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Globalization and its effect on the South African economy

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1. Introduction

“Globalization refers to the shift toward a more integrated and interdependent world economy.” [Hill, 2003: pg6] South Africa provides a unique opportunity to observe the effects of globalization in that the pre democratic period was a period of very little globalization, which can be contrasted with the democratic period which has been characterised by rapid globalization. This sharp contrast emphasises the effects that globalization has on a country.

The essay is a longitudinal study that seeks to understand the impact of globalization on the JSE Securities Exchange, since the democratic elections in South Africa. Firstly this essay will analyse the impact globalization has had on South Africa in general. Then the essay will analyse the effect it has had on South African monetary policy. Further to that it will then analyse the challenges that globalization poses to South Africa. Then there will be more specific analysis on the impact of globalization on the JSE securities exchange. This section will seek to discuss the characteristics of an efficient securities exchange. Comparing the JSE to this will make it possible to determine the effect that globalization has had on the securities exchange and how this has affected the markets efficiency. Then the challenges of globalization facing the JSE will be discussed. This section will try to identify key issues facing the securities exchange, and possible solutions that the exchange can take to cement its place as efficient and reliable worldwide market.

2. The Impact of Globalisation on South Africa

Before discussing the impact that globalisation has had on South Africa, the extent of globalisation in South Africa must first be established. Globalisation’s impact goes beyond economics to cultural, social and political influences as well. A comprehensive globalisation index is calculated by Foreign Policy Magazine, which includes the level of economic integration, technological connectivity, political engagement, and personal contact. The 2005 Foreign Policy Magazine Globalisation Index ranked South¬†Africa at 48; this is behind six other African countries, including Uganda (33) and Tunisia (37). The ranking shows that South Africa is not very well integrated into the global community relative to other countries. This may be due to the fact that South Africa has not been “globalising” for as long as many other countries have. The rankings support this assertion in that South Africa fairs better than China (54) and Russia (52) who have also not been “globalising” for as long as many other countries1.

Tariff, non-tariff barriers and capital controls have all been decreasing since democracy (and South Africa’s re-entry into the WTO); which is in line with the global trend. This is due to the downward pressure that globalization places on tariff structure and capital controls to maintain global competitiveness. Exports of goods and services as a percent of GDP have only increased slightly, from 24% in 1990 to 28% in 2003 [Human Development Report, 2005], and South Africa’s share in world trade has remained around the 0.5% mark since 1995 [South African Department of Trade and Industry]. This shows that South Africa is maintaining its share of exports in the rapidly increasing global exports and thus is not being marginalised by the process of globalization.

The era of globalization has seen growth in world trade exceeding world economic growth, and to discuss the impact of globalisation on South Africa would thus require a discussion on the impact of increased trade in South Africa. Since Ricardian trade theory it has been generally accepted that trade is a positive sum game, and thus when discussing the impact of increased trade in South Africa it is not a question of whether South Africa benefited or not, but rather a question of by how much does South Africa benefit. The Heckscher-Ohlin Theory attempts to clarify the question of who gains more and who gains less from trade.

The Heckscher-Ohlin theory states that “a nation will export the commodity whose production requires the intensive use of the nation’s abundant and cheap factor and import the commodity whose production requires the intensive use of the nation’s relatively scarce and expensive factor” [Salvatore, 2004, 125]. The theory has implications for inequality within a¬†country (Stopler Samuelson) and between countries (Factor Price Equalization).

The Stopler-Samuelson theory, which builds on the Heckscher-Ohlin theory, predicts that with increased trade, the nation’s abundant factor will gain and the scarce factor will lose. In terms of income inequality within a country this means that by increasing trade the lower income group, which control the abundant and cheap factor would realise an increase in income and the higher income group controlling the scarce resources would see a fall in income. The assertion by Stopler and Samuelson that increased trade would cause a decrease in inequality within a country is not strongly supported by empirical evidence. A study by Dollar and Kraay [2001] shows that in the period between 1960 and 1995, inequality has in fact slightly increased within countries that the authors have termed “globalizers “.

The empirical evidence, however, does support the Factor-Price Equalization theorem, which states that the movement of factors between countries is replaced by trade in final goods, thus international trade brings about an equalization of relative factor prices between countries. Dollar and Kraay [2001] use empirical evidence to show that through increasing trade levels the income inequality between countries is reduced. Although the process is slow, Dollar and Kraay [2001] show that through globalisation, developing countries, like South Africa, can reduce the income gap between itself and the rich nations. One must also note that Dollar and Kraay [2001] shows the disadvantage of not globalizing as seen by the widening gap in income between non globalizers and developed countries.

Trade theory thus shows that South Africa can look to globalization to catch up to the richer, developed countries. Empirical evidence shows that the large income inequality in South Africa cannot be reduced by globalizing, the solution to the challenge of reducing inequality in South Africa must come from another source. The empirical evidence of Dollar and Kraay [2001] shows no systematic increase or decrease in inequality with increases in openness, and thus the openness of a country and inequality are generally unrelated. This contradicts the argument that globalisation has a negative impact on a country by widening the income gap. It is also argued that due¬†to the increased competition that comes with globalisation, jobs are lost to maintain competitiveness. This argument is not entirely correct, inefficient jobs are lost; one need not look further than India and China to see that globalisation has the ability to create jobs. Dollar and Kraay [2001] argue that “the real losers from globalization are those developing countries that have not been able to seize the opportunities to participate in this process.”

