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Financial Openness and theFinancial Openness and theChinese Growth ExperienceChinese Growth Experience
Geert BekaertColumbia University and NBER
Campbell R. HarveyDuke University and NBER
Christian T. LundbladIndiana University
China at the Crossroads ConferenceAugust 29-30, 2005
2
Financial Openness and China Plan
1. A Panel Perspective on China's Growth
2. Financial Openness and Growth
3. Empirical Results
4. Heterogeneity of Real Effects of Financial Openness on Growth
3
Consumption Growth
Consumption Growth
Standard Deviation GDP Growth
GDP Growth Standard Deviation
Developed Countries 0.019 0.025 0.020 0.022Developing Countries 0.009 0.079 0.009 0.050Africa 0.003 0.090 0.003 0.057Asia 0.029 0.046 0.030 0.037Latin America 0.003 0.071 0.001 0.045China 0.070 0.044 0.078 0.027
Financial Openness and China Historical perspective
All real, per capita; not PPP-adjusted; from World Bank.
4
Financial Openness and China Growth experience
GDP Growth
-0.04
-0.02
0.00
0.02
0.04
0.06
0.08
0.10
0.12
0.14
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Developed Developing (ex. China) China
5
Financial Openness and China Growth experience
Consumption Growth
-0.06
-0.04
-0.02
0.00
0.02
0.04
0.06
0.08
0.10
0.12
0.14
0.16
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Developed Developing (ex. China) China
6
Financial Openness and China Growth volatility
GDP Growth Volatility(5-year rolling standard deviation)
0.00
0.01
0.02
0.03
0.04
0.05
0.06
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Developed Developing (ex. China) China
7
Financial Openness and China Growth volatility
Consumption Growth Volatility(5-year rolling standard deviation)
0.00
0.02
0.04
0.06
0.08
0.10
0.12
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Developed Developing (ex. China) China
8
Financial Openness and China Neoclassical Model
Barro (1991, 1992):
≠ growth accounting
, , , ,i t k i t i t i t kg Q Z GDPGrowth
ConvergenceEffect
Steady stateGDP determinants
, [Infrastructure (Real, Social, Human); Trade;
Financial Development; Institutions; Financial
Openness]
i tZ
9
Financial Openness and China Model
Better measure to capture risk sharing benefits: idiosyncratic consumption growth volatility
where gi,t+k = k-period average of consumption growth for country i, xi,t and zi,t = control variables i = country; w=world = conditional variance of
)x(xγσ
)z(zλβ
ε)x(xgβg
w,ti,ti,t
w,ti,ti,t
ki,tw,ti,tkw,ti,tki,t
2
1
2i,tσ ki,tε
10
Financial Openness and China Historical perspective
In late 1990s, Bekaert and Harvey begin a research program on financial openness
Time-lines constructed for• “Official” equity market liberalizations• ADR and Country Fund Launches• Capital account openness• Banking reforms• Privatizations• Capital Flows• FDI activity (to do)
11
Chronologies also contain• Important political events
• Macroeconomic events
• Information on institutions
Currently, 56 emerging markets and over 400 pages of information
• http://www.duke.edu/~charvey/chronology.htm
Financial Openness and China Historical perspective
12
Date YYMMDD
Event
901126 The Shanghai Securities Exchange reopened.a8
910409 The State Council adopted the Law Concerning the Income Tax of Foreign-Funded Enterprises and Foreign Enterprises and
eliminated a 10% tax imposed on distributed profits remitted abroad by the foreign investors in foreign-funded enterprises.a3
910426 The limit of daily price fluctuations increases from 0.5% to 1%.gk
910603 The stamp tax was decreased from 0.6% to 0.3%.gk
910926 "Regulations on Borrowing Overseas of Commercial Loans by Resident Institutions" and "Rules on Foreign Exchange
Guarantee by Resident Institutions in China" were issued.a3
910703 Shenzhen opened the country's second exchange.a8
9100 The "B" share came into existence. "B shares" can be owned by foreigners only, but they are afforded the same right of ownership as "A shares", which are reserved for Chinese nationals. In China, a share entitles the owner to a dividend
distribution, but not to a right to influence the operations of the company.jj
9203 The policy on foreign trade and investment was further liberalized, opening a large number of island and border areas to such
activities.a3
920521 Free stock price through free trading (less control of price formation). Shanghai index increases from 617 to 1266 on this
day.gk
921026 China Securities Regulatory Commission begins.gk
A Chronology of Economic, Political and Financial Events in China
Financial Openness and China Historical perspective
13
• Decreased cost of capital• Changes might make country more sensitive to
world shocks• Impact on equity volatility not clear
=> Empirical work consistent with predictions
(Bekaert and Harvey (2000), Henry (2000), Kim and Singal (2000))
Financial Openness and China What are the financial effects of openness?
