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Development finance is a subset of economics comprising hypotheses and practices on how to efficiently allocate resources towards economic and social transformation (development) of entire nations. It was born out of the challenge to promote the rapid economic transformation (development) of newly independently nations, and to reconstruct former industrial economies destroyed, physically and economically, by the two great wars of the twentieth century. For that, governments and multilateral institutions, initially embraced a policy view that governments should have an important role in promoting finance for such transformational activities—a period that have been coined as “financial repression” by its later critics. These policies included building dedicated domestic and international finance institutions, controlling international financial flows, and shaping credit conditions within national borders. From the 1970s, the pendulum turned completely on both academic and policy fronts: the view became that government activism was to be blamed for the very problems that it had been set to overcome. That is, financial repression not only resulted in inefficient allocation of existing resources but also had long-term consequences of deterring financial development and leading to other poor economic and social performance. This perspective prevailed throughout the 1980s and 2000s, and only recently, in view of the 2008–09 North Atlantic financial crisis, has been questioned. This chapter critically analyses these two periods of development finance theory and practice in the postwar period. This chapter critically analyses these two periods of development finance theory and practice in the postwar period and briefly discusses the evolution of the policy debate after the 2008–09 North Atlantic financial crisis.
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Actually, Walter Bagehot, in 1837, had already argued that the financial system had played a critical role in igniting industrialization in England, facilitating the mobilization of capital, and that better mobilization of savings could improve resource allocation and boost technological innovation. See Bagehot ( 1873).
“The entrepreneur when he decides to invest has to be satisfied on two points: firstly, that he can obtain sufficient short-term finance during the period of producing the investment; and secondly, that he can eventually fund his short-term obligations by a long-term issue on satisfactory conditions” (Keynes 1937, p. 664, emphasis added).
For a discussion of the forces responsible for the expanding international flows of trade, labor and capital in the years 1820–1913 and the impacts of the World Wars (emphasizing the consequences of the replacement of the United Kingdom by the United States in the working of the international economy), see Kenwood and Lougheed ( 1999).
For a survey of the Pioneers (made by the authors themselves), see Bauer et al. ( 1984).
The definition of Development Banks varies among authors. According to Aghion ( 1999, p. 85), the oldest government-sponsored institution created to promote development is Societé Géneral pour Favoriser L’Industrie National (Netherlands, 1822). By almost the same time, many public commercial banks were created in Europe that also pursued development goals. This was the case, for example, of T. C Ziraat Bankast (Turkey, 1863), that operated with “Homeland Funds” for supporting farmers. In the case of Banco de La Republica Oriental del Uruguay (1896) and Banco de La Nación (Argentina, 1891), although they were commercial banks, they also played very important roles for financing agriculture and, as so, promoting national and regional development. Concerning the promotion of industry, many public financial institutions were created in the beginning of the twentieth century: Societé National de Credit a L’Industrie (Belgium, 1919), Industrial Mortgage Bank in Finland (1928), Industrial Mortgage Institute in Hungary (1928), Istituto per la Ricostruzione Industriale (Italy, 1933). In Latin America, the first strict development banks were Mexico’s Nacional Financiera (1934), Chile’s Corporación de Fomento de la Producción Chile (CORFO) (1939), and Colombia’a Instituto de Fomento Industrial (1940).
See, in particular, Prebisch ( 1949).
In the H-D model, there is no endogenous mechanism of adjustment between guaranteed and natural growth rates, because the product capital ratio is considered exogenous and constant. Thus, growth can be “locked” at a low level for a long period of time—hence H-D is usually considered a Keynesian model (Hermann 2002, p. 44).
For example, exchange rates could be sold cheaper than market rates, by the government, for a specific type of imports according to national priorities.
As Amsden ( 2001, p. 21) observed: “In the immediate postwar years, to not intervene would have seemed strange … and government share in gross investment attained high levels”. For a comparison of the share of public investments in gross domestic capital formation in selected LAC and Asian countries, see Amsden (ibid. idem., p. 23).
For instance, the shares of Development Banks in total manufacturing investment in 1970 were 11.0% in Brazil (BNDES), 7.6% in India (all Development Banks), 44.7% in Korea (Korean Development Bank) and 35.5% in Mexico (NAFINSA) (Amsden 2001, Table 6.4, p. 131). In Chile, CORFO created and played an important role in the main Chilean public companies, including the production and distribution of electricity, steel, sugarcane processing, aircraft, oil extraction, telecommunications, forestry and paper and pulp sector. In Colombia, the Industrial Development Institute was responsible for a large part of the financing of machinery and equipment, while in Mexico Nafinsa infrastructure represented 68% of its portfolio in the period 1963–1970 (Moreno-Brid et al. 2018, p. 115).
