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 Globalization and FDI in Financial Services to Economies in Transition

(Abstract)

There is an ongoing debate as to the net benefit of the financial sector in developing countries (DEs). The potential positive contribution to growth via financial intermediation must be weighed against the potential negative impact on macroeconomic stabilization and on moral hazard. Such dangers clearly exist also in economies in transition (TEs) and have indeed materialized in several of them, as well as in some developing economies (DEs). The development of market oriented financial services in TEs may well be more difficult than in DEs. While in the later financial services have to be developed from scratch, in TEs there existed the socialist variety of so called "banks" under the old regime, with completely different mission and operating culture, a tradition that is extremely difficult to alter.

An existing domestic banking sector may therefore present an even greater destabilizing danger and hindrance to restructuring. Furthermore, in most DEs one can conceive of informal financial networks, such as family and friends, as substitutes for banks as the main source of financing of small and medium size businesses, the most important engine of growth. Most TEs, on the other hand have rather sophisticated production sectors dominated by large and complex firms that cannot survive, let alone restructure (as most of them need to) without an elaborate and effective banking sector.

Globalization, and in particular the information and communication revolution, helped to develop a multinational industry of trade and FDI in financial flows and in financial services. This industry may provide one promising option of helping TEs to acquire modern financial services abroad and, through FDI to build a modern financial sector in their countries, thereby to expedite restructuring in the production sector and the resumption of economic growth, not only through the provision of finance but also through the enforcement of a better governance regime. The above discussion leads one to conjecture that FDI in financial services may be the best option for TEs. The paper intends to test this hypothesis.

        Following an expanded exposition of the above, the paper will present a comparative conceptual or theoretical analysis of the options in the sphere of financial services open to TEs. It will then study and compare the experience of a number of TEs (Hungary, Russia, Poland and a few others) with different strategies and policies  for the creation of a banking sector and financial services during the first transition decade, and the impact of these experiences on macroeconomic stability, restructuring and economic growth.