Ebook Does Financial Liberalization Trigger long-run Economic Growth?
Turkey and many other developing countries have experienced the gradual but apparent liberalization of its financial sector. One of the main aims of such liberalization and integration of these economies into the world financial system was to achieve higher economic growth. Contrary to expectation, one of the major consequences of increased financial mobility due to this liberalization and integration has been the macroeconomic instability and financial crises which were mainly caused by speculative short term capital movements. At the end of 2006, Turkish economy has the highest current account deficit and the highest private sector foreign currency borrowings of its history. Such developments, once again, have increased scepticism over the positive effects of financial liberalization on economic growth. The other 10 EU members have achieved one of fastest financial integration period since 1990?s. The main question which we seek to answer in this paper is; does financial liberalization lead to a higher economic growth? We have chosen a quarterly macro panel data analysis which includes static robust panel estimates as well as dynamic panel examinations to answer this question. Our study will provide evidence from Turkey and other recent EU member countries.
The neoclassical growth model assumes no direct link between financial openness and growth. It explains that the sole determinant of long-run growth in per capita income is the exogenously determined technology, which suggests that the long-run economic growth cannot be influenced by interacting with other countries. However, endogenous growth theories (i.e. Romer, 1990) generally imply that financial development should increase growth by decreasing the cost of capital which may trigger investment hence economic growth. There are a growing number of studies analyzing the effect of financial development on economic growth. In most cases their conclusion is that „better financial systems stimulate faster productivity growth and growth in per capita output?. The theories in the finance and growth literature suggest that greater financial efficiency reduces the disincentive to entrepreneurship and encourages accumulation of human capital, thus increasing the rate of technological progress and consequently triggering higher levels of long-run economic growth.
It is clear that given the tools of endogenous growth theory almost any policy choice can be shown to have growth effects through its effect on the accumulation or allocation of physical or human capital. However, relying solely on the theory, it becomes less clear whether for a small open economy, such as Turkey, the benefits of financial liberalization would always outweigh the benefits of financial repression.
The benefits of financial repression, as opposed to financial liberalization, are debated on several points. In theory, it is believed that financial repression creates a better control over money supply and a lower interest rate (usually below market rate) which can induce a higher investment. Another argument in favour of financial repression is that government controlled usury controls on financial markets are needed, especially for capital scarce economies of developing countries. The main conviction of the advocates for financial repression is that the government knows better than the market. The repression mechanism works through the interest rate and the exchange rates. Therefore moving from financial repression to financial liberalization would require extra budgetary measures and could create budgetary problems.
On the other hand, the most cogent argument which favours financial liberalization is the increasing growth effect by stimulating savings and investment. Linking growth with savings and investment has a number of favoured arguments. Financial liberalization may increase the level of savings and improve the allocation of savings among potential investors. This may create more available funds to finance technological developments and hence lead to higher economic growth. Financial liberalization may decrease the cost of capital, but on the other hand, the effects of international speculative capital movements which cause the crises and macroeconomic instability may have a negative impact on economic growth.
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