International Business Environment

1 INTERNATIONAL BUSINESS ENVIRONMENT

2 Introduction Financial globalisation is a phenomenon that has particularly gained momentum in the last decade of the 20th Century through to the new millennium. The numerous inventions in information technology and advanced management practices have been of great influence in enabling countries to consider financial globalisation as an option for triggering and sustaining internal development. Although the phenomenon has its advantages, particularly in terms of enhancing a country’s financial system development, it may also result in crises and contagion.

In the long run, financial globalisation’s net effect has higher probabilities of being positive with risks prevalence increasing immediately after countries liberalise. This paper particularly evaluates the situation in Guidia in as far as deeper globalisation-related gains and risks are concerned.

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3 The Concept of Financial Globalisation Financial globalisation refers to the integration of the local financial system of a country with international institutions and financial markets. One of the major requirements of such integration is for the government to liberalise both the capital account, as well as the domestic financial sector; thus, the integration will be experienced immediately. The liberalised economies will begin to encounter cross-country capital movement increase, such as widespread international financial intermediaries use and local lenders and borrowers actively taking part in international markets (De la Torre et al., 2002, p. 335).

Middle income countries, such as Guidia, can still participate in financial globalisation despite the fact that the practice is still common among the developed countries. However, as Frankel (2000, p. 76) rightly points out, the global financial system is not about to realise perfect integration. Evidence of such incidences as home country bias, continuous capital market segmentation, and the correlation pitting investment, on the one hand, and domestic savings on the other, continues to shroud the entire concept. One important aspect that the Guidia government has to take note of is the fact that the potential benefit to the country’s overall economy could be realised in terms of a more complete, more stable, deeper, as well as a betterregulated financial market. Levine (2001, p. 688) notes that a financial system with additional credit and which is well functioning is important because it promotes economic growth.

However, the globalisation also comes with some feasible risks for Guidia. In particular, the country could face a higher likelihood of risk in the short term, just immediately after it opens up to the international integration. More often than not, globalisation tends to relate to financial crises. There are existing international examples, such as the Russian crisis of 19971998, Brazil in 1999, Ecuador in 2000, Turkey in 2001, as well as Argentina and Uruguay which

4 experienced financial crises in 2001 and 2002 respectively. Although each country has a unique experience and scenario with globalisation, the above examples could serve as latent risk indicators to the Guidia government, illustrating the potential risks that could abound (Forbes, 2000, p. 1).

The connection between globalisation and financial crisis occurs on numerous fronts; if the financial infrastructure in Guidia is not appropriate during the integration exercise, the overall local financial system’s health could be potentially weakened by liberalisation and capital inflows. Equally, the deterioration of market fundamentals could result in speculative attacks with capital outflows caused by both foreign and domestic investors. Thus, the government must ensure its economic fundamentals are strongly maintained if successful integration is to be realised. The supervision of the local markets needs to be regularly done (Aghion, Bacchetta and Banerjee, 2004, p. 1077).

Stronger economic fundamentals are important because, with all other factors held constant, there is a tendency of globalisation intensifying the sensitivities of a country to foreign shocks. Guidia, for instance, relies on her relatively little natural gas and the textile processed in the export zone. In instances where international market imperfections are experienced, such as herding, boom-bust cycles, panics, as well as capital flows fluctuations, the country can easily plunge into a crisis and contagion (Matsuyama, 2007, p. 1).

There is also the aspect of segmentation, which is a potential risk factor that results from globalisation. Given Guidia’s population profile where 65 per cent actually reside in the urban areas, this could be a clear demarcation of the population size with the ability to take part in the international financial system (Claessens, Klingebiel and Schmukler, 2002, p. 167). It potentially implies that the bulk of the country’s $4,000 per capita income is actually concentrated within

5 the urban areas, while the rural population only contributes a smaller percentage. Often, middle income countries have the majority of their financially stable populations congregating in the urban areas where economic means and infrastructure can also be easily accessed. Majority of the people living in rural areas, on the other hand, often have weaker financial power and means.

Thus, globalisation will more likely segment the Guidian population into two groups on the basis of those having the ability to play a part in the international financial or economic system, and those who will have to rely on the domestic financial sectors.

For the policy makers, the integration into international market poses challenges to them in terms of determining how the country can enjoy full advantage of all the generated opportunities, while ensuring the implied risks are minimised. This is an important factor in the sense that there are chances of globalisation deepening over time as a result of its potential benefits.

Latest Trends in Globalisation The two most important developments resulting from globalisation include the new kind of capital flows and the rising utilisation of international financial intermediaries (Wright, 2006, p. 120). From the 1970s to date, emerging economies’ net capital flows have been registering sharp increases. During this period, it is quite significant that capital flows composition to developing countries has registered changes. The substance of official flows reduced by more than a half, while the major source of capital shifted to the private capital flows for a majority of emerging economies. The private capital flows’ composition also significantly changed with foreign direct investment, FDI, continuously growing throughout the 1990s.

