25) finance sector and economic development Flashcards
The financial sector of an economy comprises different types of…
financial businesses, e.g. retail banks, investment banks, insurance companies, pension funds etc, as well as different markets, e.g. money markets, bond markets, stock markets and foreign exchange (FOREX) markets.
how can the financial sector promote development?
The organisations that make up the financial sector are potentially of critical importance to achieving economic development. Their services enable businesses, governments and other organisations to operate smoothly, take risks, grow, make profits, reinvest profits. They also help households to save, plan for the future, enjoy life etc. Think of it as like the oil needed to lubricate the engine of the economy. Therefore, the financial sector helps to shift the AD and SRAS curves to the right. This increases Real GDP in an economy. Higher RGDP should lead to higher Real GNI and, ceteris paribus, higher RNGI per capita. This should (ceteris paribus) improve HDI (development) scores.
more specific to developing countries how can the financial sector promote development?
More specific to developing countries, a better finance sector will make it easier for households and businesses to save for the future. savings provides the funds that banks need in order to make the loans that fund mortgages and business investment (I) Investment is spending by businesses on increasing or improving their capital stock; e.g. buying new equipment, buildings, vehicles; acquiring other businesses etc. Investment is really important for development as is enables new businesses to set up, existing businesses to survive and grow, all adding to employment and income levels, therefore (hopefully) improving GNI per capita.
can the finance sector not promote development?
Development is mainly a key macro-objective for developing and emerging economies- it matters less if your economy is already fully developed. The problem however, is that economies who most desperately need to develop further (developing economies), don’t have the capability to fund this through savings and investment. One reason for this is that household and business income is so low that there is no spare income to fund savings or retained profits. Consequently, unlike developed economies, there is little incentive to be part of the finance sector in many developing countries. This means that there is very little finance available to fund investment meaning limited growth in AD/SRAS, only small gains in GNI per capita, restricting the ability of governments to raise revenue via taxation, further restricting the prospects of improvements in education and health standards. So, in reality, the finance sector does not always promote development.
what is a solution to the financial sector not promoting development?
One solution to this problem is the advent of Microfinance. This is a type of banking that provides financial services to low income individuals or groups of people who would otherwise have no access to finance. Banks and financial sector organisations now use microfinance to fund small enterprises setting up in developing countries (e.g. SSA countries like Togo). This facility has greatly widened the levels of access to finance in developing countries. It has allowed households to save more, new businesses to start up and existing small businesses to survive and expand. where previously they might have failed. On the other hand, Interest rates for microfinance are high; also, schemes are often not linked to sustainable development so may only bring short-term improvements.
judgement: it depends…
The financial sector has the potential to promote economic development in developing countries. Whether they actually do so or not might depend on the incentives those countries can offer to attract financial sector organisations. This depends on their potential profitability which in turn depends on the whether the economy is starting to achieve high growth levels. The financial sector may well help turn growth into development but may not be as helpful in initiating the required growth Therefore, you could conclude that other sectors (e.g. domestic government/public sectors, foreign governments (through overseas aid) and the voluntary sector (charities, religious groups) may be more successful at promoting economic development in poor countries than the financial sector. As a developing economy evolves into an emerging economy the role of the financial sector at promoting development may become more crucial
