UBC Theses and Dissertations

UBC Theses Logo

UBC Theses and Dissertations

A study of the relationships between money financial markets and economic growth Lang, Eva Maria 1970

Your browser doesn't seem to have a PDF viewer, please download the PDF to view this item.

Item Metadata

Download

Media
831-UBC_1971_A8 L35.pdf [ 6.13MB ]
Metadata
JSON: 831-1.0093317.json
JSON-LD: 831-1.0093317-ld.json
RDF/XML (Pretty): 831-1.0093317-rdf.xml
RDF/JSON: 831-1.0093317-rdf.json
Turtle: 831-1.0093317-turtle.txt
N-Triples: 831-1.0093317-rdf-ntriples.txt
Original Record: 831-1.0093317-source.json
Full Text
831-1.0093317-fulltext.txt
Citation
831-1.0093317.ris

Full Text

A STUDY OF THE RELATIONSHIPS BETWEEN MONEY, FINANCIAL MARKETS AND ECONOMIC GROWTH by EVA MARIA LANG A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF ARTS i n the Department of Economics We accept t h i s the s i s as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA November, 1970 In p r e s e n t i n g t h i s t h e s i s i n p a r t i a l f u l f i l m e n t o f t h e r e q u i r e m e n t s f o r a n a d v a n c e d d e g r e e a t t h e U n i v e r s i t y o f B r i t i s h C o l u m b i a , I a g r e e t h a t t h e L i b r a r y s h a l l make i t f r e e l y a v a i l a b l e f o r r e f e r e n c e a n d s t u d y . I f u r t h e r a g r e e t h a t p e r m i s s i o n f o r e x t e n s i v e c o p y i n g o f t h i s t h e s i s f o r s c h o l a r l y p u r p o s e s may be g r a n t e d by t h e H e a d o f n y D e p a r t m e n t o r by h i s r e p r e s e n t a t i v e s . I t i s u n d e r s t o o d t h a t c o p y i n g o r p u b l i c a t i o n o f t h i s t h e s i s f o r f i n a n c i a l g a i n s h a l l n o t be a l l o w e d w i t h o u t my w r i t t e n p e r m i s s i o n . D e p a r t m e n t o f Economics T h e U n i v e r s i t y o f B r i t i s h C o l u m b i a V a n c o u v e r 8, C a n a d a D a t e November 12, 1970 A B S T R A C T This study i s concerned with the causal r e l a t i o n s h i p between money, f inance and growth. In the f i r s t chapter , some of the e m p i r i c a l research on the subject i s d i scussed. I t e s tab l i shes evidence of a p o s i -t i v e dependence between r e a l and f i n a n c i a l growth. The f indings do not , however, exp la in the d i r e c t i o n of c a u s a l i t y . In the second and t h i r d chapters , the cause-effect r e l a t i o n s h i p i s therefore analyzed i n theore-t i c a l terms. The theory i s based on a bar te r system i n t o which money, and subsequently d i r e c t and i n d i r e c t f i n a n c i a l markets, are introduced. The ob j ec t ive i s to determine whether these innovations are l i k e l y to induce increases i n the e q u i l i b r i u m growth rate o f an economy. I f e i t h e r or both increase growth i t fol lows that money and/or f inance i s causa l . At the same t ime, these markets would acquire great p r a c t i c a l s i g n i f i c a n c e for the development process . The ana lys i s refutes the hypothesis of c a u s a l i t y from money and f i n a n c i a l markets to growth. Neither steady s tate growth rates can be shown to increase , nor savings r a t e s . The-sole s i g n i f i c a n t e f f ec t of both innovations appears to be a r i s e i n income-per-capita l eve l s but not i n t h e i r rates of growth. The concluding chapter uses the r e s u l t s of the theory for d e r i v i n g p o l i c y recommendations for Tha i l and . At f i r s t , p o l i c y ob jec t ives are de-f i n e d and t h e i r imp l i ca t ions for the optimal savings r a t i o . A c t u a l Thai data are then compared with the optimum c o n d i t i o n and i t i s found that past performance may s a t i s f y long-term savings objectives-.