does financial liberalization spur growth? geert bekaert columbia university and nber campbell r....
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Does Financial Liberalization Does Financial Liberalization Spur Growth?Spur Growth?
Geert BekaertColumbia University and NBER
Campbell R. HarveyDuke University and NBER
Christian T. LundbladIndiana University
Emerging Markets Corporate FinanceFebruary 2003
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Real GDP Growth Five Years Before and After Financial Liberalizations
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Pre-Liberalization Post-Liberalization
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Financial Development
Growth
Financial Liberalization
Relaxing FinConstraints
Investment
GrowthOpportunities
Efficiency ofInvestment
Cost of Capital
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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” and induce capital flight (Stiglitz & others)
Financial Liberalization and 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 GrowthOutline:1. Did liberalization spur growth?
– Large panel of data– Cross-sectional growth regression with temporal dimension
2. How did liberalization spur growth?3. Accounting for the liberalization effect
– Is is macro-economic reforms?– Is it financial development?– Other simultaneity biases?
4. Conclusions
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Financial Liberalization and Growth
Caveats:Not much guidance from theory.
• As a result, it is important to conduct extensive robustness experiments
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Financial Liberalization and Growth
Econometric Framework:
ktititiikkti LibXQy ,,,1980,,,
where yi,t+k,k is real per capita GDP growth between t and t+kQi,1980 is initial GDP,Xi,t represents control variablesLibi,t is a Liberalization indicator variable
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Financial Liberalization and Growth
Econometric Framework:
)](Z)SX[()](Z)SX[(ˆ
as written becan estimator The
],,[
],,[
Let
111
,,1980,,
YZXZ
LibXQx
TT
titiiti
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Financial Liberalization and Growth
Econometric Framework:
NN
kktitii
X
X
X
Z
X
X
X
yYxX
00
00
00
,
][ and ][given where,
2
11
,,,
ST is the variance covariance matrix of the sample orthogonalityconditions
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Financial Liberalization and Growth
Key issues:• Temporal dimension• Different weighting matrices• Liberalization variable• Choice of “k”• Endogeneity of the liberalization decision
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Financial Liberalization and Growth
Liberalization dates:
• Use Bekaert and Harvey (JF 2000) “official liberalization” dates
• These dates are based on a detailed chronology of important regulatory events
• Augmented with IFC frontier markets and three developed markets, Spain, New Zealand and Japan
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Financial Liberalization and Growth
Data: Four samples determined by availability of data
• Sample I: 95 countries
• Sample II: 75 countries
[macroeconomic and demographic data]
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Financial Liberalization and Growth
Data: Four samples determined by availability of data
• Sample III: 50 countries• Sample IV: 28 countries[add financial development indicators]
As data requirements become more stringent, the variance of GDP levels across countries in the sample decreases.
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Financial Liberalization and Growth
Liberalization dates:• Use Bekaert and Harvey (JF 2000) “official
liberalization” dates• These dates are based on a detailed
chronology of important regulatory events • Augmented with IFC frontier markets and
three developed markets, Spain, New Zealand and Japan
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Financial Liberalization and Growth
Liberalization dates:• Robustness of our results checked by examining
Bekaert and Harvey (2000)’s “First Sign” dates• These dates based on the earliest date of {official
liberalization, first ADR and first closed-end fund}
• Example: Thailand – “Official” 1987:09– “First Sign” 1985:07
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Financial Liberalization and Growth
Liberalization dates: • Capturing “intensity” or “comprehensiveness”
of the liberalization– Ratio of IFC investable market cap to global stocks
(Bekaert (1995) and Edison and Warnock (2002))– U.S. holdings of domestic market capitalization
• Is it just a proxy for capital account openness? [See Rodrik-Edwards debate]
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Financial Liberalization and Growth
Are the dates exogenous?
