The Role of Finance in the Market Economy: Lessons for Economic Growth and Development

THE ROLE OF FINANCE IN THE ___ MARKETECONOMY: LESSONSFOR ECONOMIC GROWTH AND DEVELOPMENT WilhelmHankel öince the decline ofcommunism, establishing market economies has become imperative for the less developed countries ofthe noncapitalist world. Yet the record ofboth diird-world and the former second-world countries in reforming their economies is disappointing. The majority ofthird-world countries suffer still from a lack of self-sustained and self-financed development They remain poor, under-industrialized, and with high rates of unemployment In the former Soviet-bloc countries die impact of the transition from planned to market-oriented economies has been mosdy negative: painful losses in real wealth and income; high unemployment inflation, social unrest and inequality; and outbursts ofcriminality. Reform in the sense of"Westernization" has been discredited by starvation, social disparity, and diminishing life chances, and die term "market economy" has become synonymous with "mafia." One of the main factors behind diese failures is the wide lack of understanding about aie role and function ofdie financial sector in nie process of social change and economic development1 This lapse is astonishing. Analysts and politicians should have noticed diat banks in diird-world and former Soviet-bloc countries are not playing a role in the economic transition or in financing economic development. Money for these purposes comes either 1 Wilhelm Hankel, "Capital Markets and Financial Institutions in the Development Process," in Economics (Tübingen), vol. 44 (1991): 34-65. Wilhelm Hankel is professor and chairman ofmonetary and development economics at J.W. Goethe University in Frankfurt am Main. He has served as deputy undersecretary for monetary affairs in the federal government in Bonn and president of the State Bank of Hessia. He is currendy establishing a center for banking education in Russia funded by the European Community. 47 48SAIS ReviewSUMMER-FALL 1994 from abroad, such as development aid or capital imports, or from the state, through budget oudays or money printing, or both. Neither the developing world nor the former communist countries can rely on their own financial sectors. These countries lack financial infrastructure in regional areas. The existing banks are located in die national capitals and odier centers of economic activity and lack networks of branches that are necessary to attract money deposits and savings. Banks have also specialized in services rather than providing credit for more longer-term activities. The developing countries aTe "underbanked" for historical reasons. Only in Western Europe and North America are banks well-established, having been created prior to the period of industrialization. Those banks that were established in the industrialization period in die former communist countries, especially Eastern Europe and the former Soviet Union, were liquidated (not merely nationalized) during and after the Russian Revolution of 191 7. Banks in the USSR fulfilled a sole external function: dealing with the "class enemy," namely, die foreign capitalist countries. The banks were forbidden from affecting internal developmentand financing. Planning, steering, and financing die investment process was the task of public authorities, specifically gosplan, the national planning bureaucracy, and not of private financial markets and institutions. Private banks were not allowed to provide credits to die stateowned economy. Only GOSPlAN had die right to assign and allocate the necessary resources to the sectors and branches ofdie people's economy. The existence ofan official and organized capital market ofthe western style would have undermined both pillars ofthe soviet regime: state ownership ofproduction and die gospian bureaucracy's planning monopoly.2 As a result credit activities in the communist countries were reduced to purely personal and familial relations. The capitalist division between production and finance or between the entrepreneurial and banking sectors never existed in the former communist world. Why is diis division so significant to the process of development? In other words, why is the role of the banking sector so important to the developmentofan efficient marketeconomy? The answer can be derived from theoretical reasoning and the lessons ofhistory. 2 Wilhelm Hankel, Dollar und ECU, Leitwährungen im Wettstreit (Frankfurt am Main: Fischer Pocket Books, 1992). THE ROLE OF FINANCE IN THE MARKET ECONOMY 49 The History of Economic Doctrines The lasteconomic school fearingdiatlackofmoney and financial facilities could handicap die process of economic change and development were the Mercantilists. Mercantilism's...