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Tài liệu Resource Mobilization, Financial Liberalization, and Investment: The Case of Some African Countries doc

Resource Mobilization, Financial Liberalization, and
Investment: The Case of Some African Countries



Mohammed Nureldin Hussain, Nadir Mohammed and Elwathig M. Kameir
Introduction
The role of interest rate in the determination of investment and, hence economic
growth, has been a matter of controversy over a long period of time. Yet, what constitutes an
appropriate interest rate policy still remains to be a puzzling question. Until the early 1970s,
the main line of argument was that because the interest rate represents the cost of capital, low
interest rates will encourage the acquisition of physical capital (investment) and promotes
economic growth. Thus, during that era, the policy of low real interest rate was adopted by
many countries including the developing countries of Africa. This position was, however,
challenged by what is now known as the orthodox financial liberalization theory. The
orthodox approach to financial liberalization (McKinnon-Kapur and the broader McKinnon-
Shaw hypothesis) suggests that high positive real interest rates will encourage saving. This
will lead, in turn, to more investment and economic growth, on the classical assumption that
prior saving is necessary for investment. The orthodox approach brought into focus not only
the relationship between investment and real interest rate, but also the relationship between
the real interest rate and saving. It is argued that financial repression which is often associated

with negative real deposit rates leads to the withdrawal of funds from the banking sector. The
reduction in credit availability, it is argued, would reduce actual investment and hinders
growth.
Because of this complementarity between saving and investment, the basic teaching of
the orthodox approach is to free deposit rates. Positive real interest rates will encourage
saving; and the increased liabilities of the banking system will oblige financial institutions to
lend more resources for productive investment in a more efficient way. Higher loan rates,
which follow higher deposits rates, will also discourage investment in low-yielding projects
and raise the productivity of investment. This orthodox view became highly influential in the
design of IMF – World Bank financial liberalization programmes which were implemented by
many African countries under the umbrella of structural adjustment programs.
The purpose of this chapter is to provide a theoretical and empirical examination of
the question of resource mobilization in the context of African countries as envisaged by the
theory of financial liberalization. The chapter begins by developing the conceptual framework
for the whole study. This involves the examination of the theory of financial liberalization,
and the development of an analytical framework which exposes the theory and its critique.
The chapter concentrates on examining the empirical relationship between the real interest
rate, saving and investment. It draws a distinction between total saving and financial saving
and estimates separate functions with special emphasis on the role of the real interest rate in
the determination of each category of saving. For the relationship between the real interest
rate and investment, this section employs a 3-equation investment model which tests for the
effect of below equilibrium and above equilibrium interest rates on investment. The model
also allows the calculation of the net effect of the real interest rate on investment after taking
into account the effect of the real interest rate on the provision of credit and the cost of
investment.

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Resource Mobilization and Financial Liberalization
Resource Mobilization and Financial liberalization: A Conceptual Framework
The accumulation of capital stock through sustained investment is indispensable for
the process of economic growth. In a closed economy, investment itself can only be financed
from domestic saving. Because the acts of saving and investing are usually conducted by
different people, the financial sector is entrusted with the functions of channeling resources
from savers to investors. The relationships between domestic saving and economic growth
can be examined through the Harrod-Domar Result:
g = p(S/Y) = p(I/Y) (1)
where g is the rate of growth of real output, p is the productivity of capital and (S/Y) is
the ratio of total domestic saving to income which, in equilibrium, is equal to the ratio of
investment to income (I/Y). Accordingly, given the productivity of capital, the growth rate
should increase the higher the ratio of saving (investment) to income. Conversely, if the ratio