--The study concludes by est imating the r e l a t i v e s i ze o f output, due to i n e f f i c i e n c y i n the present s t ructure and performance o f the f i n a n c i a l sector i n T h a i l a n d . E x i s t i n g i n e f f i c i e n c i e s are shown to be s i g n i f i c a n t , thus n e c e s s i t a t i n g p o l i c y changes. Page ABSTRACT i i LIST OF TABLES V LIST OF CHARTS v i Chapter I . EMPIRICAL EVIDENCE ON FINANCE AND GROWTH 1 I I . MONEY, FINANCE AND GROWTH . . 16 I I I . FINANCIAL MARKETS AND GROWTH 75 IV. SOME EMPIRICAL NOTES ON OPTIMALITY AND EFFICIENCY IN THAILAND 97 BIBLIOGRAPHY • 133 APPENDIX 141 L I S T OF TABLES I - l RELATIONSHIP BETWEEN THE .EFFECTIVENESS OF FINANCIAL INSTITUTIONS, GNP PER C A P I T A , AND THE RATES OF.GROWTH OF GNP FOR 73 SELECTED COUNTRIES (1950-1964) 9 I I - l MONETIZ ATION E F F E C T S FOR A CLOSED AND AN OPEN ECONOMY . 64 I V - 1 RESERVE HOLDINGS OF THE. BANK OF THAILAND I N RELATION TO TRADE FLOWS AND GROSS NATIONAL PRODUCT FOR THE PERIOD 1957 t o 1967 .113 I V - 2 RELATIONSHIP BETWEEN .TOTAL MONETARY RESERVES, THE BALANCE OF PAYMENTS FOR 1957-1967 , AND INVESTMENT FOR 1963-1967 . . . .114 LIST OF CHARTS Chart Page 1-1 RATE AND FORM .OF HOUSEHOLD SAVINGS IN FOUR ECAFE COUNTRIES (1954-1959) 14 IV-1 PERCENTAGE OF CURRENCY.HELD BY PUBLIC TO MONEY SUPPLY .122 IV-2 PERCENTAGE OF DOMESTIC CREDIT TO NATIONAL INCOME . . .122 EMPIRICAL EVIDENCE ON FINANCE AND GROWTH A. Introduct ion Economic growth appears to be the declared ob jec t ive of a l l nations and p a r t i c u l a r l y o f the le s s developed count r i e s . Per c a p i t a income growth requires c a p i t a l accumulation which i n turn depends upon the l e v e l and rate of savings . Investment and savings are thus s t r a t e g i c v a r i a b l e s i n the process of development to higher income l e v e l s . The present study focuses on those economic factors which connect the borrowing and lending s ides of the saving-investment sec tor : money and the f i n a n c i a l system. The ob jec t ive of t h i s paper i s to determine the importance of these markets i n the growth process . Money and f inance acquire t h e o r e t i c a l and p r a c t i c a l s i g n i f i c a n c e i f one or both of the fo l low-ing funct ions i s achieved by the f i n a n c i a l s ec tor : 1. A permanent r i s e i n the savings r a t e . 2. An improvement i n the e f f i c i e n c y of the a l l o -c a t i o n of resources given the l e v e l of savings . At f i r s t , some d i r e c t l y per t inent empi r i ca l research i s reviewed and evaluated i n terms of the above two p r o p o s i t i o n s . I n i t i a l l y , i t was hoped to obta in some i n d i c a t i o n as to the d i r e c t i o n of c a u s a l i t y between f inance and growth. However, the r e s u l t s of these i n t e r n a t i o n a l s tudies proved inconc lus ive and made i t thus impossible to base subsequent work on the e m p i r i c a l f i n d i n g s . In a negative way, they prescr ibed the analy-t i c a l s t ruc ture for the main par t of t h i s paper. I t became obvious that a theory about the r e l a t i o n s h i p between finance and growth should most appropr ia te ly be i n i t i a t e d by an ana lys i s of a non-monetized economy. By in t roduc ing money and f i n a n c i a l intermediar ies stepwise i n t o the bar ter system, the economic e f fec t s of both changes can be analyzed most c l e a r l y . In a d d i t i o n , t h i s approach seems to y i e l d the i d e n t i f i c a t i o n of the c r u -c i a l factors