The Efficiency of Financial Systems, Liberalization, and Economic Development

Abstract

For at least twenty years, mainstream development economists have argued that financial liberalization is the road to higher levels of domestic savings/investment and more efficient allocation of capital. Efficiency is thus clearly associated with a more liberalized, deregulated financial system. This argument, in turn, is implicitly based on the dominant view on the working of financial markets that is, that financial institutions can be pictured as mere intermediaries between savers and investors. Further, the argument also relies on the view that the prices of financial assets reflect the underlying conditions of the final issuers of such assets, a view that has more recently been formalized as the efficient market hypothesis. If financial markets are the loci of allocation of capital, and asset prices are shown to guide savers toward investment with the highest productivity, financial markets are efficient allocators of capital. The aim of this article is to present a critical assessment of the concept of macroeconomic efficiency usually implicit in most mainstream analyses, and, therefore, of the financial liberalization hypothesis. Furthermore, this critical appraisal will be the basis upon which we will attempt to build an alternative Post Keynesian view of the role of the financial system in economic development. Such a view is concerned not so much with answering established questions (such as, Should we liberalize or not, and how rapidly?), as with presenting a set of other relevant, but often forgotten, ques