,” Calomiris said, referring to recent crises in East Asia and Argentina. In today’s economy, even countries considered institutionally unstable, unreliable and inept have access to global capital flows. Unable to attract foreign direct investment and international banking operations, weak economies settle for new forms of high-risk capital, often in the form of short-term, dollar-denominated debt, which is especially risky if they are already at risk of devaluation.
Current capital flows, therefore, have created new problems, said Calomiris. Whereas historical capital flows rarely ever produced so-called twin crises — simultaneous collapses of a financial system’s exchange rate and its banking system — the past 25 years have produced about 60 such crises. Individual crises are twice as common.
“This is a problem that’s related to the whole question of the liberalization of capital markets and international capital flows,” said Calomiris, but capital flows themselves are not the problem. “When countries have weak financial institutions and weak fiscal institutions and weak government institutions, generally, they tend to not be able to attract the most desirable kinds of capital. They also tend to, because of their weaknesses, produce the kinds of collapses in their financial systems and their exchange rates that made the attraction of that capital especially costly.”
Capital flows can do an enormous amount of good, but they are risky and should be regulated. Short-term debt flowing to weak institutions in developing countries that rely on external flows to finance growth only exaggerates those weaknesses and endangers growth. “Unlike historical emerging market countries that had certain dimensions of fundamentals that were very resilient, emerging market countries today are sort of weak structures,” Calomiris said. “And when the wind blows, often, they fall down.”