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Financial integration
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<h2 id="history">History</h2> <p>Financial integration is believed to date back to the 1690s and was briefly interrupted at the start of the <a href="/facts/French_Revolution/PIkDlrC0">French Revolution</a> (Neal, 1990<a class="footnote-ref" id="fnref:4" href="#fn:4"><sup>4</sup></a>). At the end of the 17th century, the world’s dominant commercial empire was the Dutch Republic with the most important financial center located in Amsterdam where Banking, foreign exchange trading, stock trading and bullion trading were situated. And it was Amsterdam where Dutch investors directed funds abroad at the time. The Amsterdam Exchange had positioned itself as a world marketplace where many different types of securities and commodities were exchanged. It was also in this period that London and Amsterdam were closely integrated financially (Eagly and Smith, 1976;<a class="footnote-ref" id="fnref:5" href="#fn:5"><sup>5</sup></a> Neal, 1990<a class="footnote-ref" id="fnref:6" href="#fn:6"><sup>6</sup></a>); Amsterdam assumed the role as the senior partner in acting as the stabilizing force for London during times of English <a href="/facts/Financial_crisis/lVXVuazP">financial crisis</a>. </p><p>However, it was in the Classical <a href="/facts/Gold_Standard/jnG3YIGo">Gold Standard</a> Era (the period from the mid-1870s until the start of <a href="/facts/World_War_I/vITTUanQ">World War I</a>) that financial integration began to take shape in Europe. In these periods, for examples, the securities and foreign exchange markets were closely linked; stock and bond markets were internationally linked; international arbitrage activities were no strangers; and commercial and investment banks in major economies established a linkage (Jackson and Lothian, 1993;<a class="footnote-ref" id="fnref:7" href="#fn:7"><sup>7</sup></a> Lothian, 2000.<a class="footnote-ref" id="fnref:8" href="#fn:8"><sup>8</sup></a> </p><p>Eventually the 1980s and 1990s saw a significant increase in financial integration (Lothian, 2000<a class="footnote-ref" id="fnref:9" href="#fn:9"><sup>9</sup></a>). For example, facing a sharp increase in real exchange rate volatility and the increased risk in these years, institutions surrounding international finance worked together to address these challenges. Regulatory restrictions on international capital mobility such as capital control, interest rate ceilings, etc. were weakened and removed because such regulatory framework was costly in the new market environment. To contain the adverse effects of exchange-rate volatility, new financial instruments and markets were developed. </p> <h2 id="benefits">Benefits</h2> <p>Benefits of financial integration include efficient capital allocation, better <a href="/facts/Governance/I4tEBlhT">governance</a>, higher investment and growth, and risk-sharing. Levine<a class="footnote-ref" id="fnref:10" href="#fn:10"><sup>10</sup></a> (2001) shows that financial integration helps strengthen the domestic financial sector allowing for more efficient capital allocation and greater investment and growth opportunities. As a result of financial integration, efficiency gains can also be generated among domestics firms because they have to compete directly with foreign rivals; this competition can lead to better <a href="/facts/Corporate_governance/ISvl8hIn">corporate governance</a> (Kose et al., 2006<a class="footnote-ref" id="fnref:11" href="#fn:11"><sup>11</sup></a>). If having access to a broader base of capital is a major engine for <a href="/facts/Economic_growth/kEXm3jWm">economic growth</a>, then financial integration is one of the solutions because it facilitates flows of capital from <a href="/facts/Developed_economies/4KRrMBaM">developed economies</a> with rich capital to <a href="/facts/Developing_economies/eTfS4kxl">developing economies</a> with limited capital. These capital inflows can significantly reduce the <a href="/facts/Cost_of_capital/WgbbmNQ0">cost of capital</a> in capital-poor economies leading to higher investment (Kose et al., 2006<a class="footnote-ref" id="fnref:12" href="#fn:12"><sup>12</sup></a>). Likewise, financial