CHAPTER ONE

INTRODUCTION

1.1.  Background to the Study

International financial globalisation occurs when the exchange controls are removed and the capital account is freed to allow financial resources to flow freely in and out of the country. With the rise of global integration rates in the world, many countries, especially developing countries, are now trying to uplift barriers to cross borders and financial regulation, easing monetary policy on capital restrictions and deregulating domestic financial system. According to Trichet (2005), consolidation of financial integration promotes financial development, which in turn creates opportunities for higher economic growth. Financial globalisation facilitates economic efficiency, increases scale of production and increases the provision of funds for investment. The real process of globalisation also promotes competition and market growth, thus leading to continued financial improvement. Subsequently, fiscal improvements could lead to a more efficient allocation of funds and a reduction in capital costs. At the same time, financial globalisation is blamed for increasing the country’s risk or vulnerability to global financial crises, which often occur in times of sudden fluctuations or reversals in international financial flows.

Growing interactions among economies with varied domestic macroeconomic structures, a feature of evolving trends in international commerce, continues to be a key macroeconomic trend responsible for significant growth in most developed and developing economies. Although the Smithian and Ricardian views, as well as the modern dynamics of international trade differ somewhat, in terms of how international trade and economic interactions affect the participating economy, common consensus suggests that many participating economies benefit from such cooperation. These benefits, according to the literature, range from broad market access, and subsequent transactions due to differences in resource wealth and technology information. Expansion in cross-national trade necessitated by such fundamental disparities has also been found to be crucial in bridging major economic gaps among participating economies with varied domestic macroeconomic structures. These benefits notwithstanding, present trends in international commerce suggests the drive to major on country specific comparative advantages, a central tenet in international commerce, had led to, and continues to foster economic interdependence especially among developing economies. This drive to gain access to external markets in order to support regional export oriented policies, has also inadvertently exposed most less developed economies to macroeconomic volatilities inherent in the global market place (mostly dominated by advanced and emerging economies).

Related literature, for example (Kraay and Ventura, 2007; Addison et al., 2007), suggest that the less developed economy, which has been severely restricted by excessive trade transformation due to limited transactions and disclosures, is now increasingly at risk of being shocked by occasional international trade-offs. Understanding the effects of these growing connections and exposure to emerging global market markets is important; In that sense, the condition describes how important performance indicators in the region ultimately influence economic growth and living standards. For example, Addison et al. (2007) have shown that the volatility of global markets has a profound effect on both the major regional and national economic indicators of participating economies.

Evidence-based findings, however, on the (external) level of macroeconomic volatility impact macroeconomic perturbations than others suggest that effects of occasional volatility and shocks associated with international commerce might be more severe on less developed economies than their developed counterparts; Kraay and Ventura (2007). Referencing this conclusion, some analysts have argued that SSA economies are more prone to external volatilities resulting from increasing involvement in global commerce due to relatively weak regional economic structures and constrained economic policies needed to manage the condition. Analysis of historical trade dynamics on Sub-Saharan Africa show that until recent decades, the sub region, compared to other economic blocks around the world had minimal interactions and limited access to global markets due to trade barriers and socio-political constraints.

Recent trends, however, suggest that much of the region’s economy is increasingly being integrated into the global market economy through exports, direct foreign investment, network financial systems etc. In addition to these well-known traditional methods of establishing and expanding economic cohesion, the available evidence also suggests that the recent growth in the economic integration of most economies in the region has resulted in equally socio-economic benefits. For example, trade agreements aimed at promoting an economic export base in the sub-region to support poverty alleviation programs, as well as access to online-based financial network systems that have made it possible to integrate financial services with banks in the global financial system are few of these emerging features. These dynamic conditions along with other drivers of the macroeconomic region continue to expose the area under potentially dangerous economic conditions associated with international trade.

