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Financial Liberalization, Bank Crises and Growth (Management Project)

This paper studies the effects of financial liberalization and banking crises on growth. It shows that financial liberalization spurs on average economic growth. Banking crises are harmful for growth, but to a lesser extent in countries with open financial systems and good institutions.

The positive effect of financial liberalization is robust to different definitions. While the removal of capital account restrictions is effective by increasing financial depth, equity market liberalization affects growth directly. The empirical analysis is performed through GMM dynamic panel data estimations on a panel of 90 countries observed in the period 1975-1999.

Introduction:

In the last two decades an increasing number of countries have eliminated controls on international capital movements. However, the global economic crises of recent years have led many economists to reconsider the beneficial effects of financial liberalization on economic performance. Although the issue has been widely debated, there are no conclusive results on the effects of financial integration on growth.

In theory, international financial liberalization softens financing constraints and improves risk-sharing, thereby fostering investments. It may also have a positive impact on the functioning and development of financial systems, and on corporate governance. These arguments suggest that we should expect a positive relation between international financial liberalization and economic growth.

However, the presence of distortions may reduce the positive effects of liberalization. In fact, information asymmetries may lead to a bad allocation of capital, and weak financial and legal systems could induce capital flights towards countries with better nstitutions. Moreover, banking crises may come along with financial liberalization, as it is well documented in the literature.
Authors: Alessandra Bonfiglioli, Caterina Mendicino

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