1 Introduction
The purpose of this paper is to develop an analytical framework for discussing the link between financial systems and economic growth. This framework can be used to evaluate policy settings that affect New Zealand’s financial system. The paper does not attempt to assess the adequacy of New Zealand’s financial system in providing financial services. Rather it highlights the importance of financial development for economic growth and identifies key policy priorities.
Financial systems, i.e. financial intermediaries and financial markets, are important for economic growth.[1] They can lead to a more efficient allocation of resources because they reduce the costs of moving funds between borrowers and lenders, and help overcome an information asymmetry between borrowers and lenders. If they do not function well the economy can not operate efficiently and economic growth will be negatively affected.
Information asymmetry arises because borrowers generally know more about their investment projects than lenders. Imperfect information can lead to a lack of market coordination (Akerlof 1970). As financial systems represent the market response to such a possibility, they are crucial institutions. Policy settings are important as they can affect the production and discovery of information, key functions of financial systems.
The paper proceeds as follows. Section 2 reviews the role of financial intermediaries and markets and their comparative advantages in providing external finance to firms. Section 3 establishes the broad link to economic growth. The cost of external finance is discussed in section 4 and the empirical evidence is reviewed in section 5. Section 6 discusses the importance of the legal environment and other policy influences for financial development and section 7 assesses the potential effects of the New Zealand tax system on the financial system. Section 8 discusses financial regulation and supervision, and the last section summarises and concludes.
Notes
- [1]Financial markets refer here to institutions organised for the creation and trade of financial assets, such as a stock exchange. Financial intermediaries are those institutions that carry out the market function of matching providers of funds with users of funds, such as banks, unit trusts or venture capitalists.