determining the causal nature i n the process of r e a l and f i n a n c i a l growth. B. Review o f L i t e r a t u r e There obvious ly ex i s t s some r e l a t i o n s h i p between a country ' s f i n -a n c i a l s t ructure and i t s stage of economic growth. Any d e f i n i t i o n of a stage i n the development of a country ' s economy mentions money, c a p i t a l markets, and f i n a n c i a l i n s t i t u t i o n s . G e n e r a l l y , more complex f i n a n c i a l markets are associated with "h igher" stages of growth, although t h i s asso-c i a t i o n i s ne i ther c l e a r nor unambiguous. I t avoids a r igorous d e f i n i t i o n of both f i n a n c i a l s t ructures and economic growth which i s a p recond i t ion for any ana lys i s of the mutual i n t e r r e l a t i o n s h i p . The c e n t r a l problem i s , there fore , not so much whether a r e l a t i o n -ship between finance and growth e x i s t s , but how these two var i ab le s a f f ec t each other . In func t iona l form, the problem can be expressed as the fo l lowing a l t e r n a t i v e s : (a) Y* = f I K ( t ) , L ( t ) , A( t ) ] (b) F(t ) = g[ (Y/LXt) , Y*J (c) S(t) = h l Y / L ( t ) ] with h = const . (a') Y * ' = f ' l F ( t ) , K ( t ) , L ( t ) , A( t ) ] (b') (Y/L) (t) = g ' [ F ( t ) , F * , ' , K ( t ) , L ( t ) , A( t ) ] (c 1) (S/Y)(t) = h ' [ F ( t ) ] where * dY(t) L ( t ) . dL(t) ' Y ( t ) ' * <2F(t) F - -F ( t ) ' Y = t o t a l output; = c a p i t a l s tock; L = labor fo rce ; F = s i ze and complexity of the f i n a n c i a l system i n r e l a t i o n to n a t i o n a l wealth;^" A = exogenous t e c h n i c a l progress f ac tor ; S = aggri savings . The f i r s t formulat ion assumes that the s i ze and the growth of f i n a n c i a l markets depend upon the rate of growth of output and i t s absolute l e v e l and that savings are a constant r a t i o of income per c a p i t a . The second reverses the d i r e c t i o n of c a u s a l i t y : f i n a n c i a l markets are assumed to "*"How t h i s should be measured need not concern us here . represent c a t a ly s t s i n the process o f development, determining s i g n i f i c a n t -l y the rate of growth of output and inducing increases i n the rates of saving. This paper attempts to i d e n t i f y those economic fac tors which al low us to exp la in the cause-effect r e l a t i o n s h i p . Should the ana lys i s i n t h i s and the fo l lowing chapters show that the f i n a n c i a l s t ructure merely pre-sents a mir ror image of a l e v e l of economic development a lready reached (equations a , b and c) f i n a n c i a l p o l i c i e s could be c l a s s i f i e d as o f second-ary importance fo r r a i s i n g rates of income growth. I f , on the other hand, f i n a n c i a l i n s t i t u t i o n s appear to be more appropr ia te ly expla ined as factors determining growth over time (equations a ' , b ' and c 1 ) the formulat ion of opt imal f i n a n c i a l p o l i c i e s would acquire great opera t iona l s i g n i f i c a n c e . A priorij i t can be s a i d , that a simple answer for one or the other a l t e r -nat ive should not be expected. The problem i s too complex to be compre-hens ive ly dea l t with i n a r e l a t i v e l y short paper l i k e t h i s . To gain some f i r s t i n s i g h t i n t o the causal nature of the r e l a t i o n -ship between f i n a n c i a l markets and growth we can b r i e f l y review the f i n d -2 ings of three s tudies on the sub jec t , by Goldsmith, Adelman and T a f t -3 4 Morrxs , and a United Nations repor t . R. W. Goldsmith, "The Determinants of F i n a n c i a l S t r u c t u r e , " Orga-n i s a t i o n for Economic Cooperation and Development (O.E.C.D.)