Chapter 15

Finance and
Fiscal Policy for
Development

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The Role of the Financial
System
• Providing payment services
• Matching savers and investors
• Generating/distributing information
• Allocating credit efficiently
• Pricing, pooling, and trading risks
• Increasing asset liquidity

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The Bumpy Road to
Macroeconomic Stability
• Macroeconomic stabilization has three
objectives:
– Getting inflation under control
– Restoring fiscal balance by reducing
governmental spending and by raising
government tax revenues
– Eliminating the current account deficit by means
of devaluation and export promotion

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The Bumpy Road to
Macroeconomic Stability
• Differences between MDC and LDC
financial systems
– Monetary policy
– Money supply
– Who are the Keynesian economist?
– What is currency substitution?
– Currency substitution

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The Bumpy Road to
Macroeconomic Stability
• Differences between MDC and LDC
financial systems (cont’d)
– Transparency
– Organized and unorganized money market
– Financial liberalization

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The Bumpy Road to
Macroeconomic Stability
• The role of central banks:
– Issuer of currency and manager of foreign
reserves
– Banker to the government
– Banker to domestic commercial banks
– Regulator of domestic financial institutions
– Operator of monetary and credit policy

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Table 15.1 Central Banking
Institutions

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The Bumpy Road to
Macroeconomic Stability
• The role of development banking
– Development banks
• Informal finance
– Rotating savings and credit association
(ROSCAs)

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Microfinance Institutions

• What is microfinance?
• Group lending schemes

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Reforming Financial Systems

• Financial liberalization, real interest rates,

savings, and investment
– Rationing
– Financial repression

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Figure 15.1 The Effects of Interest-
Rate Ceilings on Credit Allocation

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Reforming Financial Systems

• Financial policy and the role of the state

– Stiglitz’ seven market failures:
• The public good nature of monitoring financial
institutions
• Externalities of monitoring selection, and lending
• Externalities of financial disruption
• Missing and incomplete markets

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Reforming Financial Systems

• Financial policy and the role of the state

– Stiglitz’ seven market failures (cont’d):
• Imperfect competition
• Inefficiency of competitive markets in the financial
sector
• Uninformed investors

• Debate on the role of stock markets

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Fiscal Policy for Development

• Macrostability and resource mobilization

• Taxation: direct and indirect
– Five factors of the taxation potential of a country

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Table 15.2 Comparative Average
Levels of Tax Revenue, 1985–1997, as
a Percentage of GDP

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Table 15.3 Comparative Composition
of Tax Revenue, 1985–1997, as a
Percentage of GDP

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Public Administration: The
Scarcest Resource

• Case of the Tazara railroad through

Tanzania and Zambia

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State-Owned Enterprises
(SOEs)
• Improving the performance of SOEs
• Privatization: Theory and experience

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Military Expenditures and
Economic Development

• What is military expending?

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Table 15.4 Trends in Global Military
Spending, 1960–2000 (billions of U.S.
dollars)

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Table 15.5 World Military Expenditures,
1994–2003 (billions of 2000 U.S.
dollars)

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Table 15.6 Military and Social
Expenditures in Developing and
Industrial Countries, 1995

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Table 15.7 Countries with the Highest
and Lowest Expenditures on the
Military, 2002 (% of GDP)

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Table 15.7 Countries with the Highest
and Lowest Expenditures on the
Military, 2002 (% of GDP)

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Case Study:
Chile

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Case Study: Poland

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Concepts for Review

• Central bank • Group lending schemes

• Currency board • Indirect taxes
• Currency substitution • Informal finance
• Development banks • Macroeconomic
• Direct taxes stabilization
• Financial liberalization • Microfinance
• Financial repression • Monetary policy
• Money supply

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Concepts for Review (cont’d)

• Organized money • State-owned

markets enterprises (SOEs)
• Privatization • Transparency
• Rationing • Unorganized money
• Rotating savings and markets
credit associations
(ROSCA)

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