Wadiah Akbar, Mba-1 500366, Macroeconomics: Ma’am Maryam Khalid

Identify characteristics that are pertinent and specific to emerging

and developing economies?
Emerging markets are those that are striving to become advanced economies through
increased production, development of regulatory bodies and exchanges, and increasingly
sophisticated markets. Emerging market economies often have lower per capita income than
developed countries, and often have liquidity in equity markets, are instituting regulatory bodies
and exchanges, and see rapid growth. Some countries like China and India have high production
and industry, other factors like low per capita income or a heavy focus on exports qualify even
large countries as emerging markets. Developing economies are those economies that are not as
advanced as the rest of the world. Developing economies are country with less developed
industrial base and a low human development index relative to other countries.

There are several aspects that characterize an emerging market. Firstly, emerging markets
typically have a lower-to-middle per capita income. This means that the per capita income of the
countries' economies is generally lower than other more developed countries like the U.S. or
similar countries. For example, the per capita income (PCI) of India in 2018 is said to
be around Rs 1,12,835, or around $1,606.54 USD. The per capita income is used as one indicator
of how prosperous a country is. However, because emerging markets are striving to become
more industrialized quickly, they often have higher growth per year than the most developed
countries like the U.S. or U.K. emerging markets typically have some sort of regulatory body as
well as a market exchange for investment and a common currency. For example, China has a
common currency - the Chinese Yuan, as well as a regulatory body, The China Securities
Regulatory Commission. While emerging markets often have a higher rate of growth compared
to developed countries, they are often plagued by higher sociopolitical instability and volatility.
Many emerging markets have military unease and social upheaval that create high volatility. In
fact, volatility is a major facet of emerging markets. For countries like Thailand or Sudan,
droughts or tsunamis drastically impact markets, as both are more traditional economies with a
focus on agriculture or natural resources. However, emerging markets generally have lower
industrial production compared to advanced economies like the U.S.

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Wadiah Akbar, Mba-1 500366, Macroeconomics: Ma’am Maryam Khalid

Common characteristic of developing economies are low per capita real income, high
population growth/ size, high rates of unemployment, dependence on primary sector, and lastly
dependence on exports primary commodities.

What is Financial Liberalization?

Financial liberalization is defined as the removal of government intervention from financial
markets. Liberalization includes eliminating the restrictions listed in the previous section—bank
interest rate ceilings; compulsory reserve requirements; barriers to entry, particularly foreign
financial intermediaries; and credit allocation decisions. These policies reduce the government’s
interference in financial markets, leading to the privatizing of state-owned banks; introducing the
convertibility of the currency on the capital account (i.e., capital account liberalization);
improving prudential regulation; and promoting local stock markets. In the past three decades,
both industrial and emerging market countries have moved toward this form of liberalization of
their financial systems. Financial liberalization has two main effects, which can have both
benefits and costs.

Liberalization can lead to faster economic growth. But it can also increase the financial
vulnerability of a country, even leading to a financial crisis. The expected benefits of financial
liberalization—and particularly a liberalized capital account—are the ability to undertake
investments in excess of the level of domestic savings (which is especially important for Latin
American countries with low savings rates) and finance economic growth; the technology
transfers associated with foreign direct investment; and the increased competition in the financial
sector due to the removal of barriers and also as a result of the entry of foreign banks.
Conversely, the abolition of financial repression and the reduction or elimination of public sector
banks stimulate competition, and market based allocation of credit, domestic savings,
investment, and growth. Therefore, by favoring financial development, financial liberalization
increases the long-run growth rate of the economy. Stability and financial crises represent the
other side of financial liberalization. Opponents of financial liberalization argue that it would
lead to financial crises.

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Wadiah Akbar, Mba-1 500366, Macroeconomics: Ma’am Maryam Khalid

What is the main arguments made in the Mckinnon and Shaw

hypothesis?
Government intervention in the determining of the price and allocation of credit was
termed as ‘financial repression’ by McKinnon and Shaw in early 1970s. Interest rates control by
government, credit controls, barriers to entry to financial sector, state control of banking sector,
government ownership of banks and restrictions on capital flows are six elements of financial
repression identified by Williamson and Mahar (1998). Proponents of financial liberalization
argue that financial repression is the cause for lower growth rates that otherwise would be higher
if open market would decide the flow of capital to projects. Assumed costs associated with
repression are described as follows:

(1) Deteriorating growth rates for countries with high levels of financial repression.
(2) Widespread bank insolvencies as the result of low quality lending.
(3) Limited access to financial resources for individuals and small firms, whereas wealthy
elites take advantageous position in financial repressed system.
(4) Increased dependence on external financing because of negative real interest rates which
results in capital flight.
(5) Excessive use of capital-intensive production techniques, because artificial low real
interest rates makes those projects attractive.
(6) Reduced monitoring and financial resource allocation functions of financial
intermediaries as the result of state allocation of financial resources to inefficient state-
owned enterprises.
(7) Increased risk for external crises, as the result of deteriorating fiscal balances, increased
external financing or money printing.

