Indicators of Capital Market Integration

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The three major measures of globalization, or the elimination of differences across space, are trade, capital and migration. It is clear from statistics that the amount of global trade in the current era of globalization has surpassed levels of the 1st era of globalization. On the contrary, migration peaked in the first era. The level of capital flows is less certain, although it is believed that capital flows also peaked in the first era of globalization. There are two main indicators of the amount of global capital flows, which in turn informs the state of economic globalization.

The first relates to the current account balances of countries. The balance of payments is often accounted for by compensating a surplus or deficit in one account (current or capital) with the other. If there is a current account surplus, and exports exceed imports, then the country will invest in foreign assets and there will be a capital outflow to stabilize the balance. Conversely, a current account deficit will result in a net capital inflow. In this way, high average current accounts (usually taken as percentage of GDP) generally denote lower global capital flows and vice versa. This mechanism has shown that integration has not reached levels of the first ‘Golden Era’.

The second indicator of capital integration is in the world variation of interest rates. If the return on a financial asset such as the interest payment for a gov’t bond is greater in country A than country B, people will sell bonds from country A and buy them from country B. This would drive up the price of bonds and lower the return in country B, and lower prices and increase the return in country A thereby equalizing the difference in interest payments/rates in the two countries. Therefore, markets that are more integrated are those with less of a difference in interest rates, as money is being transferred faster. As from 1960 on has seen interest rate variation of less than 5%, this model may show a more integrated world today than in the first era of globalization. [1]

  1. Grieco & Ikenberry, Ch 7: “Economic Globalization and Political Backlash.”