Bulgaria And Romania Financial Development And Economic Growth

1. Introduction

Although the relationship between financial development and economic growth has received a great deal of attention during the recent decades, there are conflicting views concerning the role that the financial system can play in economic growth. The analysis of this relationship started with the works of Goldsmith (1966), McKinnon (1973) and Shaw (1973) and has continued with some theoretical and empirical studies which have tried to deepen the understanding of the different aspects of this relationship by exploring the direction of causality between the financial development and economic growth (King & Levine, 1993; Levine, 1986; Thakor, 1996). Financial development includes both the expansion of financial services and the growth of financial institutions as well as an increase in per capita amount of financial services and institutions or an increase in the ratio of financial assets to income (Ahmed & Ansari, 1998).

Financial sector development in developing countries and emerging markets is a part of the private sector development strategy to stimulate economic growth and reduce poverty. A solid and developed financial sector is a powerful engine behind economic growth. It generates local savings, which in turn leads to productive investments and a superior allocation of resources.

In the last two decades, many countries, especially the developing ones, have implemented a variety of financial liberalization measures that have led to the increasing intermediation role of the stock markets and significant changes in their financial structures. Recent works in endogenous growth literature have showed that the financial intermediaries can contribute to economic growth through various aspects of productive activity.

This proposal is organized as follows. Section 2 describes the aims and objectives of the project. Section 3 provides a literature review. The transformation process of the financial development and economic growth in Bulgaria and Romania from 1990s till today is in section 4. The description of the data and the measurements for the financial development and economic growth is in Section 5. Section 6 provides conclusions.

2. Aims and objectives

The purpose of this project is to investigate the relationship between financial development and economic growth, to evaluate the role of financial development in economic growth in Bulgaria and Romania over the period of 1990-2009.

The question is whether the credit growth of the last few years will have a similarly positive effect on long-run economic growth. Levine (2004) discusses five main functions that the financial system has to perform in order to have a positive effect on long-term growth: 1) Produce information ex ante about possible investments and allocate capital; 2) Monitor investments and exert corporate governance after providing finance; 3) Facilitate the trading, diversification, and management of risk; 4) Mobilize and pool savings; and 5) Ease the exchange of goods and services. Unless these functions are performed well by the financial system, the effect of the credit growth will be limited to a short-term stimulus. In fact, the development of a financial system can be defined as the degree to which it performs these functions well. Therefore, an increase in credit activity is a necessary but not a sufficient condition for the financial system to exert a positive effect on growth.

This project is an attempt to determine what the impact of the financial development over the economic growth is in the two countries, which joined the EU in 2007 after the long period since the collapse of the communist regime in 1989.

3. Literature Review

There is a large body of theoretical and empirical literature regarding the role of financial development in economic growth. This literature indicates that researchers in economic domain hold different views regarding the existence and direction of causality between financial development and economic growth.

Some authors consider finance an important element of growth (Schumpeter, 1934; Goldsmith, 1969; King and Levine, 1993), whilst for others it is only a minor growth factor (Robinson, 1952; Lucas, 1988). Goldsmith’s paper (1969) was the first to show empirically the existence of a positive relationship between financial development and GDP per capita. He demonstrated that financial development directly increases savings in the form of financial assets, encouraging capital formation and economic growth. McKinnon (1973) and Shaw (1973) believed that the effect of financial development on the economic growth depends on the effects of financial development on the interest rate. King and Levine (1993) used mostly monetary indicators and measures of the size and relative importance of banking institutions and also found a positive and significant relationship between several financial development indicators and GDP per capita growth. While Levine (1997) believes that financial intermediaries enhance economic efficiency and, ultimately, growth by helping allocate capital to its best uses, Lucas (1988) asserts that the role of the financial sector in economic growth is ‘over-stressed’. More recently, Levine (2005) has also been reported a positive effect of financial development on economic growth through its sources (capital accumulation and productivity), and even on income inequality and poverty.

However, only a few studies have focused on the transition economies from Eastern Europe (Berglöf and Bolton, 2002; Kenourgios and Samitas (2007), mostly finding a positive relationship between several financial indicators and economic growth.

4. Financial Development and Economic Growth in Bulgaria and Romania: The Transformation

Since the reform of the financial sector in the last new entrants in the EU, Bulgaria and Romania, started from the banking sector, its transformation has been one of the most important aspects of the transition process from a centrally planned to a market economy. Initially a heavily regulated industry, the banking system has been rapidly turned into one of the most dynamic sectors of the economy. The process started in the early 1990s when foreign banks began investing in the region. From 2004, these have been holding majority shares in all Central and Eastern European countries. Their entry into the market has resulted in considerable benefits for the sector and the economy in general, but they have had to face various challenges deriving mostly from the underdevelopment of key institutional support for banking growth.

The economic development of Bulgaria during the period after the collapse of the communist regime was marked by a series of upheavals. The instability and the major disruptions in the social and the political fields affected greatly the economy of the country. The first years after 1989 saw tremendous changes in all spheres of life. Bulgaria took a course towards transition to market economy and abandoned the paradigms that directed its economic and social life. The weak governments could not handle the intensive dynamics of the new transition reality which affected seriously the whole country. As a result by 1997 the economy of the country shrunk to almost half of what it was in 1989. The negative economic trend reached its peak in 1996-1997, when financial collapse, mass bank and other enterprise bankruptcies worsened the economic situation dramatically. After this, a period of consolidation and reforms followed. The decisions of the governments after 1997 led to stabilization and economic revival. The country took a stable course to integration in the Euro- Atlantic structures, a process that successfully led to the EU accession in January 2007.

Bulgaria

After the Communist regime was overthrown in late 1989, Romania experienced a decade of economic instability and decline, led in part by an obsolete industrial base and a lack of structural reform. During transition to a market economy, there-establishment of Romanian private business community was facing severe obstacles. The Romanian economy can be described as firstly going through a sluggish growth what was followed by a decline during the nineties. From 2000 onwards, the Romanian economy was transformed into one of relative macroeconomic stability, characterised by high growth, decreasing unemployment and declining inflation. Despite the global slowdown in 2001-02, GDP growth has been kept above 4%. The Romanian economy grew at 7.7% in 2006 and it was 6% in 2007 according to the provisional data. Still the 2004 remains the peak year of economic growth, with 8.5%, the same year when Romania joined the NATO. The economic performance of Romania has gained momentum since the country’s EU accession on January1, 2007. The economic growth of the Romanian economy is satisfactory and it is among the fastest in the EU.

Romania

5. Data and methodology

6. Conclusions