elson - governing global finance; the evolution and reform of the international financial architecture (2011)

Governing Global Finance
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Governing Global Finance
The Evolution and Reform of
the International Financial
Architecture
Anthony Elson
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10.1057/9780230118010 - Governing Global Finance, Anthony Elson
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GOVERNING GLOBAL FINANCE
Copyright © Anthony Elson, 2011.
All rights reserved.
First published in 2011 by
PALGRAVE MACMILLAN®
in the United States—a division of St. Martin’s Press LLC,
175 Fifth Avenue, New York, NY 10010.
Where this book is distributed in the UK, Europe and the rest of the world,
this is by Palgrave Macmillan, a division of Macmillan Publishers Limited,
registered in England, company number 785998, of Houndmills,
Basingstoke, Hampshire RG21 6XS.
Palgrave Macmillan is the global academic imprint of the above companies
and has companies and representatives throughout the world.
Palgrave® and Macmillan® are registered trademarks in the United States,
the United Kingdom, Europe and other countries.

ISBN: 978–0–230–10378–8
Library of Congress Cataloging-in-Publication Data
Elson, Robert Anthony, 1941–
Governing global finance : the evolution and reform of the international
financial architecture / Anthony Elson.
p. cm.
Includes bibliographical references and index.
ISBN 978–0–230–10378–8
1. International finance. 2. Banks and banking, International.
3. Financial crises. 4. Global Financial Crisis, 2008–2009. I. Title.
HG3881.E445 2011
3329.042—dc22 2010031399
A catalogue record of the book is available from the British Library.
Design by Newgen Imaging Systems (P) Ltd., Chennai, India.
First edition: March 2011
10 9 8 7 6 5 4 3 2 1
Printed in the United States of America.
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To Marjorie
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Contents
List of Figures and Tables ix
1 Introduction 1

2 Financial Globalization and the International Financial
Architecture 9
3 The Evolution of the Global Financial Order 27
4 The Breakdown of the Bretton Woods System and
First Reform of the International Financial Architecture 49
5 Emerging Market Financial Crises and the Second
Reform of the International Financial Architecture 75
6 The Challenge for Developing Countries in a
World of Financial Globalization 109
7 Financial Globalization and the Onset of the Global
Financial Crisis of 2008–9 129
8 The Role of the International Financial Architecture in
Crisis Prevention and Crisis Management 149
9 The Third Reform of the International Financial
Architecture 177
10 Conclusion 207
Appendix: A Brief Guide to the Committees, Groups, and
Institutions That Comprise the International Financial
Architecture 217
Notes 233
Bibliography 255
Index 269
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Figures and Tables
Figures

2.1 Financial globalization (global aggregate assets and
liabilities, as percent of GDP) 12
2.2 Financial globalization for advanced
and developing countries (total assets plus liabilities,
as percent of GDP) 13
2.3 Private capital flows to low- and middle-income
countries (as percent of GDP) 13
2.4 Global imbalances (absolute sum of current
account imbalances as percent of world GDP) 14
2.5 Index of financial openness 17
2.6 International financial architecture (2007/8) 24
6.1 Flow of private capital, official aid, and remittances
to developing countries (as percent of GDP) 110
7.1 US Gross financial flows and current account
deficit (US $ billions) 130
7.2 Foreign exchange reserves (as percent of GDP) 132
7.3 Current account imbalances
(as percent of World GDP) 135
Tables
5.1 Major emerging market financial crises (1994–2002) 82
5.2 Financial rescue packages for selected financial
cases (1995–2003) 88
5.3 International standards and codes 99
7.1 Changes in real effective exchange rates,
December 2001–December 2007 (percentage
change – minus sign equals depreciation) 136
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10.1057/9780230118010 - Governing Global Finance, Anthony Elson
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CHAPTER 1
Introduction
I
n September 2008, policy makers in the major financial center
countries feared a collapse of the international financial system
and an economic crisis unprecedented since the Great Depression
of the early 1930s. Indeed, in the space of a couple of months, a prob-
lem that had developed in the subprime mortgage market of the US
financial system was transformed into a global financial crisis. The size
of this financial shock and the speed of its transmission were largely
unanticipated by market analysts and policy makers. The economic and
financial costs of this crisis in terms of lost output, unemployment,
and the decline in personal wealth have been enormous. The crisis has
also raised important questions about the stability of the international
financial system and the actions that are needed to reinforce the collec-
tive governance of that system.
This crisis marked the end of the latest phase in the globalization
of finance that has been under way since the late 1950s. As a window
into these recent events, this book attempts to explain the main devel-
opments in financial globalization that have taken place during the
post–World War II period and to examine the institutional and other
cooperative arrangements for collective governance that governments
have put into place to promote an orderly development of the interna-
tional financial system.
Financial globalization refers to the increasing size of cross- border
financial flows among countries and the growing integration of capital
markets across national borders. It is an attribute of the larger phe-
nomenon of economic globalization by which the production of goods

