The 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.