Impact of Globalization on Financial Markets
In the recent times, globalization of the world financial markets can be seen as a significant milestone that has happened in the financial markets. Various factors have contributed to globalization that include the advancement of technology and remote access, which the financial markets companies have been utilizing. The rise of international institutions providing financial services to various sectors and firms, irrespective of geographical areas and jurisdictions has also contributed to globalization. Other factors include the liberalization trends, reduction and in some situations the removal of trade barriers and restrictions on foreign ownership, the collaboration, merging and integration of the regional financial exchanges as well as the clearing and settlement organizations that exists in the global fronts among other factors. Financial globalization as seen by many analysts is beneficial and advantageous since it leads to the improvement of the market efficiency, and it leads to the lowering of risks because of diversification. Moreover, globalization has been credited in the usage of arbitrage. Contrary to the benefits that globalization brings, it leads to price volatility and instability in the market since the correlation of the major stockholders and the trading. This implies that when the major stock markets are affected by any condition, the effect is felt by almost all the players in the financial markets. As explained by Mishkin (2007), globalization refers to the opening of the domestic markets to foreign trade and direct investment as well as the interaction and cooperation of the local and foreign capital and financial institutions. This being the case, globalization of financial markets has mixed reactions and effects on the performance of the global financial markets. Despite this fact, globalization has helped in fostering faster cash inflows in the economy, though this does not give any evidence of faster growth or equivalent growth. In the light of the above, this paper aims at identifying the effect of globalization on the financial markets with an emphasis on the capability of globalization to internalize the financial markets, the globalization of finance, new financial products invented, good and effective financial reporting and liberalization effects.
History of globalization
Globalization refers to the growing interdependence that exists between countries that usually arise as a result of increasing integration of trade, people, finance and ideas in the market place (Bigman, 2007). The main elements of global integration include the international trade and the cross border investment flows (Bigman, 2007). The history of globalization started after the Second World War but has seen significant increase since the 1980s. This increase has been generated by two main factors, which include technological advancement, which has led to the reduction of the cost of transportation, communication and the costs that are involved with the computation whereby the firm finds it economically feasible to locate various production phases in different countries (Bodie, 2013). Globalization has also been affected by the liberalization of trade and the rise of the capital markets. Most of the governments have reduced the conditions that foreign countries are supposed to meet before investing in their countries. The existence of non trade barriers, limited export restraints and few legal requirements led to the creation of various organizations like the IMF, World Bank among others. The WTO established in 1995 is an example of organizations that promote free trade instead of protectionism. Research indicates that globalization has increased economic growth in country economies like china, Korea and Singapore. Despite this fact, it should be noted that not all of the developing countries benefit from globalization. The less developed economies have been slow to adapt to the international integration, with some especially the sub Saharan Africa having a declined share since the 1960s. Since the drop of oil share in the 1980s, many countries have been engaging actively in globalization. This comes with both benefits and challenges.
Advantages of financial globalization
One of the merits to nations participating in globalization is engaging in foreign market trading includes the access to larger international market (Taylor, 2002). Some national economies benefits from the international division of labor and are able to face the competition in the global arena. The local producers are also able to produce more efficiently because of the pressure that comes from international competition as well as the global specialization. The net effect of this is that the consumers are able to enjoy a wide range of local and international goods at reduced prices. Another benefit that national economies acquire from globalization of trade is the technological spillovers ( Kenen, 2007). As a result of the countries trading in foreign financial markets, knowledge and other skills are embedded on these countries and this helps them to catch up faster with the developed countries. Economies that isolate themselves suffer from information, skills and expertise deficiency and this makes it difficult to compete in the international markets. Financial globalization also helps in the reduction of capital since capital flows in different countries will help increase the local stock markets to a more liquid state. This will help in reducing the risk premium and hence lowering the capital costs. Others include widening the liquidity constraints, diversification, and the development of the financial labor market
Disadvantages of financial globalization
Challenges that countries face as they trade in the international arena includes strong competition. Competition has direct impact in that those who are not able to adapt to the international standards and are less competitive are forced out of business. Overreliance of the international market for essential national supplies is dangerous since international effect may affect the national outlook. For example, reliance on the delivery of food from the international market may lead to disaster when imports are cut off. For the developing countries, protectionist is necessary to protect the local economy. This is dangerous as it allows the local producers to produce less efficiently. Nations that try to produce everything domestically may lack the international specialization benefits. Overreliance of the international market for a product or several products can be disastrous if the world’s demand for the product is affected by factors beyond a nation’s intervention. This being the case, to correct the terms of trade that can be affected, a country should engage in diversification. In general, financial globalization leads to financial imbalances as well as the creation of the financial laissez faire.
