GLOBAL ECONOMIC SYSTEM AND LARGE MULTINATIONALS

TOPIC 1: THE NEW GLOBAL ECONOMIC ORDER

1. Historical Visions of World Order

Throughout history, different civilizations have proposed their own concepts of world
order. The Peace of Westphalia in 1648 marked the end of the Thirty Years’ War and
introduced a system of sovereign states, each with the authority to govern within its
own territory and a commitment to non-intervention. This system was based on the
principle of balance of power.

China developed a very different model, centered on the Emperor who ruled “All Under
Heaven.” The Chinese order was hierarchical, radiating from the imperial capital and
based on the idea of harmony rather than sovereignty.

In contrast, the Islamic vision of world order combined religious and political authority.
Beginning in the 7th century, Islam expanded through the Middle East, North Africa,
and parts of Europe. The Ottoman Empire, under leaders like Sultan Mehmed II,
claimed a universal governance based on one empire, one faith, and one sovereignty.

2. Changes in the Global Economy Since the 1980s

In the mid-1980s, the global economy underwent a profound transformation with the
expansion of multinational corporations (MNCs) and foreign direct investment (FDI).
These developments marked the beginning of a new era where global economic
activity was increasingly driven by private firms operating across borders. Although the
concept of “multinational” is global, it was initially synonymous with the international
growth of American companies.

Despite the rise of globalization, the nation-state remained the central actor in both
domestic and international economic decision-making. However, economic regionalism
began to reshape trade dynamics, and new alliances formed based on shared economic
interests.

3. Post-Cold War American Leadership and Global Integration

Following the Cold War, the United States and its allies prioritized political and security
cooperation over economic rivalry. American leadership dominated the international
order, while international trade grew at an accelerated pace. New technological
advances, particularly in communication and transportation, lowered transaction costs
and stimulated global trade.

Financial deregulation contributed to a more integrated global financial system.

Innovations such as derivatives and the growth of foreign exchange markets linked
national economies more closely. This financial revolution made capital more
accessible, especially for developing countries, but also introduced new risks and
instability into the global system.

4. The Growing Power of Multinational Corporations

Multinational corporations became major players in shaping the global economy.
Globalization was not only driven by market forces but also by international economic
cooperation. Under American guidance, both industrialized and emerging economies
took steps to reduce trade and investment barriers. Agreements like GATT, and later
the World Trade Organization (WTO), institutionalized these efforts through rounds of
multilateral negotiations such as the Uruguay and Doha Rounds.

5. Markets vs. States in the New Global Economy

In this evolving context, markets increasingly replaced states as the main forces
shaping both economic and political affairs. Many analysts believe that we are entering
a phase where an open global capitalist economy dominates, characterized by
unrestricted trade, free capital flows, and the global operations of multinationals. The
global economy has shifted from being state-led to being driven by market-oriented
principles, including neoliberal economic policies that promote deregulation and
privatization.

6. Consequences of Economic Globalization

Despite the benefits, economic globalization has also created significant problems.
Income inequality has increased both within and between nations. Western Europe has
faced persistent high unemployment, and environmental degradation has worsened.
Many communities have experienced exploitation and economic instability. These
downsides have sparked debates about whether globalization produces more losers
than winners. German Chancellor Helmut Schmidt warned that global economic
competition might eventually result in regional blocs controlled by dominant powers.

7. The Rise of the Information Economy

The digital revolution and the rise of the information economy have deepened
globalization. The late 20th century saw a shift from manufacturing to service sectors,
such as finance, IT, and retail, particularly in developed countries. Industry relocated
from older industrial centers like the USA, Japan, and Western Europe to emerging
economies in Pacific Asia and Latin America. Although the United States still holds a
significant share of global wealth, its relative dominance has declined. Asia, especially
after the 1997 financial crisis, has shown strong economic performance and resilience.

8. American Economic Philosophy

American economists and policymakers often support a vision of the global economy
based on market principles. According to this view, international governance should
prioritize free trade, capital mobility, and open access for multinational firms. In
addition, they emphasize the importance of norms, values, and the broader interests of
society and politics in shaping economic rules.

9. Theoretical Perspectives on the International Economy

To understand the global economic system, it is important to consider different
ideological perspectives. Economic liberalism advocates for open markets, free trade,
and minimal government intervention. Marxism offers a critique of capitalism, arguing
that it creates inequality and international conflict. Economic nationalism emphasizes
the role of the state, national interests, and the belief in the moral superiority of one's
own nation.

10. Realism and the State-Centric Approach

State-centric realism remains an influential framework in international relations. Realist
scholars, such as Hans Morgenthau, focus on power, national interest, and the balance
of power as key elements in global affairs. Realism aims to analyze and manage conflict
through diplomacy and pragmatic policy. Although often associated with nationalism,
realism is primarily a method of interpreting international dynamics through a sober
and cautious lens.
TOPIC 2: THE STUDY OF INTERNATIONAL POLITICAL ECONOMY

1. Neoclassical Economic Theory

Neoclassical economics is based on the principle of market equilibrium, where supply

and demand reach a natural balance. It emphasizes free markets and views individuals
and producers as rational agents who make decisions based on perceived value and
utility. According to this theory, savings drive investment, and marginal utility refers to
the additional satisfaction a consumer receives from consuming one more unit of a
good or service. Neoclassical economists focus on efficiency, assuming that markets, if
left undisturbed, will allocate resources optimally.

2. The Field of International Political Economy (IPE)

International Political Economy, or IPE, builds upon neoclassical economics but is

distinct in its focus on the political and social dimensions of economic activity. While
neoclassical economics is not concerned with how gains from international markets are
distributed, IPE is deeply interested in this issue. In practice, international markets
rarely benefit all economic actors equally. Governments, therefore, are often
concerned with the distribution of returns from trade and foreign investment.

A foundational concept in IPE is the principle of comparative advantage, developed by

David Ricardo in the 18th century. According to this theory, each country can gain in
absolute terms from engaging in free trade and specializing in the production of goods
for which it has a relative efficiency. Ricardo argued that international economic
exchange should be seen not as a zero-sum game, but as a positive-sum game in which
all parties can benefit.

3. The Politics of International Regimes

International regimes are frameworks created to address specific global problems.

They are composed of principles, norms, rules, procedures, and decision-making
processes that guide the behavior of states and institutions. Scholars such as Robert
Keohane and Joseph Nye, in their work Power and Interdependence, highlighted the
need for international regimes to manage economic activities and reduce uncertainty.
A liberal international economy is characterized by open markets, capital mobility, and
nondiscrimination. However, such an economy can only function effectively if it
provides public goods like a stable monetary system, well-functioning institutions, and
mechanisms to prevent market failures. The Bretton Woods institutions—the
International Monetary Fund (IMF), the World Bank, and the World Trade Organization
(WTO)—are considered essential to this liberal economic framework.

