Politics, Finance and Growth

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.

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.