ERROR LOADING HTML FROM SOURCE (http://ncf.sobek.ufl.edu//design/skins/UFDC/html/header_item.html)

The Effects of Financial Liberalization on the Growth of the Jamaican Economy

Permanent Link: http://ncf.sobek.ufl.edu/NCFE004173/00001

Material Information

Title: The Effects of Financial Liberalization on the Growth of the Jamaican Economy
Physical Description: Book
Language: English
Creator: Shukla, Aditi
Publisher: New College of Florida
Place of Publication: Sarasota, Fla.
Creation Date: 2009
Publication Date: 2009

Subjects

Subjects / Keywords: Jamaica
Financial Liberalization
Oligopoly
Real Effective Exchange Rate
Genre: bibliography   ( marcgt )
theses   ( marcgt )
government publication (state, provincial, terriorial, dependent)   ( marcgt )
born-digital   ( sobekcm )
Electronic Thesis or Dissertation

Notes

Abstract: This paper examines the role of financial liberalization in the nation of Jamaica and its effect on the economic development of the country. In particular, this paper investigates the important link between the oligopolistic structure of the nation's banks and the obstacles placed in the path to liberalization and globalization. This research involves an evaluation of the interest rate spread found as the difference between the loan and deposit rates of the nation. The paper also addresses the way in which the Jamaican real exchange rate reacted to an influx of foreign capital following liberalization of the financial sector. The findings associated with the study of the real effective exchange rate (REER) are in line with the results achieved by economist Dani Rodrik which suggest a positive correlation between the REER and the growth�defined by GDP growth�of an economy.
Statement of Responsibility: by Aditi Shukla
Thesis: Thesis (B.A.) -- New College of Florida, 2009
Electronic Access: RESTRICTED TO NCF STUDENTS, STAFF, FACULTY, AND ON-CAMPUS USE
Bibliography: Includes bibliographical references.
Source of Description: This bibliographic record is available under the Creative Commons CC0 public domain dedication. The New College of Florida, as creator of this bibliographic record, has waived all rights to it worldwide under copyright law, including all related and neighboring rights, to the extent allowed by law.
Local: Faculty Sponsor: Khemraj, Tarron

Record Information

Source Institution: New College of Florida
Holding Location: New College of Florida
Rights Management: Applicable rights reserved.
Classification: local - S.T. 2009 S56
System ID: NCFE004173:00001

Permanent Link: http://ncf.sobek.ufl.edu/NCFE004173/00001

Material Information

Title: The Effects of Financial Liberalization on the Growth of the Jamaican Economy
Physical Description: Book
Language: English
Creator: Shukla, Aditi
Publisher: New College of Florida
Place of Publication: Sarasota, Fla.
Creation Date: 2009
Publication Date: 2009

Subjects

Subjects / Keywords: Jamaica
Financial Liberalization
Oligopoly
Real Effective Exchange Rate
Genre: bibliography   ( marcgt )
theses   ( marcgt )
government publication (state, provincial, terriorial, dependent)   ( marcgt )
born-digital   ( sobekcm )
Electronic Thesis or Dissertation

Notes

Abstract: This paper examines the role of financial liberalization in the nation of Jamaica and its effect on the economic development of the country. In particular, this paper investigates the important link between the oligopolistic structure of the nation's banks and the obstacles placed in the path to liberalization and globalization. This research involves an evaluation of the interest rate spread found as the difference between the loan and deposit rates of the nation. The paper also addresses the way in which the Jamaican real exchange rate reacted to an influx of foreign capital following liberalization of the financial sector. The findings associated with the study of the real effective exchange rate (REER) are in line with the results achieved by economist Dani Rodrik which suggest a positive correlation between the REER and the growth�defined by GDP growth�of an economy.
Statement of Responsibility: by Aditi Shukla
Thesis: Thesis (B.A.) -- New College of Florida, 2009
Electronic Access: RESTRICTED TO NCF STUDENTS, STAFF, FACULTY, AND ON-CAMPUS USE
Bibliography: Includes bibliographical references.
Source of Description: This bibliographic record is available under the Creative Commons CC0 public domain dedication. The New College of Florida, as creator of this bibliographic record, has waived all rights to it worldwide under copyright law, including all related and neighboring rights, to the extent allowed by law.
Local: Faculty Sponsor: Khemraj, Tarron

Record Information

Source Institution: New College of Florida
Holding Location: New College of Florida
Rights Management: Applicable rights reserved.
Classification: local - S.T. 2009 S56
System ID: NCFE004173:00001


This item is only available as the following downloads:


Full Text

PAGE 1

THE EFFECTS OF FINANCIAL LIBERALIZATION ON THE GROWTH OF THE JAMAICAN ECONOMY BY ADITI SHUKLA A Thesis Submitted to the Division of Social Sciences New College of Florida in partial fulfillment of the requirements for the degree Bachelor of Arts Under the sponsorship of Professor Tarron Khemraj Sarasota, Florida May 2009

PAGE 2

ii Abstract THE EFFECTS OF FINANCIAL LIBERALIZATION ON THE GROWTH OF THE JAMAICAN ECONOMY Aditi Shukla New College of Florida 2009 ABSTR ACT This paper examines the role of financial liberalization in the nation of Jamaica and its effect on the economic development of the country. In particular, this paper investigates the important link between the oligopolistic structure of the nation' s banks and the obstacles placed in the path to liberalization and globalization. This research involves an evaluation of the interest rate spread found as the difference between the loan and deposit rates of the nation. The paper also addresses the way in which the Jamaican real exchange rate reacted to an influx of foreign capital following liberalization of the financial sector. The findings associated with the study of the real effective exchange rate (REER) are in line with the results achieved by econ omist Dani Rodrik which suggest a positive correlation between the REER and the growth defined by GDP growth of an economy. Tarron Khemraj, Thesis Adviser Economics

PAGE 3

iii Table of Contents THE EFFECTS OF FINANCIAL LIBERALIZATION ON THE GROWTH OF THE JAMAICAN ECONOMY Introduction 1 Conditions of Financial Liberalization in Jamaica 3 (1) Economic and Political History 4 (2) Financial Repression 8 (3) Financial Liberalization 10 Obstructions and Essen tial Factors 18 (4) Looking at Oligopolies 19 (5) Criticism of Financial Liberalization 24 (6) Capital Flows and Financial Globalization 27 (7) Jamaican Financial Crisis 29 Empirical Relations: REER, Growth, Investment and Saving s 34 Jamaican Data 34 (i) GDP Growth 35 (ii) Investment & Savings 37 (iii) Interest Rate Spread 40 (iv) Real Effective Exchange Rate 47 (v) Human Development 58 Conclusion 60

PAGE 4

1 INTRODUCTION The purpose of this thesis is to argue the relevance of financial liberalization's effect on the economic development and growth of a nation Jamaica This is also an evaluation of the extent to which the oligopolistic structure of the Jama ican banking sector blocked the involvement of financial liberalization to economic growth. This entails examining the interest rate spread of Jamaica, a factor which is linked to the oligopolistic configuration of the Jamaican banking system. In addition to discussing the liber alization of the banking sector, interest rate spread, and the obstruction of Jamaican economic growth, this thesis is also a discovery of financial globalization's contribution to real effective exchange rate appreciation. The resea rch conducted for the purpose of this paper arrived at findings which are in line with that of economist Dani Rodrik's hypothesis which states that increased flows of foreign capital appreciate the real exchange rate which in turn impels economic growth A dditionally, financial l iberalization should lead to mobilized savings and increased investment; this is a claim for which supporting data is provided. This thesis also presents alternate views on the subject in the form of criticisms of financial liberali zation.

PAGE 5

2 Chapter one Conditions of Financial Liberalization in Jamaica begins by providing a basic sense of Jamaica through fundamental information and facts which are then followed by a brief summation of the nation's economic and political history as w ell as a discussion of financial repression and, of course, financial liberalization. Here we visit the findings of economists McKinnon and Shaw and Maxwell Fry. The second segment Obstructions and Essential Factors commences by addressing the influences of oligopolies and other important issues raised by Khemraj (2008). This section also incorporates critical voices of financial liberalization, with a primary focus on the writings of Joeseph Stiglitz. Dani Rodrik and Arvind Subramanian's arguments concer ning capital flows and fin ancial globalization are also a major component of the second chapter which aims to support the oligopoly and real effective exchange rate theses previously expressed. Also addressed is an overview of the Jamaican financial crisis with references to the research of Colin Kirkpatrick and David Tennant. Finally, the third part Empirical Relations: REER, GDP Growth, Investment, Savings which pr ecedes a final conclusion, presents pre mid, and post liberalization data in the form of bar and line graphs as well as scatter plots. It is here that we touch on the aspect of human development and the thesis is tied up with the use of International Monetary Fund data 1 1 It is important to note that the findings of this thesis are suggestive and not conclusive

