ISSN : Editor: Professor Badi H. Contributions to Economic Analysis publishes research that has contributed to development of economic analysis. The purpose of this series is to stimulate the international exchange of scientific information and to reinforce international cooperation by publishing original research in applied economics.
Both editors and authors of this series represent a broad range of geographic and subject matter interests in economics, and the series includes research from all areas of macroeconomics and microeconomics. These books have in common a quantitative approach to economic problems of practical importance. If you would like to propose a volume for Contributions to Economic Analysis please contact the series editors Badi H Baltagi: bbaltagi maxwell.
By the middle of the 19 th century, the cost, speed, and safety of human transport across the Atlantic had all progressively improved, especially with the replacement of wooden sailing vessels by iron-made steam ships. These improvements in passenger transportation continued through the 19 th and into the 20 th century.
Indeed, my grandmother Marie Noel earned sufficiently good wages as a skilled seamstress for high fashion houses in New York where speaking French was an important advantage , and was sufficiently suspicious of American doctors, that she sailed back to France in to give birth to her fourth son, before returning to live out the rest of her life—generally quite happily—in America. A couple of them, after experience in the new world, returned permanently to Italy.
Beyond these anecdotes, there is evidence of significant back and forth movement of people between Europe and the Americas in the period shortly before World War I. This phenomenon of back-and-forth movement is significant. It suggests that by no later than the early part of this century, the costs and risks of transportation had fallen to the point that in contrast to earlier times they were no longer a substantial factor in economic decisions about migration.
Also, this reduction in transportation costs probably interacted with tastes in a way that enhanced the likelihood of migration. Even if, as is often the case, one knows family or friends who have migrated to a new country and culture, there must be uncertainty and concern about adapting to a new environment. If the decision to migrate is seen as practically irreversible, deterrence to migration is relatively high. Undoubtedly, the transportation costs of migration have continued to decline since World War I.
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Why has the pace of immigration into the United States slowed? For migration from Europe, the answer is partly that income differentials have narrowed and so too have the economic and non-economic incentives for migration. However, economic incentives for migration to the United States and most other industrial countries from developing countries remain very large. Here, it is clear that public policies restricting migration—even though not fully effective—are the key reason why migration has declined from the high rates prevailing before World War I. Indeed, for the United States, there was no restriction on inward migration until the Chinese Exclusion Act of adopted because of domestic political opposition, especially in California and other western states, to further immigration of Chinese laborers for railroad construction and other work.
General restrictions on immigration from other countries did not come until the National Origins Act of Interestingly, as will be discussed further below, enactment of this highly restrictive measure was part of the general retreat of the United States into isolationism during the interwar period.
This retreat, which was not limited only to the United States, reflected a general shift in tastes toward opposition to many forms of involvement and interaction with foreign countries. Traditionally, economists tend to focus on trade in goods and, to a lesser extent, services as the key mechanism for integrating economic activities across countries and as a critical channel but not the only important one for transmitting disturbances between national economies.
Indeed, in the economic theory of international trade specifically the Hecksher-Ohlin-Samuelson theory described in most textbooks , trade in goods is seen as a substitute for mobility of factors of production. Under certain restricted conditions, which do not apply completely in practice, the theory says trade in the outputs of production processes may be an essentially perfect substitute for mobility of factors, with the result that factor returns are equalized internationally—i. If the conditions for factor price equalization did apply, there would be no economic benefit from international mobility of factors of production.
Full economic efficiency could be achieved exclusively through trading outputs. These barriers take two forms: natural barriers to trade in the form of transportation costs and also costs of information about product prices and availabilities at different locations; and artificial barriers to trade arising from tariffs, quotas, and other public policy interventions. Indeed, even if the broader conditions for factor price equalization e. Specifically, if there were literally no natural or artificial barriers to trade in goods or services, then the relative prices of all goods and services would be equalized everywhere, and integration through the channel of trade would be perfect and complete.
In practice, of course, there are important natural and artificial barriers to trade which preclude such perfection. Thus, it is relevant to consider what has been happening to barriers to trade as a means of assessing what has been happening to international economic integration through this important channel.
