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East Asia and Global Imbalances: Saving, Investment, and Financial Development Menzie Chinn University of Wisconsin and NBER Hiro Ito Portland State University Presentation at the 2nd Annual Open Macroeconomics and Development conference, Université de la Méditerranée CEDERS, July 2-3, 2007. Motivation “… some of the key reasons for the large U.S. current account deficit are external to the United States, ... Providing assistance to developing countries in strengthening their financial institutions … could … increase both the willingness of those countries to accept capital inflows and the willingness of foreigners to invest there. … Thus, we probably have little choice except to be patient as we work to create the conditions in which a greater share of global saving can be redirected away from the United States and toward the rest of the world - particularly the developing nations.” Bernanke (2005) Global Imbalances Source: Figure 1.14, IMF, World Economic Outlook, Sept. 2006 What is the main cause of US current account deficits? Twin deficit hypothesis public dissaving due to U.S. fiscal policy shift in 2001 Saving glut hypothesis Excess net saving in East Asia US comparative advantage in financial market development Chinn and Ito (2007) A 1 %-point increase in the budget balance would increase the CA balance by 0.10 to 0.49 %-points for industrialized countries US CA deficit slightly underpredicted, E. Asian surplus slightly underpredicted. More FD leads to higher saving for countries with underdevelopment institutions and closed financial markets that includes most of East Asian EMGs FD reduces the level of CA, especially for non-U.S. IDCs and Asian EMGs, but that effect is achieved, not through a reduction in savings, but through increased levels of investment What do we do in this paper? We undertake a closer look at the effect of FD on CA balances and the S-I determination by investigating The effect of different types of FD (e.g., banking, equity, or bond) Different dimensions of FD, such as size, degree of activity, and efficiency How FD interacts with financial openness and institutional development How/whether FD functions as a magnifier for the effect of budget balances Findings Budget balances matter for IDCs when bond markets are incorporated Both credit to the private sector and stock market capitalization appear to be equally important determinants of CA behavior. Increases in the size of financial markets induce an increase in the CA balance in developing countries. However, because of nonlinearities incorporated into the specifications, this characterization is conditional Countries with highly developed financial markets could experience a smaller current account balance when they increase the level of financial openness Empirical Approach Data span 1986-2005, 19 IDCs, 70 LDCs Use five year panels to focus on medium-term determinants Macro variables: BuS, initial NFA, per capita income, per capita income squared, income growth, TOT variability Demographics Structural/Policy: Trade, capital acct openness (Chinn-Ito), financial deepening All the variables, except for net foreign assets to GDP, are expressed as deviations from their GDP-weighted world mean Empirical Model yi ,t 1 FDi ,t 2 LEGALi ,t 3 KAOPENi ,t 4 FDi ,t LEGALi ,t 5 LEGALi ,t KAOPENi ,t 6 KAOPENi ,t FDi ,t X i ,t u i ,t Dependent variables (y) = the CA balance, national saving, and investment (1) Measures of Financial Development, Financial Openness, Legal Development LEGAL = first principle component of Law and Order, Corruption and Bureaucratic Quality (Sourced from