Sub-Saharan African countries received the largest foreign exchange earnings (estimated US $ 966.73 million in 1985, US $ 4.53 billion in 1995, US $ 19.49 billion in 2005 and US $ 27.15 billion in 2010), indicating a strong increase in capital flows to other developed and developing countries over the past decade. Although these flows were briefly delayed during the crisis, very low interest rates in developed countries and reduced global risk resilience also encouraged investors to travel around the world in search of attractive investment opportunities (IMF, 2011). The volume of international financial flows in sub-Saharan Africa was extensively revealed in World Economic and Financial Surveys of IMF, 2011. It was argued that during the last two decades, external sources of funding for investment and growth in sub-Saharan Africa have undergone a noteworthy transformation. First, a six-fold increase has occurred in total flows, especially since 2000. Second, in sharp departure from the previous decade, most of the increase has come from the private sector, even when excluding South Africa and Nigeria (these two large countries typically account for 50 to 60 per cent of total flows). Inflows from private capital in the form of both foreign direct investment (FDI) and portfolio flows have increased rapidly, although not all countries in sub-Saharan Africa have participated equally in this transformation, particularly in the ability to attract portfolio inflows. The same trend has occurred in transfers, whereby remittances have overtaken official transfers (grants) that have been declining during the past decade. Total net private inflows amounted to about US$41 billion in 2010, with South Africa accounting for more than 40 per cent of the total. However, there is need to examine the impact of financial globalization on economic activities in sub-Saharan Africa.

Many developing countries have been reluctant to open up their financial services, however, due to growing demand for financial transactions, the situation has changed dramatically for the benefit of excess capital in both developing and emerging markets. Policy redress on the regulation of loose funds has been observed. This impetus in policy shift is motivated by the predictions of standard theoretical models of international finance which suggest that financial integration generally cause a decline in the relative volatility of consumption and other main macroeconomic variables. Most countries are concerned of macroeconomic volatility as it increases uncertainties in operating environment which distorts the efficient allocation of economic resources and renders macroeconomic policies ineffective. Increased capital mobility has helped to finance the saving-investment gap and consumption which seemed to be erratic for developing countries. As such, in contemporary times, the nexus between international financial integration and economic growth continues to be one of the most debated issues in global macroeconomy. Many developing countries need strong evidence that financial integration is essential to the stability of a large economy. This lack of evidence has forced developing countries to resist cash release and to use production holidays in a safer but lower-income economy. The few existing episodes of cash account release have hampered intensive research efforts.

In theory, financial integration, and in particular, cash flow, increases efficiency and productivity in the real sector (Grossman and Helpman, 1991; Stulz, 1999) and finance sectors (Levine, 1996, 1997); which allows for efficient use and investment by sharing international risks (Sach, 1981; Obstfeld and Rogoff, 1996); promotes good economic behavior (Obsfeld, 1998); reduces major economic instability (Razin and Rose, 1994; Sutherland; 1996; Caballero and Krishnamurthy, 2000); and as a result promotes growth (MacDougall, 1968; Kemp and Liviatan, 1973; McKinnon, 1973; Hanson, 1974; Frenkel, 1976; Grossman and Heplman, 1991; Levine, 1997; Klein, 2005). However, global financial integration can be costly, as abstracted by Agénor (2003), such as the focus on large amounts of foreign currency, the unequal distribution of resources, the loss of macroeconomic stability (inflation pressures, real exchange rate recognition, foreign inequality, etc.), infection, and the risk of sharp reversal of cash flow.

In practice, countries have imposed, with varying degrees of intensity and span, restrictions and controls on capital flows. The expected benefits of these policies are related mainly to macroeconomic stability, in terms of lower volatility of output, consumption, and employment. The costs are associated with the administrative difficulties in managing the regime and the negative economic consequences derived from the protectionism provided to the domestic financial sector. The realization of those benefits and costs has been conditioned to the effectiveness of the isolation of the economy from capital flows, which is not always the case.

With regard to the evidence of the effects of financial trading on macroeconomic fluctuations, the literature used is limited. In addition, it focuses mainly on studying the outflow of variables and minimal in the use and transformation of investments. Recent evidence provided by Prasad et al. (2004) show that global financial integration appears to have declined, on average, consumption fluctuations and output volatility in the industrial economy and the “low financially integrated (LFI)” in emerging economies; however, they have only gradually reduced the “more financially integrated(MFI)” developing economies. Even in MFI countries, the volatility of private consumption increased in the 1990s compared to the 1980s. Bekaert et al. (2004) found that equity market freedom and capital account openness are associated with lower consumption volatility, in contrast to the findings of Stiglitz (2000) and Agénor (2003).