Globalization is not only associated with increased trade, but also increased foreign investment; either foreign direct investment (FDI) or foreign portfolio investment (FPI). The difference being that FDI is considered a long term commitment where assets within a country are managed by a foreign owner. In the case of stocks being purchased by a foreigner, an investment of 10% and above of total ownership (or equivalent) is FDI, while less is FPI. From this difference in definition, it is clear that FPI is potentially much more volatile than FDI as foreign portfolio investors can simply withdraw their funds from a country whenever they wish (assuming a fairly liquid market).

Appendix B shows the FDI and FPI flows over the period 1972 – 2004, and from observation it is clear that since 1991 the relative size of all flows both into and out of South Africa have increased greatly, suggesting greater global economic integration. In particular, since the “Big Bang” in 1995, FPI increased dramatically until the crash of the Rand in December 2000. Thus the democratic period of South Africa is associated with much larger investment inflows and outflows as compared to the pre democratic period, thus indicating South Africa’s increased integration after democracy.

3. The Impact of Globalisation on Monetary Policies

During the oil price crises of the late 1970s, South Africa borrowed US Dollars extensively, and when international sanctions were placed against South Africa, South Africa was thrown into a debt crisis. This crisis was largely due to the lack of foreign reserves held by the reserve bank, and the fact that it was difficult for South Africa to earn the necessary foreign exchange through trade to pay back the external debt. In order to curb imports, the South African government drastically increased interest rates which decreased investment and consumption, which lead to a decrease in aggregate demand, production and income. The Apartheid regime also led South Africa into large budget deficits due to the large government spending during the regime, and this put further strain on the current account.

It was against this backdrop that the newly elected democratic government undertook the Reconstruction and Development Program (RDP) in 1994, in order to stimulate economic growth and redistribute past inequalities. In 1996, however, fiscal conservatism led to the abolishment of the RDP and the introduction of the Growth, Employment and Redistribution (GEAR) program. This classical approach reflected the international trend at the time, which included reducing budget deficits and inflation. Monetary policy in South Africa is shaped by the inflation targeting approach, with a target of between 3% and 6% inflation in the CPIX.

The inflation rate of South Africa’s major trading partners fluctuates between 1% and 5% [Van Den Heever, 2001, pg169]; and thus the target is set at a similar inflation rate to that of its trading partners so as to maintain South African competitiveness of exports. The choice of the South African government to ascribe to the Bretton Woods institutes recommended monetary policy reflects their desire to maintain global norms within an increasingly globalized world, and thus globalization has shaped the monetary policy of South Africa. This policy may, however, not be best suited to the South African economy, and this topic will be discussed in the challenges of globalization to South Africa.

With the prominence of financial crises in the recent decades, there has been much attention given to exchange rate policy as part of the monetary policy of a nation. The current exchange rate policy in South Africa is that of a free floating (or flexible) exchange rate, thus determination of the exchange rate is through market forces and there is no government intervention. The greatest disadvantage of this policy is that of the volatility associated with flexible exchange rates. An increase in the volatility of the Rand increases the risk of buying Rand denominated assets,¬†and this in turn increases the required rate of return for these assets. The graphs in Appendix A show the percentage change in the Rand / US Dollar exchange rate from the previous day’s rate, and as can be observed there is a great degree of volatility. The standard deviation of the daily percentage change for the period 03/01/2005 to 03/03/2006 is 0.988831.

This shows that the daily percentage changes are spread on average just less than 1% away from the mean of 0.032366%. This has large implications for foreign investors who may find the volatility of the Rand as an obstacle to investing in South Africa. The fact that South Africa is a small open economy with a free floating exchange rate means that exchange rate volatility is unavoidable; the most effective method for reducing this volatility is to fix the exchange rate, or use a managed float or peg. It is generally argued and backed by convincing empirical evidence, as in Bubula and Otker-Robe [2004], that countries are more prone to financial crises if they use intermediate exchange rate regimes (soft pegs and managed floats). Thus, to avoid speculative attacks due to the predictable movements of exchange rates in an intermediate regime, South Africa only has the alternative of a hard peg.

There are strong arguments against this regime, including that South Africa does not have the foreign reserves required to effectively maintain the peg; a flexible exchange rate allows automatic balance of payments adjustment through changes in the exchange rate, whereas a hard peg does not; and possibly the most important restriction of a hard peg to South Africa is that it removes government control of monetary policy. This clashes with the monetary policy of inflation targeting in South Africa. Globalization is pushing countries to ascribe to either a hard peg or free floating exchange rate regime, and this has disallowed South Africa to gain the benefits of a more stable exchange rate while still maintaining some degree of autonomy of its monetary policy that is achievable through intermediate exchange rate regimes.

