DEVELOPMENT ECONOMICS
DEVELOPMENT ECONOMICS
Sponsored by a Grant TÁMOP-4.1.2-08/2/A/KMR-2009-0041 Course Material Developed by Department of Economics,
Faculty of Social Sciences, Eötvös Loránd University Budapest (ELTE) Department of Economics, Eötvös Loránd University Budapest
Institute of Economics, Hungarian Academy of Sciences Balassi Kiadó, Budapest
DEVELOPMENT ECONOMICS
Author: Katalin Szilágyi
Supervised by Katalin Szilágyi January 2011
ELTE Faculty of Social Sciences, Department of Economics
DEVELOPMENT ECONOMICS
Week 12
Financial openness and development
Katalin Szilágyi
Credit markets in developing countries
• Credit markets: imperfections
• Information is imperfect → strong institutions needed for contract enforcement
• Developing countries: institutions missing → information problems amplified
• Inefficient allocation of funds, high interest rates (spreads) etc.
Financial liberalization
• Does liberalization help?
• Trade openness ~ financial openness?
• Theory and empirics
Outline
1. Historical trends in financial openness
2. Empirical evidence on financial
liberalization
1.Historical trends
Economic history
• Gold standard
• International system of fixed exchange rates (gold parity)
• Fully liberalized capital flows
• No independent monetary policies for individual countries
Bretton Woods
• Objective: promote international co- operation (trade)
• Fixed (but adjustable) exchange rates
• Full convertibility of national currencies for flow transactions, but capital controls prevail
Capital controls
• Diverse controls
• Fears of hot money, bad experience from the 1930s-40s
• Governments eager to follow
independent policies (interest rates), free flow of capital is a danger
International finance
• Current account imbalances are
financed by international institutions (IMF), official loans and international reserves
• No private funds involved in international capital flows
Controversies
• Trade flows booming, free
internationally ↔ constrained capital flows
• Recourse to trade credit
• Accounts for trade partners
• Financial transactions in trade disguise
• Financial restrictions create competitive disadvantages
End of fixed exchange rates
• Free trade flows result in gradual financial liberalization
• Expectations of currency devaluations, speculative flows
• From 1970s: financial globalization
• Supported by IT development
Revealed preference?
• Historical trends: all country groups
move towards more liberalized capital flows
• De jure and de facto
• Different pace
De jure openness
De jure openness
Forrás: Edwards (2007)
De facto openness
Forrás: Lane—Milesi-Ferretti (2007)
Exchange rate regime
Forrás: Világbank (2006)
2.Empirical evidence
Effect of financial liberalization
• On asset prices / rates of return
• Levels?
• Volatility?
• Correlation with the world?
• Sensitivity to world market (beta)?
Rates of return (annual average)
-0,10 0,00 0,10 0,20 0,30 0,40 0,50 0,60
Argentina Brazil
Chile Colombia
Greece India
Indonesia Jordan
Korea Malaysia
Mexico Nigeria
Pakistan Philippines
Portugal
Taiwan Thailand
Turkey Venezuela
Zimbabwe Average
Pre Post
Source: Bekaert-Harvey-Lundblad (2002)
Rates of return (standard deviation)
0,00 0,10 0,20 0,30 0,40 0,50 0,60 0,70 0,80 0,90 1,00
Argentina Brazil
Chile Colombia
Greece India
Indonesia Jordan
Korea Malaysia
Mexico Nigeria
Pakistan Philippines
Portugal
Taiwan Thailand
Turkey Venezuela
Zimbabwe Average
Pre Post
Rates of return (correlation with the world)
-0,10 -0,05 0,00 0,05 0,10 0,15 0,20 0,25 0,30 0,35 0,40 0,45
Argentina Brazil
Chile Colombia
Greece India
Indonesia Jordan
Korea Malaysia
Mexico Nigeria
Pakistan Philippines
Portugal
Taiwan Thailand
Turkey Venezuela
Zimbabwe Average
Pre Post
Rates of return (beta)
-0,60 -0,40 -0,20 0,00 0,20 0,40 0,60 0,80 1,00 1,20 1,40 1,60
Argentina Brazil
Chile Colombia
Greece India
Indonesia Jordan
Korea Malaysia
Mexico Nigeria
Pakistan Philippines
Portugal
Taiwan Thailand
Turkey Venezuela
Zimbabwe Average
Pre Post
Effect of financial liberalization
• Macroeconomic effects
• Growth?
• Output/consumption volatility?
• Macro policies?
• Institutions?
Growth effects
• Growth depends on other factors, too
• Controlling for usual suspects:
k t i t
i t
i i
k k t
i
Q X Lib
y
, , ,1980 , , ,[BHL, JDE 2001]
Growth regressions
• Results (five-year horizon):
• Very strong effect
• Mechanism?
• Capital accumulation? TFP?
• How to disentangle?
Initial
Log(GDP) Gov/GDP
Secondary- School Enrollment
Population
Growth Log(Life)
Official
Liberalization Indicator
-0.0082 -0.0144 0.0004 -0.1911 0.0975 0.0097
0.0010 0.0131 0.0048 0.0774 0.0076 0.0020
[BHL, JFE 2005]
Robustness
• To time horizon: yes
• To control variables: yes
• To fixed effects: yes
• To the concept of liberalization?
• de jure vs. de facto
• continuous vs. discrete
• self-defined vs. external sources
Capital Account Openness
Official Liberalization Indicator 0.0097 0.0094 0.0120 0.0077 0.0115
Std. error 0.0020 0.0021 0.0022 0.0023 0.0022
IMF Capital Account Openness Indicator 0.0010 0.0020
Std. error 0.0017 0.0017
Quinn Capital Account Openness Indicator 0.0179
Std. error 0.0040
95 countries 76 countries
Problems
• Casual effect?
• Problem with endogenity
• Robustness?
• Problem with heterogenity
Endogenity
• Financial liberalization is not an independent (exogenous) event
• Happens when growth prospects are good anyway
• Hard to handle
• Would need an instrument that
correlated with financial liberalization but has no direct effect on growth
prospects