ICRG). KAOPEN = Chinn-Ito index, based upon the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) Measures of Financial Development, Financial Openness, Legal Development FD: Financial development SIZE = the sum of private credit creation (PCGDP) and stock market capitalization (SMKC), % of GDP ACTIVENESS – stock market total value (SMTV, % of GDP), stock market turnover (SMTO) EFFICIENCY – (INV)NETINT = bank’s net interest revenue as a share of its total assets BOND MARKET – private bond market capitalization (PVBM) and public bond market capitalization (PBBM) Figure 2: Financial Market Development (Size) Figure 4: Private Bond Market Development Private Bond Market Capitalization (% of GDP) 50 0 0 100 200 pvbm (pvbm/GDP) 300 100 400 Fin. Market Development (size) 1981-1985 1986-1990 1991-1995 U.S. Japan China Middle East & N. Africa 1996-2000 1986-1990 2001-2005 1991-1995 U.S. Japan China Middle East & N. Africa Western Europe East Asia & Pacific ex. China Latin America Others 1996-2000 2001-2005 Western Europe East Asia & Pacific ex. China Latin America Others Figure 5: Public Bond Market Development Figure 3: Financial Market Development (Activeness) Public Bond Market Capitalization (% of GDP) 0 100 50 0 50 100 150 pbbm (pbbm/GDP) 200 150 Stock Market Total Value (% of GDP) 1981-1985 1986-1990 1991-1995 U.S. Japan China Middle East & N. Africa 1996-2000 2001-2005 Western Europe East Asia & Pacific ex. China Latin America Others 1986-1990 1991-1995 U.S. Japan China Middle East & N. Africa 1996-2000 2001-2005 Western Europe East Asia & Pacific ex. China Latin America Others Figure 6: Legal and Institutional Development 60 0 20 40 legal 80 100 Legal/Inst. development, US=100 1981-1985 1986-1990 1991-1995 Western Europe East Asia & Pacific ex. China Latin America Others 1996-2000 2001-2005 Japan China Middle East & N. Africa Figure 7: Financial Openness by Region 80 60 40 20 0 KA Openness (KAOPEN) 100 Financial Openness, US=100 1981-1985 1986-1990 1991-1995 Western Europe East Asia & Pacific ex. China Latin America Others 1996-2000 2001-2005 Japan China Middle East & N. Africa Table 1: Current Account Regressions with SIZE Industrial Less Countries Developed (IDC) (LDC) (1) (2) Government budget balance … … Financial Develop. (SIZE) Legal development (LEGAL) SIZE x LEGAL Financial open. (KAOPEN) KAOPEN x LEGAL KAOPEN x SIZE … … Observations Adjusted R-squared LDC w/out Africa (3) Emerging Market (EMG) (4) 0.236 [0.162]15% 0.151 [0.112] 0.211 [0.134] 0.146 [0.117] … … … … … … … … -0.032 [0.015]** 0.023 [0.012]** 0.014 [0.012] 0.016 [0.012] 0.01 [0.008] 0.03 [0.014]** 0.015 [0.010] 0.017 [0.009]* 0.015 [0.006]** -0.013 [0.006]** 0.001 [0.002] -0.006 [0.003]* … … … … … … … … 81 0.52 156 0.55 125 0.52 125 0.59 0.015 0.014 [0.012] [0.009] 0.02 0.021 [0.011]* [0.010]** 0.013 0.019 11% [0.008] [0.007]*** -0.014 -0.014 [0.008]* [0.007]** 0.001 0 [0.002] [0.002] -0.009 -0.008 [0.004]** [0.003]** Table 2: Current Account Regressions with SIZE, SMTO, and INVNETINT Industrial Less Countries Developed (IDC) (LDC) (1) (2) Government budget balance Financial Develop. (SIZE) Stock Market Activeness (SMTO) Net Interest Margin (INVNETINT) INVNETINT x KAOPEN Legal/Inst. development (LEGAL) SIZE x LEGAL Financial openness (KAOPEN) KAOPEN x LEGAL KAOPEN x SIZE Observations Adjusted R-squared 0.187 [0.191] -0.03 [0.013]** 0.015 [0.012] -0.901 [0.505]* 0.809 [0.367]** 0.025 [0.011]** 0.01 [0.012] 0.019 [0.010]* 0.002 [0.008] 0.029 [0.013]** 77 0.56 LDC w/out Africa (3) Emerging Market (EMG) (4) 0.228 0.231 0.237 [0.113]** [0.152] [0.126]* 0.019 0.02 0.02 [0.009]** [0.011]* [0.009]** 0.009 0.007 0.009 [0.004]** [0.004]* [0.005]* 