4. The Gold Exchange Standard and Institutional Design

Under the post-war Bretton Woods system, international currencies were linked to the
U.S. dollar, which itself was tied to gold. This created a fixed exchange rate system
where other currencies were convertible into the dollar, and the dollar into gold. This
arrangement offered a clear value reference for global economic transactions and
enhanced trust in international monetary stability.

5. The Role of International Regimes and Their Functions

Robert Keohane’s work After Hegemony emphasized that international regimes are
essential to the smooth functioning of the world economy. These regimes are shaped
by technological, economic, and political forces. States, even while pursuing their own
national interests, create regimes to enhance both individual and collective benefits.
The main tasks of regimes include reducing uncertainty, minimizing transaction costs,
and preventing market failures.

At the same time, regimes are influenced by the self-interest of modern welfare states,
which tend to protect their economic autonomy and limit access to their welfare
systems—for example, by restricting immigration. States also seek to manipulate
regimes to serve their own political and economic agendas, especially when these
regimes affect national security or domestic welfare.

6. U.S. Hegemony in the Global Economy

The post-World War II liberal economic order was built upon the political and economic
leadership of the United States. Through its military, financial, and technological power,
the U.S. played a key role in establishing international regimes that reflected its
interests. The U.S. dollar became the dominant reserve and transaction currency,
facilitating American foreign policy and economic dominance. While this gave the U.S.
structural power, it also allowed it to behave both responsibly and irresponsibly within
the international system.

American leadership also shaped the Bretton Woods system of trade and monetary
regimes. The negotiations that led to its creation were primarily driven by the U.S. and
the U.K., but other powers such as Canada, Japan, and Western Europe supported the
system for economic and geopolitical reasons, particularly in the context of the Cold
War and the threat posed by the Soviet Union.

7. The Theory of Hegemonic Stability

The theory of hegemonic stability exists in both liberal and realist versions. It argues
that a liberal international economy requires a leading hegemon that is committed to
maintaining liberal economic principles. In the 19th century, that hegemon was Great
Britain; in the 20th century, it was the United States. However, while the presence of a
hegemon is necessary, it is not a sufficient condition for the maintenance of a liberal
economic system. This theory assumes that international cooperation is essential, but
not always guaranteed.

Economist Barry Eichengreen has argued that the decline of American leadership has
contributed to the growing importance of bilateral negotiations and regional economic
arrangements. As American influence has waned, states increasingly seek more
localized forms of cooperation that reflect their immediate interests and strategic
needs.

TOPIC 3: THE POLITICAL SIGNIFICANCE OF THE NEW ECONOMIC THEORIES

1. National Governments and Domestic Economies

In modern economies, all major actors—whether corporations, governments, or

interest groups—seek to influence economic outcomes. Among them, national
governments remain the most important agents in defining the rules and institutions
that regulate markets. Each state sets its own policies and legal frameworks to control
the movement of goods and capital in and out of its territory. Governments intervene
in markets not only to protect their economies but also to promote national interests
and improve the welfare of their citizens.

Despite the rise of neoliberalism and increasing globalization, national leaders are
often reluctant to leave economic results entirely to the forces of the market. Nobel
laureate Douglass North described this as the “incentive structure” of society, shaped
by its economic institutions. The goals of national economies range from ensuring
consumer welfare to expanding national power. Some economies adopt a laissez-faire
approach, as seen in the United States, while others, like Japan, involve the state more
directly in economic management.

2. Oligopoly and Power in Economic Outcomes

Oligopolies are markets dominated by a few powerful firms, often with one company
leading the market. These companies use their economic influence to manipulate
exchange conditions and often act as price-setters. A clear example is Saudi Aramco in
the oil market. Oligopolistic competition alters how markets function and requires
different analytical tools to understand.

Game theory, developed by Von Neumann and Morgenstern, is one such tool. It helps
predict the outcomes of strategic interactions between a limited number of actors. In
this framework, each player must anticipate the actions of others and adjust their
strategy accordingly. Game theory reveals how decision-making under uncertainty can
shape market dynamics, especially in concentrated sectors.

3. Technological Innovation

Technological progress plays a key role in determining the structure and behavior of
the world economy. New theories of growth, location, and strategic trade take into
account how advances in technology force countries to adapt their economic
strategies. In the 21st century, scale economies and imperfect competition have made
global trade patterns and production locations more dependent on national policies
and corporate strategies than ever before.

Technological innovation influences several aspects of the economy. First, it affects

international competitiveness through product development, marketing, and flexibility
in responding to market changes. Design, distribution, and services have become
crucial elements of competitive advantage. Second, the organization of production has
evolved significantly, especially with the emergence of the Fourth Industrial Revolution.

The First Industrial Revolution, beginning in the late 18th century in the UK, was driven
by steam power and iron. The Second, in the late 19th century, introduced steel,
electricity, and internal combustion engines, enabling mass production. The Third
Industrial Revolution, led by Japan and the U.S. in the 1970s, brought about
automation, computerized systems, and lean production models like Toyota’s Just-in-
Time approach. Today’s Fourth Industrial Revolution integrates advanced technologies
such as artificial intelligence, robotics, and biotechnology into all aspects of production.

In addition to changing production, globalization and intensified competition in the

1990s reinforced the role of multinationals and reduced communication and transport
costs. These developments transformed production management and expanded
transnational alliances.

The impact of technological innovation is also visible in the international division of

labor. Developed countries like the U.S. have transitioned into service economies,
relying heavily on information-related activities. Meanwhile, countries like Japan, South
Korea, and Taiwan experienced rapid technological advances in electronics, changing
the global manufacturing landscape.

Technology has also become a source of power. Access to cutting-edge technology is

often restricted, with leaders like the U.S., Japan, and the EU working to protect their
intellectual property from foreign competitors. This control limits the diffusion of
innovation and creates tensions in global trade.

Technological leapfrogging occurs when emerging economies adopt new technologies

faster than established powers. These shifts can disrupt global economic hierarchies. As
Mancur Olson argued, success in one stage of development may hinder progress in the
next if existing structures become rigid. New breakthroughs may benefit rising powers
while disadvantaging established economies burdened by high wages and institutional
inertia.
Finally, global competition for technological leadership has intensified. Nations that
gained economic dominance—like Great Britain, the United States, Germany, Japan,
and now China—did so by capitalizing on industrial revolutions. Today, the contest
takes place in high-tech sectors such as computing and information technology, with
global supremacy and political power hanging in the balance.

