The Performance of International Capital Markets - Case Study Example

TOPIC: To what extent has the ability of governments to improve economic performance diminished over the last two decades Analyze the efforts of the state to improve national competitiveness. In the past two decades economies of the world have taken different approaches to improve the standard of living. Government plays a major role in developing an economy. Polices made by government have a great impact on the economic structure of the country. In a sense much of the role of government can be viewed as establishing infrastructure in its broadest sense-the educational, technological financial, physical, environmental, and social infrastructure of the economy. Since markets cannot operate in a vacuum, this infrastructure is necessary if markets are to fulfill their central role in increasing wealth and living standards, because constructing the broad infrastructure is beyond the capacity or interest of any single firm, it must be primarily the responsibility of government. Problems faced by developing & transition economies, in which more markets are lacking, the markets that do exist may function less effectively, and information problems are more severe than in industrial countries simply because of the rapid change in the economic environment. While markets failures loom larger over this developing and transition economies, the capacity of the government to correct these market failures is often weaker. So the question arises is what should have been the role of the government in the past two decades. Assessing the appropriate role of the government requires the recognition of both the need for and the limitation of the government action. Successful governments have helped create markets such as bond and stock markets and long- term credit institution. They have established and enforced laws and regulations that have financial markets more stable and increased competition in all sectors. In many cases government has acted as a surrogate entrepreneur, encouraging the firms to enter the certain markets. Especially in export markets governments have provided firms with strong incentives. Some econometric evidences suggest that many of these interventions were quite effective. For instance, an analysis of the mild financial restraint evidenced in most East Asian economies suggest that it did lead to more rapid economic growth, but it can not be inferred that all governments are infallible. Even in the East Asian economies governments have made mistakes. The Japanese government for example initially prevented Honda from entering the automobile industry. Government cannot fix every problem. Government definitely has a place, but it should know its place. Economic growth in the last 20 years has shown a very clear decline in progress for some countries as compared with the previous two decades (1960 - 1980). The poorest group of countries went from a per capita GDP growth rate of 1.9 percent annually in 1960-80, to a decline of 0.5 percent per year (1980-2000). For the middle group (which includes mostly poor countries), there was a sharp decline from an annual per capita growth rate of 3.6 percent to just less than 1 percent Progress in education also slowed in the last two decades. The rate of growth of primary, secondary, and tertiary (post-secondary) school enrollment was slower for most groups of countries. There are some exceptions, but these tend to be concentrated among the better performing groups of countries. By almost every measure of education, including literacy rates, the middle and poorer performing groups saw less rapid progress in the period of globalization than in the prior two decades. The rate of growth of public spending on education, as a share of GDP, also slowed across many countries. Over the past few years the persistent economic crisis in Asia has called into question much of the received wisdom that liberalization has enhanced the economic contribution of international capital markets. The Asian crisis is but the most recent example of other similar episodes: the financial crises in Latin America in the early 1980s, the European exchange rate crises of 1992, and the Mexican bond crisis of 1994. The explanations offered for these severe disruptions are various; indeed each crisis has a set of local explanatory factors, but they also have a common element - the impact of highly liquid international capital markets. These recurring episodes, most of which involve severe costs in terms of unemployment, loss of real income, and even stagnation, pose important questions for policy-makers: Given that every crisis has its own specific characteristics, what do their common factors suggest about particular strategies in international financial policy Should the ubiquitous policy stance of the past three decades in favor of international financial liberalization be qualified in the light of experience If so, how Is any consistent policy toward financial markets, other than liberalization, practically possible Or can the genie never be put back into the bottle The succession of financial crises in the past 20 years, the scale of what is happening now in Asia, and the reverberations of the Asian problems throughout the world, suggest that there is an urgent demand for answers to these questions. Increasingly, financial crises are not "local". They have worldwide systemic implications. Satisfactory answers will require a clear and convincing theoretical and empirical characterization of the relationship between financial liberalization and economic performance. For without such a widely shared characterization it will be almost impossible to formulate an internationally acceptable policy stance, even at the most general level. If there is anything economists should have learned from the experience of the past 20 years, it is humility! The argument in brief International capital market liberalization began in the late 1950s when American and British banking authorities permitted external Eurocurrency credit markets to emerge, beyond their regulatory control. However, the crucial change came in the early 1970s with the collapse of the Bretton Woods system of fixed exchange rates buttressed by capital controls of varying effectiveness. With that collapse, foreign exchange risk, previously borne by the public sector, was privatized. Financial liberalization and the massive increase in financial flows have undoubtedly brought some benefits to some countries at some times. Flows of investment toward emerging markets were seen, in the early 1990s, as a welcome replacement for official development financing. The relaxation of external capital constraints led to increases in growth and reductions in inflation. However, the overall economic record of the post-liberalization period, 1970 to the present, is less satisfactory. There has been the series of severe financial crises. But as well as these shocks and the associated losses in real income, trend growth rates have slowed throughout the world. In every G7 economy trend growth in the 1980s and 