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Frederic S. Mishkin

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"The Next Great Globalization offers real understanding of both the causes of recent financial crises around the world and the dramatic opportunities we have in future development in world financial architecture. Mishkin's thoroughness and at the same time his grasp of the big picture come through beautifully in this book."--Robert J. Shiller, author of Irrational Exuberance and The New Financial Order

"At long last a book that stares the financial sector firmly in the eye, shows its serious faults, identifies the factors that lie behind them, and proposes constructive solutions for developing economies. This highly readable book is rooted in state-of-the-art research on recent developments in emerging market economies. It convincingly posits a central and controversial proposition: namely, that private financiers, given the right set of incentives, can open the doors to progress, while their absence will likely perpetuate inefficiency and cronyism. Mishkin has thrown down his gauntlet to the antiglobalizers for whom the financial sector is a bête noire. Readers will enjoy this book, and engaging in the debate that will certainly follow."--Guillermo Calvo, University of Maryland, former chief economist at the Inter-American Development Bank

"This is a fabulous book, and I can hardly endorse it strongly enough. It is simply the best single thing I have ever read on financial globalization, and I felt tremendously educated, entertained, and motivated after reading it. It is a great blend of technically accurate and careful argumentation with accessible exposition that will appeal to a wide audience. Indeed, Mishkin's clear, jargon-free, concise writing, combined with his technical expertise and reputation, puts this book far above the vast majority of writings by economists for broader audiences."--William Easterly, author of The White Man's Burden: Why the West's Efforts to Aid the Rest Have Done So Much Ill and So Little Good

"The past six decades have seen a steady forward march in the interdependence of national economies. While many aspects of this globalization process have proved controversial, none has been as potentially explosive as financial globalization-the international integration of national financial markets. Mishkin carefully reviews the factors that have caused financial meltdowns in past emerging-market globalization episodes, and lays out a blueprint for avoiding such crises in the future without cutting off access to foreign finance. Compelling, comprehensive, and accessible, this book makes the case that developing countries can safely embrace financial globalization, and should."--Maurice Obstfeld, University of California, Berkeley

"Eschewing sharp rhetoric in favor of cogent analysis, Mishkin calmly and convincingly explains why developing countries that get financial globalization right will ultimately far outperform those that try to shut it out. Even China will be no exception."--Kenneth Rogoff, Harvard University, former chief economist and director of research, International Monetary Fund

"This is the first book to make a comprehensive and compelling argument for financial globalization. It makes a powerful case that financial globalization is a necessary part of policy reforms to promote economic growth among stagnating countries and provides guidance on how to proceed while avoiding the crises that are sometimes associated with reform. Mishkin has an extraordinary ability to write for a broad audience without sacrificing intellectual rigor. This book should be read by everyone interested in economic development, as well as those focused on financial sector issues."--Ross Levine, Brown University

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The Next Great Globalization

Princeton University Press

Chapter One

In 1960 South Korea was one of the poorest countries in the world, with an average income per person less than that in many countries in sub-Saharan Africa. It was only minimally engaged in trading goods and services with the rest of the world, and the flow of capital from abroad into South Korea was minuscule, amounting to less than $400 million per year. Today South Korea is a member of the rich-countries club, the Organisation for Economic Co-operation and Development (OECD), and the booming metropolis of Seoul looks like any prosperous, world-class city. International trade is a key feature of the Korean economy, with over a third of the economy engaged in exporting, and the annual net flow of foreign capital into South Korea has increased over twentyfold to more than $10 billion.

What has happened to South Korea to allow it to grow like this? Globalization, the increasing involvement of its economy in world markets.

What Is Globalization?

Globalization is a term that is often used imprecisely and can mean many things. This book focuses on economic globalization, the opening up of economies to flows of goods, services, capital, and businesses from other nations that integrate their markets with those abroad.

