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Economic Commission for Latin America and the Caribbean (ECLAC)
Chapter V
This alters the risk pattern and the profile of financial innovation, making it more difficult to assess risk. Additionally, the profound interconnectedness of the financial system means that financial innovations can generate a complex network of external factors at the micro- and macroeconomic levels. For example, a rise in interest rates may affect the solvency of individual production and financial units at the microeconomic level, and fragility and systemic risk at the macroeconomic level.4 The specific features of financial innovation make it difficult to analyse and evaluate its global economic and social impact. The few empirical studies that specifically tested the hypothesis of a global economic and social impact, or that provided a quantitative analysis of financial innovation, failed to reach any definitive conclusion. Uncertainty as to the empirical effects of financial innovation is due to the absence of a coordinated mechanism whereby its potential benefits can be channelled into the real economy (see table V.7). Table V.7 Relationship between financial development and growth Author and year
Characteristics
Findings
Goldsmith, 1969
Compilation of data from 35 countries during the period 1860-1963, on the value of financial assets as a percentage of output. The author maintains that the size of the financial intermediation sector has a positive correlation with the quality of the financial services provided.
The author documents the positive correlation between financial development and level of economic activity, but does not interpret whether financial development is a cause of growth.
King and Levine, 1993
The authors study 77 countries during the period 1960-1989, systematically controlling for other factors that may affect longterm growth. They measure the size of financial intermediaries, the proportion of total credit allocated by the central bank and commercial banks, and credit to private firms divided by GDP, and also examine the empirical relationship between these indicators.
The difference between the slowest growing and the fastest growing quartile of countries in the sample was 5% per annum during the study period. The increase in financial depth accounted for 20% of the difference in growth rates. It was found that financial depth in 1960 was a good predictor of subsequent economic growth rates, physical capital accumulation, and improved economic efficiency.
La Porta, López de Silanes and Schleifer, 2001
The authors begin with the level of public-sector ownership of banks around the world, in order to construct an alternative indicator to reflect the financial development of an economy.
Higher levels of public ownership are associated with lower levels of banking sector development and slower economic growth.
Levine and Zervos, 1998
The authors design several measures of stock market development to assess its relationship with economic growth, capital accumulation and productivity growth. A sample of 42 countries is used for the period 1976-1993.
Both the initial level of stock market liquidity and the initial level of banking development had a significant positive correlation with future economic growth rates, capital accumulation and productivity growth in the subsequent 18 years. These findings were confirmed even after controlling for a series of relevant variables. The depth of the stock market, measured as market capitalization over GDP, has no correlation with growth, capital accumulation, or productivity gains.
La Porta and others, 1998 The authors introduce instrumental variables referring Levine, Loayza and Beck, 2000 to aspects of the legal and regulatory environment, in order to assess simultaneity bias.
A strong connection was found between financial intermediation and long-term economic growth.
Beck, Levine and Loayza, 2000 The authors use a Generalized Method of Moments (GMM) panel estimator to exploit the benefits of using time series and cross-sectional data, and of using instrumental variables for all regressors. This in turn avoids biases associated with cross-country regressions.
There is a robust relationship between indicators of financial development, economic growth and increased productivity.
Beck and Levine, 2004
Economic growth depends on the capacity of agents to exchange property rights in the sphere of technology.
The authors study longer-run growth factors based on data averaged over five-year periods.
Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of the cited authors. 4
Financial fragility stems from market economies’ endogenous trend towards growth based on increased borrowing, and from the possible difficulties faced by different economic units and agents (especially firms in the real and the financial sector) in meeting their debt obligations. In such a scenario, small shocks can have disproportionately large reactions. Schwarcz (2008) defines systemic risk as “the risk that (i) an economic shock, such as a market or institutional failure triggers (through a panic or otherwise) either (X) the failure of a chain of markets or institutions or (Y) a chain of significant losses to financial institutions, (ii) resulting in increases in the cost of capital or decreases in its availability, often evidenced by substantial financial-market price volatility”.