The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European...
-
Upload
norma-carpenter -
Category
Documents
-
view
216 -
download
0
Transcript of The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European...
![Page 1: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/1.jpg)
The Role of Finance in Economic Development:Benefits, Risks and Politics
Thorsten BeckEuropean Banking Center Discussion Paper
No. 2011-038, 2011
![Page 2: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/2.jpg)
Introduction:• Alexander Hamilton (1781): « banks were the
happiest engines that ever were invented »• However, the financial sector is also a major source of
risk and fragility• Moreover, « the financial sector is often at the top of
the policy agenda »
• In this article: investigation about the role of the financial sector for growth, the causes and consequences of financial fragility and the politics behind financial deepening and fragility
• Nb: the 2008 crisis put these issues to the forefront of the academic and political debates
![Page 3: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/3.jpg)
Outline of the paper:• Comprehensive survey of the theoretical and
empirical literature on:
1) Finance and Economic Development
2) Financial Fragility: Causes and Policies
3) The Politics of Financial Development
• Nb: this article seeks to bring together these three strands of the literature and to relate them to the 2008 crisis
![Page 4: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/4.jpg)
I.Finance and Economic Development
![Page 5: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/5.jpg)
1. FINANCE AND GROWTH : THEORY
![Page 6: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/6.jpg)
WHY DO FINANCIAL MARKETS AND INSTITUTIONS EXIST?
• Market frictions : asymmetric information (agency pbs, risks of liquidity, default).
• Stiglitz&Weiss (83) : economize screening & monitoring costs, diversify risk.
• Pool Savings : people with different time liquidity needs.
![Page 7: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/7.jpg)
BUT EXISTS AMBIGUITIES
• Aghion, Howitt and Mayer-Foulkes (05) : low and middle income-per-capita most important
• Financial sector attracts too many resources relative to real sector : bad for growth.
• Better resource allocation ; depress saving rates ; overall growth decreases.
![Page 8: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/8.jpg)
2. FINANCE AND GROWTH : FROM CORRELATION TO CAUSALITY
![Page 9: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/9.jpg)
TRYING TO EXPLAIN THE RELATIONSHIP:
• More micro-data : channels through which dvt is associated with eco growth.
• Goldsmith (69) : first to show empirically positive correlation between financial dvt and GDP/capita.
• Levine, Loyaza and Beck (2000) : IV (reverse causation, omitted variables).
![Page 10: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/10.jpg)
• Arcand, Berkes and Panizza (2011) : relationship turns negative for high-income countries.
• With (private credit/GDP) ratio
• 110% is turning point
• 150% turns significant (level reached by some countries in early 2000s.
![Page 11: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/11.jpg)
CRITICS OF GROWTH AND FINANCE RELATIONSHIP.
• Johnson, McMillan and Woodruff (2002) : property rights rather than credit, encourages reinvestment of profits.
• Cull and Xu (2005) : quality of contractual institutions matters
• Acemoglu and Johnson (2005) : prop rights from expropriation by governments more important.
![Page 12: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/12.jpg)
3. BANK VS MARKETS : DOES FINANCIAL STRUCTURE MATTER?
![Page 13: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/13.jpg)
BECK AND LEVINE (2002) :
• What is better? More bank-based or market-based financial systems?
• Overall level of dvt,not structure that plays an important role.
• Not so important of who delivers financial services
![Page 14: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/14.jpg)
4. INTERNATIONAL DIMENSION : FINANCE AND TRADE PATTERNS.
![Page 15: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/15.jpg)
EFFECT OF FINANCE ON TRADE BALANCE:
• Kletzer&Bardhan (87) , Beck (2002), Matsuyama (2005) : financial dvt turns into a comparative advantage for countries with higher needs for external finance.
• Becker&Greenberg (2007) : total exports in financially more developed countries, more sensitive to exchange rate movements.
![Page 16: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/16.jpg)
5. ACCESS TO FINANCIAL SERVICES.
![Page 17: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/17.jpg)
DISTRIBUTIONAL EFFECTS OF FINANCE :
• Benefits different groups of households or firms differently : small enterprises and the poor suffer the most.
• Beck and al. (2009) : positive effect of financial deepening comes mostly through enerprise credit. No significant importance of HH credit.
![Page 18: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/18.jpg)
6. DISTRIBUTIONAL EFFECTS : THEORY AND EVIDENCE.
![Page 19: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/19.jpg)
AMBIGUOUS PREDICTIONS :
• Pro-poor : efficient K allocation, growth accelerator, relax credit constraints (heavier on the poor), reduces income inequality.
• Pro-rich : poor rely more on family connections for K, at early stages of K dvt only the rich can access financial markets.
• Broaden finance beyond micro-credit : have better savings services, payments services (remittances) and insurance services.
![Page 20: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/20.jpg)
CONCLUSIONS AND LOOKING FORWARD.
• Historically, theoretically and Empirically : a lot of evidence for positive role of financial deepening.
• But, cross-country heterogeneity and non-linearity in relationship poses new challenges.
• Therefore importance on the nex section.
![Page 21: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/21.jpg)
II. Financial Fragility: Causes and Consequences
![Page 22: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/22.jpg)
1.FRAGILITY : CAUSES AND POLICIES.
![Page 23: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/23.jpg)
TWO TYPES OF FRAGILITIES.
• Liability risk : maturity mismatch, depositors withdraw funds prematurely and unexpectedly (can be information-based or irrational). Can lead to bank runs and collapses.
