Can financial infrastructures foster economic development?☆
Introduction
The need to build financial infrastructures is an important feature of economies in transition, where banking practice was lost after several decades of central planning, and Less Developed Countries (LDC).1 It is often held as a precondition for economic development, as financial intermediaries facilitate transactions, allocate capital and collect savings.2 Financial infrastructures facilitate the collection of savings by banks, and channel more resources towards the modern sectors of the economy. When the financial system is rudimentary, some households may not have access to a bank or other institutions in which they could deposit savings. Moreover, a lack of confidence in the banking sector connected to failures to maintain property rights could make people wary of depositing, so that some kind of government action can lower the costs of intermediation and increase the collection of savings.3
Binswanger et al. (1993) show with the help of a panel data analysis for rural India that public infrastructures and financial intermediaries exercised a joint positive influence on agricultural investment and output and that “bank expansion is greatly facilitated by government investment in roads and regulated markets which enhance the liquidity position of farmers and reduce transaction costs of both banks and farmers”.4
A distinction can be made between general purpose public infrastructures, such as roads and telecommunications, used for many transactions other than financial ones, and what can be called financial infrastructures. The role of these infrastructures for economic development is emphasized in this paper. The services provided by these financial infrastructures lower the costs of financial transactions. Many public goods are specific to the financial sector. First of all, there is a specific knowledge in both private and central banking practice (project appraisal, accounting, credit scoring, …). It requires the education of banks employees as well as the education of depositors.5 Second, there exist a specific and common capital and technology shared between banks for transactions purpose and the efficient working of the payment system.6 Third, a specific authority must enforce banking laws and regulation in order to preserve the stability of property rights of banks and depositors' assets and provide other services (supervision and coordination of the payment system…).7
This paper presents a model of endogenous growth with local banking monopolies. Banks face spatial competition on the deposit market as in Salop's (1979) model, but depositors' transaction costs and banks' intermediation costs are endogenous and depend on financial infrastructures. We characterize financial infrastructures as a means to explicitly reduce transaction costs of depositors or fixed intermediation costs of banks and thus to foster saving. An increase in the number of banks will positively affect the level of aggregate savings.8 Public intervention will determine the amount of financial infrastructures in the economy and thus indirectly influence the extent of imperfect competition in the banking sector, which will in turn affect economic growth and consumer welfare.9 An adequate amount of financial infrastructures may also allow a country to take off from a poverty trap.
The paper follows the following progression. Section 2 describes the behaviour of firms, of households and of a banking oligopoly. Section 3 provides the equilibrium growth rate for given financial infrastructures. Section 4 computes the level of financial infrastructures that maximizes the growth rate or the aggregate welfare. Conclusion and possible extensions of the model are dealt with in Section 5.
Section snippets
Firms
We consider a constant returns to scale production function for the private sector with capital K and labour N in a Cobb–Douglas specification.10 Capital is entirely depreciated in one period.11
Growth
As Barro (1990), we assumed that the government runs a balanced budget financed by a proportional tax at rate τ on the aggregate of gross output.From this equation and the production function, we get an expression for G1:Therefore, the production function can be written as:
It follows that the share of financial infrastructure devoted to fixed investment in banking with respect to capital is a linear function of the tax rate τ3θ3=G3/Kt=(τGP)(1−α)/αA1/ατ3.
Financial infrastructures and banks fixed intermediation costs
The welfare maximising tax rate is given by:with gτ3=∂g/∂τ3 and rτ3c=∂rc/∂τ3. It is therefore necessary to compute gτ3. From Eq. (22), one obtains:
A decrease in fixed intermediation costs due to financial infrastructures increases growth through an increase in the amount of savings due to a rise in the number of depositors for each bank and an increase in the number of
Conclusion
This paper deals with the effect of financial infrastructures on economic growth, with financial intermediaries as local monopolies due to horizontal differentiation. Financial infrastructures decrease depositors transaction costs or fixed intermediation costs. They change consumer welfare through an increase of the proximity of financial services, which in turn increases savings and endogenous growth. Endogenous growth models have mostly stressed the effect of public capital directly inside
Acknowledgements
We thank without implicating Ron Anderson, Jean-Paul Azam, Bernard Bensaïd, Olivier de Bandt, David de la Croix, Guy Gilbert, Michel Guillard, Toni Haniotis, Chantal Kegels and Philippe Thalmann for helpful comments. The opinions expressed in this paper do not necessarily reflect those of the Banque de France.
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Views expressed in this paper do not necessarily reflect those of institutions to which authors belong.