Despite the risks associated with globalization, in the recent times, most of the countries have opted to globalize their economies and this has affected their financial markets (Kenen, 2007). Many countries have invested in the international financial trading more than they do in their GDP. The foreign investment is important to most economies and especially the developing countries because they are more in need for the goods and service, labor and the natural resources. Despite having these products in their nationals, they may lack the capacity to produce and therefore requires the presence of large multinationals that will provide the labor, expertise and capital to finance these projects. This helps to induce capital inflows into the country that benefits the country’s economy. It also helps in bringing down interest as competition between the local and international companies compete for the supply of their services. If the country is growing, the possibility of getting foreign direct investment is high since the investors view such places as being less risky. The below illustration showing the development countries and financial globalization
Reference: Economics, Management &
Financial Markets, Dec2013, Vol. 8 Issue 4, p42-58, 17p, 1 Diagram
Diagram; found on p53
Overall, globalization has helped countries to increase outward orientation and this helps such nations to improve their balance of payment. At the same time, globalization has enabled countries to exchange technologies thus improving productivity nationally. At the same time, the increase of foreign interaction in the local market has helped boost the competitiveness of the domestic market. The improved productivity is likely to lead to backward linkages effects.
Financial market liberalization
The regulatory changes that have been implemented in the last decade have been adopted by many of the global stock exchanges. Globalization has enabled the member countries to adopt liberalization of the stock markets as well as the regulation of the financial institutions. Through linearization, many of the countries have been able to remove the restrictions that are levied and imposed on other states. This has helped attract more foreign investors to invest in the national stock exchanges, thus, increasing the foreign shares in the national stock exchanges as well as permitting direct investment from the foreign investors.
Through globalization, various legal changes were introduced in the major financial stocks. The legal changes included their economic status, profit targets as well as other conditions that include the place of financial market trading, revenue sources, legal entity and owners among others. This led to the majority of the global stock exchanges undergoing demutualization and privatization. The legal changes have made many of the financial stock exchanges be owned by private and public enterprises. It should be noted that due to the changing global changes, some of the states that did not allow foreigners to have a stake in their national financial stock have been issuing special shares for the foreigners.
The financial globalization has been on the increase since the 1990s. Advanced countries have invested in the international markets large amount of money that is more than their own GDP. This has led to substantial capital flows in the world, but despite this fact, financial globalization has failed to improve the global productivity (Underhill, 2010). The less developed economies do not receive their part of the global share though they contribute to the global economy. The integration of global finance helps in promoting income growth through better allocation of investments and insurance possibilities and this helps in improving the macroeconomic policies and other structural reforms (Taylor, 2002).
Despite this fact, when there is a large capital inflow into a country, numerous challenges can be faced which implicates the macroeconomic management (Jaumotte, Lall & Papageorgiou, 2013). The increased private capital inflows are likely to generate an upward pressure on the real exchange rates. This may lead to the currency deteriorating or increased competitiveness thus leading to macroeconomic dilemmas. It should be noted that with increased capital inflows, there often credit booms in the country, which affects the credit quality. This is likely to impact on the cost of the financial assets and real estate prices and this affects the wealth condition of the economy. In situations where such inflows are available, there is a possibility of misappropriation and misallocation of the fund. This has the effect of deteriorating and destabilizing the financial systems. At the same time, the financial crises may bring in other economic and social costs. In general, the sudden inflow of capital affects the financial and other banking institutions.
Global markets can be said to be the markets where the law of uniform price applies. This means that irrespective of the location that one is, the prices remains relatively the same when purchased and then sold outside the national boundaries. Globalization of the financial markets has helped the industry players to spread financial innovation globally. The global finance the continued integration of the international financial markets has led to the reduction in the cost of public corporations around the globe. The worldwide diversification of these corporations has enabled the investors to spread the risks associated with the running and holding of stocks for these organizations. It has also increased the synchronization/correlation of the international business and the world financial markets. Globalization has enabled banks and other financial institutions to diverse and expands geographically. They have therefore acted as lenders and borrowers across national borders. Innovations are being made whereby newly issued securities are offered to the public so as to attract the international investors. These have led to the elimination of the barriers to entry while increasing the liberalization of the national financial market. The increased liberalization has made more money available thus helping in the improvement of financial possibilities. With the cross boarder business, financial transactions have become easier and more secure.