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The development of ocean-going sailing vessels beginning in the late 15 th century expanded the horizons for trade to a truly global scale. However, despite gradual and cumulatively substantial improvements in transportation technology, during the era of sail high sea transportation costs including risks from piracy or misadventure generally remained an important barrier to trade over substantial distances.
For most goods, shipping by land for more than a few score miles was prohibitively expensive. Unlike recent times when there is a good deal of two-way intra-industry trade in very similar products, trade over long distances consisted primarily of products which were not produced domestically or of payment flows of gold and silver. Gradually, as sailing vessels became larger and piracy and other hazards to ocean-borne commerce were reduced. Nevertheless, well into the s, transportation costs remained an important natural barrier to global trade.
The invention and development of steam-powered iron ships during the second half of the 19 th century further reduced the costs of ocean shipping.
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By the end of the century, the cost of shipping a ton of cargo across the Atlantic was probably less than one-fifth of what it had been at the start of the century. Artificial barriers to trade in the form of import tariffs and other public policy interventions have a very long history. No doubt, there has always been some interest in such measures as means of providing protection to domestic producers often including monopolists and cartels from foreign competition.
However, raising revenue for the state probably remained the most important reason for the imposition of tariffs until the 19 th century. In the United States, in particular, tariffs were generally the most important source of revenue for the federal government up to World War I. Despite the continuing importance of revenue as a reason for imposing tariffs, it appears that interest in these measures as a means of providing protection to domestic producers increased as natural barriers to trade from transportation costs declined and as the revolution in manufacturing technology created important new competitive threats to more traditional and higher cost producers.
Manufactured products typically had quite high ratios of value to weight, and even the quite high transatlantic shipping costs of the s offered comparatively little natural protection for American producers of such products. By the end of the 19 th century, ocean shipping costs for high valued products like most manufactures had generally declined to the point that they were no longer a substantial natural barrier to trade among the industrialized countries bordering the Atlantic.
The interwar period witnessed a collapse in the volume of world trade. This collapse reflected both the worldwide depression of economic activity in the s and the widespread and massive increase in tariffs and other trade restrictions during this period. The retreat into protectionism included, and to an important degree was probably stimulated by, two massive increases in tariffs imposed by the United States.
The first was imposed just after the end of World War I and was intended as both a revenue measure to absorb the elimination of the wartime income tax and to help pay-off debts accumulated during the war. The second was the infamous Smoot-Hawley tariff of which must be seen largely as an effort of protectionism. Since World War II, the world economy has enjoyed a remarkable era of prosperity that has spread quite broadly, but not universally, across the globe. Over the past five decades, real world GDP has risen at somewhat more than a 4 percent annual rate, with real GDP in developing countries as a group growing in per capita terms at about the same pace as the industrial countries.
The result has been that real living standards, as measured by real per capita GDP, have improved on average about three-fold in just half a century; see Table 1. During this era of remarkable economic growth, world trade in goods and services has expanded at nearly double the pace of world real GDP. As a result the volume of world trade in goods and services the sum of both exports and imports rose from barely one-tenth of world GDP in to about one-third of world GDP in By this measure—and by others as well—there has indeed been an increase in the degree of global economic integration through trade in goods and services during the past half century.
The two fundamental factors that appear to have driven this increasing global economic integration are continuing improvements in the technology of transportation and communication and a very substantial, progressive reduction in artificial barriers to international commerce resulting from public policy interventions. For transportation, the most dramatic improvements have been for air cargo, which except for airmail, did not exist as a commercially important phenomenon fifty years ago.
Now, for a wide array of products from fresh flowers to electronic components to airplane parts, air cargo is the speedy and cost effective means of international transport. For some of these products, international trade would not be feasible without comparatively cheap air cargo.
Also, it is clear that many modern production management practices including just-in-time inventory techniques utilized by different divisions of multinational corporations are heavily reliant on the use of air cargo. Ocean shipping costs have fallen substantially in the past half century, perhaps by as much as a factor of four or five.