and services, trade and finance have transcended national borders in
response to advances in communication and transport, on the one
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Governing Global Finance
hand, and reductions in policy- based barriers to cross- border transac-
tions in goods, services, and financial assets, on the other. Financial
globalization has also been driven by innovation in the development of
new financial instruments, which have expanded the reach of financial
markets or have facilitated the management of risk. The development of
so- called structured finance in the form of new securitized instruments
and the expansion in the use of credit derivatives were major factors
in the latest phase of financial globalization leading up to the current
crisis.
Economic and financial globalization have been hailed by many
as the process by which the benefits of capitalist development rooted
in the industrial revolution of the nineteenth century will be diffused
throughout the world in an inexorable process that will bring about
global prosperity. The benefits of globalization have clearly been visible
and important, but they have been skewed in favor of certain countries
and uneven in their distribution of costs and benefits. In addition, as
reflected in the antiglobalization protests around the turn of the last
century, globalization has exceeded the power of national governments
to control its de velopment and to l imit col latera l da ma ge to other sphere s
of the global system, such as the environment. The growth of the global
financial system has also been prone to certain cycles of boom and bust
that have caused substantial harm to developing and emerging market

economies in the past and now most recently to the global economy.
The fact that economic and financial markets have become increas-
ingly global in scale, while governmental control and accountability
are still predominantly based on the nation- state, represents the funda-
mental challenge of globalization. Within the national sphere, a proper
system of collective governance arrangements in terms of financial reg-
ulatory regimes, financial safety nets, common legal and accounting
procedures need to be in place to support a healthy development of a
domestic financial system. However, there is no global political author-
ity to establish comparable arrangements at the international level. In
its place, governments have devised a variety of institutional and coop-
erative mechanisms, which have come to be known as the international
financial architecture (IFA), that are needed globally to promote an
orderly process of financial globalization.
The IFA in its current form has followed a clear evolutionar y path since
the end of World War II and has expanded into a variety of formal and
informal arrangements, both public and private. The concept of the IFA
first came into use in connection with the debates on international finan-
cial reform, which took place in the late 1990s in response to a series of
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Introduction
●
3
financial crises among emerging market economies that called attention
to the need for greater international coordination on financial policy and
regulatory issues. After a period of relative calm in international financial
markets following the terrorist attacks of 9/11, the idea of IFA reform has
surfaced again in policy debates among the Group of 20 (G20) industrial