Counter examples
• Spain in the EU
• Some countries cannot liberalize their financial markets
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Financial Liberalization and Growth
Findings so far:
• We document a liberalization effect on growth with certain "standard control variables"
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Table 2Classic Growth Regression and the Impact of LiberalizationAnnual Average Real GDP Growth Rate (Five-Year Horizon)
A: Classic Growth RegressionSample I II III IV
Constant -0.2369 -0.2581 -0.1559 -0.3438 Std. error 0.0181 0.0216 0.0295 0.0538
Log(GDP) -0.0071 -0.0069 -0.0093 -0.0156 Std. error 0.0006 0.0006 0.0007 0.0011
Govt/GDP -0.0044 -0.0175 -0.0212 -0.0158 Std. error 0.0085 0.0096 0.0105 0.0164
Enrollment 0.0277 0.0059 0.0162 0.0624 Std. error 0.0079 0.0098 0.0119 0.0174
Population Growth -0.5978 -0.6037 -0.9389 -1.2056 Std. error 0.0577 0.0642 0.0791 0.1121
Log(Life Expectancy) 0.0746 0.0806 0.0624 0.1182 Std. error 0.0049 0.0057 0.0079 0.0140
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Table 2Classic Growth Regression and the Impact of Liberalization
B: Classic Growth Regression with Liberalization IndicatorConstant -0.2281 -0.2374 -0.1493 -0.2018 Std. error 0.0179 0.0214 0.0286 0.0658
Log(GDP) -0.0094 -0.0088 -0.0115 -0.0158 Std. error 0.0007 0.0007 0.0008 0.0011
Govt/GDP -0.0039 -0.0178 -0.0187 -0.0301 Std. error 0.0087 0.0098 0.0105 0.0165
Enrollment 0.0305 0.0112 0.0243 0.0566 Std. error 0.0077 0.0097 0.0116 0.0171
Population Growth -0.5594 -0.5731 -0.8159 -1.1013 Std. error 0.0621 0.0691 0.0835 0.1151
Log(Life Expectancy) 0.0755 0.0781 0.0627 0.0838 Std. error 0.0049 0.0056 0.0076 0.0167
Official Liberalization Indicator 0.0095 0.0083 0.0113 0.0130 Std. error 0.0016 0.0017 0.0020 0.0036
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Financial Liberalization and Growth
Findings so far:
• 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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Table 3Robustness of the Liberalization Effect
A: Sensitivity to Regional InfluencesSample I II III IV
Official Liberalization Indicator (Latin) 0.0089 0.0075 0.0068 0.0138 Std. error 0.0034 0.0034 0.0035 0.0071
Official Liberalization Indicator (Not-Latin) 0.0108 0.0099 0.0136 0.0133 Std. error 0.0016 0.0017 0.0019 0.0035
B: Sensitivity to Contemporaneous World Growth and Real Interest RatesSample I II III IV
OECD GDP growth (contemporaneous) 0.1469 0.1177 0.1435 0.1695 Std. error 0.0301 0.0328 0.0315 0.0394
World real interest rate (contemporaneous) -0.0625 -0.0484 -0.0132 -0.0182 Std. error 0.0282 0.0309 0.0300 0.0372
Official Liberalization Indicator 0.0097 0.0085 0.0124 0.0141 Std. error 0.0016 0.0017 0.0020 0.0036
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Table 5Alternative measurements of liberalization
Sample I II III IV
Official Liberalization Indicator (Table 2) 0.0095 0.0083 0.0113 0.0130 Std. error 0.0016 0.0017 0.0020 0.0036
First Sign Liberalization Indicator 0.0102 0.0091 0.0105 0.0094 Std. error 0.0015 0.0016 0.0018 0.0033
Intensity Indicator A 0.0101 0.0089 0.0131 0.0132 Std. error 0.0015 0.0018 0.0016 0.0038
Intensity Indicator B 0.0120 0.0110 0.0159 0.0155 Std. error 0.0015 0.0018 0.0016 0.0036
Official Lib. Indicator*(U.S. Holdings/MCAP) 0.0352 0.0325 0.0291 0.0173 Std. error 0.0067 0.0067 0.0067 0.0073
IMF Capital Account Lib. Indicator 0.0022 0.0014 0.0061 0.0043 Std. error 0.0007 0.0008 0.0008 0.0010
IMF Capital Account Lib. Indicator 0.0004 0.0001 0.0044 0.0033 Std. error 0.0008 0.0009 0.0007 0.0009
Official Liberalization Indicator 0.0092 0.0082 0.0098 0.0123 Std. error 0.0016 0.0019 0.0016 0.0044
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Financial Liberalization and Growth
Channels of increased growth:
• 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
On the mechanism ...
