1. Does Financial Liberalization Spur Growth?
Emerging Markets Corporate Finance
February 2003
Does Financial Liberalization Spur Growth?
Geert Bekaert
Columbia University and NBER
Campbell R. Harvey
Duke University and NBER
Christian T. Lundblad
Indiana University

2. Real GDP Growth Five Years Before and After Financial Liberalizations

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

4. Financial Liberalization and Growth
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)

5. 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

6. Financial Liberalization and Growth
Outline:
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

7. Financial Liberalization and Growth
Caveats:
Not much guidance from theory.
As a result, it is important to conduct extensive robustness experiments

8. Financial Liberalization and Growth
Econometric Framework:
where
yi,t+k,k is real per capita GDP growth between t and t+k
Qi,1980 is initial GDP,
Xi,t represents control variables
Libi,t is a Liberalization indicator variable

9. Financial Liberalization and Growth
Econometric Framework:

10. Financial Liberalization and Growth
Econometric Framework:
ST is the variance covariance matrix of the sample orthogonality
conditions

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

12. 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

13. Financial Liberalization and Growth
Data: Four samples determined by availability of data
Sample I: 95 countries
Sample II: 75 countries
[macroeconomic and demographic data]

14. 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.

15. 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

16. 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

18. 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]

19. Financial Liberalization and Growth
Are the dates exogenous?
Counter examples
Spain in the EU
Some countries cannot liberalize their financial markets

20. Financial Liberalization and Growth
Findings so far:
We document a liberalization effect on growth with certain "standard control variables"

23. 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

26. 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)

27. Financial Liberalization and Growth
On the mechanism ...
Liberalization does not lead to consumption binge
investment increases
trade balance decreases

30. 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

32. Financial Liberalization and Growth
On the mechanism ...
Productivity increases
and this is not just a banking development effect

34. 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

35. 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

37. 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

40. 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

44. 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

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

46. Financial Liberalization and Growth
Conclusions
Financial liberalization has a very important economic effect
Consider economic impact of improvements plus a equity market liberalization
Liberalization
Total Growth = 3.02%

47. Financial Liberalization and Growth
Future and on-going research
Growth volatility
Financial development
Liquidity and asset pricing
The sequencing of liberalizations