Filling the Gap between Economic Growth and Financial Development

The current economic crisis has erased a significant portion of global wealth. However, developing nations in its path toward development and the revaluation of financial assets will cause a renewed offer of financial resources in search of investment alternatives in coming decades. This fact, called by Bernanke as "Global Saving Glut", will continue affecting financial flows and the economic global performance, and mainly, may damage the economic conditions again through creation of bubbles and promoting imbalances on external accounts as is happening with USA and some Asian countries. That is the reason why is important to take appropriate decisions with the goal to improve the world financial architecture.

The root of the current U.S. mortgage crisis was the high supply of mortgages with low interest rates and poor risk assessment policies. This was possible from a set of economic developments, of which four I think deserve special attention:

First, the technology shock by the introduction of technologies based on silicon increased significantly the levels of productivity in the economy. Among its implications, one very important was that technological advance caused less funding needs to business investments  because it allowed create more value added with smaller amounts of financial resources, freeing resources for other economic sectors, particularly to funding consume and housing.

Second, the high degree of openness, depth and incentives for financial innovation in financial market of U.S., make it the most attractive place for investments in the world. The investment alternatives in the nation, besides being large in relation to other markets, have liquidity; enjoy legal protection, trust, and transparency. This availability of resources allowed to financial intermediaries raised money easily and brings it to their citizens at lower cost through consumer and housing credits.

Third, China’s imprudent exchange rate policy. Economic planners in this country guided their vast amount of labor resources toward industrialization for exportation; where the cornerstone was keep an exchange rate as undervalued as possible. This situation reduced the external demand, mainly consumer goods; international reserves rose to extraordinary levels; and that situation was deepened by the high savings rates of their households, not only for saving for precautionary purposes, risk of be fired (after all, the economy was strong), demographic profile or consumer habits, but it was important too, the absence of lending instruments for financing the purchase of housing and durable consumer goods. This caused an enormous amount of dollars which could only have a single market destination, a market of large sovereign debt (giving the recommendations on risk management of international reserves by a central bank); and it was only available the U.S. governmental market that met this requirement, causing a huge debt market, with its seemingly benign implications for monetary policy and fiscal United States (sustainability of the twin deficits) and their impact on the availability of credit and disposable income of consumers in United States.

 

Fourth, low development in financial systems of developing economies. Under free market conditions, it is expected that economic growth of a nation is reflected in a development more or less similar in its financial system. However, it has not happened in many nations. For example, Venezuela was unable to channel more efficiently excess oil revenues because its expansionary fiscal policy, poor property rights, lax laws regarding the recovery of delinquent collateral clients, government intervention in banking, and high inflation by inappropriate monetary policies; these factors prevented the proper functioning of financial intermediaries to allocate better the high surplus of revenues. The same happens in other nations at different intensities and with negative results. Affecting not only the loss of funding opportunities of important sectors such as education, housing, business, technological innovation and improvement of public finances, but also by limiting the investment international opportunities to  few financial markets as Unites States, causing the glut in financial resources in a few development financial spots and low interest rates in some markets. Sadly, these countries didn't create the financial frame to promote their development.

Asymmetrical development of the financial system in developing nations has not been given enough attention as a cause and solution of this financial crisis. The current situation a decision needed and automatic will be downsize the nation's financial sector in economies typically "obsessive" of global savings (USA, Spain, Ireland, Iceland, etc.), But the huge supply of resources will continue there, and will require more and better balanced financial systems in countries with high development potential (China, India, Argentina, Mexico, etc.).. The incentives are clear, through a harmonious development between the real economy and financial system, economic growth is sustainable, durable and beneficial to the welfare of their societies.

Obviously, this won’t happen overnight. It must address carefully and the form of system evolve in each country will determine the financial success of their results. In this regard, the International Monetary Fund and other global financial authorities will be responsible for providing guidelines on how each country to develop its financial infrastructure. However, the general principles should aim to: encourage competition in financial services, improve the legal framework for recovering the collateral upon default, encourage the use of the stock market by the companies as a channel of funding, encourage the use of funds from the retirement savings for private investment in other financial instruments, promote the creation of an information market to value financial instruments, balancing public finances, keep the good monetary policies, promote financial literacy among the population, improve the arrangements bankruptcy, and others concerning regulation matters.

In countries which had problems recently in their financial system, the adjustments are clear: more regulation, more transparency, less non-bank intermediaries unregulated, the change in incentives to avoid recurrence of the "moral hazard" created by the background in this recession, and so on. But in those countries that remained immune, they need to play a more active role in reducing systemic risks, balance the global imbalances, and doing so, encourage the economic growth endogenously.