Oil tankers of roughly 10, tons displacement have been replaced by supertankers of up to , tons, with no increase in crew size. Merchant steamers of 5, to 8, tons have been replaced by containerized cargo carriers displacing , to , tons. Loading and off-loading by large crews of longshoremen has been virtually eliminated.
Integration with the domestic transportation networks of road and rail is speedy, efficient, and less prone to disruption. Land transportation costs are directly important for a good deal of international trade between contiguous countries and indirectly important for connecting international trade with domestic production and consumption. Land transportation costs trucking and rail have clearly declined during the past half century, although proportionately much less than for air cargo. Communications costs—for voice, text, and data—have dropped enormously in the postwar era, and are continuing to fall precipitously under the influence of rapid improvements in information and communications technology.
Although not often given much attention in traditional trade theory, this has had broad implications for international trade, as such trade generally necessitates a good deal of communication between actual and potential buyers and sellers and a variety of middlemen and facilitators. Probably the most important effect of improvements in communications has been felt on trade in services. For a variety of services, modern communications technology makes it possible and cost efficient to separate production and use in ways that were not previously feasible.
Design of new computer chips can be done in Silicon Valley and implemented in production facilities in East Asia. Software can be written under contract in India or Ireland and e-mailed back to the United States. Doctors can diagnose patients using transmitted MRI images and other data. Methods are even being created whereby operations can be performed robotically by a specialist surgeon thousands of miles away from his patient.
Financial services to be discussed below are a particularly important area where modern communications technology is helping to transform the arena for international trade in services. More broadly, the decline in communications costs is surely one of the important reasons why for the United States exports of non-factor services in recent years has been growing more rapidly than either GDP or merchandise exports; see Chart 3. For government imposed artificial barriers to international trade, the postwar era has undoubtedly seen a dramatic reduction. The extent of the reduction is hard to measure with great precision.
The disruption of the war and of postwar reconstruction and the widespread use of exchange restrictions and other non-transparent policies during and for some time after the war are one special set of problems. Resort to import quotas, voluntary export restraints, and other non-tariff interventions in more recent years is another difficulty.
Also, trade flows undoubtedly respond with lags, perhaps quite significant lags, to changes in the level of barriers to trade. Nevertheless, assuming that there was a significant overhang effect from the war and war time measures that tended to restrict trade shortly after the war, and taking account of the decline in tariff rates for the main industrial countries since the war to very low levels today, it is possible that levels of protection for domestic manufacturing industries in industrial countries have declined by as much as 90 percent since World War II.
This includes the fact that tariffs have been eliminated within the European Union and within Nafta and that inflation has eroded the ad valoren equivalent of many specific tariffs. While significant import protection remains for industrial countries, it is concentrated on a few key sectors, most notably agriculture, and also textiles and a few manufactured goods. For developing countries, the situation is more mixed and levels of protection generally remain higher than those in the industrial countries. However, during the past twenty years there has been a significant move by most economically important developing countries to liberalize their trade regimes.
Taking account of the fact that, measured at market prices and market exchange rates, developing countries account for only about one-fifth of world output and world trade, it is probably not much of an exaggeration to say that artificial barriers to international trade from government policy interventions have fallen by between 80 and 90 percent since World War II. This is obviously an enormous accomplishment in the direction of public policies that seek to secure the benefits of a more efficiently integrated world economy.
How much the of rise in the volume of world trade relative to world GDP might plausibly be explained by this accomplishment? A back of the envelope calculation sheds some light on this question. Suppose that the combination of the reduction in artificial barriers to trade from government policies the main factor and reduction in natural barriers to trade a much more modest factor in the postwar era have reduced the total barriers to trade from an effective average of 35 percent to an effective average of only 5 percent.
Suppose that these figures apply to the United States. Standard estimates of trade elasticities see Goldstein and Khan suggest that the volume of imports would rise by roughly 2 percent of U. This is much smaller than the actual increase in the share of imports in U. GDP from under 5 percent in to nearly 15 percent in For more open economies with high initial ratios of trade to GDP, the estimated increases in the trade to GDP ratio would be larger than for the United States, but the actual trade share gains are also generally larger.
