The Global Financial Resource Curse

On the need to revisit globalization

The Global Financial Resource Curse is now a forthcoming paper in the American Economic Review: see here.

While this is not strictly related to Central Banking, which is the focus of this newsletter, I thought it would be interesting to share the insights of this research with my substack community. The link to the paper is on my homepage: here.

Other relevant links:

“The Keynesian Growth Approach to Macroeconomic Policy and Productivity”, Liberty Street Blog at the Federal Reserve Bank of New York

“The Fed’s Trap and Fiscal Primacy” Central Banks Watcher blog.

“Macro Musing Podcast” with D. Beckworth.

“The Dollar's Imperial Circle”, IMF Economic Review.

“The Dollar’s Imperial Circle”, Liberty Street Blog at the Federal Reserve Bank of New York.

Hypothesis and Intellectual Background

A key pillar of the early 2000s Washington Consensus was the promotion of globalization, particularly through the liberalization of capital flows and trade. In recent years, and especially in the aftermath of the global financial crisis, this consensus has been challenged, acknowledging the complexity of market functioning and social outcomes.

In the “Global Financial Resource Curse” (jointly with Luca Fornaro and Martin Wolf), we show how simple departures from traditional frameworks and conventional wisdom could refine the debate of integration and globalization further.

Let me summarize the key departures and findings.

a)        When we think about integration, most of the time we, as economists, fail to acknowledge the importance of considering relevant differences among countries. What is relevant of course depends on a case-by-case basis. In the Ricardian model, the relevant asymmetry depends on differences in endowment among countries.

In the Global Financial Recourse Curse, we examine two key asymmetries. We study financial integration between one technologically advanced country (say the U.S.) that is at the frontier of technological development and a set of countries that are less technologically developed. In the model, the U.S. leads the technological innovation process while developing countries absorb knowledge from the U.S. Moreover, we consider a setting in which capital flows are directed toward the most developed country. This reflects for example preferences towards financial assets available in the U.S.. Another way to capture this asymmetry is to assume that the most advanced country runs a permanent trade deficit.

b)        Another aspect that is less explored in the economic literature, but we are examining in the paper, is the importance of linking growth with other dimensions of an economy.  The main theme of my research work with Luca Fornaro is directed at exploring this aspect along different dimensions. In “Stagnation Traps”, we lay out the features of what we call the Keynesian Growth approach to the study of economic fluctuations: the cycle can shape the trend (growth). Demand policies can have long-lasting effects, or, to revisit Say’s law, demand creates its own supply.

In “The Financial Resource Curse,” (joint with Luca Fornaro) we explore the interaction between growth and capital flows from the perspective of a small open economy: financial market openness can lead to the misallocation of resources. In “Reserve Accumulation, Growth, and Financial Crises” (joint also with Luca Fornaro and Martin Wolf) we study the importance and the dual role of international liquidity, which can be used both as a tool to manage the exchange rate and as a tool to mitigate the consequences of a financial crisis: reserve accumulation is a good second-best policy from the perspective of a small open economy.

In the Global Financial Resource Curse, we also assume that dynamic productivity gains are mainly concentrated in the traded sector as opposed to the non-traded sector and we study the global implications of financial integration of economies that share this feature.

What are the main results? What is the Global Financial Resource Curse?

The Global Financial Resource curse is a depressed growth outcome under financial integration, as capital flows toward the U.S. economy increase non-traded goods demand and shift resources away from the traded sector (the engine of growth in the model). This shift leads to less innovation in the U.S., and lower productivity growth not just in the U.S. but also globally. This curse is reminiscent of the natural resource curse, but its origins are financial and its implications are global.

The U.S. economy faces a “real” exorbitant duty: lower growth is the cost of the exorbitant privilege associated with the desirability of its own assets.

The world economy ends in an equilibrium with lower innovation, lower productivity growth, and super-low real interest rates.

What are the policy implications?

We do not conduct a full-fledged welfare analysis, but we do examine the role of policies that can mitigate this outcome.

From a normative perspective, the first-best policies should aim to stimulate innovation in the U.S. and direct resources toward the sector that has the potential to generate dynamic productivity gains, the tradable goods sector (the manufacturing sector for example).

When such policies are not viable or constrained, second-best policies should be deployed to limit the trade deficit or capital flows toward the U.S. economy.

Connections

In “The Fed’s Trap and Fiscal Primacy” I lay out the importance of fiscal policy in shaping the post-pandemic economic outlook for the U.S. economy. This structural shift is significant not only for the U.S. economy but also carries global repercussions, as the U.S., being the world's largest economy, plays a pivotal role in influencing the global business cycle.

Additionally, I want to emphasize that the structural shift discussed in the paper provides the background for the analysis of the role of the dollar in the context of the international monetary system: this is what we explore in “The Dollar’s Imperial Circle” a joint research paper with Ozge Akinci, Serra Pelin, and

Jon Turek

.

Finally, our framework builds upon several simplifying assumptions to capture the essence of the interaction between capital flows and global growth so policy implications should acknowledge these limitations. Nevertheless, the complexity of the real world and its evolving challenges require research efforts that build upon these complexities, tackle these challenges and question established assumptions.