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Financial Globalization in Botswana and Nigeria: A Critique of the Thresholds Paradigm

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The Review of Black Political Economy

Abstract

Since the Asian financial crises, economists are more circumspect in their advocacy of ‘financial globalization’. A new consensus emerged which contends that increased financial liberalization and capital account openness may only produce economic benefits when countries are open to trade and have good institutions and policies in place. This paper critically reviews this consensus, which we term the ‘thresholds paradigm’, through a survey of the available literature and a comparative case study of two African countries that have undertaken financial and capital account liberalization: Nigeria and Botswana. The paper argues that the thresholds paradigm leaves important theoretical and policy-related questions unresolved, in particular, the origins of good institutions and policies. Further, while at first glance the paradigm appears to capture the divergent outcomes of financial globalization policies in Nigeria and Botswana, a deeper investigation reveals important factors that are neglected and occluded. The paper concludes that economists need to be more methodologically ambidextrous and must integrate institutional factors in their theoretical frameworks in order to better understand the outcomes of ‘financial globalization’ and to provide useful policy advice to developing countries contemplating financial reforms in the future.

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Notes

  1. Elements of the threshold paradigm are also evident in the earlier literature on the sequencing of economic reforms (see Gibson and Tsakalotos 1994).

  2. Another argument presented by Kose et al. (2006, 2010) is that financial globalization produces important ‘collateral benefits’ that bolster growth. Rodrik and Subramanian (2009) and Stiglitz (2008) provide a robust critique of the collateral benefits argument, which we do not address explicitly in this paper.

  3. See Levine 2005; Levine and King 1993; Evans et al. 2002, although question remain about the direction of causality Demetriades and Arestis 1996; Ram 1999; Arestis and Sawyer 2005; Rousseau and Wachtel 2011

  4. On this issue see Williamson and Mahar (1998); Demetriades and Arestis (1996), Ram (1999), Arestis et al. (2002), Ang (2008).

  5. For example In Kenya, Malawi and Cote d’Iviore the saving rates dropped from 20.7 %, 13.3 % and 21.3 % between 1981 and 1986 to about 15.3 %, 5.8 % and 15.6 % in 1987–1997 respectively. On the other hand, public savings rate in Nigeria dropped from about 3.6 % to −1.2 % in same period (Ahmed 2005).

  6. It should be noted, however, that some control variables, such as population growth and inflation, and concomitant policy reforms (trade, fiscal policy etc.) are not controlled for.

  7. In Tanzania, Odhiambo (2009) finds a positive relationship between interest rate reforms and growth but not via increased financial depth. In Kenya, Odhiambo (2009) finds a link between interest rate liberalization, depth and economic growth.

  8. See van Hulten and Webber (2010) for a more recent literature review.

  9. Alfaro et al. (2010) suggest, however, that when non-private capital flows are removed from the data series used in previous studies that capital flows and relative growth rates are positively correlated as predicted by neoclassical theory.

  10. Derived from UNCTAD FDI database.

  11. “Development”, here, means financial depth measured by some monetary aggregate. See Bonfiglioli and Mendicino 2004; Durham 2004; Bekaert et al. 2005; Klein and Olivei 2006.

  12. Klein 2005; Fratzscher and Bussiere 2004; Bekaert et al. 2005. Further, countries with the “best” institutions are most likely to be net recipients of foreign capital and the least likely to experience non-FDI outflows (Papaioannou 2009; Alfaro et al. 2008; Ju and Wei 2007).

  13. Edison et al. 2002; Aizenman et al. 2004; Quinn and Toyoda 2008

  14. Studies cited by Kose et al. (2010) focus more on financial crisis and investment levels rather than economic growth.

