Politics, Finance and Growth

Lead Research Organisation: University of Leicester
Department Name: Economics

Abstract

Although the recent financial crisis in the developed world has led to suggestions that there can be too much finance, for many low income countries around the world financial development remains elusive. At the end of 2009, the most widely used indicator of financial development (domestic credit to the private sector, expressed as a percentage of GDP) in Low Income Countries (LIC's) was 26%, compared to 73% in Middle Income Countries (MIC's) and 165% in High Income countries (HIC's).

In Sub-Saharan Africa, according to an influential World Bank study, banks continue to lend little to domestic customers, prefering to invest abroad or in government paper, while households and firms complain about a lack of credit. Moreover, financial reforms have frequently been associated with banking crises, as has been the case for example in Latin America. Even where financial development has taken place, as has been the case for example in many Asian countries, its effects on the poor are generally unknown, although more evidence is now coming to light. There remain, therefore, many important unanswered questions as to how finance can help promote pro-poor economic growth in LIC's.

The proposed project will analyse the linkages between politics, finance and growth with special emphasis on Sub-Saharan Africa.

It will build on work carried out by the investigators in the context of two ESRC projects: "National and international aspects of financial development" (graded 'Outstanding'), and the recently completed "The political economy of African financial under-development".

The project has the following three aims, broadly stated:

(i) To analyse the causes of financial under-development using appropriate methods and data.

(ii) To re-examine key aspects of the finance-growth relationship, in light of what we have learned from the recent global financial crisis, focussing on LIC's.

(iii) To explore the relationship between financial development and poverty in LIC's using a range of different approaches and data.

Under the first aim we will examine what is behind high loan default rates in Sub-Saharan Africa that deter banks from lending to domestic households and firms. We will also examine the role of incumbent financiers in deterring the entry of new firms that may erode their rents. We will then explore why economies based on natural resources have less developed financial systems.

Under the second aim we will analyse the consequences of opportunistic behaviour by banks on financial instability. We will also examine the effects of different types of financial reforms on bank soundness and construct a new measure of banking fragility for a large number of countries. The latter will enable us to examine if it is increased fragility that explains the recent weakening of the finance-growth relationship.

Under the third aim, we will examine the effects of financial development on poverty and health outcomes using country-level data, with particular focus on Sub-Saharan Africa and Latin America. In addition, we will carry out an investigation of the same issues at the micreoconomic level, using household data from Ethiopia and South Africa. We will also conduct a study of the relationship between finance and poverty in India using yearly data across different Indian states.

We expect to produce a minimum of ten academic papers that will be aimed at the most prestigious academic journals. The papers will be presented at academic and policy conferences nationally and internationally. Key findings will be summarised in a non-technical language and published in policy portals such as VOX-EU.

At the end of the project we will organise a conference in South Africa aiming to disseminate our findings to key policy makers and academics in Sub-Saharan Africa.

Planned Impact

The work we are proposing will inform policy makers, at both national and international level, as to how to better design policies that help to promote economic growth and reduce poverty, particularly in LIC's.

The results of the project will intitially be published in the form of University (or NBER/CEPR) discussion papers in the UK, the US, Europe and Africa.

The papers will be presented at seminars and conferences nationally and internationally. In addition to the three workshops we are proposing, we will also submit papers to relevant conferences organised by central banks or other regulatory bodies, the World Bank and the IMF, as appropriate. Such conferences typically attract greater numbers of policy makers than academic conferences. Finally, we will aim to publish the papers in prestigious academic journals with high impact factors. The PI and CI's have an excellent track record in terms of academic publications and are highly cited authors.

In addition to the above activities, we will also offer to organise a half-day workshop in London under the auspices of the Money, Macro and Finance Research Group (MMFRG). MMFRG is a UK-based study group, regularly funded by the ESRC, which exists to promote and disseminate economic research in the money, macro and finance areas and its membership includes academics and policy makers. As MMFRG reimburses reasonable travel costs for participants within the UK, the workshop will help to ensure that UK academics and policy makers have an opportunity to benefit from the results of this research with no additional cost to the project. Demetriades is MMFRG Treasurer and has in the past organised several workshops and the group's annual conferences in 2000, 2005 and 2010. In 2009, he organised an MMF-WEF workshop on finance and growth at Birkbeck College where Rousseau was the keynote speaker.

We will also aim to publish non-technical summaries of our results in shorter papers for policy websites such as CEPR's VOX-EU. Research results that are deemed worthy of wider release will be summarised appropriately and released to the press through the ESRC (and/or University of Leicester) press office. Press releases will be timed to coincide with workshops or conferences where the papers are being presented.

The PI and CI's have considerable experience in successfully disseminating research results outside the academic community, through for example VOX-EU and the ESRC press office. The PI has received ESRC media training by the CEPR in 2010.

The project's findings will be showcased at a conference that will take place in South Africa towards the end of the project. At this conference, we will invite key policy makers and academic economists from other countries in Sub-Saharan Africa. We will liaise closely with the DFID-ESRC Programme directorate in planning this conference to ensure maximum impact.

