The Welfare Economy Analysis Of Financial Systems

Financial system is defined as a whole set of ways to allocate financial resources. Financial systems direct the flow of the deposit of household sectors to the firms and allocate resources among firms. On the one hand financial systems enable the household sector to smooth the consumption fluctuations and to share the risks. On the other hand, financial systems make it possible for firms to smooth their intertemporal expenditures and to find different ways of financing. A financial system requires efficiency, stability and the reduction of fluctuation and fragility. The above functions make a good financial system.However, when we review the financial systems of different countries, we find that different countries have different financial systems that carry out their functions. In the broadest sense, we may classify financial systems into two broad categories: capital market-oriented and bank mediation-oriented. Each category of financial systems can be sub-divided into developed and underdeveloped. How do we evaluate these financial systems? Firstly, developed capital market-oriented nations as the U.S and the U.K or the developed mediation-oriented nations as France and Germany enjoy a long-term GDP growth. Further more they have an approximately resource allocation efficiency. So, as for the role of financial systems on economic growth, these two types of financial systems seem to function well. Secondly, according to classic finance economics theorems, it is hold that capital market is the idea way of resource allocation. If the conditions of Arrow—Debreu—Mackenzie model are satisfied, financial mediation can not exist. However, in reality we haven't a perfect capital market assumed in the neoclassic economics, we have transaction cost, asymmetric information, adverse selection and incomplete legal and political factors, which makes the capital marketing reality deviate from that assumed in neoclassic economics. As a result, financial mediation help to overcome the obstacles of market dysfunction and incomplete information. Thirdly, when carrying out their functions, what are the differences between capital market-oriented financial systems and financial mediation-oriented financial systems? Their ways of risk sharing are different. Capital market can solve the problems of interregion risk sharing and financial mediation can solve the problems ofintertemporal risk smoothing. The finance of firms must solve financial decision problems under the condition of the diversification of views caused by uncertainty. Different industries, for example, the emerging industry and established industry, have different degrees of diversification of views. They must choose whether to finance on capital market or finance through mediations. It 's obvious that investor with different risk preference choose differently. Or the investors may demand risk sharing and intertemporal smoothing at the same time, so the capital market and financial mediation are both necessary. The characteristics of information transformation and risks of different industries decide the different ways of the finance of the firms. Fourthly, how to evaluate the stability and fragility of financial systems when they function? What are the characteristics of the stability and fragility of different financial systems? Is it a good choice to achieve the stability of a financial system only? How to judge an optimal solution?We realize that different financial systems are justified to exist because when they function they have different characteristics, though they vary a lot Then, how the current financial systems formed and developed in different nations? The problem that the dissertation tries to solve is as follows: how do the current academics explain the evolution of the financial systems? What are the rationality and flaws of these explanations? Can this dissertation propose an explanation of the evolution financial systems and their types?After a systematic review of current literature on financial systems and capering financial systems, the author find that the general equilibrium theorem of welfare economics and the Pareto optimal theorems can better explain the evolution of the financial systems. If welfare economics theorems can explain the cause of the existence of the current financial systems, they can also deduct the future evolution trend of the financial systems and can find the path to improve the level of a nation's welfarefinancial systems-----to search a higher level of Pareto optimal. So, the following are thethree questions that the dissertation aims to answer and argue:1. Why do we use welfare economics but not other theorem to explain the cause of the existence and evolution of different financial systems?2. The welfare analysis principle of financial systems. How does economic welfare influence the choice of different types of financial systems? What are the welfare characteristics when in equilibrium?3. When applying welfare economics theorem to research China's financial systems, can we achieve a rational explanation of the current characteristics of China's financial systems? Does the financial system in China differ from the standard financial systems? What its welfare explanation and the path for the Pareto improvement?Recently, laws and finance are important theories in explain financial systems. Represented by LLSV, the research begins with the corporate governance and extends to the concentrated ownership of the listed companies and the intensity and extensity of the capital market. They find that the path for external finance varies a lot, which is commonly