integration can help capital-poor countries diversify away from their production bases that mostly depend on agricultural activities or extractions of natural resources; this diversification should reduce macroeconomic volatility (Kose et al., 2006<a class="footnote-ref" id="fnref:13" href="#fn:13"><sup>13</sup></a>). Financial integration can also help predict consumption volatility because consumers are <a href="/facts/Risk-averse/erarEwDf">risk-averse</a> who have a desire to use <a href="/facts/Financial_markets/T8g8qFT5">financial markets</a> as the insurance for their income risk, so the impact of temporary idiosyncratic shocks to income growth on consumption growth can be softened. Stronger comovement of consumption growth across the globe can also be a result </p> of financial integration (Kose et al., 2006). Furthermore, financial integration can also provide great benefits for international risk-sharing (Lewis, 1999;<a class="footnote-ref" id="fnref:14" href="#fn:14"><sup>14</sup></a> Obstfeld, 1994;<a class="footnote-ref" id="fnref:15" href="#fn:15"><sup>15</sup></a> van Wincoop, 1999<a class="footnote-ref" id="fnref:16" href="#fn:16"><sup>16</sup></a> ). <h2 id="adverse-effects">Adverse effects</h2> <p>Financial integration can also have <a href="/facts/Adverse_effects/vAhfbr1J">adverse effects</a>. For example, a higher degree of financial integration can generate a severe <a href="/facts/Financial_contagion/HfNPlvVP">financial contagion</a> in neighboring, regional and/or global economies. In addition, Boyd and Smith<a class="footnote-ref" id="fnref:17" href="#fn:17"><sup>17</sup></a> (1992) argue that capital outflows can journey from capital-poor countries with weak institutions and policies to capital-rich countries with higher institutional quality and sound policies. Consequently, financial integration actually hurts capital-scarce countries with poor institutional quality and lousy policies. </p> <h2 id="recent-development">Recent development</h2> <p>During the past two decades, there has been a significant increase in financial integration; this increased financial integration generates a great deal of cross-border capital flows among industrial nations and between industrial and developing countries. In addition, this increase in financial integration pulls global <a href="/facts/Financial_markets/T8g8qFT5">financial markets</a> closer together and escalates the presence of foreign financial institutions across the globe. With rapid capital flows around the world, the currency and financial crises in the late 1980s and 1990s were inevitable. Consequently, <a href="/facts/Developing_countries/eTfS4kxl">developing countries</a> that welcomed excessive capital flows were more vulnerable to these financial disturbances than <a href="/facts/Industrial_nations/sqwTSDHm">industrial nations</a>. It is widely believed that these <a href="/facts/Developing_economies/eTfS4kxl">developing economies</a> were much more adversely impacted as well. Because of these recent financial crises, there has been a heated debate among both academics and practitioners concerning the costs and benefits of financial integration. This debate is ongoing.(Kose et al., 2006<a class="footnote-ref" id="fnref:18" href="#fn:18"><sup>18</sup></a>) </p> <h2 id="references">References</h2> <ol> <li id="fn:1"><p>Kose, M. Ayhan; Eswar Prasad; Kenneth Rogoff; Shang-Jin Wei (August 2006). "Financial Globalization: A Reappraisal" (PDF). IMF Working Paper. 06 (189): 1. doi:10.5089/9781451864496.001. <a href="http://www.nber.org/papers/w12484.pdf" target="_blank">http://www.nber.org/papers/w12484.pdf</a> <a href="#fnref:1" class="footnote-back-ref">↩</a></p></li> <li id="fn:2"><p>Lothian, James (2000). Capital Market Integration and Exchange Rate Regimes in Historical Perspective. New York: Elsevier Science, Inc. <a href="#fnref:2" class="footnote-back-ref">↩</a></p></li> <li id="fn:3"><p>Juraev, Q. Nosirjon (2012). "Financial Integration and Economic Growth". MPRA Paper. <a href="#fnref:3" class="footnote-back-ref">↩</a></p></li> <li id="fn:4"><p>Neal, Larry (1990). The rise of financial capitalism. Cambridge University Press. <a href="#fnref:4" class="footnote-back-ref">↩</a></p></li> <li id="fn:5"><p>Eargly, Robert; V. Kerry Smith (1976). "Domestic and International Integration of the London Money Market". Journal of Economic History. 