Impact of Financial Globalization on the Scope of Economic Theory and Policy

This chapter deals with the changes in the global financial and economic environment over the last two decades that have led to an unprecedented increase in the global capital flows based on foreign direct investment and portfolio investment. The chapter shows that the process of globalization of production based on vertical intra industry trade between the advanced and largest developing countries has caused the production costs of globally active multinational companies to decrease, on the one hand, and has led to an increase in the global systemic risk of internationally active investment funds. An enormous growth of the global capital flows has led to a significant increase in the importance of prices of assets in the measurement of inflation, as well as in analysing the effects of monetary and fiscal policy. Therefore the process of globalization has actually caused that almost all the macroeconomic models and theories, whether based on the neoclassical or the new Keynesian thought, have failed in predicting and suggesting measures of economic policy that have been necessary to prevent the global collapse. Since the theories are mostly based on the law of decreasing returns, and on the role of the private sector companies and households’ goal functions in establishing the general equlibrium, not taking into account the importance of profit-motives of financial institutions and the importance of speculative demand for money for the analysis of investment cycle, they haven’t been able to offer a consistent theoretical explanation of the major causes of the global crises. The author ends this chapter by pointing out that Keynes’s theory of the demand for money with a special reference to the speculative demand for money has been an extraordinary theoretical achievement in the history of economic science, and is especially important for the analysis of current economic and financial problems in the world. In addition, the author calls for a new macroeconomic model based on two large economies one of which is a representative of the advanced countries and the other a representative of the developing countries.