Emerging Markets: Finance and the Real Economy Campbell R. Harvey Duke University and NBER Southern...

Emerging Markets: Emerging Markets: Finance and the Real EconomyFinance and the Real Economy

Campbell R. HarveyDuke University and NBER

Southern Finance Association MeetingsKey West,

November 22, 2002

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Materials in my presentation are largely drawn from my past and on-going collaborations with Geert Bekaert at Columbia University.

Emerging Markets Research

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Emerging Markets Research Program

Bekaert and Harvey JFE97Emerging Market Volatility

Bekaert WBER95Investment Barriers

Harvey RFS95; WBER95 Predictable Risk

Bekaert and Harvey JF95Time-Varying Integration

Bekaert and Harvey NBER98 Capital Flows

Bekaert and Harvey JF2000 Foreign Speculators

Bekaert, Harvey & Lumsdaine JFE2002 Dating Integration

Bekaert, Harvey & Lumsdaine JIMF2002 Dynamics of Capital Flows

Bekaert, Erb, Harvey & Viskanta BOOK, JPM97 Behavior of Returns and Asset Allocation

Bekaert, Harvey & Lundblad JDE2002 Finance and Growth Econometrics

Bekaert, Harvey & Lundblad WP2002 Liberalization and Growth

Bekaert, Harvey & Lundblad WP2002 Liberalization and Growth Volatility

Bekaert, Harvey & Lundblad WP2002 Emerging Mrt Liquidity & Expected Returns

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My first look at the data

• Data through June 1992

• Published in RFS 1995

• What has happened since?


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-0.20

-0.10

0.00

0.10

0.20

0.30

0.40

0.50

Average Annual Geometric Returns Through June 1992

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-0.20

-0.10

0.00

0.10

0.20

0.30

0.40

0.50

Average Annual Geometric ReturnsThrough June 1992 – What Happened After?

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0.00

0.20

0.40

0.60

0.80

1.00

1.20

Average Annualized Standard Deviation Through June 1992

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0.00

0.20

0.40

0.60

0.80

1.00

1.20

Average Annualized Standard Deviation Through June 1992 –What Happened After?

Data through April 2002

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-0.20

-0.10

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

Correlation with World Through June 1992

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-0.20

-0.10

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

Correlation with WorldThrough June 1992 – What Happened After?


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-0.50

0.00

0.50

1.00

1.50

2.00

Beta with World Through June 1992

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-0.50

0.00

0.50

1.00

1.50

2.00

Beta with World Through June 1992 – What Happened After?


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0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

Date

Ro

llin

g C

orr

ela

tio

n Evolution of World Correlation Five-Year Rolling Window: 20 Countries

Data through April 2002.

IFC Composite

Average of 20 Emerging Countries

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0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

Date

Ro

llin

g B

eta

Evolution of World Beta Risk Five-Year Rolling Window: 20 Countries

Data through April 2002.

IFC Composite

Average of 20 Emerging Countries

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Why is the picture different?

• Financial liberalizations


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Official First First Estimate ofLiberalization ADR Country Fund Increase in Net

Country Date Introduction Introduction US Capital FlowsArgentina 89.11 91.08 91.10 93.04Brazil 91.05 92.01 87.10 88.06Chile 92.01 90.03 89.09 88.01Colombia 91.02 92.12 92.05 93.08Greece 87.12 88.08 88.09 86.12India 92.11 92.02 86.06 93.04Indonesia 89.09 91.04 89.01 93.06Jordan 95.12 n/a n/a n/a Korea 92.01 90.11 84.08 93.03Malaysia 88.12 92.08 87.12 92.04Mexico 89.05 89.01 81.06 90.05Nigeria 95.08 n/a n/a n/a Pakistan 91.02 n/a 91.07 93.04Philippines 91.06 91.03 87.05 90.01Portugal 86.07 90.06 87.08 94.08Taiwan 91.01 91.12 86.05 92.08Thailand 87.09 91.01 85.07 88.07Turkey 89.08 90.07 89.12 89.12Venezuela 90.01 91.08 n/a 94.02Zimbabwe 93.06 n/a n/a n/a