Economic globalization takes many forms. When a New Yorker orders a Mercedes that is made in Germany, rather than a Cadillac built in America, she is taking advantage of the globalization process. When MGM sells a DVD of one of its hit movies to a teenager in Singapore, this also is a result of globalization. When a company based in London makes use of an Indian computer programmer in Bangalore, globalization is again at work. All of these examples of globalization involve international trade, the flow of goods (Mercedes cars and DVDs) and services (computer programming). Globalization of trade in goods and services has expanded at an extremely rapid pace in the past forty to fifty years, growing from a little over $1 trillion (at current prices) in 1960 to over $15 trillion today.

Economic globalization can take another form: the movement of capital and financial firms across borders, a process called financial globalization. When a Japanese investor buys a U.S. Treasury bill or a share of IBM stock, capital has moved from Japan to the United States, and the purchase is an example of financial globalization. Citibank's loan to a Malaysian shoe manufacturer is also financial globalization. The opening of a Spanish bank office in Santiago, Chile, is a further move toward financial globalization. Financial globalization has also expanded dramatically. Since 1975, when the data were first collected, international capital flows have increased more than eightfold to over $1.4 trillion per year today.

The globalization process has given a new name to a class of countries that have only recently opened up their markets to the flows of goods, services, and capital from other nations: emerging market economies. The advent of emerging market economies and the huge increases in international trade and international capital flows suggest that we have entered a new Age of Globalization.

The First Age of Globalization, 1870-1914

The current Age of Globalization is the second great wave of globalization of international trade and capital flows. The first occurred from 1870 to 1914, when international trade grew at 4% annually, rising from 10% of global output (measured as gross domestic product or GDP) in 1870 to over 20% in 1914, while international flows of capital grew annually at 4.8% and increased from 7% of GDP in 1870 to close to 20% in 1914. John Maynard Keynes captured the feel of this era with the following famous passage from his The Economic Consequences of the Peace, which was published in 1919:

What an extraordinary episode in the economic progress of man that age was which came to an end in August 1914! The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages; or he could decide to couple the security of his fortunes with the good faith of the townspeople of any substantial municipality in any continent that fancy or information might recommend.

This first wave of globalization was accompanied by unprecedented prosperity. Economic growth was high: from 1870 to 1914, world GDP per person grew at an annual rate of 1.3%, while from 1820 to 1870 it grew at the much smaller rate of 0.53%.

But did this greater economic growth translate into a better deal for the poor of the world? If economic growth during this Age of Globalization had been associated with growing income inequality, then the poor might not have benefited. However, this is not what happened for countries involved in the globalization process. The income gap narrowed between wealthy and poor nations that actively participated in global markets (although there was little effect on income distribution within these countries). Japan provides an extraordinary example. Starting in the seventeenth century, Japan completely cut itself off from the rest of the world, allowing only one Dutch ship per year to land in Nagasaki to engage in a small amount of trading. When Commodore Matthew Perry and his black ships arrived on Japanese shores in 1853 to force Japan to trade with the United States, Japan began to open up to the rest of the world. The resulting shake-up of Japanese society eventually led to the Meiji restoration in 1868, as a result of which Japan became fully engaged in the global economic system. In 1870, at the start of this period, Japan was a backward country with an average income per person that was less than a quarter of that in the United Kingdom. From 1870 to 1913, its income was able to grow at 1.5% in comparison to a growth rate of 1.0% for the United Kingdom, thereby narrowing the gap. Argentina's growth experience during this period was even more extraordinary. From 1870, when its income per person was a little over 40% of that in the United Kingdom, its income grew at 2.5% through 1913, raising its income per person to over 75% of that in the United Kingdom. The Japanese and Argentine examples illustrate how poverty was reduced in the countries that were active in the globalization process.

However, not all countries engaged in that process. Globalizers did well, but, as critics of globalization point out, some countries were unable to take advantage of globalization. For example, countries like India and China actually deindustrialized during this period, with China's income per person falling from 24% of the United Kingdom's in 1870 to 13% in 1914. However, this increase in income inequality between globalizers and non-globalizers occurred because non-globalizers did so badly relative to globalizers. For countries that were able to take advantage of the globalization process, income inequality actually fell because...