The Limits of Financial Globalization

Although barriers to international investment have fallen sharply over the last 60 years, the positive impact of financial globalization has proved far more limited than expected. Predictions by economists (including the author) that cross‐country differences in investment and financing would narrow or even disappear have largely failed to materialize. Investors everywhere continue to hold disproportionate amounts of domestic securities in their portfolios; levels of national investment continue to be tied (and largely limited) to local savings and income; and corporate ownership structures remain more concentrated, and capital structures more highly leveraged, in countries perceived to offer less protection to outside investors. The main explanation for the persistence of these cross‐country differences in investment and financing centers on the importance of two “agency problems”: First, in companies with controlling shareholders (which tend to be the rule in developing economies), those shareholders can use their power to transfer value from minority shareholders. Second, those who control the state can use their power to expropriate wealth from both controlling and minority shareholders. In countries with limited protection for minority shareholders, where these “twin agency problems” are most pronounced, corporate insiders tend to “co‐invest” more with outside investors, and ownership is thus more concentrated. But however necessary it may be to attract outside capital, such co‐investment also works to limit the benefit of financial globalization, making it less likely that risks will be shared internationally and capital invested where it is most productive. The author closes with the prediction that, as countries and their companies find more effective ways to manage these twin problems, developing and developed nations alike will benefit from increasingly global financial markets.