0.374 0.376 0.246 [0.152]** [0.197]* [0.152]11% 0.042 0.081 0.018 [0.066] [0.076] [0.062] 0.031 0.032 0.032 [0.009]*** [0.012]*** [0.009]*** 0.024 0.022 0.027 [0.006]*** [0.008]*** [0.006]*** -0.016 -0.017 -0.019 [0.006]*** [0.008]** [0.007]*** 0 0.002 0 [0.002] [0.002] [0.002] -0.009 -0.012 -0.011 [0.003]*** [0.004]*** [0.003]*** 140 114 112 0.63 0.58 0.65 Robustness Checks 2SLS analysis – instrument the SIZE variable with the determinants of financial development: inflation rate, legal origins, and regional dummies Generally, qualitatively similar results. The estimation results for LDCs and EMGs get stronger Robustness Checks (con’t) Repeat the exercise using a different FD measure First principle component of private credit creation (PCGDP), stock market capitalization (SMKC), stock market total value (SMTV), private bond market capitalization (PVBM), public bond market capitalization (PBBM), inverted net interest rate margin (INVNETINT), and life insurance premium as a ratio to GDP (LIFEINS) The results get stronger for LDCs and EMGs, but weaker for IDCs Figure 2: Financial Market Development (Size) 300 200 0 100 SIZE (PCGDP+SMKC) 400 Fin. Market Development (size) 1981-1985 1986-1990 1991-1995 1996-2000 U.S. Japan China Middle East & N. Africa 2001-2005 Western Europe East Asia & Pacific ex. China Latin America Others Figure 8: Comparison by “Financial Development Index” 128.1 115.6 100 83.2 74.9 73.6 50 56.1 44.8 44.2 25.3 70.1 65.4 55.2 47.6 46.4 29.7 74.8 66.0 60.2 61.3 43.6 48.3 42.0 47.6 49.2 39.1 25.1 24.9 0 Financial Development (fd) 150 Financial Development Index, US=100 1986-1990 1991-1995 Western Europe East Asia & Pacific ex. China Latin America Others 1996-2000 2001-2005 Japan China Middle East & N. Africa Figure 2: Financial Market Development (Size) 300 200 100 0 SIZE (PCGDP+SMKC) 400 Fin. Market Development (size) 1981-1985 1986-1990 1991-1995 1996-2000 U.S. Japan China Middle East & N. Africa 2001-2005 Western Europe East Asia & Pacific ex. China Latin America Others Figure 9: “Adjusted” Financial Market Size Adjusted Fin. Market Development (size2), US=100 150 130.1 100 127.0 50 78.2 55.9 47.6 51.6 33.3 25.9 14.4 72.7 62.4 52.9 50.2 30.7 24.1 13.8 49.2 26.8 22.0 17.3 2.9 60.6 51.4 50.7 22.6 14.3 17.5 7.3 26.7 16.1 17.7 13.1 0 size2 (Adj.PCGDP+SMKC) 159.3 1981-1985 1986-1990 1991-1995 Western Europe East Asia & Pacific ex. China Latin America Others 1996-2000 2001-2005 Japan China Middle East & N. Africa Adjustment for Government-owned Financial Institutions PCGDP might be an inaccurate measure of FD In some economies, a large portion of financial intermediary is provided by public financial institutions (e.g., China) Adjustment for Government-owned Financial Institutions (cont’d) Adjust PCGDP by following the procedure outlined by Bekaert et al. (2006) Use the La Porta et al. (2002) estimates of the ratios of government ownership of banks, and interpolate data over our sample period Using the “adjusted” PCGDP, we reconstruct the SIZE variable (SIZE2A) and reestimate Adjustment for Government-owned Financial Institutions (cont’d) Interestingly, the estimation results are intact Table 3: Total Effects of a 10 % Point Increase in FD (SIZE) Cond’l on LEGAL and KAOPEN (in percentage points) C: Matrix for Emerging Asia B. Emerging Market Countries CURRENT ACCOUNT Low 10 percentile LEGAL Mean High 10 percentile closed Low 10 percentile KAOPEN -0.186 -0.327 -0.565 0.113 0.450 -0.028 0.310 -0.267 0.071 Mean open High 10 percentile NATIONAL SAVING Low 10 percentile LEGAL Mean High 10 percentile Low 10 percentile LEGAL -0.193 -0.071 0.066 -0.206 -0.084 0.053 -0.227 -0.106 0.032 0.079 -0.054 -0.204 0.130 -0.003 -0.153 0.216 0.084 -0.066 INVESTMENT Low 10 percentile LEGAL Mean High 10 percentile KAOPEN Mean High 10 percentile Low 10 percentile Mean Bangladesh Indonesia, Philippines, Sri Lanka China India, Korea, Malaysia, Thailand, ex-China EA High 10 percentile Hong Kong, Singapore Table 4: Total Effects of a One Unit Increase in KAOPEN Cond’l on LEGAL and FD (in percentage points) B. Emerging Market Countries Less devl’d SIZE More devl’d Low 10 percentile Mean High 10 percentile Low 10 percentile 0.216 -0.607 -2.520 Mean 0.216 0.216 -0.607 -0.607 -2.520 -2.520 -0.374 -0.927 -1.553 -0.449 -1.002 -1.627 -0.623 -1.176 -1.801 -0.036 -0.589 -1.214 0.263 -0.290 -0.915 0.959 0.406 -0.220 CURRENT ACCOUNT LEGAL High 10 percentile NATIONAL SAVING Low 10 percentile LEGAL Mean High 10 percentile INVESTMENT Low 10 percentile LEGAL Mean High 10 percentile C: Ranking of Financial Openness for Emerging Asia Country Hong Kong Singapore Indonesia Philippines Korea Malaysia Thailand China KAOPEN [0, 4.37] 4.37 4.37 2.99 1.95 1.71 1.71 1.71 0.66 Table 5: The Impact of Public Bond Market Development in CA Regressions Government budget balance Budget balance x PBBM Public Bond Mkt. Dev. (PBBM) Financial Develop. (SIZE) Industrial Countries (IDC) Emerging Market (EMG) Industrial Countries (IDC) Emerging Market (EMG) (1) 0.503 [0.153]*** -0.767 [0.394]* 0.005 [0.017] -0.022 [0.011]* (2) 0.105 [0.300] -0.216 [1.116] -0.054 [0.038] 0.013 [0.014] 0.02 [0.010]** 0.024 [0.012]* -0.008 [0.009] 0.022 [0.006]*** 0.005 [0.011] 80 0.65 0.019 [0.013] 0.016 [0.009]* -0.024 [0.010]** -0.002 [0.003] -0.009 [0.004]** 72 0.60 (3) 0.619 [0.176]*** -1.11 [0.278]*** -0.004 [0.015] -0.027 [0.012]** 0.022 [0.009]** -0.332 [0.445] -0.395 [0.493] 0.016 [0.011] 0.031 [0.012]** -0.011 [0.009] 0.022 [0.009]** 0.001 [0.010] 76 0.71 (4) 0.199 [0.309] 0.628 [1.375] -0.135 [0.036]*** 0.02 [0.012] 0.016 [0.006]*** 0.686 [0.238]*** 0.226 [0.083]*** 0.032 [0.010]*** 0.028 [0.007]*** -0.026 [0.009]*** -0.001 [0.003] -0.017 [0.003]*** 65 0.77 Stock Market Activeness (SMTO) Net Interest Margin (NETINT) NETINT x KAOPEN Legal/Inst. development (LEGAL) SIZE x LEGAL Financial openness (KAOPEN) KAOPEN x LEGAL KAOPEN x SIZE Observations Adjusted R-squared Debtor Industrial Countries (IDC) (5) 0.481 [0.241]* -0.741 [0.590] 0.016 [0.019] -0.034 [0.015]** 0.027 [0.012]** -0.309 [0.460] -0.327 [0.518] 0.026 [0.015]* 0.034 [0.014]** -0.015 [0.011] 0.022 [0.010]** -0.003 [0.011] 55 0.63 Debtor Emerging Market (EMG) (6) 0.076 [0.366] 0.952 [1.664] -0.144 [0.038]*** 0.038 [0.016]** 0.015 [0.006]** 0.616 [0.306]* 0.208 [0.108]* 0.027 [0.013]** 0.025 [0.010]** -0.022 [0.010]** -0.002 [0.003] -0.012 [0.006]** 58 0.49 Ending Thoughts Both credit to the private sector and stock market capitalization appear to be equally important determinants of CA behavior. Ending Thoughts (cont’d) The effect of FD is contingent upon legal/institutional development and financial openness EMG countries with lower levels of legal/inst. development could experience a worsening in CA while the deterioration is severe when the country is more financially open). The CA worsening is due to a ↓in NS and an ↑in I Ending Thoughts (cont’d) The effect of financial opening is contingent upon legal/institutional development and FD Financial opening could induce EMG countries to experience a deterioration in CA balances esp. when they are characterized by highly developed financial markets Ending Thoughts (cont’d) Budget balances matters for IDCs when bond markets are incorporated – the estimation results are consistent with the higher end of the range of 0.10 – 0.49 found in Chinn and Ito (2007)