Global Capital Market Integration: Implications for U.S. Economic Performance

Publication Date: January 2001

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Economics

Type:

Abstract:

The post-war period has seen a steady and sizable expansion of international economic integration. Trade in goods has grown rapidly, but trade in assets (e.g. bank accounts, stocks, bonds, and real property) has grown far faster. The rapid growth of international asset markets suggests that they confer important economic benefits. However, that growth also raises concerns about international capital flows as initiators or conduits of economic crisis among nations.

Several factors have contributed to the rapid growth of international capital flows. The collapse of the Bretton Woods System of international monetary management also initiated a fairly quick abandonment of controls on international capital flows in most industrial countries. Expanding investment opportunities in both developed and developing nations raised the incentives for cross border investing. Innovations in communication and information technology have dramatically reduced the cost of international communication and expanded access to data for assessing risk and reward. Also of importance has been the creation of new financial instruments that improve investment decision making.

The extent of capital market integration is evident in the huge increases in most financial realms over the last twenty years. These include bank deposits, securities (stocks and bonds) and foreign exchange. Foreign exchange transactions world-wide have grown so much that the value of annual foreign exchange trading exceeds the value of goods transactions by a factor of 50. Despite this growth data indicate that asset market integration still falls well short of creating one world market in assets.

The economic benefits of international capital flows are significant. The presence of well functioning international asset markets can extend the benefit of international trade well beyond the gains associated with the exchange of goods and services. International capital markets can facilitate a more efficient allocation of saving and investment across nations, allowing an optimal spreading of consumption spending over time. International trade in assets can also enable greater diversification of investment portfolios, leading to reduced investor risk. In conjunction with flexible exchange rates, high capital mobility also enhances the power of monetary policy as well as alters how monetary forces are transmitted and distributed through the economy.

Economists and policy makers have also long recognized that increased financial integration carries risks. One risk is that more points of economic and financial contact raise the prospect of the transmission of negative economic shocks, so called "contagion" effects. In addition, some argue that asset markets themselves are often destabilizing and can generate periodic crises. For the U.S. the main problem associated with mobile global capital has been occasional misalignment of the dollar exchange rate. For the U.S., a large, predominately domestically oriented economy, with a well developed financial system and a resilient structure of private markets, large international flows of capital are absorbed to economic advantage, with a minimum of disruption, even in the face of large currency swings.