and emerging market countries that have tried to formulate a response to
the global financial crisis since November 2008.
This book seeks to explain the factors that gave rise to the near col-
lapse of the international financial system in late 2008 and the reasons
why the IFA was unable to prevent the financial crisis that has occurred.
In particular, the book attempts to deal with the following questions:
What is the IFA, and why is it needed? How has the IFA evolved dur-
ing the post–World War II era in response to changes in economic and
financial globalization? Why was it not working in being able to prevent
or anticipate the global financial crisis that erupted in late 2008? And
how does the IFA need to be reformed to make it work more effectively
in the future?
Main Outline of the Book
The rest of this book attempts to trace the key markers in the evolution
of financial globalization during the post–World War II period and in
the development of the IFA, with a view to explaining the background
and causes for the recent global financial crisis. The book concludes
with recommendations for the reform of the IFA as a means of minimiz-
ing the risk of future financial crises. The narrative and arguments of
the book are laid out in the following chapter sequence.
Chapter 2 provides a brief review of the nature and evolution of
financial globalization in recent decades, as reflected in a variety of
quantitative measures and regulatory changes. In addition, the chapter
explores the particular market failures that can arise in financial global-
ization and the public goods that the IFA needs to provide to deal with
these failures. The chapter concludes with a brief description of the IFA,
as it existed before the onset of the recent financial crisis.
Chapter 3 provides an historical context for considering the current
age of financial globalization by tracing the evolution of financial glo-
balization since the time of the gold standard (1870–1914), which has

been called the first era of financial globalization. The chapter also
examines the formal and informal arrangements that underpinned the
IFA during the period leading up to World War II. Particular attention
is given to the origins of the post–World War II IFA during the Bretton
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Governing Global Finance
Woods system (1945–73) and the special roles given to the IMF and
World Bank.
Chapter 4 explores the various cooperative efforts that were made
to support the Bretton Woods system, including the critical role that
capital controls were intended to play under this system. The chapter
then examines the factors that played a role in its breakdown, which led
to the first reform of the IFA. This reform resulted in the dissolution of
a post–World War II consensus on international financial cooperation
and began a process of fragmentation in the IFA and a period of more
rapid growth in financial globalization.
Chapter 5 examines the second reform of the IFA following a period
of rapid expansion in the international financial system and a series of
devastating crises among emerging market economies during the 1980s
and 1990s. Particular attention was given to the role of the IMF in crisis
management and crisis prevention. This reform also attempted to bring
together a number of previously uncoordinated activities within the IFA
and to establish safeguards for a further expansion of financial global-
ization. The reform identified issues of global financial stability for the
first time and established the twin peaks of the IMF and the Financial
Stability Forum (FSF) for financial system oversight.

Chapter 6 focuses on the recent pattern of private financial flows
to developing countries and the challenges of financial globalization
for low- income countries, in particular. The preconditions and proper
sequencing of capital account liberalization are considered. The role of
official development finance within the IFA in filling a “missing mar-
ket” for the financing needs of low- income countries is discussed. The
key role of the World Bank in development finance, the problems of aid
effectiveness, and official debt restructuring via the Paris Club are also
examined in this chapter.
Chapter 7 focuses on the most recent period of financial globaliza-
tion leading up to the global financial crisis of 2008–9. The chapter
examines the macroeconomic, microeconomic, and ideological factors
that helped to bring about the crisis. The chapter also identifies the
common causes of the recent crisis and the emerging market crises of
the 1990s in terms of heavy reliance on foreign capital inflows, mon-
etary and regulatory ease, and unsound banking practices.
Chapter 8 looks at the role of the IFA in carrying out its responsibili-
ties of crisis prevention and crisis management relating to the recent cri-
sis. In the area of crisis prevention, the chapter examines defects in the
international adjustment mechanism, the oversight of global financial
stability, international financial regulation, and the international lender
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Introduction
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5
of last resort mechanism. The absence of an effective international forum
to focus political debate on emerging risks in the international financial
system and to coordinate policy responses is also highlighted. In the

