Question

Commonly used measures for the globalisation of markets and production are the following ratios: World Exports / World GDP and World Inward FDI / World Gross Capital Formation. There are also other measures to consider such as university students, patents, venture capital, internet traffic, equity investments, news media, bank deposits and many more, which are expressed as a percentage of world totals.

Identify six different countries in Africa: two from the Southern African Development Community (SADC), two from the East African Community (EAC) and two from the Common Market for Eastern and Southern Africa (COMESA) and use globalisation measures to analyse the most globalised of the six countries in the three economic trade regions. Use the analysis to write an expository essay that illustrates the extent to which the six countries are globalised.

Answer 1

There are at least three motives for inquiring on the comparative African regional economics of globalization under financial allocation efficiency, notably, the growing relevance of regional integration, substantially documented concerns of surplus liquidity, and ongoing debates surrounding the effects of globalization.Footnote1

First, consistent with Asongu (2013a), integrated economies have several advantages, namely more efficiency in capital allocation (Chen et al. 2002); stimulation of cross-border flow of funds, improved volumes of trade transactions, more market liquidity, lower cost for investors (Kim et al. 2005); financial stability owing to the minimization of the probability of asymmetric shocks (Umutlu et al. 2010); and the amelioration of the capacity of economies to absorb shocks (Yu et al. 2010). These advantages, inter alia, have motivated a growing literature stream on economic integration in Africa (Njifen 2014; Kayizzi-Mugerwa et al. 2014; Akpan 2014).Footnote2 Second, financial intermediary development in Africa is limited by the substantially documented concerns of surplus liquidity that are constraining the optimal transformation of mobilized deposits into credit for economic operators (Saxegaard 2006; Asongu 2014a).

The recent global financial and European Monetary Union (EMU) crises have reignited the debate about the potential advantages of liberalization and regionalization, especially within the framework of financial allocation efficiency in developing countries (Asongu 2013b). Some authors consider that the recent global financial crisis has substantially unraveled the drawbacks of regionalization and liberalization because many developing economies that had previously experienced surges in inflows of foreign capital also experienced a sharp reversal in the same flows (Rodrik and Subramanian 2009; Kose et al. 2011; Asongu 2014b). Essentially, the financial channels that have fueled the global economic turmoil have resurfaced issues surrounding the appeals of globalization and its corresponding externalities (e.g., volatility and growth) in developing countries.Footnote3

The skeptical literature strand starkly contrasts with the theoretical appeals of globalization and regionalization, which are expected to be high in developing nations. From a theoretical perspective, globalization/regionalization should promote international/regional risk-sharing and efficient capital allocation. These potential rewards are expected to be higher in developing nations compared to their developed counterparts because poorer countries are labor-rich but have scarce capital. Hence, given their higher marginal productivity of capital, globalization/regionalization enables the flow of capital from capital-rich to capital-poor countries. Moreover, developing countries are also expected to enjoy higher welfare gains because they are characterized by more volatile outputs compared to their developed counterparts (Kose et al. 2011; Asongu 2014b).

The current wave of regionalization/globalization efforts began in the 1980s with an increase in the cross-border trade and financial flows between advanced and developing nations. The integration processes were facilitated by the liberalization of capital controls in many nations because it was estimated that growing cross-border flows would engender substantial rewards in terms of capital allocation and enhance international risk-sharing possibilities. According to Kose et al. (2006), many developing countries rapidly embraced integration polices because the anticipated rewards were higher compared to those for developed nations. Unfortunately, the surge in financial flows was associated with financial and currency crises in the late 1980s and 1990s. The pattern of these crises motivated scholars to advocate that, compared to developed countries, developing nations that liberalized their capital and trade accounts have been affected more by global crises (Henry 2007; Kose et al. 2011; Asongu 2013b).

However, the recent literature on the effect of globalization on financial development has failed to consider the comparative economics of regional integration in African countries. Henry’s (2007) and Kose et al.’s (2011) hypothesis of initial financial development conditions for financial development benefit from financial globalization have been investigated by Asongu (2014b) who further established thresholds for the rewards of financial globalization. In the post-crisis literature, Price and Elu (2014) have concluded that credit contraction during the 2008–2009 financial crisis has been associated with more adverse growth externalities in sub-Saharan African (SSA) nations that belong to the French African Colonies’ (CFA) currency union. Asongu (2013c) has investigated real and monetary policy convergence in the CFA zone in light of the EMU crisis, concluding there is an absence of policy harmonization in the common responses to serious disequilibria. Motelle and Biekpe (2015) have examined whether enhanced financial integration is a source of domestic financial sector instability to confirm Kose et al.’s (2011) hypothesis within the framework of the Southern African Development Community (SADC). Asongu et al. (2015a) have extended Price and Elu’s (2014) and Motelle and Biekpe’s (2015) studies in the context of the pre- and post-crisis effects of financial globalization in domestic financial development to confirm the relevance of the debate on the rewards of liberalization.