1990s has slowed to around two-thirds of the rate in the 1960s. In developing countries taken as a whole the average rate of growth has also slowed, to roughly the same extent. Even prior to the current crisis in East and Southeast Asia, trend growth per capita slowed in four out of seven of the region's major economies. The fundamental point at issue is what might be the connection between international financial liberalization and this widespread deterioration in performance. It has become the conventional wisdom that trend performance is determined by "the structure of the real economy". From this perspective, financial factors may result in severe shocks and significant deviations from trend, but will not alter the underlying performance of the economy. Financial factors will not change the fundamentals. The only qualification of this separation of real and monetary phenomena is that liberalization, by removing financial imperfections, should improve trend performance. In developing countries, the recent round of crises has been associated with clearly destabilizing behavior by the private sector. The tell-tale signs included rapidly rising ratios of foreign and domestic debt to GDP as a consequence of external deficits readily financed by capital inflows (at least for a time), together with maturity and currency imbalances in national balance sheets. Standard market practices pushed local financial sectors toward taking long positions in domestic assets and short positions in foreign holdings. A private sector build-up of foreign currency borrowing (without proper hedging, despite the alleged ability of international capital markets to provide such services) was an immediate precursor of both the Mexican and East Asian crises. It was abetted by pro-cyclical financial regulation. Efforts made to improve National competitiveness: Creating effective competition among vendors is an effective step in ensuring that goods and services are available at lowest possible prices, but the task of competitive procurement is more difficult than it is often realized. It used to be thought that competitive bidding was the simplest way to ensure that government does not pay too much for a good or service. Competitive bidding, however, typically requires the government to draft precise specifications for the item being purchased. For example a T- shirt could take thirty small print-pages. Since most firms do not normally produce to those precise specifications, they may find it unattractive to bid even if their products have similar performance characteristics. Thus the number of bidder is often relatively small. As a result the Government may have to pay higher prices than the public at large. Even when competition is not a viable option, it may be desirable to incorporate features of a private firm. When competition is not a viable, however, the danger of abuse of monopoly power is real. To constrain the abuse of power, policymakers need to ask three key questions: Is there a dedicated source of revenue related to the benefits conferred Are there a governance structure that can ensure efficiency and a regulatory structure that can protect against the abuses of monopoly power Can production issues be separated from other public policy issues, including those related to externalities and safety, for example Privatization represents only one point along a spectrum of organizational forms that includes a variety of corporatization structures within the public sector. Sappington stiglitz's (1987) Fundamental theorem on privatization established that the conditions under which privatization could fully achieve the public objectives of equity and efficiency were extremely restrictive- and similar to the conditions under which competitive markets attain Pareto- efficient outcomes. Because of the differences in risk aversion and time discounting, the state may receive less-possibly far less than the expected present discounted value of the profits of the enterprise. The Theorem's main thrust is that privatization has to be justified on a case-by-case basis: the increase in economic efficiency must be sufficient to outweigh the disadvantages of privatization. In many cases (in telecommunications) that case has been clearly established. When privatization has been determined to be desirable, it must be implemented correctly, with appropriate built-in protections- including protection against abuse of any monopoly power. Appropriately designed competitive auctions are the most effective way of ensuring that the public obtain full value of the public owned resources. The carefully structured spectrum auctions in the United States illustrate how to raise public revenues while promoting competitive markets and innovation. A focus on performance is also critical that regulations achieve their objective at minimum cost. In many countries the environmental regulations of the past two decades have brought about enormous improvements in air and water quality. In some cases, however the objective could have obtained at lower cost. Rather than focusing on performance criteria, policymakers imposed designed standards. In some cases such standards were imposed because there was no effective way to monitor Performance. But appropriately designed regulations could have provided incentives for the development of monitoring technology. Conclusion: It has become almost a clich to refer to the vast changes in our world and the need to adapt to those changes. Yet the fact remains that extraordinary changes have taken place and the societies that adapt better to those changes will perform better, in terms of raising living standards than those that do not. Government can help societies embrace change. Making Government perform better is an important concern everywhere. Good policies on education, health, and the environment are not the luxuries to be postponed to a later date. Making government focus more on customer orientation, performance and competition is also essential. Indeed, the scarcity of resources and tightness of fiscal constraints facing developing countries today make it imperative that resources be spent efficiently. Sources: Sappington, David E. M. and Joseph E Stiglitz. 1987. "Privatization, information and incentives" Journal of policy Analysis and Management 6 (4) 567-82. Papers prepared for the International Capital Markets and the Future of Economic Policy project (most are available on the website: www.newschool.edu/cepa). Blecker, Robert (1998) International capital mobility, macroeconomic imbalances, and the risk of global contraction Block, Thorsten (1998a) Financial market liberalization and the changing character of corporate governance Block, Thorsten (1998b) The gold standard, financial markets, and the Great Depression Corbett, Jenny, and David Vines (1998) The Asian crisis: competing explanations D'Arista, Jane (1998) Financial regulation in a liberalized global environment Eatwell, John, and Lance Taylor (1998) The performance of international capital markets Singh, Ajit (1998) "Asian capitalism" and the financial crisis. Read More