The Opening of Equity Markets in Emerging Countries

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Prices

High Expected Announcement Implementation Low ExpectedReturns of Liberalization Returns

PI

PS

Time

Segmented Integrated

Asset Prices and Market Integration

Return to Integration

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-0.10

0.00

0.10

0.20

0.30

0.40

0.50

0.60Pre Post

Average Annual Geometric ReturnsPre and Post Bekaert-Harvey Official Liberalization Dates

Data through April 2002. There are no pre-liberalization data for Indonesia.

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0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00 Pre Post

Average Annualized Standard DeviationPre and Post Bekaert-Harvey Official Liberalization Dates


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-0.10-0.050.000.050.100.150.200.250.300.350.400.45 Pre Post

Correlation with WorldPre and Post Bekaert-Harvey Official Liberalization Dates


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-0.60-0.40-0.200.000.200.400.600.801.001.201.401.60 Pre Post

Beta with WorldPre and Post Bekaert-Harvey Official Liberalization Dates


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Implications

• Lower cost of capital

• More investment, employment

• More economic growth

Current research with Geert Bekaert and Chris Lundblad explores the relation between equity market liberalization and the real economy


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Geert Bekaert, Campbell Harvey and Chris Lundblad, Does Financial Liberalization Spur Growth? Working paper 2002


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Real GDP Growth Rates1980-1997

-0.04

-0.02

0

0.02

0.04

0.06

0.08

0.1

Gro

wth

rate

Pre-liberalization Post-liberalization

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Real GDP Growth Rates1980-2000

-0.04

-0.02

0

0.02

0.04

0.06

0.08

0.1

Gro

wth

rate


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Financial Development

Growth

Financial Liberalization

Relaxing FinConstraints

Investment

GrowthOpportunities

Efficiency ofInvestment

Cost of Capital

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Controversial exercise• Liberalization implies consumption booms and

inefficient investment (crisis literature)

• Liberalization may lead to reduced savings (endogenous growth literature)

• Liberalization may lead to “hot speculative capital” and induce capital flight (Stiglitz & others)

Financial Liberalization and Growth

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What we already know (too many references to list!):

• Financial/banking development associated with higher growth

• Cost of capital decreases

• Investment increases

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Financial Liberalization and GrowthOutline:1. Did liberalization spur growth?

– Large panel of data– Cross-sectional growth regression with temporal dimension

2. How did liberalization spur growth?3. Accounting for the liberalization effect

– Is is macro-economic reforms?– Is it financial development?– Other simultaneity biases?

4. Conclusions

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Caveats:Not much guidance from theory.

• As a result, it is important to conduct extensive robustness experiments

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Econometric Framework:

ktititiikkti LibXQy ,,,1980,,,

where yi,t+k,k is real per capita GDP growth between t and t+kQi,1980 is initial GDP,Xi,t represents control variablesLibi,t is a Liberalization indicator variable

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)](Z)SX[()](Z)SX[(ˆ

as written becan estimator The

],,[

],,[

Let

111

,,1980,,

YZXZ

LibXQx

TT

titiiti

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NN

kktitii

X

X

X

Z

X

X

X

yYxX

00

00

00

,

][ and ][given where,

2

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,,,

ST is the variance covariance matrix of the sample orthogonalityconditions

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Key issues:• Temporal dimension• Different weighting matrices• Liberalization variable• Choice of “k”• Endogeneity of the liberalization decision

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Data: Four samples determined by availability of data

• Sample I: 95 countries

• Sample II: 75 countries

[macroeconomic and demographic data]

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Data: Four samples determined by availability of data

• Sample III: 50 countries• Sample IV: 28 countries[add financial development indicators]

As data requirements become more stringent, the variance of GDP levels across countries in the sample decreases.

