Two parallel developments in the financial sector have defined present- day globalization as much as technological developments and the growth of international trade. The first is the development of the financial markets, institutions, instruments and mechanisms in developed countries.

The second is the growth in capital flows across borders in several ways, including foreign direct or short-term portfolio investments or transactions in foreign exchange markets as a result of the deregulation and liberalization of the financial sector in the industrialized and many developing countries.

It is against the backdrop of the increasing size, depth and complexity of financial markets in developed countries that the quantum increase in capital flows across borders has taken place in recent years.

According to recent United Nations Conference on Trade and Development (UNCTAD) estimates, worldwide flows of foreign investment rose by 41 per cent from $468 billion in 1997 to $660 billion in 1998, and to a record $827 billion in 1999, an increase of 25 per cent. Nearly three quarters of that increase, or an estimated $609 billion, took place among industrialized nations, with the largest share in the United Kingdom and the United States.


The composition of capital flows has changed, with private capital and short- term investments dwarfing governmental flows and longer-term investments. Short-term capital flows have grown spectacularly and, partly reflecting the integration of financial markets, transactions in foreign exchange markets are nearly 80 times larger than world trade.

The share of official financing in total capital flows fell from over 50 per cent in the 1980s to 20 per cent in the 1990s. While official flows declined from $56.9 billion in 1990 to $47.9 billion in 1998, net long-term inflows to developing countries increased from $101 billion to $338 billion in 1997 before declining somewhat in 1998 with the Asian crisis.

Capital flows from industrialized countries to developing countries accelerated in the 1980s and tripled between 1990 and 1996. FDI has been growing faster than international trade. Portfolio capital mobility accelerated even more rapidly in the 1990s. Cross-border share dealing has grown 10 times as fast as national incomes. FDI flows have been shifting from the primary to the manufacturing to the service sector, and there have been increasing flows to agri-business.

However, such capital flows remain highly concentrated, going from a small number of developed countries to a small number of emerging markets. In 1998, the top 10 recipients accounted for 70 per cent of FDI flows to developing countries, while least developed countries accounted for less than 7 per cent. FDI flows to developing countries as a whole rose by 15 per cent to $198 billion in 1999, after stagnating in 1998.


Latin America attracted $97 billion, one third of which went to Brazil, while $91 billion went to Asia, $40 billion of which went to China, the largest developing country recipient of FDI. Central and East European countries retained a stable flow of about $20 billion. Africa received between $ 10 and 11 billion, with Nigeria accounting for $2 billion and South Africa 1.3 billion.

The liberalization of financial flows, floating exchange rates, financial innovations and new communications techniques have increased financial transactions enormously, as well as the opportunity for developing countries to attract foreign investment and capital for purposes of business and development, albeit on commercial terms.

But they have also compounded volatility inherent in these markets as a result of radical shifts of perception or in the interpretation of information, and sharp revisions of expectations not always based on sound considerations, that have resulted in panic reactions, contagion and periodic crises. Moreover, short-term capital flows, far from being a mere reflection of economic fundamentals, can actually push key macroeconomic variables, such as exchange and interest rates and the prices of such assets as property and shares, away from their long-term equilibrium and consequently affect output and employment.