Many studies since the emergence of endogenous growth theory have identified technological innovation as the main determinant of growth. There are structural factors like human and physical capital that contribute to achieving higher innovation rates. However, improving these factors is not sufficient to succeed in innovation. A country’s regulatory environment and investment climate also play important roles in the success of technology adoption strategies and innovation efforts. In a recent paper on the Effects of Licensing Reform on Firm Innovation, I provide an empirical analysis of how the regulatory environment can be crucial for innovation. The paper focuses on regulation of a particular product market that was reformed in India in the mid 1980s and then again in early the 1990s. Before the reform all firms were required to obtain a license to establish a new factory, significantly expand capacity, start a new product line, or change location. Licensing reform meant freedom from constraints on outputs, inputs, technology usage, and location choice as well as easier entry into delicensed industries. Freedom from these constraints allowed firms to take advantage of economies of scale, more efficient input combinations, and newer technologies.
Many firms in developing countries are informal, that is they operate without registering with the government. For example, in a labor market survey of Mexico, nearly 50 percent of business owners report that their firm is not registered with the authorities.
Different explanations have been put forth to explain why firms operate informally. One view, associated with De Soto (1989), is that informal business owners are viable entrepreneurs who are being held back from registering their firm due to complex regulations. Another view, expressed for example by Tokman (1992), sees informal business owners as individuals who are trying to make a living while they search for a wage job.
I used to be partial to the De Soto view. However, a few years ago, I wrote a paper on the impact of a business registration reform in Mexico (Bruhn, 2008), expecting that I would find that the reform led informal business owners to register their business. Surprisingly, this is not what I found. The reform had positive effects, creating more registered businesses and employment, but these businesses came from wage earners setting up new businesses, and not from informal business owners registering.
“You never want a serious crisis to go to waste.”
Rahm Emanuel, former White House Chief of Staff
Looking in the rearview mirror, the recent U.S. subprime crisis seemed to be precipitated by a cauldron of events which were embedded in the fundamental problem that credit risk management was compromised on various levels. Naturally with a few years of hindsight, academics, economists, regulators, and supervisors have all wondered how the crisis could have been adverted or at least mitigated.
In this light, the existence of information data gaps and the importance of complete, accurate and timely credit information in the financial system have become more poignant. As a result of accelerated financial innovation, the banks offered new, but opaque, vehicles for investment. This made it difficult to assess risk levels and the true extent of credit leverage. Thus, as financial institutions began to develop and issue more convoluted instruments, credit risk management became more imprecise and at times erroneous. Without proper regulatory oversight and amid highly liquid credit markets (i.e. high demand for CDOs, ABSs, etc.), it further enabled banks to loosen their lending policies and thus continue to take riskier positions. As this occurred, banking supervisors and regulators often lacked the appropriate information to readily monitor the developments unfolding in the marketplace.
Words, words, words: do they matter in finance? And, more to the point, do reports on financial stability have an impact on, say, financial stability? New research suggests that the answer is a qualified “yes”: such reports can actually have a positive link with financial stability, if they are done well. Reports that are written clearly, are consistent over time, and cover the key risks to stability are associated with more stable financial systems.
Publishing reports on financial stability has been a rapidly growing industry, with more and more central banks and other agencies around the world now publishing such reports. As of early 2012, around 80 such reports are being issued on a regular basis (Figure 1). The stated aim of most of these reports is to point out key risks and vulnerabilities to policy makers, market participants, and the public at large, and thereby ultimately helping to limit financial instability.
Figure 1. The number of countries that publish financial stability reports
Source: Čihák, Muñoz, Teh Sharifuddin, and Tintchev (2012).