Wednesday, December 14, 2011

Does financial structure matter for poverty? evidence from developing countries

This paper analyzes the role of labor market institutions in explaining the development of shadow economies in European countries. The analysis uses several alternative measures of the shadow sector, and examines the effects of labor institutions on the shadow sector in two specific regions: new and old European Union member countries, as their respective shadow sectors exhibited a different development in the past decade.

Although the share of the shadow economy in gross domestic product averaged 27.5 percent in the new member countries in 1999-2007, the respective share in the old member states stood at 17.9 percent. The paper estimates the effects of labor market institutions on two sets of shadow economy indicators -- shadow production and shadow employment. Comparing alternative measures of the shadow sector allows a more granulated analysis of labor market institution effects. The results indicate that the one institution that unambiguously increases shadow economy production and employment is the strictness of employment protection legislation.

Other labor market institutions -- active and passive labor market policies, labor taxation, trade union density, and the minimum wage setting -- have less straightforward and statistically robust effects and their impacts often diverge in new and old European Union member countries. The differences are not robust enough, however, to allow for rejecting the hypothesis of similar effects of labor market institutions in new and old European Union member states.


While financial development and its effects on economic growth have attracted considerable attention in the literature, far less work has been done on the relationship between financial deepening and poverty. More particularly, few studies have looked into the possible importance of the structure of the financial system, i.e. whether financial intermediation is performed through banks or markets, for poverty reduction. Yet, lack of access to finance has been argued to be one of the main factors behind persistent poverty.

Furthermore, financial development is a complex process involving a number of intermediaries. Recent empirical studies have argued that, while necessary, financial liberalization may not be sufficient to foster an environment where the financial sector could function effectively. The strength of the legal environement, institutional reforms related to property rights and creditor information are crucial. Yet, the most common measure for financial developmentprivate credit—does not directly capture these dimensions.

This paper aims to contribute to the literature in several ways. First, it tries to capture the role of the structure of the financial system in reducing poverty. Second, it examines in particular the role of the quality of institutions in shaping the link between financial structure and poverty. Third, it looks specifically at developing countries, reaching more conclusive results on the role of the bank- versus market-based systems than studies with global coverage.

The results suggest that the structure of the financial system does play an important role in reducing poverty in developing countries. Financial deepening achieved through the expansion of banks contributes to poverty reduction, implying that more bank-based financial systems tend to do better in lifting people out of poverty. But as institutions grow stronger, market-based financial systems can turn to be beneficial to the poor.

In what follows, Section II reviews the literature; Section III discusses the data, describes the methodology, and presents the results; and Section IV draws some conclusions.

World Bank. Author:Kpodar,Kangni;Singh, Raju Jan.Document Date:2011/12/01.Document Type:Policy Research Working Paper.Report Number:WPS5915.Volume No: 1 of 1