Week 7 - Finance and Development


Podcast :  Bankers and the Bottom Billion, BBC-4


In " The Theory of Economic Development", Schumpeter investigates the determinants of economic development, which is thought of as the permanent shifts out of the steady state equilibrium of the  economy. In modern theory, we could think of this as investigating the determinants of long-term growth (and innovation, in a Schumpeterian perspective). In the third chapter, "Credit and Capital", he focuses on the role of credit and the banking sector, and he writes:

"Credit is essentially the creation of purchasing power for the purpose of transferring it to the entrepreneur, but not simply the transfer of existing purchasing power. (…) By credit, entrepreneurs are given access to the social stream of goods before they have acquired the normal claim to it. Granting credit (…) means entrusting [the entrepreneur] with productive forces. It is only thus that economic development could arise from the mere circular flow in perfect equilibrium."

From this viewpoint, credit is essential to growth because it is an intermediary that can provide entrepreneurs with resources to conduct innovate activities. If entrepreneurship is essential for growth, we must analyze the functioning and limitations of the financial markets in emerging countries to assess whether they are optimally achieving their intermediation role.
What other roles does the financial sector need to achieve in the economy? Are they fulfilled in emerging markets? What solutions have been proposed to financial market failures? Are they efficient?


- Chapters 6-9 in Banerjee and Duflo (2012), Poor Economics

- Bruegel, "The global debt overhang"

- Chapters 6 (macro), 12 (micro) , and 13 (micro) in Basu, "Analytical Development Economics", MIT Press.
- Introduction and Chapter 1 in "Fertilizer use in African Agricultures". Morris, et. al, The World Bank
- Fafchamps and Quinn,  "Aspire", Journal of  Development Studies, forthcoming.
- Chapters 6 and 7 in Easterly, William (2002), The Elusive Quest for Growth, (pp: 101-138)

- Kobayashi (2015), "Public debt overhand and economic growth", Policy Research Institute, Ministry of Finance, Japan

- Krugman, Introduction of "Financing vs forgiving a debt overhang", NBER working paper 2486
- Levine, Ross (1997),  Introduction of "Financial Development and Economic Growth: Views and Agenda", Journal of Economic Literature
- Chapters 14 and 15 in Debraj Ray (1998), Development Economics, Princeton University Press


Assignment 1

From 2015's final:

"Explain how information asymmetries and the resulting market failures might account for the low level of agricultural productivity in developing countries. Is there a role for policy in correcting these market failures?"

Assignment 2

From 2013's final

"Explain why interest rates on loans to poor borrowers are so high. Why are microcredit organizations able to charge lower interest rates than informal money lenders? Should policy-makers in poor countries focus on the development of the micro-finance sector?"

Assignment 3

From 2011's final

"Foreign borrowing can be a healthy complement to domestic savings, but excessive foreign debt is a serious threat to economic growth in the long run." Discuss