Part of the resolution of this conundrum comes from recognizing that when trade barriers are reduced all around the world economy, there is a mutually reinforcing effect not captured by considering each country individually. Taking account of this interaction effect and relying on standard estimates of relevant elasticities, the assumed reduction in artificial and natural trade barriers might plausibly explain as much as a doubling in the volume of world trade relative to world GDP; that is, an increase in the share of imports from 6 percent to 12 percent of world GDP or an increase in the combined share of imports and exports from 12 percent to 24 percent of GDP.
The actual increases in these world trade shares, however, amount to a tripling—which is beyond the range of reasonable results using standard estimates of relevant elasticities. Three things might plausibly explain the substantial remaining gap. It is possible that because of the disruptions of the war and its aftermath and the policies pursued before, during, and shortly after the war, that the effective barriers influencing volumes of trade in were much higher than has been assumed and that, correspondingly, the reduction in these barriers should be substantially greater than the assumed average effective reduction from 35 to 5 percent.
Alternatively, it is possible that, even though the empirical estimates are quite robust, the relevant elasticities are actually a fair bit larger than the consensus suggested by the bulk of empirical studies. Then, there is the possibility that the standard theory linking trade volumes to relative prices and income or expenditure levels leaves out something important, especially in a longer-term context. Specifically, if trade between two countries tends to rise proportionately with respect to each of their economic sizes and diminish with the distance between them, then the suggestion is that doubling the size of both economies should raise their bilateral trade by a factor of four rather than by a factor of two.
Regardless of which, if any, of these explanations is correct, the conclusion remains that the massive reduction in artificial barriers to trade and the substantial, although quantitatively less significant, reduction in natural barriers to trade in the postwar era contributed very importantly to increasing global economic integration. Surprisingly, however, the extent of global economic integration through international trade today is, by some key measures, not much greater than it was a century ago.
Specifically, the rising shares of trade relative to GDP in the postwar era have only just recently restored these shares to about where they were just before World War I. This seems surprising because artificial barriers to trade would appear, on balance, to be lower than they were at that time, and natural barriers to trade are surely much lower than they were then. However, as discussed by Bordo, Eichengreen, and Irwin and summarized in Crafts , the result is less surprising when account is taken the massive change in the structure of national outputs during the past century.
Around , roughly two-thirds of GDP was in the goods producing sector of the typical industrial country. Now that situation is reversed, and roughly two-thirds of GDP is in the service sector of the typical industrial country with a somewhat higher services share in the United States. This supports the view that international integration of markets for goods is significantly greater today than a century ago. Looking forward, how might the fundamental factors of technological developments affecting natural barriers to trade and of public policies affecting artificial barriers to trade be expected to evolve and thereby to influence the extent of global economic integration through international trade in goods and services.
Almost surely, technological improvements will continue to reduce the costs of transportation and communication, both domestically and internationally. For transportation, because costs cannot go negative, further absolute cost reductions cannot generally be as large as what has been achieved in the past century.
Even in proportional terms, it seems likely that the pace of advance will slow from the pace of the past century. In fact, during the past quarter century, while there have been continuing efficiency gains in transportation, the main technologies of land, sea, and air transport have not changed. Nevertheless, as the natural barriers to international trade for most goods arising from transportation costs are already quite low, technological limits on the likely pace of future cost reductions will probably not be very important, at least for the industrial countries.
For developing countries, where the infrastructure of modern transportation is generally less well developed, opportunities for reductions in transportation costs that would enhance economic integration both within the domestic economy and internationally are clearly greater. For communications as discussed further below , the situation is very different. A technological revolution is underway and appears likely to continue for some time.
Costs of communication, domestic and international, have fallen rapidly; and these declines also seem likely to continue. International trade surely benefits from improvements in communications. As previously discussed, the areas likely to benefit the most are those that rely particularly heavily on communications, with financial services being an important example. Concerning the future of public policies toward trade, the successful postwar effort to reduce trade barriers has virtually eliminated most significant restrictions on trade in most goods among industrial countries, with notable exceptions for a number of agricultural products and a few manufactured products.
