Merits of Financial Market Development for Developing Countries

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Financial market development has its impact on economic development wide beyond national boundaries. Here multinational enterprises (MNEs) play a crucial role. Recent empirical studies carried out by Görg and Kersting (2016) and Donaubauer et al. (2016) found, among others, that:

• Well-developed financial markets, either in source or host countries, foster bilateral foreign direct investment. Well-developed financial markets in source countries compensate for poorly developed financial systems in host countries by generating FDI flows. Conversely, the positive effect of a better developed financial market in the host country diminishes, if the source country already offers a positive financial environment.
• Enterprises that are part of MNEs are less constrained by lack of finance. They make less use of bank loans compared to purely domestic firms. Enterprises that have newly become part of a MNE reduce their bank loan funding compared to funding from internal sources.
• When the state of a local financial market improves, funding from sources external to firms gains importance over firm-internal funding. Domestic firms benefit from this improvement more than MNE affiliates which have less need for external funding.

The importance of financial institutions in the developed world for growth in the developing world needs to be well considered when discussing and designing new or revised rules for financial markets.

The abovementioned core findings of the two recent studies are provided in more detail in Görg et al. (2016), Merits of Financial Market Development for Developing Countries, VoxEU.