Reforms in financial sector generate own momentum, IMF study finds

• Pages: 208-209

Page 208

Governments around the world have been busy liberalizing their financial sectors during the past quarter century. What prompted them to do this, and how does the process work? A new IMF statistical analysis of the causes and timing of financial reform finds that liberalization occurred as a combination of responses to changes in the economic and political environment ("shocks") and momentum gained from previous reforms ("learning").

While financial sector reform has been high on the agenda of policymakers for several decades, the experience of different countries with liberalization has varied considerably. The pace of reform has ranged from sluggish to swift and the magnitude of changes has run the gamut from minor tweaking to complete overhaul.

Many studies have looked at the consequences of financial sector liberalization, but the causes have received less attention. In a new study, "Financial Reform:What Shakes It? What Shapes It?"Abdul Abiad and Ashoka Mody of the IMF's Research Department draw on a newly constructed crosscountry database of financial liberalization to examine the experiences of 35 countries over the period 1973-96 to analyze the underlying causes of reform.

What they find is that liberalization is a combination of discrete changes in response to economic and political "shocks," reinforced by a self-sustaining dynamic-a process the authors refer to as "learning."

Reforms in neighboring countries also seem to have an influential effect. Of the economic shocks, crises trigger action, but these include reversals as well as reforms. "There was apparently a need to do something, anything, when things got bad," the authors observe.

Role of learning and shocks

What produces change? Abiad and Mody draw five specific conclusions from their extensive crosscountry data.

* First, countries whose financial sectors are fully repressed (meaning unliberalized) are the ones with the strongest tendency to maintain their policy stance and hence remain closed and highly regulated.However, where initial reforms occur, and the financial sector becomes even only partially repressed, the likelihood of further reforms increases substantially.

The self-sustaining nature of reforms can be explained in several ways, the study says. Initial reforms can reduce uncertainty regarding the benefits that can be gained from reform. They will also tend to strengthen those who benefit from...