Comments on “State-Owned Banks: Do They Promote or Depress Financial Development and Economic Growth?” Dani Rodrik February 25, 2005

New(ish) cross-national evidence Regressing private sector credit growth or economic growth on state ownership of banks yields negative coefficient on state ownership The relationship is not very strong or robust… … but it is almost always negative Therefore, evidence of negative impact is weaker than previously thought, but still no evidence of positive impact.

What do we make of these results? Theory suggests state ownership of banks responds to –market imperfections, or –political motives Neither is directly observable Problem not so much omitted variables, as endogeneity due to one motive or another (or both) –so introducing rule-of-law or other policy variables does not solve problem With such endogeneity, interpretation of results quite problematic (as I will show)

A key problem : Under reasonable formulations of the two motives stated above (market-failures versus political) –the cross-national association between state banks and economic performance should be always negative –this is true regardless of which motive is dominant in practice –and, in particular, even if governments maximize social welfare and state banks serve a useful purpose, we will not get a positive association between state banks and economic performance So a more correct interpretation of the cross-national evidence would be that “it is uninformative” (not just that “it is weak”). Here is a simple model to see why

IV might solve the problem But need the instrument to satisfy both the exogeneity and the exclusion conditions SOE share of the economy not appropriate as instrument, since presumably it responds to the same motives as state banks do. Need different empirical strategies

So d o state banks promote or depress financial development and economic growth? We don’t know No need for anyone to alter their priors on the basis of the cross-national work to date.