Download Mr. Hamidur Rashid

International Trade as an Engine for
Development
Financial Services Liberalization, Foreign Bank Presence and Growth
Hamid Rashid, PhD
Director General (Multilateral Economic Affairs)
Ministry of Foreign Affairs, Government of Bangladesh
Outline
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Trade-Growth linkages
Gains of trade
Trade liberalization and its effects on consumption
Trade liberalization: Effects on employment, wages
and investment
Industrial policy and dynamic comparative
advantage
Effects on fiscal policy and public sector spending
Effects on financial sector
Financial services liberalization, foreign bank entry
and its impact on growth
Trade-Growth linkages
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Trade cause growth or growth causes trade?
 Economists are yet to solve the simultaneity problem in standard
trade models
 Trade is endogenous in most growth models
 Trade volume (export plus import) is an incorrect measure of
trade openness – it is an outcome variable not a policy variable
 Weighted average tariff is a more appropriate measure – no
causality between trade openness and growth (Rodrik), let alone
between trade and development
Trade is, at best, a necessary condition but not a sufficient
condition for growth
For trade to be an engine for growth and development,
governments must play an active and positive role not only in
areas of trade policy, but also in fiscal policy, monetary policy,
industrial policy and human resource development
Trade-Growth Linkages
Source: Rodrik, Dani: “Global Governance of Trade as if Development Mattered”, UNDP, July 2001
Gains of Trade
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Trade liberalization can lead to growth and higher income, exploiting
comparative advantage and economies of scale
Trade liberalization improves incentives and increases competition –
another source of gain
Gains of trade is there, but surely exaggerated
There are clear winners and losers after liberalization – but winners
seldom want to compensate the losers (re-distribution of gains is
almost impossible to implement)
But more importantly, conditions under which trade liberalization can
increase national welfare is highly restrictive
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and these conditions – such as, no unemployment, no
externalities or other form of market imperfections, no
increasing return to scale, no adverse effect on fiscal
balance, no large trade deficit etc. - are typically not
satisfied in most developing countries
Trade Liberalization and Its Effects on
Consumption
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Trade liberalization expands the opportunity set for consumption
Consumption growth can be instantaneous, whereas production
often exhibits a lag
Excess demands are met through imports, often with consumer
loans, adversely impacting savings and crowding out private
investment
Liberalization can lead to the rise in ‘conspicuous’, ‘competitive’ or
‘invidious’ consumption in developing countries
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34.4 million mobile phone users in Bangladesh at the end
of 2007, up from 21.8 million in 2006 and 9.5 million in
2005
Negative impact on domestic savings and investment and also on
balance of payment
Strong import demand (for goods and services) encourages central
banks to maintain a strong exchange rate, often at the expense of
export competitiveness – it negatively impacts growth
Trade Liberalization: Effects on
Employment, Wages and Investment
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With trade liberalization, labor often moves from low productivity
import-competing sectors into unemployment, not to high
productivity export sectors - result is that there is often increased
unemployment – adjustment is costly and takes time
In Heckscher-Ohlin framework of trade: given the technology, trade
liberalization increases demand of the relatively abundant factor and
hence increases the price of that abundant factor and lowers price
of relatively scarce factor
In developing countries, this should lead to reduced wage inequality,
but in fact, inequality increases because of labor market
imperfections and also because of the preferential treatment of
capital (capital is mobile, but labor is not)
As liberalization is often associated with greater volatility in income
and exchange rates, “risk premium” for the country that liberalizes
can increase, which can discourage investment
Industrial Policy and Dynamic
Comparative Advantage
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Liberalization argument is often based on a static model of
comparative advantage and offers a one-time efficiency gain
But it largely ignores dynamic comparative advantage
Static models can trap a country in a low-skill, low-value added
