1. Does Financial Liberalization Spur Growth? Geert Bekaert Columbia University and NBER Campbell R. Harvey Duke University and NBER Christian T. Lundblad Indiana University American Finance Association Meetings January 2002

2. 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) Financial Liberalization and Growth

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

4. 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

5. 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"

6. 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

7. 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)

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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

15. Financial Liberalization and Growth Econometric Framework: where y i,t+k,k is real per capita GDP growth between t and t+k Q i,1980 is initial GDP, X i,t represents control variables Lib i,t is a Liberalization indicator variable

16. Financial Liberalization and Growth Econometric issues: Temporal dimension Different weighting matrices Liberalization variable Choice of “k” Endogeneity of the liberalization decision

17. 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]

18. 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

19. Financial Liberalization and Growth Conclusions Financial liberalization has a very important economic effect

20. 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

21. Financial Liberalization and Growth Future research Growth regimes Explore the channels of growth with firm level data