International Economics and International Economic Organizations
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Universiteit Antwerpen (UA)
Summary of the slides, notes (and some mandatory texts) for the course “International economics and international economic organizations”) part on Finance (Prof. Cassimon)
International Economics and International Economic Organizations
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International Economics and Economic
Organizations
Introduction
Text 1: “The role of International Institutions” (only public goods part), Chapter 2 and “Trade and
the Balance of Payments”
Text 2: Chapter 9, in James Gerber (2014), International Economics, Sixth Edition, Pearson
Education, Inc.
1. Global public goods (GPG)
Characteristics:
Nonexcludable
Nonrival
Inherent problem of free riding
Therefore not optimally produced by free markets (and national level: government taxes)
Multilateralism
Public good - quasi public good - joint product - private good
Trends: globalization, spill-over
Provision technologies:
Summation
Weakest link
Best shot
Economic growth requires provision of order + reduction of uncertainty. Institutions and regulations
are established, such as WTO, IMF, World Bank.
Global financial stability as a GPG (pos.) = avoidance of a global economic crisis (neg.)
2. Balance of payments (BOP)
Every nation’s transactions with the rest of the world (during a specific period of usually a year) are
summarized in its BOP, which has 3 components:
Current account (CA): record of a nation’s trade, investment income, and transfers between the
nation and the rest of the world. (non-financial)
Trade balance of goods and services: X – M
Net factor/investment income
Net unilateral transfers: foreign aid, remittances
Financial account: record of financial capital flows between the nation and the rest of the world.
Private assets flows are the largest part of the financial account.
Assets abroad (-)
Official reserve assets
All forms of international debts are settled with reserve assets, especially key currencies; when reserve
assets become scarce in a country, it signals that potentially serious problems are arising.
Government assets (non-reserve)
Private assets: foreign direct investment; portfolio investment (foreign securities,
loans to foreign firms/banks, stocks, bonds)
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, Domestic foreign-owned assets (+)
Foreign official assets
Other foreign (private) assets (direct or portfolio investment)
Net change in financial derivatives (other investments)
Capital account: record of some specialised types of relatively small capital flows, such as debt
forgiveness, personal assets of migrants, transfer of real estate etc.
The BOP must always sum to zero; individual components can be unbalanced, but the total BOP
surplus or deficit cannot exist, because of the system of double entry-booking (accounting principle):
each transaction holds a credit (+) and a debit (-) entry-booking. One is always of monetary nature
and the other is always of real nature.
BOP “identity”: CA + capital account + financial account = 0
⇒ |CA| = -|capital + financial account| (every purchase or sale of a good or service must generate a payment or a receipt)
Credit (+): exports, income and current transfers received, decrease of foreign assets, increase of
foreign liabilities.
Debit (-): imports, income and current transfers paid, increase of foreign assets, decrease of foreign
liabilities.
In general: (money coming in is positive, money going out is negative)
Everything leading to forex inflows is +; forex inflow itself is -
Everything leading to forex outflows is -; forex outflow itself is +
In reality the record of all of the transactions in the BOP is incomplete (financial flows are intangible).
Errors and omissions are added to the BOP to balance the total accounting record. Large
discrepancies can indicate incentives to hide financial flows (money laundering, drug trade).
Thus, a trade or current account deficit is not necessarily problematic as foreign capital inflow
enables countries to increase investment in physical assets that raise living standards and income.
The key is to capture the benefits of increased investment while minimising the risks of capital flight.
A problem occurs when deficits are too large and increase a country’s vulnerability to sudden
outflows of financial capital. The sudden outward flight of foreign capital can generate a debt crisis
and throw a country into deep depression. A structural overall or global deficit indicates a loss of
foreign exchange reserves (over the period) and a problem occurs when there are no substantial
foreign exchange reserve to cover this gap.
Financial globalization (FG) and capital account
openness
Text 3: Kose et al (2009) , “Financial Globalization: A Reappraisal”, IMF Staff Papers, 56(1), 8
62.
1. Indicators of capital account openness
De jure (in policies)
AREAERS is an annual report of the IMF tracking exchange arrangements and
exchange restrictions of all members of the IMF
KAOPEN or Chinn-Ito is an index measuring a country’s degree of capital account
openness/financial openness
De facto (in practice)
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, Flows: financial account balance
Stocks: net foreign assets (EWN database)
Price based indicators: parity relations between inflation rates, exchange rates and
interest rates
There is no necessary correlation between de jure and de facto account openness.
Evolution of global gross capital flows (graph.) = inflows (liabilities/passiva) + outflows (assets/activa).
3. Advanced and emerging economies and the Lucas paradox
Lucas paradox: the expectation that capital flows (de facto financial globalization FG) from developed
countries in the ‘North’ to countries in the ‘South’ where capital is relatively scarce, as theory
assumes the return to be higher there (the scarcity of capital relative to labour should mean that the returns related to the
infusion of capital are higher) versus the observation that capital still largely flows between and to advanced
economies.
Developing countries/emerging economies:
Restricted (but increasing) inflows (in GDP terms); outflows linked to investment of foreign
currency reserves (to advanced economies, mainly USA)
Small impact of global financial crisis 2008
Huge differences between inflows to emerging markets and low income countries (Sub
Sahara Africa) which still largely depend on development aid (and remittances = capital
inflows in broad sense)
4. Causality between FG and economic growth
Traditionally, economists focus on the importance of channels through which capital flows could
directly increase GDP growth and reduce consumption volatility:
More efficient international allocation of capital
Capital deepening
International risk sharing
However, little systematic evidence was found.
Recently, a framework was developed (Kose et al, 2009) acknowledging the relevance of these
traditional channels, but also arguing that FG appears to have the potential to play a catalytic role in
generating an array of collateral benefits that may help boost long-run growth:
Financial market development
Institutional development
Better governance
Macroeconomic discipline
Link Lucas paradox: investors perceiving these collateral benefits as below standards remain reluctant to invest. Furthermore, threshold
conditions determine the positive or negative outcome of capital inflows. Some countries end up in a virtuous cycle (cf. China) and others
are trapped in a vicious cycle of low economic growth.
Premature opening of the capital account in absence of basic supporting conditions can delay the
realization of these benefits, at the same time making a country more vulnerable to sudden stops of
capital flows. Financial globalization leads to better macroeconomic outcomes when certain
threshold conditions are met. This generates a deep tension as many of the threshold conditions are
also on the list of collateral benefits:
Financial market development
Institutional quality, governance
Macroeconomic policies
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