of saving (investment) to income is given, the growth rate can be increased by improving the
efficiency of investment which will raise the productivity of capital (p). To do this, it is
necessary to promote investment that support efficient production in sectors where rapid
growth in effective demand can be expected (Okuda 1990).
The orthodox approach to financial liberalization suggests that, financial liberalization
will both increase saving and improve the efficiency of investment (Shaw 1973). By
eliminating controls on interest rates, credit ceilings and direct credit allocation, financial
liberalization is said to lead to the establishment of positive interest rates on deposit loans.
This, in turn, is said to make both savers and investors appreciate the true scarcity price of
capital, leading to a reduced dispersion in profits rates among different economic sectors,
improved allocative efficiency and higher output growth (Villanueva & Mirakhor 1990).
Figure (1) provides a diagrammatic illustration of the theory backing financial
liberalization programs. The figure exhibits the behavior of savings (S) and investment (I) in
relation to the real rate of interest (r). The savings schedule slopes upwards from left to right
on the (classical) assumption that the rate of interest is the reward for foregoing present
consumption. The investment schedule slopes downwards from left to right because it is
assumed that the returns to investment decreases as the quantity of investment increases,
which means that a lower real rate of interest is therefore necessary to induce more investment
as the marginal return to investment falls. If the interest rate is allowed to move freely (i.e., no
interest rate controls), the equilibrium rate of interest would be r* and the level of saving and
investment would be at I*. If the monetary authorities impose a ceiling on the nominal saving
deposit rate, this will give a real interest rate of, say, r
1
. If this rate is also applicable for
loans,
1
saving will fall to S
1
and investment will be constrained by the availability of saving to
I
1
. At r
1
the unsatisfied demand for investment is equal to AB. According to the financial
liberalization theory, this will have negative effects on both the quantity and the quality of
investment. That is, credit will have to be rationed, consequently many profitable projects will
not be financed. There will also be a tendency for the banks to finance less risky projects, with
a lower rate of return, than projects with a higher rate of return but with more risk attached.
If the ceiling on interest rate is relaxed, so that the real interest rate increases to r
3
,
saving will increase from I
1
to I
3
, and the efficiency of investment also increases because
banks are now financing projects with higher expected returns. Unsatisfied investment
demand has fallen to A
1
B
1
and credit rationing is reduced. It is argued that savings will be
«optimal» and credit rationing will disappear, when the market is fully liberalized and the real
rate of interest is at r*.
Although it appears convincing, the financial liberalization theory suffers from major
shortcomings. As it has been argued by Warman & Thirlwall (1994), the financial

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liberalization theory makes no clear distinction between financial saving and total saving. To
be sure, the saving symbol which appears in equation 0) stands for total saving and not
financial saving. The relationships suggested by the Harrod-Domer result, between saving,
investment and growth, are complicated by the fact that a significant portion of domestic
saving may be held in the form of real assets (e.g., real estate, gold and livestock), exported
abroad in the form of capital flight, or claimed by informal markets such as the informal credit
market, the underground economy and the black market for foreign exchange. The fact that
financial saving is only one form of saving, raises many important issues regarding the theory
of financial liberalization. In what follows, a simple conceptual framework is developed to
restructure the debate on financial liberalization and to articulate the arguments against the
financial liberalization theory. It puts into focus some of the worries, criticisms and
limitations of the financial liberalization theory which are important to bear in mind when
evaluating the implementation of policies in the context of African countries.
Total Saving, Financial Saving, and the Leakage
The flow of total national saving can be decomposed into public saving and private
(household and enterprise) saving:
S
T
= S
G
+ S
P
(2)
Where S
T
, S
G
and S
P
are total, public, and private savings respectively. The flow of
private saving can be divided into two major components: private financial saving which
comprise the portion of private saving that is kept in the form of financial assets in the formal
financial sector (F
P
) and private saving residue which comprises the portion of private saving
which is kept in non-financial forms or put into other uses (L). That is:
S
P
= F
P
+ L (3)
Substituting equation (3) into (2), we get:
S
T
= S
G
+ F
P
+ L (4)
The flow of total financial saving (F
T
) comprise public financial saving (F
G
) and
private financial saving (F
P
). That is:
F
T
= F
P
+ F
G
(5)
On the assumption that all government saving is kept in the form of financial assets
(so that F
G
= S
G
) and substituting equation (5) in (4), and rearranging we have:
L = S
T
— (F
G
+ F
P
) (6)
and,
F
T
= S
T
– L (7)
Dividing equation (6) by S
T
, we obtain:
FT/ST = 1 – s (8)
Where, s = L/S
T
, which measures the proportion of total saving that is leaked out of, or
not captured by the formal financial sector. If equations (6), (7) and (8) are expressed in stock
rather than flow terms, they can be interpreted as giving the condition for the case of what can
be called full financial deepening where the whole stock of total saving is kept in financial
forms and the leakage, L, is zero. The degree of financial deepening at any point in time, can
be measured by equation (8), where the smaller, s, the higher will be the degree of financial
deepening. The equations can also be used to clarify the confusion in the literature between
total saving and financial saving. Total saving and financial saving are identical only in the
case of a zero leakage (i.e., L=0).

