Figure 11.7

Index of Capital Controls in Emerging Markets

Note: Index ranges from 0 to 1. 0 = No capital controls, 1 = Tight capital controls.

Source: IMF database.

puted by the IMF has declined from a high of 0.66 to around 0.56 (the index would be 1.0 if all emerging economies had tight capital controls, and 0.0 if they had no controls). According to the World Bank, capital flows into the emerging economies of the world went from less than $50 billion in 1990 to over $336 billion in 1997.¹³

As of 1998, the trends toward deregulation of financial services and removal of capital controls were still firmly in place. Given the benefits associated with the globalization of capital, the growth of the global capital market mapped out in Figures 11.4 to 11.6 can be expected to continue for the foreseeable future. While most commentators see this as a positive development, there are those who believe that there are serious risks inherent in the globalization of capital.

Global Capital Market Risks

Some analysts are concerned that due to deregulation and reduced controls on cross-border capital flows, individual nations are becoming more vulnerable to speculative capital flows. They see this as having a destabilizing effect on national economies.¹⁴ Harvard economist Martin Feldstein, for example, has argued that most of the capital that moves internationally is pursuing temporary gains, and it shifts in and out of countries as quickly as conditions change.¹⁵ He distinguishes between this short-term capital, or "hot money," and "patient money" that would support long-term cross-border capital flows. To Feldstein, patient money is still relatively rare, primarily because although capital is free to move internationally, its owners and managers still prefer to keep most of it at home. Feldstein supports his arguments with statistics that demonstrate that although $1.2 trillion flows through the foreign exchange markets every day, "when the dust settles, most of the savings done in each country stays in that country."¹⁶ Feldstein argues that the lack of patient money is due to the relative paucity of information that investors have about foreign investments. In his view, if investors had better information about foreign assets, the global capital market would work more efficiently and be less subject to short-term speculative capital flows. Feldstein claims that Mexico's economic problems in the mid-1990s were the result of too much hot money flowing in and out of the country and too little patient money. This example is reviewed in detail in the accompanying Country Focus.

A lack of information about the fundamental quality of foreign investments may encourage speculative flows in the global capital market. Faced with a lack of quality information, investors may react to dramatic news events in foreign nations and pull their money out too quickly. Despite advances in information technology, it is still difficult for an investor to get access to the same quantity and quality of information about foreign investment opportunities that he can get about domestic investment opportunities. This information gap is exacerbated by different accounting conventions in different countries, which makes the direct comparison of cross-border investment opportunities difficult for all but the most sophisticated investor (see Chapter 19 for details). For example, German accounting principles are very different from those found in the United States and can present quite a different picture of the health of a company. Thus, when the Germany company Daimler-Benz translated its German financial accounts into US-style accounts in 1993, as it had to do to be listed on the New York Stock Exchange, it found that while it had made a profit of $97 million under German rules, under US rules it had lost $548 million!¹⁷

Given the problems created by differences in the quantity and quality of information, many investors have yet to venture into the world of cross-border investing, and those that do are prone to reverse their decision on the basis of limited (and perhaps inaccurate) information. However, if the international capital market continues to grow, financial intermediaries likely will increasingly provide quality information about foreign investment opportunities. Better information should increase the sophistication of investment decisions and reduce the frequency and size of speculative capital flows. Although concerns about the volume of "hot money" sloshing around in the global capital market have recently increased as a result of the Asian financial crisis, IMF research suggests there has not been an increase in the volatility of financial markets over the past 25 years.¹⁸