FINANCE AND THE REAL ECONOMY ISSUES AND CASE STUDIES IN DEVELOPING COUNTRIES editors: Yilmaz Akyüz Giinther Held United Nations University/World Institute for Development Economics Research Economic Commission for Latin America and the Caribbean United Nations Conference on Trade and Development Responsibility for the papers rest solely with the authors. Collection: Social and Political Studies Inscription N9 88.481 I.S.B.N.: 956 - 7363 - 02 - 1 © S.R.V. Impresos S.A., Tocomal 2052, Santiago - Chile. Printed in Chile Compositor: Patricio Velasco G. Santiago, September 1993 INDEX INDEX INTRODUCTION ................................................................................................. 11 FINANCIAL LIBERALIZATION: THE KEY ISSUES....................................................... 19 \/ Introduction ....................................................................................................... 23 I. Interest rates and savings................................................................................... 24 II. Financial liberalization and deepening................................................................ 27 III. Allocative efficiency............................................................................................ 30 IV. Productive efficiency and cost of finance............................................................. 35 V. Regulation of finance and financial stability........................................................ 37 VI. Options in financial organizations..................................................................... 42 VII. External liberalization and financial openness..................................................... 49 VIII. Conclusions........................................................................................................ 60 EAST ASIAN FINANCIAL MARKETS: WHY SO MUCH (AND FAIRLY EFFECTIVE) GOVERNMENT INTERVENTION? ............................................. 69 Introduction ....................................................................................................... 73 I. Why so much government intervention?............................................................. 74 II. Repression in financial m arkets........................................................................... 76 III. Discipline of business ........................................................................................ 78 IV. The government's ability to impose performance standards................................ 79 V. Keeping the costs of investment finance low: the case of the Republic of Korea's financial reform.................................................... 83 VI. Conclusions........................................................................................................ 88 SAVINGS AND FINANCIAL POLICY ISSUES IN SUB-SAHARAN A FR IC A................... 103 Introduction ....................................................................................................... 107 I. Fragmentation of savings mobilization and financial intermediation in Sub-Saharan Africa................................................................. 108 II. Financial dualism and market fragmentation....................................................... 124 III. Policy required to overcome market fragmentation.............................................. 128 THE INDONESIAN EXPERIENCE WITH FINANCIAL-SECTOR REFORM ..................... 149 Introduction ....................................................................................................... 153 I. The 1983 financial reforms: background and content............................................ 154 II. The 1988-91 financial reforms: background and content....................................... 164 III. Effects of the financial reform............................................................................. s 168 IV. Conclusions........................................................................................................ 194 J PENSION SYSTEM REFORMS AND SAVINGS IN LATIN AMERICAN AND CARIBBEAN COUNTRIES WITH SPECIAL REFERENCE TO CHILE ............................ 201 Introduction ....................................................................................................... 205 I. Current status and challenges of pension systems............................................... 206 II. Population, employment and returns to pension system funds............................. 215 III. Development of capital markets and returns on pension system fu................. n d s 219 IV. TheChilean experience with an individual capitalization schem......................... e 224 V. Conclusions........................................................................................................ 237 j BANK REGULATION, LIBERALIZATION AND FINANCIAL J INSTABILITY IN LATIN AMERICAN AND CARIBBEAN COUNTRIES........................ 241 Introduction ....................................................................................................... 245 I. Bank regulation and supervision......................................................................... 247 II. Bankregulation in the Chilean financial liberalization experience......................... 259 III. Overview of recent financial instabilities in Latin American and Caribbean countries.............................................................. 273 IV. Conclusions........................................................................................................ 286 NOTE ON THE AUTHORS ........................................................................................... 291 INTRODUCTION Yilmaz Akyüz Giinther Held Introduction 13 This book is a product of a joint work programme on "Financing for Deve­ lopment" between the Economic Commission for Latin America and Caribbean (ECLAC) and the United Nations Conference on Trade and Development (UNCTAD), designed to study national experiences in financial-policy reforms and mobilization of domestic resources with a view to drawing policy conclu­ sions for developing countries. ECLAC and UNCTAD gratefully acknowledge the financial support provided by the World Institute for Development Economics of the United Nations University (UNU-WIDER), without which this work would not have been possible. The present volume contains six papers on financial-policy issues and country experiences, presented at a joint ECLAC/UNU-WIDER/UNCTAD seminar held at ECLAC headquarters in Santiago, Chile, on 5-6 October 1992. In the first, Yilmaz Akyuz discusses key issues in financial liberalization. Next, Alice Amsden analyses East Asian financial policies, pondering the reasons why there is so much effective government intervention. Machiko Nissanke then addresses savings and financial-policy issues in Sub-Saharan Africa. Afterwards, Donald Hanna assesses the Indonesian experience with finandal-sector reform, followed by Andras Uthoff's study of pension-system reforms and Giinther Held's study of bank regulations, liberalization and financial instability in Latin America and Caribbean countries. Akyüz examines a number of issues in financial liberalization, drawing on the experience of industrial and developing countries in the 1980s. He argues that the focus of financial policies in developing countries should be industrialization and stability, and that a common feature of all modem examples of industrialization is that they have succeeded in making finance serve industry and trade, not vice versa. He rejects as fallacy the proposition that financial liberalization stimulates savings, arguing that there is no simple 14 Y ilmaz A kyüz / G ünther H eld relation between the two. Financial liberalization often gives rise to deepening, but the latter is not always associated with a better use of resources since, inter alia, it tends to increase financial instability and fragility which, in turn, underminebothproductive and allocative efficiency. Prudentialregulations, while necessary, may not always be sufficient to prevent instability, particularly in developing countries, where financial liberalization often leads to escalation of interest rates and excessive risk taking. It may be necessary not only to act directly on the asset portfolios of banks but also to use interest ceilings. Efficiency also depends on the way finance is organized, since it influences the degree of risk, uncertainty and instability. The German- Japanese system of bank-based finance tends to be more stable and efficient than the Anglo-American system of capital-market-based finance, provided that the required fiscal and monetary discipline and prudential regulations are in place. Financial instability may be increased, and efficiency reduced, also by excessive financial openness. The speculative element that dominates international capital flows is capable of generating gyrations in exchange rates, giving rise to considerable uncertainty regarding prospective investment yields with respect of traded goods. This can be particularly damaging at a time when developing countries place greater reliance on trade as an engine of growth. Amsden discusses the rationale for government intervention in financial markets in late industrializers and the factors that account for successful intervention in the Republic of Korea and Taiwan Province of China. Challenging the conventional wisdom that latecomers industrialize by "getting prices right" on the basis of low wages that procure them a comparative advantage in labor-intensive industries, she