As the South African Reserve Bank (SARB) has set no targets for exchange rates, it is free to ascribe to its inflation targeting policy, and the necessary market interventions required to control inflation. The approach of inflation targeting works as follows: the government sets a target of 3%-6% (this should be backed by a model which predicts inflation, taking into account all possible influences on South African prices), the labour force and firms must then adhere to this target and only increase wages and prices by between 3% and 6%, and thus the eventual outcome is an inflation rate within the targeted bracket. Central to inflation targeting is that the government must fully commit to the target, and take any necessary intervention to keep inflation within the target.

Thus if the SARB anticipates inflation exceeding the upper limit, usually due to an exogenous shocks, it should reduce money supply or increase the interest rate so as to decrease aggregate demand and thus prices. Soon after the implementation of inflation targeting in South Africa, inflation soared above the 6% mark, but since mid 2003 inflation has been within the bracket which has created the much needed confidence in the SARB [South African Reserve Bank Monetary Policy Review, 2005]. A major implication is that South Africa has managed to control inflation with minimal intervention in the economy and thus not having to incur excessive inflation unemployment trade-off as posited by the Phillips curve.

If there is an exogenous shock to the South African economy, such as the recent high oil prices, the SARB has two options, it could either address the shock using the traditional inflation controlling mechanism of a decrease in money supply or increase in interest, or use an “escape clause”. This clause is essentially an excuse as to why the inflation is higher than that predicted by the model used by the reserve bank, and thus aims to allow higher inflation rates while still maintaining the credibility of the SARB. In some cases an exogenous shock’s impact on inflation could be greatly reduced using interest rates, but an escape clause may be preferable so as to avoid the cost of controlling inflation in the short run.

4. The Challenges of Globalisation in South Africa

Econometric analysis by Dollar and Kraay [2001] show a statistically significant relationship between growth and trade; an increase in openness by 20% increases GDP growth by 0.5%-1% annually. This is a very large increase in openness and a relatively small increase in growth, thus although there is a positive relationship between trade and growth, trade is not sufficient as an engine for growth. The challenge for South Africa is not to be consumed by the craze of globalization and the pressure to subscribe to the international trend, but to rather focus on creating economic growth and employment in South Africa. Although these two forces can be complimentary, this is not necessarily the case. In South Africa there has been much attention given to the creation of a policy environment conducive to globalisation, but South Africa has not achieved the required growth to alleviate poverty and unemployment. Critics of South African economic policy may argue that there is a need for demand side policies as prescribed by Keynesian economics, but this goes against the current global trend.

The GEAR program aims to create economic growth through a stable economic environment attracting foreign investors. In particular, inflation targeting in South Africa is to ensure price stability, and thus lower the risk of investing in South Africa. Price stability has been achieved in South Africa but many economists would argue this is at the expense of growth. South Africa, in attempting to gain the benefits of globalization through increased trade and investment, may have reduced growth in the economy.

The GEAR program requires foreign investment to stimulate growth, and thus considers increases in the interest rate as a trade off for attracting foreign investment. Appendix B shows that FDI flows into South Africa have not been impressive, and with the exception of the large FDI inflow in 2001, FDI plays an almost negligible role in the South African economy. The reason for this is that it is not sufficient to simply remove the disincentive to invest in South Africa, but to attract FDI the government needs to introduce incentives for investment. The fact that the anti export biases for South African goods are all positive, with the exception of motor vehicles and meat, shows that the current tax and tariff structure creates a disincentive to export.

This disincentive to export, coupled with the fact that South Africa is a relatively small economy means that there is no reason for a foreign company to voluntarily produce in South Africa. Globalization presents a good opportunity for less developed countries to generate growth and improve technology through FDI, unfortunately South Africa has not managed to allow this facet of globalization to impact South Africa. The challenge that globalization presents to South Africa is to create an economic and policy environment that will attract FDI, and if South Africa fails to do so it will continue to be marginalized by the ruthless forces of demand and supply.

In contrast to FDI, FPI has increased dramatically, and although this may be seen as a positive, the challenge for South Africa is not to allow “hot money” to create economic instability through contagious withdrawals from South Africa allowed by globalization and the opening of financial markets. Kim [1998] as referenced in Stern and Chew [2004, pg463] defines “Hot money” as “international flows or funds that are highly sensitive to differences in interest rates, perceived economic growth rates, and expected returns”. The volatility associated with FPI, and the increased FPI flows due to globalization, has led to the increased concern of capital flight, and thus there has been much debate over whether to liberalise capital controls.

With no capital controls, portfolio investors are free to withdraw all their capital simultaneously, with the result being financial crisis. If capital is rapidly deposited in a country, it can put inflationary pressure through an increase in money supply. On the other hand reducing capital controls gives investors greater confidence in the economy, and allows foreign capital to contribute to the growth of the economy. Instead of using capital controls to ensure economic stability, it is argued that a country should rather create economic stability through price and exchange rate stability to avoid large destabilising capital flows. This is the case in South Africa whereby the very strong capital controls evident in the pre democratic period have been slowly reduced in the post democratic period in accordance with the liberalisation of the South African policy in this period.

