{
  "title": "Financial Markets and Economic Growth, by Anne O. Krueger, Special Advisor to the Managing Director",
  "publication": "IMF News, September 29, 2006",
  "sourceUrl": "https://www.imf.org/en/news/articles/2015/09/28/04/53/sp092806",
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  "summary": "Tokyo",
  "authors": [
    "Anne O. Krueger Special Advisor"
  ],
  "publishDate": "2006-09-29",
  "sections": [
    {
      "heading": "Evolution of development thinking and context",
      "content": "- Mid-20th century view: world divided into \"developed\" and \"underdeveloped\" countries with low per capita incomes, low life expectancies, low literacy, little capital stock, and low savings rates.\n- Early policy prescription: capital accumulation as key; government-led accelerated investment in industry to overcome a \"vicious\" circle of low savings and low capital.\n- 1960s shift: increased emphasis on \"human capital\" (education, health, nutrition) alongside physical capital.\n- Trade policy evolution:\n  - Early protectionism, import licensing, and high tariffs produced chronic \"foreign exchange shortages\" and disincentives for exports.\n  - By the late 1980s, prescription shifted to reducing trade barriers and adopting an open economy strategy.\n- East Asian experience:\n  - Hong Kong, Singapore, South Korea, and Taiwan (\"tigers\") exhibited sustained rapid growth; South Korea more than doubled per capita income every decade by 1990.\n  - Other Asian economies (China, Thailand, Malaysia, Indonesia) followed similar high-growth patterns in the 1980s.\n- Financial crises history:\n  - Earlier crises often linked to overvalued exchange rates and exchange controls.\n  - The \"Asian crises\" of 1997 revealed that highly successful countries could still founder when faced with capital outflows and external shocks.\n  - Consensus lessons: fixed exchange rate regimes can remove shock absorbers; need to assess debt sustainability and ensure consistency between monetary/fiscal policy and exchange rate regimes."
    },
    {
      "heading": "Role of the financial sector in development",
      "content": "- Financial sector importance increases with economic complexity:\n  - In simple, subsistence economies family finance and informal credit rationing may suffice.\n  - As manufacturing, agriculture, and services diversify, the ability to identify and fund the best projects requires more developed financial intermediation.\n- Financial markets must broaden and deepen as economies grow:\n  - Banks must become more sophisticated at assessing risk and return.\n  - Development of other financial sources (equity, bond markets) is necessary to sustain long-term, rapid growth.\n- Historical examples:\n  - 19th-century London and 20th-century New York developed financial centers that supported and exported financial services and capital.\n  - Recent growth in hedge funds illustrates continuing complexity in financial markets.\n- Financial crises of the 1990s emphasized that financial sector health is bound up with overall economic performance."
    },
    {
      "heading": "Korean experience (illustrative case)",
      "content": "- Context and turnaround:\n  - Korea was one of the poorest countries in the 1950s; reform program (late 1950s–1960s) turned Korea into an open economy.\n  - Real GDP grew at an average annual rate above 10 percent for the entire decade starting in 1963.\n  - Real per capita income in 1995 was estimated to be close to 9 times what it had been in the early 1960s.\n- Trade statistics:\n  - 1960: exports 3 percent of GDP (88 percent primary commodities), imports 13 percent of GDP.\n  - 1970: exports 14 percent of GDP.\n  - 19890: exports 33 percent of GDP. (textual source)\n  - Between 1960 and 1969, dollar export earnings grew at an average annual rate of 41 percent.\n- Chaebol dynamics:\n  - Chaebol were family-owned conglomerates central to export-driven growth; export incentives were uniform and mandated access to low-interest credit.\n  - Early real rates of return for chaebol averaged 35 percent or more.\n  - Over subsequent decades rates of return declined: slightly above 4 percent in the latter part of the 1980s, under 2 percent in the early 1990s, and negative by 1997.\n  - By the mid-180s the largest 30 chaebol were growing around 20 percent annually, and the largest 5 at 30 percent. (textual source)\n  - Between 1985 and the crisis: assets were 14 times higher for the largest 30 and 19 times higher for the big 5.\n  - By 1997, the largest 5 chaebol accounted for about 40 percent of manufacturing sector assets.\n  - Chaebol exhibited high leverage: in the manufacturing sector as a whole debt was about 3.5 times equity in the mid-1990s; chaebol were even more highly leveraged.\n- Banking sector issues:\n  - Banking remained tightly controlled even as trade liberalized; credit rationing persisted and interest rate deregulation began only in the late 1980s.\n  - Bank assets rose sharply in the five years prior to the crisis, but net banking income had peaked in the early 1990s; rate of return on bank assets and on equity fell continuously.\n  - Nonperforming loans (NPLs) did not significantly increase prior to the crisis largely because of \"evergreening\"; NPLs rose sharply after the crisis began.\n  - Foreign currency borrowing was used to sustain rapid domestic credit expansion, but the fundamental problem was deterioration in domestic portfolio quality.\n- Outcome:\n  - Korea underwent a severe crisis in 1997-1998; domestic vulnerabilities made the system a \"disaster waiting to happen.\"\n  - Reforms were undertaken and output rebounded to precrisis levels within 18 months; growth rates were solid thereafter."