4. Economic Growth and Global Inequality

Economic growth patterns reveal both convergence and divergence among nations and
within regions. While some countries grow rapidly and integrate into the global
economy, others stagnate or grow more slowly. A study by Robert Barro and Xavier
Martin showed that the expected convergence between rich and poor countries has
largely not occurred. Instead, disparities in growth rates persist.

The world economy continues to be structured around a core-periphery model, as

explained by Paul Krugman. Core economies serve as centers of capital, investment,
and markets, while peripheral economies typically provide raw materials and labor. The
core is far less dependent on the periphery than vice versa. This imbalance reinforces
global inequality.

Despite this, cooperation between core and periphery is essential for global stability.
Uneven development results from conflicting economic forces that either concentrate
or disperse industrial activity. To address these imbalances and promote convergence,
many regions have pursued integration, such as through the formation of the European
Union. These regional arrangements aim to strengthen economic capacity and political
influence in an increasingly competitive global economy.

TOPIC 4: NATIONAL SYSTEMS OF POLITICAL ECONOMY

1. Introduction: Types of Capitalism and National Differences

National systems of political economy vary significantly from one another. This lesson
compares the economic systems of the United States, Japan, and Germany, focusing on
three core aspects: the goals of economic activity, the role of the state in the economy,
and the structure of corporate governance. Despite their differences, these countries
share common purposes such as promoting citizen welfare, consumer well-being, and
national power.

2. The USA: Market-Oriented Capitalism

In the American model, the primary purpose of economic activity is to benefit

consumers while maximizing wealth creation. The distribution of that wealth is a
secondary concern. Individuals are assumed to act in their own self-interest, while
corporations are expected to maximize profits. The U.S. economy is based on the
assumption of competitive markets and promotes competition where it is lacking.

During the 20th century, the U.S. saw the emergence of managerial capitalism, where
corporate management was separated from ownership. The New Deal of the 1930s
expanded the role of the federal government, emphasizing economic equity and social
welfare. After World War II, the Full Employment Act of 1946 marked a shift toward
Keynesian policy, where the government accepted responsibility for maintaining full
employment through macroeconomic policies. However, the 1980s saw a return to
conservative economic thinking under Ronald Reagan, prioritizing deregulation and
free markets.

The economic role of the American state is shaped by neoclassical theory and the U.S.
political system. Power is divided among executive, legislative, and judicial branches,
and between federal and state governments. Responsibility for economic management
is shared between institutions like the Treasury, the Federal Reserve, and various
agencies. There is a political divide: Republicans generally oppose strong state
involvement, while Democrats are more supportive.

Fiscal policy is managed by Congress and the executive branch, while monetary policy
falls under the control of the Federal Reserve. The state is expected to provide a
neutral business environment, regulating markets, correcting failures, and supplying
public goods. Industrial policy includes targeted support for sectors such as education,
national defense, research, and high-tech industries believed to create high-value jobs.

Corporate governance in the U.S. is characterized by fragmentation and minimal

coordination. Antitrust policies are designed to prevent concentration of corporate
power. Shareholders often own small percentages of large corporations, and there is a
clear separation between industry and finance. The American model is based on
shareholder capitalism, focusing on profit for investors with minimal obligations to
employees or local communities.

3. Japan: Developmental Capitalism

After World War II, Japan rejected the U.S. recommendation to focus on labor-intensive
industries and instead pursued industrial and technological parity with the West. Led
by the Ministry of International Trade and Industry (MITI), Japan aimed for economic
self-sufficiency and national advancement. In Japan, the economy is considered
subordinate to broader social and political goals.

Japan's model is known by several names: developmental state capitalism, stakeholder

capitalism, strategic capitalism, neomercantilism, and "Japan Inc." In this system, the
state plays a central role in national economic development and in competing with
Western economies. The government actively assists, regulates, and protects key
industries to enhance global competitiveness. Japanese society emphasizes cultural
uniqueness, domestic harmony, and social equity alongside economic efficiency.

The Japanese state collaborates with the ruling party and the private sector, which
assumes responsibility for social welfare. Japan's industrial policy includes import
protection, subsidies, and low-cost financing to foster industrialization, especially in
high-tech sectors. Resource-poor but capital- and labor-rich, Japan built its strength on
manufacturing and innovation. The government selected a few powerful firms for
protection and support, granting them tax breaks and subsidies.

Corporate practices in Japan reflect long-term thinking. Core workers in major firms like
Sony and Toyota often enjoy lifetime employment and are paid based on seniority.
These workers are seen as valuable assets, and companies invest heavily in them. The
keiretsu system links firms through long-term trust and relationships. Government-
backed bank loans and the postal savings system provide firms with access to low-cost
capital, reinforcing Japan’s strategic capitalism.

4. Germany: Social Market Capitalism

Germany combines features of both the American and Japanese models, with an
emphasis on exports, savings, and investment over consumption. The German
economy is oligopolistic, with strong alliances between large corporations and private
banks. It balances social concerns with market efficiency and offers a comprehensive
welfare system.

German capitalism includes elements of corporatism, where labor and social groups
are represented in corporate governance. Capital organizes labor, and the government
cooperates with the private sector in managing the economy. The German state,
together with the Länder (federal states), has created a stable environment for private
enterprise through legal frameworks that encourage high savings, investment, and
growth.

The Bundesbank, Germany’s independent central bank, plays a key role in maintaining
macroeconomic stability, defending the euro, and preventing inflation. It ensures a
stable climate for investment through low interest rates and responsible monetary
policy.

Corporate governance in Germany resembles that of Japan, especially in its emphasis

on cooperation and long-term relationships. The Mittelstand—Germany’s medium-
sized, family-owned firms—plays a vital role in the national economy. These companies
are major exporters and key suppliers in sectors like chemicals and machinery. Bank-
linked corporations dominate the economy, with representatives from Deutsche Bank,
Commerzbank, and other major firms sitting on each other's supervisory boards.

5. Is One System Superior to the Others?

It is difficult to declare one system as superior, since each national model reflects
different values, historical trajectories, and social standards. The United States
prioritizes market competition and shareholder returns, Japan focuses on strategic
national development and social harmony, while Germany seeks a balance between
economic performance and social welfare.