PAGE 6

3 CONDITIONS OF FINANCIAL LIBERALIZATION IN JAMAICA Jamaica is a na tion with a strong sense of identity which asserts itself though a rich culture including distinct music and food s Since its independence from Great Britain in the early sixties, political power has interchanged between the social democratic People's Nati onal Party and the conservative Jamaica Labor Party. All the while, Queen Elizabeth II remain ed, and remains, the nation's head of state for this parliamentary government. On a whole, the results of the Jamaican election process have always been accepted a nd its institution of politics has remained legitimate. However, general political stability has not translated in to economic, or social, concord and Jamaica is a living paradox as luxury tourist resorts often coincide with overpopulated and poverty ridden ghettos. This nation of 2.7 million (UN, 2007) and 4,243 square miles has a gross national income (or GNI, the average income of a country's citizens) of $3,710 US dollars (World Bank, 2007). Traditionally, Jamaica's main exports have been agricultural an d primarily dependent upon sugar and bananas as well as rum. A bauxite and alumina industry started up in the 1950's was closely followed by a by a spike in tourism, a strong component of Jamaica's current economy (King, 2000)

PAGE 7

4 (1) Economic and Political History Up u ntil 1967 Jamaica's financial system was overrun with foreign commercial banks which lacked a true domestic stake in the financial system And so, the policies and fate of these intermediaries were decided upon overseas. Over the next couple of decades the Jamaican government pulled in the reins and pushed itself onto the operations of the financial institutions it hosted including a direct power o ver the interest rate structure This practice of Jamaica's government enforced controls on the financial sector of its economy was, and is, a form of financial repression Other factors of financial repression include controlling capital in order to prevent the in and out flows of ce rtain kinds of foreign capital and channeling credit into priority sectors. Another form of financial repression is presented through weighty taxation on the financial sector (Tennant, 2007) On one hand, the start of Jamaica's economic reform can be identified as the passage of the 1977 Stand by Agreement with the Inte rnational Monetary Fund (IMF) coupled with their standard list of conditionalities for economic reform. On the other hand, w hile Jamaica can be recognized as an early reformer by commencing with the aforementioned IMF agreement in the late seventies, key p rescribed economic reforms were not put into action until 1991. As a result, some argue that Jamaica's economic reform is an event of the nineties (King, 2000) 2 The essential liberal ideas which serve as a foundation for structural adjustment reforms wer e unpopular in Jamaica and therefore were reluctantly imposed on the Jamaican people to facilitate concord with the 2 The following discussion, and remainder of this section titled "Econ omic and Political History," is taken from King (2000), The Evolution of Structural Adjustment and Stabilization Policy in Jamaica

PAGE 8

5 current trend in global economics. This reluctant commitment is important in understanding the irregularity in the Jamaican reform process e xemplified by the realization of some parts of economic reform in the early 1980s, and putting other phases off until the 1990s as well as entirely discounting a few elements Jamaica's economic climate in the 1950s and 1960s was stable and defined by rema rkable growth rates as well as increasing industrialization. However, the 1970s and 1980s stood in great contrast to this with significantly increased government intervention in economic issues, high inflation, currency depreciation, wide ranging economic stagnation and rising poverty rates. It is argued that the difference between the two decades can be attributed to the reigning government's motivation for intervention. While the state control of the 1970s was motivated by populism, the Seaga administrati on (lead by Edward Seaga, Prime Minister and leader of the Jamaica Labor Party from 1980 1989) of the 1980s had a less overtly ideological rationale and was fairly, but not too deeply, controlled by the commitments required of struct ural adjustment program s. Next came the 1990s as a pe riod of serious economic reform ; this was however coupled with macroeconomic crises. The growth and development of the 1960s Jamaican economy was impressive both in relation to other developing economies and when measured ag ainst its own subsequent economic performance. GDP grew at a steady rate while inflation was well managed. Meanwhile, as the value placed on agriculture declined and the service sector boomed, investment in industrialization resulted in the growth of a pro mising and emerging young manufacturing sector. All the while, the mineral industry, which relied heavily on bauxite ore, and the tourism industry, which secured Jamaica as a mass tourist

PAGE 9

6 destination, drove economic growth. The striking growth rates of the period were a derivative of the primary investment in, and utilization of, resources. Nevertheless the reach of this economic prosperity was not wide spread by any means; a large portion of the population was ignored and not included in the process of ec onomic development. During the populist Manley administration from 1972 to 1980, lead by Prime Minister Michael Manley, Leader of the People's National Party of Jamaica, the economic role of government expanded and its policy in Jamaica was driven by redi stribution. Growth was considered a given as the focus of the economic administration shifted to the matter of economic equa lity. This called for increased public health, housing and education expenditures and subsidies on stable foods. With this vast expa nsion of the Jamaican government regarding economic issues came an increasing responsibility for production. This resulted in the nationalization of utilities, mining and the banking sector. Over time, as the economy weakened, the Jamaican government acqu ired failing businesses in an effort to sustain the employment rate; these failing enterprises would go on to pose a burden on government accounts Jamaica closed its doors to international trade in the 1970s and foreign capital was discouraged through the government acquisition of formally foreign owned ventures (as mentioned above). In 1974, Jamaican exchange controls were raised and remained rigid throughout the decade. Additionally, tariffs increased, a license requirement was established in order to im port consumer goods, and a large variety of imported goods became subject to restrictions and, in some cases, a ban. Soon, following the founding of the Jamaica Commodity Trading Corporation, foreign consumer goods were no longer available for purchase in Jamaican stores. Macroeconomic performance faltered as the

PAGE 10

7 economy c ontracted, investment decreased and inflation and the unemployment rate increased Jamaica visibly started out the eighties in a very poor economic state with governm ent intervention at i ts highest as f inancial repression hindered domestic productivity, among other things. A new administration in 1980 came with a slight change in approach to economic policy. The eighties came to stand for rational, state guided advancement and, turning bac k to the World Bank and IMF agreements, Jamaica began to reform its economy. Stagnation remained persistent throughout the decade but in the late eighties the economy showed real growth for the first time in many years. Unfortunately, soon after, in 1989, the tropical tempest that was Hurricane Gilbert paid Jamaica a visit. As a result of this inopportune visit, a considerable share of the country's infrastructure and capital reserves were sm ashed, causing a large setback in terms of growth. Then, in 1989, there was a step up with regard to economic reform following the reemergence of Manley's People's National P arty of Jamaica Finally, factors of the IMF prescribed reform which were not before implemented were brought out, this adjustment was quite bumpy a nd the economy suffered once again as the removal of capital controls triggered very high rates of depreciation and inflation This marked the lifting of financial repression and formal initiation of financial liberalization in the Jamaican economy.

PAGE 11

8 (2) F inancial Repression Financial repression is an implementation of government enforced policies, laws, and controls forced on the financial sector of an economy. A nation's financial sector is comprised of a commercial banking system central bank and numero us other financial in termediaries. Fina ncial intermediaries are firms such as banks, credit unions, insurance companies, savings and thrift institutions, mutual and pension funds that act as middlemen between savers and investors by borrow ing from consumer s and savers and lend ing to individuals and companies that require resources for investment It is important to note that a "key stylized fact about financial systems in developing countries is that they are dominated by commercial banks" (Fry, 1997 p. 75 4 ) G overnment operated actions of financial repression influence prices as well as both domestic and foreign exchange rates. Financial systems in developing nations are apt to practice forms of financial repression; the main tools used to apply financial repression are ceilings implemented on the interest, deposit and loan rate as well as high reserve requirements which allow governments to finance themselves at artificially low interest rates. Jamaica's polic ies of financial repression led to inefficienc ies in its financial institutions and intermediaries characterized by low domestic savings and investment, unproductive allocation of resources and high interest rate spreads. It is clearly understood that financial repression stunted economic growth in Ja maica and during these low times (1 986 1988 ) the World Bank presented the nation with the option of financial liberalization via a prescribed Structural Adjustment Program. This called for the pr ivatization of c ommercial banks credit controls were remove d and Jamaica was set

PAGE 12

9 on a path toward a market determined deposit rate as a result of this newly liberalized financial sector. Privatizations of banking systems and the lessening of capital account constraints are commonly acknowledged as primary feature of economic development. Capital and credit control removal has long been backed as a steadying factor of the development process to improve efficiency and to perhaps reinstate economies to their previously productive position (Eicher & Hull, 2004) By 199 0 1991 the IMF employed new targets which called for mass deregulation of savings rates, credit ceilings and exchange rate controls. By the mid nineties the Jamaican financial sector's institutions picked up as "Large financial conglomerates emerged and v entured into the acquisition and operation of real sector projects. There was also rapid expansion of lending to the private sector, which increased in real terms by approxim ately 25% between 1985 and 1993 (Tennant, 2007, section 2) Above, it i s noted th at Jamaica's financially repressive policies lead to high interest rate spreads, it is important to have a feeling of what this means. The interest rate spread is a powerful and straightforward economic instrument used to predict recessions b y starting wit h the yield on the U.S. Treasury bond and then subtracting the rate banks charge each other for overnight loans, the Federal funds rate we can find the interest rate spread. As b onds have diverse time structures indicated by the time period before they ma ture and are repaid (U.S. Treasury: bills, 10 years) their y ield usually differs by said time structure, and can be illustrated by a yield curve Basically, t he interest rate spread effectively evaluates two points on a yield curv e. However, yield curves typically do not exist in cases of financial repression.

