Our newest Federal Reserve System governor, Frederic Mishkin, on how globalization of the financial system can help to lift poor countries out of poverty. This was written just before his appointment to the Fed:
Promoting the next great globalisation, by Frederic Mishkin, Commentary, Financial times: While much of the talk about globalisation is of either the “for” or “against” variety, this is a false choice. The real question is whether political and business leaders will take the world in the prosperous direction of the next great globalisation, that of the financial systems of emerging market countries, or the perilous path of the next great reversal, a retreat from free flows of goods, services and capital across borders.
The globalisation of trade and information in the past half century has lifted vast numbers of people out of extreme poverty. World economic growth since 1960 has been the highest ever. There has been a convergence of income per capita and a reduction of poverty in countries that have taken advantage of globalisation by becoming export-oriented. In India and China, globalisation has led more than 1bn people out of extreme poverty.
Countries that have not been able to take advantage of globalisation, such as most of sub-Saharan Africa, have not only seen their position relative to globalisers fall, but have experienced absolute drops in per capita income...
Globalisation is not inevitable, nor does it march immutably forward. What we are experiencing is actually the second great globalisation of trade and capital flows in modern times. The first began in 1870 and ended with the start of the first world war in 1914. The war disrupted capital flows and international trade between nations. The world economy never fully recovered from this Great Reversal and the 1930s saw a global depression, the rise of fascism and the start of the second world war.
Could there be another Great Reversal in which globalisation retreats and the world suffers political, social and economic upheaval and destruction? The answer is yes. In recent years there have been notable electoral successes of anti-globalist politicians in developing countries.
What can be done to help poorer countries reach the next stage of economic development so they can eventually get rich? The development of an efficient financial system will enable emerging market economies to allocate capital to its most productive uses. Institutions need to be created that promote strong property rights and a well-functioning legal system. Institutional reform must be put at the top of the agenda in developing countries. This can be difficult because ... rich elites and special interests have much to lose from anything that encourages an efficient financial system and promotes competition.
The solution is to increase demand within developing countries for more robust financial activity. Financial globalisation helps create these incentives because when domestic companies in developing countries can borrow from abroad or from foreign financial interests, domestic financial firms start to lose business. They will need to find new customers to whom they can profitably lend. ... These firms will need to push for institutional reforms... They will be more likely to encourage legal reforms to protect property rights.
Rich countries can help encourage this institutional development by providing the right incentives. As William Easterly has pointed out in his book, The Elusive Quest for Growth, aid has generally not worked well in promoting development because it has not provided the right incentives for governments to act in their citizens’ interest.
What promotes development is encouraging poorer countries to pursue an external orientation and develop a successful export sector. This not only forces the economy to become more efficient, but creates a demand to improve institutions. In addition to offering technical assistance and greater incentives for institutional development, advanced countries can also help to alleviate poverty by opening up their markets to exports from poorer countries. Those who lose their jobs in advanced countries from this opening of markets deserve our sympathy and our support to find new jobs, but displaced workers can be assisted in other ways than trade restrictions.
Free trade, fuelled by effective financial support, raises productivity in developing and advanced countries alike. “Trade not aid” will help make globalisation work to the benefit of poorer countries. Financial reform in developing nations is the first step in promoting this happier state of affairs.