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This weeks readings explored a variety of approaches to finance and development.

Gerschenkrons (1962) institutional approach considers the heterogeneous nature of

industrialization, rejecting a singular path to growth. Looking at the European experience, he finds

a key role for state involvement and banking institutions in development. Gerschenkorn rejects the

idea of certain prerequisites that all countries must meet in order to develop. Backward countries

will not industrialize in the same manner as todays advanced countries.

Krieckhaus (2002) follows Gerschenkron in acknowledging the need for capital late-

developing countries. He focuses on the impact of public savings on growth. He extends

developmental state theory beyond allocation to include mobilization of financial resources. A case

study of Brazil supports Krieckhaus claim that savings caused an increase in economic growth.

The post-Keynesian approach finds that liberalization leads to speculative-led development

which is marked by instability and negatively affects the macroeconomy. The focus on short-term

speculative activities, rather than long-run investment, wastes resources and misallocates credit

and investment capital. Thus liberalization results in greater volatility and susceptibility to crises.

Neostructuralism rejects sweeping liberalization and instead promotes a more balanced

approach. Capital movements, exchange rates, and trade policy should be regulated. Resources

should be directed toward investment, and direct and indirect policies used to acquire comparative

advantage. Structural readjustment is promoted in order to generate more sustainable capital flows.

The state should undertake selective policies to reduce expenditure and move production closer to

the production frontier. Rather than indiscriminate openness, attracting long-term capital inflows

should be the focus of incorporation into the global economy (Ffrench-Davis 1993).

In examining the role of formal and informal financial sectors in Asia, Ghate1 (1992)

describes a continuum of formality, rather than a distinct break, between these generally

complementary sectors. Credit availability following liberalization is inconclusive, with some

studies suggesting increases in both formal and informal markets, while others refute this claim.

Ghate concludes that the informal market will remain important and continue to grow in many

developing countries, despite growth in the formal sector, as informal lenders are more efficient at

offering credit to small, poor, risky borrowers. This has important policy implications.

1 Ghate, P. (1992). Interaction between the Formal and Informal Financial Sectors: The Asian Case. World Development. 20(6):859-872.

7/31/2019 Critique of Neoclassical Theories of Finance and Development

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FitzGerald (2007) reviews financial depth and financial structure. In opposition to orthodox

theory, FitzGerald refutes a clear directionality in the relationship between financial development

and economic growth, finding little evidence to suggest that financial liberalization increases

savings. While orthodox theory holds that certain organizational forms of financial institutions will

result in rapid economic growth, the author finds that many different institutional forms may carry

out the same function. FitzGerald suggests a gradual approach to liberalization, with selective

intervention, to reduce instability and facilitate a successful transition.

Critiques

As Grabel notes, the neostrucutralist approach is theoretically underdeveloped, and suffers

from a lack of empirical basis. She refutes its claim that liberalization does not result in growth,

showing instead that speculative-led development occurs. While Grabels critique ofthis approach

centers on curb markets, they are not included in Ffrench-Daviss description of neostructuralism.

Neostructuralist and post-Keynesian approaches both fail to account for the particular

context within each country, which can give rise to markedly different outcomes from a given

policy prescription, instead relying on abstract theory. A more nuanced approach is needed to

reduce the deleterious effects of well-intentioned but misguided policy prescriptions. While

Gerschenkrons institutional approach acknowledges this variation and rejects singular approaches

to development, his focus on domestic conditions in 19th century European may be misplaced for

countries affectedand constrainedby todays globalization.

State capacity is a central issue to the above approaches. The neostrucutralist need for an

efficient state and public sector may be unrealistic and outside of the capacity of many developing

countries, rendering this policy approach inappropriate in certain contexts (Ffrench-Davis, 1993:

158). Krieckhaus notes a decline in Brazils rate of savings once democracy was restored.

Additionally, Brazils highly efficient and effective administrative system was key to its success in

increasing growth through savings. Finally, the state led approaches may be socially undesirable.

Brazil (Krieckhaus 2002) and Russia (Gerschenkron, 1962) relied on repressive measures to force

development, while Brazils military regime raised taxes and implemented forced savings.