equilibrium – if a country is excessively dependent on low-skill
exports, then demand for skills may go down, which may, in turn,
dampen demand for education – the country will continue to produce
and export low-skill intensive goods (Rodrik and Rodriguez 2001)
For a country to exploit its dynamic comparative advantage, it must
have an industrial policy to ensure transitions from low to medium to
high skill intensive production
Industrial policies can include long-term skill development, policies
of financial restraint, targeted lending and other institutional support
for specific sectors at specific stage of development
But free market proponents scorn industrial policy as central
planning
Effects on Fiscal Policy
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There is general consensus that increasing human capital through
education is critical for economic growth, poverty reduction and income
distribution – even Milton Friedman supported public sector spending
for education (“Neighborhood effect”)
Dabla-Norris and Matovou (2002) find that reducing private costs for
primary education has the largest impact on growth and poverty
reduction
It is also shown that public spending on tertiary education can have the
largest impact on growth once universal primary schooling has been
achieved
Public sector spending on education positively affects growth, but
government must have a predictable revenue source
Trade liberalization can deprive government of a predictable revenue
source – losses in tariff revenues is not readily compensated by other
forms of tax revenue
Countries like Korea and Ireland had significant public sector outlays for
education, which was largely financed by predictable tariff revenues
 In 1970, over 20% of government revenue in Ireland came from
import duty – the highest for any country in that income group (per
capita income of $5000-$8000) and the share did not drop until 1986
Public Sector Spending on Education Matters –
Evidence from Few Countries
1970
Argentina
Greece
Ireland
Korea
Ghana
1975
1980
1985
1990
1995
2000
Spending Per Child[1]
121
161
237
100
246
327
459
GDP Per Capita
6,823
7,310
7,785
6,347
6,422
7,422
8,174
Spending Per Child
194
236
324
404
482
670
1,119
GDP Per Capita
7,487
9,299
10,442
10,459
10,875
11,242
13,175
Spending Per Child
415
586
729
769
926
1,350
1,938
GDP Per Capita
7,908
9,334
10,895
11,871
15,084
18,453
27,796
Spending Per Child
70
103
153
281
387
585
846
GDP Per Capita
2,381
3,153
4,078
5,551
8,310
11,493
13,628
Spending Per Child
15
18
9
6
9
14
13
GDP Per Capita
474
407
383
313
343
369
400
Education Spending Per Child and GDP Per Capita
Source: World Development Indicators, the World Bank
Tariff Revenue is Often Least Volatile
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Tariff or import duty has been, more often than not, the least volatile
source of revenue for many developing country governments
Tariff revenue is less volatile than total tax revenue (including
income tax and other forms of taxes) and ODA
Average Volatility (Coefficient
of Variation) during 1991-2001
in Low Income Countries
GDP Per Capita (constant 1995 dollars)
0.052
Per Capita Education Expenditure (constant 1995
dollars)
0.164
Per Capita Health Expenditure (constant 1995 dollars)
0.155
Per Capita Import (constant 1995 dollars)
0.133
Per Capita ODA (constant 1995 dollars)
0.268
Per Capita Tax Revenue (constant 1995 dollars)
0.199
Per Capita Tariff Revenue (constant 1995 dollars)
0.106
0
Effects on Financial Sector
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Trade liberalization is often associated with tight monetary policy,
which may inhibit job creation – effects of high interest rates and
strong exchange rates:
 Lower level of borrowing and investment
 Reduced export competitiveness
This is because most central banks are mandated to focus on
inflation and balance of payment considerations than on job creation
Banks move away from long-term lending to short-term consumer
loans and trade credits for imports
Liberalization in goods is often accompanied by liberalization of
financial services (capital market liberalization), leading to larger
presence of foreign banks
 Foreign banks tend to lend less to the real sector
 Lending to SMEs go down
 More trade finance
Impact of Foreign Bank Entry: Before and After
Before:
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Domestic banks enjoy monopoly rent
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High profitability leads to higher equity value
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Higher equity provides higher lending base
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More lending not only to large corporations, but also to SME
After:
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In a Bertrand Competition, domestic banks are forced to raise
