World GDP Growth

The recent financial crisis and world recession has brought to the forefront research that looks into how deep the recession is relative to how developed the financial markets are. As a simple exposition, Figure 1 displays growth rates of aggregated income quintiles from high to low income. The precipitous drop in late 2006 in GDP growth rates largely displays how much of a drop the world's markets took. The anomaly of these drops is that the poorer the countries are, the less GDP growth dropped with the wealthiest countries actually having negative growth for a period of time. Why might this be? My explanation for this is simply that this world recession was derived from a financial crisis and poor countries do not have highly developed financial markets.

Figure 1: World GDP Growth. Source: World Bank and Chase DeHan

There is significant research on the "finance-growth nexus" where higher levels of financial development are directly correlated to a higher GDP per capita. However, this research is somewhat misleading as a country may get rich before developing their financial markets, rather than developing financial markets for increased growth (for a detailed survey of the literature see Ang 2008). What can be seen from the recent financial crisis is that growth rates were in the same range for rich and poor countries until they began to diverge in the early 2000s, but when large financial crises emerge, those without large amounts of exposure to those markets will fare the storm better. Well-functioning financial markets can be beneficial to growth, but there exists a point where financial markets exceed their societal benefits. While this is a simplistic examination of the subject, it is interesting to note that countries with less developed financial markets did not suffer as deep of a recession.