The crash of the Rand in December 2001 shows both how open the South African economy is to the contagion effect, and how susceptible it is to capital flight. Following the Argentinean financial crisis and debt default, investors lost confidence in developing countries, and thus many investors¬†withdrew investments from developing countries. This is observed by the negative value of FPI inflow (an outflow in the BOP) recorded in 2001 of -2.35% of GDP. What is interesting is that the outflow of FPI at 4.28% of GDP, which is South Africans pulling their money out of South Africa and into foreign portfolio investments, far exceeded that of the foreigner’s withdrawal.

This is consistent with the empirical findings of Kim [1998] as referenced in Stern and Chew [2004, pg 465] that in the Mexican and East Asian financial crises it was the local investors that were largely to blame for the massive capital outflows and thus the massive instability. Kim [1998] as referenced in Stern and Chew [2004, pg 465] argues that foreign investors are more stable as “they are aware of the volatility, instability, and risk of the emerging stock markets”. For this reason it could be argued that globalization, and opening up of financial markets, does not create a large, unstable foreign capital base, but instead presents the positive opportunity to increase capital and investment and thus increase the production within an economy.

The inflation targeting monetary approach in South Africa has resulted in keeping inflation between 3% and 6% the priority of the reserve bank, but this may be at the expense of economic growth. The Bellasa-Samuelson effect shows that higher rates of inflation than a country’s trading partners should be allowed for a developing country, to inhibit this inflation would be to inhibit economic growth. In trade between two countries, one a developed country and the other a developing country, Bellasa-Samuelson assume that the developed country is more productive in producing traded goods than the developing country, but that they are equally productive in the production of non traded goods. It is also assumed that purchasing power parity holds for the traded goods.

During the process of globalization, the developing country trades more, and this increases the productivity in traded goods due to the increased competition and the inflow of capital and technology. This increased productivity results in wage increases for labour in the production of traded goods, but as wage movements within a country are not separated between production of traded and non-traded goods, the wage levels increase throughout all production, this increases the price of non-traded goods, in particular services, and this creates inflation in the economy. This inflation, however, has no effect on the exchange rate as it is due to increases in the price of non-traded goods. This theory shows that in a developing country, where the production of services (non-traded goods) is expanding, that inflation is inevitable, and to reduce this inflation would be at the cost of economic growth.

5. Impact of globalization on the JSE:

In order to assess the impact of globalization on the JSE, the role it plays in the South African economy must first be clarified. As Roy Anderson, ex-Executive President of the JSE, said in the 1996 annual report, “It (the JSE) plays a central role in the South African economy by providing a secure and efficient mechanism through which the capital and savings of domestic and foreign investors can be channelled into the best areas of investment.”

More specifically a securities exchange looks to fulfill three basic functions, namely: channeling savings into investments, providing investment liquidity, and evaluating securities and companies’ management [Mkhize, working paper: 5]. Firms that wish to expand operations or enter into new projects look to the primary market the JSE provides to raise capital. It is here that economic units with surplus resources look to invest their funds and the JSE therefore serves to bring the surplus economic units and the deficit economic units together to make greater economic profits possible and create employment opportunities. In a securities exchange, it is also important that savings are channeled into companies that have the best growth prospects and thus will be more beneficial to the economy. Companies with good growth prospects will be able to earn a higher price for the issue of their shares because of potential gains to investors.

This will decrease the cost of raising capital as the dilution of ownership to the current shareholders is reduced (as the firm will have to issue less shares for the required increase in capital). Companies with a high potential for growth have high share prices in relation to their earnings. Therefore, they are encouraged to obtain additional funds on the capital market because they have high NPV projects in which to use these funds. Companies with low growth have less incentive because they do not have high NPV projects in which to use these funds. The implication of this allocative efficiency is that firms with better growth prospects will be more willing to acquire funds as it is cheaper and the limited savings of the country will be channeled to the companies that can make the best use of it.[Mkhize, working paper: 6].

In order for this to happen there needs to be a sufficient secondary market for securities in order to correct the liquidity problem between investors and the firms. The problem is that the lenders prefer short term investments while the borrowers require the funds for a longer term. To solve this mismatch of liquidity preferences, the securities exchange must provide the lender with the ability to convert securities to cash on short notice – it must provide them with liquidity. The secondary market is therefore necessary for the primary market to function correctly as the savers would not invest without liquidity.

By listing on the JSE, a company is required to publish their financial statements and results, and potential investors in the JSE will therefore have enough information to determine the intrinsic value of the company’s shares. This leads to a market price of the shares that reflects all information available to the public and in turn provides an evaluation of the company’s, and its management’s, performance. There is also pressure on management to create a positive public image of the company. This is best done by good performance, so the securities exchange works to improve the profitability of the companies listed on it.

Looking at the empirical evidence over the period in question it is possible to analyze key market indicators, as to the performance of the JSE as a securities exchange and assess how globalization has effected them. Firstly it is important to look at the JSE’s ability to raise new equity capital for firms. New equity raised increased from R10 billion in 1994 to R82,155 billion in 2005. This is a clear indicator of how globalization has positively affected the JSE and helped to fulfil its functions as a securities exchange. There are a number of different reasons for this effect from globalization.