explained by the protection of investors. The variation of investor protection is due to the different legal origin and implementation. The innovation of LLSV lies in its effective legal perspective compared with the traditional capital market-oriented and bank -oriented perspective. Or when explain the choice of financial systems by different countries, laws provide a cause and effect relationship. However, the types of financial systems in the nations with the same law origin, in the past 20th century, do not stay constant, on the contrary, it reversed, why? Roe, as a representative of political economists, explains the structural change and the transfer of the types of the development of financial system using the political variants. The political variant is the advantage enjoyed by institutions with financial monopoly. They trade off among financial development and financial control, which results in the open and close of the capital market. The most direct cause for the political variant as the driving force and decisive factors for financial systems are as follows: an economy's welfare and its Pareto improvement. So, we may hold that the concept of welfare economy can include the legal and political explanation, thus establishing the welfare analysis as the controlling clues of the dissertation, which is also justified by logic and an extensive refinement.If we focus on the welfare analysis of the financial systems, then the important question is whether different financial systems cause great difference of the welfare of different economies? Or they are just different in their forms and have the same function? The questions introduced here is the relationship between welfare of an economy and financial systems. The dissertation analyzes the welfare of the financial systems from three perspectives.How does household sector, as the supplier of the funds, allocate their assets between capital market and financial mediation? What is the cause for their choice ofdifferent assets? Starting from the general equilibrium theorem, the dissertation research the contingency securities, Arrow security, and Arrow—Debreu—Mackenzie paradigm (ADM), and then research the deviation of the capital market from the ADM , the influence of function of the interregion risk sharing of the capital market and the intertemporal risk sharing of the financial mediation on the welfare of the household sector to find the internal cause for assets allocation.On the other hand, the welfare analysis of the firms, as the demander of the funds, when making financial decisions, is justified by the logic of the former questions. The structure of firms' finance using capital market, financial mediation and self-finance constructs the forms of assets allocation. Different ways of financing influence the welfare of firms, which is caused by the different roles, played by different financial systems in information releasing. The difference of the financial systems leads to , different ways in participating in corporate governance, which influence the welfare of the firms. The greatest differences between capital market and financial mediation lies in the current financing of the hi-tech and established industry and the principle of optimization of the welfare leads to the choice of the ways of financing.If doing further researching on the welfare of the financial systems, besides researching the welfare from the perspective of household sector and firms, we must the influence of the stability and fragility of financial systems on the system's welfare. The degree of the competition among financial mediation may influence the profitability: if the degree of competition is too high, the profit will decline, which will encouraging risk taking and result in the harm of the stability and the welfare of the financial systems. So, the optimal welfare requires adequate competition. The fragility of financial systems is defined as the assets price fluctuation caused by the liquidity shock and their influence on the financial system. Different equilibrium conditions have different influence on the welfare. The dissertation analyzed these equilibriums.To research the welfare of the standard market—oriented and intermediation— oriented types of financial systems is not the sole aim of the dissertation. We must use financial systems theorems to research the welfare of China's financial system. China keeps improving, developing and constructing its financial system to support a sustainable, speedy and stable growth in the twenty years after reform and opening policy was adopted. China always keeps developing the finance of the capital market andpromoting the efficiency and the competitiveness of the banks to improve the risk sharing and promote the efficiency of the resource allocation and the stability of its financial system. The dissertation researches positively the investors choice, firm finance and governance and the stability and fragility of China's financial system. The dissertation also explains the cause of the type of china's financial system from the welfare economics perspective. The conclusion is as follows: under the current institution and economic background, China's financial system follows a less optimal path of evolution. The principal guiding both the development of the capital market and the improvement of bank's efficiency is to improve the welfare level of the financial system. China shouldn't copy any of a standard type of financial system; on the contrary, it should take the change of external and internal environment into thorough consideration to search a higher Pareto optimal under the background of a changed equilibrium.