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The Great Divide and Beyond - Financial Architecture in Transition

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  • Berglöf, Erik
  • Bolton, Patrick

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.

Suggested Citation

  • Berglöf, Erik & Bolton, Patrick, 2003. "The Great Divide and Beyond - Financial Architecture in Transition," CEPR Discussion Papers 3476, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:3476
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    More about this item

    Keywords

    economic transition; financial development; fiscal discipline; rule of law;
    All these keywords.

    JEL classification:

    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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