area of crisis management, the chapter focuses on the role that the G20
has played in the international coordination of policy responses, the
mobilization of financial resources to deal with the effects of the crisis,
and the preparations for a postcrisis world.
Chapter 9 evaluates the third reform of the IFA that is under way as
a result of the G20 process that began in November 2008. It identifies
the main areas in which changes are being made, as well as those areas
in which the reforms are likely to fall short and areas for reform that
have not been addressed thus far.
Chapter 10 concludes the study and attempts to draw lessons from
the history of reform of the IFA. It also identifies the critical areas for
reform action in the future.
An appendix appears at the end of the book, which provides a brief
summary description of each of the committees, groups, and institu-
tions that make up the IFA.
Key Themes of the Book
Many themes are present in the narrative of this book, which are useful
to summarize at the beginning.
1. Since the mid- twentieth century, the globalization of finance has
been an important force in the integration of the global econ-
omy. By all measures, it has expanded rapidly, especially since
the mid- 1970s as actions to liberalize domestic financial markets
and dismantle controls on cross- border capital movements took
hold in the advanced countries. The suddenness of the eruption
of the current global crisis is testimony to the intensity of inter-
dependence of national capital markets among the advanced and
emerging market economies that has taken place since the turn of
the new century.
2. The IFA has also expanded in response to financial globalization
as governments have struggled to put in place a workable arrange-

ment for collective governance of the international financial sys-
tem that would promote its sound development, while minimizing
its propensity to periodic crisis. This process has evolved in an
ad hoc and incremental fashion, which has relied increasingly on
informal cooperative arrangements (of both a public and private
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Governing Global Finance
nature) and adaptive reforms of existing institutions, rather than
any attempt at grand redesign, to deal with deficiencies and to fill
gaps in the IFA.
3. Throughout the post–World War II era, there has been a tension
in the development of global finance between the importance
given to financial liberalization to promote market efficiency
and the weight given to systems of governance to limit the nega-
tive effects of unfettered markets. In the immediate postwar era,
the balance of collective decision making was overwhelmingly in
favor of the latter, whereas four and a half decades later at the
beginning of the 1990s, the pendulum had swung sharply in favor
of market efficiency and a belief in the self- regulating power of
markets. In the wake of the current financial crisis, a new balance
will need to be struck between these two forces.
4. The IFA has evolved mainly in response to the periodic onset of
crises in the international financial system, in much the same
way that governance arrangements for financial systems at the
national level have evolved. Prominent among these crises have
been the collapse of the Bretton Woods system in the early 1970s,

the international debt crises of the 1980s, and the financial crises
of emerging market economies of the 1990s. The global financial
crisis of 2008–9 will become another benchmark in this evolving
process of reform.
5. The IFA has become increasingly complex and fragmented over
time in a way that has hindered its effectiveness, as regards both
crisis prevention and crisis management. It is also complicated by
a redundancy and overlapping of functions among different insti-
tutions and groups. Although the origins of the current crisis can
be traced to regulatory failure, flaws in the corporate governance
and risk management of large financial institutions, and policy
lapses in the United States, the IFA failed to deal with imbalances
in the global economy and the risks to global financial stability
that were building before the crisis. Weak coordination of actions
to deal with impaired banks with large cross- border exposures
and the absence of an effective international lender of last resort
mechanism fostered contagion once the crisis erupted in the cen-
ter country (USA).
6. As the pace of financial globalization has intensified over time,
the need for a strengthened IFA to govern the international
financial system has also increased. Given that political legiti-
macy only exists at the level of nation- states and the reluctance of
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Introduction
●
7
national governments to cede sovereignty to international bodies,
the international system faces a continuing challenge of build-

ing effective forms of cooperation and coordination in the finan-
cial domain. At the same time, countries want to maximize the
degree of national control over economic and financial policies
and determine the pace at which they achieve integration into the
international financial system.
In the light of these themes, the recent global crisis has pointed to the
need for a greater harmonization of rules for the regulation of finan-
cial institutions with significant cross- border activities and for their
resolution in the event of insolvency. At the same time, there needs
to be stronger international oversight of national regulatory regimes
and a more effective administration of the international adjustment
mechanism. These changes can only be achieved, if there is in place
an effective governance arrangement for the IFA that involves stronger
political oversight and an effective system of national participation and
accountability.
Much has been written about the IFA, especially during the second-
reform period of the late 1990s when the term first came into general
use. Undoubtedly much more will continue to be written in the light of
the ongoing crisis. Most of this literature deals with either a particular
period of international financial reform or the history of one of the
key components of the architecture, such as the International Monetary
Fund. In writing this book, I have benefited greatly and drawn many
insights from this literature. My purpose in this study has been to pro-
vide a relatively concise chronicle of the principal markers in the evolu-
tion of the IFA with a view to understanding how it has come to take
the shape that it has and how it was able to cope, effectively or not, with
the current crisis. This background is essential for any attempt to bring
about its future reform.
My interest in this topic has developed over many years since the
time I was a graduate student in international economics at Columbia

