The Great Divide and Beyond - Financial Architecture in Transition

56 Pages Posted: 21 Feb 2003

See all articles by Erik Berglöf

Erik Berglöf

Institute of Global Affairs, London School of Economics and Political Science

Patrick Bolton

Columbia University - Columbia Business School, Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Date Written: February 2003

Abstract

A growing and deepening divide has opened up between countries where economic development has "taken off" and those caught in a vicious cycle of institutional backwardness and macroeconomic instability. This "Great Divide" is visible in almost every measure of economic performance, such as GDP growth, investment, government finances, growth in inequality and general institutional infrastructure, and increasingly in measures of financial development. Countries that have made it to the "right" side of the divide (Hungary, Poland, Slovenia, the Baltic States) have pursued a remarkable diversity of policies aimed at financial development. Yet, strikingly, the basic financial architectures of these frontrunners today are remarkably similar: strongly dominated by commercial banks, increasingly foreign owned, which lend primarily to government. Stock markets are highly volatile and illiquid, and their sustainability is in question as the numbers of listed firms are stagnating or even falling. Enterprises rely most on internally generated funds, and essentially all external long-term finance comes from foreign direct investment. This article finds little evidence that finance has lead to increased growth in the transition countries; in fact, financial expansion has in some countries lead to soft budget constraints and undermined growth. Financial development and growth appear to be jointly determined by fiscal and monetary discipline, at the macro level, and contract enforcement, at the micro level. These factors, in turn, seem related to underlying variables like income inequality and recent experience of rule of law.

Keywords: Economic transition, financial development, fiscal discipline, rule of law

JEL Classification: G20, O16

Suggested Citation

Berglöf, Erik and Bolton, Patrick, The Great Divide and Beyond - Financial Architecture in Transition (February 2003). Available at SSRN: https://ssrn.com/abstract=382300

Erik Berglöf (Contact Author)

Institute of Global Affairs, London School of Economics and Political Science ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Patrick Bolton

Columbia University - Columbia Business School, Economics ( email )

420 West 118th Street
New York, NY 10027
United States

HOME PAGE: http://www0.gsb.columbia.edu/faculty/pbolton/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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