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Press, Journal Article
had - in addition to finance-led growth - a further dream ready: that of growth through openness
to international capital flows. The dream suggested that developing and emerging economies
should allow international finance to enter the country without restrictions. Such a capital
account liberalisation, as it is called, would lead to higher growth rates. The dream was
constructed on the basis of state-of-the-art economic theory at that time. And most developing
and emerging economies went along with it.
4 …and the reality
Both dreams crumbled once they were hit by a financial crisis.
The growth through capital liberalisation dream fell apart with the onset of the Asian financial
crisis in 1997. Since then, studies have clearly shown that capital liberalisation has no direct
positive effect on growth, and only rarely has an indirect one as a result of improving markets.
Rather, it seems that those countries grow faster that rely less, not more, on foreign capital.
[2]
Most importantly, the studies suggest one crucial insight: whether capital liberalisation is a good
thing for an economy depends heavily on its specific situation. For example, if a country has
insufficient savings, foreign capital might be the solution. If, however, there are not enough
incentives or opportunities to invest in a country, additional capital won’t help.
Which brings me to the other dream, that of finance-led growth. This was not challenged until
the financial crisis of 2007 hit. But this has changed thanks to more recent academic studies.
They show that increased credit and a higher volume of financial transactions can have negative
effects, too. There are two reasons why more finance can be negative.
First, higher credit volumes lead to more frequent and more serious financial crises.
[3]
In other
words, as more credit is granted and more financial transactions are carried out, a financial
system becomes more crisis-prone.
Second: the larger the mountain of debt that has built up until a crisis erupts, the more severe the
crisis typically is and the longer it typically lasts.
[4]
Debt was at a very high level before the
most recent crisis, too - which is why many economies are still suffering from the fallout.
The more growth through finance dream became the more crises through finance nightmare.
Excessive credit growth leads to greater vulnerability to crises and their consequences, but it
also unleashes yet another negative effect. Most recent studies provide evidence that it really is
possible to have "too much of a good thing" - which is to say too much credit and too much
financial market.
Various analyses show that economies expand more slowly when they arrive at an
unsustainable, excessively high credit volume.
[5]
These studies do not state a universally valid
limit. But they do suggest that additional credit growth adversely affects growth when the ratio
of total private sector loans to gross domestic product oversteps 90 to 100 per cent. Many
developed economies exceeded that level before the crisis - and, unfortunately, they still exceed
it today.
In a nutshell, this means that more lending and the expansion of financial market activities is not
unreservedly positive. The effect is better described by an arc. Growth can pick up in times of
weak economic development; at later stages of development, a further increase can have
negative implications. For developed countries, this means that more financial market alone will
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