Firstly, globalization has the affect of lowering the required rate of return to investors. This is done via the portfolio perspective and improvements in corporate governance. The portfolio perspective describes the added diversification benefits from holding a globally diversified portfolio instead of a portfolio that is only diversified locally. The local portfolio will require a premium on return for risk that is systematic to the local market but not to the global market. By opening an investor up to global investment opportunities, he is able to take advantage of these extra diversification benefits by diversifying away the country-specific risk, and can therefore reduce the risk premium and therefore the cost of capital.{ADD MORE}

Corporate governance partly determines the cost of capital for a firm. The better the corporate governance systems that are in place in a company, the lower the cost of capital ceteris paribus. This is because shareholders are less at risk of managers acting in their own interest by taking on projects that may not raise the value of the company. Globalization benefits corporate governance in many different ways and therefore serves to further decrease the cost of capital.

Companies that have weak or ineffective boards of directors, that will not remove or discipline managers, will have a higher cost of capital. Firms that wish to raise equity from foreign investors will need to elect a strong board in order to gain the confidence of the foreign investors thereby decreasing the cost of capital.

By entering into foreign markets, firms will have access to more investment bankers to market their shares. Good companies will therefore be able to issue shares with more reputable banks, increasing investment confidence in the firm.

Firms with foreign shareholders need to protect themselves against the legal systems of all shareholders. Firms from countries that have less protective legal systems therefore gain from the addition of foreign investors in a reduction of cost of capital.

The more concentrated the ownership of a company is, the more monitoring management is likely to go through because it is only profitable for large shareholders to engage in monitoring efforts. Opening up a firm to global investors increases the chance of large shareholders entering the firm.

Companies that are open to foreign investment are also more vulnerable to takeovers or the possibility of investors buying a controlling share. This places more pressure on management to perform well so that they do not lose their job.

Companies can also commit to higher standards of disclosure by listing on other exchanges. This makes it safer for investors because it is harder to hide poor performance when more information is disclosed.

Another reason, it that globalization opens the JSE to a much larger market. This is because the JSE now has access to the huge world markets. A large, and increasing, number of potential investors increases the amount of new capital that can be raised each year. This gives companies an infinitely deeper pool from which to draw their funds. Looking at the foreign trading statistics, it is seen that foreign activity has greatly increased since the pre-1994 era. The foreign percentage of the total trading has risen from 40,7 % in 1991 to XXX% in XXXX. This foreign investment falls under two broad categories: FDI (Foreign Direct Investment) and FPI (Foreign Portfolio Investment). FDI “…occurs when a firm invests directly in facilities to produce and or market a product in a foreign country.”(www-biz.aum.edu/jclark/305/Chap6.htm)

The main difference between FDI and FPI is that FDI involves an investment for a controlling stake in the investment. FDI occurs when an investor makes a greater than 10%, of an asset, investment, in another country. FPI involves investing a less than 10% stake in a foreign asset. Both can be used as indicators of the impact of globalization. In South Africa the FDI figure, for 2004, was R355 Billion, up from RXXX , in XXXX. The FPI figure, for 2004, was R352 Billion, up from RXXX, in XXXX. The globalization of the JSE has allowed this great increase in capital raised each year. (see figure X)

Liquidity is another important indicator of a securities exchanges performance. The JSE’s liquidity figure was 4,1% in 1992. The 2004 figure was 27,2%, this relationship is shown by the following graph.

This indicates a large impact on the JSE. The factors that affect liquidity and their relation to globalization will now be discussed to further the understanding of how globalization has impacted the JSE.

Firstly, the number of transactions per year can be analyzed. The number of transactions effects liquidity because a higher number of transactions implies a market with a lot of activity. This means that the market is more competitive and that the shares are constantly being traded. Due to this consistent trading the investments become a lot more liquid because investors are more quickly able to buy and sell shares. Globalization has increased the amount of transactions each year because it has opened the JSE to the huge worldwide markets. The statistical data from South Africa shows an increase in the number of transactions from 460 200 in 1992, to 5 064 042 in 2005. So globalization has increased the number of transactions each year and made the market more efficient.

Globalization also allows for technology sharing which increases the speed of transactions and allows the securities exchange to process more transactions every year.

This technology flow is a dynamic process in which the JSE seeks to integrate itself more strongly in the worldwide markets. The JSE has been forced to take these actions, as it would not be able to stay competitive, on the world markets, if it did not. As such the search for technological efficiency is central to the JSE’s ability to function as a leading exchange, in these times of globalization.

After the 1994 elections, there was pressure for the JSE to restructure. This restructuring was called the “Big Bang”. It involved numerous internal regulation changes within he JSE. The regulations changed to allow foreigners membership to the exchange, brokers commissions changed and brokers were allowed to at as the principle and agent. Following from this the JSE made a move toward automated trading. The pressure to stay competitive, mentioned above, made the JSE align themselves with global trends. This was the overall goal of the Big Bang Restructure [Mkhize, 2005]

The first major trading system to be introduced was the JET System. The JET System is an automated system, taken from the Chicago Stock Exchange, that took over from the open outcry system between March and July, 1996. This following extract from the JSE’s 1996 annual report, [www.jse.co.za/publications/arep/1996ann.htm], fully indicates the impact of this system, “The JET System has already resulted in significant improvements in transparency, price formation, security, liquidity and cost of trading on the JSE.” In its first year alone the system increased odd lot sales by 30% [JSE Annual Report, 1996]

