It is remarkable that no matter how much you read there are academics whose work you have been missing along. The reading list keeps expanding.
I came across this paper by Stephen Haber of Stanford and was simply amazed. Haber is an expert on political economy of financial development. HE simply asks if finance is important for growth, why don’t governments build efficient financial systems? His view:
It is difficult to bring about broad based financial devleopment in absence of political reforms that enhance democratic governance
He provides a framework where let us imagine there are 3 agents in an economy:
1. incumbent financiers – has accumulated finance
2. politicians – runs government machinery
3. industry – needs credit to expand
He goes on to show that markets do not develop as the interest of all 3 cannot be aligned.
1. incumbent financiers: want to maintain its rents and create barrier to entry. Thus prefers high cost of credit
2. Politicians: need banks to channelise taxes, loans etc
3. Industry- needs low cost credit
Between 1 & 2 there is a obvious problem of aligning their incentives. 2 wanst lost cost credit and competitition and 1 opposes it. Haber goes on to explain the problem of alignemnt between each and hence, it is difficult to push reforms in financial sector. A fantastic perspective. Highly recommended reading.
The paper reminded me of another superb paper by Rajan & Zingales which looks at underdevelopment from very similar angle.