PAGE 13

10 (3) Financial Liberalization The extreme opposite of financial repression, financial liberalization is believed by some to be more effective than its officious counterpart. Supporters of liberalization of the financial sector and limited government intervention be lieve that repression impedes the de velopment of financial markets and th erefore development and growth in general. This approach believes in leaving t he market with the responsibility of determining interest rates and is characterized by low levels of control over capital and credits as well as their d irection into priority sectors in order to drum up savings and increase deposits. However, there are dr awbacks to this; lower levels of funds manage to find their way into the financial sector and the allocation of resources are disturbed T hese changes lead to lower ed saving and investment levels. Still, financial liberalization has proven itself to be ben eficial for development in East A sian nations; liberalization le d to increased borrowing from abroad by East Asian banks and firms. However, ultimately t heir success is credited to their economically stable settings, strong institutional structures of regu lation and organized banking systems (Thirlwall, 2006) Jamaica is a remarkable case study of financial liberalization for various reasons. For example, the diverse aspects of Jamaican economic reform transpired during discrete periods. Jamaica's case is in high contrast to those like Chile. In the late 1970s, Chile drastically changed their economic policy in a fairly short period of time. The Jamaican case, therefore, may be helpful in better understanding issues related to the introduction and progressi on of reform. Also, Jamaica is known for one of the most unpleasant records of economic performance during the period of reform when juxtaposed with other

PAGE 14

11 reforming economies in the area Although the average growth percentage in the region was 2.2 % annual ly in the eighties, Jamaica grew a mere 1.4% per year; the difference only deteriorated in the nineties. The nearby Latin American and Caribbean economies averaged 3% yearly in the early to mid nineties, but Jamaica's average growth rate struggled at only 1.3%. While investigating the relation between growth and equity market reform, economists Geert Bekaert, Campbell Harvey and Christian Lundblad, from the National Bureau of Economic Research, are finding that financial liberalization does stimulate growt h: "In a large sample of countries over a period since 1980, financial liberalization leads to a 1% increase on average in a country's annual growth rate over a five year period." One such way that financial liberalization can lead to increased growth is through open markets of capital which can facilitate higher efficiency within the markets and even spur financial development. I t is important to realize that f inancial liberalization is only superior to financial repression if implemented in a nation whic h can support it F or example: the Bekaert, Harvey, and Lundblad paper also concludes that a small government, well built legal system and a large number of enrollees in the secondary level of school all contribute to the aug mentation of liberalization. I n addition, the auth ors explain that financial liberalization is a beneficial policy option that may very well lead developing nations into the group of countries which display conditional convergence (Bekaert, Harvey & Lundblad, 2001) An expansion on the meaning of the aforementioned term "conditional convergence" is in order. This requires touching on the Solow model and its discussion of conditional convergence as well as absolute convergence. The absolute convergence hypothesis

PAGE 15

12 declares that countries which have equal access to the same technology, population growth rate and have equal propensities to save, yet differ in their capital to labor ratios, can be expected to converge to the same growth rate. The conditional convergence hypothesis states tha t nations which differ in their propensity to save and primary capital to labor ratio but share similar technological potential and population growth rates, should theoretically converge to the same growth rate. However this does not necessarily happen at the same capital to labor ratio for both countries. FIGURE 1: Solow Model Conditional Convergence 3 3 Figure replicated from the following website: cepa.newschool.edu/het/essays/growth/neoclass/solowconv.htm#conditional) !"# $%& # ( "#)% # "#+ $%& # "#+ $%& # % ,# % *# ,# ,# *# k= K/L y= Y/L ) # { *# ,# { !"# $%& # ( "#)% # "#+ $%& # "#+ $%& # % ,# % *# ,# ,# *# k= K/L y= Y/L ) # { *# ,# { !"# $%& # ( "#)% # "#+ $%& # "#+ $%& # % ,# % *# ,# ,# *# k= K/L y= Y/L ) # { *# ,# { !"# $%& # ( "#)% # "#+ $%& # "#+ $%& # % ,# % *# ,# ,# *# k= K/L y= Y/L ) # { *# ,# { !"# $%& # ( "#)% # "#+ $%& # "#+ $%& # % ,# % *# ,# ,# *# k= K/L y= Y/L ) # { *# ,# { !"# $%& # ( "#)% # "#+ $%& # "#+ $%& # % ,# % *# ,# ,# *# k= K/L y= Y/L ) # { *# ,# { !"# $%& # ( "#)% # "#+ $%& # "#+ $%& # % ,# % *# ,# ,# *# k= K/L y= Y/L ) # { *# ,# {

PAGE 16

13 Two economists, and a couple of the strongest advocates for financial liberalization, as well as authors of highly influential books, are K. McKinnon and E. Shaw. Together they were the first to argue for maximum liberalization and showcase the dangers of financial repression McKinnon is known for his Complementarity Hypothesis which states money and capital are complements and not substitutes like John Maynard Keynes determined. This hypothesis was argued with a classical analysis, using loanable funds theory. McKinnon also believed that "lumpy" investments, such as those in factories and power plants, require a prior accumulation of savings. He states that positive, high real interest rates are integral to the allow ance of building up of money balances. A s long as the real rate of return on investment exceeds the real rate of interest investment will continue Altern atively Shaw did not assume prior savings, but he is a firm supporter of financial deepening to help along development. Shaw's debt intermediation view states that the market should be left alone to determine interest rates but the primary focus should be fixed entirely on modernizing the financial sector and developing capital markets for stocks and bonds. He stressed the beneficial aspects of high interest rat es on savings and increased liabilities which allow for increased lending of resources for productive investment in a more efficient way (Thirlwall, 2006) The ideas of McKinnon and Shaw carry a lot of weight, so much so that they helped shape the positio ns of the International Monetary Fund and the World Bank when they were designing the formation of the financial parts of their well known (perhaps even infamous) structural adjustment programs McKinnon Shaw and endogenous growth theory prescriptions for the financial sector are as follows : (1) liberalize interest rates; (2) discard credit controls; (3) privatize all banks; (4) develop money and stock

PAGE 17

14 markets; (5) use indirect monetary policy (manipulate interest rates and the money supply for desirable ou tcomes); (6) and remove capital controls to make way for capital inflows and, in turn, growth. FIGURE 2: McKinnon Shaw Model 4 As shown in the illustration above, the McKinnon Shaw equilibrium is signified by "x" with a n optimal rate of interest a t r* and an optimal level of savings and investment at I*. The delineation of the McKinnon Shaw argument indicates savings as positive in relation to the real interest rate while investment is shown as having a negative relationship with the real interest rate. A.P. Thirlwa ll explains the positive function as "reflecting the idea 4 T h is figure was taken from the Development Economics textbook of Thirlwall 2006, p.425 !" #$% &'( ")" *(% !# (" % &'+"*(,"'( % A A' B' B x S I I A I A' I B I B' I* r 2 r 3 r 1 r !" #$% &'( ")" *(% !# (" % &'+" *(,"'( % A A' B' B x S I I A I A' I B I B' I* r 2 r 3 r 1 r !" #$% &'( ")" *(% !# (" % &'+"*(,"'( % A A' B' B x S I I A I A' I B I B' I* r 2 r 3 r 1 r !" #$% &'( ")" *(% !# (" % &'+"*(,"'( % A A' B' B x S I I A I A' I B I B' I* r 2 r 3 r 1 r !" #$% &'( ")" *(% !# (" % A A' B' B x S r 2 r 3 r 1 r !" #$% &'( ") "*(% !# (" % &'+"*(,"'( % A A' B' B x S I I A I A' I B I B' I r 2 r 3 r 1 r &'(")"*(% !#("% % -".$.'/* % !" #$% &'( ") "*(% !# (" % &'+"*(,"'( % A A' B' B x S I I A I A' I B I B' I r 2 r 3 r 1 r &'(")"*(% !#("% % -".$.'/* %

PAGE 18

15 of time preference and the interest rate as the reward for abstaining from present consumption" and the negative function as "reflecting the diminishing marginal efficiency of inve stment (Thrilwall, 2006, p.425). The graph below was used in an article by Heather Gibson and Euclid Tsakalotos, The Scope and Limits of Financial Liberalisation in Developing Countries: A Critical Survey in order to explain the McKinnon Shaw hypothesis. FIGURE 3: The McKinnon Shaw Financial Liberalization Hypothesis 5 5 This figure was found in an article by Gibson and Tsakalotos (1994) p. 586.