Share Transactions Totally Electronic (STRATE) was a further technological advancement introduced in 1999. “STRATE was a provider of a growing number of products, data and services in line with market demands and trends.”, [Mkhize, 2005: Page 23] This system was an answer to the problem of the paper-based system. It made all the transactions electronic and allowed for much more efficient settlement, and a much more efficient exchange. It was also up-to-date with international trends and increased the JSE’s competitiveness a securities exchange [Mkhize, 2005]

A more recent technological advance has been the introduction of the Stock Exchange electronic Trading Service (SETS), in May 2002. This system was taken from the London Stock Exchange (LSE) after a deal between the two exchanges fuelled by globalization. This system can handle more volume and is expected to improve the JSE’s performance, according to the JSE CEO, Russell Loubser. The LSE has the same platform, and the idea was that, when exchange controls go, investors from both London and South Africa will be¬†able to benefit from this technology sharing.

” (SETS) is new technology which is flexible, scaleable and robust and it is working like magic,” JSE chief executive officer, Russell Loubser.

All in all these changes have helped integrate the JSE with worldwide market. They have also helped the exchange become more efficient, and handle the greatly increased activity that globalization had brought: Globalization has provided the driving force behind these changes. Now more statistical indicators will be looked at to further gather the impact of globalization.

Market turnover is very closely related to liquidity as it measures the value of the transactions that took place during the year. When compared to the market capitalization it gives a very good idea of the liquidity of the market. Globalization increases the market turnover because the market size has increased, and increases more as the world economies become more integrated. Globalization also allows for technology flows and reduces exchange controls (Big Bang), as explained above, which allow the securities exchange to function at a higher turnover. This larger turnover increases the liquidity of the market because most of the assets are traded more frequently and with greater competition. This allows investors to invest in assets that can be converted into cash in the short-term. The statistical evidence in South Africa shows this effect. The value traded in 1992 was R22 billion. This figure grew to R1278,69 billion in 2005 [see Table A above]. Whilst it is acknowledged that part of this growth is due to the increase in the market capitalization, part of it results in an increase in liquidity.

Another factor that affects the JSE is the number of companies listed. Globalization increases the information that investors have on assets, and it also puts companies in the public spotlight. This puts pressure on companies to perform. Companies that have bad performance will be forced to de-list, so the overall effect will be that the better companies will attract the majority of the investments, and bad companies will be forced to de-list. This channels the money of the investors into the most productive areas, as explained by allocative efficiency above. It also lowers the selection of companies that investors have to choose from. This increases the competition between investors funds, and works to drive the exchange towards efficiency. In the JSE there were 740 companies in 1991. By 2005, this number had dropped to 388 [See Appendix D]. At the same the market capitalization has increased enormously from R508 billion in 1991, to R3586.1 billion in 2005 [See Table A above]. So this huge growth is subject to a few selected companies. This increases competition, and hence efficiency.

More foreign companies listed on local exchanges also effect a securities exchange because of global diversification. Investors will try to achieve diversification in their portfolios. If an economy has foreign companies listed, this allows local investors to diversify by investing in these companies, in their domestic exchange. It also serves to better diversify the securities exchange as a whole. In the there were 30 foreign countries listed in 1991. This figure has decreased to 24 at the present time [See Appendix D]. Even though the absolute number of foreign firms has decreased, the relative overall amount has increased. This means that both the securities exchange and investors can now benefit from better global diversification.

{Rory I haven’t had time to start a conclusion, pls put everything together and send it back to me. I will only be able to do the conclusion later]

6. Challenges of globalization on the JSE: (Pre-1994)

Financial globalization can be defined as “the integration of a country’s local financial system with international financial markets and institutions. This integration typically requires that governments liberalize the domestic financial sector and the capital account. Integration takes place when liberalized economies experience an increase in cross-country capital movement, including an active participation of local borrowers and lenders in international markets and a widespread use of international financial intermediaries.” (Schmukler, S. and Zoido-Lobaton, P., 2001) ‘Globalization’ of the JSE, as an international exchange, can¬†typically be described as the practice of undergoing dynamic technological and regulation development to improve efficiency and increased regional and global integration.

The JSE is a financial market in pursuit of the benefits of globalization, seeking further integration with other international financial markets. It is written in the Bible: “Can two walk together, lest they be agreed?” (Amos 3:3) And this is true of the globalization process. The world’s leading financial exchanges are characterized by high liquidity, near perfect public information, low transaction costs and almost instant and accurate pricing information. This means that in order for other international markets like the JSE to integrate with these world market leaders, they need to share very similar regulations, standard of technologies, and strategic goals, or else pairing close relationships (integration) is almost impossible.

Prior to democracy, the JSE, along with the entire South African economy, was suffering from the ‘squeeze’ of international isolation. Whilst the leading financial markets of the world had established a financial network , the JSE was essentially a shrinking market characterized by illiquidity, inefficiency and concentration.

This abased situation had led to next to zero globalization due to the near perfect isolation of South Africa brought on by years of international sanctions; as discussed in 5. above.

