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financial tsunami that has already swept over markets
in the developed world is now threatening to engulf
many developing countries, including India, as well.
And so now the dangers posed by unregulated financial
markets are amply clear even to the most diehard market
enthusiasts.
It was already known that financial liberalisation in
developing countries resulted in an increase in financial
fragility, making these economies prone to periodic
financial and currency crises. But now that such a crisis
has hit the core of capitalism, in ways that are still
unravelling and which will take a long time to play
out fully, in the industrial countries the talk is all
about nationalisation of major financial institutions
and introducing new regulation to control dodgy and
potentially risky practices
But as usual we in the developing world are late in
coming to terms with reality. This is bad news, because
financial liberalisation in developing countries has
even worse consequences, because it can retard or even
reverse the development project. There are several ways
in which this happens. In addition to creating the conditions
for greater fragility, financial liberalisation generates
a bias towards deflationary macroeconomic policies and
forces the state to adopt a deflationary stance to appease
financial interests. It also reduces the ability of
the state to direct resources towards developmental
goals.
To begin with, the need to attract internationally mobile
capital means that there are limits to the possibilities
of enhancing taxation, especially on capital. Typically,
prior or simultaneous trade liberalization has already
reduced the indirect tax revenues of states undertaking
financial liberalisation, and so tax-GDP ratios often
deteriorate in the wake of such liberalization. This
then imposes limits on government spending, since finance
capital is generally opposed to large fiscal deficits.
This not only affects the possibilities for countercyclical
macroeconomic stances of the state but also reduces
the developmental or growth-oriented activities of the
government.
These tendencies affect real investment in two ways.
First, if speculative bubbles lead to financial crises,
they squeeze liquidity and increase costs for current
transactions, result in distress sales of assets and
deflation that adversely impact on employment and living
standards. Second, 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. Thus,
despite the fact that social returns to agricultural
and manufacturing investment are higher than that for
stocks and real estate, and despite the contribution
that such investment can make to growth and poverty
alleviation, credit at the required rate may not be
available.
Not surprisingly, therefore, most late industrializing
countries created strongly regulated and even predominantly
state-controlled financial markets aimed at mobilizing
savings and using the intermediary function to influence
the size and structure of investment. This they did
through directed credit policies and differential interest
rates, and the provision of investment support to the
nascent industrial class in the form of equity, credit,
and low interest rates. They created development banks
with the mandate to provide long-term credit at terms
that render such investment sustainable.
Liberalisation can dismantle the very financial structures
that are crucial for economic growth. While the relationship
between financial structure, financial growth and overall
economic development is complex, the basic issue of
financing for development is really a question of mobilising
or creating real resources. When the financial sector
is left unregulated or covered by a minimum of regulation,
market signals determine the allocation of investible
resources and therefore the demand for and the allocation
of savings intermediated by financial enterprises. This
aggravates the inherent tendency in markets to direct
credit to non-priority and import-intensive but more
profitable sectors, to concentrate investible funds
in the hands of a few large players and to direct savings
to already well-developed centres of economic activity.
The socially necessary role of financial intermediation
therefore becomes muted. This certainly affects employment-intensive
sectors such as agriculture and small-scale enterprises,
where the transaction costs of lending tend to be high,
risks are many and collateral not easy to ensure. The
agrarian crisis in most parts of the developing world
is at least partly, and often substantially, related
to the decline in the access of peasant farmers to institutional
finance, which is the direct result of financial liberalisation.
Measures which have reduced directed credit towards
farmers and small producers have contributed to rising
costs, greater difficulty of accessing necessary working
capital for cultivation and other activities, and reduced
the economic viability of cultivation, thereby adding
directly to rural distress. In India, for example, there
is strong evidence that the deep crisis of the cultivating
community, which has been associated with to a proliferation
of farmers’ suicides and other evidence of distress
such as mass migrations and even hunger deaths in different
parts of rural India, has been related to the decline
of institutional credit, which has forced farmers to
turn to private moneylenders and involved them once
more in interlinked transactions to their substantial
detriment.
By dismantling these structures, financial liberalisation
destroys an important instrument that historically evolved
in late industrialisers to deal with the difficulties
of ensuring growth through the diversification of production
structures that international inequality generates.
This implies that financial liberalisation is likely
to have depressing effects on growth and sustained development,
even beyond the deflationary bias in public spending.
So in countries like India, it is even more important
to have a controlled and regulated financial sector
than it is in developed countries. Yet the Finance Minister
is trying to meet the current financial crisis by doing
exactly the opposite: more deregulation and more incentives
for private finance! The tragedy is that such a strategy
will be far more detrimental for the economy than even
the real possibility of financial crisis: they can have
long-term damaging consequences for the development
project as a whole.
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