36: 198–212. doi:10.1017/s0022050700094638. S2CID 154583171. <a href="/wiki/Doi_(identifier)" target="_blank">/wiki/Doi_(identifier)</a> <a href="#fnref:5" class="footnote-back-ref">↩</a></p></li> <li id="fn:6"><p>Neal, Larry (1990). The rise of financial capitalism. Cambridge University Press. <a href="#fnref:6" class="footnote-back-ref">↩</a></p></li> <li id="fn:7"><p>Jackson, Paul; James R. Lothian (December 1993). "The Behavior of Bond Yields Across Exchange-Rate Regimes and the Integration of Capital Markets". Greek Economic Review: 1–28. <a href="#fnref:7" class="footnote-back-ref">↩</a></p></li> <li id="fn:8"><p>Lothian, James (2000). Capital Market Integration and Exchange Rate Regimes in Historical Perspective. New York: Elsevier Science, Inc. <a href="#fnref:8" class="footnote-back-ref">↩</a></p></li> <li id="fn:9"><p>Lothian, James (2000). Capital Market Integration and Exchange Rate Regimes in Historical Perspective. New York: Elsevier Science, Inc. <a href="#fnref:9" class="footnote-back-ref">↩</a></p></li> <li id="fn:10"><p>Levine, Ross (1997). "Financial Development and Economic Growth: Views and Agenda". Journal of Economic Literature. 35 (2): 688–725. <a href="#fnref:10" class="footnote-back-ref">↩</a></p></li> <li id="fn:11"><p>Kose, M. Ayhan; Eswar Prasad; Kenneth Rogoff; Shang-Jin Wei (August 2006). "Financial Globalization: A Reappraisal" (PDF). IMF Working Paper. 06 (189): 1. doi:10.5089/9781451864496.001. <a href="http://www.nber.org/papers/w12484.pdf" target="_blank">http://www.nber.org/papers/w12484.pdf</a> <a href="#fnref:11" class="footnote-back-ref">↩</a></p></li> <li id="fn:12"><p>Kose, M. Ayhan; Eswar Prasad; Kenneth Rogoff; Shang-Jin Wei (August 2006). "Financial Globalization: A Reappraisal" (PDF). IMF Working Paper. 06 (189): 1. doi:10.5089/9781451864496.001. <a href="http://www.nber.org/papers/w12484.pdf" target="_blank">http://www.nber.org/papers/w12484.pdf</a> <a href="#fnref:12" class="footnote-back-ref">↩</a></p></li> <li id="fn:13"><p>Kose, M. Ayhan; Eswar Prasad; Kenneth Rogoff; Shang-Jin Wei (August 2006). "Financial Globalization: A Reappraisal" (PDF). IMF Working Paper. 06 (189): 1. doi:10.5089/9781451864496.001. <a href="http://www.nber.org/papers/w12484.pdf" target="_blank">http://www.nber.org/papers/w12484.pdf</a> <a href="#fnref:13" class="footnote-back-ref">↩</a></p></li> <li id="fn:14"><p>Lewis, Karen K. (June 1999). "Trying to Explain Home Bias in Equities and Consumption". Journal of Economic Literature. 37 (2): 571–608. CiteSeerX 10.1.1.201.3800. doi:10.1257/jel.37.2.571. <a href="/wiki/CiteSeerX_(identifier)" target="_blank">/wiki/CiteSeerX_(identifier)</a> <a href="#fnref:14" class="footnote-back-ref">↩</a></p></li> <li id="fn:15"><p>Obstfeld, Maurice (1994). "Risk-taking, Global Diversification, and Growth". American Economic Review. 9 (4): 73–96. <a href="#fnref:15" class="footnote-back-ref">↩</a></p></li> <li id="fn:16"><p>Van Wincoop, Eric (1999). "How Big are Potential Welfare Gains from International Risk Sharing?" (PDF). Journal of International Economics. 47 (1): 109–135. doi:10.1016/s0022-1996(98)00007-5. <a href="https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr37.pdf" target="_blank">https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr37.pdf</a> <a href="#fnref:16" class="footnote-back-ref">↩</a></p></li> <li id="fn:17"><p>Boyd, J. H.; B. D. Smith (1992). "Intermediation and the Equilibrium Allocation of Investment Capital: Implications for Economic Development". Journal of Monetary Economics. 30 (3): 409–432. doi:10.1016/0304-3932(92)90004-l. <a href="/wiki/Doi_(identifier)" target="_blank">/wiki/Doi_(identifier)</a> <a href="#fnref:17" class="footnote-back-ref">↩</a></p></li> <li id="fn:18"><p>Kose, M. Ayhan; Eswar Prasad; Kenneth Rogoff; Shang-Jin Wei (August 2006). "Financial Globalization: A Reappraisal" (PDF). IMF Working Paper. 06 (189): 1. doi:10.5089/9781451864496.001. <a href="http://www.nber.org/papers/w12484.pdf" target="_blank">http://www.nber.org/papers/w12484.pdf</a> <a href="#fnref:18" class="footnote-back-ref">↩</a></p></li> </ol>