Turning Development Upside Down
A book about reforming relief and development

Sunday, January 16, 2005

Chapter 2 - Problems - Financial Sector

Maybe the Weakest Link in Development

The financial sector has a long history of being a facilitator of progress. If we look at the history of what the financial sector has done, it is remarkable. They have facilitated enormous progress over the past hundred and fifty years or so, and in the process have also become wealthy. And if that is all there is, the bankers are are winners.

But in the last fifty years, there has been a dark side to banking that has too much been ignored. In the process of creating enormous wealth, the financial sector has also facilitated others becoming terrible poor. Is it sufficient to service a wealthy client while the client's community is deathly poor. Is the ethical requirement something a little more. Is the financial sector merely about making money by “conning” the clients and basically making money for one group at the expense of another, or is it something much bigger than that.

I do not have an answer to this question. But I do know that if the global financial sector believed that it could make money out of development there would be no shortage of finances to do all the development that was proposed. The problem is that nobody has yet convinced the global financial community that there is money to be made in development, and they are right to avoid direct investment in development.

I remember doing work in Thailand in the early 1980s. Part of the work concerned an assessment of the investment potential of Thailand and the enabling environment of law and culture and institutions that would make Thailand a good place to invest. Of course the analysis of law and the banking sector and the regulatory environment and everything else made one draw the conclusion that Thailand was not going to be a good place to invest. Not to mention that very few people spoke English and the language and even the alphabet was incomprehensible. But before I concluded my work, I asked another simple question. Why was it that money was being invested in Thailand? And of course it turned out that a lot of money could be made in Thailand if it was invested in profitable enterprise. Money flow was not constrained by things that I had been studying. It was all about economic value adding and earning profit. Brothels, tourism were profitable. End of analysis.

Development will never be successful as long as the financing of development is limited to the initiatives of the official development assistance (ODA) community. Most of their decisions are driven by a social dimension that has little to do with economic value adding and profit. And after forty or more years of this, the flow of funding for ODA work is miniscule.

And something else has been going on. As the failure of development became a pandemic, which probably happened in the late 1970s, the financial community has sought to limit its losses, more often than not be tightening the terms and in fact making failure more certain. What was bad in 1980 had become horrendous by 2000. But almost all was due to bad lending into economic value losing propositions, and a bad problem was made even more serious by the financial community's strategy.

And as this was going on the major financial organizations created communities of interest to ensure that the borrowing nations were even more limited in their options. The UN Round Tables and the Paris Club negotiations ensure that fifty big institutions are able to gang up on a small developing country and get it to do whatever they call for. In any other field of trade or commerce this would be called a cartel, and would be the subject of great criticism, but I do not think I have seen anything in the NORTH press that sees this as an undesirable feature of the international financing scene.

Actually, this would not be too bad a way to move forward if the financial community was asking for economic value adding initiatives. But in fact the international financial community rarely has this on the agenda, and the outcomes are frequently very damaging to the SOUTH country.
Over the years I have had assignments where I have been collaborating with IMF and World Bank teams, and I have seen some of the work they do. And some of it is very bad. Not only is the work done too fast, it is done with too little understanding of the problems. The agenda is from the NORTH, and the SOUTH country has little of no say in the negotiation or the conclusions. It is a terrible process. It is worth commenting that the IMF and the World Bank have some great and experienced staff, but they are likely to be working on the big high profile problems, while the staff working on the boring problems of any of 100 or so poor SOUTH countries are not so likely to be of this caliber, and even if they are good, do not they have the seniority to get policy changes made when they are needed. This is a terrible process.

The basic financial flows do not serve development well. The World Bank and the other Regional Development Banks (RDBs) are able to borrow money from the capital markets. They then onlend to SOUTH governments who onlend to programs. The repayment flow is essentially SOUTH people fund SOUTH government to repay WB and RDBs. The missing link is that program should benefit people so that people are able to repay without it being a problem. But this missing link has been missing for decades. In theory the programs benefit people, but it is pretty apparent from the ODA publications that most programs have resulted in rather little benefit for the people and their is a growing debt arising year after year with little development progress.

There is a debt dilemma. The financial sector in most developing countries is in a difficult situation, and the debt crisis does not make it any better. Solving the debt crisis is not best handled by getting tough about repayment and debt service, it is much more about getting tough about economic value adding in the debtor countries. This may to some extent be addressed by improved governance and better policy options from government, but it also needs to be addressed by improved financing modalities and focus on economic value adding activities.

The problem goes far beyond just corruption in SOUTH governments. It is also about the whole framework of economic value destruction that arises with much of the existing flows of investment and assistance to developing countries. Economic value destruction in developing countries is being aggravated by a lot of Foreign Direct Investment (FDI), by a lot of the rule making going on in the Geneva based international organizations such as the WTO and the ICU.

It is not a pretty sight.


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