Financing Problems of Developing Countries

The decade of the 1970s saw major external shocks to the economies of developing countries. Oil prices increased almost threefold in real terms in 1973–4, this was followed by a 9 per cent decline in real terms in 1975–8, and an increase of over 80 per cent in 1979–80. These events in energy markets were accompanied by a marked slowing-down of the rate of growth of industrial countries — a process which had started already in 1970–71. The growth rate of industrial countries averaged 3.3 per cent a year in the 1970s, down from over 5 per cent in the 1960s; there were major variations in annual growth rates both among countries in the group and for the group as a whole. Furthermore, there was a marked acceleration in inflation in industrial countries and it became common to talk about ‘double-digit’ inflation, as well as about ‘stagflation’.

The patterns of domestic financing in developing countries are as varied as economic reality itself, one aspect of which can be expressed in terms of income difference. According to the latest data, (World Bank, 1980) the distribution of the 124 developing countries of the world in terms of the average income level was as in Table 2.1.

Financial institutions play a central role in the process of economic development, channeling consumer savings into sectors where capital is most productive. How well they perform this role determines in large part the rate and distribution of economic growth.

This paper attempts to outline an approach to economic development that aims at avoiding domestic inflationary pressures and external payments’ imbalances, while increasing the per capita consumption of certain commodities which are treated as ‘basics’. Predictably, a prior assessment of the availability of and demand for ‘basics’ emerges as the keystone of policies for balanced development. The argument is offered, however, as no more than a tentative first step toward strengthening the real economic content of policies for financial balance. Also, the aim is not so much to present a complete formal system as to assemble a few operationally related ideas. As such, the most that the paper can offer is a theoretical basis for further reflections upon a somewhat new framework for analysing an old problem.

The endemic ‘fragmentation’ of financial markets in less-developed countries (LDCs) is by now a widely documented fact.¹ The phenomenon owes its origin primarily to governmental policies which foster the development of certain ‘priority’ sectors in the economy through the liberal provision of highly subsidised bank credit to them. Since a large portion of the available supply of credit is absorbed by these sectors, only a limited volume remains available for allocation to the remaining sectors of the economy, which are perforce constrained to pay much higher rates of interest on whatever loans are provided to them. The resultant wide dispersion in interest rates charged on bank loans, simply on account of differences in the sectoral allocation of these loans, constitutes the essence of the phenomenon of financial fragmentation.

Since the term ‘public sector’ implicitly excludes centrally planned economies, this paper deals with a market economy in which the public sector comprises all levels of government and para-statal production units.

Among countries which have followed industrialisation policies based on import substitution, Argentina is probably the one which adhered to this strategy over the longest period of time. It is possible to identify an early process of import substitution during the first stages of Argentina’s economic development. Up to the Second World War industrialisation was mainly connected to the ups and downs of the exporting sector. The war forced Argentina to develop a much more diversified industry while the economic policies carried out after the war were aimed at protecting this sector. With changing emphasis, this strategy lasted until 1976–7, but it failed as a growth policy. Inflation was a by-product and, as a consequence, the capital market lost its importance as a source of financing, both the private and public sectors finding subsidised bank credit a convenient substitute. Financial repression was an outstanding characteristic of the use of subsidised bank credit.

This paper provides a broad quantitative picture of recent trends in the flow of financial resources to developing countries. The period covered is the last decade. Most of the data presented are derived from the statistical reporting systems of the OECD and the statistical concepts and country categories used are also those of the OECD. The paper discusses trends in: overall resource flows (Section II); major types of resource flows (Section III); resource flows to different groups of developing countries (Section IV); financial terms of resource flows (Section V); geographic origin of resource flows (Section VI); government policies for resource flows (Section VII).

For some time now the problems of economic development and the way it can be financed have been very much to the fore, not only for policy-makers and students of economic growth and development but also for members of the world financial community. The increasing importance of these problems in recent years has been evidenced by the attention given to them both in policy formulation and implementation, as well as in the enormous flow of articles in learned journals, books and semi-official and official reports examining the issued involved.

Chile from 1974 to the present is one of the few recent examples of a sustained economic liberalisation; fiscal, exchange-rate and monetary policies were manipulated more or less correctly (with the possible exception of wage indexing) to secure free trade, an unrestricted domestic capital market, rapid real growth and a stable currency.

The increases in oil prices in 1973–4 and 1979 led to a large body of literature, attempting to trace and understand their effects on the world economy. Frequently the analysis focused on the cost effects of higher-priced energy, with little attention given to the macroeconomic effects of the redistribution of world income and of the emergence of oil-surplus funds.

One of the most striking differences between the developing and the industrial countries involves the structures of their financial systems. As per capita incomes increase, financial structures expand rapidly. Thus, in the developing countries, the ratio of money to national income ranges from 10 per cent at low levels of per capita income to 30 per cent at higher levels. Similarly, the ratios of financial assets to national income and of indirect finance to direct finance are also significantly higher in the industrial countries than in the developing ones. The counterpart to a modest financial structure in countries with low levels of per capita income is extensive reliance on self-finance. Increases in these ratios, as per capita incomes increase, are associated with changes in the institutional financial structure; banks and non-bank financial intermediaries are relatively more important in the economies of the industrial countries. Moreover, the facilities for trading in various risks, including various business risks, are much more comprehensive in the industrial countries than in the developing ones.

The capacity of a country to incur debts depends, as it does for a private enterprise, on whether or not it has at its disposal profitable investment opportunities which could at least meet the interest rate demanded on the international capital market. It is obvious that the country will only then receive a loan if potential creditors are convinced that such investment opportunities exist.

The topic assigned to me is potentially vast. Of the many ways of cutting it down, I have thought it most interesting to choose an impressionistic one: namely, to address a few points which seemed particularly interesting from a policy point of view. There is some empirical evidence (particularly relating to ‘developing countries’), but much of the discussion is merely taxonomic. There are, consequently, no firm conclusions. It does not appear, however, that either the exchange-rate system or the exchange rate is a particularly apt instrument for stimulating capital flows and financing development.