TOPIC 5: THE TRADING SYSTEM

1. General Reflections on Free Trade

Most economists agree that free trade is superior to protectionism. According to this
view, even if all other countries maintain trade barriers, an open economy can still
benefit from cheaper imports, outweighing the costs of restricted access to foreign
markets. However, economic historian Paul Bairoch argued that, historically,
protectionism has been the rule and free trade the exception. While countries often
seek access to global markets, they are reluctant to open their own economies fully.

2. Economic Context and the Return of Protectionism

In the 1970s, the trend toward trade liberalization reversed. The global economy was
affected by stagflation—a combination of economic stagnation and inflation. In
response, countries like the United States adopted a new protectionism, imposing
trade barriers to shield domestic industries from foreign competition, especially from
Japan.

3. GATT and the Liberal Trade Order

After World War II, trade liberalization progressed through successive negotiations
under the General Agreement on Tariffs and Trade (GATT). This international treaty
focused exclusively on the trade of goods and did not include services. GATT lacked
enforcement mechanisms, such as surveillance and sanctions committees, but its
rounds of negotiations, driven largely by American leadership, led to substantial trade
expansion and tighter integration of national economies.

4. The World Trade Organization (WTO)

In 1993, the Uruguay Round of trade negotiations led to the creation of the World
Trade Organization (WTO), replacing GATT. The WTO was formalized through a treaty
supported by U.S. Presidents Reagan, Bush, and Clinton and ratified by the U.S. Senate.
New challenges to free trade emerged, including economic regionalism, labor
standards, environmental protection, and tensions between globalization and national
sovereignty. The 21st-century trade system shifted focus from comparative advantage
to competitive advantage, with trade penetrating deeper into domestic economies and
becoming intertwined with cultural and political issues.
5. Revisions of Conventional Trade Theory

The Heckscher-Ohlin (H-O) model suggested that countries would export goods that
intensively use their abundant factors of production, benefiting those factor owners
and disadvantaging owners of scarce factors. The model also posited that trade in
goods could substitute for trade in factors, leading to factor price equalization.
However, this theory was challenged by the Leontief Paradox, which showed that the
U.S., a capital-rich country, exported labor-intensive goods. This contradiction was
resolved by incorporating the concept of human capital, recognizing that U.S. workers
had higher education and productivity, which enriched the understanding of
comparative advantage.

6. The Role of Multinational Corporations (MNCs)

Multinational companies play an increasingly important role in global trade. In the

1990s, more than half of U.S. and Japanese trade consisted of intrafirm transactions—
exchanges between parent companies and their subsidiaries. Foreign direct investment
(FDI) significantly shaped trade patterns and wealth distribution. Raymond Vernon
introduced the product cycle theory, which added technology as a key variable in
international trade.

Michael Porter provided further insight by linking national competitiveness to domestic

conditions. Factors such as national culture, R&D, labor and capital conditions,
industrial structures, and supporting industries all influence a country’s competitive
position. For example, Japanese dominance in automobiles and electronics is partly
due to intense domestic competition.

Opinions on MNCs are divided. Some economists see them as politically neutral
entities that enhance global efficiency by optimizing resource use. Others view them as
self-interested actors whose market power allows them to shape economies to their
advantage.

7. The New Trade Agenda

Modern trade discussions increasingly include non-economic issues such as labor

standards, human rights, national sovereignty, and environmental protection. One
notable case was the dispute between Mexico and the United States over dolphin-safe
tuna. GATT ruled in 1991 that trade laws should not discriminate based on production
methods, a decision that upset environmentalists who favored stricter protections.

8. Globalization and Its Contradictions

Globalization has reshaped the business landscape. It refers to the growing

interconnection between countries and markets, making geographical borders less
relevant. As Thomas Friedman described it, "the world is flat," with advances in
technology, fiber optics, and software enabling seamless global interactions. Countries
like China and India have become critical links in supply chains for major corporations
such as Dell, Apple, and IBM.

Globalization is irreversible and demands that companies remain flexible, strategic, and
globally integrated. Corporations must reach global consumers while monitoring costs
and adapting to local markets. Globalization affects all sectors and actors, from
companies and governments to individuals.

9. Multinational vs. Global Firms

According to Theodore Levitt, multinational firms operate in many countries and adapt
products to local preferences, often at a higher cost. Global firms, in contrast, offer
standardized products worldwide at lower costs, benefiting from scale economies and
consistent marketing strategies. Levitt believed that only global firms would succeed
long-term by leveraging technology and efficiency.

Today, globalization is not limited to firms from developed countries. Companies from
emerging markets also access technology, capital, and talent, becoming global
competitors. The balance between global integration and local responsiveness—
"glocalization"—is key. As Sony's Akio Morita said: “Think global, act local.” Glocal firms
aim to combine global reach with respect for local culture and preferences.

10. Measuring Globality and Corporate Power

Gupta, Govindarajan, and Wang identified four dimensions of globality: market

presence, global supply chains, financial integration, and corporate culture. A global
company operates across borders in production, R&D, finance, and personnel
management.

The growing size and influence of MNCs have raised concerns. Critics fear these
corporations could overpower local economies and governments. The 1980s and 1990s
saw a wave of mergers, driven by deregulation and new technologies. While
globalization brought increased scale and competition, it also led to the concentration
of economic and political power in corporate hands.

11. Global Supply Chains and Non-State Actors

Today’s global supply chains involve numerous stakeholders, from suppliers and
logistics providers to regulators and consumers. The book Connectography by Parag
Khanna describes this system as an interconnected ecosystem shaped by productivity,
bureaucracy, transport, and culture. Non-state actors like global brands and NGOs play
increasingly important roles in shaping the global economy.

12. Sustainability and the Future Economy

New concerns in the trading system include environmental, social, and governance
(ESG) criteria. The green economy promotes sustainability and environmental
responsibility, while the blue economy emphasizes ocean and marine resource
management. Together, these trends reflect growing awareness that the future of
trade must balance economic growth with social and ecological goals.

TOPIC 6: THE INTERNATIONAL FINANCIAL SYSTEM

1. Introduction: The Financial Revolution

In the 1970s, a financial revolution transformed the global economic landscape. One of
its main advantages was the increased freedom of capital movement, which led to a
deeper integration of national financial markets. This development facilitated the
emergence of a global financial system, which enabled the efficient allocation of capital
resources across borders. Less developed countries (LDCs), often capital-poor, gained
access to international credit, aiding their economic development.
However, this same process also introduced new vulnerabilities. The growing volume
and volatility of international capital flows contributed to economic instability. The
global financial system itself became prone to serious crises, driven by speculation and
the rapid mobility of funds.

