9  Concluding remarks

This paper developed an analytical framework for discussing the link between financial systems and economic growth. The first part of the paper reviewed the role of financial systems, their importance for economic growth and the cost of external finance. The second part focused on areas where policy affects financial systems: the legal environment and other policy influences, taxation and finally, financial regulation and supervision.

Existing theory suggests a clear link between financial systems and economic growth. Financial intermediaries and markets can help overcome an information asymmetry in credit markets. They reduce information and transaction costs and improve the allocation of resources, leading to increased capital accumulation and faster economic growth. Empirical evidence suggests that information asymmetries are important and affect firms’ access to finance and their cost of borrowing. Removing regulatory or tax distortions that prevent/lower the production and discovery of information will lead to increased investment and output. The magnitude of these effects is uncertain but possibly significant. The economic benefit could be substantial if resolving existing distortions would increase firms’ ability to borrow in future. Moreover, additional investment may lead to technological innovation.

The existence of information asymmetry has implications for policy. Policy makers should be aware that different types of financial intermediary are likely to be providing finance to different classifications of firm or different sectors of the economy. This means that distortions arising from policy which create biases against the use of certain segments of the financial system can have impacts that are concentrated amongst particular types of firm. This paper demonstrated one way in which present tax policy may have such an impact. Given the importance of financial development for economic growth a resolution of the tax distortions should be a priority.[59]

When considering issues of cost or access to finance, policy makers should be aware that the existence of finance constraints for some firms may represent the optimal response by financial markets and intermediaries to information asymmetries. Policy that affects the production of information, the effective monitoring of firms, the enforcement of contracts, or institutions that carry out these functions can often have a more pronounced effect for firms than actions aimed at high level measures of capital availability. Because receiving finance can change the behaviour of the borrowing firm and because there is a moral hazard risk from extending funds when information asymmetry issues have not been resolved, increasing the flow of funds to some firms in response to apparent finance constraints can do more harm than good. Encouraging the production of information or removing impediments to effective firm monitoring in such cases would more closely address the cause of finance constraint for many firms. The financial environment is one of growing global integration, rapid changes in financial practice and increasing complexity of financial contracts. A better understanding of the financial instruments available to New Zealand firms would assist our assessment of the cost and access to finance and the impact of New Zealand’s financial system on economic growth.

Finally, a comprehensive assessment and evaluation of the recommendations in the IMF’s report should be of high importance. A number of reviews are currently being undertaken in relation to the financial system. Within the context of these reviews it will be important to consider the IMF’s recommendations, ensure that the regulatory regime has the flexibility to meet the financial needs of the New Zealand economy and that any changes to the financial system are considered within developed frameworks on how they can impact on economic growth.