Financial structure matters for economic growth
Research from Cardiff University and the University of Cambridge, in the UK, and the World Intellectual Property Organisation, in Switzerland, examines the links between financial structure and economic growth in fourteen countries at varying stages of development: Argentina, Brazil, Chile, Greece, India, Indonesia, Jordan, South Korea, Malaysia, Mexico, Philippines, Portugal, Thailand and Venezuela.
Financial structure refers to the mix of financial institutions, markets and instruments that channel savings and other funds to businesses and other borrowers. In a bank-based system, banks play the key role in channelling funds to businesses. In a market-based system, capital markets – including the stock and bond markets – are the more important source of funds.
Some studies have shown that as countries get richer, stock markets develop and become more efficient than banks at channelling funds. So, many developed countries have market-based financial systems, while many low- and middle-income countries have bank-based systems.
There is a long-running debate over whether bank-based or market-based systems are better for economic growth and development. For example, some early work on this subject highlighted the key role of banks in industrialisation in Germany and Japan. However, other work has claimed that the market-based systems in the UK and USA are more efficient.
More recently, a number of studies have argued that neither banks nor markets are better: both are important and can complement each other. According to these studies, the type of financial structure has no influence on economic growth.
However, the current research shows that these studies miss important differences in country experiences and so give misleading results. This is because of the research methods used, including panel data approaches which pool information on different countries.
To address these problems, the research uses different methods – including country-by-country time series analyses – to examine the relationship between financial structure and economic growth. The results take account of differences between countries, such as different production structures and levels of banking, financial and capital market development.
Key findings of the research include:
- In most of the countries studied, financial structure does influence economic growth.
- Market-based systems appear to be better for growth than bank-based systems.
- The relationship between financial structure and growth varies greatly from country to country.
- So research into this relationship needs to take account of different national experiences.
- There is only limited evidence that as countries become richer, market-based systems become more important.
- There is also only limited evidence that the influence of financial development on growth reduces as countries become richer.
The findings differ from those of previous studies because of the different research methods used. And unlike some of the previous studies, the research shows that financial structure does matter for economic growth.
