The global financial crisis that began a decade ago has left plenty of economic and political scars. It also has reshaped the way capital flows around the world.
In 2007, almost three times as much money crossed borders than it did in 2016, even as investors chase yields and pump up markets in a world of low interest rates. Banks that once saw rich futures in lending overseas are staying closer to home. And more of the money that does cross borders is in the form of long-term direct investment, ostensibly to build factories or buy stakes in companies in promising markets.
In a world where US President Donald Trump and other economic nationalists are threatening to erect new barriers to trade, debates about globalisation today are dominated by the surge in the trade of goods over the past half-century and its impact on societies. It is that goods trade that most economists cite when they express fear that the march towards greater economic integration might now be in reverse.
Less is said about the flow of capital or the state of financial globalisation. Yet the excesses of capital flows were one of the main causes of the financial crisis – and are where the next crisis might lie. The world’s financial system is more resilient today than it was a decade ago, the McKinsey Global Institute argues in a report. That, the think-tank argues, is reason for hope even as they document the 65 per cent fall in gross cross-border capital flows since 2007.
Much of the fall in money washing through the system is a reminder of where the global economy has come from. In 2007 the world was flush with liquidity, the result of financial deregulation, a surge in savings from China and other emerging economies and the then-seemingly boundless wealth of oil exporters. All of that money had to find a home and returns. Much of it landed in US property, inflating a bubble that burst with spectacular consequences.
Maurice Obstfeld, the International Monetary Fund’s chief economist, says: “We don’t want to use the period of the mid-2000s as our benchmark of what is normal and healthy.”
The main reason for the fall in flows has been a collapse in cross-border bank lending, primarily by European banks.
“It seems clear to us that what is emerging is a more stable, resilient form of financial globalisation that could well be beneficial,” says Susan Lund, a McKinsey partner and one of the authors of the report.
“What’s disappeared is a lot of cross-border lending . . . And we know from 20-30 years of financial crises around the world that cross-border lending is often the first form of capital to flow out of a country in a crisis.”
More of the capital flowing around the world today is in the form of foreign direct investment, the sort of long-term financial commitment by companies in factories and other facilities that is normally seen as productive. But a view spreading among economists is that the growth in FDI reflects an unhealthy trend – the corporate search for lower tax rates and the race by countries to service that demand.
Philip Lane, Ireland’s central bank governor, and Gian Maria Milesi-Ferretti, a senior economist at the fund, argue in a recent paper published by the IMF that the main factor behind the expansion in FDI has been the flow of investment booked in “financial centres”, the polite phrase for low-tax countries such as Ireland.
“If you think FDI is pouring into Luxembourg to build factories there, then you are mistaken,” says Mr Obstfeld.
“A lot of this represents tax-motivated profit shifting which shows up in the balance of payments as FDI flows.”
The IMF still sees risks in the financial system. The chase for returns by investors facing persistent low rates has driven down the cost of debt for borrowers across the developing world. They have responded by loading up on it.
“What we are seeing now is a level of flows and a growth in positions that looks more sustainable but that doesn’t necessarily imply that all is well,” Mr Obstfeld says.
Cross-border capital flows are down significantly from where they were when the global financial crisis began. The $4.3tn that flowed around the world in 2016 was only a third of the peak of $12.4tn in 2007. No one thinks a return to those levels would be healthy, however. The biggest contributor to the changing picture of capital flows has been the collapse in cross-border bank lending, with European banks responsible for much of the fall.
“It is hard to point to any part of the global economy that has become less global than banking,” says Susan Lund at McKinsey.
The ‘imbalances’ in the global economy have shifted. In 2007 China was the biggest surplus economy in the world, while the US had the largest surplus on its current account, which is mainly trade. But Germany now has a bigger current account surplus than China. The world’s other financial imbalances are far less extreme than they were in 2007. But the US and the UK are still the world’s leading destinations for international financial flows, according to capital and financial account data.
The composition of cross-border flows has changed significantly. Foreign direct investment and equity investment now form a bigger share of flows than bank lending. But that may have more to do with multinationals chasing low tax rates than investment in factories.
The flow of foreign direct investment around the world – or the new investments made by corporations each year – has yet to return to its pre-crisis levels. According to UN projections, it will take several more years to do so. Developed economies are sending significantly less money overseas in the form of FDI than they did before the crisis. Their share of global FDI has also been falling as China’s role has grown, leading to a backlash in Europe and the US.
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