Globalization in Financial Market: A Review of Research and Theories - Essay Sample

Abstract

In this chapter, the author looked at the work of various researchers in the field of globalization in the financial market. Once reviewed, the writer uses the outcomes of these researchers to assist him in identifying the insight in the later study. The research first identified the literature related to the topic before selecting them. After which the author explored various theories to gain a better understanding of the topic.

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Introduction

Over the last few decades, the world has experienced an increase in cross-border financial services. Many financial institutions, such as institutional investors and banks, have expanded their presence beyond their home country. In this process, the modern financial institutions act as intermediaries that channels funds between lenders and borrowers from different countries. Besides, mature securities markets have also adopted a cross-border orientation. In many cases, new securities are designed in such a way that it can attract international investors. This 'internationalization' of activities in the financial market is a result of the rise of globalization.

The term "globalization" had its origin to financial markets when it was issued to refer to technological progress that enabled international transactions back in the 1980s. The concept was, however, first used in 1961 in the Merriam Webster Dictionary(Lee &Bowdler, 2019).

The rise of financial globalization can be traced back to the technological innovations that had a series of benefits. The benefits include a) increased market for products offered by financial companies. b) Positive impacts associated with the using earth resources selectively. c) It enabled the production of excellent and cheap mass products destined for international markets. d) It provided a competitive advantage to financial institutions that embraced globalization. Despite these benefits, globalization of the financial market leads to adverse effects on financial institutions and countries that are not prepared to adopt the phenomena (Goncharuk, 2016).

On the negative side, globalization has been identified as one of the factors contributing to the increased inequalities evident among different countries. This pattern is in contrast with the globalization promise that every player or participant will gain something from it. In many cases, small companies are subjected to intense competition from big multinational organizations that can enjoy the economy of scale in the production, marketing, and sale of their products. Globalization is seen strategy used by rich developed countries to access the market of poor developing countries without restrictions. In the past, rich countries used the threat of weapons and raw force to force developing countries to open up to globalization(Japparova, &Rupeika-Apoga, 2017). Today, however, the strategy as changed. Emerging countries are forced to embrace globalization because of fear of sanctions. Besides, global power as the shift over time, and today, developed countries too are experiencing the negative impacts of globalization.

As a result of globalization, many countries have opted to privatize their national companies and financial institutions, either partially or totally. Such nations have liberalized direct foreign investments and international trade, deregulated finances and industry, and cut social income and income taxes(Nasarre-Aznar, 2016). However, since free markets are not perfect, these strategies sometimes fail, exposing countries to the adverse impact of globalization. For example, privatization of national companies has led to the decline in investment and national income t many countries(Hatipoglu, &Peksen, 2018). The deregulation has permitted trading companies to increase their profit margin using the monopoly power to exploit the market.

Most of the international institutions created in 1944, after the Bretton Woods conference, to support globalization largely contribute to the enormous discrepancies by giving a competitive advantage to countries that laid the framework. These institutions include; the United Nations Organization, World Health Organization, International Monetary Fund, World Banks, and International Regulations Bank, among others(Sargunam, Kumar, & Mary, 2016). IMF admits that globalization has failed to realize the results as it had hoped and predicted.

Theories of Globalization and International Business

Advantage theory

Adam Smith proposed the absolute advantage theory in 1776. The theory suggests that each country experiences an absolute advantage over the other in the production of certain products. The absolute advantage occurs because some countries are endowed with natural advantages in the availability of production resources such as mineral resources, cheap labor, and land, among others. As a result, these countries produce certain types of products at a lower cost compared to others. Consequently, a country will only specialize in the production of certain products and will import those goods that it cannot produce at a cheaper cost. The theory, however, fails to justify other aspects of globalization. It also was unable to give a scope of globalization for countries without absolute advantage in any field, or those having an absolute advantage in all areas (Imbs& Jean 2004).

The Comparative Cost Theory

Comparative cost theory state that different countries do business if each country has an advantage in the ability to produce a particular product relative to another as compared to a different country's relative ability to produce a similar product. According to Tabuchi (2017), the theory proposes a relative comparison of two products from two different countries. For example the relative comparison of U.S.A and France in the production beef and wine, show that U.S.A sacrifices a half bottle of wine each time it produces a pound of meat (25/50), while France sacrifices two and a half bottles of wine when it produce one pound of meat (150/60) (Tabuchi, 2017). This means that it is cheaper to produce meat in the U.S.A than in France. According to comparative cost theory, therefore, France should export wine to the U.S.A because it is economical for them, while at the same time, France should import cheaper beef from the U.S.A. The difference in the cost of production between different countries, as suggested by comparative cost theory, is the reason behind globalization.

