Jun 11, 1998

FINANCE: GLOBALIZATION NOT WITHOUT RISKS, SAYS BIS

Geneva, June (Chakravarthi Raghavan) -- The recent processes of globalization of production, enabling corporations "to slice up the value added chain", has added new dimensions to the process of integration, but "is not without risks" as evident in several Asian countries, according to the Bank of International Settlements.  

In its annual report the BIS has injected some sobriety to the debates on this issue, as also on issues about capital mobility and the growth of institutional investor industry, chasing profits through arbitrage of factor prices, and the blurring of lines (and regulatory authority) between banking and non-bank financing and security operations -- without any coordinated prudential supervision at national and nternational levels.

The report and its cautionary words come at a time when, as Prof. Gerry Helleiner, Coordinator of the G-24 Technical support project, pointed out at two recent UNCTAD meetings, there is a turf battle going on between the IMF, WTO, the BIS and the OECD. 

Symptomatic perhaps of the IMF attempts to extend its empire, are recent advertisements by the IMF trying to recruit professionals with experience in bank supervision -- an area so far dealt with by the BIS, and the Basle-based Banking Supervisory group serviced by the BIS secretariat.  

Economists in other organizations are expressing concern that if the IMF get jurisdiction in this area, both its total non-transparency, and the heavy US influence and control over the institution and the staff, would bear heavily down on the developing world and the transition economies.  

It would be a self-igniting mixture on top of an explosive social and political situation in much of the developing world, and the backlash against an asymmetric neo-liberal trading and money and finance system, and may just tip the balance. While the BIS warnings last year (in its annual report, and its quarterly and half-yearly publication of data from reporting banks) about the over-exposure of BIS area banks in Asia through short-term lending was generally ignored by the banks, and the western financial media, after the Asian crisis and the failure to heed the warning have come into the debate, one leading financial journal this week has complained that the BIS had not cried loud enough -- presumably to attract the attention of its writers.  

And in the wake of the Asian crisis, and the perception of the crisis being due to short-term bank lending and borrowing, there have been renewed attempts to promote the view that countries would not have been in such trouble if they have recourse to and attract foreign direct investments and portfolio and other funds.  

These have been coupled with some romanticised views about 'globalization' and 'integration' of emerging economies into a single global economy through liberalization of capital benefiting everyone.  

The BIS report deflates some of these claims. 

Analysing some of the recent trends in FDI, the BIS notes that while, since 1980s, FDI outflows and inflows to the industrialized countries has been very high, far outpacing expansion of foreign trade and real GDP, the FDI growth has not been very stable.  

Most of that FDI growth took place over 1981-89 -- with outflows registering an annual 14.1% growth (at current prices) and inflows a 12.7 percent -- when Japanese outflows, induced by yen appreciation and comparatively low prices of foreign equities, provided the major stimulus to global investment activities. But over the next seven years, real outflows grew by less than one percent annually, and inflows declined.  

These trends though were significantly reversed last year, as booming equity markets and low interest rates led to record level of cross-border mergers and acquisitions -- the US with a strong dollar and buoyant growth leading the rise in FDI outflows, while inflows rose even more. Outflows from Germany also reached a historical high, but inflows into Germany declined for the second consecutive year. Led by France and UK, other EU countries experienced a marked rise in both outflows and inflows.  

The short-term movements in FDI flows are highly pro-cyclical, mainly reflecting influences of reinvestment of retained earnings. And virtually all of the fall in real outflows between 1989 and 1992 can be attributed to the rise in OECD output gap, while the subsequent slow recoveries in continental Europe and Japan largely explain the continued low level of inflows. 

And since FDIs are "essentially financial flows", which may or may not be related to investment in real capital, measured outflows tend to be affected by movements in interest rates and equity prices at both source and host countries, BIS notes. 

Putting globalization in historical perspective (a view advanced for some time by several non-orthodox western economists and academics), BIS says that while growth of FDI and trade is quite impressive since 1982, it merely returns the degree of globalization and internationalization to that existing prior to 1914 "and, by some measures, not even that." 

Measured by foreign trade relative to GDP, Japan is less open now than before 1914. And while FDI outflows now equal 5-6 percent of domestic investment in the industrial countries, the UK outflows during the first decade of this century were about the same size as UK domestic investment. 

But in some respects the international integration and FDI activities are more important today than before World War I. The underlying forces and motives have changed substantially. While earlier FDI outflows were partly motivated by firms' interest in gaining access to raw materials, they mostly reflected attempts to get around artificial and natural barriers to trade.  

Such outflows favoured a horizontal production structure -- with similar plants set up in different countries.

In contrast, more recent trends have been driven by liberalization and deregulation and, above all, technological progress.

By enabling firms to 'slice up the value-added chain', the sharp decline in communication costs has created new and more efficient ways of organising production and distribution at a global level. And by allowing firms to arbitrage on factor-price differentials, it favours a vertical production structure generating stronger interactions between production and employment in affiliates and parent companies. Nevertheless for most countries the evidence suggests FDI outflows and affiliate production continue to complement rather than substitute for exports. Manufacturing affiliates tend to use intermediate goods imported from source countries, while service affiliates improve distribution of final goods produced in source countries.  

"At the same time," says BIS, "the globalization of production is not without risks. The rise in technology-driven FDI flows, amid attempts by multinational corporations to maintain or expand market shares could generate excess capacities to the extent that the multinationals as well as local companies are attracted to the same sector - by low costs and high prospective rates of return."  

This, BIS points out, has been evident in several Asian countries where inflows of foreign capital have raised high investment/GDP ratios even further. Moreover, firms with production facilities in several countries can only reduce their exposure to exchange rate movements by allowing a lower rate of capacity utilization than firms with most of the output produced at home. 

BIS notes that in the wake of the crisis, there has been a pronounced slowdown of domestic demand and activity in several Asian countries, with real depreciation of currencies triggered by plunging nominal exchange rates.

Empirical studies of effects of real exchange rate depreciation on emerging economies, BIS points out, have revealed a contractionary effect, at least in the short run. But structural linkages between exchange rate changes and economic activity are complex and have been hard to capture empirically.  

Given their strong reliance on trade as an engine of growth, a rapid and strong response of activity could be expected from real depreciation in Asia. But if depreciation is slow in triggering exports, and if capital flows suddenly reverse, all adjustments have to come from lower imports, implying an initial harsh retrenchment of domestic demand.

The weak response of output in Asia reflects the importance of intra-regional trade, and that many export industries are also heavily dependent on imported inputs from elsewhere in the region. The weakening of imports and exports have been feeding on each other in the region - and this experience is unlike that in the wake of the Mexican peso depreciation. 

Also, in an environment characterized by exchange rate overshooting and volatile inflation prospects, identifying the level at which the real exchange rate is likely to settle may be particularly difficult. And without this certainty, especially on relative price of imports for inputs, enterprises may be reluctant to make long-term output commitments. And the dominant market position of several Asian economies through heavy capacity expansion in particular industries may also be complicating recovery.