China's International Financial Integration - Impact on Financial Development and Stability

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One of the most important macroeconomic developments in the coming decades will be China's rapid financial integration into the world economy. Together as a group, emerging economies' GDP has risen from 20% to over 80% of advanced economies' GDP in the last two decades, and constitute 50% of world GDP. Global dynamics will increasingly be characterized by an advanced bloc and an emerging bloc, in which China plays a central role. There are important economic differences between the two sets of countries that can be crucial for determining the global equilibrium - perhaps most notably in financial development. In China's case its financial markets and macroeconomic conditions differ significantly from those of other emerging economies, suggesting caution when drawing historical parallels or lessons for globalization.As the world's second largest economy, China's full integration into global financial markets will invariably impact the world economy. At the same time, the ramifications on the Chinese economy - given the particular characteristics of its financial development - are still largely unknown, as a result of the dearth of frameworks to analyze heterogeneous economies in a global setting. Our aim is to study the impact of its financial liberalization for China and the rest of the world-from a positive and a normative perspective. Our research agenda focuses on developing hitherto non-existing frameworks for integrating China's particular financial market conditions in an open-economy macroeconomic setting. Typically, the existing literature focuses on the effects associated with particular financial frictions - such as collateral constraints, and limited enforcement in repayment. While these frictions may also be important for China, they are unlikely to be the most prominent. China's financial market distortions have certain distinct features: 1) financial repression; 2) a two-sector economy where the state sector is significantly less credit-constrained than the private sector; and 3) the prominence of banks in financial markets, among others.The research projects intend to explore the impact of a country with these financial frictions and the process of financial integration. Important questions that deserve a thorough investigation include: given the described frictions, what is the impact of financial globalization on capital flows, exchange rate dynamics, and growth? Under what conditions would financial crises occur, and are they more or less costly than the crises that would have occurred in a closed-economy? From a normative perspective, should financial development and financial liberalization happen sequentially or simultaneously? Would liberalization induce faster financial development? Are these policy goals potentially conflicting and/or self-defeating? How are global financial shocks transmitted to China, and conversely how are China's shocks transmitted to the rest of the world? China also differs from other emerging economies in its macroeconomic conditions. It is a net saver, and runs a significant current account surplus. Traditionally, emerging market financial crises have come from within: financial dollarisation, excessive deregulation, allocation inefficiencies due to high level of state ownership, etc. In the global financial crisis a negative shock from advanced economies was transmitted to emerging economies heavily financed through foreign investment, with domestic credit constraints amplifying these shocks. This research aims to fill a gap in the literature and directly address China's particular problems.