In the 1980s and 1990s, most African countries embarked in structural and policy adjustments that had the ultimate goal of stimulating financial development and economic growth (Janine and Elbadawi 1992; Asongu 2013b). As the first generation of reforms, policies consisted of abolishing explicit controls on the allocation and price of credit, allowance of interest rates to be determined by the market, reduction of direct government intervention in bank credit decisions, and relaxation of controls on international capital flows (see Asongu 2013b). The second generation of reforms targeted institutional and structural constraints, namely (i) enhancement of regulatory, legal, institutional, and supervisory environments; (ii) restoration of bank soundness; and (iii) rehabilitation of financial infrastructure (Batuo et al. 2010; Batuo and Asongu 2015).

Unfortunately, despite the two decades of globalization-fueled regionalization policies and reforms in the financial sector, African economies have not achieved remarkable progress in tackling the substantial surplus liquidity (Saxegaard 2006; Fouda 2009; Asongu 2014a). Hence, this inquiry on financial allocation efficiency is justified by an apparent policy syndrome on one hand and a missing link in the literature on the other. Whereas a substantial body of the literature has investigated the effect of financial reforms on financial development (Cho 1986; Arestis et al. 2002; Batuo et al. 2010), to the best of our knowledge, the literature on financial efficiency has been scarce. Moreover, the concept of financial efficiency has not been considered within the fundamental mission of banking institutions to transform mobilized deposits into credit for economic operators (Ataullah et al. 2004; Saxegaard 2006; Al-Obaidan 2008; Kiyota 2009; Kablan 2010). Some mainstream measurements of financial efficiency in African-centric literature include cost efficiency (Chen 2009; Mensah et al. 2012), profit efficiency (Hauner and Peiris 2005), and data envelopment analysis (DEA) for technical efficiency (Kablan 2009). Kukenova (2011, p.1) has suggested this may be the principal hurdle in assessing the nexus between liberalization and allocation efficiency, which is traceable to the fact that capital allocation efficiency is not directly observable.

In light of the above arguments, the contribution of this study to the literature is twofold, notably (i) it defines, creates, and measures financial allocation efficiency on a continent with severe surplus liquidity in financial institutions and (ii) comparative analyzes of regionalization policies based on ongoing efforts for regional integration across the continent. First, our concept of efficiency is contrary to the two mainstream measurements of financial allocation efficiency, namely (i) the efficiency of decision making by means of DEAFootnote4 and (ii) overall economic efficiency (OEE) with regard to scale and technical efficienciesFootnote5 or profitability- and cost-related perspectives.Footnote6 Essentially, the conception of allocation efficiency in this study considers the ability of financial institutions to transform mobilized financial deposits into credit for economic operators. Hence, this measurement is consistent with the surplus liquidity in African financial institutions. Second, the study simultaneously contributes to the ongoing debate on the effects of globalization and the evolving literature stream on regionalization in Africa by assessing the effects of regionalization policies on financial allocation efficiency. To this end, the timing of regionalization policies is tailored to comparatively investigate whether regionalization has improved or reduced financial allocation efficiency.

The rest of the study is organized as follows. Section 2 discusses the theoretical underpinnings in light of the debates on financial allocation. The data and methodology are covered in Section 3. Section 4 presents the empirical results, while Section 5 concludes the paper with implications and future directions.

Theoretical perspectives on the nexus between financial allocation efficiency and globalization

In accordance with Asongu (2013b), the decision on whether to adopt integration/liberalization to facilitate financial allocation efficiency and enjoy the benefits of regional/international risk sharing has been extensively debated in policy and academic circles. Essentially, there are two main theoretical arguments on the relevance of integration as a policy choice for developing nations in their attempts to benefit from capital allocation efficiency.

The first argument supports the rewards of “allocation efficiency” and relies heavily on the predictions of neoclassical growth models based on the seminal study of Solow (1956). According to the neoclassical growth model, liberalization and integration policies enable the efficient allocation of capital because resources flow from developed countries characterized by capital abundance to developing countries that have scarce capital and rich labor. Moreover, the return of capital is low (high) in developed (developing) countries. The related literature is broadly consistent regarding the advantages that developing countries enjoy, namely the reduction of capital cost and improvements in investment and economic prosperity that ultimately enhance living standards permanently (see Fischer 1998; Obstfeld 1998; Rogoff 1999; Summers 2000; Batuo and Asongu 2015; Javid and Katircioglu 2017; Katircioglu and Zabolotnov 2019). Hence, arguments on the gains from “allocation efficiency” have been generally used by developing countries worldwide to justify their adoption of liberalization and regionalization policies over the past decades (Asongu 2014b).

