Revisiting the issue of Capital Market Liberalisation


In the current globalized world economy, the issue of liberalization of public service sector has been a centre of discussion for the last thirty years. Favouring this idea, many argued that in order to make the sector expand, develop, more accessible, more competitive and affordable, the government should put off its hands on it and liberalize the sector and privatize those under its control. They argued that the more liberalized the sector, the more expanded, accessible, competitive and affordable will be and will give the government more time and space to focus on other sectors which needs more of its attention.
Many on the other hand counter argued that the government should play a prominent role in expanding, develop and assured that accessibility of the service provision of the sector to the mass. On the favour this, we once remember the famous statement of a high level official of the Ethiopian government who was, at the time, overseeing the operations of the country’s main service providing institutions of the likes of Telecommunications, energy and financial services.
The official, when asked why his government resisted the privatization of the Ethiopian Telecommunications service operations, he explained the reason humorously by saying “the telecommunication service is the money cow. Who in the planet earth is willing to sell his money cow?”. The issue of price competitiveness and affordability, and most importantly, provision of efficient services were, of course, secondary for the official and his government. The official’s this kind of argument was and still evolved primary on the government’s principle of developmental state.
As developmental state, the government should play a prominent role in every sector of the country’s economy.  As a result, the government is solely responsible for the development, expansion and accessibility of such public service sector. The same line of argumentation is also the true in other public service sectors.
Let’s take the issue of liberalization of the capital market in length as our main focus of discussion.  As in the others, a belief in the importance of financial market liberalisation has been a central plank of many arguments in favour of globalisation over the last three decades. Economic theory certainly suggests that capital mobility should allow for savings to flow to the most productive investment opportunities in the country, despite the puzzling observation that capital often flows ‘uphill’ to the richest economies, where the marginal product of capital tends to be lower but where there are better institutions and lower levels of risk. Yet concerns have been raised in recent years about the impact of financial globalisation on growth and economic stability. For better understanding of this, three academic findings in particular are worth considering.
First, as indicated on many of their research findings, both the IMF and OECD have concluded that large portfolio capital inflows are associated with increased risks of overheating, loss of competitiveness, the creation of credit and asset price bubbles, and increased vulnerability to the impact of crises. It is important to differentiate here between fast-moving speculative capital flows, which cause higher levels of financial instability, and more stable inflows of longer-term foreign direct investment (FDI).
This volatility is not a new phenomenon. In recent centuries, increased capital mobility has often been followed by a string of domestic banking crises. Recessions caused by banking crises are, in turn, more likely to be long-lived. Both the Asian crisis of 1997-1998 and the current crisis are indicative of how financial crises can cause substantial damage to the real economy.
Second, there is a positive correlation between capital inflows and the average overvaluation of a country’s exchange rate for non-industrial countries. This can create a version of ‘Dutch disease’, in which the impact of inflows of capital on the exchange rate make exports more expensive and therefore harms and restricts the growth of other sectors in the economy. Indeed, countries that were less reliant on capital inflows in the period 1970–2004 grew faster than those that were more reliant on imports of capital, implying that the benefits of large speculative flows are a mixed blessing at best.
Third, capital mobility encourages the build-up of reserves and, as a result, the creation of dangerous global imbalances. Since the early 1990s, there has been a rapid rise in the levels of foreign reserves held by fast-developing countries, and by China in particular. As explained on OECD 2012 report, by 2005 these had risen above 20 per cent of developing countries’ GDP, from an average level of less than 6 per cent in the 1980s.
A strategy of reserve accumulation is partly one of insurance against the negative effects of large-scale reversals in capital inflows. Evidence suggests that higher levels of liquidity can help to offset the risk of a financial crisis caused by such reversals. Indeed, in 2001, the IMF recommended that developing countries should hold reserves that were at least equal to short-term debt, if not much higher.
That said, the massive accumulation of reserves by some emerging economies and particularly by China has been linked to more commercial motives, including a desire to prevent the appreciation of their currencies so that their exports remain competitive.
This evidence leads us to the conclusion that the arguments for capital market liberalisation need to be treated separately from wider arguments about the liberalisation of trade. Capital mobility, especially short-term speculative flows of portfolio investment, can be a source of volatility and vulnerability as much as a source of valuable investment. When this concern contributes to the build-up of imbalances, becomes a defining condition of the global economy, the danger multiplies.
This does not suggest that all forms of capital mobility should be restricted, but that greater care should be taken in determining which precise elements of global financial flows are beneficial and which pose risks that ultimately outweigh the contribution they make to prospective growth. As the distinction between foreign direct investment and portfolio investment implies, this is a question of differentiating to the greatest extent possible between longer-term cross-border investment in hardware and capability, long-term cross-border investments in sovereign debt or equity, and purely speculative short-term investment.
It also requires careful assessment of the risks attached to cross-border lending, especially in foreign currencies. This can be a source of instability in crises, especially if international banking groups choose to retrench or call in lending at such times of heightened stress, as they are currently doing.
The issue of the privatization of public service sector is part of the wider debate of the issue of trade liberalization. Many research findings as well as actual practice evidences suggests that trade and growth are linked, but that trade liberalisation is not a silver bullet for growth. To produce sustainable growth, trade liberalisation needs to be managed in a way that reflects the specific needs and capabilities of individual markets and economies. This is not to argue that if trade liberalisation causes disruption or forces adjustment it should be ruled out.
Financial globalisation, as distinct from trade, is a more ambiguous prospect. The evidence suggests that it can cause instability when poorly controlled. Economies that have undertaken high levels of financial liberalisation also exhibit higher levels of inequality, partly because of the very high incomes of those working in the globalised financial sector. It is therefore increasingly clear that financial openness should not be an end in itself and needs to be managed to ensure that it balances access to important capital, with policies to manage any likely sources of volatility or vulnerability.