Finance and Growth: Empirics

1
Finance and Growth Empirics
2
Central Question

• Do countries with better developed banks and
  financial markets enjoy substantially greater
  economic success?

3
Alternative views

• Economists hold startlingly different views about
  the impact of banks and markets on long-run
  economic growth.

4
View 1 Finance promotes growth
Hamilton-Bagehot-Schumpeter banks are the
happiest engines that ever were invented for
creating economic growth
5
View 2 Finance hurts growth
Adams banks have done more harm to the
morality, tranquility, and even wealth of this
nation than they have done or ever will do good
6
View 3 Finance follows growth
Robinson ... where enterprise leads finance
follows.
7
View 4 Finance doesnt matter
Solow Growth Accounting growth is mainly due
to technological progress, leaving little role
for finance
8
View 5 Finance matters because financial
crises hurt growth
IMF/World Bank
9
Who is right?
Finance hurts growth
Finance promotes growth

• Finance
• doesnt matter

Finance matters for crises
Finance follows growth
10
Possible Channels

• Financial intermediation reduce the investment in
  liquid (but unproductive assets) and increase the
  investment in illiquid and productive assets
• Financial intermediation allows the selection of
  the best entrepreneurial projects

11
Functions of financial system

• Produce information ex ante about possible
  investments and allocate capital
• Monitor investments and exert corporate
  governance after providing finance
• Facilitate the trading, diversification, and
  management of risk
• Mobilize and pool savings
• Ease the exchange of goods and services

12
A very simple way to see it

• Traditional Growth Model Solow
• Take a very simple production function
• x is productivity at time t
• Y is GDP at time t
• K is (Physical) Capital Stock at time t
• L is Labor Force at time t

13

• Households save a fixed proportion of income
• StsYt where
• S is aggregate savings. s propensity to save
• Capital accumulates according to the rule
• d is the depreciation rate, between (0,1)

14

• Lets assume we are in a closed economy, so
  savings are equal to investment
• Rearranging the capital accumulation equation

15
Kt1
45 degrees line
K
Kt
16
Kt1
K1
K0
Kt
17
Kt1
K1
K0
K1
Kt
18
Kt1
K2
K1
K0
K1
Kt
19
Kt1
K2
K1
K0
K2
K1
Kt
20
Kt1
K2
K1
K0
K
K2
K1
Kt
21
Introduce some wasting
K is the Steady State Capital Stock of this
economy

• Only a fraction m of savings becomes investment
• The smaller is m the more inefficient capital
  markets

22
Kt1
45 degrees line
K
K1
Kt
23

• You can interpret the previous graph saying that
  more inefficient capital markets lead to lower
  capital stock, lower GDP and GDP per capita, and
  lower growth rate (at least during transition)

24
King and Levine (QJE, 1993)

• True first attempt to systematically check
  relations between finance and growth
• Adopt a cross country growth regression approach
• Regress growth rates on several measures of
  financial development

25
Econometric Specification

• The growth measures are regressed on the
  Financial Development measures and other
  controls
• Log of Initial Income (1960 Income)
• Log of Initial secondary school enrollment

26
Use Four Measures of Financial Development

• Financial Depth overall size of the formal
  financial intermediary system, i.e. the ratio of
  liquid liabilities to GDP
• Importance of Deposits Banks relative to Central
  Banks in allocating credit
• Credit Issued to nonfinancial private firms to
  total credit
• Credit Issued to nonfinancial private firms to
  GDP

27
Intuition

• Classical Measure of Financial Depth
• Breaking down which financial institutions are
  providing the most important contribution
• Commercial Banks should do a better job that
  Central Bank in managing risk and allocating
  credit
• How much resources are channelled to the private
  sector?

28
Measures of Growth

• GDP per capita growth
• Normalized labor force to 1. L1
• But also a decomposition between pure capital
  accumulation and everything else
• Where y is GDP per capita, k is capital stock
  per capita and x is everything else (or better
  Total Factor Productivity)

29
Measures of Growth

• Take the difference between the two expressions

30
How do we get growth(x)?

• So... regress the growth rate of y on the growth
  rate of k an get an estimation of alpha (and call
  it )
• The residual corresponds to the growth rate of x
• Call the growth of x total factor productivity
  growth
• Call the fitted value of the growth(y) the
  growth due to capital accumulation

31
(No Transcript)
32
(No Transcript)
33
(No Transcript)
34
(No Transcript)
35
What do we conclude?

• All measures of financial development are
  positively associated to different proxies of
  economic growth

36
Endogeneity Problem

• So far we have looked at contemporaneous
  correlations
• What about causality?
• Solved by looking at how ex-ante financial
  development affects ex-post economic growth

37
(No Transcript)
38
Levine and Zervos

• King and Levine are mainly focused on the
  importance of banks for economic growth
• Capital Markets are much more
• Look at the interaction between banks and
  financial markets (bonds, equity)

39
Dependent Variables Growth measures

• GDP Growth
• Capital Stock Growth
• Productivity Growth
• Savings

40
Stock Market Development Indicators

• Size Value of the listed domestic shares on
  domestic stock exchanges divided by GDP
• Liquidity Indicators
• Turnover. Value of trades of domestic shares on
  domestic exchanges divided by the value of listed
  domestic shares
• Value Traded. Value of trades of domestic shares
  on domestic exchanges divided by GDP
• International Integration Measures
• In perfectly integrated markets, capital flows
  across international borders to equate the price
  of risk. If capital controls impede capital
  movements, the price of risk may differ
  internationally.

41
Stock Market Development Indicators

• Volatility of stock returns. Twelve months
  rolling standard deviation estimate that is based
  on market returns
• Banking Development. Loans made by commercial
  banks and other deposit taking banks to the
  private sector divided by GDP

42
(No Transcript)
43
(No Transcript)
44
(No Transcript)
45
(No Transcript)
46
(No Transcript)
47
(No Transcript)
48
(No Transcript)
49
(No Transcript)
50
Summarizing

• Both the banking sectors and the stock exchanges
  are important for economic growth
• Both measures of Stock Market Liquidity are
  positively and significantly correlated with
  current and future measures of economic growth
• Banking development is also a good predictor of
  economic growth
• None of financial variables are robustly related
  to savings