2. Globalization of International Finance

Global financial globalization has become a defining characteristic of the modern world
economy. It involves the seamless movement of capital across borders, integrating
national economies into a single global system. With technological advances, billions of
dollars can now be moved from one market to another at the click of a button. Most
international financial flows today are short-term (less than 12 months on average) and
speculative in nature.

Although globalization is widespread, some countries still maintain capital controls to

protect their economies from excessive volatility. Until the early 2000s, financial
investments showed a “home bias,” meaning investors preferred to keep their funds
within their own countries. This trend has weakened, but not disappeared entirely.

The rise of hedge funds, speculative financiers like George Soros, and globally active
banks has increased the vulnerability of the international system. These actors often
target emerging markets, creating booms and busts that can destabilize entire
economies. Financial crises have become a recurrent feature of international
capitalism.

Examples of such crises include the debt crisis in Latin America in the 1970s, the
collapse of the European Exchange Rate Mechanism in 1992–1993, the Mexican Peso
crisis in 1994–1995, the Russian financial crisis in the 1990s, the East Asian crisis in
1997, the global financial crisis of 2007–2009 sparked by the U.S. subprime mortgage
collapse, and the COVID-19 economic crisis starting in 2020.

3. The Nature of Financial Crises

Economist Hyman Minsky proposed a theory to explain how financial crises develop.
According to Minsky, a crisis typically begins with a displacement—an external shock
such as a war or the introduction of a major new technology. This creates high profit
opportunities in certain sectors, which leads to a surge in credit and an investment
boom.

This boom can evolve into a speculative bubble, as asset prices rise and speculative
behavior becomes widespread. Eventually, some insiders begin to realize that the
market has peaked and start converting their assets into safer investments. This
triggers a chain reaction, often called a domino effect, where others rush to do the
same. Panic spreads rapidly, creating a “stampede” toward security. Lending stops,
credit markets freeze, and the economy may fall into recession or even depression.

Although Minsky’s model offers a compelling narrative, many economists reject the
idea that a general theory of financial crises can be developed. They argue that each
crisis is unique and shaped by historical accidents. Furthermore, neoclassical
economists assume that market actors are rational and deny the possibility of
speculative bubbles. Nobel laureate Milton Friedman went so far as to say that
speculation cannot exist in a rational market economy.

In contrast, historian Charles Kindleberger claimed that financial crises are a recurring
feature of global capitalism, especially at the international level. He observed that the
history of global markets is marked by repeated episodes of manias, panics, and
crashes. According to Kindleberger, factors such as risky speculation, aggressive
monetary expansion, rising asset prices, and a rush into safe assets are natural by-
products of global investors’ pursuit of high returns.

TOPIC 7: THE INTERNATIONAL FINANCIAL SYSTEM (II)

1. The East Asian Financial Crisis (1997)

In the summer of 1997, the East Asian economies experienced a sudden and severe
collapse, despite having been praised just a few years earlier by the World Bank for
their macroeconomic stability. The crisis began in Thailand and spread rapidly to other
countries in the region. No expert had anticipated a crisis of this magnitude. While
globalization played a role, the root causes lay in poor domestic economic
management and structural vulnerabilities, such as large external deficits, inflated
asset prices, poor regulation, and rigid exchange rate pegs to the U.S. dollar.

In Thailand, the crisis was triggered by the inability to sustain a fixed exchange rate
amid mounting current account deficits and speculative attacks. The depreciation of
the Japanese yen also contributed to competitiveness problems. When the Thai baht
collapsed, it signaled the start of a regional financial panic.

South Korea, the world’s 11th largest economy at the time, was also hit. Despite low
inflation and unemployment, Korean banks and corporations held massive short-term
foreign debt—over three times their foreign exchange reserves. This unsustainable
situation led to a crisis of confidence and forced the country to accept a $57 billion IMF
bailout.

2. The Russian Financial Crisis (1998–1999)

During the mid-1990s, Russia was transitioning from a planned economy to a market-
based one. This shift caused social upheaval, extreme inflation, and widespread
poverty. Budget deficits were financed by the Central Bank, and tax evasion was
rampant. A lack of fiscal discipline and political resistance to reforms led to the collapse
of investor confidence.

By early 1999, the Russian ruble had lost 70% of its value, and inflation had reached
90%. Although the country did not experience a full banking crisis, it declared a
suspension of payments on both public and private debts. Institutional instability and
poor macroeconomic coordination worsened the situation.

3. The Latin American Debt Crisis: Brazil (1998)

Brazil’s economy was shaken in the wake of the East Asian crisis. The resulting
contagion worsened global financial conditions and placed intense pressure on Brazil’s
capital account. The government implemented emergency fiscal and monetary
measures, including spending cuts and interest rate hikes, but foreign exchange
reserves still dropped dramatically.

To stabilize the situation, Brazil secured an $18 billion IMF standby agreement. The
Clinton administration supported this rescue, fearing a collapse in Brazil—a major U.S.
trade partner—would disrupt the global economy. The U.S. Federal Reserve cut
interest rates, helping to restore market confidence and stabilize the American
economy.

4. The Eurozone Crisis (2010s)

By 2010, the eurozone faced major financial instability. The currency union had grown
too large and diverse, and there were no fiscal mechanisms to redistribute resources
among member states. Emerging European economies such as Georgia, Hungary, and
Ukraine required assistance, and within the eurozone itself, countries like Greece,
Ireland, Portugal, and Cyprus faced deep fiscal and banking problems.

These countries suffered from balance sheet vulnerabilities and large current account
imbalances, which could not be corrected due to the rigidity of the shared currency.
The European Central Bank's strict anti-inflation mandate, combined with the absence
of a unified fiscal policy, made coordinated responses difficult.

5. The Great Depression vs. The Great Recession

There are important parallels between the Great Depression of the 1930s and the
Great Recession of 2008–2009. Both periods were marked by high unemployment,
social unrest, and frustration. In both cases, nations engaged in "currency wars"
through competitive devaluations, imposed trade barriers, and failed to coordinate
policies effectively. These events highlight the need for multilateral approaches to
manage global economic crises.

6. The Debate on Financial Regulation

Following the turmoil of the 1990s, there was significant debate over whether
international financial flows should be regulated. In the United States, the dominant
view—especially under the Clinton administration—was that markets should regulate
themselves without government interference. However, many European countries,
including Germany, France, and Japan, argued for greater control over international
financial movements.

The East Asian crisis served as a wake-up call, showing that poorly managed capital
flows could devastate economies. While some economists believe that markets alone
should govern the financial system, others—along with institutions like the IMF—
support financial openness accompanied by strong surveillance mechanisms at both
domestic and international levels.

