Financial Liberalization Theory detailed

Presentation on theory

1. Financial Liberalization Theory Theory originated in the separate work of McKinnon ( 1973) and Shaw (1973). The hypothesis supporting this theory proposed that financial development and economic growth were strongly attached. The more liberalization of financial systems , the more growth in economic development. McKinnon , R. I. (1973). Money and capital in economic development, Brookings Institution Press. SHAW , E.S. (1973), Financial Deepening in Economic Development , New York, Oxford University Press. Financial liberalization gained attention in the early 1970s due to the seminal work of McKinnon (1973) and Shaw (1973) in which they argued that liberalization of the financial sector will lead to increase in savings, encourage investments and induce economic growth. Hence, many countries especially developing countries have embraced financial liberalization as the way forward for their economies. Financial liberalization became a useful and important monetary policy in many countries following the directive from the “Washington Consensus” or “Bretton Woods.” Financial Liberalization and Economic Growth in Nigeria: An Empirical Evidence Anthony Orji, Jonathan E. Ogbuabor , Onyinye I. Anthony-Orji

2. Problem Addressed by the Theory: Problem of financial repression Financial repression is a term that describes measures by which governments channel funds from the private sector to themselves as a form of debt reduction. The overall policy actions result in the government being able to borrow at extremely low interest rates, obtaining low-cost funding for government expenditures In the 1970s McKinnon and Shaw developed a theoretical framework that helped to explain growth-inducing effects of financial liberalization in contrast to financial repression . McKinnon (1973) and Shaw (1973) coincidentally raised arguments against policies of financial repression. Financial repression is the main focus of the McKinnon-Shaw school. They assert that this policy is harmful for long-run growth because it reduces the volume of funds available for investment. Financial repression reduces the demand for money in favour of productive capital, thus raising the capital/labour ratio and accelerating economic growth . Finance and Growth: A Survey of the Theoretical and Empirical Literature Tinbergen Institute Discussion Paper No. TI 2004-039/2 Felix Eschenbach

3. The Political & Social Significance of the Problem Political system is evolving and state is created to protect customers and production decision resides with private sector. Previously it was argued that there is a role for government intervention in the working of financial markets which is in sharp contrast to the work of McKinnon and Shaw (1973) where it was argued that state intervention in formal markets leads to their repression and therefore, stunts economic growth. Financial Liberalization and Economic Growth in Nigeria: An Empirical Evidence Anthony Orji, Jonathan E. Ogbuabor , Onyinye I. Anthony-Orji Free Market Society . Full financial liberalization is realized when market forces are given free rein to determine interest rate Thus, McKinnon–Shaw framework argues that in order for an economy to experience economic growth via greater efficiency in capital accumulation and allocation, interest rate and ceilings, credit control and other restrictive financial legislations should be removed. Free capital movements facilitate a more global allocation of savings, and help channel resources into their most productive uses, thus increasing economic growth and welfare . Rethinking the effects of financial liberalization Fernando A. Broner Jaume Ventura Working Paper 16640

4. Historical Background Liberalism is one of the famous political philosophies based on the ideas of liberty and equality. Liberals generally favor the concepts like free and open trade, freedom of religion and press , free and fair elections, protection of civil rights and private property . This doctrine was mainly founded by Jhone Locke who was 17th-century’s philosopher and argue that each individual’s life , control over own actions, and property are not dependent upon laws or beliefs of a particular culture or government . In twentieth century the ideas of liberalism spread more with different forms like liberal democracies and social liberalism in Europe and North America. Liberalization, literally, means the “removal of controls .” When we talk about financial liberalization, we refer to the removal of controls and restrictions placed on the financial sector by a governing authority. Financial liberalization in Pakistan, desired and actual outcomes: an assessment under philosophy of liberalism Dr. Abdus sattar abbasi, dr. Asad afzal humayon, haji suleman ali, ali iftikhar choudhary Moral Significance Growth is better There should be perfect competition Freedom in financial services Material well being

5. Nature of Human Being Material Perpetual to accumulate homo economicus Most important elements of economic freedom are voluntary exchange and individual or organizations autonomy to come into and compete in markets whiles the government protecting them and their property . Economic freedom ensure the independent choice of consumers and what they consider the best for themselves while every individual and company is free to instigate a business or involve in international trade and compete fairly in the market. Independent peoples will lead to make free markets which benefits to everyone . The basic purpose of economic freedom is to increase peoples wealth and over all well being . A number of empirical evidences are present which have found that in developed countries economic freedom is much more as compare to the developing or poor nations . Governments have a control over determining the economic freedom in a country, if governments are interested in increasing the economic freedom they will reduce or eliminate the trade restrictions, taxes and duties. On the other hand, if the governments are interested in decreasing the economic freedom they can impose new taxes or duties or boost the existed rates . Financial liberalization in Pakistan, desired and actual outcomes: an assessment under philosophy of liberalism Dr. Abdus sattar abbasi, dr. Asad afzal humayon, haji suleman ali, ali iftikhar choudhary

6. Nature of Institution Financial Institutions Shaw (1973), proposed the “debt-intermediation hypothesis” whereby expanded financial intermediation between savers and investors resulting from financial liberalization (higher real interest rate) and financial development increases the incentive to save and invest, stimulates the investment due to increased supply of credit and increased level of average efficiency of investment. For Shaw, the investment is a decreasing function of real interest rate and the saving is an increasing function of economic growth rate and real interest rate. i.e., He further argued that increased financial intermediation provided the impetus for growth more directly. Liberalization would result in an expanded, improved and integrated financial sector that would lead to an increase in the savings rate, an increase in the rate of investment (by facilitating more lumpy investment); and a direct enhancement to growth (by improved financial technologies). Hence, McKinnon–Shaw (1973) viewed financial liberalization as 1. Market-determined interest rates; 2. Greater ease of entry into the banking sector to encourage competition ; 3. The elimination of directed credit programmes; 4. Reduced fiscal dependence of the state on credit from the banking system (to allow for greater expansion of credit to the private sector); Financial Liberalization and Economic Growth in Nigeria: An Empirical Evidence Anthony Orji, Jonathan E. Ogbuabor , Onyinye I. Anthony-Orji

7. Paradigm

8. Criticism It is supposed that liberalization is essential but not provide adequate condition for economic growth. There are various other things which can affect the economic growth like political and institutional environment to behavior of macroeconomic factors. In short, liberalization is a disputed concept. However, in general it is viewed as beneficial for economic growth. But it has many unfavorable effects like increase in poverty, income inequality and reduction in public expenditures on health, education and other basic human necessities as founded by various empirical studies. It seems that the extent of benefits obtained from liberalization in any country depend upon intention of policy makers, macroeconomic policies, market infrastructure, excellence of institutions and political stability . Financial liberalization in Pakistan, desired and actual outcomes: an assessment under philosophy of liberalism Dr. Abdus sattar abbasi, dr. Asad afzal humayon, haji suleman ali, ali iftikhar choudhary

9. Thanks