To make further meaningful progress, the industrial countries need to address the few remaining hard cases especially agriculture in goods trade and deal with a complex of restrictions that artificially suppress opportunities for trade in services—trade that is increasingly being made feasible by advances in communications and other technologies.
For developing countries, the agenda includes both reducing import restrictions that remain relatively high for products where industrial country barriers are already quite low and securing from the industrial countries reductions in barriers against exports of products for which developing countries have an important comparative advantage. We have found that these international links have been increasing over the past decade — especially for high-grade, financial instruments traded actively in the wholesale markets of major financial centers.
Capital markets in developing countries too are becoming more closely integrated with markets in the rest of the world, although they have progressed less far in that direction than the industrial countries.
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It is still way too early to speak of a single, global capital market where most of world saving and wealth are auctioned to the highest bidder and where a wide range of assets carry the same risk-adjusted expected return. Some important components of wealth like human capital are scarcely traded at all, and currency risk, the threat of government intermediation especially during periods of turbulence , and the strong preference for consuming home goods and investing in more familiar home and regional markets, still serve to restrict the range and size of asset substitutability. But the forces making for stronger arbitrage of expected returns are already powerful enough to have made a large dent in the autonomy that authorities have in the conduct of macroeconomic and regulatory policies.
We see little in the factors underlying the evolution of international capital markets to suggest that this increased clout of private markets will reverse itself in the future. We would not go so far as to suggest that the growth and agility of private capital markets now makes it unrealistic to operate a fixed exchange rate arrangement durably and successfully.
But we do believe that these factors have made the conditions for doing so more demanding With the benefit of perfect hindsight, it is not hard to identify instances over the past decade or so when international capital flows like domestic ones did not pay enough attention to fundamentals.
Toward this end, two conditions in addition to open capital markets themselves are worth emphasizing. More comprehensive reporting of off-balance sheet borrowing by private firms and sovereigns alike , greater transparency in the obligations of related entities in conglomerates and the like , greater international harmonization of accounting standards more generally, and more prompt disclosure of losses, would all be helpful.
Second, market discipline cannot be effective if market participants believe that the borrower will be bailed out one way or another in the case of an actual or impending default. None of this implies that authorities should be indifferent to the potential prudential and systemic risks that may be associated with the trend toward global capital market liberalization and innovation.
The message however should not be to try and halt financial liberalization and the international integration of capital markets but rather to accompany that liberalization and integration with a strengthening of the supervisory framework that permits the attendant risks to be properly priced and that encourages risk management programs to be upgraded.
As the debt crisis of the s so powerfully illustrated, these issues of the proper pricing and management of risk in international capital markets are of deep concern to developing countries, as well as to industrial countries. What should be added to these conclusions from Mussa and Goldstein ? I would stress four points relatively briefly and develop one key issue at somewhat greater length—namely, the integration of the world economy through the globalization of the financial services industry. First, as suggested in Mussa and Goldstein, during the past seven years, financial markets, especially wholesale markets for high grade instruments, have tended to become more tightly linked internationally, especially among the industrial countries and also including many important emerging market economies.
Most notably and as a clear example of the influence of public policy on economic integration, the advent of EMU and the anticipation of this event has eliminated exchange rate fluctuations among the eleven participating countries and has led to a dramatic reduction in interest rate spreads and in the volatility of these spreads. For the industrial countries, the only significant suggestion of any weakening in international capital markets linkages relates to Japan.
Government measures to help re-capitalize and restructure Japanese banks was subsequently instrumental in reducing the Japan premium. Nevertheless, many Japanese banks have substantially scaled back their involvement in international financial markets. It is noteworthy that the Asian crisis, which effectively began with the attack on the Hong Kong dollar and stock market in mid October , was preceded by a massive surge in gross private capital flows to emerging market countries and a deep compression of spreads for emerging market borrowers; 13 see Chart 5.
