Financial globalization and host country effects: An empirical analysis

The dearth of capital in many countries, developing in particular, and the ability of foreign capital to augment domestic capital and stimulate domestic investment motivate countries to take steps at increasing the global integration of their domestic financial markets. However, the recent financial crises that occurred in various parts of the world in the last two to three decades bring to light the costs associated with financial globalization, especially with short-term capital mobility, and questions the policy decision to open-up domestic financial market.; The study undertakes an analysis of the effect of financial globalization on the economic growth of 51 developing and developed economies during the period 1975 to 2005. It also studies the volatility reducing capability of financial globalization on domestic consumption of 21 developed and developing countries. A panel estimation approach with White Heteroskedastic-consistent covariance is carried out on data averaged over 5-year periods, and an outlier robust estimation of consumption volatility is adopted.; The study revealed that not all aspects of financial globalization have beneficial effects on the host economies. Net foreign direct investment inflow was found to have a significant positive impact on economic growth in both developed and developing economies even after controlling for the level of domestic financial sector development. Net portfolio investment inflow was growth retarding in developing economies and it was found that the more developed is their domestic financial sector, the greater is the negative impact of net portfolio investment inflow on economic growth.; In addition, the study showed that both net foreign direct investment inflow and net portfolio investment inflow reduced the volatility of consumption but the findings were statistically insignificant. However, the total net foreign capital inflow was statistically found to reduce the volatility of consumption.; The study recommended that countries should make policy decisions that are conducive to and that encourage foreign direct investment inflows into their economies, and should create guidelines for the use of shorter-term foreign investment inflows. Countries should create institutions that are capable of monitoring shorter-term foreign investment inflows, such institutions must periodically evaluate the vulnerability of their economies to the adverse effects of shorter-term foreign investment inflows. The policy decisions should be consistent with maintaining macroeconomic stability, political stability and good governance.