University. It was also nurtured by many years of service on the profes-
sional staff of the IMF where I had an opportunity to participate in a
wide range of its activities, which constitute a critical part of the IFA,
namely its surveillance, financing, advisory, training and evaluation
functions, as well as its links with the Paris Club on official debt restruc-
turing operations and poverty alleviation work of the World Bank. This
experience also allowed me to witness from an operational perspective
some key developments associated with the reform of the IFA such as
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Governing Global Finance
the Latin American debt crisis of the 1980s, the Asian financial crisis
of the late 1990s, and the development of international standards and
codes in conjunction with the Financial Stability Forum. During the
past several years, I have gained further perspective on the IFA from
teaching courses related to this topic at the Duke University School
of Public Policy, the Johns Hopkins School of Advanced International
Studies, and Yale University and from serving as a consultant to the
World Bank and an NGO (New Rules for Global Finance) that has
been active in the promotion of governance reform of the IMF.
In the course of writing this book, I wish to acknowledge the excel-
lent research assistance I received from David Bulman, including the
preparation of figures and the provision of inputs for the appendix. I
am also grateful to Gordon Bodnar, James Boughton, David Bulman,
and Domenico Lombardi for providing comments on an earlier version
of the book manuscript. None of them of course should be implicated
in any of the judgments, conclusions, and recommendations found in

the book.
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CHAPTER 2
Financial Globalization and the
International Financial Architecture
T
his chapter provides a brief review of the recent evolution of
financial globalization and examines the rationale for the inter-
national financial architecture (IFA). It also describes the main
institutional features of that architecture, as it existed before the cur-
rent global crisis. The succeeding chapters (chapters 3–5) attempt to
explain how it came to take the shape that it has.
The Recent Evolution of Financial Globalization
Financial globalization has been a major feature of international eco-
nomic relations in the second half of the twentieth century and an
important aspect of economic globalization. The suddenness of the
onset of the current global financial crisis was a striking, but pain-
ful, example of the rapid growth in financial interdependence among
the advanced and emerging market economies. This process has largely
been a market- driven phenomenon that has affected countries to differ-
ent degrees, depending on their location and income level.
Financial globalization has many roots and justifications. At its sim-
plest level, the demand for foreign finance will grow with the devel-
opment of foreign trade, as exporters and importers seek short- term
foreign lines of credit to support the production of tradable goods on
a revolving, self- liquidating basis. In the absence of barriers to foreign
capital inflows, investors in one country will seek equity stakes in prof-
itable companies abroad, in the form of foreign direct investment (FDI),

because of domestic market conditions or significant export potential.
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A particular form of FDI that is relevant to financial globalization is
the acquisition by large banks in the advanced countries of equity stakes
in bank operations in emerging market or developing countries, and
the opening of branch operations or subsidiaries in foreign countries.
FDI flows have been strongest among the advanced countries, espe-
cially with the growing activity of multinational corporations, and have
been an important force in bringing about a convergence of economic
growth rates among these countries. They have also been an important
source of growth for many emerging market economies in East Asia (in
particular, China) and Latin America.
More generally, the international trade in financial assets and the
operations of international capital markets play an essential role in
intermediating savings in one part of the global economy to invest-
ment in another part, in the same way that financial markets oper-
ate across different regions within national borders. They also provide
a means for diversifying risk for domestic firms and individuals, for
example, in the case of a small economy with high savings and a limited
domestic capital market. In addition, the trade in financial assets can
provide countries with a mechanism for compensating a shortfall in
exports due to some exogenous shock or accommodating an important
long- term investment without a severe compression of consumption
(“consumption- smoothing”).
In a world of interest and exchange rate volatility, active trade in

