Friday, April 20, 2007

Finance irrelevant for growth??

I really do not know where to begin. Should I focus on authors or on topics or on interesting academic papers or ???

Let me begin on my thoughts first. I have been reading a bit on what leads to development and growth in a country. It has traditionally been studied by people studying development economics (or dev eco as it is popularly called in campuses). It seeks answer to one question:

  • What are the causes of growth? sustainabale growth?
This topic has always been at the centre of economic research. There are numerous ways economists have analysed growth and its factors. I would discuss the different factors in my next blogs.

What has been appalling to me most is that most of the works (read academic papers) in this field do not recognise the role of finance in development. The growth literature is quite old but none mention role of finance. Nobel Prize winner Merton Miller remarked "that financial markets contribute to economic growth is a proposition almost too obvious for serious discussion." Alternatively Nobel Laureate Robert Lucas (1988) holds that the role of finance in economic growthhas been "over-stressed" by the growth literature.

How can a country grow without having a good financial system? If it is growing (like China is), then the problems would simply blow up. The objective of the financial system is to allocate finance to the most productive activities in the economy. The better a financial system is at that purpose, the better are the growth prospects in any economy.

It is only recent works by Ross Levine, Raguram Rajan , Luis Zingales, etc. we have some papers, some thoughts on how finance leads to development. Most of the credit however goes to Levine for bringing tons of empirical work on the subject.

There is a lot of work since then and to keep updated of the papers so far, there is an excellent lietrature survey on the above by Levine. Also read the comments by Zingales on the survey. Excellent stuff!!


Paranoid.. said...

Couldn't have agreed better to this, If it is growing (like China is), then the problems would simply blow up. The objective of the financial system is to allocate finance to the most productive activities in the economy.. But then guess China's finally woke up.. its apparently investing $400B in the next 4 years, primarily in infrastructure. Thats a whopping amount, which could finance the London Olympics 41 times!! But yeah, perhaps not too much for a country which crossed a trillion dollars in forex last year.

Amol Agrawal said...

I think you misunderstood the things... China may be spending on infrastrcuture...that doesnt make its fianncial system any stronger....I could not undersatnd the link..

My point was say a country is growing like India. What are the factors that have led to growth? Is it due to software industry? If yes then how much is software contributing? Can we implement this software model in other countries? What are the factors that are responsible for growth of software indsutry?

In similar domain, a fiance professional would ask.. what is it that we are contributing to the growth of the country? If there is no finance can the country grow?

Being an economist you then look at the various ways in which finance helps... That is what those 2 surveys are for.

Chian crossing forex dollars is a different matter altogether. What I understand from your point is that you think China shd invest its forex reserves into infrastructure...Well there are many problems with this point and loads of debate on the same. Would explain more later... zKeep reading the blog...

Ayan said...

The Chinese are very concerned with mianzi, or 'face'. I was talking to one infrsstructure analyst (Chinese and covering China) said that this is "one" driving force for getting the development off its feet. Financial Services in China, as we know, is quite ordinary compared to India (mch higher Bank NPA and very inefficient Capital Markets). Infrastructure "prevents" many investors to look into India.

China has Hong Kong and Shanghai and Mumbai is nowhere on the Asia map.

Financial System is not the way where people don't get food to eat and general illiteracy is more than half (financial illiteracy may well be over the 95% mark) the population.

India's growth factors are known. Large comsumer market and a large number (but small fraction) of English speaking techies and low-waged low-end services.

Financial system in India is as poor as the West was 30 years back. You don't or vaguely use any stochastic models in India for any valuation. The link between finance and accounting is strong (as is in weakly efficient markets).

India has a really long way to go. China ia ahead by around 10 years.

Paranoid.. said...

My point was not that China's financial system is stronger. All I was talking was about allocating finances. Building on your reserves without spending can be put a price on the circulation of cash, thereby affecting the econony on the global stage, especially if the cash is in order of trillion $$$ as in China's case. My emphasis was on allocation of funds, not 'bout the financial system. May be, I digressed off the point though..

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