14
• If cost of capital decreases, more projects NPV>0
• Investment increases
Financial Openness and China What are the real effects of openness?
15
Financial Openness and China What are the real effects of openness?
Financial Development
Growth
Financial Liberalization
Relaxing FinConstraints
Investment
GrowthOpportunities
Efficiency ofInvestment
Cost of Capital
16
• 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 Openness and China Sharply different views from literature…
17
Financial Openness and China Previous research
• Bekaert-Harvey-Lumsdaine (Journal of Financial Economics, 2002)– Dating the integration of world markets
• Bekaert-Harvey-Lundblad (Journal of Financial Economics, 2005)– GDP growth positively impacted by financial openness
• Bekaert-Harvey-Lundblad (Journal of International Money and Finance, 2006)– Growth volatility does not increase, on average, after opening
• Bekaert-Harvey-Lundblad-Siegel (Working paper, 2005)– Growth opportunities linked to growth
18
Financial Openness and China Previous research
• Bekaert-Harvey (Journal of Finance, 1995)– Model of time-varying world market integration (expected returns)
• Bekaert-Harvey (Journal of Financial Economics, 1997)– Model of time-varying world integration (expected returns; volatility)
• Bekaert-Harvey (Journal of Finance, 2000)– Financial openness impacts cost of capital, volatility, country’s sensitivity
to world events
• Bekaert-Harvey-Lundblad (Journal of Development Economics, 2001)– Econometric framework developed for panel growth regressions
• Bekaert-Harvey-Lundblad (Journal of International Money and Finance, 2002)– Capital flows, liberalization and the real economy
19
Financial Openness and China Financial openness
20
Financial Openness and China Financial openness
21
Financial Openness and China Financial openness
22
Financial Openness and China Results
Table 4
Growth PredictabilityAnnual Average Real Consumption and GDP Growth in excess of the World (Five-year horizon)1980-2003
Panel A EstimateStandard
Error Estimate Standard Error
Constant -0.0066 0.0020 -0.0058 0.0020Initial GDP -0.0077 0.0014 -0.0091 0.0012Log(Life Expectancy) 0.0843 0.0109 0.0975 0.0112Population Growth -0.1730 0.0887 -0.2851 0.1052Gov/GDP 0.0154 0.0149 -0.0078 0.0138Log(1+Inflation) 0.0011 0.0030 -0.0053 0.0027Trade/GDP 0.0064 0.0029 0.0071 0.0018Private Credit/GDP 0.0026 0.0026 0.0018 0.0030Financial Openness 0.0068 0.0023 0.0054 0.0029R2
Official Equity Market LiberalizationConsumption Growth GDP Growth
0.153 0.237
23
Financial Openness and China ResultsTable 4
Growth PredictabilityAnnual Average Real Consumption and GDP Growth in excess of the World (Five-year horizon)1980-2003
Panel A EstimateStandard
Error Estimate Standard Error
Constant -0.0070 0.0022 -0.0067 0.0023Initial GDP -0.0083 0.0014 -0.0098 0.0011Log(Life Expectancy) 0.0876 0.0107 0.1003 0.0109Population Growth -0.1795 0.0862 -0.2809 0.1055Gov/GDP 0.0165 0.0147 -0.0071 0.0138Log(1+Inflation) 0.0011 0.0031 -0.0052 0.0028Trade/GDP 0.0067 0.0030 0.0078 0.0019Private Credit/GDP 0.0026 0.0027 0.0014 0.0032Financial Openness 0.0071 0.0023 0.0073 0.0030R2
Equity Market OpennessConsumption Growth GDP Growth
0.152 0.238
24
Financial Openness and China ResultsTable 4
Growth PredictabilityAnnual Average Real Consumption and GDP Growth in excess of the World (Five-year horizon)1980-2003
Panel A EstimateStandard
Error Estimate Standard Error