1.2.  Statement of Problem

Barro (2001) pointed out that financial instability leads to slowing economic growth. This weak growth is the result of excessive inflows and outflows and, in general, residual financial instability (Prasad et al., 2003; World Bank, 2000) and IMF, 2001). Indeed, financial instability can contribute to poverty and other social ills (World Bank, 2000). Thus, the state of a large stable economy represents a major pillar of long-term economic growth. Jeanne (2004) argued that the global economic downturn in developing countries is also exacerbated by international infections. Although not directly linked, it has been proven that countries that are more open to trade are also financially open (Lane, 2000; Heathcote and Perri, 2004). Pursuing financial globalisation by SSA countries with the aim of enhancing the financial sector’s ability to consolidate resources and allocate productive regional sectors, is an important pillar in the development of the financial sector. The leadership of the SSA countries has taken this approach to the pursuit of sustainable development. However, the general experience of macroeconomic instability which is one of the key elements of the developing economy should be controlled. This is because, experience has been said to have harmful effects on long-term economic growth and development (Calderon and Schmidt-Hebbel, 2008).

The recent wave of financial integration since the mid-1980s has been marked by an increase in the flow of money between industrialized nations, and, in particular, between industrialized and developing countries. Although these cash flows are associated with high growth rates in some developing countries, several countries have experienced periodic fluctuations in growth rates and major financial crises during the same period, disasters that have wreaked havoc on macroeconomic and social costs. As a result, a heated debate has erupted in both the academic and policy circles on the effects of financial integration on emerging economies. In relation to this controversy, Prasad et al. (2007) argue in their analysis that the effects of a large financial trading economy are sober but, in many ways, informative from a policy perspective. They argue that it is true that many developing economies with high levels of integration and high levels of growth. They also say, it is also true that, in theory, there are many channels that financial openness can improve growth. However, a systematic review of the evidence suggests that it is difficult to establish a strong causal relationship between the level of financial integration and the effectiveness of product growth. All in all, the evidence is mixed.

Some studies suggest that financial independence exacerbates instability (Bae et al., 2004) and leads to economic instability (Stiglitz, 2004). Some suggest that the liberalization of financial markets has increased the correlation between domestic and foreign market profitability but not the volatility of the domestic markets themselves (Bekaert and Harvey, 1997), and that financial liberalization leads to more efficient, high-profit stock markets. increased flexibility (Han Kim and Singal, 2000). Even though the level of international risk sharing associated with large-scale financial globalisation is likely to be very low, and limited only to developed economies (Kose et al. 2009), Umutlu et al. (2010) find a negative relationship between financial freedom and volatility; while Esqueda et al. (2012) find evidence of a negative correlation between financial integration and volatile financial outcomes but not in developed economies. More importantly, in financial integration negotiations the difference has been made between financial globalisation policies and procedures. In this view, the impact of de jure and de facto globalization of finance on economic growth and volatility has taken a toll on the negotiations (Makoto, 2020; Bush, 2018; Estrada et al., 2015; Orji, 2016). It is therefore important to take this approach of investigating the channels through which financial transactions can affect major economic instability in sub-Saharan Africa (SSA).

1.3. Research Questions

1.3.1. Main Research Question

What is the effect of financial globalization on macroeconomic volatility in SSA?

1.3.2. Specific Research Questions

1. What is the effect of de jure financial globalisation on macroeconomic volatility in SSA?
2. What is the effect of de facto financial globalisation on macroeconomic volatility in SSA?

• What is the effect of market concentration on macroeconomic volatility in SSA?

1.4. Research Objectives

1.4.1. Main Research Objective

To analyse the effect of financial globalisation on macroeconomic volatility in SSA.

1.4.2. Specific Research Objectives

1. To examine the effect of de jure financial globalisation on macroeconomic volatility in SSA.
2. To assess the effect de facto financial globalisation on macroeconomic volatility in SSA.

• To investigate the effect of market concentration on macroeconomic volatility in SSA