The impact of foreign direct investment, financial crises and organizational culture on managers' views as to the finance-growth Nexus.

Author:Tennant, David

Numerous theoretical models argue that financial institutions can facilitate the creation of economic growth through three main channels--by mobilizing savings, by allocating savings to the most productive investments, (1) and by facilitating the smooth flow of trade needed in any market-driven economy (2) (Levine 1997, 689-701). Such models are typically rooted in neoclassical economic theory where it is assumed that managers and officers of financial institutions fill these roles because it is rational for them to do so as utility-maximizing agents. Institutional economics, suggests that viewing individual agents as utility-maximizing is inadequate, as the decisions made by individuals are affected by institutional, cultural and historical factors (Hodgson 2000, 318; Elliot and Harvey 2000, 397). Such factors are not usually accounted for in empirical studies on the finance-growth relationship, as they are not easily quantified. Their omission has led to an incomplete understanding of the finance-growth process, and to confusion as to why similar empirical tests yield completely different results in different countries. (3) More importantly, failure to understand the factors that impact and influence the direction of financial sector intermediation has led to broad policy prescriptions that may not be applicable in specific country circumstances.

This article addresses these issues by analyzing and reporting the results of a survey of views of selected financial sector managers. The Jamaican case study allows for the investigation of an interesting paradox--expansion of the financial sector, as the economy simultaneously experienced declining growth rates. (4) Analysis of the views of key stakeholders in this environment leads to some important conclusions as to the validity of the theorized functions of the financial sector; the constraints facing the sector in effectively performing those functions; and suggestions for improved performance.

Important distinctions are made between the views highlighted by managers of:

(i) indigenous and foreign financial institutions;

(ii) institutions that were positively and adversely impacted by the recent financial crisis; and

(iii) different types of financial institutions.

These distinctions allow for an assessment of how foreign direct investment (FDI), financial sector crises, and organizational culture affect managers' views of their roles in the economy, and the challenges they face in fulfilling those roles.

The article is divided into six subsequent sections. The second section summarizes the analytical and historical framework of the study. Section 3 outlines the methodology used in conducting the study. The next three sections highlight the impact of FDI, financial crises and organizational culture on managers' views as to the financial sector's theorized role in fostering economic growth, constraints faced in fulfilling these roles, and suggestions for improving the performance of the sector. The final section presents the summary and conclusion.

Analytical and Historical Framework

With the spread of financial and capital market liberalization in the developing world, current discussion is focusing on whether liberalized financial markets are effective in attracting funds to developing countries and efficient in allocating such capital, or "if in fact they add unnecessary instability to already weak economies and ... promote policies ... detrimental to the poorest members of those societies" (Harvey and Klopfenstein 2001, 439). Institutional economics suggests that the outcome of financial sector intermediation in a liberalized environment depends on numerous factors that influence decision-making in financial institutions. Such factors are integrally related to the country's culture and history, the financial sector's history, and each organization's culture and structure.

In highlighting financial sector managers' views of their roles and challenges, these factors will be considered by distinguishing between indigenous and foreign-owned institutions; institutions that were positively and adversely impacted by the financial sector crisis of the mid-1990s; and different types of financial institutions. These distinctions address important policy debates that are briefly outlined in the paragraphs that follow.

The Role and Impact of Indigenous versus Foreign-Owned Financial Institutions

With liberalization, the number of foreign-owned financial institutions operating in developing countries has surged in recent years. Debates focus on the relative impact of foreign-owned and indigenous financial institutions on developing countries. Typical neo-classical arguments focus on increased competition from foreign firms as a catalyst for improved operations of indigenous financial institutions. Competitive pressures generate positive macro-economic implications, as financial sector costs are reduced, quality and availability of financial services increased, more modern and efficient banking techniques introduced, regulation and supervision of the financial sector improved, and the country's access to international capital enhanced (Claessens, Demirguc-Kunt, and Huizinga 2001, 893; Hermes and Lensink 2004, 208210).

Clarke, Cull and Peria (2001, 20) suggest that "even if increased penetration by foreign banks improves sector efficiency, sector stability and competition, it might have some harmful side effects ... (as it) might result in less credit to some sectors of the economy." Clarke et al. (2003, 43) also indicate that foreign-owned financial institutions may be more oriented toward lending to large companies, as the typically large foreign institutions "may be impeded by organizational diseconomies in providing relationship lending services to small businesses at the same time that they are providing transactions lending services and wholesale capital market services to their large clients." Further, the smaller domestic banks have a competitive advantage in lending to borrowers who are less visible in capital markets, such as small and medium-sized enterprises that require credit for their working capital needs. Domestic financial institutions can be more effective in creating and maintaining relationships with small borrowers by using more idiosyncratic borrower information, which is not easily quantified or transferable. It is further posited that foreign financial institutions tend to have priorities that cause them to ignore local objectives, while domestic financial institutions may be more amenable to the country's development priorities.

Much of the empirical evidence on the relative roles and impact of foreign-owned versus indigenous financial institutions is derived from case study analyses. For example, as cited in Claessens, Demirguc-Kunt and Huizinga (2001, 893-894), Bhattacharaya (1993) notes that in Pakistan, Turkey and Korea foreign banks increased domestic projects' access to foreign capital, and Terrell (1986) concludes that countries which allow foreign bank entry, experience lower gross interest margins and operating costs. In a more recent cross-country study, Claessens, Demirguc-Kunt, and Huizinga (2001, 895) note the relative impact and performance of foreign and domestic banks may depend on the reasons for which foreign banks enter the domestic market, as well as competitive and regulatory conditions in the host country. They argue that because these factors differ significantly between developed and developing countries, foreign banks in developed countries have lower interest margins, overhead expenses and profitability than domestic banks, while the opposite is true in developing countries.

Historical and institutional factors may therefore be important in determining the relative role and impact of foreign-owned and indigenous financial institutions. This is especially true for the Caribbean, where foreign ownership of large segments of Caribbean economies has been a consistent feature of the region's history. Caribbean economists including Norman Girvan (1971) and George Beckford (1972) have argued that foreign ownership of national resources contributed to underdevelopment in the region, as the utilization of such resources did not facilitate national development. Michael Manley (1990, 79) explains by noting that "local production for local use was actively discouraged since production of this sort could only take place at the expense of metropolitan exports." Winston Griffith (2002, 89) argues that FDI in the financial sector was a key contributor to this experience as "many commercial banks are subsidiaries of metropolitan multinational corporations, and cater primarily to the import-export trade." Further, he argues that biases in commercial bank lending toward the distributive trades and personal loans were features of colonial banking, which have continued to hinder structural transformation in the post-colonial period.

Maurice Odle (1981, 28, 74) refines these issues by noting that multinational banking in the Caribbean has a long history associated with the earliest forms of colonial penetration. Foreign banks first entered the region as service bankers, to facilitate the operations of multinational corporations primarily in the mining and sugar industries (Thomas 1974, 38). Foreign banks, therefore, focused on financing primary exports by providing credit to foreign enterprises engaged in importation and distribution of metropolitan commodities. Since the 1970s, under pressure of Third World economic nationalism, multinational banks have been forced to make changes to their operations, but Odle (1981, 58) asserts that these changes relate primarily to the quantity of loans issued rather than the quality of lending. He (1981, 7) argues that multinational banks have always shown an exaggerated sense of risk aversion, and can be accused of "diverting funds from development needs to consumption purposes and from...

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