TOPIC 8: THE STATE AND THE MULTINATIONALS

1. Introduction: Historical Perspective

Multinational companies (MNCs) are not a new phenomenon. They have existed for
centuries, with examples such as the Dutch East India Company and the British
Western India Company. However, the nature and influence of MNCs have evolved
drastically in the 20th and 21st centuries, making them central actors in the global
economy and increasingly relevant in discussions about international political and
economic governance.

2. Theories about Multinational Corporations

There are several academic approaches to understanding MNCs.

Neoclassical economists argue that firms are guided by market signals regardless of
their nationality and that foreign direct investment (FDI) leads to the efficient
allocation of resources through comparative advantage. These firms often operate in
imperfect markets shaped by national government policies like trade protection and
industrial policy.

Paul Krugman highlights the oligopolistic nature of MNCs, noting that their decisions
about whether to export or invest abroad influence global trade patterns and growth.
Richard Caves emphasizes the concept of “appropriability,” or a firm’s ability to protect
valuable assets like trademarks and technology.

Business economists, including Alfred Chandler and Raymond Vernon, have focused on
corporate behavior. Vernon’s product cycle theory explains how U.S. firms expanded
abroad due to domestic advantages in innovation, market size, and R&D, especially in
the post-WWII period.
John Dunning’s Eclectic Theory combines factors such as ownership advantages,
location-specific advantages, and the benefits of internalization. This theory explains
why MNCs outperform domestic firms by leveraging global deregulation and FDI
opportunities.

Michael Porter’s strategic theory conceptualizes international business as a value

chain. MNCs, or “transnational corporations,” strategically locate each stage of
production where it is most efficient. They use tools such as FDI, strategic alliances,
outsourcing, and licensing to operate across borders.

Political economists take a state-centric approach. Robert Gilpin argues that the
success of MNCs is not just economic but political, enabled by favorable global
conditions often shaped by hegemonic powers like the U.S. after WWII. Scholars like
Paul Doremus emphasize that MNCs are deeply influenced by their home societies and
reflect national values.

3. MNCs and the International Economy

MNCs are key players in the global economy. According to Doremus, they account for
80% of global industrial output and employ two-thirds of their workforce in their home
countries. FDI has grown dramatically in recent decades, reshaping trade patterns.
Intrafirm trade—transactions between subsidiaries of the same firm—represents a
significant share of global commerce. In the U.S., it accounted for one-third of exports
and two-fifths of imports in 1994.

MNCs are heavily concentrated in capital- and technology-intensive sectors and are
central to the global flow of knowledge. Their influence extends beyond economics,
affecting the political and social structures of many countries.

4. Taxation and MNCs

Taxation is a key issue in international business. When a U.S. corporation opens a

subsidiary abroad, such as in the UK, it may be taxed both by the host country and the
U.S. under a worldwide tax system. To avoid double taxation, the U.S. offers a foreign
tax credit, though this still places U.S. firms at a disadvantage compared to companies
from countries with territorial tax systems. The debate over global minimum corporate
taxes, such as the proposed 15% rate, reflects growing concerns about tax fairness and
competition.

5. Regionalization of Services and Manufacturing

Despite globalization, production and services are increasingly regional. Falling

communication and transport costs have allowed MNCs to integrate activities across
borders, but the benefits are unevenly distributed. Technology tends to spread slowly
from developed to developing countries, and most FDI remains concentrated in the
Triad (the U.S., Western Europe, and Japan—or more recently, China, Hong Kong, and
Singapore). Economist Charles Oman emphasizes that while finance and competition
are global, production is increasingly regional.

6. The Debate Between MNCs and Nation-States

There are divergent views on the role of MNCs in global governance. Some see MNCs
as agents of globalization that reshape global politics and economics, reducing the
importance of nation-states. Others argue that this view exaggerates MNC influence
and that states still set the rules that corporations must follow. Scholars like John
Stopford and Susan Strange emphasize the continuing rivalry between states and firms
in shaping international outcomes.

7. Toward a Regime for FDI and MNCs

There is no consensus on whether a global investment regime is necessary. Some

economists argue that markets will discipline both firms and states. Others, like
Canadian negotiator Sylvia Ostry, suggest that a fair system should include the right of
establishment, national treatment, and non-discrimination.

These principles state that firms should be allowed to invest anywhere, receive the
same treatment as domestic companies, and not be discriminated against based on
nationality. However, the extraterritorial application of national laws—such as the
Helms-Burton Act, which punishes foreign firms dealing with Cuba—creates tensions
between corporate freedom and state sovereignty. Developing countries seek
protection from corporate dominance, while firms want guarantees against arbitrary
state actions.
8. Do Global Corporations Pose a Threat?

The increasing size and power of MNCs raise concerns about their influence. In the
1980s and 1990s, corporate power expanded rapidly in the U.S. and Western Europe
through waves of mergers, deregulation, and technological innovation. These firms
now manage vast operations, dominate global supply chains, and enjoy major
economies of scale.

Some fear that MNCs are becoming more powerful than states, especially in the areas
of technology, investment, and political influence. Corporate globalization is associated
with both growing competition and increased consolidation of power.

TOPIC 9: THE NATION-STATE IN THE GLOBAL ECONOMY

1. Introduction: The Nation-State and Global Forces

In recent decades, nation-states have lost their status as the only dominant actors in
the international system. Their power has been increasingly shared with international
organizations and non-governmental actors. At the same time, identity politics and
ethnic conflicts challenge the internal integrity of many states, with various groups
demanding independence or autonomy, such as the Kurds or Palestinians.

Vincent Cable, from the Royal Institute of International Affairs in London, noted that
the impact of globalization is highly uneven across nations and varies depending on the
issue. Finance is far more globalized than other sectors, such as services or
manufacturing. Many of the problems attributed to globalization are actually caused by
domestic technological changes or misguided national policies rather than globalization
itself.

2. Historical Context

The idea that the nation-state is in decline is most applicable to highly developed
regions such as the United States, the European Union, and possibly Japan. The end of
the Cold War marked the conclusion of a long era of industrial and military competition
that began in the 19th century.
Events such as the American Civil War, the Franco-Prussian War, and the Russo-
Japanese War were followed by two World Wars and the Cold War, which strengthened
the role of the state as an economic and military power. During this time, national
economies were often shaped to serve the needs of war. There is little evidence that
emerging economies will avoid the same mistakes made by industrialized powers in the
past.

3. The Consequences of Economic Globalization

Many of the issues blamed on globalization—such as environmental degradation or

economic inequality—are in fact the result of poor national policies. Environmental
problems like air and water pollution, or deforestation in the Amazon, are primarily
caused by domestic decisions, such as government subsidies and weak regulation.