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Liberalization dates:• Use Bekaert and Harvey (JF 2000) “official

liberalization” dates• These dates are based on a detailed

chronology of important regulatory events • Augmented with IFC frontier markets and

three developed markets, Spain, New Zealand and Japan

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Liberalization dates:• Robustness of our results checked by examining

Bekaert and Harvey (2000)’s “First Sign” dates• These dates based on the earliest date of {official

liberalization, first ADR and first closed-end fund}

• Example: Thailand – “Official” 1987:09– “First Sign” 1985:07

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Liberalization dates: • Capturing “intensity” or “comprehensiveness”

of the liberalization– Ratio of IFC investable market cap to global stocks

(Bekaert (1995) and Edison and Warnock (2001))– U.S. holdings of domestic market capitalization

• Is it just a proxy for capital account openness? [See Rodrik-Edwards debate]

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Are the dates exogenous?

Counter examples

• Spain in the EU

• Some countries cannot liberalize their financial markets

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Findings so far:

• We document a liberalization effect on growth with certain "standard control variables"

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Classic Growth Regression and the Impact of Liberalization

Sample I II III IV

Constant -0.2281 -0.2374 -0.1493 -0.2018 Std. error 0.0179 0.0214 0.0286 0.0658

Log(GDP) -0.0094 -0.0088 -0.0115 -0.0158 Std. error 0.0007 0.0007 0.0008 0.0011

Govt/GDP -0.0039 -0.0178 -0.0187 -0.0301 Std. error 0.0087 0.0098 0.0105 0.0165

Enrollment 0.0305 0.0112 0.0243 0.0566 Std. error 0.0077 0.0097 0.0116 0.0171

Population Growth -0.5594 -0.5731 -0.8159 -1.1013 Std. error 0.0621 0.0691 0.0835 0.1151

Log(Life Expectancy) 0.0755 0.0781 0.0627 0.0838 Std. error 0.0049 0.0056 0.0076 0.0167

Official Liberalization Indicator 0.0095 0.0083 0.0113 0.0130 Std. error 0.0016 0.0017 0.0020 0.0036

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Findings so far:

• The liberalization effect is robust to– different definitions of liberalization dates– to business cycle or interest rate controls– allowing for intensity of liberalization

...and independent of capital account liberalization

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Robustness of the Liberalization Effect

A: Sensitivity to Regional InfluencesSample I II III IV

Official Liberalization Indicator (Latin) 0.0089 0.0075 0.0068 0.0138 Std. error 0.0034 0.0034 0.0035 0.0071

Official Liberalization Indicator (Not-Latin) 0.0108 0.0099 0.0136 0.0133 Std. error 0.0016 0.0017 0.0019 0.0035

B: Sensitivity to Contemporaneous World Growth and Real Interest RatesSample I II III IV

OECD GDP growth (contemporaneous) 0.1469 0.1177 0.1435 0.1695 Std. error 0.0301 0.0328 0.0315 0.0394

World real interest rate (contemporaneous) -0.0625 -0.0484 -0.0132 -0.0182 Std. error 0.0282 0.0309 0.0300 0.0372


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Alternative measurements of liberalization

Sample I II III IV


First Sign Liberalization Indicator 0.0102 0.0091 0.0105 0.0094 Std. error 0.0015 0.0016 0.0018 0.0033

Intensity Indicator A 0.0101 0.0089 0.0131 0.0132 Std. error 0.0015 0.0018 0.0016 0.0038

Intensity Indicator B 0.0120 0.0110 0.0159 0.0155 Std. error 0.0015 0.0018 0.0016 0.0036

Official Lib. Indicator*(U.S. Holdings/MCAP) 0.0352 0.0325 0.0291 0.0173 Std. error 0.0067 0.0067 0.0067 0.0073

IMF Capital Account Lib. Indicator 0.0022 0.0014 0.0061 0.0043 Std. error 0.0007 0.0008 0.0008 0.0010

IMF Capital Account Lib. Indicator 0.0004 0.0001 0.0044 0.0033 Std. error 0.0008 0.0009 0.0007 0.0009


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Channels of increased growth:

• Both: » increased investment, partially through a cost of capital

effect and » increased productivity (which is different from the

financial development literature)

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On the mechanism ...

