The extended period of relatively slow growth and low employment experienced until recently in many European countries has led to increased efforts to identify policies that can improve economic performance. The reasons for the economic slowdown are manifold, and the Lisbon Agenda underlines the need for a multi sector approach. This paper focuses on the financial sector and potential ways to improve both its functioning and contribution to productivity, innovation and growth in Europe.
This focus on the financial system seems to be particularly timely, as various recent events have put a question mark on the global competitiveness of European financial institutions and markets. For example, in parallel with the introduction of the euro overseas, financial institutions significantly extended their market share in the underwriting of the growing market for European corporate bonds (see e.g. Santos and Tsatsaronis, 2003). Recent research also suggests that US banks may have a comparative advantage in the cross-border provision of financial services, whereas non-US banks find it difficult to conduct this business profitably (see e.g. Berger et al., 2000 and 2004). Moreover, a major European stock exchange, Euronext, has merged with the New York Stock Exchange and another one, London Stock Exchange, is partly owned by NASDAQ. Last but not least, settling securities across European borders remains very costly compared, for example, to settling them in the United States (see e.g. Schmiedel et al., 2006).
These developments are particularly surprising, as the introduction of the euro and further integration of European capital markets were very much expected developments and, in many respects, they did strengthen the internal market for financial services and increase the competitiveness of European financial institutions and markets. The relative success of overseas operators compared with domestic European markets and institutions may be indicative of a more pressing need for further reforms to increase their international competitiveness and enhance the contribution of the single market for financial services to employment and growth in Europe.
Based on an extensive literature underlining the role of financial systems in productivity, innovation and growth, this paper analyses the performance of European capital markets and their contribution to the performance of European economies. In contrast to the finance and growth literature, which concentrates very much on developing countries and emerging market economies, the emphasis is placed more on industrial countries to allow stronger conclusions for the “old” European Union Member States to be drawn.
This paper is structured as follows. The next section outlines a conceptual framework for the analysis of the functioning of financial systems and their contribution to economic performance. In so doing, it also summarises briefly the main results from the relevant literature on the effect of financial development and modernisation on productivity and overall growth. Section 3 presents 17 indicators for the performance of the euro area financial system, in particular its efficiency, as compared to similar systems. Apart from 12 euro area countries, this paper covers other European countries (Sweden, Switzerland and the United Kingdom), as well as Japan and the United States. The indicators span eight dimensions of a financial system that can be used to characterise its performance. Since the European Central Bank has already published a wide set of indicators for financial integration (see ECB, 2007a), the emphasis here is more on indicators of financial development or modernisation. Section 4 summarises the main results of current research that investigates a specific channel how the efficiency of a financial system contributes to productivity growth. This approach tests whether economies with more developed financial systems allocate capital faster from declining industries to those with better growth opportunities. The aim is to identify, in particular, those features that would accelerate this reallocation of capital in the EU-15, which already comprises relatively developed financial systems. The results of Sections 3 and 4 indicate the areas in which further European policy efforts may be justified.
The results are derived from internal and external research. They do not necessarily reflect the position of the European Central Bank (ECB) and the ECB is not committed by them. They are presented to generate discussion and identify areas in which more work could be undertaken to further substantiate advice for policy-makers. They also have to be interpreted in relation to the economic literature, to specific assumptions made by the different approaches used and keeping in mind other caveats listed below. Some indicators used that refer to legislation and law enforcement should not be interpreted from a legal or even criminal perspective, but only in terms of their relevance for financial system efficiency.
CONTENTS
ABSTRACT
EXECUTIVE SUMMARY
1 INTRODUCTION
2 FINANCIAL SYSTEMS AND ECONOMIC PERFORMANCE – CONCEPTS AND LITERATURE
- 2.1 Conceptual framework
2.2 Literature on the determinants of financial system efficiency and growth
3 MEASURING THE EFFICIENCY OF THE EUROPEAN FINANCIAL SYSTEM
- 3.1 Size of capital markets and financial structure
3.2 Financial innovation and market completeness
3.3 Transparency and information
3.4 Corporate governance
3.5 Legal system
3.6 Financial regulation, supervision and stability
3.7 Competition, openness and financial integration
3.8 Economic freedom, political and socio-economic factors
4 FINANCIAL DEVELOPMENT, REALLOCATION OF CAPITAL AND PRODUCTIVITY – ECONOMETRIC RESULTS
- 4.1 Data and description of the estimated speed of inter-sectoral capital reallocation
4.2 Role of capital market size
4.3 Driving factors of capital market size
REFERENCES
EUROPEAN CENTRAL BANK OCCASIONAL PAPER SERIES
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