  15. See Kose et al. (2006) for a review.

  16. Demetriades and Law (2006) find that good institutions increase the positive effect of financial depth on economic growth. This effect is greatest in middle income countries, and limited in low income countries. Importantly, the policy determinants of financial development (i.e. “repressive” versus “liberal” policies) is not explored. Angkinand et al. (2010) find that financial liberalization in the presence of good institutions decreases the chances of banking crises. See Yilmazkuday (2011) for discussion of thresholds in relation to the finance-growth nexus.

  17. On this issue see Williamson and Mahar (1998), Demetriades and Arestis (1996), Ram (1999), Arestis et al. (2002), Galindo et al. (2007), Ang (2008).

  18. See Ang (2008) for a review of the literature presenting this view. Demetriades et al. (2008) discuss how China’s banking system, with high levels of government ownership and financial controls, has fostered economic growth and financial depth.

  19. For example, Kose et al. (2011:15) state “China comes out looking very good by this measure despite the weaknesses in its financial sector, which is dominated by state-owned banks. This is a useful reminder of the potential pitfalls of using a particular uni-dimensional measure of financial development. And of course the worldwide crisis that first hit the U.S. and then spread to other industrial countries has shown that financial depth is not equivalent to financial stability.”

  20. Rather, Kose et al. (2006) suggest that foreign capital inflows may have a positive effect on institutional quality by creating a new foreign constituency to lobby for regulatory reforms and by exposing governments to the discipline of international capital markets. They label these effects a ‘collateral benefits’ of financial globalization. Adapting this argument, Cassimon et al. (2010) suggest that weak institutions may result in the poorest countries being unable to attract capital and acquire these collateral benefits, irrespective of their financial and capital account policies.

  21. Baker (2005) estimates illicit capital flows from developing countries at US$539-US$778 billion in 2005, while Kar and Cartwright-Smith (2008) estimate a figure US$675-US$806 billion in 2006. Christian Aid (2008) estimate tax evasion through transfer mispricing costs the developing world US$160 billion a year in foregone government revenue.

  22. See Baker (2005), Palan et al. (2010) and Shaxson (2011).

  23. In this vein, Neeman et al. (2008) explore the relationship between corruption and growth and find only a negative relationship in open economies. They posit that this relationship may be explained by the capital drain that is made possible by trade and capital account openness; a problem that was less pressing when today’s industrialised countries were industrialising and developing their own state institutions.

  24. Whilst various techniques exist to estimate illicit capital flows from official data sources (e.g. see Epstein 2005), Baker (2005) suggests that these are poor proxies as the both the trade and capital flows of interest often do not appear on official accounts in either recipient and source countries. Illicit capital flows can be considered a sub-set of private capital flows and, ideally, should be accounted for when testing the relationship between openness, capital flow, institutional quality and economic growth. Illicit capital outflows reduce the amount of capital available for domestic private investment and undermine the tax revenues available to states for investments in better institutions.

  25. See ‘Investing in Botswana’, BEDIA annual report 2007, page 17.

  26. In the early 2000s, Nigeria successfully implemented an oil-price-based fiscal rule. Assisted by high oil prices, these fiscal rules produced rapid declines in external debt and strong fiscal surpluses after 2003 (Okonjo-Iweala and Osafo-Kwaako 2007; IMF 2009).

  27. Nevertheless, recent reviews raise concerns about the narrowness of Botswana’s tax base (IMF 2007; Clausen 2008; Kojo 2010).

  28. On fiscal policy see Collier (1996) and Ikpeze et al. (2004). On monetary policy see Osoba (1996) and Nnanna (2001). On exchange rate policy see Forrest (1986), Azam (1999) and Kohli (2004). On trade and industrial policy see Ikpeze et al. (2004), Kohli (2004) and Ajayi and Osafao-Kwaako (2007).

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Ahmed, A.D., van Hulten, A. Financial Globalization in Botswana and Nigeria: A Critique of the Thresholds Paradigm. Rev Black Polit Econ 41, 177–203 (2014). https://doi.org/10.1007/s12114-013-9170-x

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