International Financial Markets and Economic Development of Nations
Final Report Abstract
According to standard neoclassical theory, measures promoting the globalization of financial markets create equalizing economic forces between economies, which induce convergence of real economic performance across countries even without international mobility of primary factors. Thus, real trade opportunities should follow the tendency to equalizing performance in the financial market among participating countries. A number of empirical studies have shown evidence against convergence of economic performance across countries, implying the need to explain why the neoclassical prediction does not hold. The purpose of the project was – to develop a model to analyze explicitly the relationship between international financial transactions and economic growth, – to identify the market forces and the structural characteristics of economies leading to different long-run behavior of world income distribution, – to exhibit conditions under which convergence or nonconvergence may take place, – to identify the channels through which some countries gain from the global financial market while others do not. Within the project, the standard model of economic growth with overlapping generations of consumers was amended to include a market of four different types of financial assets (shares (stocks), government bonds, tangibles, and land), and their consequences were analyzed. In such economies domestic consumers choose optimal portfolios under risk, and choose their real savings (capital accumulation) endogenously depending on their income, their risk attitudes, and their expectations for future return of the two investment possibilities. Thus, the dependence of savings on asset returns generates the endogenous mechanism and interaction between real and financial markets, which causes economies to follow different paths of growth under different scenarios. Therefore, the consequences of the existence of the asset market for the long–run development of closed and open economies and of the international financial markets could be investigated. Among the main findings are: • risk attitudes of consumers together with substitutability properties in production may be responsible for the occurrence of the poverty trap phenomenon in closed economies with productive assets (shares) and with tangibles; • even when the poverty trap feature is absent, the globalization of asset markets between two similar countries may induce symmetry breaking, thus inducing the long–run divergence of identical countries after asset market integration; this implies that globalization may lead to a permanent disadvantage to underdeveloped (low–income/low–capital) countries versus developed (high–income/high–capital); • with asymmetric steady states appearing between countries after integration of asset markets, the symmetric steady states no longer maintain their stability and endogenous permanent business cycles can occur; • when the asset is a government bond with some small sovereign risk, similar results hold; in particular in small open economies accessibility to an international bond market may cause instability of the symmetric stable steady state relative to autarky; • the existence of uncertainty/randomness is a necessary condition for the occurrence of any of the results, since in an environment with complete certainty and perfect foresight the strong neoclassical hypothesis of convergence holds with any assets and under globalization, if there are no other market restrictions.
Publications
- (2005): “Welfare and the Role of Equity in an Economy with Capital Accumulation”, Discussion Paper no. 547, Department of Economics, Bielefeld University, Bielefeld
Böhm, V., T. Kikuchi & G. Vachadze
- (2006): “Asset Pricing with Markovian Productivity Growth”, Discussion Paper no. 558, Department of Economics, Bielefeld University, Bielefeld
Böhm, Kikuchi & Vachadze
- (2006): “On the Role of Equity for the Dynamics of Capital Accumulation”, Discussion Paper no. 551, Department of Economics, Bielefeld University, Bielefeld
Böhm, Kikuchi & Vachadze
- (2007): “Risk, Factor Substitution, and Asset Market Integration”, in Dynamik Internationaler Märkte, Wirtschaftswissenschaftliches Seminar Ottobeuren, ed. by W. Franz, J. Ramser, H. & M. Stadler, vol. 36, pp. 49–69. Mohr Siebeck, Tübingen
Böhm, V., T. Kikuchi & G. Vachadze
- (2008): “Asset Pricing and Productivity Growth: The Role of Consumption Scenarios”, Computational Economics, 32, 163–81
Böhm, V., T. Kikuchi & G. Vachadze
- (2008): “Capital Accumulation with Tangible Assets”, Journal of Economic Behavior and Organization, 68, 248–57
Böhm, V. & G. Vachadze
- (2008): “International Asset Market, Nonconvergence, and Endogenous Fluctuations”, Journal of Economic Theory, 139, 310–334
Kikuchi, T.