» Liberalization does not lead to consumption binge – investment increases– trade balance decreases
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Table 7The Channels of the Liberalization Effect Liberalization and the Components of GDP
Sample I II III IV
Investment/GDP 0.0141 0.0116 0.0079 0.0127 Std. error 0.0025 0.0026 0.0034 0.0053
Consumption/GDP 0.0082 -0.0246 -0.0085 0.0123 Std. error 0.0043 0.0046 0.0049 0.0071
Government/GDP -0.0027 0.0006 0.0053 0.0041 Std. error 0.0006 0.0009 0.0013 0.0019
Exports-Imports/GDP -0.0211 -0.0107 -0.0061 -0.0231 Std. error 0.0017 0.0013 0.0029 0.0024
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Macroeconomic Impact of Liberalization
-0.0300
-0.0250
-0.0200
-0.0150
-0.0100
-0.0050
0.0000
0.0050
0.0100
0.0150
0.0200
I II III IV
Investment/GDP Consumption/GDP Government/GDP Exports-Imports/GDP
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Financial Liberalization and Growth
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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Table 8Investment, the Cost of Capital and the Liberalization Effect
Sample II III IV
Official Liberalization Indicator -0.0581 -0.1090 -0.1802 Std. error 0.0166 0.0321 0.0466
Log(Credit Rating) -0.0016 -0.0068 -0.0181 Std. error 0.0016 0.0061 0.0095
Log(Credit Rating)*Lib Indicator 0.0172 0.0315 0.04900.0041 0.0081 0.0113
Minimum credit rating requiredfor liberalization to positively 29.3 31.8 39.6impact investment
Official Liberalization Indicator 0.0213 Std. error 0.0071
Dividend Yield -0.0719 Std. error 0.0403
Div Yield*Lib Indicator -0.2209 Std. error 0.0538
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Financial Liberalization and Growth
On the mechanism ...
» Productivity increases– and this is not just a banking development effect
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Table 9Liberalization, Total Factor Productivity and Capital Growth
Sample I II III IV
Official Liberalization Indicator 0.0055 0.0058 0.0047 0.0077 Std. error 0.0010 0.0011 0.0014 0.0033
Private Credit/GDP 0.0036 0.0037 0.0033 -0.0023 Std. error 0.0013 0.0013 0.0014 0.0019
Official Liberalization Indicator 0.0047 0.0049 0.0044 0.0081 Std. error 0.0010 0.0011 0.0014 0.0033
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Financial Liberalization and Growth
Accounting for the liberalization effect:
• 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
Accounting for the liberalization effect:
Macroeconomic reforms ...
» Liberalization not spuriously reflecting macroeconomic reforms– we control for trade openness, inflation, black market
premiums, and government deficits
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Table 10Macroeconomic Reforms and Financial Liberalization
Sample I II III IV
Trade 0.0090 0.0105 0.0089 0.0084 Std. error 0.0007 0.0007 0.0010 0.0012
Log(1+Inflation) (Latin) 0.0010 0.0004 0.0011 -0.0003 Std. error 0.0017 0.0016 0.0017 0.0024
Log(1+Inflation) (Not Latin) 0.0088 0.0057 0.0036 -0.0450 Std. error 0.0021 0.0024 0.0053 0.0149
Log(1+Black Market Premium) -0.0093 -0.0096 0.0005 0.0048 Std. error 0.0014 0.0015 0.0014 0.0071
Fiscal Deficit -0.0738 Std. error 0.0178
Official Liberalization Indicator 0.0088 0.0072 0.0110 0.0074 Std. error 0.0011 0.0014 0.0017 0.0032
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Financial Liberalization and Growth
Accounting for the liberalization effect:
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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Table 11Financial Development and Financial Liberalization
A. Banking sector development Sample I II III IV
Private Credit 0.0204 0.0234 0.0159 0.0298 Std. error 0.0030 0.0033 0.0046 0.0082
Private Credit*Lib indicator -0.0213 -0.0244 -0.0131 -0.0329 Std. error 0.0031 0.0034 0.0045 0.0082
Official Liberalization Indicator 0.0195 0.0199 0.0178 0.0301 Std. error 0.0023 0.0027 0.0027 0.0056
