Transcript International Finance and India

Financialization and industrial
development
C. P. Chandrasekhar
Jawaharlal Nehru University
New Delhi
Finance and development
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Mainstream view: financial development and
deepening favour growth in general and
industrialization in particular because of the
multiple functions that finance performs
While there appears to be some relation
between level of development and financial
development, countries at the same level of
development can display significant differences
in the degree of financial development
Moreover much evidence recently that
financialization hinders industrial development in
many ways.
Financialization in the developing world
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Rising financial assets to GDP ratio,
increased financial intermediation, high share
of financial transactions within the financial
sector and real actors turning to finance.
Occurs after financial liberalization in DCs
Financial reform involves reshaping of
financial systems in developing countries in
the image of the ‘market-based’ systems that
emerged and evolved in the US and the UK
since the 1980s
Finance for industrialization: the
developmentalist view
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Financial policy is an instrument to further
industrial development in late industrializers:
stressed by Gerschenkron among others
Some degree of pre-emption of credit for
government spending and through imposition of
sectoral targets
Use of state banking and specialized
development banking institutions to direct credit
Regulation of interest rates to reduce
competition and keep them in line with real rates
Regulation of entry and diversification besides
prudential regulation
Financial structure, financial growth and
development
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Investment and growth
Finance and investment: finance only one of the
technologies, with others like taxation and terms
of trade adjustments available
The question was one of real resources
However, structure of output influences the
investment ratio and growth
Role of finance lies primarily in influencing
allocation of investment and composition of
output
Finance and mercantilist strategies
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For growth based on a rapid acquisition of larger
shares in segments of the world market for
manufactures, target segments have to be
identified by an agency with greater seeing
power than individual firms
That agency must also ensure an adequate flow
of cheap credit to these entities so that they can
make investments in frontline technologies and
internationally competitive scales of production,
as well as have the wherewithal to sustain
themselves during the long period when they
build goodwill.
Finance and industrial policy: components
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Moving large volumes of capital to selected
units, including capital meant to close the
shortfall in long-term finance
Using the leverage provided by this activity to
coordinate and influence investment decisions
across the industrial sector
Recognising the performance interdependence
of finance and the real sector
Choosing an appropriate institutional framework
and an appropriate regulatory structure.
Market driven finance
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Private rather than overall social returns
determine the allocation of savings and
investment
With financialization expectation of profit
rates increase
Allocation may not be in keeping with that
required to ensure a certain profile of the
pattern of production, needed to raise the
rate of saving and investment.
Outcomes
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Basic and Heavy industrial or infrastructural sectors
characterised most often by lumpy investments, long
gestation lags, and (relatively) lower profit bypassed
Given the “economy-wide externalities” associated
with such industries, inadequate investments would
constrain growth.
Inherent tendency in markets to direct credit to nonpriority and import-intensive but more profitable
sectors, to concentrate funds in the hands of a few
large players and direct savings to already welldeveloped centres of economic activity.
Financialization and banking
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A liberal banking policy is a prerequisite for
financialization since financial proliferation
requires the prime depository institutions,
which are the first port of call for a nation’s
savings, to enter and experiment with new
markets, institutions and instruments.
Means of managing risk.
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One is a growing emphasis on capital adequacy,
The second is the sharing of risk, through the
transfer of credit risk.
Sources of fragility
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Credit becomes a tradable asset that banks
(because of their credibility and reach) can
easily create and pass on for a fee
Inevitable tendency towards credit proliferation.
Creator of the credit asset is not carrying the
risk. Opaque assets.
Expanding the universe of borrowers requires
bringing a larger number of “retail borrowers”
into the credit net: borrowing to invest in
housing, to buy automobiles or durables, or just
enhance current consumption with the asset as
collateral
Consequences
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Creates a banking ethos in which there is
less willingness to lend to productive sectors
Reduced lending long-term to industrial
projects that are considered less lucrative
and more risky credit targets.
The task of closing the gap for long term
finance remains uncompleted
Lending is not broad-based or inclusive
Fragility increases
Financialization and financial fragility
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Financial markets left to themselves are
known to be prone to failure because of the
public goods characteristics of information
which agents must acquire and process
Since expected private returns increase, it
could result in a situation where marketdriven players take on unnecessary risks in
search of high returns.
Effect on investment
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Inasmuch as speculative bubbles lead to
financial crises, they squeeze liquidity, induce
distress sales of assets and result in
deflation, all of which adversely impacts on
employment and living standards.
Inasmuch as the maximum returns to
productive investment in agriculture and
manufacturing are limited, there is a limit to
what borrowers would be willing to pay to
finance such investment.
Why does this happen?
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“Tolerated” partly because of the demand side
effects of the proliferation of credit
State uses the financial system to engineer
reasonable or even creditable growth in the real
economy.
Loans finance housing investment and
consumption, on the one hand, and speculation
in stock and real estate markets on the other.
Asset price inflation that such speculation
generates magnifies the value of the wealth held
by households, encouraging them to borrow and
spend even further.
Financialization and the real sector
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Growth led by the demand not supply side,
which for a variety of reasons is not
accompanied by inflation in the prices of goods
but only in the prices of assets.
To keep this process going, credit has to go to
those who borrow beyond what their incomes
would warrant at terms they couldn’t afford
making asset price inflation the unstable anchor
to which the system is tethered.
The relationship between finance and industrial
development depends on the phase of the cycle
being observed.
Financial liberalization and fiscal policy
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Financialization results in the substitution public
sending (including debt-financed public
spending) with debt-financed private expenditure
as the principal stimulus for growth.
Undermines what has been an important
stimulus for industrial growth
Inasmuch as financial liberalization increases
the presence of financial agents in the economy,
it forces the state to adopt a deflationary stance
to appease financial interests.
Financial liberalization and monetary
policy
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Finance favours reliance on monetary policy
pursued by an “independent” central bank rather
than on fiscal policy.
Focus on inflation rather than growth or employment
targeting
Even limited deficits that occur should not be
“monetised”
Since the interest rate on such borrowing tends to
be much lower than the interest rate on borrowing
from the open market, its reduction results in a
sharp rise in the average interest rate on
government borrowing.
Conclusions
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Financialization adversely affects availability of
long term finance
Adversely affects financial broadening and
inclusion
Shifts the role of finance away from the supply
side to the demand side
Proliferates credit and risk increasing fragility
Leads to conflicts between the objectives of the
State and the financial sector
Constrains industrialization