11/3/2012: Did Global Financial Integration Contribute to Global Financial Crisis Intensity?

An interesting paper (link here) from Andrew Rose titled International
Financial Integration and Crisis Intensity
ADBI Working Paper 341 ).

The study looked at the causes of the 2008–2009 financial crisis “together with its
manifestations”, using a Multiple Indicator Multiple Cause (MIMIC) model that allows for simultaneous causality effects across a number of variables.

analysis is conducted on a cross-section of 85 economies. The study focuses “on
international financial linkages that may have both allowed the crisis to
spread across economies, and/or provided insurance. The model of the
cross-economy incidence of the crisis combines 2008–2009 changes in real gross
domestic product (GDP), the stock market, economy credit ratings, and the
exchange rate. The key domestic determinants of crisis incidence that [considered] are taken from the literature, and are measured in 2006: real GDP per
capita; the degree of credit market regulation; and the current account,
measured as a fraction of GDP. 
Above and beyond these three national sources of
crisis vulnerability, [Rose added] a number of measures of both multilateral and
bilateral financial linkages to investigate the effects of international
financial integration on crisis incidence.”

The study covers three questions:

  • First, did the degree of an economy’s
    multilateral financial integration help explain its crisis? 
  • Second, what about
    the strength of its bilateral financial ties with the United States and the key
    Asian economics of the People’s Republic of China, Japan, and the Republic of
  • Third, did the presence of a bilateral swap line with the Federal
    Reserve affect the intensity of an economy’s crisis? 

“I find that neither
multilateral financial integration nor the existence of a Fed swap line is
correlated with the cross-economy incidence of the crisis. [Pretty damming for those who argue that the crisis was caused / exacerbated by ‘global’ nature of the financial markets and for those who claim that ‘local’ finance is more stable. Also shows that the Fed did not appeared to have subsidized european and other banks, but instead acted to protect domestic (US) markets functioning.] There is mild
evidence that economies with stronger bilateral financial ties to the United
States (but not the large Asian economies) experienced milder crises. [This is pretty interesting since so many European leaders have gone on the record blaming the US for causing crises in European banking, while the evidence suggests that there is the evidence to the contrary. Furthermore, the above shows that we must treat with caution the argument that all geographic diversification is good and that, specifically, increasing trade & investment links with large Asian economies – most notably China – is a panacea for financial sector crisis cycles.]”

Core conclusion: “more financially integrated economies do not seem to have suffered more during
the most serious macroeconomic crisis in decades. This strengthens the case for
international financial integration; if the costs of international financial
integration were not great during the Great Recession, when could we ever
expect them to be larger?”

Here’s a snapshot of top 50 countries by the crisis impact:

Quite thought provoking. One caveat – data covers periods outside Sovereign Debt crisis period of 2010-present and the study can benefit from expanded data coverage, imo.