» Liberalization does not lead to consumption binge – investment increases– trade balance decreases

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Macroeconomic Impact of Liberalization

-0.0300

-0.0250

-0.0200

-0.0150

-0.0100

-0.0050

0.0000

0.0050

0.0100

0.0150

0.0200

I II III IV

Investment/GDP Consumption/GDP Government/GDP Exports-Imports/GDP

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» Investment increases - but you need a minimum “country quality level” to see effect– decreased cost of capital associated with more

investment

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Investment, the Cost of Capital and the Liberalization Effect

Sample II III IV

Official Liberalization Indicator -0.0581 -0.1090 -0.1802 Std. error 0.0166 0.0321 0.0466

Log(Credit Rating) -0.0016 -0.0068 -0.0181 Std. error 0.0016 0.0061 0.0095

Log(Credit Rating)*Lib Indicator 0.0172 0.0315 0.04900.0041 0.0081 0.0113

Minimum credit rating requiredfor liberalization to positively 29.3 31.8 39.6impact investment

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» Productivity increases– and this is not just a banking development effect

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Liberalization, Total Factor Productivity and Capital Growth

Sample I II III IV


Private Credit/GDP 0.0036 0.0037 0.0033 -0.0023 Std. error 0.0013 0.0013 0.0014 0.0019


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Accounting for the liberalization effect:

• We investigate whether part of the effect can be ascribed to» macroeconomic reforms» financial development» other regulatory reforms

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Macroeconomic reforms ...

» Liberalization not spuriously reflecting macroeconomic reforms– we control for trade openness, inflation, black market

premiums, and government deficits

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Macroeconomic Reforms and Financial Liberalization

Sample I II III IV

Trade 0.0090 0.0105 0.0089 0.0084 Std. error 0.0007 0.0007 0.0010 0.0012

Log(1+Inflation) (Latin) 0.0010 0.0004 0.0011 -0.0003 Std. error 0.0017 0.0016 0.0017 0.0024

Log(1+Inflation) (Not Latin) 0.0088 0.0057 0.0036 -0.0450 Std. error 0.0021 0.0024 0.0053 0.0149

Log(1+Black Market Premium) -0.0093 -0.0096 0.0005 0.0048 Std. error 0.0014 0.0015 0.0014 0.0071

Fiscal Deficit -0.0738 Std. error 0.0178


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Financial development ...

» Degree of banking and equity market development is important but independent boost from liberalization – we examine the size of private credit, equity market

activity, and equity market size

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Financial Development and Financial Liberalization

Banking sector development Sample I II III IV

Private Credit 0.0204 0.0234 0.0159 0.0298 Std. error 0.0030 0.0033 0.0046 0.0082

Private Credit*Lib indicator -0.0213 -0.0244 -0.0131 -0.0329 Std. error 0.0031 0.0034 0.0045 0.0082


Impact on growth of increasing private credit from median of segmented countries to median of liberalizedNonliberalizing country 0.0097 0.0101 0.0061 0.0101Liberalizing country 0.0139 0.0126 0.0145 0.0145Increment to growth by liberalizing 0.0042 0.0025 0.0084 0.0044

Impact on growth resulting from liberalization with no change in private credit/GDPLow level of private credit/GDP 0.0143 0.0130 0.0134 0.0156High level of private credit/GDP 0.0042 0.0025 0.0084 0.0044

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Financial Development and Financial Liberalization

Trading activity

Turnover 0.0170 0.0097 Std. error 0.0037 0.0071

Turnover*Lib Indicator -0.0145 -0.0078 Std. error 0.0038 0.0074

Official Liberalization Indicator 0.0135 0.0151 Std. error 0.0019 0.0040

Impact on growth of increasing turnover from median of segmented countries to median of liberalizedNonliberalizing country 0.0042 0.0009Liberalizing country 0.0132 0.0132Increment to growth by liberalizing 0.0090 0.0124

Impact on growth resulting from liberalization with no change in turnoverLow level of turnover 0.0126 0.0131High level of turnover 0.0090 0.0124

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Other regulatory reforms ...