Criticism of globalization often comes from two ideological extremes: nationalists and
xenophobes on the political right, and anti-capitalists on the political left. However,
globalization and regionalism pursue different goals and should not be treated as
equivalent sources of modern challenges.

4. The Role and Limits of Macroeconomic Policy

The decline of the nation-state is often interpreted as a loss of economic control.

However, national governments continue to shape their economies through
macroeconomic policy, even if it has become more complex in a highly integrated
world.

Macroeconomic policy is built around two main tools: fiscal policy and monetary policy.
Fiscal policy refers to government spending and taxation. A budget deficit can stimulate
the economy, while a surplus can reduce economic activity. Monetary policy involves
controlling the money supply and interest rates. Institutions like the Federal Reserve or
the European Central Bank adjust interest rates to influence economic growth: lower
rates stimulate growth, while higher rates slow it down.

The principal constraints on these policies are often domestic—such as political

opposition or public debt levels—rather than global.

5. Consumer Spending and Post-Pandemic Recovery

The global economic recovery from the COVID-19 pandemic is expected to be driven
largely by consumer spending. During lockdowns, households in major economies
accumulated significant savings—estimated at $2.9 trillion globally. Half of this amount
is held by U.S. households alone.

As pandemic restrictions ease and vaccination efforts expand, these excess savings are
likely to fuel a surge in consumption. Bloomberg Economics suggests that this could
power a strong recovery, with consumer demand becoming a key engine of growth. In
the U.S., the cash saved equals roughly the entire annual output of South Korea,
illustrating the potential impact on global economic momentum.

TOPIC 10: GOVERNING THE GLOBAL ECONOMY

1. Introduction: Interdependence and Fragmentation

Richard Cooper, in Economics of Interdependence, argues that the global economy is

shaped by the clash between the unifying forces of trade, investment, and finance, and
the political fragmentation of the world. He believed the ideal solution would be some
form of international governance, but also recognized that states are unlikely to
surrender sovereignty for the sake of a more stable global economic system. While
North Atlantic economies share a market-oriented vision of capitalism, Japan has
traditionally followed a model with strong government-business coordination.

Cooper also stressed that effective international cooperation is only possible when it is
supported by the major economic powers. In this context, economic regionalism has
grown in importance, with regional blocs such as the European Union, USMCA, ASEAN,
RCEP, and MERCOSUR playing key roles in shaping the governance of the global
economy.

2. Neoliberal Institutionalism

Neoliberal institutionalism recognizes the central role of the nation-state but sees it as
a liberal, market-oriented actor more concerned with cooperation and absolute gains
than with rivalry. This theory maintains that international institutions are strong
enough to manage the challenges of a globalized world economy. Key examples include
the WTO, which replaced the GATT and gained more authority and enforcement
capabilities, as well as reforms in the IMF and World Bank.

However, the expansion of markets has created tensions. Some countries resist full
market liberalization. Malaysia imposed capital controls, and South Korea rejected U.S.
pressure to dissolve its chaebol conglomerates. Anglo-Saxon capitalism has often been
rejected by Japan and continental Europe, where companies are also expected to
provide social benefits.

A major issue within these institutions is the so-called “democratic deficit.”

Organizations like the WTO, IMF, and World Bank operate with limited transparency,
often excluding public scrutiny for fear of disrupting global markets. The WTO is
relatively democratic, with each country having one vote. In contrast, the IMF and
World Bank use weighted voting systems that favor the U.S., the EU, and Japan.

A further challenge is the mismatch between institutional authority and the global
distribution of economic power. The leading roles in the IMF and World Bank have
traditionally been controlled by the U.S. and the EU, which has led to growing
dissatisfaction from emerging powers like China, India, Brazil, and other developing
countries. While U.S. leadership has shaped the liberal order for decades, no single
country can lead the global economy alone today.

3. New Medievalism

The theory of New Medievalism challenges the traditional model of nation-state

sovereignty, which dates back to the Treaty of Westphalia (1648). This theory suggests
that state sovereignty is eroding due to internal fragmentation and the rise of non-state
and supranational actors, such as MNCs, international organizations, and NGOs.

Governments are losing their monopoly over information in the digital era, and civil
society actors are taking on greater roles in areas traditionally reserved for the state.
Wolfgang Reinicke, in his book Global Public Policy: Governing Without Government?,
advocates for new international standards, such as those found in the Basel Accords, to
regulate international banking and prevent systemic financial crises.
Samuel Huntington, in The Clash of Civilizations, cautions that many individuals across
the globe reject Western liberal values like secularism, individualism, and human rights.
He argues that NGOs, despite their influence in the West, may not play the same role in
regions like China or India due to cultural and political differences.

4. Transgovernmentalism

Anne-Marie Slaughter’s concept of transgovernmentalism offers a third model of global

governance. It accepts the continuing role of nation-states but sees governance
functions as increasingly delegated to specialized intergovernmental bodies. Non-state
actors such as NGOs support states by contributing to policymaking processes.

Transgovernmental networks include experts, regulators, business executives, and legal

professionals who collaborate across borders to solve shared challenges, particularly in
technical fields like banking regulation (e.g., Basel Accords), antitrust law, and legal
cooperation.

According to Keohane and Nye, this model assumes that government institutions can
operate independently of national foreign and security policies. However, it has been
criticized for downplaying power dynamics and ignoring the political nature of
governance, assuming that technical problems can be solved outside of broader
national concerns.

5. Governance for What Purpose?

Ultimately, any effort to govern the global economy must answer a central question:
governance for what? Governance refers to the exercise of power to achieve specific
objectives, and its purpose must be clearly defined.

In the post-Cold War era, neoliberalism defined the goal of global governance as the
facilitation of free trade, capital mobility, and open access to markets for multinational
corporations. Others argue for alternative goals such as protecting the environment,
safeguarding jobs, or promoting global wealth redistribution.

As the global economy becomes more integrated, the number and diversity of actors in
global governance increase. States, companies, NGOs, and international organizations
all participate in shaping the rules of the new global economic order. This reality
presents a complex landscape for scholars and practitioners of international political
economy.

TOPIC 11: CLASH OF TITANS – USA VS CHINA

1. Recent History: The Rise of a Rivalry

In recent decades, the relationship between the United States and China has evolved
into a strategic and economic rivalry with global implications. This clash of titans has
been shaped by rapid economic development in China, growing political assertiveness
on both sides, and contrasting models of governance and capitalism.

