Abstract:
Politicians fashionably argue in favour of financial development to promote economic
growth following the seminal study of King and Levine (1993a, 1993b). Financial
development, however, could come through alternative channels that are sometimes not
compatible in small open economics. A relatively popular channel promotes
privatisation of domestic financial intermediaries but with restrictions on foreign
ownership. The other competing channel works through foreign direct investment (FDI)
requiring foreign ownership of national assets. Until the last decade of
globalisation, from sixties through early nineties, in many APEC countries and
especially in the East Asia, privatisation of national banks went hand in hand with
a regime of financial repressions. Under that regime governments kept the domestic
interest rate above the world rate by imposing barriers against FDI. Recent trend in
globalisation creates a political tension between those who welcome and the others
who oppose FDI. This paper evaluates the relative contribution of those two
alternative channels of financial development to economic growth. The model of
analysis builds on King and Levine (1993b) but restricts its attention to small open
economies of the APEC. Contrary to the previous findings, privatisation of domestic
financial sector alone turns out to have a negative impact on the growth of
efficiency measured by the growth of total factor productivity. This discrepancy
could possibly be rationalised by a special characteristic of the APEC sample where
a negative effect on efficiency came from the regimes of financial repression that
blocked FDI. Financial integration led by FDI does bring the prospect of lower
economic growth due to increased business fluctuations especially for the small open
economies. Nevertheless, it is surprising to find that a significant improvement in
efficiency and growth came to the APEC nations through the international channel
with the flow of FDI. Consequently, barriers to globalisation out of a purely the
nationalist concerns may be ill fated even for small open economies.
