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1. I have read the section on plagiarism that appears on the reverse side of this sheet.
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REVIEW ESSAY QUESTION (20% of Unit Marks, 1,500 word limit)
Using the two papers by Rousseau and Sylla, what lessons can be drawn by emerging markets economies from the experiences of the countries covered? In your answer, include issues relating to the creation of a viable financial system (and the different ‘models’ employed), as well as the impact of these on economic growth and trade.
There are various lesson which we can draw from the distinct relationships between a strong financial system, economic growth and infused trading. Both papers of Rousseau and Sylla namely, “Emerging Financial Markets and Early U.S. Growth” and “Financial Systems, Economic Growth and Globalization” provide the insightful view of these learning points. From the point of view of an emerging market economy of these well-established financial markets and/or countries, an ideal financial system can be described which can be of great impetus for an economy’s rapid growth and competitiveness in a highly competitive, globalized financial and economic markets.
The very top lesson is that a well defined, highly established and innovative financial structure is the key to a country’s economic take off and further growth. This was evidenced by the United States’ rise to economic powers at the onset of the Industrialized Period. After the Revolutionary War, the U.S. was bankrupt and it was the establishments of many chartered banks that spurred their economy towards greater wealth and stability.
The U.S. leaders developed a mechanism for mobilizing the resources required to patch the country’s land mass through economic infrastructure, promotion of local and international trade, and the development of a productive modern sector. By political leadership, its Congress chartered a national bank, the Bank of the United States, which was a combination of public and private equity. Private investors tendered federal debt to participate.
Through this important bank, the U.S. was able to improve the country’s credit standing and establish a more uniform currency. Dollars were defined through gold and silver as the moneraty bases. A federal mint was also established to make their coins. Thus, the three aforementioned institutional bnaks grew and 8 new banks were chartered by different U.S. states in the 1790s. (State-chartered banks were similar to federally chartered Bank of the United States. They were corporations with limited liability, hence, they attracted tremendous capital investments.) Another 73 banks were chartered over the nex ten years. These banks profits ignited the rapid expansion that multiplied these financial institutes into 834 state banks by 1840. (Rousseau & Sylla, 1999) After another twenty years, these banks doubled.
Hence, by the 1820s, the U.S. had an innovative financial system in place. These banks have indeed expanded the financial system and strengthened the country’s public finances. Banks financed smaller and more information-intensive investments until they grow into a considerable size worthy of direct public investment. These banks also attracted diverse capital and they were the key to the establishment of an early securities markets in the country.
Another important lesson is to model one’s financial system to a highly institutionalized system, build on it and be more innovative. This is what the U.S. did. They intially looked into the well established banks in Europe and mdoeled a simialr system from these. They introduced the innovation by chartering these banks and induce competition instead of a monopoly. As such, from the 1790s up to the middle of the nineteenth century, the U.S. banking system grew as a robust, highly competitive business enterprise. After six or seven decades, the old nations also followed the U.S. financial model and let competition grow among their corporate banks.
The U.S. also developed their security, equity and stock markets. These financial markets proved to be the backbone of their commercial and industrial success. All these defined the development of the modern sector of the U.S. economy. These were driven by the onset of technologies and infrastructure investments which spurred production and efficiency. After the growth of chartered banks, the U.S. securities markets steadily grew. As we see, the innovative financial system led the growth and modernizatinof the U.S. economy.
Emerging economies can also realize the value of an efficient taxing system which generate national revenues for the country. In the case of the U.S., Hamilton established a federal revenue collection system through import tariﬀs and domestic excise taxes which were all legalized by their Congress. They also excised taxes from lands, however slow moving these were during that period. (Rousseau and Sylla, 1999)
Another important lesson which the emerging economies can learn from the established ones is that the better the financial systems, the more conducive for the economies to engage in international trading, which, in turn, lead to better growth and rapid expansion of their national economies. Another important correlation is that a very strong and dynamic domestic finances also becomes a gateway to a nation’s participation in the global markets.
According to the authors, there are key components of a good ﬁnancial system and these are: (a) sound public ﬁnances and public debt management; (b) stable monetary structures; (c) diversity of banking institutions, some are local and some are international, or both; (d) a central bank that stabilizes local ﬁnances and manages international ﬁnancial links; and (e) well-functioning securities markets.