Even though the recent years have witnessed an increased flow of net private capital, not all the countries receive an equal flow of this private capital. While other countries will tend to

6 receive huge inflow amounts, others receive comparatively little foreign capital. While developing countries’ flows generally increased, the leading 12 countries that recorded the highest flows also received the overwhelming bulk in as far as the net inflows are concerned.

Additionally, the 12 countries also experienced the highest rapid growth during the 1990s as concerns the private capital flows. Consequentially, there has been a decrease of the ratio of flows to low and middle-income countries excluding the leading pack of 12 countries. The fact that Guidian does not make the list of the 12 leading countries implies that its relative flows could likely be less attractive.

It is important to point out the above factor because if a number of countries are benefiting from foreign capital, a small percentage of the countries will be the ones who have the chance to benefit the most. The fact that developing country’s income is often diverging is reflected on the capital flows’ unequal distribution. In the case of Guidian, for instance, the fact that a majority of the country’s population is actually urban point out to the higher likelihood of the income flows being divergent (Kehoe and Perri, 2004, p. 184). As pointed out earlier on, developing countries tend to concentrate a majority of their economic means within urban areas, thus attracting huge migrations of the population to the urban areas.

The second development, financial services internationalization, refers to the local investors and borrowers relying on international financial intermediaries. Increased existence within local markets of global financial intermediaries, like foreign banks, comprises the first channel. In this regard, therefore, Guidia will have to restructure its entire financial sector control framework in order to allow for international financial companies and institutions to operate freely within the country. The second channel comprises of the use of foreign based global financial intermediaries by the locally based investors and borrowers. An example illustrating

7 this channel is the local shares trading in some of the major stock exchanges in the world, mainly in depositary receipts form.

Main Agents Globalisation literally has four major agents that include governments, borrowers, investors, as well as financial institutions. Each of the agents plays a crucial role in aiding countries to realise more financial integration. The governments take part in globalisation by relaxing domestic sector financial restrictions as well as the balance of payments’ capital account. This means any practice by the Guidia government in regulating the domestic financial sector through restrictions on credit allocation will have to stop. Price and quantity controls will also have to cease. This could portend a risky situation for the natural gas deposits in the country, which need to be closely regulated to protect against chances of exploitation both in the domestic and international market. Governments often use a myriad of instruments so as to put restrictions on the capital account, including restricting foreign exchange transactions, lending activities carried out by corporations and banks, derivative transactions, as well as the participation of investors from foreign countries within the country’s local financial system.

According to Kaminsky and Schmukler (2002, p. 292), many governments have, over time, managed to lift the heavy regulations on domestic financial sector, as well as on the capital account. However, it is worth pointing out that in spite of the gradual withdrawal of restrictions by governments, there were instances where reversals were noted, leading to the re-imposition of restrictions. The debt crises of the 1982 and mid-1990s, as well as the aftermath of the Argentine crisis are some of the situations that had forced governments to re-introduce restrictions. This challenges and scenarios are still existent at the present and could still force the Guidia government to rethink its stand on deregulating the financial sector. The global credit crisis that

8 kicked off in mid-2007 is the recent in the series of the international financial crises that have destabilised a majority of countries worldwide. With the occurrence of other international debt crises being totally out of control of the Guidia government, there are still chances that the company might be forced to re-impose restrictions on its financial and economic sector (Tobin, 2000, p. 1101).

Borrowers and investors, with the inclusion of households and firms, also play very crucial roles in globalisation. Firms and individuals, by borrowing abroad, can loosen up their financial-related constrains and, in turn, smoothen investment and consumption. Globalisation in Guidia will, thus, enable firms to expand their alternatives to financing by directly raising funds through equity and bonds issues within the international markets. This will enable them to reduce their cost of capital, increase liquidity, and expand their investor base. Added financing alternatives assist foreign investors in overcoming direct, as well as indirect investment barriers.

As Tesar and Werner (1998, p. 167), and Obstfeld (1994, p. 13) argue, international investors benefit from the advantage of globalisation in achieving cross-country risk diversification.

Investors from Guidia will spread their investment risks across a number of nations as a result of the country adopting globalisation. This way, the risk of an overall loss is reduced considerably and the investors will have increased optimism and agility for participating in international business.

Financial institutions, through financial services internationalisation, also play a key role in globalisation. The International Monetary Fund (2000, p. 28) discusses the fact that developing and developed countries have undergone changes that underscore financial institutions’ main contribution in globalisation. As Guidia contemplates integrating with the international market, one thing will be common with its financial sector and institutions. Foreign

9 companies and banks will gain entry into the country and compete with the locally based financial institutions (Mundell, 2000, p. 327). Because the local banks and institutions have for years been used to protect, there is a possibility that the international firms will win the market and render the local firms less profitable. On the other hand, the local firms could still thrive and beat the strong competition from international firms by virtue of the fact that the local firms are well versed with the domestic market and will not require time to settle and try to understand it (Glick and Hutchison, 2001, p. 35).