Constant -0.0043 0.0016 -0.0058 0.0019Initial GDP -0.0101 0.0014 -0.0121 0.0012Log(Life Expectancy) 0.0878 0.0113 0.1032 0.0111Population Growth -0.3481 0.0818 -0.4842 0.0968Gov/GDP 0.0011 0.0143 -0.0220 0.0164Log(1+Inflation) 0.0016 0.0030 -0.0032 0.0027Trade/GDP 0.0041 0.0024 0.0065 0.0019Private Credit/GDP 0.0065 0.0023 0.0037 0.0029Financial Openness 0.0159 0.0038 0.0197 0.0036R2
Capital Account Openness (Quinn)Consumption Growth GDP Growth
0.176 0.297
25
Financial Openness and China Components
26
Financial Openness and China Financial development
27
Financial Openness and China Decomposing the growth regression
28
Financial Openness and China Decomposing the growth regression
29
Financial Openness and China Components
Consumption/GDP
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Developed Developing (ex. China) China
30
Financial Openness and China Components
Investment/GDP
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
0.50
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Developed Developing (ex. China) China
31
Financial Openness and China Components(Exports-Imports)/GDP
-0.10
-0.08
-0.06
-0.04
-0.02
0.00
0.02
0.04
0.06
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Developed Developing (ex. China) China
32
Financial Openness and China Growth, Investment, and Total Factor Productivity
33
Financial Openness and China Adding investment to growth regression
Reduces coefficient on private credit to GDP
Significant in consumption but not in GDP growth regressions
Raises predicted GDP growth by 0.4%
34
Financial Openness and China Growth volatility
Table 7
Idiosyncratic Volatility PredictabilityAnnual Real Consumption Squared Growth Residuals1980-2003
EstimateStandard
Error
Constant 0.00071 0.00010Initial GDP -0.00005 0.00006Log(Life Expectancy) -0.00056 0.00046Population Growth 0.01509 0.00484Gov/GDP 0.00367 0.00162Log(1+Inflation) 0.00002 0.00023Trade/GDP 0.00048 0.00022Private Credit/GDP 0.00021 0.00014Financial Openness -0.00031 0.00015R2 0.069
Official Equity Market
Liberalization
35
Financial Openness and China Growth volatility
Table 7
Idiosyncratic Volatility PredictabilityAnnual Real Consumption Squared Growth Residuals1980-2003
EstimateStandard
Error
Constant 0.00079 0.00011Initial GDP 0.00000 0.00006Log(Life Expectancy) -0.00071 0.00044Population Growth 0.01418 0.00483Gov/GDP 0.00366 0.00163Log(1+Inflation) 0.00000 0.00023Trade/GDP 0.00043 0.00023Private Credit/GDP 0.00027 0.00015Financial Openness -0.00052 0.00013R2 0.071
Equity Market Openness
36
Financial Openness and China Growth volatility
Table 7
Idiosyncratic Volatility PredictabilityAnnual Real Consumption Squared Growth Residuals1980-2003
EstimateStandard
Error
Constant 0.00064 0.00008Initial GDP 0.00004 0.00006Log(Life Expectancy) -0.00173 0.00058Population Growth 0.01778 0.00496Gov/GDP 0.00104 0.00117Log(1+Inflation) 0.00007 0.00026Trade/GDP 0.00066 0.00016Private Credit/GDP 0.00016 0.00014Financial Openness -0.00007 0.00019R2 0.088
Capital Account Openness (Quinn)
37
Financial Openness and China Why do countries respond differently to openness?
Estimate Standard Error Estimate Standard ErrorPriv/GDP 0.00242 0.00252 0.00024 0.00014Fully Open 0.00881 0.00171 -0.00068 0.00012Low value 0.00101 0.00330 0.00007 0.00021High Value 0.01047 0.00425 -0.00032 0.00019
Mean Volatility
38
Financial Openness and China Why do countries respond differently to openness?
