ECON 390 ISSUES AND PROBLEMS IN DEVELOPING ECONOMIES

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ECON 390 ISSUES AND PROBLEMS IN DEVELOPING
ECONOMIES

• Lecture 16 Urbanization and Rural-Urban
  migration Financial markets and development

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Goals for today

• Class update?
• Homework 4 due next time
• Practice questions posted on website
• Urbanization and Rural-urban income gap
• Financial markets and development

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Figure 7.9
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Results of Todaro model

• Flexible-wage market economy, with full
  employment
• Agricultural wage Manufacturing wage
• Minimum wage in manufacturing
• Gap between agriculture and manufacturing wages
• Workers now compare agricultural wage to their
  expected wage from manufacturing

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Banerjee study of Delhi

• Controlling for human-capital variables, earnings
  in formal sector are still 9 higher than in
  informal sector.
• Earnings in informal sector
• Non-wage employment (earnings 47 more than
  formal sector workers)
• Wage workers
• Low mobility between formal/informal sectors,
  only a small minority of informal-sector workers
  actively seek formal sector work.

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Lucas study of Botswana

• Migration to five urban centers
• Urban earnings 68 higher than rural earnings
• Higher a persons expected earnings, higher
  probability of employment, greater chance of
  migration.
• Creation of one new job in urban center draws
  more than one new migrant from rural areas.

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Policy Implications

• Reduce urban bias of development policies
• Urban job creation is insufficient, and may
  induce migration.
• Expansion of educational systems must be
  carefully considered.
• Wage subsidies can be counter-productive.

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A Comprehensive Migration and Employment Strategy

• Create a urban-rural balance
• Expand small, labor intensive industries
• Eliminate factor-price distortion
• Choose appropriate technologies
• Modify the linkage between education and
  employment
• Reduce population growth
• Decentralize authority

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Role of the Financial System

• Providing payment services
• Matching savers and investors
• Generating and distributing information
• Allocating credit efficiently
• Pricing, pooling and trading risks
• Increasing asset liquidity

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Financial systems in developing countries

• Limited information
• Dual monetary system
• Formal, organized money market
• Interest rate ceilings
• Catering to firms in modern, industrial sector
• Large, unorganized informal money market
• Uncontrolled, often usurious
• Often only market accessible by low-income
  households

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Development banks

• Supply medium, long-term funds for the
  creation/expansion of industrial enterprises.
• Primarily focused on large-scale loans
• Growth facilitated by a variety of sources of
  capital, 20 foreign-owned share capital

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Gap between development banks and
moneylender/pawnbroker

• Development banks often refuse loans less than
  20,000.
• Important role of small-scale firms in developing
  economies
• 40-70 of labor force employed by these firms.
• 1/3 of recorded domestic output
• Moneylenders may charge up to 20 a day for
  small, short-term loans.

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Grameen Bank

• 1976 started by Muhammad Yunus in Bangladesh.
• Initial loans provided by Bangladesh agricultural
  development bank, personally guaranteed by Yunus.
• Currently 2000 branch offices throughout
  Bangladesh

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Process of lending

• Potential borrowers form 5 member groups.
• 2-week training session for each member.
• Weekly group meetings with a bank officer
• Incentives to repay loan
• Collateral of social pressure
• Financial incentives
• Individual may increase loans by 10 if
  repayment has been timely.
• 100 group attendance at meetings, all loans are
  repaid, 5 increase in loans for each borrower

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Training

• Practical matters
• Bank procedures
• Group savings program
• Role of the center chief and the chairperson of
  the five-member group
• How to write their signatures
• Moral component banks 16 principles or
  decisions to be adhered to by each member

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16 decisions a few examples

• 3 We shall not live in dilapidated houses. We
  shall repair our houses and work toward
  constructing new houses as soon as possible.

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6 We shall plan to keep our families small
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7 We shall educate our children and ensure
that they can earn to pay for their education
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We shall collectively undertake bigger
investments for higher incomes.
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Key features of lending program

• As of Jan. 2007, 97 of borrowers are women
• 96 own less than half an acre.
• Borrowers own 75 of Grameen stock, remainder
  held by government.
• Loan size
• Starting 50-100
• Average 140

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Effect of Grameen

• Use of loans
• 46 for livestock, poultry raising
• 25 for processing and light manufacturing
• 23 for trading, shop keeping
• Working capital of borrowers tripled on average
  within 27 monhs
• Effect on consumption
• Increase of 18 taka for every additional 100 taka
  borrowed by women
• Increase of 11 taka for every additional 100 taka
  borrowed by men

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Grameen phone ladies

• Lack of landlines in developing countries
• Bangladesh 5.94 lines per 1,000 people.
• Uganda 2.57 lines per 1,000.
• United States 606 lines per 1,000 people.
• Grameen Telecom simple goal provide the
  poorest woman in each village with a cellular
  phone.

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Effect of program

• Income per phone lady 60 per month after
  expenses.
• Difficulty minimal requirement, need for phone
  lady to do accounts. Phone ladies typically
  good-standing Grameen members
• Service
• 34,000 villages, 1 million subscribers
• 32,000 phone ladies, 17 of total airtime.

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Challenges facing micro-credit lenders

• How responsive are Grameens borrowers in the
  face of shocks?
• Bolivia competition among providers of
  micro-finance regarded as partly responsible for
  financial crisis.
• Cultural challenges Grameen and other programs
  challenge traditional status quo.
• Need to be flexible
• Low-cost cooperative health insurance
• Education loans

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Reforming financial systems

• Difficulties faced by commercial banks,
  development banks
• 1980s half of development banks reporting 50
  or more of loans in arrears
• Numerous lending restrictions, very low interest
  rate ceilings
• Possible solution allow market to determine
  nominal interest rates

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Market failures in developing countries Public
goods and externalities

• Public good monitoring of financial
  institutions
• Externalities
• Monitoring, selection and lending
• Financial disruption

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Market failures in financial markets lack of
information

• Missing and Incomplete markets
• Imperfect competition
• Inefficiency of competitive markets in financial
  sector
• Uninformed investors