Financial market integration

In contrast to goods trade, liberalization of assets trade has not been centre stage in the postwar international arena. Attitudes towards capital account transactions have been influenced by a belief that controls permit countries some independence in setting their macroeconomic policies. Thus, for example, a country could gain full membership of the International Monetary Fund (IMF) by making its currency convertible for current account transactions while at the same time not being required to liberalize capital account transactions. As a result, there were limitations on portfolio and direct investment flows and barriers to the establishment of foreign financial institutions.

Integration of capital markets in Europe has taken a significant leap forward with the Single Act and the endorsement by the Council of Ministers (in Madrid in May 1989) of economic and monetary union (the Delors Report). These call for removal of virtually all barriers to free trade in financial services and the acceptance of rights of establishment of one member country's financial institutions in any other.

There are several factors that have prompted this change. The first is that capital market integration is a natural extension of the economic integration that was set in motion by the Treaty of Rome. This in part had its origins in the belief that economic integration and political harmony went hand in hand and that conflict between states, which has been so much a feature of European history, could at last be eradicated.

The second is that capital market liberalization is a necessary condition for improvements in efficiency in goods and factor markets. Capital market restrictions distort product market behaviour.