Università degli Studi di Torino

Whence Policy?Government Policies, Finance,

and Economic Integration

Giuseppe Bertola ; Anna Lo Prete Università di Torino and CEPR; Università di Torino

Economic integration

Finance

Government policies

MORE

MORE

LESS

1980s – early 2000s :

…aftermath of 2008-09 crisis ?

Panel OECD, 1980-2007,5-year averages of standard country-level data:

TRENDS

Financial Development Openness ?

050

100

150

200

Financial Developm

ent

0 50 100 150 200O penness

Levels

-100-50

050

100

Financial Developm

ent

- 40 -20 0 20 40O penness

Deviat ions f rom count r y means

050

100

150

200

Financial Developm

ent

0 5 10 15 20Financial St ruct ure

Levels

-100-50

050

100

Financial Developm

ent

- 10 -5 0 5 10Financial St ruct ure

Deviat ions f rom count r y means

050

100

150

200

Financial Developm

ent

0 50 100 150 200O penness

Levels

-100-50

050

100

Financial Developm

ent

- 40 -20 0 20 40O penness

Deviat ions f rom count r y means

050

100

150

200

Financial Developm

ent

0 5 10 15 20Financial St r uct ur e

Levels

-100-50

050

100

Financial Developm

ent

- 10 -5 0 5 10Financial St r uct ur e

Deviat ions f rom count r y means

Financial Development Financial Structure ?

FINANCE and OPENNESS

(Tressel Detragiache, 2008)

(Rajan Zingales,2003)(Do Levchenko,2007)(Beck,2002)

Openness Government Size ?

Openness Social Policy ?

GOVERNMENT POLICIES and OPENNESS

510

15

20

25

Governm

ent Size

0 50 100 150 200Openness

Levels

-4

-2

02

4

Governm

ent Size

- 40 -20 0 20 40Openness

Deviat ions f rom count r y means

010

20

30

40

Social Policy

0 50 100 150 200Openness

Levels

-5

05

10

Social Policy

- 40 -20 0 20 40Openness

Deviat ions f rom count r y means

510

15

20

25

Governm

ent Size

0 50 100 150 200Openness

Levels

-4

-2

02

4

Governm

ent Size

- 40 -20 0 20 40Openness

Deviat ions f rom count r y means

010

20

30

40

Social Policy

0 50 100 150 200Openness

Levels

-5

05

10

Social Policy

- 40 -20 0 20 40Openness

Deviat ions f rom count r y means

(Rodrik,1998)

(Agell, 2002)

(Rodrik,1997)(Sinn,2003)(Bertola Lo Prete,2008)

Financial Development Government Size ?

Financial Development Social Policy ?

FINANCE and GOVERNMENT POLICIES

050

100

150

200

Financial Developm

ent

5 10 15 20 25Government Size

Levels

-100-50

050

100

Financial Developm

ent

- 4 -2 0 2 4Government Size

Deviat ions f rom count ry means

050

100

150

200

Financial Developm

ent

0 10 20 30 40Social Policy

Levels

-100-50

050

100

Financial Developm

ent

- 5 0 5 10Social Policy

Deviat ions f rom count ry means0

50

100

150

200

Financial Developm

ent

5 10 15 20 25Government Size

Levels

-100-50

050

100

Financial Developm

ent

- 4 -2 0 2 4Government Size

Deviat ions f rom count r y means

050

100

150

200

Financial Developm

ent

0 10 20 30 40Social Policy

Levels

-100-50

050

100

Financial Developm

ent

- 5 0 5 10Social Policy

Deviat ions f rom count r y means

Substitution(Bertola Koeniger,2007)

Substitution/complement?

A SIMPLE MODEL

Two periods/contingencies:

t

financial transaction unit cost μ? Constraint:

cH = cL = ሺyL + yHሻ/2 perfect financial markets?

full smoothing:

Max log utility:

Can be improved by (costly) redistribution τ:

t

max

With set

Financial market yields welfare

Government redistribution: less needed if smaller μ,

more costly if larger λ (deadweight loss).

