Archive for February 4th, 2009

Impact of financial liberalisation on growth: India vs Thailand

February 4, 2009

One often gets to read this in media and blogs- The impact of crisis on India is less as India is less financially liberalised. What about empirical research on the issue?

Romain Ranciere of IMF has done extensive research (with Aaron Tornell and Frank Westermann) on this issue. He says financial liberalisation is beneficial but leads to crisis as well. He compares a country that adopts financial liberalisation with a relatively less liberalised economy. He then sees the growth of the two over a long time period to see how the 2 economies have performed. His answer: financially liberalised econs perform better than non-financially liberalised even if former has more crisis than latter.

The research paper is  here (a shorter note here as well, presentation, his article at voxeu ). His research mainly compares two economies  – India and Thailand. Thailand belongs to the first category and India to second category. Findings:

Thailand and India illustrate the choices available to countries with weak institutions. While India followed a path of slow but steady growth, Thailand experienced high growth, lending booms and crisis (see Figure I). GDP per capita grew by only 114 percent between 1980 and 2002 in India, whereas Thailand GDP per capita grew by 162 percent, despite the e¤ects of a major crisis.

The link between skewness and growth is economically important. Our benchmark estimates indicate that about a third of the di¤erence in growth between India and Thailand can be attributed to systemic risk taking. Needless to say this finding does not imply that financial crises are good.

This is interesting. It says despite the cost of the crises, financially liberalised economies tend to do better than non-financially liberalised economies. However, one must take this with a pinch of salt. We would like to see the comparisons across other economies as well- say other South East Asian nations, Latin American nations etc. as well. Though, the authors point out they have studied 83 countries from 1960-2000 and the findings are similar, still it makes sense to compare the growth patterns for others as well. It would also be interesting to include ongoing crisis in the database to see whether relation still holds.

The paper also adds the importance of institutions. It says best policy is to get institutions right first and then move towards financially liberalisation. However, as all this institutions setting takes time, it might not be wrong to get financial liberalisation going on. After all, it generates more growth on an aggregate despite the costs of the crisis.

However, is paper is highly technical and I am still trying to figure it out. It points to some literature on the issue. So, it is a place to begin research on the hot issue.

Widening of Libor: Liquidity or credit risk?

February 4, 2009

Simon Kwan of FRBSF has written a short note on how Libor has behaved in this crisis. He explains the Libor movement and asks what drove it- increase in liquidity risk or credit risk?


Institutions or macro policies: A case from Barbados and Jamiaca

February 4, 2009

Peter Blair Henry of Stanford University and Brookings has written a paper which questions the “Only institutions matter school”.

He uses an event study. Barbados and Jamaica inherited similar institutions from their colonial masters. Barbados got independence in 1966  and Jamaica in 1962 and had similar propery rights and legal system. So, both should have near similar econ performance going forward. However, Barbados’ GDP per capita grew 3 times of Jamaica and income gap is now 5 times. Why? Henry says it is because of macroeconomic policies pursued by the two.

Jamaica Govt spent more than its revenues and financed the deficit by borrwing from its Central Bank. This led to huge inflation and collapse in investment. It also nationalised companies, erected trade barriers and imposed exchange rate controls. Barbados despite starting with high inflation due to oil shocks, brought inflation down and managed its expenditure. It also avoided nationalisation and allowed private sector to prosper.

In the end, Henry says:

Differences in macroeconomic policy choices, not differences in institutions, account for the heterogeneous growth experiences of these two Caribbean nations.  

This is quite an interesting account of economic history. I am sure it would keep Acemoglu et al interested. However, the question that still remains unanswered is – why were the macroeconomic policies of the two different? What determines that a country (like Barbados) makes better macro policies than some other country (like Jamaica)? Was it just because of political economy? or did Brits miss (or did not add) something in Jamaica?

Interesting throughout.  Quite a stimulating paper.

BIS report on Capital Flows

February 4, 2009

BIS has issued a new report on the impact of capital flows on emerging econs. The report is chaired by RBI’s Deputy Governor, Rakesh Mohan.

The flow of capital between nations, in principle, brings benefits to both capital-importing and capital-exporting countries. But very large flows can also create new exposures and bring new risks. The failure to analyse and understand such risks, excessive haste in liberalising the capital account and inadequate prudential buffers to cope with the greater volatility in more market-based forms of capital allocation have at one time or another compromised financial or monetary stability in many emerging market economies. On the other hand, rigidities in capital account management can also lead to difficulties in macroeconomic and monetary management.

This Report takes stock of the policy debate in this complex area over the past 20 years and examines the vulnerabilities associated with these capital movements. It finds that it is a combination of policies – sound macroeconomic policies, prudent debt management, exchange rate flexibility, the effective management of the capital account, the accumulation of appropriate levels of reserves as self-insurance and the development of resilient domestic financial markets – that provides the optimal response to the large and volatile capital flows to the EMEs. How these elements are best combined will depend on the country and on the period: there is no “one size fits all”.

Just notice the number of factors needed to be in place for capital flows to be effective:

  • sound macroeconomic policies,
  • prudent debt management,
  • exchange rate flexibility,
  • the effective management of the capital account,
  • the accumulation of appropriate levels of reserves as self-insurance and
  • the development of resilient domestic financial markets

Phew! That is nearly everything under the sun (Much like the Washington Consensus).

I also see this being added to most reports on reform- How these elements are best combined will depend on the country and on the period: there is no “one size fits all”. The Growth Commission said the same in its report – there is no “one size fits all policies” to generate sustained growth.

This “no one size fits all” is a sea change from the Washington Consensus. However, the list of “to do” much like WC- includes everything under the sun.

PS. Just a quick glance at the report, suggests it is quite good. It has a lot of case studies and full of graphs and charts. Despite near similar conclusions (see these papers from Rogoff , Obstfeld and numerous others), it is worth a read.

Assorted Links

February 4, 2009

1. TTR on credit crunch in India

2. Krugman points paradox of thrift

3. WSJ Blog points loads of Bernanke speak in February

4. Nudges asks has it led to airline marketing scams? This is quite interesting.

5. Becker on Buy American

6. Rodrik asks why not allocate SDRs at this time??

7. Fin Prof pointsto Reinhart-Rogoff lessons for crisis

8. SternFinance points expect more shadow banking losses.

9. Econbrowser points to rapidly falling auto sales in US

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