Long-Run Growth and International Saving Flows

Claude BISMUT

University Montpellier-I

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

Globalization from goods to capital markets

• Together with trade liberalization, the integration of capital markets has been one of the major long-run trends of the world economy over the last sixty years.

• It was believed to foster growth, in particular in developing countries, thus speeding up convergence.

• What can we reasonably expect from capital market integration?

• Has it worked as expected?

• How could the outcome of this process be improved?

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

I. What can we expect from international financial integration?

• Welfare increasing? Because households have a larger choice.

• Speeding convergence? Because foreign saving can supplement insufficient domestic resource for investing in less developed countries.

• More growth? Because market forces enhance private efficiency and government discipline.

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

1. Consumption smoothing

Integrated capital markets allow to smooth consumption against asymmetric shocks.

• A country can borrow in bad times and lend in good times.• Aging countries can transfer savings to young countries. • Consumption smoothing is welfare increasing• Current account deficits are not a concern, if sustainable.

• On average, does not lead to faster growth.

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

2. Financial integration and convergence

Open domestic capital markets, savings will move from low to high return places.

This does not change the long run rate of growth but speeds up convergence.

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

Essence of the neoclassical argument

Two countries, DC and LDC, have the same neoclassical production function, ...

Y

K

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

Essence of the neoclassical argument

…, but, initially, DC is much more capital intensive than LDC.

Y

K

Less developped country

Developped country

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

Essence of the neoclassical argument

Two domestic capital markets: neoclassical theory predicts convergence in the long run.

Y

K

Less developped country

Developped country

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

Essence of the neoclassical argument

Merge the two capital markets in a unique global one: then, savings move rapidly from DC to LDC.

Y

K

Less developped country

Developped country

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

3 Factors enhancing growth

Foreign investment bears the seeds of efficiency gains. • FDI favors transfers of technology and importation of

management practices. • Portfolio investment accelerates the development of the

equity market. • Governments are subject to markets’ judgement, which

enhances discipline. • Opening the current account is also expected to

increase the efficiency of domestic banks.• However capital flows must be directed toward

productive investments.

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

Less developed countries : net capital inflows

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20

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60

80

100

120

140

1970 1974 1978 1982 1986 1990 1994 1998

Foreign portfolio investment

Foreign direct investment

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

II. Has financial integration delivered its expected benefits?

• Financial opening does not necessarily bring about more convergence or more growth.

• Current account imbalances are not a concern if countries remain solvent.

• Catching-up works on average, but not for all LDC.

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

1 Is the internationalization of savings actually at work?

Disconnection between saving and investment

• Close correlation found between saving and investment in the 80s and early 90s raised doubts on capital mobility.

• One reason is that governments have implemented macro policies to contain current account deficits.

• More recent evidence indicates that investment and saving have actually been disconnected, and that internationalization of savings is at work.

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

2 Who’s afraid of current account imbalances?

Current account imbalances have to be accepted do not automatically lead to convergence.

• Opening the current account and refusing deficit is somewhat contradictory.

• But deficit have to be sustainable.

• Governments are under markets judgement, and fear financial crises and sharp exchange rate corrections.

• Sound macroeconomic policy is crucial.

• But faster convergence will not necessarily follow.

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

3 Has the convergence process been

effective? At work on average, but not for all.

• Some economies -- notably in transition -- have benefited from globalization.

• Less developed countries still have too limited access to capital markets.

• However, there is some evidence of negative correlation between growth and income per head.

• But too many countries remain trapped in a vicious circle.

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

Convergence is at work

Claude Bismut Global Convergence Scenarios, OECD Workshop, Jan. 16,2006

Concluding remarks :Strategy for growth and convergence