Abstract
Governments have created development banks in hopes of accelerating growth. Theoretical growth models that assess the pertinence of these banks are scarce and, none of them analyzes the implication of these banks under weak institutions and underdeveloped financial markets, which are two common problems in poor countries. This article studies the implications of subsidies to producers, a monopoly bank, or to a development bank, for the technology adoption and welfare in a Schumpeterian growth model in which creditors cannot completely eradicate moral hazard. I find that under these circumstances, the innovator will under-invest in research and, although subsidies contribute to a higher level of technology in the economy, they may harm the welfare of the working class. Subsidies to a development bank can be the most effective measure in terms of catching up with advanced economies, but this policy can be the most negative for the economic environment by diverting a large amount of resources from investment in research. Finally, this policy harms workers’ welfare when they finance the subsidy.
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Notes
Among the theoretical works, Roubini and Sala-i Martin (1995) shows that these policies can be inflationary and also harm investment and growth because they reduce investments for a given level of savings. Espinosa and Yip (1996) finds that aggressive binding reserve requirements refrains economic growth. On the contrary, Courakis (1984) demonstrates that ceiling in deposit rates can boost total deposits and loans under certain circumstances.
There are private development banks, but this article will focus only on the public ones. Also, there are public banks without an explicit mandate of promoting growth.
Most of the Schumpeterian models only considers the creation aspect of the process of technological progress. However, Acemoglu et al. (2006) and Vandenbussche et al. (2006) also consider the dimension of adoption. Development banks also engage in this last one by facilitating the importation and adaptation of modern technology.
Laeven et al. (2015) considers that possibility, but the analysis focus on the relevance of financial innovations for growth.
Published in the Global Development Finance of the World Bank.
The data sources are: World Development Indicators of the World Bank for the banking credit and Gross Domestic Product (GDP) per capita, Economic Freedom of the World of the Fraser Institute for the legal system, and the World Intellectual Property Organization for the granted patents.
The idea that higher financial development propitiates higher growth has been challenged by several empirical studies. I just want to refer to Cecchetti and Kharroubi (2015), which finds that the growth of the financial sector harms research and development firms that are financially dependent.
A notable example is BNDES, the main development bank of Brazil. One of its sources of funds is the Workers’ Assistance Fund (FAT) which is financed with workers’ contributions to an unemployment insurance program (and other purposes). The workers receive an interest rate far lower than the existing in the market, and because of that, the savings of the workers are “taxed” by this strategy. Although this bank has programs for small and medium enterprises (whose owners would be relatively poor citizens), the bulk of its loans are for larger companies. In addition to a theoretical model and quantitative analysis, a discussion on BNDES can be found in A. Antunes, T. Cavalcanti and A. Villamil, “The Effects of Credit Market Subsidies on Development.” Economic Theory, 1–30, 2015.
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Acknowledgements
I am extremely grateful of professors Ph.D. Noritsugu Nakanishi and Ph.D. Yunfang Hu and the rest of participants in the PHD seminar at Kobe University for very valuable comments. The research was conducted during the Ph.D studies of the author. I am also thankful of the MEXT scholarship of the Japanese Government which fully financed my Ph.D. studies. I want to thank Professor Nicole Moskowitz for proofreading this article.
Funding
The research was not directly financed. However, it was part of the Ph.D studies of the author. The Ph.D. program was fully financed by the MEXT scholarship of the Japanese Government.
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Senra Hodelin, R. Development banking under weak institutions and imperfect credit markets. Ann Finance 16, 353–380 (2020). https://doi.org/10.1007/s10436-020-00372-2
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DOI: https://doi.org/10.1007/s10436-020-00372-2