    },
    {
      "heading": "Lessons from Korea and broader evidence",
      "content": "- Key lessons:\n  - A well-regulated, transparent banking system and attention to balance-sheet soundness and currency mismatches are essential.\n  - As economies pass early development stages, financial markets (banking, bond, equity) must develop pari passu with the rest of the economy.\n  - Continued credit rationing leads to excessive reliance on bank credit, underdevelopment of equity and bond markets, and unsustainable leverage.\n- Evidence from cross-country research (Prasad, Rajan and Subramanian):\n  - Foreign capital inflows tend to spur growth in industrial countries (after controlling for standard growth-determining variables).\n  - In low-income countries the evidence suggests a perverse link, including net capital flows from poor countries to richer ones; this perverse link is not found for direct foreign investment.\n  - Conclusion: lack of financial development or propensity for overvaluation amid rapid inflows limits absorptive capacity for foreign resources."
    },
    {
      "heading": "Policy implications and recommendations",
      "content": "- For rapidly growing countries, prioritize development of a healthy financial sector:\n  - Strengthen the rights of borrowers and lenders.\n  - Develop credit rating systems (private credit bureaus).\n  - Lower the costs of obtaining credit (not by reducing the interest rate).\n  - Streamline means for settlement of disputes and improve enforceability of contracts.\n  - Increase efficiency of bankruptcy proceedings; reduce the cost of collateral.\n  - Establish an efficient and implemented regulatory framework.\n  - Promote competition within the banking system and arms-length lending practices.\n- World Bank cross-country indicators (examples preserved from source):\n  - Borrowers' and creditors' rights scale: 1 to 10 (highest). Examples: US 10, Australia 9, Argentina 3, Mexico 2, some countries 1 and even 0.\n  - Private credit bureau coverage: Brazil coverage about half the population; Costa Rica less than 5 percent; more than half of 55 countries surveyed had no private credit bureau coverage at all.\n  - Cost of creating collateral (as percent of per capita income): less than 0.1 percent in the United States and the Untied Kingdom; Korea 8.1 percent; Japan 2.7 percent; India 11.7 percent; Nigeria 20.7 percent; Morocco 62.2 percent.\n  - Time to legal enforcement (examples): around 6 months (250 days in the Untied States, 75 days in France); developing country examples: 591 days in Bolivia, 425 in India, and 1,000 in Poland.\n- Practical implications:\n  - A reasonably open capital account requires a fairly efficient domestic financial system; otherwise distortions and vulnerabilities will be transmitted via the capital account.\n  - For countries committed to growth, proactively addressing financial-sector weaknesses is preferable to waiting for a crisis to force reforms.\n\nAnne O. Krueger, Special Advisor to the Managing Director; Tokyo, September 28, 2006 — Speech: \"Financial Markets and Economic Growth.\"\n\n---\n\n\n References\n\n- India and the IMF\n- Republic of Korea and the IMF\n- Mexico and the IMF\n- United States and the IMF\n- Speeches\n- Anne O. Krueger\n- PRESS CENTER\n- https://www.imf.org/en/home\n\nSource: https://www.imf.org/en/news/articles/2015/09/28/04/53/sp092806"
    }
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    "Authors: Anne O. Krueger Special Advisor",
    "Published: September 29, 2006",
    "Mid-20th century view: world divided into \"developed\" and \"underdeveloped\" countries with low per capita incomes, low life expectancies, low literacy, little capital stock, and low savings rates.",
    "Early policy prescription: capital accumulation as key; government-led accelerated investment in industry to overcome a \"vicious\" circle of low savings and low capital.",
    "1960s shift: increased emphasis on \"human capital\" (education, health, nutrition) alongside physical capital.",
    "Trade policy evolution:",
    "East Asian experience:",
    "Financial crises history:",
    "Financial sector importance increases with economic complexity:",
    "Financial markets must broaden and deepen as economies grow:",
    "Historical examples:",
    "Financial crises of the 1990s emphasized that financial sector health is bound up with overall economic performance.",
    "Context and turnaround:",
    "Trade statistics:",
    "Chaebol dynamics:",
    "Banking sector issues:",
    "Outcome:",
    "Key lessons:",
    "Evidence from cross-country research (Prasad, Rajan and Subramanian):",
    "For rapidly growing countries, prioritize development of a healthy financial sector:",
    "World Bank cross-country indicators (examples preserved from source):",
    "Practical implications:",
    "[India and the IMF](http://www.imf.org/external/country/IND/index.htm)",
    "[Republic of Korea and the IMF](http://www.imf.org/external/country/KOR/index.htm)",
    "[Mexico and the IMF](http://www.imf.org/external/country/MEX/index.htm)",
    "[United States and the IMF](http://www.imf.org/external/country/USA/index.htm)",
    "[Speeches](https://www.imf.org/en/news/searchnews)",
    "[Anne O. Krueger](https://www.imf.org/external/np/omd/bios/ak.htm)",
    "[PRESS CENTER](http://presscenter.imf.org/)",
    "[https://www.imf.org/en/home](https://www.imf.org/en/home)"
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