Finance for development

  • Financial system and economic devp: fin system: demand for fin services comes from activities of nonfin firms(real sector), Monetary policy in dev: regulate economic activity and inflation,
  • ↑ supply $ -> ↑ loanable funds -> more investments + ↓ i/r
  • Why dev different? They have highly organized, economically interdependent and efficient functioning(spatially fragmented) money and credit markets. Consistency&uniformity in i/r across different sectors®ions
  • Constrained by the openess of their economies. (pegging of currencies to USD + have to trade in well accepted currency) (impossible trilemma of free capital flow/fixed exchange rates/soveriegn monetary policy)
  • Central bank conducts banking (to govt/commerical banks)/regulatory(fin institutions)/supervisory functions(operator of monetary and credit policy) Economic (no provision of direct credit to govt) & Political autonomy (ability to select final objectives of monetary policy)
  • Development banks are specialised public and private fin institutions that supply medium and long-term funds for the creation or expansion of industrial enterprises. (Provide loans to those projects that commerical banks refuse)
  • Criticisms: excessive concentration on large-scale loans, need to focus on small entrepreneurs since they are excluded from access to credit at reasonable i/r.
  • Informal & Microfinance : Why? No profit to be made for commerical banks by making small loans, informal borroweres also don’t have necessary collateral to secure formal sector loans. Rotating savings and credit associations( ROSCAs): a group who collects a fixed amount of savings from each member then funds reallocated to one member randomly interest free.  Lending rates > Deposit rates
  • Characteristics: Extreme variability of i/r, those who make larger loans pay lower rates, credit limit is proportional to borrower net worth, rates of defaults are low
  • Model:
  • Motivation? Availability of credit is a binding constraint for microenterprise development. Microfinance: It is the supply of credit, saving vehicles and other basic financial services made available to poor and vulnerable people who might otherwise have no access to them or could borrow only on highly unfavourable terms. MFIs: Specialise in delivering these services, in various ways and according to their own institutional rules. (e.g. a commerical bank can also be a MFIs as long as they provide credit to the poor)
  • Group lending schemes: A group of potential borrowers form an association to borrow funds from a commercial bank, a government development bank -> lower rates
  • With at least implicit joint liability, group members have a vested interest in the success of the enterprise and therefore exert strong peer pressure on borrowing members to repay on time.
  • Pros Joint liability: Reduce adverse selection(distinguishing creditworthy borrowers) & moral hazard(encouraging diligent efforts + discourage absconding/faking bankruptcy due to social pressures) Cons: Low flexibility, loss of capital due to factors beyond control(natural disasters), peer pressure to untake excessively risk averse activities.
  • Targeting woman borrowers in microfinancing-> decrease incentive to default without even actual joint liability due to intrinisic characteristics of woman.
  • Subsidies and MFI (Inefficient use of govt funds?) Microfinance Plus: using availability of credit may act as a medium to get them enrolled in health and education programs.
  • Limitations: microfinance is necessary but not sufficient, but it needs to be complemented with other growth.
  • Pop Growth: (Hidden momentum)Even after a decline in birthrates to replacement levels, population growth continues because of a large young population that widens the potential parent base. Implication: population will not stabilize until after a couple of generations. High birth rates cannot be altered overnight. Leads to demographic dividend, working class pop> children -> invest more in human capital
  • Demographic transition attempts to explain why all contemporary developed nations have more or less passed through the same three stages of modern population history. I: High BR and DR, II: Continued high BR, falling DR, III: Falling BR & DR eventually stabilizing. BRs in developing countries still much higher currently.
  • Malthusian Pop trap: Pop grows at geometric while food supply grows linearly. Inevitable that a country will reach lower levels of living in the long run on the current levels of BR. Technogical innovation can be a way out.
  • Model?
  • Assumption of increase in per capita income stimulates pop growth does not hold irl, not the primary determinant.
  • Household theory of fertility: Household income, net $ of children, relative prices of goods, strength of tastes for goods relative to children. 
  • Model?
  • When ↑ in the education of women, ↑ in female non-agricultural wage employment opportunities,↑ family income levels, reduction in infant mortality, development of social security safety nets for old age outside of the extended family network-> falling BR
  • High fertility is not a singular causal factor in low standard of livings but it is an intensifier/multipier of existing problems. Some counterarguments: Underdevl is the real problem, with economic progress and social mechanism, auto regulation of pop growth & distribution. / False issue deliberately contrived by rich countries to stifle developinf countries in a dependent condition. / It is actually desirable -> market fundamentalism -> free markets adjust to scarcities created by issue -> Drive up prices and signal need for new cost saving production tech. / Extremist argument of urgent pop decline needed through compulsory sterilization/ ???? − ???? = ????( ???? − ???? )+ t, y=GNI growth, ????= labour force growth, k=capital stock growth, ????=capital elasticity of output
  • Rate of growth LHS(per capital income) = Rate of growth (Capital Labour ratio) + tech. Without tech, ↑rate of pop growth, more rapid of k needed. ↑Savings and investment to ~ income/pax
  • Migration: Agglomeration economies: Urbanisation vs localization -> saving on firm to consumer/firm transportation/ Firm benefit from knowledge spillovers/Consumer benefit from urban amentities. The rise of Industrial Districts
  • Cons: Congestion cost + More extensive (expensive) capital and infrastructure are required in urban areas+differing efficient scales for different industrial specialisations imply different city sizes.
  • Internal migration disproportionately increases the growth rate of urban job seekers relative to the urban pop growth, Urban job creation is generally more difficult and costly to accomplish
  • Harris Todaro Model: Migration is rationaldespite high urban unemployment, depends on E(x) rather than actual differentials. Potential migrants compare present value of urban expected income over planning horizon vs cost of migration+ average rural income.
  • Model?
  • Policy implications: Reduction of urban bias/Urban job creation is not sufficient(leads to induced migration)/Curtailing public investment in higher education to prevent Indiscriminate educational expansion/Wage subsidies and scarcity factor pricing can be counterproductive/Programs of integrated rural development should be encouraged(equal emphasis on demand&supply policies)