• Asset risk : Principal-Agent problem : asymmetric information
![Page 24: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/24.jpg)
POSSIBLE SOLUTIONS.
Diamond and Dibvig (83) : deposit insurance ; reduce likelihood of bank runs.
Bagehot (73) : Liquidity support by a lender-of-last-resort ; solves pbs of ST liquidity.
Capital requirements and lending restrictions.
Strong supervisors.
![Page 25: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/25.jpg)
2. THE TRANSMISSION OF IDIOSYNCRATIC SHOCKS TO SYSTEMIC DISTRESS.
![Page 26: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/26.jpg)
Idiosyncratic : a structural or behavioral characteristic peculiar to an individual (incentive misalignment and inherent fragility)
Systemic : refers to something that is spread system-wide, affecting a system as a whole.
![Page 27: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/27.jpg)
SYMPTOMS
Bank credit and assets inherently cyclical and volatile.
Systemic fragility related to financial liberalization : credit and asset booms, aggressive risk taking (importance of regulatory reforms)
Fragility related to currency crises : rapid real exchange rate movements undermine banks solvency , can affect exchange rate stability.
![Page 28: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/28.jpg)
MACRO SIGNALS OF SYSTEMIC CRISES
Real exchange rate appreciation
Low growth
High interest rates
inflation
![Page 29: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/29.jpg)
TRADE-OFF?
Rancière, Tornell and Westerman (2006) : benefits of financial deepening outweigh the costs of systemic banking distress.
Conclusions tend to support idea that finance is, in the end, good for growth.
![Page 30: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/30.jpg)
III. The Politics of Financial Development
![Page 31: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/31.jpg)
Finance and politics:
• Different theories to explain why financial institutions/markets are on the top of agendas:
• The « public interest view »: maximize the social welfare (normative public economics)
• The « private interest view »: maximize the private interest of politicians/bankers/elites (positive public economics)
![Page 32: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/32.jpg)
The public interest view:
• The policy makers act in the best interest of the society:
• Market failures in financial markets require public interventions
• Production of information, regulation and supervision
![Page 33: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/33.jpg)
The private interest view :• Access to finance can be used:• As barriers to entry into the real
economy (small entrepreneurs suffer, Feijen and Perrotti, 2005)
• To protect rents and dominant positions
• Evidences from the US history:• Benmelech and Moskowitz (2010): when
low voting suffrage, the ruling elites use interest rate ceilings into banking to prevent competitors from gaining market shares.
![Page 34: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/34.jpg)
From Government banking to Activist Policies
• Government ownership: Government intervention in the financial sector has been strong throughout history
• It can lead to misallocation of resources and political capture:• Firms with political connections have easier
access to state banks and receive larger loans but are less likely to repay (Faccio 2006)
• Public ownership is associated with with lower financial development and economic growth (La Porta et al., 2002)
![Page 35: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/35.jpg)
• Public intervention can take many forms: reserve requirements, credit quotas, rate ceilings and floors (« financial repression », Fry, 1988)
• Most of these policies benefited the elites rather than marginal groups: markups on smaller loans, unadequate risk premiums for big firms, lack of incentive for financial services to become more efficient
• Consequence: reforms towards privatization, more market-based financial systems
From Government banking to Activist Policies
![Page 36: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/36.jpg)
Finance liberalization is not a panacea:
• The success of reforms is discussed (Clarke et al. 2006)
• It can lead to financial fragility: • Mexico (1988), privatization of banks but
the domestic shareholders lacked experience, public recapitalization was required (after a boom-and-bust period)
• Some conclusive cases in Central Europe (90’): • In order to impose hard budget constraints
to state owned firms/government, banks were sold to foreign institutions
![Page 37: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/37.jpg)
Political structure as basic factor:
• Why have some countries political structures consistent with financial developement ?
• Basic condition : constraints on political power and protection of individual property rights
• Several studies highlight that autocratic/corrupt government inhibit the financial development (Barth and al.,2006) and more restrictions on political power are more conducive to financial development (Bordo and Rousseau, 2006)
• History of Europe independent cities (North Italy, the Netherlands)
• Two main theories can be mobilized
![Page 38: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/38.jpg)
Legal origins:
• Historical events in Europe shape the legal and regulatory framework accross the globe today
• Spread of these models accross Europe/the world with Napoleonic wars/colonization
• Napoleonic legal tradition = less independent justice, weaker property rights protection and contractual institutions = less conducive to external finance through weaker protection for minority shareholders by instance (see La Porta et al. 2004, Beck et al. 2003)
![Page 39: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/39.jpg)
Mode of colonization:
• Settler and extractive colonies (Acemoglu et al. 2001, 2002), with stronger property rights protection in the former (links with diseases and native population)
• Countries colonized for extractive purposes have less developped financial markets today (Beck et al. 2003)
• Conclusion: importance and persistence of political structures in finance systems development (« path dependency »)
![Page 40: The Role of Finance in Economic Development: Benefits, Risks and Politics Thorsten Beck European Banking Center Discussion Paper No. 2011-038, 2011.](https://reader036.fdocuments.net/reader036/viewer/2022062805/5697c0121a28abf838ccc3fa/html5/thumbnails/40.jpg)
Conclusion:
• The three strands of literature are closely linked:• Growth benefits of finance and financial
fragility are two sides of maturity transformation
• Financial institutions reduce agency problems between investors and entrepreneurs (growth) but face these problems with depositors (fragility)
• Underlying both growth and fragility are political constraints, historically determined
• Current crisis and developement of financial markets in the US is an interesting background on which to bring these 3 themes