Overlapping stages of economic development
Economies in the world are at different stages of development. An economy passes through a typical sequence of stages; as an infant grows to an adolescent stage and then to an adult, a primitive economy evolves into an agriculture-based commercial economy and then to an industry-based commercial economy.
Integration of markets in infant and adolescent economies with those in advanced economies involves frictions, which include, for example, up-hill flows of capital as articulated by Lucas(1990)'s observation of capital flowing from poor countries to rich countries and Bernanke(2010)'s 'global savings glut' argument; the environments for business and investments in developing countries are so bad as to drive whatever private capital accumulated in developing countries move to advanced countries in search of better investment opportunities; or, the macroeconomics of developing economies are so vulnerable to external shocks that public capital accumulated by developing countries move to advanced countries in search of safe haven.
Besides, market integration with advanced countries provides infant and adolescent economies with the opportunities to grow; the opportunities come with the risks to perpetuatue imbalances between the infant and adolescent economies and adult economies.
As a result of market integrations between developing and developed economies, a typical developing economy comes to have a dual structure consisting of modern and tranditions sectors with stages of economic development overlapping with each other; although the modern sector is integrated with advanced economies, the traditional sector is adamentaly isolated. Persistence of different stages of economic development in an economy reflects the failure of the economy to make a transition to the next stage.
Mechanism of econmic transition
Transformation of a primitive economy to a higher stage has usually been initiated by domestic reforms to establish private properties or any other institutions to provide individuals with incentives to work hard. For example, the transition from an agriculture-based commercial economy in 17th century U.K. was preceded by the Glorious Revolution in 1688, through which private properties on land had been ensured.
The transition to an industry-based commercial economy was stimulated by the agriculture-based commercial economy's interaction with other countries.
Effects of financial and monetary integration
According to a research on the effects of capital account liberalization (CAL) on capital flows (OECD 2011.6), CAL leads to increases in both foreign debt stock and net foreign debt(current account deficit) while trade opening leads to an increase in foreign debt stock and a decrease in net foreign debt in a panel data on average. It implies that CAL leads to an accelerated and unsustainable growth of debts and thus to a financial crisis.
Mody and Murashid (2011.4) have shown that CAL has positive spillovers on economies with the capabilities to cope with growth volatilites while it has no positive, sometimes negative, effects on growth of the economies which had not attained such capabilities yet.
Stages of economic development overlap with each other and persist in a developing economy. Suppose a developing economy. Financial integration of the economy with advanced economy without monetary integration more often than not results in opportunities to gain from regulatory arbitrage trading. Exchange rate volatility will hamper capital to flow downhill or uphill.
But, financial integration together with monetary integration of the economy with an advanced economy will facilitate capital flow downhill. The capital account will be in surplus while the current account will be in deficits. The former will drive the latter. Private and public debts increase together with increases in private and public investments. The downside is that, more often than not, debt sustainability is put into question.
Policy implications
Is it possible for a present-day agriculture-based commercial economy to benefit from financial integration with the advanced economies in proceeding to a higher stage of economic development?
For some countries, financial control is to blame for economic underdevelopment. For other countries (South Korea in 1960s and 1970s), financial control is to be praised for economic development. For the Gambia which lacks a robust borrower base, financial and capital account liberalization did little good. The effects of financial and current account liberalization depend on which stage of development the economy lies in.
Financial and monetary integration of Greece with Euro economy has been premature. But, it allowed capital flow to flow downhill within the EURO area.
Economies in the world are at different stages of development. An economy passes through a typical sequence of stages; as an infant grows to an adolescent stage and then to an adult, a primitive economy evolves into an agriculture-based commercial economy and then to an industry-based commercial economy.
Integration of markets in infant and adolescent economies with those in advanced economies involves frictions, which include, for example, up-hill flows of capital as articulated by Lucas(1990)'s observation of capital flowing from poor countries to rich countries and Bernanke(2010)'s 'global savings glut' argument; the environments for business and investments in developing countries are so bad as to drive whatever private capital accumulated in developing countries move to advanced countries in search of better investment opportunities; or, the macroeconomics of developing economies are so vulnerable to external shocks that public capital accumulated by developing countries move to advanced countries in search of safe haven.
Besides, market integration with advanced countries provides infant and adolescent economies with the opportunities to grow; the opportunities come with the risks to perpetuatue imbalances between the infant and adolescent economies and adult economies.
As a result of market integrations between developing and developed economies, a typical developing economy comes to have a dual structure consisting of modern and tranditions sectors with stages of economic development overlapping with each other; although the modern sector is integrated with advanced economies, the traditional sector is adamentaly isolated. Persistence of different stages of economic development in an economy reflects the failure of the economy to make a transition to the next stage.
Mechanism of econmic transition
Transformation of a primitive economy to a higher stage has usually been initiated by domestic reforms to establish private properties or any other institutions to provide individuals with incentives to work hard. For example, the transition from an agriculture-based commercial economy in 17th century U.K. was preceded by the Glorious Revolution in 1688, through which private properties on land had been ensured.
The transition to an industry-based commercial economy was stimulated by the agriculture-based commercial economy's interaction with other countries.
Effects of financial and monetary integration
According to a research on the effects of capital account liberalization (CAL) on capital flows (OECD 2011.6), CAL leads to increases in both foreign debt stock and net foreign debt(current account deficit) while trade opening leads to an increase in foreign debt stock and a decrease in net foreign debt in a panel data on average. It implies that CAL leads to an accelerated and unsustainable growth of debts and thus to a financial crisis.
Mody and Murashid (2011.4) have shown that CAL has positive spillovers on economies with the capabilities to cope with growth volatilites while it has no positive, sometimes negative, effects on growth of the economies which had not attained such capabilities yet.
Stages of economic development overlap with each other and persist in a developing economy. Suppose a developing economy. Financial integration of the economy with advanced economy without monetary integration more often than not results in opportunities to gain from regulatory arbitrage trading. Exchange rate volatility will hamper capital to flow downhill or uphill.
But, financial integration together with monetary integration of the economy with an advanced economy will facilitate capital flow downhill. The capital account will be in surplus while the current account will be in deficits. The former will drive the latter. Private and public debts increase together with increases in private and public investments. The downside is that, more often than not, debt sustainability is put into question.
Policy implications
Is it possible for a present-day agriculture-based commercial economy to benefit from financial integration with the advanced economies in proceeding to a higher stage of economic development?
For some countries, financial control is to blame for economic underdevelopment. For other countries (South Korea in 1960s and 1970s), financial control is to be praised for economic development. For the Gambia which lacks a robust borrower base, financial and capital account liberalization did little good. The effects of financial and current account liberalization depend on which stage of development the economy lies in.
Financial and monetary integration of Greece with Euro economy has been premature. But, it allowed capital flow to flow downhill within the EURO area.
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