An Interest Group Theory of Financial Development
Richardson, Nela N. Thomas
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My work contributes to current explanations of the variance in financial development across countries by considering the role of political and legal structure in determining the effect of private interests on financial policy and illustrating the political obstacles that policymakers face when reforming the financial system. In Chapter 2, I present a political economy model to study the role of politics in the process of financial development across emerging markets. The model concludes that both special interest groups and political structure affect the level of credit market development chosen in equilibrium. When policymakers are constrained by political institutions that require democratic accountability, they are more likely to improve the level of creditor rights enforcement in the financial system. Financial reform is also more likely to occur in wealthy and highly productive economies. In contrast, the model shows that openness to international capital inflows impedes financial development. Furthermore elite special interest group members benefit more from financial repression when wealth is unequally distributed; hence, income inequality provides a further obstacle to financial reform in emerging markets. Chapter 3 empirically investigates the role of political institutions in implementing financial reform under three different levels of democratic accountability, Free Countries, Partly Free Countries and Not Free Countries. I find that the institutional details of the political system, as summarized by the number and cohesion of its veto players - individuals whose consent is required for policy change - are weakly associated with credit market development in Partly Free Countries. Chapter 4 (co-authored with A. Knill) investigates the role of security laws on the ability of firms to raise external finance by issuing capital. We find that securities laws have disparate effects on capital issuance between small and large firms in G10 and emerging market countries. Private enforcement of securities laws that codify existing market arrangements is found to be a deterrent to capital issuance for small firms and firms in emerging markets. Public enforcement of securities laws by government regulation significantly increases the probability of issuance for emerging market firms.