International financial integration and economic growth in developing and emerging economies: an empirical investigation

Abstract

This paper explores the relationship between international financial integration (IFI), external vulnerability and economic growth. It proposes a taxonomy of typical IFI profiles and applies it to a sample of 90 developing and emerging economies (DEEs) for the 1992–2016 period using a dynamic panel data model. Drawing from a Post Keynesian and Structuralist analytical framework, it argues that what matters for economic growth is less the degree of IFI per se and more the profile, or “quality,” of this integration. The results suggest that DEEs which succeed in integrating into global financial markets under a more balanced and autonomous profile may experience, at best, negligible benefits for economic growth, while a more financially dependent and vulnerable profile exacerbates the risks of financial globalization, undermining growth in the long run. Moreover, the growth path in the latter tends to be more affected by external financial shocks, even though systemic shocks also impact the former.

Keywords:

• International financial integration
• external vulnerability
• economic growth
• developing and emerging economies

JEL CLASSIFICATION:

• F3
• F4
• O4

Notes

1 The literature generally uses the terms “financial integration”, “financial liberalization” and even “financial globalization” as synonyms, since most models assume that under conditions of perfect capital mobility, an economy automatically reaches the level of perfect financial integration. However, it is reasonable to argue that “financial liberalization”, in practice, is the situation in which legal restrictions on capital movements are removed for greater “financial integration”, i.e., financial liberalization is a necessary but not a sufficient condition for financial integration. Similarly, the concepts of “financial globalization” and “financial integration” are different. “Financial globalization” involves increasing global linkages through international financial markets, while “financial integration” refers to an individual country’s linkages (Prasad, Rogoff, et al. 2007; Akyüz 2017; Ocampo 2018).

2 In a report published in 2012, the IMF recognized the legitimacy of capital controls as a useful instrument to cope with the macroeconomic instability generated by capital flows (IMF 2012). Whilst conceding that financial globalization bears potential adverse effects, the IMF’s advice was to continue to avoid capital controls whenever possible and to maintain a financially open economy, restricting destabilizing capital flows only as a last resort and on a temporary basis. Hence, the new IMF posture is seen by many experts as insufficient to deal with the problems of financial globalization. For diverse views on macroprudential tools and/or reforms in the global financial system see, for example, Jeanne, Subramanian, and Williamson (2012), IMF (2012, 2016), Kregel (2016), Akyüz (2017), Ghosh, Ostry, and Qureshi (2018), Korinek (2018) and Ocampo (2018).

3 See Jeanne, Subramanian, and Williamson (2012) and Rodrik and Subramanian (2009) for a critique on the indirect effects’ argument.

4 Broadly, the term “financialization” is used to describe the increasing dominance of the financial sector over the real sector, i.e., a process in which financial markets, financial institutions and financial elites acquire growing importance on the economic dynamic (economic policy and economic performance) both nationally and internationally (see Epstein, 2005; Bonizzi, 2013; Stockhammer, 2013).

5 A comprehensive synthesis of this literature can be found in Claessens and Kose (2013), Frankel and Saravelos (2012), Tularam and Subramanian (2013) and Goldstein and Goldstein (2015).

6 It should be noticed that FDI-derived reinvestments may be redirected to liquid domestic financial assets, being equivalent to short-term portfolio investments. To that extent, only greenfield projects represent direct contribution to production capacity. In addition, the impact of FDI on the balance of payments is often negative even when investments are export oriented (UNCTAD 2014; Akyüz 2017).

7 Being $r^{\mathit{NFL}}NFL$ the net cost of foreign liabilities (net income sent abroad) in each period, from a medium-long-term perspective, the condition for $\mathit{NFL}$ not to follow an explosive path can be expressed by $g_{\mathit{NFL} =} r^{\mathit{NFL}}-\frac{NX}{{\mathit{NFL}}_{-1}},$ where $g_{\mathit{NFL}}$ is the growth rate of $\mathit{NFL}$ and $NX$ are net exports.

9 The choice of countries was based on data availability and are listed in the Appendix 1, Table A1. The overall distinction between developing and developed countries follows the United Nations’ definition. The definition of emerging economies follows the Institute of International Finance (IIF) definition, since the UN does not provide a distinction. See UNDESA (2016) and IIF (2016).

10 For instance, the IFI-ST is used by Lane and Milesi-Ferretti (2003, 2007) when analyzing the evolution of IFI for several countries, but they do not estimate its relationship with economic growth. Similarly, we built the IFI-FT considering aggregate capital flows. For a review on the traditional IFI indicators, see Kose et al. (2006) and Jeanne, Subramanian, and Williamson (2012).

11 The IIF regularly analyses 30 economies considered emerging markets: Argentina, Brazil, Chile, Colombia, Ecuador, Mexico, Peru, Venezuela, China, India, Indonesia, Malaysia, Philippines, South Korea, Thailand, Egypt, Lebanon, Nigeria, Saudi Arabia, South Africa, United Arab Emirates (UAE), Morocco, Czech Republic, Hungary, Poland, Bulgaria, Romania, Russia, Turkey and Ukraine. Due to lack of data in some years, UAE, Lebanon, Czech Republic, Russia, and Ukraine were not considered.

12 As it would be interesting to allow all coefficients to vary between the two groups, and not just the coefficients of the IFI variables and external shocks, we chose to split the sample. Splitting the sample is simpler but equivalent to having an interaction dummy for every independent variable. Although, for reasons of space, we have not shown the complete results of the regressions, it is worth mentioning that for the group with high external vulnerability, the inflation rate was, in general, statistically significant and negative, and the fiscal balance of the general government was statistically significant with a positive sign. For the less vulnerable economies, the inflation rate was also generally significant, but with a positive sign, while for the fiscal balance the coefficient was negative. This type of result is not new in the literature on economic growth. Although there is a consensus about the negative effects of uncontrolled inflation and public accounts on growth, several studies point to ambiguous results, to the existence of thresholds or a non-linear relationship between these variables and output. In any case, when we look at Table A2, we can see that the group of low vulnerability economies according to our classification presents, on average, better results than the group with high external vulnerability in terms of fiscal balance and inflationary control, suggesting the existence of a non-linear relationship between these variables and economic growth for the set of DEEs analyzed here. These issues, however, are beyond the scope of this article.

Additional information

Notes on contributors

Samuel Costa Peres

Samuel Costa Peres is an Assistant Professor at the Department of Economics of State University of Maringá (UEM), Paraná, Maringá, Brazil and a Researcher at the Brazilian National Council for Scientific and Technological Development (CNPq).

André Moreira Cunha

André Moreira Cunha is a Full Professor at the Department of Economics and International Relations, Federal University of Rio Grande do Sul, Porto Alegre, Brazil and a Researcher at the Brazilian National Council for Scientific and Technological Development (CNPq).

Luiza Peruffo

Luiza Peruffo is an Adjunct Professor at the Department of Economics and International Relations, Federal University of Rio Grande do Sul, Porto Alegre, Brazil.