The period from 1880-1913 was a period of globalization in both goods and financial markets comparable to the present era of globalization. Growth of international trade surged. The average ratio of merchandise exports to GDP doubled between 1870 and 1913. Transportation costs fell, and tariffs stayed low compared to their levels after 1913. It was also an age of mass migration with few impediments to the flow of people across borders. Financial globalization burgeoned; current account deficits persisted for long periods; and several nations imported foreign capital to the tune of at least three to five percent of GDP each year. In 1913 Obstfeld and Taylor (2004) estimate that the ratio of net foreign liabilities to global GDP was on the order of 25 percent. Of great importance, capital controls were non-existent.
Today, opponents and supporters of “globalization” argue vigorously about the benefits of such a process. With respect to financial globalization, optimists suggest that opening up to global capital markets can make crucial investment funds available at a lower cost, enhance risk sharing, transfer technology and reign in errant policy makers. Pessimists suggest that global capital flows are fickle and move for reasons unrelated to fundamentals causing financial disruption and economic volatility. Decoupling from the global capital market through the use of capital controls can help protect a country from temperamental financial markets.
Optimists might cite as evidence for their view the late nineteenth century when many countries seem to have benefited from the free movement of capital. The areas of recent European settlement such as Australia, Canada, the United States, and even parts of Argentina and Brazil had high standards of living and witnessed rapid economic growth. Inward investment to these areas, coming largely from Great Britain, was massive prior to 1913. Much of this financing went into fixed interest rate long-term bonds that national governments and local companies issued in London to fund infrastructure and railroads. The standard view in economic history holds that funds were essential in building productive capacity and improving the infrastructure that would allow goods to reach ever larger international markets.
But countries often squandered these inflows on frivolous military campaigns, excessive public consumption or poorly engineered projects. In addition, many countries built up large net foreign liability positions and were perilously unprepared for the rapid cessation of capital inflows that periodically afflicted such exposed countries. These sudden stops and reversals often culminated in financial crises particularly in financially vulnerable countries. Currency crises, banking crises and twin crises were not an uncommon feature of the period. A number of nations also faced debt crises that led to economic catastrophe and debilitated nascent domestic financial systems.
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Foreign Capital and Economic Growth in the First Era of Globalization
