phd lecture series | ewa karwowski, lecturer in economics | 17 june 2015 finance, financialisation...
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PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Finance, financialisation and development
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Lecture OverviewWhat is development?
• Schumpeter’s Theory of Economic Development • Two-gap model• Harrod-Domar model & development policy
Development & finance
• Old development economics & finance• Financial repression hypothesis• Heterodox economics & finance
Some empirics
• Financial deepening in Africa…• …and why it does not support structural transformation
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
What is development?
Old development economics (Lewis, structuralists etc.):
Fundamental difference between growth & development. Structural transformation is needed not just
growth (manufacturing, technology etc.) E.g. dual sector models
This view is also shared by another eminent economist: Joseph Schumpeter
Growth is doing more of the same thing.
What countries need is development!
For Schumpeter, development is innovation: new ‘combinations’!
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
What is development? – Old DevEcon
Arthur Lewis, LA structuralists, Albert Hirschman etc.
Lewis (Economic development with unlimited supplies of labour, 1954):
‘The central problem in the theory of economic development is to understand the process by which a community which was previously saving and investing 4 or 5 per cent of its national income or less, converts itself into an economy where voluntary saving is running at about 12 to 15 per cent of its national income or more.’
≠ China’s gross saving rate: ca. 50% (World Bank, 2015)
Savings determine investment Lewis explicitly rejected Keynes’s ideas since labour, capital and land
are assumed to be in unlimited supply
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Old DevEcon policy making: Two-gap model
National accounting identity without government:
Y = C + I + (X – M)
Another way to express it:
Y = C + S
Output (Y)Consumption (C)Investment (I)Exports (X)Imports (M)Saving (S)Bring them together:
C + S = C + I + (X – M)
(M – X) = (I – S)Foreign exchange gap
Savings gap
According to the two-gap model saving & foreign exchange are crucial impediments to growth.
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Old DevEcon policy making: Harrod-Domar model
In many developing countries policy making was aimed at increasing saving rates.
Simple Harrod-Domar model: g = s/v
g: growth rate
s: saving rate
v: capital-output ratio (assumed fixed)
Interestingly: Harrod stressed the instability of growth!
Which variable should you look at if structural transformation is your aim?
Lewis (Economic development with unlimited supplies of labour, 1954):
‘This is the central problem because the central fact of economic development is rapid capital accumulation (including knowledge and skills with capital).’
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Old DevEcon policy making: in practiceAfter WWII, many governments actively used finance for development purposes:
• Interest rate caps
• Subsidised loans
• Credit rationing
• Government ownership of banks
• Capital controls
Real interest rates were often negative (see Amsden on South Korea and Wade on Taiwan)
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Mainstream answer: Financial repression
Shaw-McKinnon hypothesis (Shaw & Gurley, 1960, Shaw, 1973, McKinnon, 1973)
Low interest rate policies inhibit growth (and generate inefficient allocation) because people do not save.
Households do not hold bank deposits limited stock of money (M)
This inhibits investment & growth.
How? Lower investment than under a free-floating interest rate.
Inefficient allocation of resources (interest rate as price).
Reform? Private banking sector & financial liberalisation
free-floating interest rate
increased saving
high investment rates
Mechanism? Shaw: more efficient financial intermediation
McKinnon: more saving for investment
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Financial repression & loanable funds theory
The financial repression argument is based on loanable funds theory.
Demand and supply of loanable funds (saving & credit) should determine interest rate (P) & credit volume (Q).
Price capping or rationing is inefficient according to mainstream theory.
It can result in ‘too much’ investment (McKinnon).
It is assumed that all saving transforms into investment ( Lewis model).
What happens if interest rate is capped?
icap shortage
Qcap
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Financial repression & its critics
The financial repression hypothesis argued that interest rates were too low.
High interest rates larger savings more credit more growth
Two criticisms: Informal sector finance is absent (neo-structuralist argument):
Informal sector can intermediate more efficiently since no reserve requirement
Once again loanable funds framework Asymmetric information & risk (Stiglitz & Weiss, 1981):
Bank profit is not a linear function of interest rate Adverse selection Credit rationing by banks themselves Interest rates can be too high Still stuck with loanable funds
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Where are we today?
Since 1990s, revival of the financial repression hypothesis & pushing for financial liberalisation:
King & Levine (1993), Levine (1997) financial depth predicts growth over subsequent decades
Beck et al. (2000)
finance increases total factor productivity impacting growth positively
Plus: asymmetric information & transaction costs
Banks exist because of transaction costs & for financial intermediation (Santomero, 1984)
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Where are we today?
Functions of the financial system (Levine, 2005): Produce information & allocate capital Monitor investment & exert corporate governance Manage risk (especially important, Allen & Santomero, 2001) Pool saving Facilitate exchange of goods & services
Until recently, the believe that financial development will result in growth (King & Levine 1993, Levine 2005) was firmly held among mainstream economists.
Note the rhethoric: financial development
not economic development or financial growth
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Financial repression & policy
The financial repression hypothesis was used to push for financial liberalisation as happened in East Asia (before the East Asian Currency and Financial Crisis).
Many economists criticised financial liberalisation (speed, sequencing, general rational) after the EA crisis (Hellman et al., 1997, Wade & Vernoso, 1998).
Liberalisation allowed for a Minsky-type shift from hedge to speculative financing (Arestis & Glickman 2002).
