Development Finance

Instructor: Bisrat Gebru (Assistant Professor)

 UNIT ONE
INTRODUCTION

Section One
The role of the modern state in the
context of structural adjustment programs
 The Role…Under SAP
 In the post-1970s period many developing countries
faced two major problems in their economies.
• Internal imbalance: manifested in the form of inflation
and low capacity utilization
• External imbalance: characterized by lack of forex

 To tackle these problems the governments follow two

methods of stabilization programs.
• Expenditure switching: involve exchange rate
devaluation and price liberalization
• Expenditure reducing: reducing the public sector
deficit.
 The Role…Under SAP
Under the context of SAP, the governments of
these developing countries were forced to
have limited role, limited to:
• Macroeconomic Management : the budgetary
position of the government and exchange rate
• Provision of Regulatory and Promotional
Framework
• Human Capital and Infrastructure Development
• Protection of the Poor and Vulnerable Sections
of the Society
Section Two: The Economic Rationale
and Functions of the Modern
State/Government
Market Failure and the Economic
Functions of Government
 Economic Rationale and Functions of
the modern state
Allocative Function of the State
a) Property rights: right of private property
ownership
b) Common property resources
c) Positional goods
d) Public goods: characterized
by------------------------------
 Economic Rationale and Functions of
the modern state
Characteristics of Public Goods
• Non-excludability
• Non-rivalness
• Non-rejectable
• Public goods cannot be sold
 Economic Rationale and Functions of
the modern state
Distributive Function of the state
• Progressive taxation
• Subsidies to the poor section of the society
• Provision of public goods such as education,
health and housing services which are usually
termed as ‘merit goods’.
 Economic Rationale and Functions of
the modern state
Regulatory Function of the state
The government has to regulate the decisions
of producers and consumers thereby reducing
monopoly elements and externalities. E.g. Fair
trading and monopolies commission, anti-
pollution regulation, etc.
 Economic Rationale and Functions of
the modern state
• There are three major problems regarding the
regulatory functions of the state:
 ‘who regulates the regulator?’
 Regulatory functions of the government tend to
favor big businessmen. Big companies gain
control over the regulatory agencies and small
and disorganized firms are ignored.
 Through time, regulatory activities become
regular and routine- become predictable & easy
to evade
 Economic Rationale and Functions of
the modern state
Stabilization Function of the
State
• Instability in the economy arises mainly due to
imbalance among saving, investment and
consumption; and discrepancy between
demand and supply
 Economic Rationale and Functions of
the modern state
• Monetary, fiscal, public expenditure and
exchange rate policies are the major areas
where the government has stabilizing role.
• Another major area of stabilizing role is
insurance as far as the issue of social security
is concerned. In this regard, the government
has to provide insurances like unemployment
fee, health insurance and pensions.
 Section Three: The Concept and
Concerns of Public/Development
Finance
Public/Development Finance Defined
 Public finance can be understood as a practice and as an
area of study.
 As a practice it is a planned action of the government in
financing public sector activities. In this sense it involves
 Identifying the public activities of the government
 Identifying and mobilizing the necessary resources to
perform these public activities
 Spending the resources in a planned manner, and
 Evaluating and investigating the legality and
appropriateness of such public spending
 Concept and Concerns of
Public/Development Finance
As an area of study, public finance
systematically studies financial matters of
government activities such as government
revenue and expenditure.
Section Four: The Growth of Financial
Systems from Financial Repression to
Financial Liberalization

• The financial system approach before the

1970s was financial repression.
• The financial sector was considered as being
very small and was not developed.
From Financial Repression to Financial
Liberalization
System of financial repression was
characterized by the following problems:
o Low interest rate which was artificial
o Barrier to entry in the banking and financial
sector
o Lack of competition in the banking and the
insurance sectors – controls that inhibited the
growth of the financial sector
o High reserves requirement
From Financial Repression to Financial
Liberalization
o Financial institutions were not running from a
business perspective and this resulted in lack
of innovation in the institutions
o The insurance sector was generally neglected
o Fragmentation of the credit market
o In the credit programs lending was not based
on market criteria that credit programs were
provided to borrowers who are preferred by
government
From Financial Repression to Financial
Liberalization
o Under financial repression it was difficult to
issue small loans such as loan to farmers and
microcredit, and this excludes a large number
of potential borrowers
o Loans were directed to projects and
technologies which were inappropriate
From Financial Repression to Financial
Liberalization
• Financial repression had the following
negative consequences on the financial sector
and the whole economies of the countries
that followed this system:
The rate of growth in the sector was very low
Most of the countries which followed financial
repression had balance of payment problem
From Financial Repression to Financial
Liberalization
• After the 1970s, for most African countries
financial liberalization which is also called
financial deepening, was imposed by the World
Bank & IMF under their two programs i.e.
Structural Adjustment Lending (SAL) and
Structural Adjustment Program (SAP).
• Under financial liberalization the financial sector
is considered proportionally large sector & it
grows faster than other sectors. Financial
liberalization lays the way to smooth functioning
of the financial sector.
From Financial Repression to Financial
Liberalization
• The basic features of financial liberalization are:
 abolishing interest rate control
 lowering restrictions to entry in to the banking
sector
 discontinuing government control of the
allocation of credit
 stimulating the development of securities market
 liberalization of the foreign exchange
 attention is given to small loans – microcredit