deposit rates to retain customer base
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Even if domestic banks do it optimally, it loses a significant
amount of deposits to foreign banks
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Lower lending base of domestic leads to less lending overall
Impact of Foreign Bank Entry
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In a partial equilibrium analysis, higher foreign bank presence
makes the multinationals (MNC) in the host country better off
but makes the small and medium enterprises worse off (lower
overall lending base)
In general equilibrium analysis, even the multinationals are
worse off – as SMEs face limited growth, the demand for the
output of multinational companies go down
Overall, negative impact on growth rates
Higher profitability of foreign banks do not impact foreign
banks’ equity base in the host country – foreign banks
repatriate their profit
Larger the foreign bank presence, higher the demand for
foreign currency to repatriate their profits
Holding everything else constant, higher and more volatile
demand for foreign currency make the host country currency
more volatile
Financial Liberalization: Bank Credit in Low
Income Countries
BANKCREDIT_GDP
.318476
.180995
1990
2003
year
Bank Credit in Other Country Groups
BANKCREDIT_GDP
1.91239
BANKCREDIT_GDP
.991827
.493286
1.11508
1990
2003
year
Asian Miracle Countries
1983
2003
year
France, Germany, Japan, United
Kingdom and the United States
0
.5
1
1.5
Foreign Bank Share in Low Income Countries
and Availability of Total Credit
0
.5
1
FOREIGNBANK
TOTALCREDIT
1.5
Fitted values
2
Foreign Banks Lend Less!
0 domestic banks
1 foreign banks
LOAN_TOTALASSET
.47618
.343765
1996
Year
2003
Foreign banks allocate a smaller share of its total assets for loans in the
low income countries – this is, in fact, true for all income groups
Foreign Bank Presence and Availability of Credit
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We find strong negative correlation between foreign banks’ share in
the banking sector (as a percentage of the total banking sector
assets) and the loans to private sector in the low income countries –
holding everything else constant, a 1% increase in foreign banks’
share leads to a .14% decline in domestic banks’ loans to the
private sector
We find that for the full sample, and also for both low and upper
middle income groups, foreign banks’ holding of other earning
assets (securities etc) is positively and significantly correlated with
domestic banks’ holding of other earning assets
Foreign bank presence lowers the availability of credit to the
domestic private sector – this is true even when we control for
capital market development (possible alternative source of
finance)
The results are based on cross-country regressions on 36 Low
Income Countries whose GNI per capita was $765 or less and 54
Middle Income Countries whose GNI per capita was higher than
$765 and less than $9,385
0
.5
1
1.5
2
2.5
Foreign Bank Presence and the
Terms of Credit
0
.5
1
AV_FBCLAIM
AV_SPREAD
1.5
2
Fitted values
Both Interest Rate Spread and Real Lending Rate are positively correlated
to the share of foreign bank claims
0
.05
.1
.15
Foreign Bank Presence and Volatility of
Exchange Rates
0
.2
.4
.6
AV_FBCLAIM1
AV_VOLATILITY
.8
1
Fitted values
Foreign bank share is strongly and positively correlated with exchange rate
volatility both in low income countries as well in our full sample
.02
.04
.06
.08
.1
.12
Foreign Banks and Growth
0
.5
1
AVFOREIGN
AVGROWTH
1.5
2
Fitted values
We find that foreign bank presence is negatively correlated to growth in low
income countries – the effect is less pronounced for upper middle income
countries (GNI per capita between $3,036 and $9,385)
Concluding Remarks
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Trade liberalization can be a positive factor for growth
But much will depend on the pace and sequence of liberalization
Liberalization must take into account the dynamic comparative
advantage, not just the static gains – industrial policies can help
optimize the gains of trade over time
Developing countries should first welcome liberalization in sectors
where it has comparative advantage (labor intensive goods and
services) and not in sectors such as financial services
Financial services liberalization and large presence of foreign banks
can negatively impact lending to the real sector, interest rate
spreads, exchange rate volatility and growth in the developing
countries
Foreign bank entry can have positive impact on growth only if they
can be duly regulated against pro-cyclical behaviors
Negative impacts of foreign bank presence can be minimized with
policies such as Community Reinvestment Act in the US, branching
requirements and sound monetary policies with focus on job creation