Decreasing in λ, and also in μ as long as positive

finance, i.e.

t

yields welfare

If lowering λ and μ is possible but costly (lower output if close the economy,

more instability if spur finance?)do it,

depending on shape of costs and benefits.

THEORETICAL MECHANISMS

Openness, larger mean of market incomes

perhaps larger dispersion

Less government

More private finance

Financial market liberalization: smaller transaction costs

less effective national government policies: larger deadweight losses

Financial market development’s policy roots: Financial structure Openness Government size Social policy

What drives related changes?

Country specific choices,Shaped by exogenous conditions

WHENCE POLICIES?

Country characteristics… …global trends

“Globalization”(it)by legal origin (l)

Natural Openness (i)

Legal Origin (l)Global Trade (t)

Globalization

international trade opportunitiesdiffer across countries/over time:

25

.95

95

71

75

.22

111

7.6

76

34

10

7.0

59

3

2 1 9 .2 0 1 2 2 3 2 3 .2 2 4 7 3 0 .1 3 6 3 1 9 5 8 .6 3 5

French English

German Scandinavian

Op

en

ne

ss

Global izationGraphs by legor

GLOBALIZATION and OPENNESS by Legal Origin

Potentially useful instruments

2.8

21

.15

115

7.5

20

2 1 9 .2 0 1 2 2 3 2 3 .2 2 4 7 3 0 .1 3 6 3 1 9 5 8 .6 3 5

French English

German Scandinavian

Fin

an

cia

l S

tru

ctu

re

Global izationGraphs by legor

GLOBALIZATION and FINANCIAL STRUCTURE by Legal Origin

Potentially useful instruments:correlated with policies,

11.3

39

91

18

.67

99

96

.36

32

88

15

.20

47

5

2 1 9 .2 0 1 2 2 3 2 3 .2 2 4 7 3 0 .1 3 6 3 1 9 5 8 .6 3 5

French English

German Scandinavian

Go

ve

rnm

en

t S

ize

Global izationGraphs by legor

GLOBALIZATION and GOVERNMENT SIZE by Legal Origin

Potentially useful instrumentsdifferently correlated with different policies,

1.9

01

05

63

2.3

34

88

11.2

20

97

27

.19

83

4

2 1 9 .2 0 1 2 2 3 2 3 .2 2 4 7 3 0 .1 3 6 3 1 9 5 8 .6 3 5

French English

German Scandinavian

So

cia

l P

oli

cy

Global izationGraphs by legor

GLOBALIZATION and SOCIAL POLICY by Legal Origin

Potentially useful instrumentsalong with main effects (can’t show).

Potentially useful instruments.

Financial Development,

Determinants of policies:=

Legal Origin (l)Global Trade (t) Globalization (it)

Natural Openness(i)Globalization*Legal Origin (lit)

Not the most important! but: exogenous.

Table 3. OLS regressionsDependent Variable: Financial Development

1 2 3 4

Financial Structure 5.227 5.445 4.965 3.8788.13 7.99 7.75 5.30

Openness -0.106 -0.059 -0.146

-1.01 -0.59 -1.30

Government Size -3.263 -5.000-3.29 -4.93

Social Policy 1.9913.16

Observations 132 132 132 132R2 0.298 0.303 0.367 0.414

insignificant

-100

-500

5010

0Fin

ancia

l Dev

elopm

ent

-40 -20 0 20 40Opennes s

-100

-500

5010

0Fin

ancia

l Dev

elopm

ent

-10 -5 0 5Financ ia l Struc ture

-100

-500

5010

0Fin

ancia

l Dev

elopm

ent

-4 -2 0 2 4Gov ernment Siz e

-100

-500

5010

0Fin

ancia

l Dev

elopm

ent

-5 0 5 10Soc ia l Po l i c y

with country dummies

Table 4. IV regressionsDependent Variable: Financial Development

1 2 3 4 5 6 7 8Endogenous:Financial Structure 7.092 7.598 8.643 10.393 7.643 8.349 7.364 5.936

