• Financial liberalisation

Financial liberalisation

An important influence on an emerging economy’s rate of growth is its ability to finance economic development through attracting international finance.

This study investigates where and why investors from the most advanced countries have historically directed funds, ultimately helping finance economic development in emerging market countries. As an indication of investors’ attitudes towards emerging economies, it examines the size of external liabilities, and the yields that investors required to hold such liabilities. The analysis draws on evidence from the pre-WWI era and present era waves of financial globalisation.

The paper finds that institutional variables, together with human capital, have been a key determinant of emerging market countries' ability to attract international investors. In addition, it finds that countries that had a high proportion of European settlers also had higher levels of investment – and thus a faster rate of economic development. This occurred, the authors contend, because settlers brought with them both institutions and human capital. Importantly, however, the paper also finds that the interpretation of the "institutions" that matter in fostering the ability to attract international investors is quite broad.

Key findings from the analysis include:

• in the first period of financial globalisation, UK colonial status significantly increased the supply of financing, thereby reducing the cost of borrowing. Formal educational attainment was a lesser influence
• the share of Europeans in the total population, by facilitating acquisition of technology from countries then at the technological frontier, may have raised the marginal product of investment, thereby increasing the demand for (and possibly supply of) financing in emerging countries
• settlers brought with them institutions as well as informal human capital—namely, the ability to operate as entrepreneurs (or, more specifically, to run farms and mines, and to build railways), and function in a market economy governed by such institutions
• in the modern era, both subjective indicators of institutional quality and - to a lesser extent - educational attainment are significantly and positively associated with the stock of external liabilities that international investors are willing to hold
• de facto institutional quality as well as educational levels are reflected to this day in the countries where Europeans settled in large numbers more than a century ago
• primary enrolment and the share of European settlers in 1900 are good predictors of both institutional quality and educational attainment in modern times.

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