McKinnon and Shaw argued that low interest rates or negative interest rates have negative effect
on savings rates, which leads to lower amount of funds available for investment through
financial intermediaries. Additionally, it results in inefficient allocation of resources as low-
yielding investment opportunities would be considered as good investment. It was predicted that
after capital account liberalization, capital would be allocated efficiently around the world to the
investment opportunities that offer highest rate of return, thus increasing global growth rates and

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growth rates within individual countries. Furthermore, by being able to invest both internally and
externally investors were able to diversify their investment, which would result in lower risks.

What is main evaluation of the Mckinnon and Shaw Hypothesis?

Financial repression has several negative effects on economic growth, which McKinnon and
Shaw, among others, have pointed out:
(1) Administrative interest rates would undervalue real interest rates, give an incentive to
reduce savings and investment, and have a negative impact on the rate of economic
growth.
(2) Individuals would find ways to export capital abroad (capital flight), creating pressure on
the exchange rate.
(3) Administrative determination of credit—not established by the market price—would lead
to an inefficient allocation of resources. This “bad” allocation would compound the
negative impact on growth because the most promising investments would not get
financed and therefore would not contribute to economic growth.
(4) Access to credit was granted for developmental purposes to big state owned and private
companies, while the rest of the economy started to have some access to consumer credit.
Pakistan has taken lot of steps towards financial liberalization to achieve higher level of growth. Now it
is important to conduct an empirical research to determine the effectiveness of financial liberalization
policies with regard to growth in a developing country like Pakistan. Examining the impact of financial
liberalization policies is particularly important in the case of Pakistan, which followed restrictive policies
till early 1990s. A low level of financial savings, investment and economic growth were the costs of these
restrictive policies. Pakistan is basically an underdeveloped country and facing a lot of problems like
unstable political system, low levels of education, high unemployment, less efficient banking sector,
rural based industries and less modernized technology. To achieve high economic growth, there are
many social and economic policies which can be implemented and policy of financial liberalization is one
of them. Financial sector reform program was started at the end of 1989 in Pakistan. The major goals
were:
(1) To liberalize interest rates by switching from an administered interest rate setting to a market-
based interest rate determination.
(2) To enhance competition and efficiency in the financial system by recapitalizing and restructuring
the nationalized commercial banks and allowing private banks to enter the market.

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Wadiah Akbar, Mba-1 500366, Macroeconomics: Ma’am Maryam Khalid

(3) To create and encourage the development of a secondary market for government securities.
(4) To reduce controls on credit by gradually eliminating directed and subsidized credit schemes.
(5) To improve prudential regulations.
Pakistan has made a lot of progress in financial sector by adopting lot of financial policies, but, at the
same time, there are lot of dangerous challenges ahead and a very complex action is needed to meet
these challenges so all policies should be implemented actively. To achieve high growth levels and
benefits of financial liberalization policies, it is very necessary to implement policies with credibility and
also provide conducive environment to get required results. Political system, infrastructure, social evils
and lot of other factors can be a cause of the failure of implemented policies in developing countries like
Pakistan.

What is lenders risk hypothesis?

The lender's risk hypothesis suggests that a pool of borrowers with a higher individual
probability of default on the average is charged a higher interest rate than one with a relatively
lower average individual probability of default. There is no excess profit, high rates to cover
involuntary and voluntary losses.

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Wadiah Akbar, Mba-1 500366, Macroeconomics: Ma’am Maryam Khalid

References
https://www.thestreet.com/markets/emerging-markets/what-are-emerging-markets-14819803

https://www.intelligenteconomist.com/characteristics-of-developing-economies/

https://www.bpastudies.org/bpastudies/article/view/68/146

https://www.ukessays.com/essays/economics/the-theory-and-practice-of-financial-liberalization-
economics-essay.php

https://pdfs.semanticscholar.org/0027/b3f44e22541f4240b95a1a9048bee59cfc98.pdf