These developments signal a shift in tastes of global investors either toward lower assessments of the risks of investing in emerging markets or toward greater acceptance of such risks. With the onset of the Asian crisis, there was an apparent sudden shift of tastes of global investors away from emerging market risks, especially for Asian emerging market economies; and, as gross private capital flows dropped precipitously especially for Asian emerging markets , spreads for emerging market borrowers spiked upwards.
In this episode and in later episodes of the series of crises during —99, many emerging market countries lost effective access to global financial markets. In many cases, the loss of access proved relatively brief—in contrast to the experience of many Latin American countries during the debt crisis of the s—but in a few cases access has not yet been restored. Consistent with Mussa and Goldstein, while some progress has been made, the linkage of developing countries to global financial markets remains weaker and more tenuous than for industrial countries.
Second, although not original to Mussa and Goldstein, the observation that for a country highly open to private international capital flows, the policy requirements for successful operation of a pegged exchange rate regime are quite demanding has certainly proved prophetic. For Mexico in the tequila crisis, for Thailand, Malaysia, Indonesia, and Korea in the Asian crisis, for Russia in , and for Brazil in , the combination of a pegged exchange rate regime with a relatively high degree of openness to private international capital flows proved unsustainable and contributed to substantial financial crises.
Countries that supported their pegged exchange rate policies with firm commitments to consistent monetary policies and maintained well-capitalized and well-regulated banking systems—notably Argentina and Hong Kong—were able to weather recent crises without collapses in their policy regimes. However, emerging market countries that maintained more flexible exchange rate regimes—such as Singapore, Taiwan Province of China, South Africa, and Mexico after —were generally better sheltered from the effect of recent financial crises.
The general lesson here and also earlier from the ERM crises of —93 appears to be that the public policies that support the highest degree of international capital market integration—rigidly pegged exchange rates and free capital mobility—are feasible, but only if other key macroeconomic policies, most importantly national monetary policies, are subordinated to this goal of financial integration. Where the requisite degree of subordination is not feasible or not desirable, a choice of public policy orientations must be made.
For some countries—notably those that have comparatively weak financial systems and have in place systems of controls on private capital flows—maintenance of some restrictions on private capital flows at least for some period of time may be a desirable option that allows greater stability of the exchange rate.
While it is true that flows of foreign direct investment to developing countries have expanded considerably during the s and have come to dominate net flows of private capital to these countries see Chart 6 ; and flows of FDI have also proved to be quite stable during recent financial crises. Nevertheless, the international financial system was certainly not free of important problems during the past seven years.
On the positive side, as previously noted, many of the emerging market countries that lost access to global capital markets in recent crises did rapidly regain it—a sign of enhanced resiliency. Bank lending as a source of finance for emerging markets—which proved quite volatile in recent crises—has continued to decline, while FDI has strengthened further and net portfolio equity flows have recovered.
In a number of emerging market countries, domestic debt markets have developed considerably and have become an important source of finance for sovereigns and corporates. Although the global investor base for emerging market bonds remains somewhat fickle, emerging market equities seem to be gaining more of an independent foothold. Fourth, the emphasis in Mussa and Goldstein on efforts to improve market discipline through better provision of information, heightened transparency, harmonization of accounting standards, etc. Already at this stage important progress has been made in these reform efforts; but much remains to be done on the implementation of reforms.
It is still to be seen how much these reforms will improve the performance of the international financial system. In my view, the main omission from the discussion of global capital market integration in Mussa and Goldstein is the relative lack of emphasis on the globalization of the activities of providing financial services—a phenomenon which is part of the broader revolution in this sector brought on primarily by rapid advances in information and communications technology.
The rapid reductions in the costs of storing, accessing, analyzing, and communicating information are both dramatically reducing the costs of producing virtually all existing forms of financial services and creating new products and services such as many OTC derivatives which would have been prohibitively expensive with older technologies. At the national level, the structure of the financial services sector is changing as the distinctions that used to exist between commercial banks, investment banks, securities dealers, insurance companies, and other financial service providers become increasingly blurred.
There is no doubt that advances in information and communications technology are the most important technological advance of the past quarter century. In the United States, technological advances in these areas account for much of the rise in total factor productivity in recent years. As a result of these technological advances, the costs of processing and communicating all forms of information have been all declining very rapidly; i.