5.98 5.36 4.81 4.35 7.10 7.31 6.68 5.03Openness -0.097 -0.122 0.041 -0.182 -0.127 -0.334

-0.79 -0.91 0.18 -1.49 -1.08 -2.18Government Size 3.738 6.776 -3.264 -5.795

0.94 1.38 -2.75 -4.98Social Policy -2.599 2.982

-1.02 3.12Exogenous:English 9.609 7.305 8.019 3.239Common Law 1.20 0.81 0.83 0.26German 45.288 43.796 55.347 70.499Commercial Code 5.10 4.78 3.11 2.85Scandinavian 1.690 1.221 -19.060 -14.950Commercial Code 0.17 0.12 -0.75 -0.59Statistics:Over-identifying 3.435 2.429 1.214 0.386 18.549 17.088 14.546 6.452restrictions a (0.633) (0.657) (0.750) (0.824) (0.017) (0.017) (0.024) (0.265)

Specification test b 6.966 9.041 9.638 10.493 14.394 14.902 13.827 14.039(0.008) (0.011) (0.022) (0.033) (0.000) (0.001) (0.003) (0.007)

Relevance of the instruments c

18.261 13.958 3.960 6.232 12.993 10.840 9.088 16.824

Observations 132 132 132 132 132 132 132 132

Similar to OLS but larger and statistically different

Table A.1. ROBUSTNESSDependent Variable: Financial Development

Different Sets of Instrumental Variables Different exogenous time-varying trends

Different dependent

variable

Add per capita

GDP

Add dummy for Advanced

countries

Country dummies instead of

Legal Origin indicators

Shipment Costs

World Trade

Volume

Stock Market Capitalization

Endogenous:Financial Structure 6.121 5.872 6.950 3.079 5.044 7.864

5.22 4.88 6.24 3.51 4.57 5.55Openness -0.372 -0.356 -0.218 -0.388 -0.279 -0.356

-2.69 -2.86 -2.02 -2.48 -1.72 -2.90Government Size -6.112 -6.007 -4.345 -6.608 -6.328 -2.810

-5.10 -5.08 -4.12 -5.43 -4.85 -0.95Social Policy 3.308 3.235 1.659 3.993 2.616 2.588

3.68 4.45 2.28 4.06 2.56 1.55Statistics:Over-identifying 6.479 6.580 49.797 15.132 8.549 4.348restrictions a (0.372) (0.361) (0.001) (0.010) (0.128) (0.500)Specification test b 26.129 29.986 4.132 6.852 10.583 28.593

(0.000) (0.000) (0.388) (0.144) (0.032) (0.000)Relevance of the instruments c

9.780 8.742 5.955 10.738 14.676 16.824

Observations 132 132 132 132 132 132

Structural policy determinants of Financial Development:

Financial Structure 5.936

5.03Openness -0.334

-2.18Govt. Size -5.795

-4.98Social Policy 2.982

3.12

Negative (small),

Indirect effects

through other

policies.

Structural estimates, What if an instrument changes?

10 p.p. decline of Global Trade (…after crisis?)

Countries Predicted change in

(Legal Origin)Financial Structure Openness Government

SizeSocial Policy

Financial Develop.

Portugal -3.36 -10.68 0.70 -1.97 -26.32(French)

United Kingdom -3.12 -11.06 0.97 -1.32 -24.43(English)

Germany -3.05 -9.21 1.15 -1.68 -26.75(German)

Finland -3.02 -7.09 1.86 -0.04 -26.45(Scandinavian)

Causes and effects of policies

We use exogenous “Globalization”to identify roots of Financial Development

in policies.• Can assess implications of any possible

change in policy for Financial Development…instability, fragility…

• Future work: welfare (growth, distribution, …)