CONSTRAINTS ON BANK CHOICES AND FINANCIAL REPRESSION IN LESS DEVELOPED COUNTRIES
| DOI | http://doi.org/10.1111/j.1468-0084.1984.mp46004005.x |
| Published date | 01 November 1984 |
| Date | 01 November 1984 |
| Author | Anthony S. Courakis |
OXFORD BULLETIN OF ECONOMICS AND STATISTICS, 46, 4 (1984)
03054)049 $3.00
CONSTRAINTS ON BANK CHOICES AND
FINANCIAL REPRESSION IN LESS DEVELOPED
COUNTRIES
Anthony S. Courakis
I. INTRODUCTION
With regard to policy design in less developed countries (LDCs), con-
siderable attention has centred in recent years on the effects of govern-
ment-imposed constraints that in almost all such countries limit the
freedom of deposit-taking intermediaries in selecting the quantities of,
and rates on, the assets and liabilities in which they deal. Although the
particular forms that these constraints take vary across countries,1 as
does the modus operandi of policy (in the sense of deployment of each
of these constraints and other instruments of policy at each point in
time and over time), the common aim is to alter the responses of these
institutions to market stimuli in order to realize patterns of expenditure
that imply a higher level of social welfare than will be attained through
the unimpeded operation of market forces.
That quantity and rate constraints affect expenditure patterns no-
one doubts. What is a matter of dispute is whether they imply more
desirable outcomes than will obtain in their absence. In the extreme,
objections to constraints sometimes reflect reluctance to recognize even
the possibility that market failure can ever arise. More common is the
tendency to recognize the likelihood of market failure, but to fear
government failure (in the sense of political and bureaucratic criteria
crowding out both market signals and social preferences) even more.
For the most part, however, arguments against the use of such instru-
ments stress either that, with regard to the objectives that they are
meant to serve, some instruments are invariably misconceived while
others are misapplied, thus detracting from the objectives invoked to
justify their existence, or that constraints employed with some objec-
tive in mind detract from the attainment of some other objective.
With respect to capital accumulation and output growth, constraints
on bank choices are seen to reduce the volume and productivity of
investment by (a) reducing the volume of funds channelled to deposit-
See, for instance, Aghelvi et al. (1979) and Lee and Jao (1982) for South East Asian
countries; Courakis (1981, 1982) respectively for Greece and Portugal; Galbis (1979), Gaba
(1981); McKinnon (1981, 1982) and Mathieson (1982, 1983) for Latin American countries;
and Pereira Leite (1982) for some African countries.
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342 BULLETIN
taking financial intermediaries, and (b) causing a less efficient distribution
of any given volume of such funds.2
Constraints, it is argued, reduce the rate(s) payable on deposits and
thus imply a lower rate of return to wealth held in financial form. For
any given level and rate of growth of income, the effect of this is pos-
sibly to reduce the savings ratio and certainly to reduce the willingness
of the public to hold wealth in financial form. To the extent that the
former is true, capital accumulation declines. But even abstracting from
the possible negative effects on the savings ratio, in contrast to the
message commonly drawn from Keynesian and neoclassical paradigms
stressing substitution between holdings of financial assets and claims to
future streams of output (productive capital), both in terms of willing-
ness of surplus units to undertake capital investment and in ternis of
availability to deficit units of finance for such investment, 'repressed'
real rates of return on financial intermediary liabilities reduce the rate
of accumulation of productive capital.3
On this reasoning, therefore, effects on productivity of investment
apart, the direct effect of constraints on bank choices on growth is
negative. In addition, for any given rate of investment the effect of
constraints is to lower the productivity of investment.4 This is partly
because direct finance is less efficient than indirect finance, but also
because, for any given volume of funds channelled to deposit-taking
financial intermediaries, constraints on loan rates cause a less efficient
allocation of these funds by inducing banks to opt for loans to low-risk
projects that carry low (or zero) rates of value added, a process that
compounds the negative effects on growth that quantity constraints
(pre-empting resources for particular, not immediately productive, uses)
cause.In turn, the lower rate of growth that all these negative direct and
static) effects define results in a lower savings ratio (since the savings
ratio is positively related to the rate of growth of income), and thus a
lower rate of investment, and also detracts from the flow of funds avail-
able to the government and other recipients whose expenditure the
constraints aim to favour. In the extreme, the process provokes policy
responses that compound the problem, as the authorities seek to resolve
the dilemmas that the situation accentuates by increasing recourse to
inflationary finance and by reinforcing the constraints on bank choices
2Sce Gurley and Shaw (1955, 1960), Shaw (1973), McKinnon (1973, 1981), McKinnon and
Mathieson (1981), Fry (1978, 1980), Khatkhate and Coats (1980), and Courakis (1981, 1982).
For surplus umts the complementarity between demand for financial assets and cita1
investment results from indivisibilities in productive investment that imply that the hater
warrants the prior accumulation of real money balances (see McKinnon, 1973).
See Shaw (1973), McKinnon (1973), Johnson (1974), Fry (1978, 1980) and Coutakis
(1981, 1982).
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