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In their flow forms the equations can be interpreted as giving the ‘dynamics’ of the
process of financial deepening. The case of a zero leakage with L = s = 0, corresponds to what
can be called full financial augmentation where all the additions to total saving are kept in the
form of financial vessels (so that S
T
= F
G
+ F
P
in equation (6) and F
T
/S
T
=1 in equation (8)). A
reduction in the leakage (i.e., s L<0) implies an improvement in the process of financial
deepening while an increase in the leakage (i.e., s L>0) implies an increase in the process of
financial shallowing. The equations also illustrate the important result that even though total
saving might be stagnant (i.e., s S
T
=0) financial saving can increase if sL<O. To elucidate this
result, the leakages of saving outside the formal financial sector may be divided into the
following main components:
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the portion which is kept in the form of real assets including
livestock and gold (R); the portion which is claimed by the informal financial sector (N), the
proportion which is claimed by the underground economy including the black market for
foreign exchange (U), the portion which goes into capital flight (C) (this is usually kept
abroad in the form of foreign currency deposit accounts, financial assets or physical assets)
and; the portion which is hoarded by households in the form of domestic or foreign currency
holdings (H). Using these definitions in equation (8), we obtain:
F
T
= S
T
— (R + N + U + C + H) (9)
Equation (9) is a restatement of the fact that financial saving is only one type of
saving. The main other types of saving are represented by the components of the leakage on
the right hand side of the equation. According to the equation, if saving is stagnant (i.e., s
S
T
=0), financial saving can still increase — keeping other things constant — by reducing the
stock of saving which is kept in real assets (i.e., sR<0); by reversing the process of capital
flight (i.e., sC<0); by attracting the resources of the informal sector into the formal sector (i.e.,
sN<0); by reducing the amount of saving claimed by the underground economy and; by
encouraging dishoarding of foreign and domestic currency by households (i.e., sH<0).
Conversely, large additions to total saving might not increase financial saving if they are
offset by an equal increase in any of the components of the leakage, say, capital flight. Also,
substitution among the components of the leakage might occur without affecting financial
saving. An increased dishoarding of domestic and foreign currency, for instance, might be
offset by an equal increase in capital flight (i.e., -sH=sC) leaving financial saving unchanged,
and so on.
The Orthodox Versus the New Structuralist
Equation (9) allows us to reinterpret the controversy between the proponents of the
orthodox financial liberalization theory and their opponents from the New Structuralist
School. In the context of our model, this controversy concentrates mainly on the interactions
between financial saving and the components of the leakages shown by the equation.
According to McKinnon (1973), in most developing countries, a significant proportion of
working capital for the financing of inventories, goods in process, trade credit and advances to
workers is obtained through bank financing. The supply of bank credit determines the level of
available working capital, and thus of net output. An increase in deposit interest rates, is thus
expected to increase holdings of financial assets (broad money) and hence working capital
and output. This increase in financial saving will occur through the reduction in the leakage.
For the new structuralist, an increase in deposit rates is likely to result in an increased
holdings of financial assets, but the outcome will not necessarily be a positive increases in
working capital and output. This depends on which component of the leakage is reduced and
on whether the reduced component will cause an offsetting reduction in output. Two basic
reasons (assumptions) are usually given to explain the position of the new structuralist: first,
the intermediation of the informal credit market is said to be complete while that of the formal
market is not and; second, the informal credit market is assumed to support equally
productive and efficient activities, while the other components of the leakage do not. As for