Internationalization of the Financial and Stock Market
Because of the emerging technology, many countries have adopted new financial market practices that have helped in the advancement of the financial market in the global arena (Hausler, 2002). One of such is the use of the internet services to trade in the stock markets. Through the internet, many financial transactions are channeled directly through the internet stocks trading. This has prompted the internet to change the direction and the mechanism used in the financial and stock exchange to make decisions about the global stocks. The trading decisions in the contemporary times spread globally unlike in the past where it was concentrated on the stock exchanges only. This has been attributed by the use of the internet where the financial transactions have been increasing over the internet. The online stock and financial market is said to be more speculative, more active, but less profitable (Barber, 2002). Because of this, the reaction of the internet advisors, investors and other specialists is usually unpredictable when the market is unstable (Barber, 2002). Technology has enabled many foreign traders to transact in the global stock market. This has been made possible by the growing practice where GDR and ARD instruments are being used in the US and other European markets in international public offerings.
Cross listing is a strategy that has been employed by many firms to trade in the international financial markets. Cross listing is a situation where the shares of a give firm are traded on more than one stock exchange (Sabri, 2002c). Firms, which do not meet the requirements for cross listing usually, use depository receipts to trade in the international market. Cross listing of the stock and financial securities improves the financial and economic ties between various regions and increases and develop their linkage between (Sabri, 2002c). Despite this fact, cross listing is likely to weaken the local stock exchanges by reducing their annual revenues. It may also lead to the local stock exchanges lacking the local confidence if the major player decides to transact more on the international front than in the local financial and stock exchanges. Cross listing may also lead to price fragmentation of the local stock exchange.
Unlike the traditional financial market setting, where the stock exchanges were the sole tool and avenues of stock and financial markets where the prices of various stocks are determined, the advancement of technology has enabled the alternative trading system to take place. The alternative trading system uses the electronic communications networks, which offer the investors to order or send their orders in real time using the electronic system. This has the advantages in that it helps eliminate that conflict the usually do appear between the brokers and dealers in relation to the interests of the securities (Macay & O’Hara, 1999). On the other hand, it helps the players to trade throughout since electronic transfer can be affected any time by the system and does not rely on the availability of the brokers. The capability of the firms of individuals to trade anonymously in the financial market has been promoted by alternative trading methods. This situation could not have been achieved in the traditional system since the work was restricted to the brokers and the dealers in the stock market. Using this type of trading, less costs are incurred, the regulations are reduced and can be very efficient when the market trading is booming.
Financial Sector Development
Financial globalization has helped promote development of the financial sector. The presence and participation of the foreign investors in the local financial institution helps the institutions to be able to increase the financial pool while at the same time increasing the availability of funds. International financial institutions at the same time are likely to affect the competition rate in the country in the sense that they may lead to the reduction of interest by the local institutions. At the same time, it will help the local institutions to be more efficient to keep up with the international standards thus improving the domestic financial market. The global presence of the financial markets may help in reducing the economic shocks and economic slowdowns in the sense that, as the economy experiences shocks and slow downs, the international financial institutions may offer borrowing which reduces the macroeconomic volatility of the financial sector in the country. The effect of globalization may also help to improve the macroeconomic policies and regulating institutions with the aim of attracting more investors (Prasad et al., 2003). This may lead to the reduction of barriers and other restrictions on the outward and inward flow of capital thus attracting more capital into the country. Financial globalization can be defined as the integration that exists in the global markets this being the case, globalization and liberalization help in the economic development of the states involved and reduces barriers that came as result of international trading. The chart below shows the movement of capital flows in the developed countries
Obtained from http://dgff.unctad.org/chapter1/1.2.html
Globalization enables cross border transactions as well as mergers, acquisitions and joint ventures (Evenett, 2004). This being the case, the globalization risks can be shared internationally sine the cost of capital is likely to be reduced as a result of cost sharing and the firm merging or acquiring other services in already an existing platform. This reduces the costs that would have otherwise been used as startup costs, it also reduces the legal requirements and costs that are new entrants ought to pay to the state. This leaves more capital for trading. Diversifying risks, therefore, reduce the cost of raising capital.
Unlike in the past where only a few companies could engage in financial market trading, new products have been introduced that accommodates many players in the financial markets. Moving of capital from a foreign to a domestic country, not only increase the GDP, but also augments the domestic savings, thus allowing for increased consumption or investment beyond ordinary budget constraints (Banytte, 2009). The presence of increased international finances is likely to facilitate increased growth, thus, leading to higher output and increased total GDP. Through globalization therefore, a person who had a lower opportunity cost of investing could do so since money could be available to borrow. This helped in widening the liquidity constraints this can be explained in the case of Australian GDP as a result of financial market engagement.