These components can ignite economic growth once installed and mobilized to acquire domestic capital. This model can be described as “ the first modern economy” which signalled the era of vast development and prosperity. The old economies like those of the Dutch, English, Americans, other Europeans and even Japanese were characterized by these components. Hence, their economic growth can be well explained according to these financial structures. It is important to emphasize, at this point, that the key components of an efficient financial system do not work independently but instead work congruently towards a general stance of financial stability and well maintained operations.
Another important lesson is the efficient management of public finance which maintained the growth of the modern economies during those periods. Sound public ﬁnance consists of creating and managing public expenditure priorities, raising adequate taxes or revenues to fund them eﬃciently, and debt servicing. It can be said that the good financial systems were developed in the context of the old economies’ needs for ﬁnancing. They often required these for building their infrastructures and for financing their wars.
Public finance can be considered as a great impetus for the globalization of the economies. The needs of national governments to raise and deploy funds globally for various national or state reasons resulted in the development of ﬁnancial systems that allow international mobilizationof capital to be justly deployed for productive, economic agenda.
Central banks, are also crucial component of a sound financial system because it prevents financial problems and/or alleviate them when they occur. They regularly monitor and regulate their banks’ operations in such a way that problems are minimized. The central banks act as the lenders of last resort. Meanwhile, the securities markets facilitate the issuance of public and private debt securities and private equity securities. Specialized banks serve as ﬁnancial intermediaries of bonds, stocks, and other forms of securities between the borrowers/issuers (governments and business compnaies) and the lenders/investors who purchase securities. A established securities markets pave the way for the more mobile transfer and liquidity of investments which appeal to international and local investors.
This has been exemplified by Japan, the only non Western country that was able to modernize its economy through the key components of the financial system and stand among the old economies of Europe and North America. It was said that Japan modernized its economy during the Meiji era through a sophisticated ﬁnancial system similar to the U.S. and the rest of the Western economies. Their financial system included a stable public ﬁnances, sound money, banks, a central bank, and securities markets. It propelled the poor and relatively isolated Japan in 1870 to be an emerging market and a dynamic economy.
In the middle phase of the economic modernization, there are components like the TFP or the total factor of production and debt accumulation channels. These are the outcomes of the long run expansion of economic activities that in turn generate demand for ﬁnancial services and create a larger intermediating sector. To further relate financial stability with international growth and trading, it is important to see that modern economies and well established ﬁnancial systems, are able to function within a wider flexible exchange rates conditions globally along with their TFP and debt accumulation channels. On the contrary, peripheral developing economies with new ﬁnancial systems anchor their currencies to these well established financial markets. This implies that the road towards economic growth will defintely travel through the development of a sound and strong financial system.
LONG ANSWER QUESTIONS (500 word limit each)
1. Using the ‘Minutes of the Monetary Policy Meeting of the Reserve Bank Board’ for March 6, 2012, what is the dilemma currently faced by the RBA in its conduct of monetary policy? (10% of Unit Marks)
The dilemma faced by the RBA in easing out its monetary policy rests on international financial market factors that could affect its currency. The RBA is faced with concerns about debt as the sovereign debt problems in the Euro persisted in the second half of 2011. This turbulence will spread to global financial markets and will lead to tighter wholesale funding conditions for banks around the world, including Australia.
While the global financial market conditions have improved since December 2011, the current financial difficulties experienced by the European financial markets continue to threaten the security of the financial markets.
It is interesting to note that the Australian banks, especially the larger ones, have already made themselves stronger to withstand tightened funding conditions. They have improved in terms of their capital positions, funding and liquidity. (“Minutes of the Monetary Policy Meeting of the Reserve Bank Board, 2012, p. 2) They have also managed their wholesale funding task well. Banks' non performing asset levels had decreased a little but remained robust for business loans. The Australian banks are in good shape, generally but the slow credit growth environment is expected to deter these positive growths in the future.
Overall conditions continued to change across the Australian business sector. Meanwhile, their local economy continued to make crucial structural adjustment vis a vis the high exchange rates and terms of trade. The Australian household sector has also improved its resiliency to future shocks. The household saving rate at around 10 per cent remains high. This was due to the many households who quickly repay their debts and to their generally conservative investment stance. Their debt servicing capacity is well supported by the strong growth in income. While their mortgage arrears rate are somewhat higher, the aggregate measures of financial threats are low. Inflation is contained in a manageable target range.