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the first reason, the funds in the informal market are said to be transmitted, in full, to
production entities with no holding of reserves, while in the formal sector the transmission is
less than full. The required reserve ratio and the holding of excess reserves constitute another
leakage in the flow of funds between savers and investors. This can be illustrated by assuming
that financial savings are equal to bank time deposits. The relationship between financial
saving and the supply of bank loans may be written as:
B
C
= (1 – T) F
T
(10)
where B
C
is the supply of bank loans, T is the required and excess reserves ratio held
by banks and F
T
is financial saving. Thus, while reductions in any of the components of the
leakage in equation (9), keeping all other parameters constant, will bring about an equal
increase in financial saving, the supply of bank loans will not increase by the same amount
because of the leakage caused by banks’ holdings of reserves.
As for the second reason, according to Van Wijnbergen’s (1983) new structuralist
model, if the increase in financial saving occurs through the reduction in hoarded cash
balances [-H in equation (9)] and other intrinsic unproductive assets, then it will have a
positive effect on output. If, however, it is at the cost of informal credit market (-N) it will
lead to a fall in total private sector credit, working capital and output. The loss of informal
sector credit without an equal compensating increase in formal sector lending, is said to bid
up the informal sector lending rate and reduce net working capital causing a decline in output.
The new structuralist argument rests, therefore, on the contentions that the
intermediation of the formal sector is not full and that informal sector resources, and not the
other components of the leakage in equation (9), are likely to be the closest substitute for time
deposits. However, it has been argued by Serieux (1993), that less than full intermediation can
only occur if we assume away the money creation capacity of banks. That is, most informal
sector loans are essentially cash loans. It follows that a shift from informal sector resources to
bank resources would imply a surrender of cash to the formal banking sector. This, will
increase banks’ reserves and hence their credit creation capacity. Accordingly, bank
intermediation might be complete or even multiplicative. Also, an increase in bank deposit
rates, may lead to shifts among the components of the leakage such that the available informal
credit remains intact.
The Real Interest Rate and the Determinants of Saving and Investment
in Africa
As outlined in the conceptual framework, the financial liberalization theory, is based
crucially on three postulates concerning the relationship between the real interest rate, saving
and investment:
1. that saving is positively related to the real rate of interest;
2. that investment is determined by prior saving; and
3. that the effect of the real rate of interest on investment will depend on
whether the real interest rate is below or above the equilibrium rate.
Although the financial liberalization theory places more emphasis on the desirable
effects of raising the real interest rate towards equilibrium, it also postulates that the impact of
the change in the real interest rate on investment depends on whether the actual interest rate is
below or above equilibrium. Below the equilibrium interest rate, investment is constrained by
saving. An increase in the real interest rate towards equilibrium, will increase saving and
investment. Hence, as long as the equilibrium interest rate is not reached, investment is
positively related to the real interest rate (see Figure 1). Beyond this equilibrium, an increase
in real interest rate will have a negative effect on investment as the economy moves along the

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negatively-sloped investment demand curve. The relationship between the real interest rate
and investment as postulated by the financial liberalization theory is depicted by Figure (2).
Against this theory which is based on classical notions, we have the Keynesian
framework which postulates that saving is positively related to income and investment is
negatively related to the price of credit for which the interest rate stands as a proxy. However,
the proponents of this Keynesian view concede that the real interest rate might also have a
positive effect on investment through the provision of credit. That is, as financial saving and
the rate of interest are positively related, interest rate may also have a positive effect on
investment through the process of financial deepening and the provision of credit to the
private sector (Warman & Thirlwall 1994). Thus the net effect of the real interest rate on
investment will depend on the relative strength of its negative effect through the cost of
investment and its positive effect through the provision of credit. In what follows, we discuss
the empirical models that we are going to use to examine the validity of the postulates of the
financial liberalization theory.
Total Saving and Financial Saving: Empirical Models
The financial liberalization theory postulates that saving is positively related to the
real interest rate. The theory, however, does not make clear distinction between total savings
and financial saving. Total domestic saving consists of private and public savings of which
financial savings is a part. While financial saving is the portion of total saving that is
channeled through financial assets which comprise short and long-term banking instruments,
non-bank financial instruments such as treasury bills and other government bonds and
commercial paper. It is prudent, therefore, to examine the role of the real interest rate in the
determination of both total saving and financial saving. To this end, the following two
equations for total saving and financial saving are specified:
T
S
= s
0
+ s
1
+ s
2
Y (12)
F
S
= T
0
+ T
1
+ T
2
Y + T
3
(C/M
1
) (13)
It is hypothesized that, total real domestic saving (T
S
is a function of real income (Y)
and the real interest rate (r). It is expected that total saving is positively related to real income
(Y). Whether the total saving is positively or negatively related to the real interest rate, will
depend on the relative strength of the income and substitution effects of changes in the rate of
interest [see Warman & Thirlwall (1994)]. The substitution effect of a higher interest rate is to
encourage agents to sacrifice current consumption for future consumption, but the income
effect is to discourage current saving by giving agents more income in the present, and the
two effects may cancel each other out.
As saving is a flow concept, financial saving is measured by the change in the stock of
such financial assets. It is hypothesized that real financial saving (F
S
is positively related to
real income (Y), and also positively related to the real rate of interest (r) as postulated by the
financial liberalization theory. Also, because of the important role played by the informal
credit market in many African countries, an attempt is made to capture its effect on formal
financial saving. This is done by including as an independent variable, the ratio of currency
outside banks to narrow money M
1
. The proportion of narrow money (M
1
) held as currency is
commonly accepted as a measure of the size of the informal credit market (see Shaw 1973
and Serieux 1993), on the grounds that the higher this ratio the larger will be the size of the
informal credit market.
An Investment Model
As it has been noted before, the financial liberalization theory suggests a differing
effect of the real interest rate on investment, depending on whether the real interest rate is
below or above the equilibrium rate. It is also noted that, on Keynesian grounds, the real

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