Political Economy of Financial Development

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.

6 Responses to “Political Economy of Financial Development”

  1. Financial Md » Political Economy of Financial Development Says:

    […] Original post by Mostly Economics […]

  2. Political economy of finance reversed? « Mostly Economics Says:

    […] economy of finance reversed? I had pointed earlier about a superb paper from Stehen Haber where he shows why financial systems remain […]

  3. Hernando De Soto’s view on this crisis « Mostly Economics Says:

    […] So,  Soto says it could be some special interests. This is actually opposite of what Stephen Haber and Rajan/Zingales have said – financial systems have not developed because of special interest […]

  4. Financial Oligarchy at its best « Mostly Economics Says:

    […] This was advocated by Raghu Rajan and Luigi Zingales in their paper and Stephen Haber in this paper. They look at political reasons for non-development if financial systems in developing economies. […]

  5. The Political Economy of Global Finance « Mostly Economics Says:

    […] famous pieceby Jagdish Bhagwati explores the rise of US Treasury and Wall Street. Then Stepen Haber looks atpolitical economy of financial development which I thought had […]

  6. Politics of Financial regulation « Mostly Economics Says:

    […] are ample papers which speak on political economy of finance development. These papers say that financial sector development does not take place in developing economies […]

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