Globalization and Emerging Markets: With or Without Crash?

31 Pages Posted: 21 Sep 2005 Last revised: 9 Jul 2014

See all articles by Philippe Martin

Philippe Martin

Ecole Nationale des Ponts et Chaussées (ENPC) - Centre d'Enseignement et de Recherche en Analyse Socio-Economique (CERAS); Centre for Economic Policy Research (CEPR)

Hélène Rey

London Business School; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: August 2005

Abstract

This paper develops a theory of financial crisis based on the demand side of the economy. We analyze the impact of financial and trade globalizations on asset prices, investment and the possibility of self-fulfilling financial crashes. In a two-country model, we show that financial and trade globalizations have different effects on asset prices, investment and income in the emerging market and in the industrialized country. Whereas trade globalization always has a positive effect on the emerging market, financial globalization may not, especially when trade costs are high. For intermediate levels of financial transaction costs and high levels of trade costs, pessimistic expectations can be self-fulfilling and may lead to a collapse in demand for goods and assets of the emerging market. Such a crash in asset prices is accompanied by a current account reversal, a drop in income and investment and more market incompleteness. We show that countries with lower income are more prone to such demand-based financial crashes. Our model can replicate the main stylized facts of financial crashes in emerging markets. Our results strongly suggest that emerging markets should liberalize trade in goods before trade in assets.

Suggested Citation

Martin, Philippe and Rey, Helene, Globalization and Emerging Markets: With or Without Crash? (August 2005). NBER Working Paper No. w11550. Available at SSRN: https://ssrn.com/abstract=785008

Philippe Martin

Ecole Nationale des Ponts et Chaussées (ENPC) - Centre d'Enseignement et de Recherche en Analyse Socio-Economique (CERAS) ( email )

28, rue des Saints-Peres
75007 Paris
France
+33 1 4313 6385 (Phone)
+33 1 4313 6382 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Helene Rey (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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