PAGE 19

16 Maxwell Fry takes issue with interest rates ceilings, shown in the graph above by providing four ways in which they misrepresent the economy. 1 ) Low interest rates encourage investing i n present and existing consumption instead of looking to the future and possible consumption at that time. This means savings may not be at an appropriate level for future prospects. 2 ) Next, in place of advancing the lending process through a financial intermediary such as by depositing money in a bank, prospective lenders may engage in relatively l ow yielding direct investment. 3 ) Another way in which interest rate ceilings misrepresent the state of the economy is disregarding the capital intensive pr ojects that low interest rates will allow b ank borrowers to fund. 4 ) And finally, entrepreneurs are also borrowers and would rather not borrow money to fund their projects at higher market clearing interest rate (Fry, 199 7) Figure 3 clearly shows that if the government i n this case were to employ slight liberalization by raising the real interest rate to ceiling 2, still keeping the interest rate below the market equilibrium, the result would be a favorable increased investment. Additionally credit ra tioning post quasi liberalization shrinks to CD from the pre quasi liberalization amount of AB. If the hypothetical government exemplified in the above graph were to fully liberalize and release its control over interest rates then the issue of credit rat ioning would disappear as the market would theoretically drift toward equilibrium. D oes this actually happen? It is often the case that the competitive market mechanism is trumped by the pricing power of financial intermediaries such as #$"% Ceiling 2 Ceiling 1 !"# $ % & !"# % & !"# ( % & &'(")*+,--./ #'01"2,-0-*,03"4,5(!03,607,.-"89:.7'(;,; ) (& & )* & & ) (' & ) $& & + & & & & / & % 0 $& & 0 & 0* & &

PAGE 20

17 commercial banks i n developing countries. These banks would have been privatized in a liberalized economy in conjunction with other measures of repression. Khemraj (2006) argued, in the hands of privatized banks, as a result of their quest for maximized profit, oligopolisti c pricing of the loan rate comes into play.

PAGE 21

18 OBSTRUCTIONS AND ESSENTIAL FACTORS This section will discuss the obstructions and essential factors of financial liberalization in Jamaica. One possible reason for an underdeveloped financial sector within a nation is the blockade of structural barriers which thwart supply from meeting the demand of citizens. In certain cases there may not be sufficient social capital or political system to construct a practical financial sector In our view, the strength of political forces in favor of financial development is a major variable factor. The challenge for such a theory is to identify who is opposed to something as economically beneficial as financial development. We believe that incumbents, in t he financial sector and in industry, can be hostile to arm's length markets. This is because arm's length financial markets do not respect the value of incumbency and instead can give birth to competition. There are occasions, however, when the incentives, or the ability, of incumbents to oppose development is muted (Rajan & Zingales, 2003, p. 7 ) The passage above shows how "incumbents or reigning oligopolies could work to impede the development process in order to protect their own best interest and prevent the introduction of new competition into the economic environment. General financial liberalization theory is based on the assumption that it will be implemented in an environment with a competitive financial system. By nature, an oligopolistic fin ancial system is in opposition to competition and so the ensuing growth benefits of a financially

PAGE 22

19 liberalized nation with roots in an oligopolistic system will not necessarily produce desirable results to the extent that they could in a perfectly competiti ve environment With this thesis I will explore how the interest rate spread, which is an indicator of the amount of pricing power a banking system wields, measured up against GDP growth savings and investment levels in Jamaica and how this relationship me asured up to general FL theory. (4) Looking at Oligopolies An oligopoly market in one in which a limited number of firms (a minimum of two) are in command of a certain market allowing them to exert control over supply and pricing very much like the way a m onopoly is able to control its specific market. Due to the small number of firms which participate in an oligopoly they are able to monitor each other's actions and they therefore exert great influence over each other and the market which they dominate. Kh emraj (2008) argues that excess liquidity is a structural trend embedded in the oligopolistic nature of banking and presents non remunerative excess liquidity and loans as perfect substitutes with the condition of a very high rate of interest in the oligop olistic loan market : There are two clear tendencies in the figures: (i) t he fitted preference curves tend to become flat; and (ii) the flatness occurs at a very high rate of interest. This means the demand elasticity for bank excess liquidity is perfectly elastic (or approaches perfect elasticity) at a high loan rate. Hence, commercial banks view loans and unproductive excess liquidity as perfect (or near perfect substitutes ) at very high loan rates (Khemraj, 2008, p. 3 )

PAGE 23

20 An examination of Jamaica's bank l iquidity preference curve shows that it becomes flat at approximately 17%; meaning commercial banks will not lend to the marginal borrower who wishes to pay a rate below 17%. Khemraj's study states that the loan rate is set in accordance with exogenous fac tors through a mark up over the marginal transaction costs and the "exogenous safe rate of interest (Khemraj, 2 008 ). The result of this is that a potential liquidity shock, stemming from the central bank, will not induce a reaction from the interest rate over the flat part of the bank's liquidity preference curve. As mentioned above, Jamaica's threshold is 17%. This phenomenon is especially of importance in nations like Jamaica that employ monetary policy in order to control bank credit via close supervis ion of, and some power over, short term interest rates and excess reserves; thereby influencing consumption and investment on a whole. I have included Khemraj's figure showing the loan rate measured against excess liquid assets as measured on a quarterly basis between the years 1997 and 2007. F IGURE 4: Jamaica (Loess fit) bank liquidity and the loan rate (quarterly data: 1997:1 2007:1) 6 6 This figure was taken from Khemraj, 2008, p.6

PAGE 24

21 The following graph is representative of the annual Jamaican lending rate between the years 1976 and 2007, we can see that it started off relatively flat, inclined in the eighties, peaked in the nineties and has flattened once again of late. FIGURE 5: Jamaica's Lending Rate (1976 2007) 7 Khemraj present s an oligopolistic banking model working from a banking model lacking a perfec tly competitive government bond market (as is fitting when working with LDCs) from which he derives the minimum loan rate. The same model is utilized to s how the workings of indirect monetary policy on the various structural forms of the loan 7 This figure was constructed using dat a tables on Jamaica from the I nternational M onetary F und.

PAGE 25

22 market. He th en explores the underlying meaning of his findings by connecting the loan market with the interbank money market. It is important to note that a monopoly mark et also presents similar problems. E cono mists Rag huram Rajan and Luigi Zingales (2003) mention f inancial development may very well be obstructed buy groups whose interests lie in preserving their favorable monopolistic positions and avoiding the nature of competition which comes along with financial development through liberalization Of course, this is less likely to be the case in nations with free and open trade and capital flows. However, Rajan and Zingales argue that when a country opens up to international trade and capital flows, the opposition to financial development will eventually be subdue d and muffled as the development process progresses. Khemraj (2008) also argues that the McKinnon Shaw argument does not hold true when the nature of the banking sector is oligopolistic: "The McKinnon Shaw channel is broken because higher savings from incr easing the interest rate (a key policy recommendation of the FL school) does not mean that those savings will be chan neled to productive investments (Khemraj, 2007, p. 7). Khemraj defines excess liquidity as: required bank liquidity subtracted from total bank liquidity and he argues that in many developing nations, commercial banks retain excess liquidity among their assets; much of which is not compensated for. And so he argues that banks are not performing their roles of intermediation in an efficient en ough manner to maximize productivity and economic growth. Banks, as financial intermediaries, play an important role in transferring public deposits to financial assets and channeling finds from surplus units to deficits and, therefore, facilitating wealt h creation, trade and capital formation. On the other

PAGE 26

23 hand, banks play a critical role of filtering and screening information and borrowers and, therefore, directing the flow of resources to the most deserved projects (Ahmed, 2006, p. 22) As per the exc erpt above we understand that the triumph of financial liberalization or at least progress as a result of it, hinges on the efficiency of a nation's banking sector. Khemraj also argues that financial liberalization in nations such as Jamaica trend toward s tressing stabilization policies while underplaying the role of manufacturing policies. While analyzing developed nations with repressed financial sectors, McKinnon and Shaw argued that financial repression reduced the real growth rate and size of the fin ancial system, thwarting the process of development. McKinnon and Shaw explored f inancial repression and the effects of a reduction of its power over financial systems within developing cou ntries. The men arrived at the conclusion that easi ng up on financi al restrictions, allowing the market to breathe and determine real interest rates, would positively affect growth rates of the nation. This liberalization would make room for interest rates to rise up, en route to competitive market equilibrium. They found that repression, via interest rate ceilings, would reduce the savings and capital accumulation of a nations as well as discourage an efficient allocation of resources (Gemech & Struthers, 2003) "The policy prescriptions for the financially repressed econ omy examined by McKinnon and Shaw is to raise institutional interest rates or to reduce the rate of inflation. Abolishing interest rate ceilings altogether produces the optimal result of maximizing investment and raising still further investment's average efficiency (Fry, 1997, p. 756). McKinnon assumed that the use a liberalizing approach to the financial

PAGE 27

24 sector would be associated with higher rates of interest and fuel savings, and these higher savings lead to the increase of investment and in turn, high er growth levels. However, generally, the link between interest rates and savings rates is not as clear as McKinnon's argument seems to make it out. The same is true for the relationship between liberalization and the savings rate. In fact, a 2000 study co nducted by Loayza, Schmidt Hebbel, and Serven's yielded results which imply the effects of financial liberalization are actually harmful to the private savings rates; interest rates also showed a negative reaction with the private savings rates. Conversely a 2001 study of 50 countries conducted by Reinhart and Tokatlidis demonstrated that financial liberalization resulted in higher real interest rates, more foreign direct investment and relatively constant to higher growth, but also lower investment. We wi ll later see, in the Empirical Relations section, that lowered investment was certainly not the case in Jamaica. I n addition the study presented evidence of financial deepening as a product of liberalization; but this is not true of all countries (like t hose which have low incomes). The results are about the same with regards to savings as well, in the case of some nations, savings increased with liberalization, but the opposite was true for most cases (Gemech & Struthers, 2003 p. 6 ) (5) Criticism of Fina ncial Liberalization Joseph Stiglitz is a well known critical voice against financial liberalization and proponent of maintaining interest rates below their market equilibrium level with government intervention. He argues that government involvement can im prove the state and performance of markets and the economy. W ith his In Favour of Financial Liberalisation Maxwell Fry addresses Stiglitzs' position on financial repression.