The second argument is that allocation efficiency is a fanciful means to extend the gains from the international trade in commodities to the one in financial assets. Specifically, the predictions of allocation efficiency are apparent only in the absence of distortions from the free movement of capital. Hence, given the distortions experienced by developing countries during financial crises, there is inconsistency between the reality of liberalization policies and the theoretical predictions of the neoclassical model. Within this framework, some notable studies include provocative titles such as “Who needs capital account convertibility?” (Rodrik 1998) and “Why did financial globalization disappoint?” (Rodrik and Subramanian 2009). According to the narrative, the correlation between globalization and allocation efficiency is not apparent because of the costs due to recurrent financial crises, which far outweigh the potential benefits (Rodrik 1998).

Rodrik and Subramanian (2009) have documented that, in the wake of the recent sub-prime crisis, the arguments about the externalities of financial engineering generating substantial gains in developing countries are less plausible. According to this narrative, even without the financial crisis, it is increasingly evident at the international level that the rewards of integration/globalization/liberalization are not apparent.Footnote7 The narrative further maintains that the postulated gains in terms of higher investment and growth in less developed countries are hard to identify because countries that have been developing rapidly relied less on liberalization. Therefore, globalization policies have not smoothened consumption and reduced volatility as hypothesized. Another perspective argues that the rewards of globalization today are unpersuasive, speculative, and indirect (Asongu 2014b) and it is time for a new paradigm shift in liberalization policies because more globalization is not necessarily better (Asongu 2013b). In light of the above literature review, we investigate whether the policy of regionalization increases financial allocation efficiency.

Data and methodology

Data

Globalization, financial, and control variables

We assess economic and monetary regional panels using data from the Financial Development and Structure Database (FDSD) and African Development Indicators (ADI) of the World Bank from 1980 to 2008. Financial variables are obtained from the FDSD, whereas macroeconomic variables are from ADI. Two financial allocation efficiency indicators are used, namely: (i) banking system efficiency measured by “banking system credit on banking system deposits” and (ii) financial system efficiency proxied by “financial system credit on financial system deposits.” The allocation efficiency variables consider the ability of banks to transform mobilized deposits into credit for economic operators (Demirguc-Kunt et al. 1999; Demirguc-Kunt and Beck 2009; Asongu 2013a). It is important to note that formal banking institutions are included in the financial system efficiency measurement. Accordingly, financial system efficiency is the banking system’s efficiency plus the efficiency of other financial institutions. The understanding of a financial system that embodies formal and semi-formal financial sectors is clarified in Appendix 1 (Tchamyou et al. 2019). As shown in Appendix 1, the financial system entails formal banks and a semi-informal financial sector consisting of specialized non-bank financial institutions and other non-bank financial institutions, with (i) formal banks and specialized non-bank financial institutions being licensed by the central bank and (ii) other non-bank financial institutions being legally registered but not licensed as financial institutions by the central bank and government. Not included in the definition of the financial system is the informal financial sector, largely consisting of informal banks not registered at the national level, although they can be registered as associations. The informal sector mostly entails savings collectors, savings and credit associations, and money lenders.

Three openness indicators are used, namely financial openness, trade openness, and globalization. Trade openness consists of three measurements: imports, exports and imports plus exports. Financial openness consists of foreign direct investment (FDI), private capital flows (PCF) and a composite index of the FDI and PCF. The globalization variable is the composite index of financial openness and trade openness. These composite indicators are using principal component analysis (PCA). The definitions and classification of variables in Appendices 2 and 3 are consistent with the recent openness and finance literature. The financial openness variables are in line with Lane and Milesi-Ferreti (2006) and Baltagi et al. (2009), while the composite financial and trade openness indicators are adopted from Gries et al. (2009) and Hanh (2010).

The selected control variables are consistent with the recent financial development literature, namely GDP growth, inflation, public investment, and foreign aid (Asongu 2014b). The relationship between economic growth and financial development has been substantially documented in the literature. First, a growing economy is linked to a reduced cost of financial intermediation because, inter alia, the availability of funds for productive investments and competition (Greenwood and Jovanovic 1990; Saint Paul 1992). This relationship has been further confirmed in the literature (Levine 1997, 2003a, 2003b). Second, both empirical (Boyd et al. 2001) and theoretical (Huybens and Smith 1999) views maintain that higher inflation levels are associated with less efficient, less active, and smaller financial institutions. Essentially, macroeconomic policies are conducive to low/stable inflation and higher investment levels have been documented to be associated with higher levels of financial development (Asongu 2014b). Third, a positive relationship between investment and financial development has also been established in the literature (Huang 2011). Fourth, the theoretical basis for the policies of development assistance towards developing countries is mitigating the investment–financing gap (Easterly 2005). However, from a practical standpoint, the impact of foreign aid on domestic financial development can also be negative if a substantial ratio of donor funds is: (i) siphoned by corrupt officials in recipients nations and then deposited in tax havens whose jurisdictions are traceable to the donor community and (ii) spent in donor countries.