Impact on growth of increasing private credit from median of segmented countries to median of liberalizedNonliberalizing country 0.0097 0.0101 0.0061 0.0101Liberalizing country 0.0139 0.0126 0.0145 0.0145Increment to growth by liberalizing 0.0042 0.0025 0.0084 0.0044
Impact on growth resulting from liberalization with no change in private credit/GDPLow level of private credit/GDP 0.0143 0.0130 0.0134 0.0156High level of private credit/GDP 0.0042 0.0025 0.0084 0.0044
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Table 11Financial Development and Financial Liberalization
B. Trading activity
Turnover 0.0170 0.0097 Std. error 0.0037 0.0071
Turnover*Lib Indicator -0.0145 -0.0078 Std. error 0.0038 0.0074
Official Liberalization Indicator 0.0135 0.0151 Std. error 0.0019 0.0040
Impact on growth of increasing turnover from median of segmented countries to median of liberalizedNonliberalizing country 0.0042 0.0009Liberalizing country 0.0132 0.0132Increment to growth by liberalizing 0.0090 0.0124
Impact on growth resulting from liberalization with no change in turnoverLow level of turnover 0.0126 0.0131High level of turnover 0.0090 0.0124
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Financial Liberalization and Growth
Accounting for the liberalization effect:
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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Table 12Banking Crises and Financial Liberalization
A. Growth During Crisis PeriodsSample I II III IV
During Systemic Crisis -0.0048 -0.0066 -0.0062 -0.0095 Std. error 0.0007 0.0008 0.0009 0.0018
Official Liberalization Indicator 0.0090 0.0077 0.0105 0.0083 Std. error 0.0015 0.0018 0.0018 0.0045
During Systemic and Borderline Crisis -0.0048 -0.0064 -0.0081 -0.0075 Std. error 0.0005 0.0006 0.0007 0.0011
Official Liberalization Indicator 0.0093 0.0083 0.0120 0.0099 Std. error 0.0013 0.0014 0.0018 0.0042
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Table 12Banking Crises and Financial Liberalization
B. Post Crisis Period Growth
Post Systemic Crisis 0.0062 0.0060 0.0001 0.0017 Std. error 0.0009 0.0010 0.0013 0.0042
Official Liberalization Indicator 0.0091 0.0081 0.0112 0.0132 Std. error 0.0014 0.0017 0.0018 0.0045
Post Systemic and Borderline Crisis 0.0049 0.0048 0.0033 0.0050 Std. error 0.0006 0.0007 0.0007 0.0011
Official Liberalization Indicator 0.0093 0.0083 0.0111 0.0127 Std. error 0.0014 0.0016 0.0018 0.0044
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Table 13Insider Trading and the Liberalization Effect
Sample I II III IV
Official Liberalization Indicator 0.0093 0.0079 0.0117 0.0129 Std. error 0.0016 0.0019 0.0018 0.0046
Insider Trading Law 0.0001 0.0004 -0.0005 -0.0004 Std. error 0.0006 0.0006 0.0008 0.0009
Official Liberalization Indicator 0.0092 0.0080 0.0116 0.0138Std. error 0.0016 0.0019 0.0017 0.0044
Insider Trading Prosecution 0.0036 0.0031 0.0037 0.0015Std. error 0.0008 0.0009 0.0010 0.0012
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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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Gov/GDP 75th to 50th
Enrollment 25th to 50th
Pop Growth 75th to 50th
Life Exp. 25th to 50th
Liberalization
Total Growth = 3.02%
Financial Liberalization and Growth
Conclusions• Financial liberalization has a very important economic effect
• Consider economic impact of improvements plus a equity market liberalization
Liberalization
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Financial Liberalization and Growth
Future and on-going research
• Growth volatility
• Financial development
• Liquidity and asset pricing
• The sequencing of liberalizations
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Table 1
Growth Volatility and LiberalizationGDP growth rate standard deviation
I I1980-2000 1980-1997
Constant 0.1936 0.2179 Std. error 0.0142 0.0127Initial GDP 0.0046 0.0052 Std. error 0.0003 0.0003School -0.0116 -0.0077 Std. error 0.0025 0.0032Log(Life) -0.0471 -0.0547 Std. error 0.0036 0.0035Gov/GDP -0.0106 0.0048 Std. error 0.0067 0.0074PopGR 0.1159 0.1184 Std. error 0.0989 0.1082Official Lib. -0.0057 -0.0107 Std. error 0.0007 0.0009