PAGE 28

25 Given information imperfections, Stiglitz argues that financial repression can i mprove the average quality of the pool of loan applicants. Second, financial repression increased firm equity because it lowers the cost of capital. Third, financial repression could be used in conjunction with an alternative allocative mechanism such as e xport performance to accelerate economic growth. Fourth, directed credit programmed can encourage lending to sectors with high technological spillovers (Fry, 1997, p. 760) Fry addresses the above argument by first stating that lowering interest rates do es not automatically mean increased efficiency of investment. He provides the example of entrepreneurs, and how lowered interest rates could help them take out loans to fund low yielding projects. He then speaks to the claim that the cost of capital is low ered through financial repression: "financial repression may not lower the marginal cost of capital if rationing forces borrowers to the curb market." Fry shows his frustration with the statement that financial repression could be coupled with an "alternat ive allocative mechanism." This, Fry writes accommodates the elevation of monopoly power and he reveals the use of the decisive factor of past performance as being discriminatory against new entrants. And to refute the final part of the Stiglitz case for financial repression, Fry wrote: "directed credit programmes have invariably raised delinquency and default rates, so increasing the fragility of the financial system b y forcing financial institutions to increase their risk exposure with no compensating re turn." 8 Another critique of financial liberalization is that its proponents appear to marginalize banks and treat them as mere "savings depositories," this seems to imply that the supply of credit is found exogenously. However, in reality banks wield the power to produce credit and the supply of its deposits does not determine the supply of loans; the supply of loans is endogenous and dependent upon its own demand. Keynesians and post 8 Maxwell Fry quotations taken from Fry (1997): In Favour of Financial Liberalisation

PAGE 29

26 Keynesians argue that there should not be so much emphasis on savings, b ut rather investment which may require low interest rates (like the artificially low due to ceilings interest rates of the financially repressed). They also argue that market determined high interest rates may dissuade investment as well as attract foreign capital resulting in currency overvaluation (this has its own drawbacks). The Neostructuralist School criticizes the connection between the informal and formal sectors of an economy, more specifically the regulation of funds within the curb market ( Thirl wall, 2006, p. 424 430 ) Fry (1997) argued that in order for financial liberalization to take effect and bring about positive changes (and avoid the heat of criticism ) certain prerequisites should be met by a nation; they are as follows: 1.) A n acceptable de gree of regulation for commercial banks to provide sufficient levels of accounting and legal infrastructure. 2.) A reasonable level of price stability. 3.) Fiscal discipline a sustainable government borrowing requisite which circumvents inflationary expansion of r eserve money by the central government Alternatively fiscal discipline could be practiced via the indirect effect of government borrowing resulting in increased capital inflows requiring large purchases of foreign exchange by the central bank to prevent exchange rate appreciation. 4.) Competitive, profit maximizing measures should be taken by commercial banks this eventually leads to mark up pricing of loan rates.

PAGE 30

27 5.) A tried and true tax system, one that does n ot implement discriminatory taxing practices o f an y sort on financial intermediaries and their actions (Fry, 1997, p. 760) It is very important to understand that financial liberalization should be and is paired with fiscal and monetary policy reforms as well as great regulation of the banking system (6) Capital Flows and Financial Globalization According to general theory, financial capital should flow from rich countries to their poorer counterparts. As a result, the poorer nation should eventually end up improving its position by investing in its ow n physical capital which would lead to lowered unemployment and increased wages. Via his concept of "The Paradox of Capital which delves into the allocation of foreign capital, Robert Lucas highlighted the inconsistency of capital flow although there is a definite flow of capital and foreign direct investment from rich to poor countries the levels of such a flow is not on par with the general theory of capital flow. Although it is believed that flows of capital will benefit developing nations, this is no t the t otal reality of the situation. Embedded in the problems that define a developing nation one may find one re ason why capital is not flowing to poorer nations in a way that might be anticipated "After all, any developing countries are beset by a vari ety of problems inadequate infrastructure, a poorly educated labor force, corruption, and a tendency to default on debt from abroad, among other factors that reduce the risk adjusted returns to investment (Prasad, Rajan and Subramanian, 2007,

PAGE 31

28 16 19). This risk adjusted return to investors could quite possibly be lower than expected with relation to the rate of return and therefore undesirable Dani Rodrik and Arvind Subramanian argue that capital flows into a country appreciate the real exchange rate. Thi s appreciation proves to be positive for producers of non tradable goods but negative for those who produce tradable items. Nontradables are goods and service s which are not commonly traded, produced and consumed domestically and are not close substitutes to import or export goods or services The Rodrik Subramanian table below shows how inflows of foreign savings shift invest ment demand to the left due to the appreciation association with the inflows. FIGURE 6: Rodrik Real Interest Rate and Savings & Inve stment Model 9 9 This figure was taken from Rodrik and Subramanian (2008), p. 16

PAGE 32

29 As we can see in figure 6 incoming capital flows decreased investment in, and demand for, tradable goods results in a new equilibrium (mo vement from B to the decreased i nvestment prime and real interest rate of C). In order to explain thi s phenomenon, Rodrik and Subramanian provide the following example: A barber needs more than a few implements and a stool to operate. But a garment firm depends on the reliable delivery of a whole range of public inputs and services (licenses, certificatio n, transport links, public safety, enforcement of contracts with suppliers, and so on). Therefore weak institutions impose a larger "tax" on tradables than they do on non tradables The effect of appreciation is to exacerbate thi s distortion and in a model of endogenous growth reduce growth further (Rodrik & Subramanian, 2008, p. 16 ) Rodrik and Subramanian argue that incoming capital flows increase real exchange rates and therefore affect the export s and growth of the developing world ; and so investment demand is restricting development in nations They stress the point that there are definite differences between the flows of foreign capital versus domestic capital. Increased foreign capital apprecia tes the real exchange rate while increased domestic capital depreciates the real exchange rate T he more domestic investment and investment in nontradables (goods which exist in domestic markets, unlike tradables which exist in international markets), that takes place the better the developi ng country will fare in terms of growth in the long run (Rodrik & Subramanian, 2008) (7) The Jamaican Financial Crisis Although pre crisis and post liberalization events certainly contributed to Jamaica's financial cris is the (down ) turning point is recognized as having begun with

PAGE 33

30 the illiquidity problems in the life insurance industry. These problems were prompted by a downturn in the real estate market and the stock market and swiftly spread to associate commercial ba nks which, in turn, had no choice but to appeal to the central bank for liquidity support. Banks were being bailed out with large sums of money, in 1995 one bank received liquidity support to the sum of four billion Jamaican dollars and the following year two additional banks received approximately six billion Jamaican dollars. As it became more and more evident that financial problems were mounting within Jamaica's domestic financial sector, a "flight to quality" phenomenon arose : "Depositors withdrew thei r savings from what were perceived to be weak institutions, mainly indigenous with local managers, and deposited these funds with branches of foreign banks (Kirkpatrick & Tennant, 2002, p.1936). Financial liberalization led to increase d expos ur e of the Jamaican financial sector making it susceptible to certain weakness by open ing the economy up and making it susceptible to a full blown crisis. By removing interest rate ceilings and credit controls, banks were able to go out on a limb and finance what ev entually proved to be risky ventures initiated by a hope for higher than normal returns. Unfortunately, in these cases, proper screening and regulatory procedures are sometimes overlooked or pushed aside in the built up excitement of highly expected return s. Another factor which allowed for Jamaica's financial vulnerability is the moral hazard associated with the nature of financial liberalization as explained by Colin Kirkpatrick and David Tennant One such example of moral hazard deals with the conflicts which arise within the inner workings of agencies and issues such as the misuse of insider information. This is when insiders, owners and managers of banks and other such higher ups within agencies, exploit their