Publications

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Andrianova S (2017) Ethnic Fractionalization, Governance and Loan Defaults in Africa in Oxford Bulletin of Economics and Statistics

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Andrianova S (2015) Why Do African Banks Lend So Little? in Oxford Bulletin of Economics and Statistics

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Bumann S (2016) Capital account liberalization and income inequality in Journal of International Money and Finance

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Demetriades P (2016) The changing face of financial development in Economics Letters

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Demetriades P (2017) Political economy of a euro area banking crisis in Cambridge Journal of Economics

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Fielding D (2015) Credit booms, financial fragility and banking crises in Economics Letters

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Hall S. (2015) Trust-based social capital, economic growth and property rights: Explaining the relationship in International Journal of Social Economics

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Rewilak J (2013) Finance is good for the poor but it depends where you live. in Journal of banking & finance

 
Description The most significant achievements from the grant were the following:

1. We have constructed a new database on financial fragility for 124 countries over 1998 to 2012. The (new) International Database on Financial Fragility (IDFF) is freely available to researchers and is accompanied by a 53-page discussion paper that describes its construction, advantages and limitations in some detail. We anticipate that the database would facilitate better understanding of the principal mechanisms through which crises are initiated and propagated. It will also enable new research into the disruptions that financial fragility can create to the finance-growth relationship: fragile banks are unable to support growth because they focus their efforts on deleveraging their balance sheets and strengthening their liquidity buffers in order to cope with deteriorating depositor confidence. We have already established in ongoing work that some of the new measures of financial fragility are good predictors of future crises. Importantly, analysis of the database suggests that financial fragility is most acute in low-income countries. Thus, reducing financial fragility may hold the key to enhancing the impact of financial development on both growth and poverty alleviation.

2. We have contributed to a better understanding of the blockages in the finance-growth nexus in Africa. Specifically, we have demonstrated that high levels of loan defaults discourage loan supply by banks. We have also examined the determinants of high loan defaults and have shown that besides information imperfections and weak institutions - which are the usual 'suspects' when credit markets are functioning poorly - the fractionalization of credit markets along ethnic dimensions plays an important role.

3. We have provided new empirical evidence, which suggests that the relationship between finance and growth has been changing. Specifically, we have shown that: (i) financial depth is no longer a significant determinant of long-run growth; (ii) financial reforms have sizeable growth effects that are not always positive (iii) the effects of financial reforms on growth depend on how well banks are regulated (iv) in many countries in sub-Saharan Africa monetization plays a distinct role in capital accumulation and growth.

4. We have also contributed to a better understanding of the relationship between financial development, income inequality and poverty. We have shown, for example, that financial deepening in India contributed to poverty alleviation in rural areas by fostering entrepreneurship and inducing geographic-sectoral migration. We have also examined the extent to which financial literacy training can impact on financial knowledge, financial behavior and new business start-up, drawing on a field experiment with smallholder farmers in Rwanda. In addition, we have also examined theoretically and empirically the complex ways in which financial liberalization and financial development interact to reduce or increase income inequality. Finally, we have also provided new evidence that shows that the effects of financial development on poverty alleviation vary substantially across different regions of the world and are examining the extent to which financial access/ inclusion can help reduce financial fragility by making financial systems more resilient.
Exploitation Route The financial fragility database is a public resource and it was promoted through an article in VOX EU published in October 2015. Institutions such as the ECB and the EBRD have shown interest in it already. We have presented our findings at a research seminar at EBRD and are continuing to present them at academic conferences internationally. The project's final conference at the Reserve Bank of South Africa has generated additional interest in our findings.
Sectors Financial Services, and Management Consultancy,Government, Democracy and Justice

URL https://www2.le.ac.uk/departments/economics/research/esrc-dfid-project
 
Description Professor P Demetriades has recently been invited to contribute to the 2019 edition of the Economic Report on Africa by the UN Economic Commission on Africa. The theme of the report is "Financing Sustainable Development in Africa: The Role of the Private Sector". He has been asked to contribute to a panel session on "Banking and Nonbanking Institutions in Africa" which will take place on 19 March 2018 in Addis Ababa. The UN Economic Commission on Africa was particularly interested in the papers from this project that focus on African credit markets. Specifically, they are looking for suggestions for policies that would unlock liquidity in African banks to finance development drawing on findings from the project.
First Year Of Impact 2018
Sector Financial Services, and Management Consultancy
Impact Types Economic,Policy & public services

 
Title A New International Database of Financial Fragility 
Description There is a pressing need to understand the characteristics of financial systems that are vulnerable to crises and the mechanisms through which crises are initiated and propagated. The new international database on financial fragility for 124 countries between 1998-2012 is potent in addressing such a need. The database utilises bank-level data from Bureau van Dijk's Bankscope to construct eight different measures of financial fragility, each focusing on a different aspect of vulnerability in the financial system. Seven of these relate to bank-level measures of vulnerability, including capitalisation, asset quality, managerial efficiency, earnings, liquidity, and risk exposure. The eighth measure is the Z-score measuring the distance of the entire banking system from insolvency. 
Type Of Material Database/Collection of data 
Year Produced 2015 
Provided To Others? Yes  
Impact Not yet identified. 
URL http://www2.le.ac.uk/departments/economics/research/esrc-dfid-project