Transcript Chapter 15 - IR-517: Politics and the Political Economy of

Chapter 15
Finance and
Fiscal Policy for
Development
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
Finance and fiscal policy for development
A financial system consists of:
• Central bank.
• Commercial banks.
• Savings and loans associations.
• Mortgage institutions.
• Credit and money markets.
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The Role of the financial system
1. Providing payment services:
• Inconvenient and risky to carry cash
• Financial system provides an alternative personal and commercial
checking and check clearing credit and debit cards.
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The Role of the financial system
2. Matching savers and investors and allocating credit
efficiently:
• Savers and investors must meet and agree on the terms of loans.
• Presence of credit markets (banks, venture capitalists, and stock
markets) facilitates this matching.
• Optimal allocation of investment funds by channeling these
resources to uses with highest expected rate of return.
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The Role of the financial system
3. Generating and distributing information:
• stock and bond prices represent the average judgment of investors
on expected profitability of a firm, based on publicly available
information.
4. Pricing, pooling, and trading risk:
• insurance markets and portfolio diversification provide protection
against financial risks (i.e. F/X fluctuations, default on loans, etc.).
5. Increasing asset liquidity:
• Easier to raise money through:
Selling your assets.
Borrowing (against your assets) via bond / stock insurance.
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The bumpy road to macroeconomic
stability.
Macroeconomic stabilization has three objectives:
• Getting inflation under control.
• Restoring fiscal balance by reducing governmental spending
raising government tax revenues.
• Eliminating the current account deficits by greater control on
exchange rates export promotion.
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The bumpy road to macroeconomic
stability.
Two key agencies:
• International Monetary Fund in charge of international private
lending.
• World Bank in charge of development assistance.
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Differences between MDC and LDC
financial systems.
In MDCs
• Financial intermediaries (central bank, savings banks, commercial
banks, etc.) mobilize private savings and efficiently allocate them
to most productive uses.
Central banks manipulate money supply to lower/raise the cost of
borrowing for the private sector (i.e. households and businesses).
Loanable funds continuously flow in and out of highly organized
and economically interdependent money and credit markets (with
minimum government interference).
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Differences between MDC and LDC
financial systems.
In LDCs
• Banks ration limited funds to most creditworthy firms while other
borrowers (i.e. small farmers, indigenous small-scale entrepreneurs
and traders, etc.) seek financing elsewhere.
Money and credit markets are highly disorganized, spatially
fragmented, and often externally dependent.
Commercial banking system lacks transparency (full disclosure of
the quality of loan portfolios).
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The Role of Central Banks
In MDCs
1.
Issuer of currency and manager of foreign reserves, print money,
distribute notes and coins, intervene in F/X markets.
2.
Banker to the government.
Provide bank deposit and borrowing facilities to the government.
3.
Banker to domestic commercial banks provide bank deposit and
borrowing facilities to the commercial banks and acts a lender of
last resort.
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The Role of Central Banks
In MDCs
4.
Regulator of domestic financial institutions ensure that financial
institutions conduct business in accordance with laws and
regulations.
5.
Operator of monetary and credit policy manipulate monetary and
credit policy instruments (i.e. money supply, discount rate, reserve
requirements, etc.) to achieve macro objectives.
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The Role of Central Banks
In LDCs
LDC financial systems are characterized by:
•
Foreign-owned commercial banks.
•
Informal and exploitive credit network.
•
A central bank that is neither independent nor effective.
•
Unskilled and inexperienced labor force.
•
High degree of political influence by government.
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The Role of Central Banks
In LDCs
Principal task is to attract domestic and foreign capital by
generating a sense of confidence in the:
Credibility of local currency as a viable and stable unit of account.
Prudence and reliability of domestic financial system.
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The role of development banking in LDC
industrial expansion.
•
1.
2.
•
Definition
Development banks are specialized public and private financial
institutions that supply medium and long-term loans for
creation / expansion of industrial enterprises.
How do they raise capital?
Bilateral and multilateral loans from national aid agencies
(i.e. USAID) or international donor agencies (i.e. World Bank).
Loans from their own governments.
Industrial Project Appraisal
Direct managerial, entrepreneurial, and promotional involvement in
the projects / enterprises they finance.
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Table 15.1: central banking institutions
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The bumpy road to macroeconomic
stability.
Macroeconomic stabilization has three objectives:
• Getting inflation under control.
• Restoring fiscal balance.
• Eliminating the current account deficits.
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Fiscal Policy for Development
Stabilization Policy
• Monetary policy by central bank deals with:
Money supply.
Discount rate.
Foreign reserves.
Reserve requirements.
• Fiscal policy by government is concerned with:
Taxation.
Government spending.
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Table 15.2: comparative average levels of
tax revenue (1985-1997), as a percentage
of GDP.
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Taxation: Direct and Indirect
Direct Taxes:
• Levied on private individuals (i.e. personal income tax), corporations
(i.e. corporate income tax), and property (i.e. property tax).
• Make up 30% of total tax revenues for LDCs.
Indirect Taxes
• Levied on purchase, sales, or trade of commodities (i.e. sales taxes,
import and export duties)
• Largest source of public revenues (70%) for LDC governments.
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Table 15.2: comparative average levels of
tax revenue (1985-1997), as a percentage
of GDP
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Fiscal Policy for Development
Two purposes of taxation in LDCs:
1. Tax concessions and other fiscal incentives to stimulate private
enterprise tax breaks to foreign investors to induce inflow of capital.
2. Mobilization of resources to finance public services, Health
education, and transport services, legal, economic, and military
institutions, direct transfers to poor, etc.
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Fiscal Policy for Development
Taxation potential depends on:
1.
2.
3.
4.
5.
Level of per capita real income
Degree of inequality in income distribution
Industrial structure of the economy and importance of different
types of activity extent of foreign share in domestic private enterprise
Social, political, and institutional setting and relative power of
different groups:
Landlords versus renting manufacturers.
Manufacturers versus labor unions.
Administrative competence, honesty, and integrity.
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Direct Taxes on Income and Property
Personal Income Tax: percentage x of income.
• Yield lower revenues as fraction of GDP in LDCs.
• Progressive income tax system (people with higher incomes pay a
larger percentage of their income in taxes) to raise revenues and
lower income inequalities.
Property Taxes: $y depending on the value of property.
• Efficient way of correcting social inequalities in countries where the
property ownership is heavily concentrated.
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Direct Taxes on Income and Property
Corporate Income Tax: percentage z of corporate profits.
Less than desired levels of revenue for LDC governments due to
provision of tax incentives and concessions:
Long periods of tax exemption:
Investment depreciation allowances (depreciation lowers taxable
profits).
Special tax write-offs.
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Indirect Taxes on Commodities
Import Duty (tariff): percentage t of sales price of imported
commodity:
Commodity tax revenues (import / export duties and excise taxes)
are the largest source of public revenues for LDC governments:
Are easy to assess and collect:
Don’t rely on individual reporting like personal / corporate income
taxes are charged at the time/location of transaction.
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Table 15.4: Trends in global military spending
(1960–2000) (billions of U.S. dollars).
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Table 15.5 World Military Expenditures,
(1994–2003) (billions of 2000 U.S. dollars)
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Table 15.6: Military and social expenditures
in developing and industrial countries (1995)
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Table 15.7: countries with the highest and
lowest expenditures on the military (2002)
(percentage of GDP)
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Table 15.7: countries with the highest and
lowest expenditures on the military (2002)
(percentage of GDP)
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