Estimate Standard Error Estimate Standard ErrorTurnover 0.00920 0.00268 0.00010 0.00011Fully Open 0.01021 0.00222 -0.00034 0.00009Low value -0.00651 0.00519 0.00012 0.00016High Value 0.00592 0.00406 -0.00027 0.00013
Mean Volatility
39
Financial Openness and China Financial development
40
Financial Openness and China Why do countries respond differently to openness?
Estimate Standard Error Estimate Standard ErrorMCAP/GDP 0.00297 0.00286 0.00000 0.00009Fully Open 0.01064 0.00199 -0.00027 0.00007Low value -0.00314 0.00339 0.00043 0.00012High Value 0.00592 0.00398 -0.00050 0.00015
VolatilityMean
41
Financial Openness and China Financial development
42
Financial Openness and China Why do countries respond differently to openness?
Estimate Standard Error Estimate Standard ErrorSocial Security 0.01909 0.00613 -0.00076 0.00035Fully Open 0.01017 0.00258 -0.00023 0.00009Low value -0.00570 0.00514 0.00012 0.00016High Value -0.00067 0.00351 -0.00015 0.00014
Mean Volatility
43
Financial Openness and China Why do countries respond differently to openness?
Estimate Standard Error Estimate Standard ErrorGov/GDP 0.01497 0.01494 0.00385 0.00166Fully Open 0.00886 0.00176 -0.00068 0.00012Low value 0.00211 0.00484 0.00013 0.00012High Value 0.00813 0.00273 -0.00032 0.00031
Mean Volatility
44
Financial Openness and China Why do countries respond differently to openness?
Estimate Standard Error Estimate Standard ErrorQuality of Inst. 0.01439 0.00655 -0.00202 0.00049Fully Open 0.00417 0.00166 -0.00024 0.00011Low value 0.00488 0.00338 0.00013 0.00026High Value 0.00192 0.00376 -0.00008 0.00019
Mean Volatility
45
Financial Openness and China Country Risk
46
Financial Openness and China Why do countries respond differently to openness?
Estimate Standard Error Estimate Standard ErrorInvestment Profile 0.04636 0.00856 -0.00053 0.00039Fully Open 0.00274 0.00195 -0.00059 0.00013Low value 0.00284 0.00337 0.00024 0.00023High Value 0.00133 0.00359 -0.00058 0.00023
Mean Volatility
47
Financial Openness and China Country Risk
48
Financial Openness and China Conclusions
China’s growth experience cannot be explained by standard growth models
Using standard growth determinants, China’s predicted growth in 2003 was 2.57% (versus 2.00% in 1980)
China is lower than average on:
• quality of institutions
• stock market development
• capital account openness
49
Financial Openness and China Further research
Embed quality of institutions; finer measures of financial development in growth decompositions
Study factor productivity growth?
Study determinants of GDP per capita?
(see Roll and Talbot, 2004)
50
Financial Openness and China Financial development
MCAP/GDP
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Developed Developing (ex. China) China
51
Financial Openness and China Financial development
Equity Market Turnover
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
Developed Developing (ex. China) China
52
Financial Openness and China Financial development
Private Credit/GDP
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Developed Developing (ex. China) China
53
Financial Openness and China Country Risk
54
Financial Openness and China Country Risk
55
Financial Openness and China Country Risk
56
Financial Openness and China Country Risk
57
Financial Openness and China Neoclassical Model
Consider the Solow (1956) model:
Y=A + K + (1-)L
where:Y = change in output per workerA = change in total factor productivityK = change in capital stockL = change in labor stockelasticity
58
Figure 2
GDP Components: China
-0.1
0
0.1
0.2
0.3
0.4
0.5
0.6
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
Consumption Investment Government Exports-Imports
Financial Openness and China Components
59
Financial Openness and China Components
Government Consumption/GDP
0.00
0.05
0.10
0.15
0.20
0.25
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Developed Developing (ex. China) China
60
Financial Openness and China Components(Exports+Imports)/GDP
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
0.90
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Developed Developing (ex. China) China
61
Financial Openness and China Components
Savings/GDP
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
0.45
0.50
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Developed Developing (ex. China) China