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Financial Liberalization

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From the perspective of economic development, provide two arguments in favour of AND two against financial liberalization?

The arguments that underpin financial liberalization are basically based on the idea that there are various kinds of financial repressions applied by central bank over financial institutions that can be harmful for development. The leading proponents for this view are represented by Mc Kinnon’s and Shaw. However they emphasize different aspect.

McKinnon argues that money holding and capital accumulation are necessary in the development process. Because the investment expenditure is always require the bigger amount and highly dependent on self-financing. Someone needs to accumulate money balances before investment. High interest is necessary to attract people to accumulate money balances, and then, this accumulated money balances will be transferred into investment when the rate of return on investment exceeds the real rate of investment. Shaw argues the importance of financial liberalization for financial deepening and the beneficial effect of high interest is to stimulate people to save and demotivate investor from investing money into inefficient (low-yielding) investment project, investor prefers to put money in industry that can serve bank interest.1

To summarize, those two arguments explain that whenever the financial repression exist in financial market it could leads to the condition namely unsatisfied demand for investment. The condition when the demand of investment cannot be fulfilled by available accumulated money.

On the contrary, the opponents of financial liberalization stem at the critical questions on the idea of liberalization supported by some empirical evidences. First critique is placed on the way the financial liberalization idea treats the bank as saving depositories that only deliver the loan into investment project once the saving accumulation is adequate. In fact, the commercial banks has an authority to create a credit under the condition that they are backed by central bank, and by then, the action of investment is not merely depend on the supply of deposit but also and strongly on the demand on investment itself. And by using this framework the supply of loan is something outside the system. Therefore this critique argues that incentives for investment is more important than incentive for saving. This view’s aligning with the keynesian and post keynesian views.

The other argument that opposes the idea of liberalization in financial sector comes from the case of Bank of Mexico studied by Fanny Warman over the period 1960-1990. It shows that there is an increase in private saving when interest rate is increased and it also shows that there is a positive flow from private saving into investment project. However, there is a negative influence of high interest rate (originally put in place to encourage saving) on investment. And this negative influence turning the net effect on investment into the other way. This empirical evidence shows that liberalization model ignores the negative effect of high interest rate on the investment in particular and generally on the economy. This situation can evoke another gloomy economic situation namely stagflation, the situation in which the inflation is high while the unemployment is also increasing. The real economic crisis is more likely to come.

The arguments that underpin financial liberalization are basically based on the idea that there are various kinds of financial repressions applied by central bank over financial institutions that can be harmful for development. The leading proponents for this view are represented by Mc Kinnon’s and Shaw. However they emphasize different aspect.

McKinnon argues that money holding and capital accumulation are necessary in the development process. Because the investment expenditure is always require the bigger amount and highly dependent on self-financing. Someone needs to accumulate money balances before investment. High interest is necessary to attract people to accumulate money balances, and then, this accumulated money balances will be transferred into investment when the rate of return on investment exceeds the real rate of investment. Shaw argues the importance of financial liberalization for financial deepening and the beneficial effect of high interest is to stimulate people to save and demotivate investor from investing money into inefficient (low-yielding) investment project, investor prefers to put money in industry that can serve bank interest.1

To summarize, those two arguments explain that whenever the financial repression exist in financial market it could leads to the condition namely unsatisfied demand for investment. The condition when the demand of investment cannot be fulfilled by available accumulated money.

On the contrary, the opponents of financial liberalization stem at the critical questions on the idea of liberalization supported by some empirical evidences. First critique is placed on the way the financial liberalization idea treats the bank as saving depositories that only deliver the loan into investment project once the saving accumulation is adequate. In fact, the commercial banks has an authority to create a credit under the condition that they are backed by central bank, and by then, the action of investment is not merely depend on the supply of deposit but also and strongly on the demand on investment itself. And by using this framework the supply of loan is something outside the system. Therefore this critique argues that incentives for investment is more important than incentive for saving. This view’s aligning with the keynesian and post keynesian views.

The other argument that opposes the idea of liberalization in financial sector comes from the case of Bank of Mexico studied by Fanny Warman over the period 1960-1990. It shows that there is an increase in private saving when interest rate is increased and it also shows that there is a positive flow from private saving into investment project. However, there is a negative influence of high interest rate (originally put in place to encourage saving) on investment. And this negative influence turning the net effect on investment into the other way. This empirical evidence shows that liberalization model ignores the negative effect of high interest rate on the investment in particular and generally on the economy. This situation can evoke another gloomy economic situation namely stagflation, the situation in which the inflation is high while the unemployment is also increasing. The real economic crisis is more likely to come.

Written by ibu didin

February 13th, 2010 at 12:55 pm