2. Economic Comparison: USA vs China

A central point of comparison between the two powers is their GDP. The United States
maintains the largest economy in the world in nominal terms, while China leads in
purchasing power parity (PPP). As of 2022, the U.S. GDP growth rate was below 3.5%,
whereas China’s GDP growth rate was under 4.5%, showing signs of slowed expansion
in both economies.

When broken down by sector, both economies exhibit different strengths. The U.S.
economy is highly developed in services and advanced technology, while China retains
strong positions in manufacturing, construction, and transportation. Agriculture
remains a much smaller part of GDP in both countries.

A more detailed comparison shows that some U.S. states, such as California and Texas,
have economies that rival entire Chinese provinces in output. However, China’s
regional economies have grown rapidly and now compete directly with key American
economic centers.

3. Current Account Balance: Deficits and Surpluses

One of the most discussed aspects of the economic relationship between the U.S. and
China is their current account balance. The U.S. has maintained a persistent current
account deficit, while China has accumulated consistent surpluses. This reflects
America's role as a major importer and China’s position as the world’s leading exporter.
This imbalance is also linked to foreign reserves. China is the largest foreign holder of
U.S. Treasury bonds, effectively making China one of America’s key lenders. This
financial dependence adds a layer of complexity to the bilateral relationship, as both
countries are economically interdependent despite political tensions.

4. Political Leadership and Economic Policy

Leadership plays a key role in shaping the economic paths of both countries. In the
U.S., different administrations—whether Democratic or Republican—have taken varied
approaches to trade policy, taxation, and regulation. In China, the Communist Party
maintains strong centralized control, with leaders such as Xi Jinping implementing long-
term industrial strategies and tightening control over major sectors.

American economic leadership often emphasizes market liberalism and individual

entrepreneurship, while Chinese leadership combines state planning with market
mechanisms, favoring strategic sectors like technology, infrastructure, and green
energy.

5. China's Influence on the U.S. Economy

China’s impact on the U.S. economy is multifaceted. As the main source of many
imported goods, China contributes to lower consumer prices in the U.S. However, it is
also blamed for job losses in American manufacturing sectors. Moreover, Chinese
investment in U.S. assets, including debt and real estate, gives Beijing leverage in
financial markets.

China’s role as a key supplier of industrial components and rare earth materials has
also raised concerns about supply chain security in the U.S., especially in times of
political tension or global crises.

6. International Perceptions: Competing Superpowers

The global community is divided in its view of which nation is the true superpower. The
United States is still seen by many as the leading political and military power, but China
is increasingly recognized for its economic influence and growing diplomatic reach.
Surveys show mixed opinions, depending on region and political alignment, with some
countries aligning more with the U.S. and others with China, based on economic
dependencies or ideological affinities.

7. The World's Creditors and Debtors

China has become one of the largest creditors in the world, while the United States is
the biggest debtor. This contrast reflects deeper global trends in savings, investment,
and consumption. Chinese banks and institutions hold vast amounts of foreign reserves
and have financed infrastructure and development projects across Asia, Africa, and
Latin America. Meanwhile, the U.S. government and private sector have accumulated
record levels of debt, relying heavily on foreign borrowing.

8. The Biggest Private Borrowers

In addition to its public debt, the U.S. hosts some of the largest private borrowers in
the world. Corporate and consumer debt in the U.S. has risen significantly, contributing
to economic growth but also raising concerns about financial stability. In contrast,
Chinese private debt has also grown, particularly in the real estate sector, but remains
more closely controlled by state mechanisms.

TOPIC 12: DIGITIZATION IN THE INTERNATIONAL ECONOMY

1. Digital Finance

In recent decades, the expansion of international trade has been strongly supported by
digital finance. Digital systems allow banks to handle complex global transactions
without ever interacting with the physical goods being traded. Instead, banks operate
solely based on documentation. While this facilitates speed and volume in commerce,
it also introduces inherent risks, particularly in the area of financial crime. The rise of
digital finance has transformed how trade is conducted but also created new
challenges in security and compliance.

2. Blockchain Technology

Blockchain is a digital ledger technology that enables secure, decentralized, and

transparent recording of transactions. Each block in the chain contains a set of
transactions and is linked to the previous block, creating an immutable sequence.
Blockchain eliminates the need for intermediaries by allowing peer-to-peer
transactions and enhances the reliability and traceability of financial operations. It also
serves as the foundational technology behind cryptocurrencies like Bitcoin. Blockchain
offers great potential for improving international trade, contract enforcement, and
fraud prevention.

3. Fintech vs Traditional Banks

Fintech companies are rapidly transforming the financial sector by offering innovative,
tech-driven services that challenge the dominance of traditional banks. These firms
typically operate with lower overhead, faster service delivery, and a focus on user
experience. Traditional banks, on the other hand, continue to play a central role in
large-scale financial operations, but often struggle to keep pace with digital innovation.

One of the most disruptive areas in fintech is the rise of cryptocurrencies. These digital
currencies operate independently of central banks and use blockchain for secure
verification. Bitcoin, the most prominent cryptocurrency, has experienced dramatic
rises and falls in value. While it has generated profits for some investors, it remains
highly volatile and speculative.

4. Financial Crime in the Digital Age

With the digitization of finance and trade, financial crime has become a global issue.
Banks face increased risks, as they are key players in international transactions but may
have limited visibility into the underlying goods or services. Financial crimes, such as
money laundering and fraud, exploit this vulnerability.

Money laundering involves disguising illegally obtained money to make it appear

legitimate. It usually follows three stages: placement, where cash enters the financial
system; layering, which obscures the origin of the funds through complex transactions;
and integration, where the cleaned funds are reintroduced into the economy via legal
investments.

Terrorist financing shares similarities with money laundering, particularly in the need to
obscure the origin or destination of funds. A major reputational risk for banks arises if
they are found to be indirectly supporting such activities. The key to preventing both
types of financial crime lies in strict customer due diligence (CDD) and Know Your
Customer (KYC) procedures. Banks are required to evaluate client risk based on factors
such as product type, jurisdiction, customer profile, and transaction volume.

5. Prevention of Financial Crime

Financial institutions combat financial crime through risk-based approaches. Before

opening accounts, banks must assess whether a potential client poses a threat. CDD
and KYC processes are vital tools for identifying and monitoring suspicious activity.

Fraud can also take many other forms in the digital finance system. Examples include
forged signatures, fake goods, inflated insurance claims, or fictitious transactions.
These fraudulent practices can have devastating consequences not only for the
financial institutions involved, but also for individuals, communities, and entire
economies.