financial assets among countries will engender the demand for deriv-
atives, by means of which investors can hedge against the exchange
and interest rate risk inherent in foreign portfolios. Such demand has
given rise to a huge growth in interest and exchange rate swaps in inter-
national capital markets. In the last decade, the growth in derivative
trading was one of the strongest components of international financial
transactions, and it became a major source of instability in the global
financial system, as explained in chapter 7. Financial innovation (e.g.,
in the form of new securitized products) has also played an important
role in the latest wave of financial globalization since the beginning of
the new century.
The globalization of finance that took root and expanded during the
last quarter of the twentieth century was the natural accompaniment of
the growth in world trade and foreign investment that was supported by
the post–World War II international economic and financial arrangements
e mb o d i ed i n t h e s o - c a ll e d Br e t t on Wo o d s i n s t it u t io n s (i . e. , t h e I nt er n a t io n a l
Monetary Fund [IMF] and World Bank) and the General Agreement on
Tariffs and Trade (GATT), which was the predecessor to the current- day
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Financial Globalization and the IFA
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11
World Trade Organization (WTO). In the early post–World War II era,
international trading in financial assets was relatively limited given wide-
spread controls on capital movements and the tight regulation of domestic
financial markets. International financial transactions began to take place
during the late 1950s in offshore, unregulated markets outside the reach of
national supervisory authorities, in particular the euro- currency or euro-

dollar markets based primarily in London, which were used by private
banks and firms to bypass restrictions on borrowing or lending activity
in heavily regulated national markets to finance international operations.
1

With the liberalization of domestic finance and the removal of national
controls on international capital flows that began among the advanced
countries during the 1970s, the cross- border exchange of financial assets
expanded sharply, first among the advanced countries and then beginning
in the late 1980s among emerging market countries. This trend was inten-
sified with the revolution in information and communications technology
and the development of derivative instruments noted earlier to cover the
risk of currency and interest rate volatility.
Economists have used various quantitative measures to gauge the
strength of financial globalization. One commonly used indicator is
the growth in the stock of foreign assets and foreign liabilities of groups
of countries in absolute US dollar terms or in relation to GDP, based
on a pioneering database assembled by Phillip Lane and Gian Maria
Milesi- Ferretti.
2
These data cover claims or debt in the form of bond
placements and bank loans, FDI, equity holdings, and a residual cate-
gory, including derivatives and official foreign reserves. Throughout the
period since 1970, the largest share of these financial instruments was
represented by debt, followed by FDI, and equity holdings. In relation
to GDP, these stocks roughly doubled in size during the period from
1970 to 1992; since then, however, they have grown by a factor of three
times, mostly on account of activity among the advanced countries (see
figure 2.1). Compared with previous decades, the period from 2001
to 2007 showed particularly rapid growth in financial globalization.

The growth in the use of securitized financial instruments, the devel-
opment of large complex financial institutions, and the impact of the
euro on the elimination of currency risk for intra- European financial
transactions each contributed to the latest phase of financial globaliza-
tion among the advanced countries.
The growth in transactions in financial assets since 1970 has far
exceeded the growth in foreign trade. According to data from the Bank
for International Settlements on foreign exchange trading, in 1970 the
total value of currency trading was roughly equivalent to the value of
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12
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Governing Global Finance
global trade. However, by 2007, this ratio had reached 50 to 1, thus
signaling an enormous expansion in the trade of financial assets.
3
As one might expect, the advanced countries accounted for the
major share of these stocks, by a factor of roughly 10 to 1 in relation
to the emerging market economies of Asia, Latin America, and Eastern
Europe, which exceeded the stocks of the rest of the developing world
by a similar order of magnitude.
4
Measured in terms of GDP, there
was a gradual, steady increase in international financial flows among
the advanced and developing countries from 1970 to the mid- 1980s, at
which point a sharp divergence emerges as the pace of financial global-
ization among the advanced countries accelerates (figure 2.2). During
the first decade of the current century, there has been a further sharp

