Financial liberalization and industry structure nexus : an investigation using dynamic heterogeneous panels from Malawian data

This thesis re-examines the relationship between finance and growth. Most previous studies that have dealt with different aspects of this relationship show that a well-developed financial system is important for economic growth. However, instead of concentrating on the aggregated perspectives of this relationship, this research investigates whether financial development influences the level of competition in the real sector, as one possible mechanism through which finance may influence growth. The study focuses on the changes in industrial structure and performance following a regime change in the financial system: from financial repression to financial liberalization. It has been suggested that financial liberalization may be a key policy to promote industrialisation as it removes the credit access constraints on firms, especially small and medium ones. Competition among financial institutions, which accompanies financial liberalization, leads to greater availability of finance and a reduction in the cost for firms of raising capital for investment. In turn, this encourages creation and entry of new firms and promotes industrial growth, particularly of those firms and sectors that are external finance dependent. The implications of financial liberalization on the real sector are investigated using industry-level panel data from Malawian manufacturing, a variety of econometric methods, and standard measures of industry structure and performance, as well as financial development indicators. The analysis aims to ascertain whether financial liberalization in Malawi has had any impact on the availability of credit for manufacturing firms and whether its effects, which are hypothesised to influence industry structure and performance, differ depending on characteristics such as the degree of external finance dependence of firms or firm size. The main empirical findings show that financial liberalization, even if it results in greater supply of credit and a larger number of lending institutions compared with the pre-reform period, does not remove financing constraints on firms, especially the small and medium ones. Instead, it is the large existing firms that benefit from a more liberal financial regime. Indeed the evidence is that financial reforms have mostly facilitated the expansion of existing establishments rather than the creation of new establishments, and have resulted in greater industry concentration. Further, profitability and output growth are disproportionately higher in large firms than in small ones. The implementation of financial liberalization in Malawi has been judged a success; nevertheless the evidence is that these reforms have been detrimental to competition in industry. What are the policy implications of these findings? This study shows that financial liberalization is not the key for the promotion of industrialisation. In the presence of pervasive market failures in financial resource allocation, as have been experienced in Malawi, the withdrawal of the state from credit allocation decisions is unlikely to result in industrial development.