} Study No. 2, (1965) . 3 I. Adelman and C. T a f t - M o r r i s , Society, P o l i t i c s and Economic De-velopment (Balt imore: The Johns Hopkins Press , 1967). 4 United Nat ions , Economic Bulletin for Asia and the Far East (Dec-ember 1962), pp. 1-15; r e s u l t s r e p r i n t e d i n A . A. Rozenthal , "Unorganized F i n a n c i a l Markets and Development S t ra tegy , " Journal of Developing Areas3 V o l . I (July 1967). The Goldsmith study i s concerned with the determinants of f i n a n c i a l s t ruc ture . The author t r i e s to measure the r e l a t i o n between the value 5 and the change of t o t a l f i n a n c i a l assets and n a t i o n a l weal th . The Gold-smith data show that dur ing economic development, countr ies u sua l ly ex-. -perience more r a p i d growth i n f i n a n c i a l assets than i n n a t i o n a l wealth or n a t i o n a l product . In other words, the e l a s t i c i t y of demand fo r f i n -a n c i a l assets was found to exceed un i ty for income and wealth. Nat iona l stocks of f i n a n c i a l assets v a r i e d from 10 to more than 200 per cent of n a t i o n a l r e a l wealth. The countr ies wi th the lowest per c a p i t a income genera l ly a l so had very low r a t i o s of f i n a n c i a l to r e a l wealth, with the values between 10 and 15 per cent . For countr ies with higher income per c a p i t a l l e v e l s , the r a t i o ranged from 30 to 60 per cent , whereas the r a -t i o s for i n d u s t r i a l i z e d nations such as France, West Germany, the United S ta tes , and Canada were 80 to 100 per cent . The highest r a t i o s were found for Japan (150 per cent ) , Switzer land (200 per c e n t ) , and the Uni ted Kingdom (215 per cent ) . ^ For the Soviet Union t h i s r a t i o amounted to only 35 per cent . This l a s t f igure ind ica te s that although d i f ferences i n income per cap i t a account fo r parts o f the vary ing l e v e l s of f i n a n c i a l wealth r a t i o s , the form o f economic and p o l i t i c a l organiza t ion i n any His FIR or " f i n a n c i a l i n t e r r e l a t i o n s r a t i o " i s a composite of sev-e r a l determinants which inc lude gross n a t i o n a l product , a monetizat ion r a t i o , a c a p i t a l formation r a t i o , the r a t i o of new issues of n o n - f i n a n c i a l un i t s to t h e i r c a p i t a l formation, the r a t i o of new issues of f i n a n c i a l i n -struments by f i n a n c i a l i n s t i t u t i o n s to new issues by n o n - f i n a n c i a l u n i t s , the r a t i o of t o t a l i s sues of f i n a n c i a l instruments to the issues of non-f i n a n c i a l u n i t s , and others . Goldsmith, op. cit., p . 2. country a l so p lays a major r o l e , i . e . , the degree to which a government chooses to l i m i t or to encourage f i n a n c i a l in te rmedia t ion . There are b a s i c a l l y two d i f f e r e n t techniques for m o b i l i z i n g sav-ings for c a p i t a l accumulation: processes o f i n t e r n a l f inance and of ex terna l f inance . In the former, inves tors draw on t h e i r own savings , i n the l a t t e r they use savings of o ther s . The methods of s e l f - f i n a n c e , where savings are channeled to inves tors by adjustments i n r e l a t i v e p r i -ces i n commodity and fac tor markets and/or i n markets fo r fore ign exchange, belong to the category of i n t e r n a l f inance processes . Furthermore, the technique of f inanc ing development through taxa t ion or i n f l a t i o n repre-sent i n t e r n a l f inance methods. A l l these non-market methods are