Growth, TFP and Financial Market Imperfections

Growth, TFP and Financial Market Imperfections

MARKET IMPERFECTIONS 5

Growth,TFP and Financial Market Imperfections

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Thisvideo lesson solves the conundrum of the capital inflow and outflows.While savings in some countries such as China is high, such statesinvest a large proportion of its asset in foreign nations whereforeign direct investments are attracted. The author employs theoryto explicate the growth experience of Asianstates, moreprominentlyChina from the 1990 to 2010. The paper is based on thepremise that changes in economic environment from the 1990sparticularly the opening of the economy to private enterprise hasbeen the key element for sustained growth. The film seeks to furtherindentify the factors that have made have China has not witnesseddecline in return on capital despite that fact that the rate oninvestment continues to be high. The study underscores the role ofState Owned Enterprises financed by banks and the repeatedlymisjudged effects of capital expropriation and moral hazard in globalimbalances. The model adopted aligns to a large degree the data forthe stylizedfacts in China such as high savings (both corporate and households),capital outflows (net), large current account surplus and lowinvestment growth.The key features to replicate the facts are the economicliberalization, capital controls during the transition period andhigh TFP growth. In addition, the salient feature of capitalmisallocation as a consequence of credit market frictions ishighlighted -a phenomenon that emanates from heterogeneous creditbarriers between state- owned enterprises and domestic privateenterprises. From the foregoing, the numerous source of capitalmisallocation means that the probability of reducing the globalimbalances is slender

Capitalmisallocation has been identified as a factor that can significantlyderail rate of investment and depress domestic consumption. Thisvideo lesson develops a dynamic general equilibrium that iscalibrated to the Chinese economy to account for the observedmovement of capital. In relation to the higher TFP growth in China,economic liberalization has been identified as the factor behind thefall of the share of state-owned enterprises. Economicliberalizations is connected to rising profits for domestic privatefirms and rise in corporate and household savings that is put intoforeign investment.

Itis eminent that funding of the state owned enterprises comes from thesavings made by households in banks. In the case of China there mustbe a significant proportion of household income saved abroad. Theassumption of moral hazard and the limitations of domestic investmentpossibilities that emanates from the capital market imperfections andcredit market frictions is what makes foreign investment a viableoption and hence capital outflow. The secret to China’s growth hasbeen pegged on reallocation of resources from low productive units tohigh productive units. This has not only increased efficiency buthas also created a conducive platform from where technology cansupport and promote productivity.

Evidently,informational imperfections in the financial markets have long beendocumented as the key elements why the rates of growth and levels ofincome between developed states and developing countries do notconverge. The accumulation of reproducible factors that is human andphysical capital can always be financed, the only limitation being atrans-versality condition (Cubizol, 2013). In this light with theavailability of appropriate contour elements for the optimizationproblem, the system can be solved for its steady-state rate ofgrowth. In a globe with imperfectly competitive markets for bothlabor and commodities, and with asymmetric information, the abilityof a business entity is access money from potential shareholders andfinancial institutions is severely curtailed by the adverse incentiveeffects. This means that credit and equity rationing can take placeas equilibrium phenomena. In this vein, production and investmentdecisions are austerely constrained by the presence of accessiblefunds in a first- generation of endogenous growth model with anunambiguous function for the financial sector. The video lessondepicts the different functions that financial intermediaries canperform in supporting and promoting growth. The main gist of thelesson is that the development of financial intermediation fostersreal economic development by serving as a tool for a better resourceallocation. This noble goal is attained by pooling risks across acontinuum of investors whenever information on the anticipated rateof return are not promptly available, or by shielding investors fromthe peril of unpredictable liquidity needs.

Economistshave devoted immense efforts to establish the source of large andcontinual productivity growth disparities across a continuum ofsectors, industries and countries. Beginning from the point of viewthat in an economy with heterogeneous production units, total TFP ispegged not only on the TFP of individual production units but also onthe quantity of inputs committed the production process in everyunit. The video lesson provide evidence from the growth pattern amongthe Asian nation to examine the extent to which institutional factorsand specific policy factors and market imperfections such asheterogeneity in cost-price markups and credit constraints shape andinfluence the aggregate TFP through generating misallocation.Heterogeneity in resource allocation efficiency across industries andstates has been established as the main source of misallocation.

References

Cubizol,D. (2013). Capital flows, public financial intermediation and firms’structure in China. Journalof Political Economy113 (5), 949-995