In order for the spiralling pattern to change to one of a globalizing exchange, major strategic shifts needed to be made in conjunction with radical political change. These strategic changes were discussed in 5. Even if the JSE had had the best will in the world to globalize pre-1994, it can be speculated that any efforts to do this would likely have been undermined by a foreign investor trading boycott; arising either from the complete lack of credibility in an unstable, insecure and illiquid South African financial market, or for moral reasons in objecting to support an economic agent of a discriminatory and oppressive government.

JSE pre-1994, as mentioned, “suffered from illiquidity, lack of information, fairly high transaction costs, as well as inefficiency of price information.” [Mkize, H., 2005] These shortcomings were symptomatic of the real underlying challenges or major obstacles to globalizing the JSE pre-1994, which can be identified as: “concentration, thin trading and illiquidity, institutional investors, and to some extent single capacity trading.” [Mkize, 2005, pg10] Reilly and Norton (1999: pg 113-114) specified criteria characterizing an efficient exchange: Informational efficiency, liquidity, internal efficiency, and external efficiency. It can be argued that in order to participate in a globalized market, these criteria had to be met first. The JSE committee was faced with the need to restructure to try and attract foreign investors by eliminating its shortcomings. [Mkize, 2005] These challenges will be broadly discussed as follows:

Concentration:

Prior to 1994, South Africa had high levels of economic concentration. In 1990, the top four firms’ capitalized value comprised roughly 80% of the capitalized value of the JSE. [Mkize, H., 2005] The reason for this high concentration was due to South Africa’s response to isolation, involving protectionary capital controls that forced companies to invest their free cash flows domestically. This spawned the creation of pyramid structures, controlled by a select few holding companies; namely the top four companies. [Mkize, H., 2005, pg 10]

These high degrees of economic concentration supported monopolistic markets that stifled competition. Relating to this market inefficiency, concentration prevented firms outside the pyramidal umbrella of the few large companies from raising long-term capital. This could contribute to eventual de-listing. Therefore, the JSE had a “modest role” in attracting entrepreneurs as a source of new equity capital. [Mkhize, H., 2005 pg 12]

Institutional Investors:

Prior to 1994, there was a rapid increase in institutional investors on the¬†JSE, combined with a decrease in private investors. Two main causes existed: to avoid high taxes and inflation, private investors sought to move their funds from banks and building societies to endowment policies; and private investors’ preferences changed from equities to unit trusts. Empirical evidence suggested institutional investors concentrate their spending on a narrow band of shares usually falling under the control of large holding companies as referred to earlier. The reason for this is that they are considered of blue chip quality and “reasonably marketable.” [Mkhize, H., 2005, pg13] Consequently, institutional investors were blamed for thin-trading, with only 20% of shares registered on the JSE actually traded. Thin trading of few shares prevents efficient trading of the remaining shares, and as with market concentration, the JSE was not able to properly fulfil its primary role as a source of capital and its secondary role as a source of liquidity.

[Mkhize, H., 2005]

Thin Trading’s effect on Recorded Price and Liquidity:

Bradfield’s study in the 1980s revealed difficulties in estimating “the beta value in JSE listed companies.” [Mkhize., H, 2005, pg14] His reason given is that shares on the JSE were thinly traded. The recorded price of a share will stagnate if no trade activity occurs, differing from the underling price which would include new information for the given period. The market index can also be distorted if thinly traded shares are present in the market portfolio.

[Mkhize., H, 2005]

Thin-trading contributed to illiquidity, as a willing and able buyer was not always instantaneously available, pressurizing the seller to sell at a discount instead of its fair value. Investment decisions were also hampered by distortions in risk measurements, such as the beta value, rendering judgements based on capital market theory to be regularly incorrect.

[Mkhize., H, 2005]

Therefore, pre-1994, the JSE was “unable to fulfil its core and essential functions.”

[Mkhize., H, 2005, pg 15]

Single Capacity Trading:

Single capacity trading is trading by brokers on behalf of their clients that exempts these brokers from having a significant capital reserve or having share interests of their own. Prior to 1994, by law, only JSE member stockbrokers were allowed to trade, and brokers had to be of South African citizenship. This gave unfair advantage to JSE member brokers, permitting them to trade on other financial markets, but prohibited other financial institutions from trading on the JSE. Market instruments often relied on JSE underlying share prices, that brokers were privy to but non-members were not (until the information became public).

[Mkhize., H, 2005]

The privileges afforded to member brokers also indirectly encouraged brokers to have contempt for small scale investors with “less than R2500 to invest.” [Mkhize., H, 2005, pg 15] The reason is that the cost of transacting such an amount exceeded R2500.

[Mkhize., H, 2005]

8. Challenges of globalization on the JSE (post-1994):

After overcoming the challenges to globalization facing the JSE of the pre-1994 period, the increasingly more integrated and technologically advanced JSE that we have today, has challenges to globalization of a less unique type than before. The apartheid era had produced many unique South African challenges of globalization when the JSE first moved toward openness. A new challenge for example, in 1999, was when the JSE realized that as an emerging financial market competing in a changing global arena, more business specific challenges needed to be the focus. All open international financial markets are susceptible to global shocks, so as a dynamic globalizing exchange, the continual advancement of business technologies and processes would have to be the cultural norm in order to increase its global competitiveness.