excluded from the subsequent d i s c u s s i o n . We concentrate on the process of exter-n a l f inance and i t s r e l a t i o n s h i p to development. Along with fore ign a i d , the debt-asset system cons t i tu te s the p r i n c i p a l method of ex terna l f inance . Since a i d i s l a r g e l y outs ide the c o n t r o l of domestic p o l i c y makers i n the development count r i e s , we a l so exclude i t . Our concern i s d i r e c t e d to market economies which r e l y on decent ra l i zed dec i s i on making. In other words, by d i s cus s ing the debt-asset system o f i n d i r e c t f inance we hope to f i n d out whether and how a f i n a n c i a l system inf luences the other sec-t o r i n a growing economy. Given t h i s ob jec t ive we can d i s regard e m p i r i c a l data l i k e that for the Soviet Union because i t obvious ly does not belong i n t o the context of a market economy. In genera l , the Goldsmith study shows a p o s i t i v e and increa s ing r a t i o between f i n a n c i a l development and r e a l growth for market type economies, thus supporting our hypothesis (a), (b)) and (c) above. I t i s not obvious, however, whether the observed c o r r e l a t i o n s r e f l e c t merely higher l e v e l s of income or whether the process of asset accumulation, by i t s e l f , contr ibuted to the attainment of these higher per c a p i t a incomes. The second study by Adelman and T a f t - M o r r i s , e n t i t l e d Society, 1 Politics and Economic Development, focuses more on the dynamic proper-t i e s of f i n a n c i a l systems and seems, there fore , be t t e r s u i t e d to provide an explanat ion to the problem. To measure the e f fect iveness of f i n a n c i a l i n s t i t u t i o n s , two i n d i c a t o r s are se lec ted to represent the long run l e v e l and the short term improvement i n the e f fect iveness of the f i n a n c i a l sys-Q tem. In each case a composite v a r i a b l e i s constructed to show the success of f i n a n c i a l intermediar ies i n a t t r a c t i n g p r i v a t e savings and the extent to which they provide medium and long term c r e d i t i n the major sectors of the economy. The fo l lowing tables are based on the Adelman and Ta f t -Morr i s f i n d -ings for the two f i n a n c i a l i n d i c e s , " e f f ec t ivenes s " and "improvement of f i n a n c i a l system." The authors d i v i d e d the 73 nations s tudied in to three ca tegor ie s : A , B, and C. Those countr ies i n which f i n a n c i a l i n s t i t u t i o n s Adelman and T a f t - M o r r i s , op. cit., pp. 120-27. 3 The f i r s t index of long run improvement i n the e f fect iveness of the f i n a n c i a l system includes two v a r i a b l e s , for which there are d i r e c t est imates : the flow of i n t e r n a l savings through a country ' s f i n a n c i a l system, measured by the gross domestic savings r a t i o , and the r a t i o of the sum of time and demand deposits by money to GNP. A t h i r d , theore-t i c a l l y important element i s added i n the form of an estimate o f the flow of c a p i t a l from the banking system i n t o medium and long term investment. Unfor tunate ly , there i s too l i t t l e r e l i a b l e s t a t i s t i c a l information to a t t r i b u t e much weight on t h i s v a r i a b l e . The second index measures the improvement i n f i n a n c i a l i n s t i t u t i o n s and i s based on the increase i n the volume of p r i v a t e savings through the banking system and the volume of l ending by banks to the p r i v a t e sec tor . are at l e a s t "moderately e f f e c t i v e " were c l a s s i f i e d under A . As pre-r e q u i s i t e fo r q u a l i f y i n g i n t h i s A group countr ies needed to have both the r a t i o of time and demand deposits plus money exceed 30 per cent . Furthermore, the gross savings r a t i o had to be greater than 13 per cent , for A - c o u n t r i e s . In the B group, f i n a n c i a l i n s t i t u t i o n s are def ined to p lay a smal ler but not i n s i g n i f i c a n t r o l e , while i n the countr ies under C f i n a n c i a l in termediar ie s a t t r a c t only a n e g l i g i b l e volume of domestic p r i v a t e savings . Domestic a v a i l a b i l i t y of c r e d i t i s minimal . The second index measuring the improvement i n f i n a n c i a l i n s t i t u t i o n s , i s again sub-d i v i d e d i n t o three groups: marked - moderate - no s i g n i f i c a n t improvement. Subs tant i a l improvement was def ined as e i t h e r an increase of more than f i v e per cent i n the r a t i o of time and demand deposits i n r e l a t i o n to gross n a t i o n a l product , or a more than f i v e - f o l d increase i n the r e a l value of p r i v a t e domestic l i a b i l i t i e s to the banking system for the per-iod 1950-1961. We supplemented the Adelman-Taft-Morris f indings by data on the l e v e l o f income per capita' .and i t s rate o f growth fo r a l l the countr ies i n t h e i r sample. Since these countr ies broadly belong to the c l a s s of market economies, the r e s u l t s should be i n d i c a t i v e for our i n -v e s t i g a t i o n . RELATIONSHIP BETWEEN THE EFFECTIVENESS OF FINANCIAL INSTITUTIONS, GNP PER CAPITA, AND THE RATES OF GROWTH OF GNP • FOR 73 SELECTED COUNTRIES (1950 - 1964) ^ . : LIST OF COUNTRIES GNP GROUPED ACCORDING PER RATES OF GROWTH IMPROVEMENT INDEX IN TO THE LEVEL CAPITA OF GNP FINANCIAL INSTITUTIONS OF EFFECTIVENESS OF FINANCIAL INSTITUTIONS (1964) (1960-64) (1950-64) (1950/51 - 1962/63) GROUP A Argent ina 780 B r a z i l 240 Greece 660 I s r a e l 1,160 Jamaica 460 Japan 860 Lebanon 480 Mexico 470 South A f r i c a 550 T r i n i d a d 630 Venezuela 850 GROUP B A l g e r i a 220 Ceylon 150 C h i l e 510 Columbia 280 Costa Rica 400 Cyprus 690 Ecuador 190 E l Salvador 270 Ghana 230 India 90 Iran 250 Iraq 270 Ivory Coast 220 Jordan 220 Kenya 90 Marocco 170 Nicaragua 330 N i g e r i a 80 Pakis tan 90 Panama 500 2.0 2.9 marked 4.3 5.6 some 8.5 6.4 marked 10.8 10.2 marked 4.7 7.3 some 9.0 7.3 marked 8.5 5.2 some 6.2 5.9 some 4.2 6.2 marked 6.8 8.9 marked 5.0 6.6 marked 1.6 6.1 none 2.9 3.4 marked 3.5 3.5 some 4.8 4.6 some 4.6 4.8 some 2.6 4.0 marked 4.0 4.5 some 12.1 6.8 some 3.7 4.0 none 4.4 3.7 marked 3.8 4.8 marked 6.2 9.4 • some 4.5 4.8 some 11.2 8.2 marked 4.3 5.0 none 3.4 2.2 some 10.1 6.4 marked 4.5 4.0 some 5.4 3.5 marked 8.1 5.6 some LIST OF COUNTRIES GNP GROUPED ACCORDING PER RATES OF GROWTH IMPROVEMENT INDEX IN TO THE LEVEL CAPITA OF GNP FINANCIAL INSTITUTIONS OF EFFECTIVENESS OF FINANCIAL INSTITUTIONS (1964) (1960-64) (1950-64) (1950/51 - 1962/63) Peru 320 7.2 5.7 marked P h i l i p p i n e s 160 4.7 5.4 marked Rhodesia 210 3.5 5.7 marked Senegal 210 - - none South Korea 150 5.6 6.1 marked South Vietnam 120 5.0 3.5 some Sudan 100 4.6 5.2 marked Surinam 360 2.8 6.1 none S y r i a 180 11.5 5.5 marked Taiwan 230 8.2 7.4 marked" Thai land 130 6.9 6.3 marked T u n i s i a 200 5.8 3.9 not shown Turkey 280 4.0 4.6 marked Uganda 100 3.3 3.7 none United Arab Republic 160 6.4 5.6 not shown Uruguay 510 .2 .7 none GROUP C Afghanis tan* 70 B o l i v i a 160 Cambodia 120 Cameroon 110 Chad 70 Dahomey* 80 Dominic. Republic 250 E t h i o p i a 60 Gabon* 400 Guatemala 320 Guinea* 80 Honduras 220 Indonesia* 100 Laos* 70 3.5 3.5 none 4.9 1.9 some 