PAGE 34

31 natural advantage of information over outs iders, those who deposit their money into banks and their creditors. From here conflicts crop up between the insiders and outsiders since the latter are not privy to the same information as the former and are therefore unable to make the best possible dec isions This goes to support that liberalization, which allows for investment in riskier ventures, increases the likelihood of conflicts resulting from a lowere d lev e l of managerial discretion and greater financial vulnerability Additionally, sudden bala nce sheet growth can also contribute to a financial crises following liberalization This is due to the inclination of control systems to weaken during this time of quick growth A factor which could contribute to this weakening is the likelihood of unbala nced portfolios when new lending opportunities are highly focused on a narrow range of business sectors. With their article, Responding to Financial Crisis: The Case of Jamaica Kirkpatrick and Tennant argue that the actualization of the aforementioned arg uments is clearly evident in Jamaica : As outlined following the second, accelerated phase of financial liberalization, risk taking by financial institutions increased signifi cantly evidenced by the deterioration in the quality of the rapidly expanding lo an portfolios, and t he exceedingly high levels of N P L s [Non Performing Loans] Instances of financial imprudence due to inexperience, overwork of loan staff, agency conflicts between managers/owners and depositors, unwarranted optimism in the economy inno vative but risky attempts to main tain market share, related party transactions, managerial overspending, and the perception of government guarantees, are numerous (Kirkpatrick & Tennant, 2002, p. 1937) To nationally implement and accommodate a financia lly liberalized system a country's government is expected to establish certain incentives and punishments to promote good conduct and discretion as well as productive performance ; basically maintaining the key role of chief regulator. In the case of Jamai ca any such incentives

PAGE 35

32 and the government's reputation as a regulator was undermined. This is because insider trading of vital information as a result of crooked capitalism was very common and widespread. The interconnectivity within financial institutio ns and between them and the corporate sector only aggravated the nation's problem with regulation. When reforms were finally implemented, they were flat out ignored or weak at best and went unenforced For example, a 1992 am endment to the Banking Act requ ired commercial banks to make provisions for NPLs six months and over but it was not until 1996 that loans which were three months past due were even categorized as nonperforming. This meant earnings and capital levels were overstated and that loan loss pr ovisions in Jamaica were not sufficient enough to cover against likely losses the nation incurred. If Jamaica's capital levels had been properly measured banks could have taken the necessary actions to help raise new capital and/or they could have restrain ed the growth of their lending in accordance with capital requirements. Ultimately, an appropriate and honored capital level to start with c ould have meant a less financially vulnerable Jamaica (Brownbridge & Kirkpatrick, 1999, p.17) Stabilization measur es and insufficient regulation of financial institutions on a macroeconomic level, along with financial liberalization are the main factors which contributed to the more recent growth and development of financial services in Jamaica. Macroeconomic stabiliz ation measures were utilized via monetary and exchange rate policies with the purpose of constricting the level of money supply and attaining a market based exchange rate. D emand was restrained by means of credit controls and high reserve requirements and a lack of legislative regulation of financial institutions certainly played a role in the growth of financial services in Jamaica. The Banking Act of Jamaica

PAGE 36

33 specifies that a domestic bank must have at least J$80 million in pledged capital in addition to a reserve fund equal to half of its upfront capital before it can be certified as licensed. However, there is no such specification concerning net worth as a fraction of deposits, a regulatory gauge of bank behavior; a tool which can be used to make sure t hat liabilities do not surpass assets. An exemplar of the usefulness of this regulatory measure is given by Helen McBain in her piece on Factors Influencing the Growth of Financial Services in Jamaica : "For example, a bank's net worth could be negative bu t its book value positive This occurs when a bank sells its high value assets (i.e. assets whose market value has increased) and retains assets whose market value has declined. The book value is therefore greater than the true value of the assets (McBain 1997 ). McBain posits that maintained macroeconomic stability and compliance with prudential regulations should allow for moderate interest rates without resorting to financial repression. She also notes that Financial Liberalization was implemented durin g a period of high inflatio n which accounts for the increasingly negative real interest rate between the years 1990 and 1992, in spite of significantly increased nominal interest rates of the time. She goes on to say that financial liberalization increase d investment in securities as well as sheer number of financial institutions without makin g a significant dent on growth.

PAGE 37

34 EMPIRICAL RELATIONS : GDP Growth, Investment, Savings Interest Rate Spread and REER (8) Jamaica Data This section is concerned wi th the empirical relationships between different factors of the Jamaican economy, with a focus on GDP growth, investment, savings, interest rate spread and the real effective exchange rate. The data which follows has been extracted from International Monet ary Fund economic information tables and mainly provides coverage of the years including and between 1967 and 2007. Displays of pre mid, and post liberalization data with respect to the Jamaican economy follow sections presenting information including, bu t not limited to, the annual changes in the Gross Domestic Product, level of investment, interest rate spread, savings rat e and gross domestic savings percentages and the real effective exchange rate of Jamaica. The piece concerned with the Jamaican inter est rate spread, a difference of the loan and deposit rates of the nation, is of special importance due to its relation to the oligopoly thesis of this paper. Also, the GDP growth and REER graphs are also of high importance as the findings are consistent w ith the Rodrik real exchange rate appreciation hypothesis as discussed in prior to this point.

PAGE 38

35 (i) GDP Growth As previously mentioned in the introduction, the launch of Jamaica's economic reform due to financial liberalization can technically be identified a s beginning in 1977 with the passage of the IMF's Stand by Agreement. While this is the case, key agreed upon economic reforms were not actually put into effect until 1991. As a result, it can also be argued that Jamaica's economic reform is an event of th e nineties. For this reason the following bar graphs depict pre liberalization GDP growth as the period o f time between 1967 and 1977; mid liberalization GDP growth from 1977 1991; post liberalization GDP growth between 1991 and 2007 and finally a view of GDP growth spanning the entire annual GDP growth from 1967 to 2007. The GDP growth rate of a nation is considered its most important gauge of economic health. An increasing GDP is indicative of an increase in personal income, employment, business, etc. A negative GDP, on the other hand, is a marker of a recession. GDP growth is the total amount of all goods and services produced in an economy GDP is used to determine the annual growth rate of a nation by measuring the percentage change from the previous y ear's cycle.

PAGE 39

36 FIGURE 7: Jamaica's GDP Growth (1967 2007) 10 10 The data used to construct this figure, a s well as those which follow (Figures 8 29), was extracted from the International Monetary Fund tables on Jamaica.

PAGE 40

37 Figure 7, shown on the previous page, is a graphical representations of the GDP growth rates of the yea rs including and flanked by 1967 to 2007. As we know, and as is shown in the GDP Growth bar graph which follows, the late sixties and very early seventies were a time of positive GDP growth for Jamaica. However, this was followed by continual negative grow th rates of the seventies, symbolic of a downturn in the Jamaican economy. The post liberalization GDP growth rates are shown between the years 1991 and 2007. The columns in the bar graph of Figure 7 are color coded. The pre liberalization time period of 1 967 1977 for Jamaica has taken on a green color. This is followed by the brown hue of the mid liberalization years between 1977 and 1991 and then the subsequent post liberalization period of 1991 to 2007 highlighted by shades of blue. (ii) Investment & Savings Gross fixed capital formation, or Investment, is an important factor when considering a nation's economy. Gross fixed capital formation is measured by the total value of a producer's acquisitions, minus disposals ( of fixed assets during the accounting per iod ) plus certain additions to the value of non produced assets (such as subsoil assets or major improvements in the quantity, quality or productivity of land) as realized by the productive activity of institutional units. Simply put, gross fixed capital formation is investment, not total investment however, but investment nonetheless.

PAGE 41

38 FIGURE 8: Jamaica's Gross Fixed Capital Formation (as a % of GDP) Figure 8 is not necessarily consistent with the Rodrik Subramanian findings which state that incoming flows of foreign capital decrease investment and therefore the demand for tradable goods. It is evident that a dip in investment cer tainly takes place in 1977 with the official initiation of financial liberalization into the Jamaican economy. However, as foreign capital continues to flow into the nation, investment slowly increased from a low of 11.82% of GDP to 30.48% of GDP. This f ig ure also disputes the Reinhart and

PAGE 42

39 Tokatlidis 2001 study of 50 countries whic h demonstrated that financial liberalization resulted in lowered investment. The savings rate of a nation is a percentage representative of the amount a population a nation saves divided by disposable income. Gross domestic savings a re calculated as GDP with a reduction of total consumption. The Jamaican savings rate data as found in the IMF tables is only available from 1977 onwards, for this reason the following depiction of th is rate starts in 1977. FIGURE 9: Jamaican Savings Rate (1977 2007)

PAGE 43

40 The graph above is in line with the aforementioned 2000 study conducted by Loay za, Schmidt Hebbel, and Serven which yielded results which implicated that the effects of financial liber alization are actually harmful to the private savings rate of a nation. FIGURE 10: Jamaican Gross Domestic Savings (as a % of GDP) (iii) Interest Rate Spread The interest rate spread is ultimately the gap between the rate of interest a bank pays on deposits a nd the higher rate it charges for loans (lending rate deposit rate). The following figure depicts the interest rate spread of Jamaica a s of 1975; lending and deposit rate data prior to this date was not available. Below the figure there is a table with

PAGE 44

41 t he exact numbers of the loan and deposit rates as well as calculated interest rate spread for each of the years between 1975 and 2007. FIGURE 11: Jamaica's Loan versus Deposit Rate Interest Rate Spread Figure 9 is of particular importance as it relates to the oligopoly thesis which posits an oligopolistic make up of a nation impedes the process of liberalization. Largely spaced interest rate spreads signify the oligopoly pricing power which banks yield (Khemraj, 2008, p. 8 ) The higher the interest rat e spread, the weaker the competition is within a nation, this also signifies higher the profits for banks.

