Is financial globalization beginning a process of reversal?

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Is the era of financial globalization over, or at least about to begin a significant reversal? Witness the disagreements over capital adequacy, regulation of derivatives, and the sudden questions from some non-European banks about holding European bank paper. Given that the European banking sector represents 65 percent of global banking, to what extent has the European sovereign debt crisis contributed to any reversal? What effect will Chinese banks have on the future of financial globalization?

Some of the world's foremost experts offer their perspectives.

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E. GERALD CORRIGAN

Managing Director, Goldman Sachs, and former President, Federal Reserve Bank of New York

To its credit, The International Economy has raised for all of us a profoundly important question.

This complex issue can best be addressed in a historical context. Financial globalization like trade in goods and services---is not new. Indeed, it has been with us for centuries. Financial globalization has, over the very long run, experienced extended intervals of very rapid growth and intervals of sharp contraction. These relatively long cycles have typically been driven by powerful and multiyear economic, technological, political, and financial trends that, for the most part, contributed to economic growth and rising standards of living. However, we have also witnessed events, including infrequent but very costly systemic financial meltdowns, that have impaired the global system of financial intermediation and called into question the benefits and the future of financial globalization.

These infrequent but major systemic financial meltdowns have triggered cumulative declines in economic activity which, in turn, have resulted in contractions in financial intermediation especially on the part of internationally active financial institutions and markets. As we have seen in the recent past, buildups in adverse financial forces having contagion elements tend to amplify the consequences of the initial financial shocks. Not surprisingly, these events also trigger powerful political and public demands for financial and regulatory reform--a phenomenon that is very much in evidence in much of the world today.

Slowly, the necessary reforms are being pieced together, but we will not know for years whether these reforms will yield a more stable and more efficient system of global finance. This uncertainty is one of the factors that is prompting questions as to the future of financial globalization.

While these concerns cannot be dismissed out of hand, I do not believe that anything like a secular decline in financial globalization will occur. I say that in part because I am highly confident that internationally active corporations will continue to internationally deploy capital and other resources with particular emphasis on investment in so-called "growth markets." That being the case, internationally active financial institutions and their clients will remain an important catalyst in mobilizing and deploying global savings and investment, especially in a context in which global capital markets will continue to play major role in financial intermediation. More importantly, even if it were highly likely that a secular decline in financial globalization were to occur, we cannot allow such an outcome to materialize because its adverse consequences for global Wade, development, and growth would be unthinkable.

That is why the policy premium on addressing the pressing problems of the day--including financial reform, debt, and deficit problems in many countries, a still-fragile global economic recovery, and a tilt toward risk aversion in the financial intermediation process--must command sustained effort within and across national boundaries. A renewed spirit of multilateralism and strengthened cooperation between the public and private sectors will be necessary parts of this effort. None of this will be easy, but if we fail to preserve the best of economic and financial globalization, while at the same time respecting cultural and societal differences among nations and regions, the costs of that failure will be pervasive and long-lasting.

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OTMAR ISSING

President, Center for Financial Studies, Frankfurt University, and Founding Member of the Executive Board, European Central Bank

The he discussion of the pros and cons of free capital movement has a long history. The current debate has delivered neither new theoretical arguments nor new empirical evidence. As with other categories of "market failures," it is always possible to create cases in which intelligent controls would deliver better results. However, how likely is it that policymakers would follow this intelligent design?

Nevertheless, it seems likely that we have seen the peak of financial globalization (at least for an extended period) as politics might fail in implementing a global level playing field of adequate regulation and efficient supervision.

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SEBASTIAN MALLABY

Director, Maurice R. Greenberg Center for Geooconomic Studios, Paul A. Volcker Senior Fellow for International Economics, Council on Foreign Relations, and author of More Money Than God: Hedge Funds and the Making of a New Elite (Penguin Press, 2010).

Reports of the death of financial globalization are greatly exaggerated. True, it has been hard to reach consensus on cross-border regulation of derivatives trading, supplementary capital requirements for systemically important lenders, and so on. But there is nothing new about regulatory discord, nor about regulatory arbitrage. Equally, foreign lending to Greece, not to mention foreign financing of U.S. real estate, has been exposed as dangerous. But international financial crises have a long history. They have not heralded the end of financial globalization so far.

The most direct threat to financial globalization comes from the new intellectual respectability of capital controls. Reversing its earlier position, the International Monetary Fund has stated that, in some instances, barriers to foreign capital inflows are a legitimate part of the policymaker's tool kit. The attraction of such barriers is obvious. Assuming they work, they can reduce temporary overvaluations of a country's exchange rate caused by hot capital inflows, protecting domestic exporters and firms threatened by cheap foreign imports. Capital controls may also help to limit asset bubbles.

But the question is: do these capital controls work? Experience suggests that they can temporarily change the composition of inflows but not the amount--which is another way of saying that they are not particularly effective. So the IMF's cautious endorsement of them is a mistake. As the norm setter in the global system, the IMF should not be legitimizing a policy tool with a false promise. Perhaps the Fund's new leader, Christine Lagarde, will see this.

Whatever the IMF does, the truth about financial globalization is that it cannot be reversed. Other aspects of the global economy are too integrated; the genie is out of the bottle. Thanks to trade, migration, multinational companies, and global supply chains, money will continue to surge across borders. Bureaucratic attempts to influence the quality or quantity of these flows will mostly be futile.

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JIM O'NEILL

Chairman, Asset Management, Goldman Sachs International

This question demonstrates one of the underlying challenges facing the Western elite. Of course financial globalization is not beginning a process of reversal, but those parties that are at the forefront might be changing.

The biggest structural development of this generation is the rise of China, India, and the BRIC group, along with some...

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