Financial Integration and Growth in the Global Economy
Rusek, Antonin, International Advances in Economic Research
This paper analyzes the growth dynamics in the developed world and its relationship to the financial structure. The new entrepreneurial economy of creativity and innovation is identified as the main growth area today. However, such an economy needs financial structure capable of coping with the higher risk inherent in the new economy. To provide such a financial structure, the financial markets must be broad, deep, and liquid. Today, only the U.S. financial markets are large enough to provide this financial structure. Hence, financial integration became the imperative for other countries--especially the European Union (EU) and Japan--in order to achieve the level of economic growth as that of the U.S. (JEL F02, F43)
The objective of this paper is the analysis of the role and the nature of financial markets and their integration (or the lack thereof) in the growth dynamics as observed especially in the developed world from the 1990's onwards. Special attention is given to increasingly divergent growth rates between the U.S., Japan, and the European Union (EU). The analysis concentrates on the role of the financial markets in facilitating the engine of the modern growth--the new economy of creativity, innovation, and entrepreneurship.
In the last 11 years--from 1993-2003, the reported average annual economic growth in the U.S. (3.23 percent) exceeded that of the EU (1.95 percent) by almost 60 percent and was more than three times as high as in Japan, which averaged 0.98 percent (see Table 1). Moreover, during those 11 years, there was only one year (2001) when the EU growth exceeded the U.S. growth rate (indeed, 2001 was a very hard year for the U.S. economy, with its performance being negatively affected by the 9/11 terrorist attack). Also, never in those 11 years was the U.S. growth less than that of Japan. This trend continues in 2003--even if complete results are not available yet. What is behind these disparities?
Conventional resource endowments (capital, labor, and technology) are about the same in the U.S., Europe, and Japan. In fact, the savings rate is higher in Europe and especially in Japan in comparision to U.S. Such a high savings rate should facilitate higher rate of investments and hence, a higher long-term growth rate in Europe and Japan compared to the U.S. However, in reality, just the opposite is happening.
The major difference between the U.S. on one side and Europe and Japan on the other side is the nature of their respective financial systems. Banks and bank-based financing play a much larger role in Japan and Europe than in the U.S. Moreover, administrative regulations of economic activities and inflexibility (caused by extensive regulations as well) of labor markets also play a much larger role in Europe and Japan compared to the U.S.
The following section reviews the basics of the discussion on relationships between the real growth, financial development, and financial integration. Then, the growth potential in the new economy that is dependent on the kind of available financial structure is analyzed. The next section evaluates the state of the financial integration in the European Union in the context of the EU growth performance in the last decade. The final section concludes.
Financial Development, Financial Integration, and New Economic Growth
The long-run correlation between the level of financial development and economic performance (long-run growth of an aggregate, like Gross Domestic Product (GDP) per capita) is generally recognized and accepted today [Goldsmith, 1969; King and Levine, 1993]. However, correlation is not causality.
Theoretically, financial development--with its economic, legal, and institutional aspects--improves the resource allocation (especially an accumulation of capital and the allocation of risk). A better resource allocation, then, increases the marginal product of capital on average across the economy and simultaneously reduces the risk via increased opportunities for diversification of wealth. …