PAGE 45

42 The figures which follow chart the relationships between Jamaica's loan deposit interest rate spread and its levels of GDP growth investment and s avings rate. FIGURE 12: Mid Liberalization Jamaican Interest Rate Spread & GDP Growth (1976 1991) FIGURE 13: Post Liberalization Jamaican Interest Rate Spread & GDP Growth (1991 2007)

PAGE 46

43 FIGURE 14: Overall Jamaican Interest Rate Spread & GDP Growth (1976 2007) Figure 12 which highlights the "mid liberalization" years, indicates the positive correlation between the Jamaican interest rate spread and GDP growth, this trend is one which would theoretically be expected to follow financial liberalization. How ever, figure 13 shows how this relationship declines in the post liberalization years as there is a clear negative correlation between the factors. Nevertheless, the overall effect of liberalization, as displayed in figure 14, is a positive one.

PAGE 47

4 4 FIGURE 15: Mid Liberalization Jamaica's Interest Rate Spread & Gross Domestic Savings as a % of GDP (1976 1991) FIGURE 16: Post Liberalization Jamaica's Interest Rate Spread & Gross Domestic Savings as a % of GDP (1991 2007)

PAGE 48

45 FIGURE 17 : Overall Jamaican Inter est Rate Spread & Gross Domestic Savings as a % of GDP (1976 2007) The figure above demonstrates a n overall negative trend, it shows how overall gross domestic savings have decreased following liberalization; this is contrary to traditional McKinnon Shaw theory which hypothesizes increases in a financially liberalized nation's savings rate. This falls in line with Khemraj 's (2008) argum ent that the McKinnon Shaw argument does not hold true when the nature of the banking sector is oligopolistic It is impo rtant to recognize that Jamaica's mid liberalization period was one with a positive link between the interest rate spread and GDP, but this was overshadowed and pulled down by the very negative relationship brought about in the past two decades. However, the figures which follow confirm that the McKinnon Shaw theory does hold water in the case of Jamaica's investment level following financial liberalization as there is a n overall strong positive relation which implies Jamaica did benefit from

PAGE 49

46 boosted inve stment after globalization. This can, no doubt, be attributed to increased foreign capital flow into the economy. FIGURE 18: Mid Liberalization Jamaican Interest Rate Spread & Investment (1976 1991 ) FIGURE 19: Post Liberalization Jamaican Interest Ra te Spread & Investment (1 991 2007)

PAGE 50

47 FIGURE 20: Jamaican Interest Rate Spread & Investment (1976 2007) (iv) R eal Effective Exchange Rate The Real Effective Exchange Rate (REER) is the weighted average of a single nation's currency in relation to an i ndex containing various other foremost currencies, all adjusted for the effects of inflation. A cross country evaluation of the relative trade balances is critical in establishing the weights by which the REER is calculated. These indexed currencies whic h include the U.S. dollar, British pound, European Euro and Japanese Yen, among others, play an integral role in the international currency market. The REER plays a large part in setting the bar for the price and overall value of imported

PAGE 51

48 goods that an ind ividual buyer deems fit when purchasing said good s at a consumer level. This price is to include all costs (transactional, tariffs, etc.) associated with importing the good. Policymakers and economists the world over consult the real effective exchange r ate to gauge the condition of their currency's in comparison to those of other countries. "The REER is an average of the bilateral RERs [real exchange rates] between the country and each of its trading partners, weighted by the respective trade shares of e ach partner. Being an average, a country's REER may be in "equilibrium" (display no overall misalignment) when its currency is overvalued relative to that of one or more trading partners so long as it is undervalued relative to others." 11 It is important to note that because market constructed baskets and trade policies (and all they entail) cannot necessarily keep up with varying consumption patterns, variation in REERs is not uncommon and does not call for immediate concern since it does not definitely ind icate deep seated misalignment in relation to other nations. Much REER variation can be attributed to the fluctuation prices of nontradables (goods which are not commonly traded) relative to tradables (goods which are commonly traded) especially among de veloping countries. Additionally, persistent changes in terms of trade, fiscal policies, tariffs and general development, as evidenced in Jamaica over the past decades, and especially when accounting for the shift from financial repression to liberalizatio n, certainly helps to explain why it is that REERs fluctuate so. 11 This statement was taken from the International Monetary Fund's explanation of the real effective exchange rate which can be found via the link which follows: http://www.imf.org/external/pubs/ft/fandd/2007/09/pdf/basics.pdf

PAGE 52

49 FIGURE 21: Jamaican Real Effective Exchange Rate (1967 2007) Figure 10 illustrates the nature of Jamaica's REER since the late sixties. The difference in shading indicates the progression from a pre liberalization period (1967 1977) to a mid liberalization (1977 1991) and then post liberalization (1991 2007). Estimating equilibrium REERs can be difficult because prices are somewhat sticky in the short run and the nominal exchange rate is not So REERS typically display considerable short run volatility in response to news and noise trading, and it's not surprising that many market participants and policy makers get things wrong sometime very wrong Imperfect though they may be, REERs have signaled large exchange rate overvaluation in the run up to many financial crises 12 12 This statement was taken from the International Monetary Fund's discussion of the real effective exchange rate which can be found via the link which follows: http://www .imf.org/external/pubs/ft/fandd/2007/09/pdf/basics.pdf

PAGE 53

50 The following figures present positive associations between GDP Growth and the real effective exchange rate during pre, mid and post liberalization periods : Pre Liberali zation y = 1.1655x 38.52 R 2 = 0.3347 Mid Liberalization y = 0.1486x 4.762 R 2 = 0.2387 Post Liberalization y = 0.1008x 3.5182 R 2 = 0.4535 Overall y = 0.0915x 2.1769 R 2 = 0.0845 This is certainly consistent with the Rodrik Subramania n hypothesis that an increase in the REER leads to an increase in GDP growth and development. In particular, capital inflows exacerbate the investment constraint through the real exchange rate channel: the increase in the real exchange which accompanies c apital inflows reduces the real profitability of investment in tradables and lowers the private sector's willingness to invest. The res ult is that capital inflows definitely boost consumption ( Rodrik & Subramanian, 2008, p. 3).

PAGE 54

51 FIGURE 22: Jamaic an Pre Liberalization GDP Growth & REER (1967 1977)

PAGE 55

52 FIGURE 2 3 : Jamaican Mid Liberalization GDP Growth & REER (19 7 7 19 90 )

PAGE 56

53 FIGURE 2 4 : Jamaican Post Liberalization GDP Growth & REER (19 91 2007 )

PAGE 57

54 FIGURE 2 5 : Jamaican Overall GDP Growth & REER (19 67 20 07 )

PAGE 58

55 As earlier discussed, Dani Rodrik and Arvind Subramanian argue that capital flows into a country appreciate the real exchange rate. Figure 6, found in the previous chapter, shows how inflows of foreign savings shift investment demand to the left due to the appreciation association with the inflows. The scatter plot below shows a positive correlation between investment and the real effective exchange rate of Jamaica between the years 1967 and 2007. FIGURE 26: Gross Fixed Capital Formation & REER (1967 2007)

PAGE 59

56 Next the savings rate and gross domestic savings as a percent of GDP is compared to the REER. These graphs plainly illustrate a negative relationship between saving and the real effective exchange rate. FIGURE 27: Savings Rate & REER (1977 2007) Figure 28: Gross Domestic Savings (% of GDP) & REER (1967 2007)

PAGE 60

57 Additionally, t he real effective exchange rate spread can be found using the following equation: [ XRt = ( XRn x Pdom )/ Prow ] O r [ XRt = ( Prow / Pdom) x XRn ] In the formu las above XRt denotes t he real effective exchange rate, separately graphed and explained above. "XRn is the nominal effective exchange rate, or NEER. The NEER is representative of the relative value of a certain country's currency, Jamaica for our purpo ses, as compared to the other foremost traded currencies which include the U.S. dollar, British pound, European Euro and Japanese Yen. A NEER coefficient of a value greater than 1 would mean that the Jamaican Dollar is of a higher value than an imported cu rrency, while a lower coefficient (of a value less than 1) would mean that the Jamaican dollar will generally be less treasured than the imported currency. The NEER also signifies a rough price which a consumer would be likely to pay for a certain imported good. Pdom is the domestic price level as considered in terms of consumer or wholesale prices. And finally, Prow is the international price level, determined b y utilizing Jamaica's major trading partner(s), the United States for our purposes (Dunn & M utti, 2004, p. 305 306)

PAGE 61

58 The following table provides the statistical significance of figures 12 20 and 22 28 presented in this Empirical Relations section: TABLE 1: Statistical Significance of Figures 12 20 and 22 28 13 Two Tailed P Value Status of Si gnificance Figure 12 less than 0.0001 extremely statistically significant Figure 13 0.0987 not quite statistically significant Figure 14 0.0187 statistically significant Figure 15 less than 0.0001 extremely statistically significant Figure 16 less tha n 0.0001 extremely statistically significant Figure 17 0.4699 not statistically significant Figure 18 less than 0.0001 extremely statistically significant Figure 19 less than 0.0001 extremely statistically significant Figure 20 less than 0.0001 extreme ly statistically significant Figure 22 0.0075 very statistically significant Figure 23 0.0113 statistically significant Figure 24 less than 0.0001 extremely statistically significant Figure 25 0.0089 very statistically significant Figure 26 0.2060 not statistically significant Figure 27 0.0260 Statistically significant (by conventional criteria) Figure 28 0.4066 not statistically significant (v) Human Development The Human Development Report provides a view of the human development index (HDI), a singl e comparative, yet not comprehensive, measure of important aspects of human welfare such as life expectancy, poverty, literacy and education levels, and child welfare. The HDI does have its drawbacks as it cannot take certain inequalities into account, it does however provide a glimpse of progresses in human development in all parts of the world. Jamaica is ranked number 101 out of 177 with a 2005 HDI of 0.736. A very important component of the HDI, adequate standard of living, is measured via GDP 13 The statistical significance was derived from the R 2 of each scatter plot. This was accomplished by calculating r values (Pearson correlation coefficient) and degrees of freedom and thereby finding t he P value of each data set.