These challenges have been met by various technological instalments on the JSE, as mentioned in 5. above, and because of the nature of technology, developments are ongoing, and the incentive is to be a dynamic market innovator to safeguard against falling behind and losing competitive edge. Globalization has a drive fueled by the lure of access to foreign diverse investment opportunities. As much as globalization is the JSE’s ‘chosen path’, the increasingly open nature of the South African economy gives little choice to the matter, as an open economy with poor fundamental macroeconomic policy backing and/or an infant financial system, can spell disaster, as was the case in the Mexican (1994) and the East Asian (1997/8) crises respectively. [Kim, 1998; as cited in Stern and Chew, 2004: pg 465-466]

In light of the above, it is clear that the JSE is locked into an ongoing globalization process, and like other liberalizing exchanges, the JSE faces the same twenty-first century challenges as liberalized financial markets. Georges Ugeux, in the Brookings-Wharton Papers on Financial Services, suggests that there are five challenges of globalization on the New York Stock Exchange (NYSE), which is arguably the most globalized financial exchange in the world. Here we paraphrase and infer on his remarks:

The first challenge to globalization is that liquidity should always be kept at the centre of an exchanges priority, because traders are “…in the reinsurance business…litigation of prices should always be kept at the lowest possible level.” (Brookings-Wharton Papers, 2000, pg 17) In other words, high liquidity translates to accurate pricing, and this trust in pricing is at the centre of a reputable exchange. It seems that Ugeux¬†suggests that in the drive for globalization, the choice of markets for further integration should not result in a disturbance of liquidity and accurate pricing. This may pose as a warning to the JSE as it strategically seeks regional globalization with less efficient exchanges than itself.

The second challenge is the issue of time zones and increased trading hours. Geographically, broad global integration has to confront often severe time differences and therefore mismatching in trading hours. This can be overcome by extending trading hours. Ugeux says the NYSE is “under tremendous pressure to have a twenty-hour trading period.” (Brookings-Wharton Papers, 2000, pg17-19) A move such as this in the future would surely ratchet-up pressure on all other open exchanges to do likewise to be as competitive and liquid. The JSE would be faced with this challenge if it is to continue pursuing its development as a global player, as its strategic objectives outline.

The third challenge relates to communication and announcements. Ugeux cautions against exchanges becoming a victim in the information race by prematurely feeling forced to communicate information; possibly even before thorough ratifications. “Creating a global alliance is such a huge challenge, and it is only possible to announce a little bit of progress made in one field or another.” (Brookings-Wharton Papers, 2000, pg19). Announcements on developments in globalization, like announcements for any listed company, need to be prudent so as to never give away too much in areas where delivery may be questionable, or too little so that progress is deemed too slowly forthcoming. Here the JSE would be cautioned to take careful consideration to the timing and the substance of its communications on global developments.

The fourth challenge concerns regulation platforms. One of the main obstacles to globalization facing policy-makers is the mismatch in regulations across national borders. For example, Ugeux, at this time in 2000, draws attention to the fact that an alliance with Canada would need several years to overcome this drawback, even though both exchanges already share strong similarities. With the rules and regulations in place at that time in 2000,¬†Ugeux says that a similar alliance with Tokyo would simply “not be doable.” (Brookings-Wharton Papers, 2000, pg19). It is suggested that the presence of technical and legal ‘red-tape’ in this matter calls for globalizing exchanges to “prepare a new regulatory landscape.” (Brookings-Wharton Papers, 2000, pg19).

The fifth and last challenge Ugeux singled out to be “the regulatory paradox.” (Brookings-Wharton Papers, 2000, pg19). Some regulations are established practices which makes changing them practically problematic. For example, with regard to cross-listings, if Japanese companies traded on the Nasdaq in Japan, they would have to implement the terms of the United States (US) Securities Act of 1933. But the reason why these companies prefer to be listed in Japan rather than the US, is that they do not wish to comply with the Act. This is a major obstacle to cross-listings between Tokyo and New York. Another aspect of the regulatory paradox would be the degree of comparability of financial data for investment analysis across national borders. For example, the NYSE has standards and regulations governing how a company may calculate profit which may not apply to another exchange.

(Brookings-Wharton Papers, 2000, pg19).

The JSE’s cross-listing with the LSE in (DATE) means that regulations and standards are shared. Because the United Kingdom and South Africa share very similar accounting standards, investment analysis between British and South African companies is comparable. Therefore, this challenge for the JSE may only be relevant to any future alliances.

If globalizing in the years to come will occur between the JSE and other international exchanges to the extent that it has occurred with the LSE, then these major challenges above will need to be strategically tackled systematically. Ugeux suggests that commitment to effective conflict resolution over differences across national markets is critical to successful globalizing, and to achieve this, the suggestion is made that “the only way that globalization will happen in a reasonably smooth way, is by building an increasingly international partnership with regulators and¬†government on cross-border issues…pointing fingers at them (regulators) and at us (government) will not work. The challenge of globalization is being around the same table and conveying the kind of regulated market that we believe we can and want to keep for investors and for companies. That is the ultimate challenge of globalization.” [Brookings-Wharton Papers, 2000, pg21]

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