Financial Liberalization and Allocation of Capital: Dark Side of the Moon

Saumitra Bhaduri and Aditi Bhattacharya
Additional contact information
Aditi Bhattacharya: Madras School of Economics

Journal of Quantitative Economics, 2018, vol. 16, issue 1, No 7, 163-185

Abstract: Abstract Although it is well established that financial liberalization leads to a positive ‘quantity effect’ with higher levels of investment, it remains uncertain whether it also improves the efficacy with which such investment funds are allocated. This paper contributes to this sparely researched aspect of liberalization (‘quality effect’) by carefully examining if the financial reforms in India have led to an improvement in the allocation of resources. Since one of the premises of better allocation is that funds are channelled to firms with higher marginal returns to capital (measured by Tobin’s Q), we propose three unique measures to track the efficiency of resource allocation: (a) dispersion-based measures; (b) the allocative efficiency index; and (c) the relative value of allocation. Contrary to the prevalent assumption that financial liberalization leads to higher capital allocation efficiency, this study’s findings could not establish a direct correlation between the opening up of markets and higher allocation efficiency, except for the latter part of the reform period. Further, this paper draws attention to the greater misallocation of funds in the post-reform period, as the increase in funds availability leads to excess capacity creation in some industries without consideration of the need for concurrent return or demand. The authors of this paper recommend that any financial liberalization needs to be accompanied by the setting up of institutions for corporate control, particularly in an emerging market like India.

Keywords: Liberalization; Tobin’s Q; Allocative efficiency index; The relative value of allocation; The efficiency of capital allocation (search for similar items in EconPapers)
JEL-codes: G32 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://link.springer.com/10.1007/s40953-018-0128-5 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:spr:jqecon:v:16:y:2018:i:1:d:10.1007_s40953-018-0128-5

Ordering information: This journal article can be ordered from
http://www.springer.com/economics/journal/40953

DOI: 10.1007/s40953-018-0128-5

Access Statistics for this article

Journal of Quantitative Economics is currently edited by Dilip Nachane and P.G. Babu

More articles in Journal of Quantitative Economics from Springer, The Indian Econometric Society (TIES) Contact information at EDIRC.
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().