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Finance and Economic Growth in a Balance of Payments Constrained Growth Model

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Some developing countries, especially Latin American countries, have had low economic growth after trade and financial liberalisation. The main idea behind the reforms was to develop their domestic financial system, which would give more opportunities to credit. The latter would finance investments which would then increase economic growth. The problem is that higher GDP growth has not materialised. To understand this problem, the paper starts from the study of growth restricted by the balance of payments. This kind of model highlights the role played by exports on economic growth, restricting the analysis to the equilibrium in trade. But balance of payments constrains cannot be restricted just to trade. One important component of the balance of payments is the financial and capital account. The objective of this paper is to introduce considerations about financing of an economy into this model of growth constrained by the balance of payments. In introducing finance into this discussion, it is crucial to explicitly consider other components of the effective demand, such as investment and consumption, trying to understand especially the impact of credit on economic growth. The reference will be a developing economy which opened their trade and finance with the aim of developing its domestic financial system to have higher economic growth. The model is applied to the Brazilian case, in which trade and financial liberalisation were introduced in the 1990s. Brazil is an interesting case in Latin America, because this country has a relatively diversified industry and from the 1950s to the end of the 1970s its economic growth was very high. The 1980s was marked by the debt crises and Brazil had to pay its debt damaging its investments. It was in that period when the reforms gained strength, with expectations of changing this situation. The main result of the model to the Brazilian case shows that trade and financial liberalisation did not induce the necessary changes in the productive structure to resume economic growth with restriction in the balance of payments. Especially highlighted are the effects of the instability of the international financial market. It greatly conditioned the effects of trade and financial liberalisation on the evolution of the economy, particularly the financial sector.

This talk is part of the Darwin College Humanities and Social Sciences Group series.

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