Australia’s outlook will have a downside risk if there is a quick deterioration in the European situation and its domino effects to the rest of the trading and financial world. However, as long as the Australian mechanism can maintain inflation, the RBA can ease policies in various scenarios.
Another aggravating fcator is the sharp slowdown in the East Asian markets, which will have a crucial effects to the demand and the commodity prices of Australian exports. (2012, p. 3)
An overall less threatening capital markets all over the world will produce positive changes in credit conditions, the exchange rate and confidence.
RBA members are concerned that the overall demand for debt has decreased even when the business credit had recently picked up. Likewise, construction activity remained less significant even when the commercial property market had contunously improved after its recent downturn.
The RBA takes positive outlook due to the fact that the prospects for the improvement in the global economy has improved from the previous month as the European policymakers make important progress in solving their region’s debt and financial issues. While the major downside risks are highly considered, the probability of an adverse outcome in the near future has somewhat decreased.
2. What are the principle strengths of Australia as a possible international financial centre? How do these strengths compare to the attributes regarded as necessary in making a financial centre attractive? (10% of Unit Marks).
The last financial crisis of 2008 has evidenced the resiliency, strength and the regulations of the well regarded Australian financial center. It remained competitive, efficient, creative, and relied upon by the Australian businesses and households. The major strengths of the Australian Financial Center are the following: proximity to the emerging markets, excellent regulatory framework as shown during the financial crisis, and its highly skilled human resources. (“Australia as a Financial Center: Building on Our Strengths,” 2009)
The Australian Financial Center can take advantage of the continuous growth of the emerging economies of its neighbors in the Asia Pacific region. The economies of these countries are remarkably growing along with the demographic factors. The major components of Australia’s financial sector are commercial and investment banking, insurance, and funds management. The relative size of Australia’s financial sector to its general economy is very similar to various developed economies such as the U.S., UK, Japan and Canada. However, it is also less significant than those in Hong Kong, Singapore and Luxembourg.
Various aspects of the Australian financial sector has shown resiliency during the financial crisis of 2008. These include its banking system, capital market, equity market, etc. Through the global financial crisis, Australia remained a strong market for raising capital. Its equity issuance has increased significantly as well. Their securitized debt market was also impressive and this was because of the Asutralian government’s guarantees on bank lending.
These strengths need to be well channeled and crafted into the international financial markets primarily because of the institutionalized features of the other large financial centers such as New York, London, Hong Kong etc. It takes more than economic strength to build upon a financial institution on a global scale. They need some specialized arrangements with international financial services such as concessions in order for them to establish their regional headquarters in various countries. (2009)
They also need to develop a wide range of financing and investment products for both local and international clients, businesses, and government institutions. While Australia already has such a base, it needs to fare well with the product offerings of larger offshore banks like UK’s Royal Bank of Scotland and Barclays.
In general, as compared with other financial centers, the Australian Financial Center still needs a high degree of “internationalisation.” Even when their systems are regulated and they have the manpower and financial capacities, the Australian Financial Center has to establish various clienteles all over the world in order to sustain its offshore operations.
This requirement is likely to inherently follow from their base characteristics. As it opens itself to the global financial markets and ocnsistently perform efficiently, competitively and remain steady, the Australian Financial Center is likely to attract offshore business.
The Australian Financial Center needs to build on their various products and services and its marketing to offshore markets. This will take a significant period of time. However, the strong financial base of the country and its emerging role in the global financial sector cannot be ignored. It will certainly develop into a valuable financial center in the Asia Pacific in the nearest future.
“Australia as a Financial Center: Building on Our Strengths,” November, 2009. Australian Financial Center Forum. [Online]. Available at: http://www.ag.gov.au/ cca. [Accessed 22 April 2012].
“Minutes of the Monetary Policy Meeting of the Reserve Bank Board,” March 6, 2012. Reserve Bank of Australia. [Online]. Available at: http://www.rba.gov.au/monetary-policy/rba-board-minutes/2012/06032012.html [Accessed 22 April 2012].
Rousseau, P. & Sylla, R., December, 1999. Financial Systems, Economic Growth, and Globalization. NBER Working Paper Series. Working Paper 8323. NBER, M.A.
Rousseau, P. & Sylla, R., December, 1999. Emerging Financial Markets and Early U.S. Growth. NBER Working Paper Series. Working Paper 7448. NBER, M.A.