------------ EH.NET BOOK REVIEW -------------- 
Published by EH.NET (December 2004) 
 
Maurice Obstfeld and Alan M. Taylor, _Global Capital Markets:  
Integration, Crisis and Growth_. New York: Cambridge University  
Press, 2004. xviii + 354 pp. $65/=A345 (hardback), ISBN: 0-521-63317-6. 
 
Reviewed for EH.NET by Marc D. Weidenmier, Department of Economics,  
Claremont McKenna College. 
 
 
Obstfeld and Taylor survey the history of international capital  
markets from the classical gold standard to today using modern  
economic theory in their monograph, _Global Capital Markets:  
Integration, Crisis and Growth_. The authors synthesize history and  
modern economic theory to produce an illuminating discussion of the  
forces that drive international financial market integration. The  
book is divided into four parts. Part One reviews the theoretical  
foundations of open economy macroeconomics and outlines the basic  
argument of the book. Obstfeld and Taylor discuss how international  
capital markets allow residents of different countries to pool risks,  
impose discipline upon governments, and allow countries with very  
little domestic savings to borrow abroad so that they can pursue  
growth policies. The authors also introduce the open economy  
macroeconomic policy trilemma to provide a theoretical framework for  
their subsequent historical and economic analyses. The open economy  
macroeconomic trilemma states that a country can pursue at most two  
elements of the "inconsistent trinity": (1) open capital markets, (2)  
independent monetary policy, and (3) a fixed exchange rate. 
 
Obstfeld and Taylor analyze the historical development of global  
capital markets in Part 2. They employ quantity and price evidence to  
measure capital mobility during the classical gold standard,  
inter-war gold standard, Bretton Woods period, and the recent float  
(1973-present). Using a new macro database assembled from primary and  
secondary sources, they examine purchasing power parity, the  
correlation of saving and investment, covered interest parity, and  
real interest rate convergence. They find that global capital market  
integration has followed a U-shaped pattern since the outbreak of  
World War I. Integration peaked during the classical gold standard  
period, declined during the inter-war period, only to recover during  
Bretton Woods. They note that market integration has increased  
dramatically in the last twenty years. Obstfeld and Taylor conclude  
that net flows of foreign capital are no larger today than they were  
during the classical gold standard period. 
 
In Part 3, the authors discuss the role of institutions in shaping  
the evolution of international capital markets. They review the  
history of international monetary arrangements and measure the degree  
of monetary independence under fixed and floating exchange rates. In  
accordance with the policy trilemma, they find that countries with  
fixed exchange rates have had very little ability to conduct  
independent monetary policy with open capital markets. Then they test  
the effect of political and economic institutions on sovereign risk  
during the classical and inter-war gold standards. They find that  
being a member of the gold standard reduced the cost of capital  
during the classical gold standard but not during the inter-war  
period. Membership in the British Empire lowered sovereign risk in  
the inter-war period, but not during the classical gold standard  
period. Obstfeld and Taylor also find that countries with high public  
debts were charged higher interest rates after World War I,  
suggesting that policymakers lost the ability to conduct independent  
policy. Their findings indicate that the inter-war gold standard was  
less credible than the classical gold standard. 
 
The authors conclude with a discussion of the policy lessons from  
their historical examination of international capital markets. They  
note that there are winners and losers from globalization and it is  
very difficult to quantify the costs and benefits of open capital  
markets. Financial liberalization, for example, is not (p. 299) "a  
universal panacea" or "a risk never worth taking." Their main lesson  
is that policymakers must take into account country-specific  
institutions and economic conditions before giving policy advice,  
especially to developing countries. 
 
Although Obstfeld and Taylor provide a thorough empirical analysis of  
international capital markets, some of their findings warrant  
additional research. In their chapter comparing sovereign risk in the  
classical and inter-war gold standards, they find that being a member  
of the British Empire reduced the cost of capital in the interwar,  
but not the classical gold standard. It is unclear why this would be  
the case. Their results may simply be driven by a very small number  
of British colonies in their sample. It would be interesting to  
expand the coverage of their sample to further test for the existence  
of an empire effect in both periods. Second, Obstfeld and Taylor  
often use time averaged rather than point-in-time data to estimate  
financial market integration in their analysis of deviations from  
covered interest parity. A number of studies have shown that a  
point-in-time analysis of covered interest arbitrage can yield very  
different results (M.P. Taylor, 1987). Third, the authors discuss at  
length the theoretical proposition that financial markets allow  
investors to pool risks and smooth consumption. A long-run empirical  
analysis of historical consumption data across countries and monetary  
regimes might be a useful exercise to shed some additional insight  
into this question. This type of study would probably be limited,  
however, given the availability of historical data on aggregate  
consumption. 
 
Overall, _Global Capital Markets_ is an excellent study of the  
evolution of international capital markets since the classical gold  
standard period. This book is a must read for economists and economic  
historians with an interest in international economics. 
 
 
Marc D. Weidenmier is an Assistant Professor of Economics at  
Claremont McKenna College and a Faculty Research Fellow at the NBER.  
He has recently published the following papers: "Gunboats,  
Reputation, and Sovereign Repayment: Lessons from the Southern  
Confederacy," _Journal of International Economics_ (forthcoming),  
"Real Shock, Monetary Aftershock: The San Francisco Earthquake and  
the Panic of 1907" (co-authored with Kerry Odell), _Journal of  
Economic History_ (forthcoming), and "Empire, Public Goods, and the  
Roosevelt Corollary" (co-authored with Kris Mitchener), _Journal of  
Economic History" (forthcoming). 
 
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