Growth, Development and Financial Markets (Anna O Krueger's Views)

Read this interesting write up by Anna O Krueger's speech (as Special Advisor to Managing Director, IMF) which talks about the ways and means to development and growth where financial markets matter throughout different stages of economic development and growth. The speech was given in Tokyo, in 2006.

Thinking about economic development has evolved over the past half century, partly in response to perceptions of poverty and theorizing about its causes (and inferring from those the presumed needed policy actions) and partly through the experience of development in countries both successful and unsuccessful. During these years, there have been a number of "fads", or virtually single causation theories, as to "the" causative factor (or, perhaps, two factors), largely in response to perceptions that development was less rapid than it should have been.

During the past decade, much of the "fad" and the emphasis has been placed on understanding the role of the financial sector, in part because earlier lessons were learned, and in part as a consequence of the financial crises of the 1990s. Understanding of the role of the financial sector has increased markedly, but research and insights continue to mount. As that has happened, some have turned to "governance issues" as "the key" to development, but lessons about the importance, and key role, of the financial sector in development have certainly been learned.

 

For countries experiencing rapid growth, development of a healthy financial sector is critical. Hence, in many emerging markets and developing countries today, emphasis must be placed (among other things) on reforms that enable improved functioning of the financial system. At early stages of development, this entails strengthening the rights of borrowers and lenders, development of a credit rating system, lowering the costs of obtaining credit (not the interest rate), and streamlining means for settlement of disputes.

The World Bank has recently provided data on a number of these phenomena across countries. It has created a scale ranging from 1 to 10 (highest) to indicate the degree to which borrowers' and creditors' rights are protected. Industrial countries generally (but not always) receive high ratings, with the US and Australia for example receiving ratings of 10 and 9 respectively. By contrast, Argentina scores 3, Mexico 2, and some countries 1 and even 0.

Provision of credit ratings, normally through private credit bureaus, is also highly variable across countries. Again, industrial countries normally score well, with coverage of most of the economy, whereas Brazil has coverage of about half the population, and Costa Rica less than 5 percent. More than half of the 55 countries surveyed had no private credit bureau coverage at all.

The cost of creating collateral for loans also varies widely. World Bank numbers estimate that it is less than 0.1 percent of per capita income in the United States and the Untied Kingdom. By way of comparison, it is 8.1 percent of per capita income in Korea, 2.7 percent in Japan, 11.7 percent in India, 20.7 percent in Nigeria, and 62.2 percent of per capita income in Morocco.

The ability to enforce contracts also matters. In most industrial countries, the time to achieve legal enforcement is around 6 months (250 days in the Untied States, 75 days in France), while in developing countries it can be much more: 591 days in Bolivia, 425 in India, and 1,000 in Poland. Clearly, inability to enforce loan obligations can itself stymie financial development.

Policy reforms entailing increasing the efficiency of bankruptcy proceedings, reducing the cost of collateral, enforcing contracts, and improving other aspects of the financial nexus are clearly important. But so, too, is the development of an efficient (and implemented) regulatory framework, and competition within the banking system. How this is achieved can vary greatly from country to country, but there is a strong presumption that the development of arms-length lending, competition within the banking system, and arrangements that permit timely enforceability of contracts clearly matter.

In Korea, reforms in many of these dimensions were undertaken in response to the crisis, and, as already indicated, growth resumed quickly and has been sustained. In some other emerging markets, reforms are proceeding, although with varying degrees of rapidity. And, as some of the numbers just mentioned indicate, there are many countries where significant improvements will need to be made in order to enable the financial system even to begin to carry out its role.

Clearly, the financial sector is not THE key to development, any more than human capital or physical capital accumulation were. Equally, however, failure to develop the financial sector can put an enormous brake on growth prospects and, indeed, if the issue is not addressed, can thwart development efforts. For countries where there is a strong commitment to growth, the lesson is clear: attention needs to be paid to financial sector issues as growth proceeds, unless it is preferred to wait for a crisis to force the necessary reforms.