Capital inflow occurs because of the desire to have increased returns with tolerated risks. The international markets search for places to invest thus stimulating and increasing the investment in the emerging markets. The search for new markets to invest in, leads to diversification, and when barriers are eliminated, the firms are likely to enjoy the economies of scale, wider markets as well as tougher competition. As capital and investments are channeled into the country, the country enjoys financial influx as well as spillover effects, which could include technical Knowhow experiences, managerial experience from the investors and the promotion of technological development. This could lead to the increase in aggregate productivity of a country. Foreign direct investment also serves as a stimulus for economic growth.
Negative Effect of Globalization on Liberalization
Liberalizing the world’s financial markets is likely to lead to volatility of the market prices. As indicated earlier, globalization has the effect of affecting the foreign exchange rates in the country since the controlling parameters are the global trend (Kohli, 2011). This being the case, the power of the national authority to control and protect the national financial markets may be impossible, especially in a situation when the global condition is unstable. Taking the world trade center as an example or during the time of recession in the United States, or even the conflict arising in the Middle East, it has been witnessed that the increased prices of the oil and oil products have affected the global financial markets. Similarly, in the case of the recession, where the effect of the crisis in the US affects the performance of the financial markets in the global arena. This indicates why there could be an increase in financial market trading, but a noticeable instability could be experienced in the trading. One effect of globalization is the fact that it also destabilizes the national economy of a country due to the equity flows. The developing, or those countries which have unstable and weak currencies are most likely to lose in case the global price dwindles.
Reference: IMF Economic Review, Jun2013, Vol. 61 Issue 2, p271-309, 39p, 5 Charts, 7 Graphs Graph; found on p283
As a result of liberalization, competition arises among the financial systems, both in the local and international stock exchanges. The effect of this is that local financial institutions are put on pressure to adapt to the international financial markets and this is likely to bring instability to the local financial markets and the financial institutions. Because of the link between the international financial players, volatility surprise in one market, may lead to similar effects in other financial markets. For example, the effect of the WTO affected the stock performance in Japan, UK and China. In the less developed countries, the effect could be severe since it could affect the national growth. This being the case, liberalization is likely to have a spillover effect on financial markets. This may not be good for the emerging markets and may deter integration of the developing countries. In general, it may lead to the incomplete harmonization and increased volatility of the capital flows (World Bank, 2001).
Globalization has reacted to the technological advancements thereby forcing all the players in every sector to adjust, update and expand their activities. In the financial and capital markets, the effects of globalization are as follows.
Globalization has resulted in the deregulation of markets through the elimination of the foreign exchange controls as well as reducing the taxes that are imposed on the investors (Harker, 2009). There has also been the reduction of the restrictions that foreigners had been levied on the purchase of the domestic securities. This has made the sector be more active, vibrant and competitive having local and international players in the same stock exchange. At the same time, globalization has led to the advancement in the telecommunication sector, such that all the players in the financial exchanges can trade in the same stock exchange. Through globalization of the information science, investors and financial players are able to transmit and access real life information on the stock exchange, thereby enabling the investors to monitor the global prices and markets. This is important, as they will be able to monitor the impact of their investment in the global arena. At the same time, money can be transferred on a real time basis across borders in the international financial markets.
The capability of money to transact in the international market and especially the cross border transactions has enabled the equity flow thus enabling firms to increase the investment returns (Kunnanatt, 2013). The increase in investment has enabled many firms to be able to raise capital, through the international listing. The sourcing of capital in the international stock exchanges has enabled the various forms to acquire an international image. This has helped the international stock exchange to acquire a national and international outlook, thereby improving the national and local stock exchanges.
Since the main trading in the financial markets is in terms of monitory terms, many of the financial institutions have been engaged in the trade. This has led to the institutionalization of the sector whereby services like mutual funds, pension funds and other insurance services are traded. With the globalization of the financial markets, individuals and firms are able to gain the opportunity for smooth consumption by borrowing from the international investors. At the same time, globalization is credited with the rapid spread of technology, the financial innovation and improved financial performance. With globalization, settling and other trading systems can be made available to all the market participants. This could help in the expansion of the financial and stock market innovation.
The Problem of Internationalization
Because of internationalization, the use of internet advice has been credited to improve the stock and financial market performance through information dissemination (Outreville, 2010). Despite this fact, speculations from the internet site may create panic on some securities when the recommendations on selling are made. These may impair the efficiency of the financial and stock market. Increasing the total foreign trading in the international stock markets may lead to speculations, which in turn may bring about instability. Some players in the financial markets may initiate changes that may affect other players in the system.