acceleration. This measure of financial globalization across countries
is significantly correlated with the level of real GDP per capita and
the degree of domestic financial development.
5
In addition, empirical
studies have shown that bilateral holdings of foreign assets and liabili-
ties are stronger among countries that share a common language, legal
system, and colonial history. Moreover, the willingness of investors to
hold external liabilities of a foreign country (and to hold them in the
form of equity- like liabilities such as FDI and portfolio equity) is higher
for countries with stronger measures of institutional quality and educa-
tional attainment.
6
Figure 2.1 Financial globalization (global aggregate assets and liabilities, as percent of
GDP)
Source: Updated and extended version of dataset constructed by Lane and Milesi- Ferretti (2007)
0
50
100
150
200
250
300
350
400
1970
1972
1974
1976
1978

1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Debt
Equity
FDI
Other
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Financial Globalization and the IFA
●
13
A rising trend can also be discerned for the emerging market and
developing countries, but on a much more muted scale. Within that
trend since 1970, there have been three waves in the extension of finan-
cial globalization to the developing countries, each larger than the pre-
vious one: the first during the second half of the 1970s in response to
the oil price hikes engineered by OPEC countries; the second during

the first half of the 1990s; and the third during the run- up to the cur-
rent global financial crisis (figure 2.3). Unlike the previous two surges,
the last one involved strong two- way flows of international assets and
liabilities of the emerging market economies, which are examined in
0
50
100
150
200
250
300
350
400
450
500
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984

1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Emerging and Developing Countries
Advanced Economies
Figure 2.2 Financial globalization for advanced and developing countries (total assets plus
liabilities, as percent of GDP)
Source: Updated and extended version of dataset constructed by Lane and Milesi- Ferretti (2007)
0
1

2
3
4
5
6
7
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993

1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Commercial banks and other
lending
Portfolio investment, equity
Foreign direct investment, net
inflows
Figure 2.3 Private capital flows to low- and middle-income countries (as percent of GDP)
Source: World Bank, World Development Indicators (WDI)
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Governing Global Finance
chapter 7. The boom and bust associated with each of these surges has
been the trigger for important changes in the IFA.

Another statistical measure, which economists have used to quantify
the extent of financial globalization, is the absolute sum of external cur-
rent account surpluses and deficits among countries to global GDP. In
contrast to the stock measure described in the previous paragraphs, this
measure provides a flow dimension to international financial transac-
tions. The current account balance measures the net surplus or deficit
of a country’s exchange of goods, services, factor income (dividends,
interest, and wages) and transfers (e.g., official aid and migrant remit-
tances) with the rest of the world, which give rise to a net accumulation
of foreign assets or liabilities. The long- term trend of this measure gives
a view of financial globalization roughly similar to the indicator used in
the previous paragraphs, with persistence in the size of these imbalances
during the 1980s and 1990s and a pronounced widening during the
current decade in the run- up to the current crisis (figure 2.4). The phe-
nomenon of growing current account imbalances in the current decade
has given rise to much debate about the sustainability of “global imbal-
ances” and their contribution to the onset of the current financial crisis,
which is also discussed in chapter 7 of this book. These imbalances were
prominently reflected in a large current account deficit of the United
States and a large current account surplus of China.
7
One additional indicator that has been used to gauge the extent
of capital market integration across national borders arising from
0
1
2
3
4
5
6

7
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998

1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Figure 2.4 Global imbalances (absolute sum of current account imbalances as percent of
world GDP)
Source: International Monetary Fund, World Economic Outlook Database (April 2008 and October
2009)
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