On making the rate moves

In The Economics of Globalization , Assaf Razin and Efraim Sadka have collected 16 papers presented at the 1996 Congress of International Institute of Public Finance. The issues covered relate primarily to tax and incentives, with a sprinkling of R&D and labour markets issues.

A paper on the benefits of global capital flows concludes that capital investment in R&D by rich countries benefits poor countries indirectly through knowledge dissemination. A pecking order of capital flows considers optimal tax design by a small host country with asymmetric information problems. Domestic investors are better or earlier informed about the profitability of investments than foreign investors. From the host-country view the preference orderings are foreign direct investment in physical goods and services, followed by portfolio debt - portfolio equity investment being the least-preferred option so far as residency of capital is concerned.

The less reversible the investment, the more residency claim it has, hence the more desirable it is to the welfare of the host country. With the problem of ever-flexible investors, and instantaneous flow of money across time and space, the discussions on issues like a world tax authority, commodity tax harmonisation, international transfer pricing included in this volume are all very timely.

An interesting paper discusses "Fiscal separation with economic integration: Israel and the Palestinian authority", which covers the area under Israel's rule won in the six-day war in 1967, minus the West Bank and the Gaza Strip. The political undertone of the Palestine-Israel customs union was present in the issue of German currency unification (July 1990). The unification shock triggered the crisis in the EMS with a lag of two years resulting in the departure of UK and Italy in September 1992 from the ERM. It has similarities with the South Asian crisis in 1997,which was initiated by the devaluation of the Chinese yuan by 40 per cent in 1994. German price stability was put above the survival of the EMS by the Bundesbank which created the demand for the Deutsche Mark in the foreign-exchange market by reducing the money supply, and boosting German interest rates (for political reasons). This is a theme echoed by Robert Solomon in Money on the Move . He relates developments in the international monetary system to macro-economic conditions in the countries involved.

Solomon's book is a history of international finance since 1980, with a common theme, that the international financial system reflects the geopolitical and sociological realities of the time. Solomon writes with authority, having been for many years the chief international economist at the Federal Reserve Board of the US. Not surprisingly he starts with the exchange-rate movements of the US dollar from the beginning of the 1980s and relates the changes in world monetary systems to the changes of fortune of the dollar. The book's major themes are the developing country debt crisis, European monetary integration, transition economies and the effects of capital mobility in the 1990s. The persistent appreciation of the dollar and the ballooning of the US payments deficit in the early 1980s reflected the numerous changes in political leadership around that time which, in turn, were a reflection of the economic traumas of the 1970s, when the price of crude oil rose 17-fold in five years and the so-called misery index (the combination of unemployment and inflation) was unusually high. The price of gold on world markets rose from $225 per ounce in 1979 to $850 in 1980, and the prime rate in the US exceeded 20 per cent in 1981. The 1980s also became the "lost decade" for a number of developing countries, some struggling to service heavy debt burdens arising from recycled capital from Opec countries. The consequence of the oil price hike was that, by 1980, the long-term bank debt of all developing countries came to $135 billion.

Solomon takes us gently through the 1980s to the Mexican Brady agreement, and to the "end" of the debt crisis. Economic and monetary integration in Europe also gets a thorough treatment, tracing its development to the European recovery programme and the Marshall plan through the turmoils of 1992 to a single currency. The capital mobility of the 1990s shows that "the world monetary system underwent three revolutions all at once - deregulation, internationalization and innovation".

The result of the revolution in information processing and transmission was the deconstruction of time and space. It also led to phenomenal growth of financial engineering and derivatives. Cross-border securities transactions in the USA increased 20-fold between 1980 and 1990.

Solomon successfully explains the major consequences of the revolution in international finance of the past two decades. These are the tranformation of the centrally planned economies, the relative economic freedom of the third world, the integration of the European economies, the mutation of economic power of the Opec countries, more visible central banking, and the growth in world trade at a rate faster than growth in output. Can we now think of bringing down the barriers to the mobility of labour worldwide? Money on the Move is an excellent, erudite addition to the literature on modern financial history.

Bimal Prodhan is senior lecturer in finance, University of Hull.