The market inefficiencies may arise and these could lead to financial instabilities. This is as a result of the information asymmetries and the transaction costs. The inefficiencies could be portrayed in various ways including the externalities and the coordination issues (Arestis & Basu, 2004). Externalities would arise in the course of electing the market infrastructures like the market payment and the settlement systems. Coordination deficiencies could arise as a result of the relationship that does exist between the borrower and the lender of the information asymmetries. Financial crises could also arise when restriction of capital flow occur in given cases. An example of financial crises arising is when the government imposes minimum reserve requirements and penalizing capital flows would have effect on the economic growth in the long term.
The financial integration has led to some kind of vulnerability whereby the foreign purchaser of the equities and the domestic currency has grown in an enormous way. This has led to the increase of foreign investment, which in some countries exceeds the direct investment; the effect of this is that in case there is a loss of confidence from the foreign investors because of global, political or economic factors, negative effects would arise in the sale of these claims (Gao, 2013). At the same time, should the investors leave a country, there could be great effect on the prices of the countries stocks and bonds and the currency of the country could depreciate due to the shock effects.
Financial globalization may also lead to financial market crises through the aspect of contagion (Wyplosz, 1998). This is through the multiple effect of shock that is transmitted across nations through various links including, real links, through financial links, or herding behavior. Contagion could occur in real link especially trade links where countries compete among themselves and in the same external market. The effect of this is that a devaluation that may occur in one country may affect the competitive advantage of the other country. This would lead to both countries devaluing their currencies in an attempt to rebalance the external sector. The financial link exists when two countries’ economies are related through the global financial system. Any negative shock in one country may affect the value of the currency in the other country. Financial crisis could also arise because of herding behavior or panic between countries. Since the information is asymmetric, investor’s remains uninformed a therefore base the future markets of the way other markets are reacting. In some cases, when a country becomes dependent on another, the sudden shift of external factors like shifts in capital flows would create financing difficulties as well as economic downturns in the dependent country. Globalization can lead to imperfection in the global financial market. Imperfections can lead to herding effect, speculative behaviors and crashing of the international market. This may occur even if the country has sound fundamentals. The imperfections like speculation can lead to the deterioration of the fundamentals thus leading to crises.
Globalization has affected the way financial markets operated in the modern times. Unlike in the traditional times when the financial markets were positioned in a central place, the current financial trading can be undertaken generally from anywhere thus reducing costs that are incurred by the brokers and interest charged on the owner of the security by the brokerage firms. It also reduces the legal requirements by the parties to the trading. Internet and the computer based trading have helped the modern trading to be more vibrant and effective unlike the traditional near manual approach. the modern trading setting has helped the various players to access instant information on what is happening in the international stock exchanges, thus making it easy to make decisions on where to invest and in what stocks. Through globalization, various financial markets have been able to consolidate, merge, and engage in alliances among other options. This has helped investors to invest outside their national boundaries, thus helping in multi listing of the companies. It has also affected the trading systems in the sense that the modern trading patterns call for faster, real time transaction, which contrasts the traditional setting where small orders were likely to take lesser time to process while the large orders took longer time. The contemporary times have an order driven system where the barriers that complicated transactions are on the verge of being completely eliminated.
The international global market has had significant changes in the recent times because of the global economy. In the modern times, trading has increased with over 50000 securities, dealers and brokers are numerous while the intermediary agencies and stockholders numbering in their millions. There has also been a significant change in the financial trading mechanism due to the technological advancement, communication proper financial management. Globalization has helped the transaction costs of the financial markets to be reduced, increased the transaction traded while at the same time increases transparency and information sharing among the parties involved. Despite this fact, there have been market inefficiencies, fragmentation of the market and new legal implications. Though these negative do not occur all the time, there is need to avoid the effects of globalization ion the financial markets.
In the face of the changing global environment, globalization can be enhanced if various strategies are put into consideration. One of the strategies that firms ought to put focus on is the technology. Creating a more robust technology is important to solve the problems that may be arising from the financial markets. With increased technology, firms and other players in the financial markets will be able to expand even in the remote areas thus ensuring an increased trading coverage and accessibility. Support offices also when established would help the participants to ensure a complete transfer of information to the developed and the developing markets. This has the potential of enhancing regional cooperation. At the same time, member countries are tasked with the role of protecting the investors the investors. This can be achieved when governments loosens some strings that prohibit investors to actively participate in the financial market.
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