crisis is good for growth

Filed in archive Global Economy on December 22, 2003

The Economist has another thought provoking article in the last issue. It argues that strong liberalization even with developing bubbles and unavoidable contractions help growth more than so much sought smooth growth path. A trio of economists in Europe and US has researched the economic data of poor countries. They have found that:

"That is, countries that have experienced occasional crises have grown on average faster than countries with smooth credit conditions. We then present a two-sector endogenous growth model in which financial crises can occur, and analyze the relationship between financial fragility and growth."

"The fear of currency crises and the subsequent unemployment, bankruptcies and stalling of economic growth have made many developing countries' governments even more wary about the free flow of capital than they are about free trade in goods. Freely flowing capital can indeed be destabilizing."

"But financial systems can be liberalized a lot without letting in hot money. If a government opens up to investment from abroad---allowing foreign banks to buy local institutions, say, or allowing domestic banks to raise money on international capital markets---local banks can lend more to businesses large and small. This matters, because bank credit is often the only source of finance for many firms. The downside is that banks may become over-eager and make loans on which the returns do not justify the risks. That can produce horrible busts."

I must say it's great to have study supporting my gut feeling, although the data analyzed might be of a too short timeframe.