However, the situation for Guidia could actually be risky because once the country liberalises its domestic market, financial firms and institutions from the developed world could rush into establishing themselves in the country. Bearing in mind that these firms originate from the developed world, their infrastructure, expertise, and experience, which is obviously much better than those of domestic firms in Guidia could immensely offer them the requisite advantage in the market (Mishkin, 2000, p. 105).

Risks and the Net Effects Globalisation can actually be equated to several financial crises that have been common in the recent past. The Euro zone, for instance, is currently grappling with deep financial crisis as member countries, including Greece, Ireland, and Portugal, among other states, are grappling with very high risks as a result of integrating with the international financial market. This globalisation, in the case of Guidia, could result into crises in the following ways. Firstly, by liberalising its financial system, Guidia will be subjected to a market discipline that is exercised by both domestic and foreign investors (Calvo and Reinhart 2002, p. 379). On the contrary, with a closed economy, it is only the domestic investors within Guidia who will have the chance to monitor the local economy and act in response in case of any unsound fundamentals.

10 In a globalised economy, both the domestic and foreign investors could join forces so as to generate a crisis, especially in the face of deteriorating fundamentals. This might prompt Guidia to try and achieve sound fundamentals, despite the long duration of time that is involved.

Additionally, the reaction of the investors could be exaggerated, given the fact that investors are often over-optimistic during good times and tend to be over-pessimistic during bad times. These actions by the investors do not necessarily point at their intention to discipline countries. Thus, small changes by the Guidia government targeting to alter the fundamentals, or even news about a compromising situation, could end up triggering sharp changes in as far as the investors’ willingness to risk their capital is concerned.

In the event that the international financial market experiences imperfections, the likelihood of Guidia plunging into a crisis as a result of globalisation will be heightened.

Bubbles, or speculative attacks, or crashes, or herding behaviour, among many other negative effects, could be generated by the imperfections within the financial markets. Even with sound fundamentals, international capital markets’ imperfections could still result in crises. For instance, if investors have a belief that Guidia’s exchange rate is not sustainable, they might end up speculating against the local currency. This, in consequence, could result in a crisis on the balance of payments that is self-fulfilling in nature, in spite of the existing market fundamentals.

Furthermore, the imperfections in the international market could still deteriorate the existing market fundamentals (Levine, 2001, p. 700). For instance, moral hazard can force the Guidia government to an over borrowing syndrome once the economy will be liberalised. This, together with implicit government guarantees, could end up increasing the chances of a crisis emerging.

Globalisation can also cause Guidia to enter into a crisis as a result of importance that the external factors bear. This could still be witnessed in spite of sound fundamentals or even when

11 imperfections within the international capital markets have been eliminated. Once Guidia becomes dependent on the foreign capital, the sudden shift in flows of the foreign capital could result in financing difficulties, as well as trigger economic downturns.

Net Effects Potential volatility increase often occurs in the short-run, immediately after a country decides to liberalise its market. The initial liberalisation of the financial sector might cause volatility and crises, especially for countries whose fundamentals are a bit vulnerable. Lack of preparedness on the part of the domestic financial sector to handle foreign flows, or is not regulated and supervised properly, a domestic crisis could result from the financial liberalisation (Levchenko, 2005, p. 237).

According to Bekaert, Harvey, and Lundblad (2001, p. 16), output growth has generally increased by about one percent following liberalisation. Despite the fact that financial liberalisations improve on financial development, there are indications that financial development measures fail to completely drive the liberalisation effect out. Financial liberalisation results in higher average growth in the long-run, although it also results in some crises as well as boom-bust cycles. In the short-run, thus, Guidia will most likely experience the crisis that is related to globalisation (Kaminsk and Reinhart, 2000, p. 145). If the country does not put very strong policies in place, the initial effects of globalisation could end up harming the economy at large.

Conclusion Globalisation basically entails a country integrating with the international market for purposes of doing business. This phenomenon has gained momentum in the last 20 to 30 years, with many countries liberalising their domestic markets to allow for players from the global

12 market an opportunity to exploit the market. There are several benefits and risks that result from a country adopting globalisation. For the case of Guidia, globalisation will imply that the government lifts all legal controls and protection of its local market to allow for firms from other countries to participate in the economy. Guidia citizens and investors, both local and foreign, can utilise the opportunity to obtain capital from foreign financial institutions and use it to build the country’s economy. Consequently, the foreign firms and institutions bring about competition which improves on the quality of service delivery, while also providing such economic advantages as employment to the locals. On the contrary, though, the opening up of the local economy to other foreign players and market basically places control of the country’s resources under the influence of the international market forces. Under the circumstances, the natural gas and textile exported from the country could actually be acquired at very low costs by the international market, a fact that will be placing the domestic economy and resources in jeopardy.

There are four main agents of globalisation which include the government, investors, borrowers, as well as the financial institutions. Each of these agents is affected in one way or the other as a result of the globalisation.

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