Does Financial Liberalization Spur Growth?

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Does Financial Liberalization Spur Growth?
American Finance Association Meetings January 2002

• Geert Bekaert
• Columbia University and NBER
• Campbell R. Harvey
• Duke University and NBER
• Christian T. Lundblad
• Indiana University

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Financial Liberalization and Growth

• Controversial exercise
• Liberalization implies consumption booms and
  inefficient investment (crisis literature)
• Liberalization may lead to reduced savings
  (endogenous growth literature)
• Liberalization may lead to hot speculative
  capital inducing capital flight (Stiglitz
  others)

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Financial Liberalization
Relaxing Fin Constraints
Growth Opportunities
Cost of Capital
Financial Development
Investment
Efficiency of Investment
Complex exercise
Growth
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Financial Liberalization and Growth

• What we already know (too many references to
  list!)
• Financial/banking development associated with
  higher growth
• Cost of capital decreases
• Investment increases

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Financial Liberalization and Growth

• What we know as a result of our research
• We document a liberalization effect on growth
  with certain "standard control variables"

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Financial Liberalization and Growth

• What we know as a result of our research
• The liberalization effect is robust to
• different definitions of liberalization dates
• to business cycle or interest rate controls
• allowing for intensity of liberalization
• ...and independent of capital account
  liberalization

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Financial Liberalization and Growth

• What we know as a result of our research
• We show the mechanism. Both
• increased investment, partially through a cost of
  capital effect and
• increased productivity (which is different from
  the financial development literature)

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Financial Liberalization and Growth

• What we know as a result of our research
• On the mechanism ...
• Liberalization does not lead to consumption binge
  
• investment increases
• trade balance decreases

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Financial Liberalization and Growth

• What we know as a result of our research
• On the mechanism ...
• Investment increases - but you need a minimum
  country quality level to see effect
• decreased cost of capital associated with more
  investment

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Financial Liberalization and Growth

• What we know as a result of our research
• On the mechanism ...
• Productivity increases
• and this is not just a banking development effect
  

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Financial Liberalization and Growth

• What we know as a result of our research
• We investigate whether part of the effect can be
  ascribed to
• macroeconomic reforms
• financial development
• other regulatory reforms

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Financial Liberalization and Growth

• What we know as a result of our research
• Macroeconomic reforms ...
• Liberalization not spuriously reflecting
  macroeconomic reforms
• we control for trade openness, inflation, black
  market premiums, and government deficits

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Financial Liberalization and Growth

• What we know as a result of our research
• Financial development ...
• Degree of banking and equity market development
  is important but independent boost from
  liberalization
• we examine the size of private credit, equity
  market activity, and equity market size

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Financial Liberalization and Growth

• What we know as a result of our research
• Other regulatory reforms ...
• The financial liberalization/growth effect is not
  a post-banking crisis effect
• The enforcement of law and institutions are
  important

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Financial Liberalization and Growth

• Econometric Framework

• where
• yi,tk,k is real per capita GDP growth between t
  and tk
• Qi,1980 is initial GDP,
• Xi,t represents control variables
• Libi,t is a Liberalization indicator variable

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Financial Liberalization and Growth

• Econometric issues
• Temporal dimension
• Different weighting matrices
• Liberalization variable
• Choice of k
• Endogeneity of the liberalization decision

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Financial Liberalization and Growth

• Data 4 samples determined by data availability
• Sample I 95 countries
• Sample II 75 countries
• macroeconomic and demographic data
• Sample III 50 countries
• Sample IV 28 countries
• add financial development indicators

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Financial Liberalization and Growth

• Conclusions
• Financial liberalization spurs growth by 1 per
  annum over the five years
• Survives a battery of robustness experiments
• We understand better the channels whereby growth
  impacted by financial liberalization
• Liberalization effect not spuriously accounted
  for by a host of other events such as
  macro-economic reforms

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Financial Liberalization and Growth

• Conclusions
• Financial liberalization has a very important
  economic effect

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Financial Liberalization and Growth

• Conclusions
• Financial liberalization has a very important
  economic effect
• Consider economic impact of improvements plus a
  equity market liberalization

Liberalization
Total Growth 3.02
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Financial Liberalization and Growth

• Future research
• Growth regimes
• Explore the channels of growth with firm level
  data