By nature, much of the activity in the financial services industry has to do with the processing and communication of information. It stands to reason, therefore, that the financial services industry would be particularly strongly affected by rapid advances in information and communications technology—and, it has been. This is readily apparent in a number of phenomena. The cost of bank transactions at the wholesale and interbank level has also dropped precipitously; and this, among other things, is reflected in the continuing rise in the volume of bank transactions relative to nominal GDP.
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Some indication of how advances in technology are affecting and likely to continue to affect retail banking transactions is suggested by Chart 7. As information and communications technology has advanced and the costs of doing virtually all forms of financial business have declined, the meaningfulness of the differences associated with different locations or with different sectors of the financial services industry appear to have eroded.
This reflects the fact it is much cheaper now than a few years ago to do financial business over a wider geographic range and over a wider scope of activities. As a consequence, there has been a tendency toward restructuring of institutions in the financial sector in the direction of broader geographic and functional scope. It is also apparent the restructuring of banking systems and the integration of banks with other types of financial institutions. Public policy in most countries has been accommodating or facilitating these developments. In the United States, the last restrictions on nation wide banking have been removed; and, with the passage of the Gramm-Leach-Bliley Act last year, most remaining restrictions on bank holding company participation in the full range of financial services have been removed.
In the European Union, under the auspices of directives from the European Commission, the banking sector is becoming more competitive; and the advent of the EMU at the start of is providing important additional impetus to restructuring in the financial sector. In Japan, partly as a consequence of difficulties of recent years, public policy is also pushing, reform and restructuring in the financial sector; see IMF Not surprisingly, the same types of changes that have been taking place within the financial service sectors of individual countries have also been occurring internationally—and in response to the same principal driving force.
The advances in information and communication technology which make it efficient to do financial business across a wider geographic and functional scope domestically, also operate across national boundaries. And, the effects are seen, for example, in the efforts to integrate the activities of stock and commodity markets internationally and in the international diversification of a number of leading firms providing financial services. As in the domestic arena, public policies are, by and large, facilitating these developments or at least accommodating them.
In particular, seeing the advantages of allowing sophisticated foreign financial institutions to provide services in domestic markets, a number of emerging market countries have liberalized or are liberalizing to permit such participation; see IMF Going forward, it is clear that advances in information and communications technology that have already been achieved and those that are in the pipeline will continue to drive the evolution of the financial services industry. People will want to take advantage of the opportunities rapid advances in technology allow—in financial services, as well as elsewhere.
Public policy can influence, to some degree, the pace and pattern of developments. It can spur or retard them; but it is unlikely to stop them. At the international level, this implies that we have strong reason to expect an increasing degree of capital market integration in the future. Information and communications costs are a natural barrier to integration of capital markets and financial services—just as transportation costs are for trade in physical goods. As these costs come down, integration should increase. There is, however, one important worry. Many empirical studies have confirmed the common-sense appraisal of the postwar experience with trade liberalization: open policies toward international trade are an important factor contributing to stronger economic growth.
Indeed, the experience in recent financial crises could cause reasonable people to question whether liberal policies toward international capital flows are wise for all countries in all circumstances. High openness to international capital flows, especially short-term credit flows, can be dangerous for countries that weak or inconsistent macro-economic policies or inadequately capitalized and regulated financial systems.
For such countries, public policy has important challenges to meet in preparing for a world economy that is being driven toward higher degrees of capital market integration. In many discussions of international economic integration, the focus is on integration through trade and factor movements, both labor and capital. There is, however, clearly another important mechanism through which economic activities in different parts of the world affect each other; namely, through the communication of economically relevant information and technology.
It may, or may not, be true that Marco Polo carried back from China to Italy the concept of noodles—and thus multiple forms of Italian pasta were born. The lesson nevertheless is clear. It is not necessary to transport large quantities of noodles by expensive and slow camel caravans from China to Italy to produce a culinary revolution. It is necessary only to transport the concept of a noodle and an understanding of how noodles are made to have this effect.