At an Economic Forum meeting at the IMF Visitors' Center, Washington DC, on 22 June, held to mark the launch of Finance and Development: Issues and Experience, published for CEPR by Cambridge University Press, Alberto Giovannini and Joseph Stiglitz reviewed the role of financial markets in promoting economic development. Giovannini is Jerome A Chazen Professor of International Business at Columbia University, a member of the Italian Treasury Ministry's Council of Experts, Co-Director of CEPR's International Macroeconomics programme, and editor of the volume. Stiglitz is Professor of Economics at Stanford University, on leave as a Member of the US Council of Economic Advisers, and a contributor to the volume. The hospitality of the Visitors' Center and financial support for the meeting from Cambridge University Press are gratefully acknowledged. The views expressed by Giovannini and Stiglitz were their own, however, not those of the above institutions nor of CEPR.

Stiglitz began by noting that the reduction of inter-regional income disparities and the role of financial institutions in achieving this have become key policy issues in the European Community's movement towards a single market and monetary union. Although the equalization of factor prices predicted by trade theory is prevented in practice by legal and linguistic barriers which impede the movement of labour and capital across national frontiers, these do not apply to trade within individual countries. Significant regional disparities within countries nevertheless persist, which highlights the need to identify the barriers that conventional economic theories neglect. One solution would be to facilitate the labour mobility such theories assume by encouraging individuals to migrate from low- to high-income regions, but regional policy focuses instead on stimulating growth within depressed regions.

Stiglitz noted that imperfect information constitutes one major neglected barrier to the free flow of capital. Financial institutions' performance in the allocation of savings to the most productive uses and their screening and monitoring of borrowers depend critically on the quality and completeness of their information. Stiglitz maintained that information is highly localized and difficult for banks to transfer among themselves; a bank may be less likely to believe information that a competitor provides at low cost in preference to investing its own money. As a result, information about the regions and especially those that are less developed does not flow freely to financial centres, which are placed at a disadvantage in lending to them.

Regional policy cannot rely on improving financial markets alone, argued Stiglitz, since these improvements arrive slowly, and policy to support and regulate banks must be supplemented by major investment in human capital. Not everyone will benefit from Europe's financial integration, which may hurt some lagging regions, but there is clearly a range of appropriate government policies even within a monetary union which may be applied to stimulate development and promote stability.

Giovannini argued that European governments' traditional approach to eliminating `pockets of poverty' by handing out transfers tends to lead to bureaucratization of the centre and corruption at the periphery. Moreover, while promoting markets and intermediation to facilitate the free flow of mobile factors into regions in which they are scarce is naturally appealing to economists, in practice it is no more effective than transfers in reducing regional disparities. There is little evidence to support the view that capital mobility ensures the convergence of growth rates and living standards. For example, in the pre-1914 British Empire, common laws and regulations and the strict enforcement of property rights should have provided an ideal environment for capital to flow from the UK to the poorer colonies where it would secure the greatest return; in practice, the greatest investment from London flowed not to India but to the US. Results of both cross-section and time-series models indicate that opening up capital markets need not lead to an investment boom, despite increased returns. And interest rates and lending rates for comparable bank loans are higher in the Italian Mezzogiorno than in the North, even if they are made by local banks that should enjoy an informational advantage.

Turning to the regulation of financial institutions, Giovannini expressed doubt about the efficacy of government intervention: many significant risks are simply uninsurable, but governments should consider what they can do jointly with capital markets to provide insurance that currently available contracts do not provide. Nor would a return to stricter controls on capital flows prove beneficial, since inappropriate government interventions in the market-place may prove very costly. Giovannini concluded that there is no magic formula for an optimal regulatory mechanism to direct mobile capital to regions in which it will yield the greatest benefits. A properly functioning financial system is only one element in a broader range of policies to promote development, which should include infrastructural investment, the enforcement of contracts and raising skill levels and investing in human capital.