Opportunity Cost Theory

Gottfried Haberl proposed opportunity cost theory in 1959. An opportunity cost is a value of an alternative product forgone to obtain a particular thing. The approach focus on the cost of the importance of an alternative, which must be foregone to meet a specific objective. According to the theory, therefore, globalization occurs because of a country as to certain foregone products to obtain other products through imports (Lane et al. 2006).

The Vent for Surplus Theory

According to the vent for surplus theory, globalization occurs because it facilitates the absorption of unemployed output as a result of surplus production that cannot be absorbed within a country. If the country fails to export the surplus products, its product labor will be laid off, resulting in the decline in the country's productivity. As a result, without globalization, the country will experience losses and shortages because of unconsumed surplus production. According to theory, therefore, globalization enables a country to fully utilize its factors of production (Findlay, &Lundahl, 2017). For developing countries, unemployed labor can be employed by exporting surplus products through globalization.

Impact of Globalization on Financial Markets

The financial market, a pioneer of globalization, is the most dynamic market due to its progressive global nature. The global liberal nature of the financial market aims at obtaining profits without taking into consideration different aspects associated with it. As a result, many scholars argue that it is wrong to impose too strict economic regulations whose intentions are to give a competitive advantage to those imposing them. Besides, globalization in the financial market is heavily criticized for its failure to create a strategy to allow each country willing to embrace globalization decide by their own on how to fulfill international standards and requirements (Prokopowicz, 2016).

In the last decades, financial mediation increased as a result of business innovation; however, the markets suffered an undesirable lack of transparency. The change in the financial sector has promoted transactional efficiency curtesy of financial instruments; however, the lack of transparency leads to uncertainty as well as producing instability, thus highlighting the systemic risks in the industry. The innovation in the financial market has, for a long time, been directed to by-pass accounting and fiscal norms and regulations(Aydemir, &Ovenc, 2018).

The deriving financial instruments are some of the innovations that have promoted capital markets. As the name suggests, their value is derived from the assets. A gamble on the chances of a share price exceeding ten dollars in the next month being an extension. Additionally, a bet on the share market price exceeding ten dollars in the next month is an extension that is based on yet another extension. As a result, financial institutions can invent many such products. Thus, extensions become two-edged swords, which are used to manage risks (Prokopowicz, 2016).

In the current era of financial freedom, the financial markets can complex products; it is difficult to understand their details and effects on matters related to risks. The complexity of these financial products is too high that specialized computerize patterns are used by the analyst to evaluate the. For this reason, the new financial instruments are considered weapons of mass economic destruction. In general, the innovatedfinancial instrument, as called swap on credit risks, improve the management of risk and even cutting the costs of transactions. It motivated people to make a risky investment by betting using a considerable amount of money with little capital(Smith, 2018). Even though the instruments were meant to manage risks, in reality, they were meant to avoid regulators. Financial markets, as a result of globalization and deregulation, are currently characterized by a lack of transparency due to the creation of complex products that are difficult, if not impossible, to understand.

The 2008 world financial crisis that affected the majority of the world financial institution was because of the increasing use of derived financial instruments, which are neither useful nor transparent in the financial market. Since derivates are efficient tools for managing risks, they should not be forbidden but instead should be regulated.

The Impact of Globalization on the Banking Service Quality

Many countries with high debs often opt to globalization as an effective solution to their financial problems. The host country will promote globalization with the hope of increasing international trade, increasing the variety of products, improving technology and encouraging savings. According to Ghosh (2016), globalization of the banking sector is more beneficial thanthe negative impact of the accompanying it. Besides, they argue that globalization enhances the quality of governance in a corporate organization by increasing the efficiency of banks. Also, it leads to the creation of new financial products that increase competition in the local banks.

According to Claessens, &Van Horen (2015), globalization promoted reforms in the local banking sector, when the government allows foreign financial institutions to transform...