» The financial liberalization/growth effect is not a post-banking crisis effect

» The enforcement of law and institutions are important

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Banking Crises and Financial Liberalization

Growth During Crisis PeriodsSample I II III IV

During Systemic Crisis -0.0048 -0.0066 -0.0062 -0.0095 Std. error 0.0007 0.0008 0.0009 0.0018


During Systemic and Borderline Crisis -0.0048 -0.0064 -0.0081 -0.0075 Std. error 0.0005 0.0006 0.0007 0.0011


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Banking Crises and Financial Liberalization

Post Crisis Period Growth

Post Systemic Crisis 0.0062 0.0060 0.0001 0.0017 Std. error 0.0009 0.0010 0.0013 0.0042


Post Systemic and Borderline Crisis 0.0049 0.0048 0.0033 0.0050 Std. error 0.0006 0.0007 0.0007 0.0011


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Conclusions

• Financial liberalization spurs growth by 1% per annum over the five years

• Survives a battery of robustness experiments

• We understand better the channels whereby growth impacted by financial liberalization

• Liberalization effect not spuriously accounted for by a host of other events such as macro-economic reforms

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Conclusions

• Financial liberalization has a very important economic effect

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Gov/GDP 75th to 50th

Enrollment 25th to 50th

Pop Growth 75th to 50th

Life Exp. 25th to 50th

Liberalization

Total Growth = 3.02%


Conclusions• Financial liberalization has a very important economic effect

• Consider economic impact of improvements plus a equity market liberalization

Liberalization

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On going research

• What about growth volatility?

Geert Bekaert, Campbell Harvey and Chris Lundblad, Growth Volatility and Equity Market Liberalization, Working paper 2002

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Standard Deviation of GDP Growth Rates1980-1997

0

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

Stan

dard

dev

iati

on


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Standard Deviation of GDP Growth Rates1980-2000

0

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0.08

Stan

dard

dev

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GDP Growth Rate Standard DeviationFull Period (1980-2000) Pre-Crisis (1980-1997)

I II III I II IIIConstant 0.1936 -0.0105 0.0004 0.2179 -0.0087 0.0045 Std Error 0.0142 0.0241 0.0304 0.0127 0.0269 0.0292Initial GDP 0.0046 0.0028 0.0070 0.0052 0.0036 0.0067 Std Error 0.0003 0.0004 0.0005 0.0003 0.0004 0.0005School -0.0116 -0.0175 -0.0161 -0.0077 -0.0136 -0.0151 Std Error 0.0025 0.0011 0.0032 0.0032 0.0016 0.0026Log(Life) -0.0471 0.0045 -0.0045 -0.0547 0.0018 -0.0059 Std Error 0.0036 0.0061 0.0074 0.0035 0.0068 0.0071Gov/GDP -0.0106 -0.0236 -0.0531 0.0048 -0.0108 -0.0157 Std Error 0.0067 0.0047 0.0121 0.0074 0.0054 0.0133PopGR 0.1159 0.3722 0.3865 0.1184 0.3973 0.3159 Std Error 0.0989 0.0362 0.0910 0.1082 0.0438 0.0863

Official Lib -0.0057 -0.0013 -0.0002 -0.0107 -0.0060 -0.0060 Std Error 0.0007 0.0008 0.0012 0.0009 0.0008 0.0012

Emerging Markets: Finance and the Real Economy Campbell R. Harvey Duke University and NBER Southern...

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Transcript of Emerging Markets: Finance and the Real Economy Campbell R. Harvey Duke University and NBER Southern...