PAGE 62

59 per capit a at purchasing power parity. The following figure charts the changes in the Jamaican economy and general welfare of the Jamaican people in terms of GDP per capita at purchasing power parity FIGURE 29: GDP per Capita, PPP (1980 2008) Figure 23 indicat es a positive trend for the per capita GDP growth, measured in terms of purchasing power parity, of Jamaica. This is indicative of the effect of financial liberalization in terms of the human welfare element of the financial shift to globalization initiate d by the 1977 Standby Agreement with the IMF. There is, of course, more that can be said for the human development aspect of financial liberalization, but for our purposes perhaps this brief take on the topic will suffice.

PAGE 63

60 CONCLUSION It is my intenti on that this thesis has provided an understanding of financial liberalization's effect on the economic development and its influence on the growth of Jamaica. The discussion above involves the liberalization of the banking sector and increased interest r ates and delves into the oligopolistic makeup's obstruction of overall Jamaican economic growth via financial globalization. Also explored is financial globalization's contribution to real exchange rate appreciation via the opened access to foreign capital flows which financial liberalization allowed. Digging into the McKinnon Shaw financial liberalization hypothesis produced support for the claim that liberalizing the financial sector should lead to increased investment. Criticisms of financial liberalizat ion were also presented in this thesis largely including the voice of Joseph Stiglitz in addition to the views of Keynesians, post Keyne sians and the Neostructuralist S chool. As the introduction posits, the body of this thesis provide d an evaluation of th e extent to which the oligopolistic structure of the Jamaican banking sector blocked the involvement of financial liberalization in economic growth. T he data chapter links the oligopolistic structure to the interest rate spread figure 11 which highlighted the pricing

PAGE 64

61 power wielded by oligopolies, awarding the oligopolistic banking system power to obstruct foreign flows of capital made possible by a liberalization of the financial sector. The Empirical Relations section also produced REER patterns covering p re, mid and post financial liberalization years (1967 2007) which show a steady positive relationship between GDP growth and the real effective exchange rate w hich is consistent with the Rodrik and Subramanian hypothesis. In closing, the research conducted for the purpose of this thesis has reaffirmed the Rodrik Subramanian hypothesis as it hol ds true in the Jamaican context. The oligopoly thesis of this study was vindicated as figure 13 showed a definite negative trend between the interest rate spread of J amaica and GDP growth; backing up the theory that financial liberalization is best implemented in competitive markets, not oligopolistic ones. In summation, today the Jamaican economy is one with heavy reliance on their service industry which provides fo r an excess of 60% of their GDP in conjunction with tourism and bauxite production. Jamaica's economy which lumbers with some of the lowest economic growth in its region will indubitably face mounting pressure as the international economy slumps. The ad ministration of the socially controversial O. Bruce Golding current face of the Jamaica Labour Party and Prime Minister, is faced with the arduous task of managing his nation's economical, social and political problems in this time of global financial unr est. 14 14 Some information presented in the conclusion was derived from the CIA Factbook available online.

PAGE 65

62 Bibliography ( / Works Used ) Ahmed, Abdullahi Dahir (2006), "The Impact of Financial Liberalization Policies: The Case of Botswana." Journal of African Development Vol. 1: 14 36. Bekaert, Geert, Campbell R. Harvey, and Christian Lundblad (2001), "Does Financial Liberalization Spur Growth." National Bureau of Economic Research < http://www.kelley.iu.edu/clundbla/growthfin_JFE_main_copy.pdf >. Brownbridge, M. and Colin Kirkpatrick (1999), "Financial Sector Regulartion: The Lessons of the Asian Cris is." Development Policy Review. 243 266 Dunn and Mutti (2004), International Economics 6 th ed., Routledge. Eicher, Theo and Leslie Hull (2004), "Financial liberalization, openness and convergence." The Journal of International Trade & Economic Developm ent. Fry, Maxwell (1997), "In Favour of Financial Liberalization." Economic Journal Vol. 107: 754 770. Gemech, Firdu, and John Struthers (2003), "The McKinnon Shaw Hypothesis: Thirty Years on: a Review of Recent Developments in Financial Liberalization Theory." University of Paisley. < http://www.esocialsciences.com/data/articles/Document1262006180.8255884.p df > Gibs on, Heather D. and Euclid Tsakalotos (1994), "The Scope and Limits of Financial Liberalisation in Developing Countries: A Critical Survey." Journal of Development Studies Vol. 30: 3578 3628 Gurley, John G. and E. S. Shaw (1955), "Financial Aspects of Eco nomic Development." The American Economic Review, Vol. 45: 515 538

PAGE 66

63 Hawke, Gary R., "New Zealand: Developing and Sustaining Economic Liberalization." Making of New Zealand. Chapter 15. Khemraj, Tarron (2006), Excess Liquidity, Oligopoly Banking, and Monet ary Policy in a Small Open Economy PhD Dissertation, New York: New School for Social Research Khemraj, Tarron (2008), Excess Liquidity, Oligopolistic Loan Markets and Monetary Policy in LCDs DESA Working Paper No. 64 Khemraj, Tarron (2007), "Monetary P olicy and Excess Liquidity: The Case of Guyana." Social and Economic Studies Vol. 56, No. 3. Khemraj, Tarron (2008 ), "The Missing Link: The Finance Growth nexus and the Guyanese Growth Stagnation." Social and Economic Studies, Vol. 57, Nos. 2 & 3. King Damien (2000), "The Evolution of Structural Adjustment and Stabilization Policy in Jamaica." Serie Reformas Economicas Kirkpatrick, Colin and David Tennant (2002), "Responding to Financial Crisis: The Case of Jamaica." World Development Vol. 30: 1933 1 950. Levine, Ross (1997), "Financial Development and Growth: views and agenda." Journal of Economic Literature Vol. 35: 688 726. Lucas, Robert (1990), "Why Doesn't Capital Flow from Rich to Poor Countries?" American Economic Review Vol. 80: 92 96 McBa in, Helen (1997), "Factors Influencing the Growth of Financial Services in Jamaica." Social and Economic Studies, Vol. 46, Nos. 2 &3. Prasad, Eswar Raghuram Rajan and Arvind Subramanian (2007), "The Paradox of Capital." Finance and Development 16 19.

PAGE 67

64 Rajan, Raghuram G. and Luigi Zingales ( 2003 ), The great reversals: the politics of financial development in the 20th century Jo urnal of Financial Economics 69. Rodrik, Dani and Arvind Subramanian (2008), Why Did Financial Globalization Disappoint? Ro drik, Dani (1998), Symposium on Globalization in Perspective: An Introduction The Journal of Economic Perspectives, Vol. 12, No. 4: 3 8 Seck, Diery and Yasim H. El Nil (1993), "Financial Liberalization in Africa" World Development Vol.21, No.11: 1867 18 81. Singh, Ajit (1997), "Financial Liberalization, Stock Markets and Economic Development." Economic Journal Vol. 107: 771 782. Stiglitz, Joseph (1989), "Financial Markets and Development." Oxford Review of Economic Policy Vol. 5: 55 67. Stiglitz, Joseph (1994), "The Role of the State in Financial Markets." The International Bank for Reconstruction and Development, The World Bank Tennant, David (2007), "A Comparison of the Mobilization and Use of Savings Across Types of Financial Intermediaries in the Jamaican Economy." Savings and Development No. 1 XXXI Thirlwall, A.P. (2006), Growth and Development Palgrave Macmillan, New York. Wyplosz, Charles (2001), How Risky is Financial Liberalization in The Developing Countries? Graduate Institute of In ternational Studies, Geneva and Center for Economic and Policy Research, Washington, D.C.


ERROR LOADING HTML FROM SOURCE (http://ncf.sobek.ufl.edu//design/skins/UFDC/html/footer_item.html)