Tuesday, October 23, 2007

Book Review: The next great globalization by Frederic Mishkin

I shopped this review around but got no takers so I decided to put it here:

The next great globalization: How disadvantaged nations can harness their financial systems to get rich
Frederic S. Mishkin
Princeton University Press 2006, 310 pages

The idea that institutions play an important role in economic growth has been gained wide acceptance. The term ‘institutions’ is a fairly nebulous concept which can mean various things, among them: how well the political system functions, how well governed a country is and how well private property rights are protected. Mishkin concentrates on how the interaction between a country’s financial system as well as strong property rights can be combined to deliver economic growth to disadvantaged systems. However, in order for a country’s financial system to function efficiently, it has to be part of the global financial markets. Efficient financial markets can channel capital to its most effective uses. Despite the dangers of globalized financial markets, Mishkin argues that developing countries should embrace it.

This book is an excellent introduction to the topic of financial globalization and the role it plays in financial crises. For a researcher who is interested in details, almost a third of the book consists of end notes and bibliography.

The danger of financial liberalization i.e., the opening up of the domestic financial markets to the rest of the world without adequate financial regulation and supervision has been reinforced by various financial crises in Latin America and East Asia. Mishkin however, goes on to warn that the regulations that work well for advanced countries do not necessarily work well for developing countries. In his case studies South Korea he describes how the Basel international standards actually encouraged short term borrowing by Korean banks. The message from the first two parts of the book is to learn from the mistakes made in managing past financial liberalization in order to give better guidance for future. While Chapters 8 and 9 provides a list of reforms and principles that he argues need to be implemented, he also acknowledges the difficulties in implementing them.

“Outlining the reforms that poor countries must take to harness the power of globalization and achieve rapid economic growth is easy – all it takes is ink and paper. Implementing these reforms, however, is very, very difficult.” (pg. 200)

For instance, how does on decide whether a country has reached a stage where financial regulation and controls is adequate before the markets are liberalized. He points to the problems in the savings and loan industry in the United States where it was clear that while regulation was inadequate, the industry was allowed to expand into new areas of lending. Mishkin warns that same forces that subvert the liberalization process in order to enrich themselves at the expense of others will also block any reforms that threaten their wealth.

Not surprisingly he devotes a chapter to the role the IMF can play in this process. He makes a strong case that the IMF should only limit its role to providing short term liquidity and in order to do this the IMF should withdraw from long term lending. He discusses the problems with balancing the role of lender of last resort with the dangers of moral hazard. However, one is left with just a tantalizing teaser that moral hazard can only be limited by adequate supervision and that acting as a lender of last resort should only be infrequent. How adequate is adequate and how infrequent is infrequent is a matter of debate.

There is also a difficulty in knowing the source of financial crises. The hindsight that previous crises have provided makes it seem abundantly clear now what should have been done but was perhaps not so obvious at the time. Commenting on the drop in the Shanghai stock market in March 2007, economist Kristin Forbes comments in the New York Times: “The crisis of the future never looks like the crisis of the past.” Perhaps this is why Mishkin himself acknowledges that his list of reforms should not be viewed as a checklist. (pg. 138) Even with what we know now, it may not be sufficient to prevent future crises. As Paul Krugman says : “The history of crisis modeling in international macroeconomics reveals that each successive wave of crises exposes possibilities for crisis that were overlooked in earlier analysis.” (Note 1)

While the IMF is criticized for its ‘one size fits all policy’ it is unclear what really constitutes a one size fits all policy. It can similarly be argued that the very title of his book is a one size fits all policy for developing nations.

Note 1: Krugman, Paul “Will there be a Dollar Crisis” April 2006

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