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
It needed a financial crisis in advanced economies
To reassess the impact of financial sector on growth:
• BIS paper (Cecchetti and K Kharroubi 2012): financial sector growth initially contributes to productivity growth, after a certain point (80-100% of credit to GDP) finance is bad for trend growth due to rising instability.
• IMF (2012): after a point larger effect of financial crash has a negative impact on growth: misallocation towards financial sector reduces growth in R&D-intensive industries.
• De la Torre et al. (2011): decreasing returns to finance and increasing cost of instability.
• Bezemer et al. (2014): the direction of finance is important. If growing financial sector simply feeds (unproductive) consumption/mortgage credit impact (on output & productivity) will be negative. If finance supports productive investment, impact will be positive.
• BIS paper (Cecchetti and K Kharroubi 2015): negative producticity impact as finance drains resources from other sectors
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
The heterodox view: How does finance relate to development?
Schumpeter: Finance (credit) is necessary for innovation
• Banks decide which new ‘combinations’ will be financed.
• Credit is available to all entrepreneurs endowed with entrepreneurial skills.
• Still influential today: entrepreneur training/skilled self-employment programmes as development policy
• Chris Blattman RCT in Ethiopia
Criticism of Schumpeter: The financial system is not a ‘democratic’ system.
Access to finance demands ownership of capital.
Only capitalists can be entrepreneurs (see Kalecki).
…of self-employment: we cannot all be micro entrepreneurs if structural transformation is the aim.
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
The heterodox view: What does PK theory tell us?
PK theory conflicts with much of old development economics
Main difficulty: savings-investment nexus Joan Robinson (1954): always take a country’s
institutions into account Vicky Chick (1992): The Evolution of the Banking System
and the Theory of Saving, Investment and Interest There are different stages in the development of a
financial system Loanable funds theory might be appropriate for the
very early stages Not appropriate with lender of last resort and steady
interest rate policy
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Stages of banking system evolution
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Stages of banking system evolution
This theoretical understanding reconciles old development economics and PK theory
Question: where does an individual developing country stand?
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Financialisation in emerging economies
Since the 1970s/80s a change in the economic system in advanced economies has been observed:
• Increased importance of financial institutions (e.g. pension funds)
• Rising returns on financial investment (e.g. stock market bubbles)
• Growing size of financial sectors & profits
• Growing political influence of financial investors (e.g. rentiers) Signs of financialisation
Many different definitions of financialisation, most broadly (Epstein, 2005, p. 3):
Financialization refers to the increasing importance of financial markets, financial motives, financial institutions, and financial elites in the operation of the economy and its governing institutions, both at the national and international levels.
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Financialisation in emerging economies
Financialisation & growth of financial markets might impact development negatively:
• Demir (2007, 2009): Negative impact of financial liberalisation on productive investment of non-financial firms in Argentina, Mexico, Turkey.
• Kalinowski & Cho (2009): “[T]he pressure from foreign and domestic financial investors led to costly efforts by Korean corporations to increase shareholder value and to defend themselves against possible hostile takeovers, which impeded productive investment.”
• Credit in some emerging economies (e.g. South Africa) is increasingly directed at households rather than non-financial firms.
• This potentially inflates real estate markets.
• Financialisation in emerging economies takes different forms than in advanced countries (financial libralisation, role of foreign banks, firms, households affected)
Questionable impact of finance on growth and financial stability.
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Some empirics
Financial development will result in growth (King & Levine 1993, Levine 2005).
How?
Hypothesis 1: Saving will increase investment increases
rise in credit volume: Shaw 1973
rise in self-financed investment: McKinnon 1973
Hypothesis 2: Credit will be allocated better productivity increases
Hypothesis 1 doubtful: for SSA effect of financial liberalisation on financial development was negative (Hamid Rashid, UNDESA, 2013)
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Analysing potential success storiesMore detailed and disaggregated country level data (Central Banks, national statistics agencies).
We have collected the data across a dozen countries which experienced fast financial deepening (Griffith-Jones & Karwowski, 2013):
Angola, Benin, Malawi, Mali, Niger, Nigeria, Sao Tome and Principe, Sierra Leone, Sudan, Swaziland, Tanzania and Uganda.
Development matters rather than growth: Hypothesis 2 of the McKinnon-Shaw story: more productive credit
Does private credit extension contribute towards development in countries that have experienced fast growth in credit volumes?
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Analysing credit by sector Impact of credit varies depending on its use:
Impact on productivity (e.g. linkages, employment, knowledge/skills creation)
Manufacturing has stronger productivity impact (Kaldor, Amsden, Rodrik, Page)
Agro-processing also has productive potential…
…and high-skill services or tertiary sector activities providing infrastructure-related services (e.g. communication)
Household credit might support domestic demand, but raises issues of debt sustainability and might weaken the external balance
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Productivity impact/transformative potential of credit by sector
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
The manufacturing share of credit has declined
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Manufacturing credit as share of total credit
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Tertiary sector credit
PhD lecture series | Ewa Karwowski, Lecturer in Economics | 17 June 2015
Results
Decreasing share in manufacturing credit in 10 out of the 12 SSA ‘success stories’
Most credit flows into the service sector
Especially into trade activity (very limited transformative potential)
Little evidence that private-sector credit is channelled to highly productive sectors