In Mexico, in 1961, 57.7% of total resources to the national development system came from foreign loans. The Industrial Finance Corporation of Thailand borrowed from the World Bank and the Korea Development Bank by issuing industrial finance debentures (brought mainly by other state banks), and by inducing foreign capital, and attracting savings deposits (Amsden 2001). Other than Development Banks, States could also provide loans indirectly through many channels. The provision of liquidity support guarantees for private banks involved in funding development projects could obviate the risks to which such banks were exposed. Monetary policy instruments, such as differentiated reserve ratios for banks that destined resources to favored projects or sectors, were commonly used in Latin America.
In fact, Korean government did adhere to the idea of interest rate reform. However, the financial reforms were only half done and the government never adopted a liberal financial orientation. On the contrary, first, all the banks were nationalized and the Korean financial system remained under strict government control at least until the beginning of the 1980s. Also, demand deposits were left out of the reform, and increases in lending rates were selective, excluding such sectors as export, agriculture and various categories of loans. See Woo ( 1991) and Castro ( 2006).
The World Bank ( 1987, p. 78) defines “Outward Oriented Model” as a situation where trade and industrial policies do not discriminate between the domestic market and exports, or between domestic or external purchases of goods and services. In contrast, an “inward-oriented” strategy is one in which there is a bias that favors local industry rather than exports. See also Bradford ( 1990, p. 34).
For the “state-led” case studies literature, that defends the large role played by the State in promoting development, see Johnson ( 1982) on the Japanese experience; Amsden ( 1989) on Korea’s; Wade ( 1990) on Taiwan’s; and Evans ( 1995) for a broader view, Castro ( 1994) on Brazil’s. See also World Bank ( 1993).
In some cases, even though it was still illegal in many cases, as in the case of Argentina, transference of financial resources by residents took place through black markets for foreign assets.
One should again keep in mind that, for complex reasons that cannot be exploited here, many of the financial liberalization processes one witnessed in developing countries by the end of the twentieth century coincided with the substitution of authoritarian political regimes by more liberal ones, conferring some credibility to the argument of liberalizers.
See Maddison ( 2006 p. 196 and p. 216).
To a discussion on fiscal revenue provided by financial repression, see Giovanni and Melo ( 1990).
All references in this paragraph are quoted in Waeyenberge and Bargawi ( 2016, pp. 6 and 7).
For discussing the losses versus benefits of financial liberalization, see Carvalho ( 2009) quote: Demigurç-Kunt and Detragiache (2001), Kaminsky and Schmukler (2003), Gruben, Koo and Moore (1998), Yeyati, Micco and Panizza (2007) and Wyplosz (2001).
In the case of National Economic and Social Development Bank of Brazil (BNDES), as in the case of Banco do Brazil, political resistance to its privatization was too strong for liberalization proponents to prevail. Instead, under more conservative governments, BNDES had its mission changed from directly supporting investment to supporting domestic capital markets and privatization processes, becoming more like an investment bank than a traditional development institution. When those more liberal governments were replaced, however, BNDES returned to its previous role and was expanded in size by government loans (as part of the anticyclical policy used after the 2008 financial crisis), at least until recently when it was hit by widespread economic and political crises that have shaken the Brazilian scene. In any case, in Brazil, where a large network of subnational development banks had been created during the first decades after the war, practically only BNDES, Caixa Econômica Federal, Banco do Brasil (the three major public banks) and a few other institutions of local significance were spared closure or privatization, although smaller institutions have been (re)created at the end of the 1990s, in the form of state agencies.
In the second half of the 1990s, the China Development Bank (CDB) was very dramatic, due to the Asian crisis. Delinquency rates reached 42.7% in 1997. Since 2005, according to the Bank statistics, default rates are (and remain) below 1%. See: Xu ( 2018).
For critics, see Musacchio et al. ( 2016), Frischtak et al. ( 2017), Torres and Zeidan ( 2016), Lazzarini et al. ( 2015). For a positive view on the role played by BNDES in promoting development, see Studart and Ramos ( 2018), Waeyenberge and Bargawi ( 2016), Rezende ( 2015), Mazzucato and Wray ( 2015).
However, this was not a new finding: Micco and Panizza ( 2006), using data for 119 countries for the period 1995–2002, had already showed that government-owned banks are less sensitive to business cycle fluctuations than private banks.
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- Development Finance: Theory and Practice
Fernando Cardim de Carvalho†
Lavinia Barros de Castro
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