Ecomomics evelopment 10th y p todaro and smith chapter 15
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Chapter 15
Finance and
Fiscal Policy for
Development
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The Role of Financial System
•
Providing payment services
•
Matching savers and investors
•
Generating/distributing information
•
Allocating credit efficiently
•
Pricing, pooling, and trading risks
•
Increasing asset liquidity
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15-2
Macroeconomic Stabilization Policy
Fiscal policy:
•
Taxation and spending actions of the government to affect employment and output
•
Expansionary: lower the income tax rate and/or increase public spending to create
jobs and income
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15-3
Macroeconomic Stabilization Policy
Monetary policy:
•
Changing the supply of money to affect interest rate, investment demand,
employment and output
•
Expansionary: increase the money supply to reduce interest rate, increase
investment demand, create jobs and income
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15-4
Requirements of Monetary
Policy
•
An independent central banking authority
•
Well organized financial market with banks and saving and loan institutions
•
Strong link between interest rate and investment demand
•
A floating exchange rate
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15-5
Role of Central Bank
•
Issue currency
•
Banker to the government
•
Banker to domestic banks
•
Regulator of domestic financial institutions
•
Operator of monetary policy
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15-6
LDC Financial Market
•
No central bank or a government-owned and managed central bank
•
Financial dualism
– Formal market: organized, but dependent financial institution, consisting of foreign
and domestic banks
– Informal market: unorganized, fragmented financial institutions, consisting of
landowners and money lenders
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15-7
LDC Financial Market
•
Weak or ineffective link between interest rate and investment demand
•
Structural inflation due to import substitution strategy
•
Fixed or pegged foreign exchange rate, giving rise to a “currency substitution”
problem
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15-8
LDC Central Banking Problems
• Public agency issuing money to cover
government deficit or finance the development
plan
• Foreign-owned commercial banks
• Informal financial markets
• Colonial heritage
• A money supply difficult to measure
• A fixed or pegged exchange rate
•Copyright
Unskilled
central
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Pearson bankers
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15-9
Emergence of Development Banks
•
Specialized public and private financial institutions providing medium- and longterm loans for the creation and expansion of industrial enterprises
•
Receive bilateral and multilateral loans from international lending agencies
•
Receive loans from domestic government
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15-10
Criticism of Development Banks
•
Excessive concentration on large-scale loans
•
Excessive concentration on financing urban-industrial development
•
Neglect of small business expansion and rural-agricultural development
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15-11
Need for Financial Liberalization
•
Many LDCs suffer from “financial repression” since their central banks control
the rate of interest, causing
– A shortage of loanable funds
– Higher interest rate charged by the informal financiers
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15-12
Financial Repression
Interest rate
r1 = Market rate
r2 = Controlled rate
r3 = Black market rate
r3
r1
Credit shortage = L1L2
r2
S
D
L1
L2
Loanable funds
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15-13
Requirements of Fiscal Policy
•
Reasonable tax rates
•
Effective tax collection agency
•
Honest tax-collectors and tax-payers
•
Balanced-budget requirement
•
Independent central bank
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15-14
LDC Fiscal Problems
•
Low level of per capita income
•
High degree of income inequality
•
Low and non-progressive individual and corporate income tax rates
•
Low property tax rate
•
Excessive foreign trade tax rates
•
High excise tax rates
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15-15
LDC Fiscal Problems
•
Ineffective tax collection agency
•
Corrupt tax collectors
•
Deficit-financing growth policy
•
Inflationary-financing growth policy
•
Mounting public debt and external debt
•
Reliance of foreign aid and foreign direct investment
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15-16
Comparative Average Levels of Tax
Revenue, 1985–1997, as % of GDP
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15-17
Comparative Composition of Tax
Revenue, 1985–1997, as % of GDP
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15-18
Public Administration Problems
•
Fragmented society due to ethnicity, religion, political affiliation, and economic class
•
Employment rather than efficiency criterion
•
Shortage of skilled administrators
•
Low salaries and inadequate benefits
•
Lack of trust and prevalence of corruption
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15-19
State-Owned Enterprises
• Large capital investment
• Public utilities, transportation and
communication systems, financial institutions,
services, natural resources, agriculture, and
manufacturing
• Contributing an average of 7-10 percent to
GDP
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Addison• Employ
30-40
percent
of the labor force
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15-20
Problems of SOEs
•
Inefficiency: employment rather than profit maximization
•
Monopoly power
•
Higher wages inducing R-U migration
•
Import-intensive ISI strategy
•
Lack of trust and prevalence of corruption
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15-21
Solution to SOCs
•
Efficiency criterion: adopt a bottom-line focus in managing public enterprises
•
Privatization: sell ownership of public enterprises to private investors
•
The Latin American and East Asian NICs have been active in the privatization of
SOCs
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15-22
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15-23
Military Spending and Development
• MDCs’ military spending is significantly
higher than that of the LDCs (i.e., $527 vs.
$200 billion)
• LDCs’ military spending share of world
military spending has risen from 8.3 percent
in 1960 to 27.5 percent in 2000
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15-24
Trends in Global Military Spending,
1960–2000 (billions of U.S. dollars)
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15-25
