The Myth of a 'Modern' Financial System for Developing Countries

The myopic vision of IMF policies

A financial system is a structure that channels funds from agents with surplus to those with a deficit. Financial systems are crucial for the allocation of resources in a modern economy. A powerful question to ask then in the context of developing countries is what the relationship between growth and the financial system is. Does growth lead to the development of the financial sector or do financial systems create growth? What can be concluded is that there is a positive correlation between growth and financial structures. The more important debate lies in the relative contribution of banks and financial markets in stimulating growth.

The financial system can affect growth through a number of ways. These include, first by determining how much saving is lost (1- φ) and secondly through affecting the marginal efficiency of capital (A). By allocating funds towards a project (through collecting information on high yield project, etc), finance can raise A. It can also affect the saving rate. The less risk is handled by the financial system the less will the economy save, the less will be investment and hence the less will be growth and subsequently development. Development also has social and non economic ideas linked to it. The neoclassical school believes that development is a technical aspect and makes no link to social and normative aspects. This view creates substantial flaws in the models of financial systems that emerge, especially for developing countries where culture and social norms play an important role.

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