March 2010, Asli Demirguc-Kunt (DECFP)
End of the year is a good time to stop and reflect. Our group has been very productive this year, producing 50 journal articles, 15 chapters in books and two volumes. We continued to generate data sets, organize seminars and training courses and held five conferences in 2009.
In our group our over-arching goal is to understand the role of the financial and private sectors in promoting economic growth and reducing poverty, and identifying policies to improve their effectiveness. Our research is always driven by policy questions and we respond to current policy needs. For example the 2008 financial crisis was a shock to conventional thinking and revealed key knowledge gaps both in finance and private sector areas. First, how do we ensure that financial systems are growth-promoting and inclusive, yet stable? What are the key trade-offs? What roles do financial liberalization, regulation and supervision, and financial education play in this process? Second, are there optimal financial structures at different stages of the development process? What does this imply for the role of banking versus market development, banking structure and size distribution? Third, which policy interventions enhance the role of private sector in promoting development? Finally, what are the new lessons from the latest crisis and how do they alter our policy advice in the areas of finance and private sector development? Our research team has a comprehensive research program which will try to address these questions in the coming years. The following are just two highlighted areas which produced outputs from this on-going research program in 2009.
Have the rules of finance changed after the crisis?
This year we continued to work on understanding the causes and consequences of the crisis. Two conferences focused on areas where we need to do more out-of-the-box thinking as a result of the crisis: financial regulation, insolvency resolution, and innovation and risk-management trade-offs. Our research has investigated causes of the crisis, attributing significant role to faulty micro-incentives. It has also investigated the implications of the crisis for our macro and financial policies, emphasizing that the challenge of financial sector policies is to align private incentives with public interest without taxing or subsidizing private risk-taking. The analysis suggests that public ownership or too aggressive regulation would simply hamper financial development and growth. But clearly striking this balance is becoming increasingly complex in an ever more integrated and globalized financial system. Investigating the financial system trends in the boom period leading up to the global crisis shows that lower margins from traditional lines of business and the search for higher returns were only possible through high risk-taking, especially in high-income countries. Also, analyzing bank activity and funding strategies during this period shows that overall, banking strategies that rely prominently on generating non-interest income or attracting non-deposit funding are very risky, consistent with the demise of the U.S. investment banking sector.
How can we promote job creation?
The recent financial crisis and the resulting high unemployment have sparked a renewed interest in government policies that can promote employment generation. Two research papers on Mexico suggest that business environment reforms, as well as expanding access to finance, can play an important role in job creation by fostering entrepreneurship. The first paper finds that a simplification of business registration procedures led to an increase in the number of registered firms and raised employment by 2.8 percent. The second paper shows that the opening of a bank for low-income individuals increased the number of informal businesses, which was also accompanied by a rise in employment, by 1.4 percent. Another paper examines the impact of labor market regulations on Chinese firms, specifically, how the downsizing program of China affected firm performance, labor wages, and China’s recent job creation performance. The results suggest that labor downsizing has negative short-term effects on productivity, and that productivity losses are smaller for private firms compared to state-owned firms (though the reverse is true for wage losses), indicating a stronger profit incentive for private firms. We also held a Conference on Entrepreneurship and Growth that examined a broader set of policies and interventions that could promote entrepreneurial activity and thereby create jobs.
Microenterprises are an important source of employment in most developing countries. Yet few of the self-employed grow beyond subsistence level. Research in Sri Lanka examines the role of credit constraints in limiting the growth of enterprises, with a surprising finding that more capital improves profits for male-owned microenterprises, but not female-owned microenterprises. The authors argue female-owned enterprises are constrained by the sectors the owners operate in, and by household bargaining issues, suggesting job creation efforts need to focus on the types of jobs created, not just whether there is a job. Another constraint to the growth of small enterprises is often thought to be informality. Research in Bolivia shows large gains to small enterprises from formalizing, but only for those firms that are constrained by information or distance from registering their businesses – sole proprietorships appear to not benefit from formalizing.
Quality and Impact
Policy relevance of our research is very important to us. Indeed, all our research staff spend thirty percent of their time involved in operational activities to ensure continued policy relevance and impact of our research. At the same time, our research work is credible and influential in policymaking precisely because it meets the requirements of high quality research. Hence, rigor is as important as relevance. Publishing in highly recognized economics and finance journals is a way of screening and disciplining us, improving our credibility and measuring the quality of our work. In 2009, quite a few of our papers also met the highest industry standards in this respect.
Ultimately, development impact of our work is what matters, which is very difficult to measure. One imperfect way of doing this is to look at citations of our research. The citation record of our recent, as well as earlier papers, suggest that we are having lasting impact in many areas.
ASLI DEMIRGÜÇ-KUNT is the Chief Economist of the Financial and Private Sector Network and Senior Research Manager of Finance and Private Sector, in the World Bank's Development Research Group.