Financial Sector in developing countries

The crucial role of saving in stimulating economic growth

→ Savings

→ Investment

→ Capital accumulation

→ Rising output

→ Rising incomes

→ Rising savings

Begins the process of growth and development

→ Banks loanable funds increase

→ Funds for entrepreneurs increase

→ Investment increases → liquidity increases

→ Confidence to invest increases

Firms invest into capital → accumulates overtime

→ Eventually invest into high quality capital

→ Due to technological advancements overtime

Increase in capital → PC increases → Q^2 increases → output increases if labour and capital are compliments

→ By having better machines → Labour productivity high

Output high → cyclical unemployment decreases

→ DD high → MRPL of workers high

→ Firms willing and able to pay higher wages

→ Workers go from no income to some income

→ Virtuous cycle

Incomes increase → Can now afford basic necessities

→ RDY increases to save

→ Process repeats itself

→ Investment into low quality capital

→ MPS in developing countries is low

→ Low human capital levels

→ Gap in savings in developing countries

→ Depreciates over time

→ Maybe can’t invest into high capital → no skilled labour

→ Lack of Fx reserves → Cant afford to import capital

→ Due to weak ER

→ Absolute poverty

→ May not trust their financial institution

→ Resort to hiding money in shoe box

→ May save in other countries (switzerland)

→ More financially stable institutions

→ Poorly capitalised in developing countries

→ Lack of entrepreneurs

May be illiterate → Output doesn’t increase

→ MR doesn’t increase → Income doesn’t increase

Developing countries can’t save

→ Plugged by foreign aid & overseas borrowing

Foreign Aid: Strong conditionality

Loans: National debt increases

MNCs: Repatriate profits

APS: Aim to have a high APS → bank liquidity increases

Capital output ratio

GDP growth: Savings ratio/Capital output

An amount that has to be spent on capital to produce £1 worth of national output

→ It should be low, don’t have to spend on it

Money sent home by migrant workers abroad, most often working in developed countries and repatriated to the developing country they’re from

→ Consumption increases massively

→ Remittances better than aid

→ Appreciation of foreign currency

£ to foreign currency → You get much higher supply

→ Able to afford needs → Absolute poverty reduced

→ HDI improves → They live for longer → multiplier

→ Effective demand increases → high MPC

→ Can now afford leisure → luxury items

{backwards bending supply curve}

Less likely to be cut off → working in developed

→ Fixed contracts → steady income flows

→ Historically the biggest driver of poverty reduction

→ Used in development indicators

Once you send remittances → have to demand their own currency

→ Demand for foreign currency increases

→ Can now import capital → sophisticated machinery

→ Exports decrease

→ Consumption subdued

→ Unstable

Foreign currency appreciates

Foreign consumers have to give up more

Exports decrease → Incomes increase → Worsens current account → multiplier decreases → EG decreases → HDI decreases → export led growth decreases

Remittances could just be saved instead of spent

Precautionary: Leakage → Banks poorly capitalised

→ Less liquidity in banks {HD model}

→ Developing : informal economy

Permanent income hypothesis: not sure about future

→ Remittance flow may be temporary

→ Remittances used to pay off debt

Depends on the economic cycle of the developed country

→ May lose their job if in a recession

Depends on the political cycle

→ Legal requirements may be imposed

Schemes that provides small scale projects/ loans in developing countries

→ Stimulates entrepreneurship

→ Helps employment levels

→ Absolute poverty decreases

→ AS increases → non inflationary EG

→ Multiplier → accelerator

→ Poorly regulated

→ Oversaturated

→ Leads to exploitation

→ Interest may be high → leads to defaults

High number of microfinance lenders

→ People lend beyond their capacity

→ No way they could pay it back

→ Leads to big defaults

Highly Indebted Poor Country

→ Implementation of market friendly policies (laissez faire)

→ Have to be a development of a poverty reduction strategy

(every country has to have their own plan to reduce poverty)

→ Should be a boost to private enterprise

→ Need to diversify their exports away from private commodities

Human capital development is important

→ Mobility increases → tertiary sector

→ Good labour to improve capital → MRPL higher

Improvement in physical infrastructure

→ Attracts FDI

→ Geographical mobility

→ Transportation costs decrease → helps firms flourish