4.0 5.7 some 1.2 1.0 some - none 1.3 1.5 none 3.2 6.0 some 3.7 4.1 none 4.0 - none 6.1 4.4 marked .1 .3 none 4.3 3.7 marked 4.8 4.3 none 3.5 2.5 none No ready GNP per cap i t a data were a v a i l a b l e and had to be computed from sources (4) and (5). LIST OF COUNTRIES GNP m IMPROVEMENT INDEX IN GROUPED ACCORDING PER RATES OF GROWTH „ , . „ , „ „ , . , , . T „ „ m T m „ m T „ „ r , FINANCIAL INSTITUTIONS TO THE LEVEL CAPITA OF GNP OF EFFECTIVENESS OF FINANCIAL INSTITUTIONS (1964) (1960-64) (1950r64) (1950/51 - 1962/63) L i b e r i a * 210 6.5 5.5 none Malagasy* 80 .7 .5 none Malawi 50 1.0 3.4 none Nepal* 70 5.3 4.8 none Niger * 80 - - none Paraguay 200 3.5 3.0 none S i e r r a Leone* 150 5.6 4.8 none Somali Republ ic * 50 .5 .2 none Tanganyika 90 3.3 3.2 some Yemen* 90 6.1 5.8 none Zambia 180 3.4 4.2 none No ready GNP per cap i t a data were a v a i l a b l e and had to be computed from sources (4) and (5). SOURCES: "'"Adelman .and T a f t - M o r r i s , op. cit., pp. 118-120. 2 Benjamin Higg ins , Economic Development, Revised E d i t i o n (New York: W. W. Morton, 1968), pp. 506. 3 Finance and Development, V o l . VI (March 1969), pp. 30-42. 4Worldmark, Encyclopedia of Nations, V o l s . II and IV (New York, 1967). 5 United Nat ions , Statistical Yearbook (New York, 1967). The data revea l a genera l ly c lose correspondence between the l e v e l of e f fect iveness of f i n a n c i a l i n s t i t u t i o n s and per c a p i t a income l e v e l s . In the case of the f i n a n c i a l improvement index and income per cap i t a the c o r r e l a t i o n i s by far l e s s c l e a r . Seven out o f 11 countr ies i n the A-group with the r e l a t i v e l y h ighes t income l e v e l s per head show marked improvements i n t h e i r f i n a n c i a l systems, but only 16 out of 36 c l a s s i f i e d under B. The l e a s t number o f "marked improvements" was found for Group C for merely two out of 26 count r i e s . Taking in to account that f i n a n c i a l improvement depends not only on the l e v e l s of output but a l so on the rates of growth of the economy, these r e s u l t s are not very s u r p r i s i n g . One would expect that a r a p i d o v e r a l l growth rate induces a high demand for f i n a n c i a l in te rmedia t ion , and that a s t a t i s t i c a l e s t i -mation of the c o r r e l a t i o n c o e f f i c i e n t s should give s i g n i f i c a n t r e s u l t s for both f i n a n c i a l ind ice s and for the two growth rate s e r i e s . How-ever , our experimentation with d i f f e r e n t regress ion equations d i d not produce the a n t i c i p a t e d good f i t . A major reason could be a t t r i b u t e d to the f ac t that the dependent v a r i a b l e i n the est imation equat ion, namely the f i n a n c i a l i n d i c e s , could only be expressed i n terms o f a dummy v a r i a b l e for lack of numerical s p e c i f i c a t i o n i n the Adelman -Ta f t -Morr i s study. Another re levant fac tor which accounts p a r t i a l l y fo r the unsa t i s f ac tory r e s u l t s may be the absence of an appropriate breakdown o f n a t i o n a l growth rates i n t o s e c t o r a l r a te s . I t i s obvious that a great var iance i n rates among d i f f e r e n t indus t r i e s causes a greater need for f i n a n c i a l i n s t i t u t i o n s to t rans fe r funds from the slow growing to the f a s t growing i n d u s t r i e s . Moreover, the s e c t o r a l d i s t r i -but ion o f saving and investment, the rate of i n f l a t i o n , and p o l i t i c a l and h i s t o r i c a l inf luences p lay a pa r t but escape measurement. The A d e l -man and Ta f t -Morr i s study does, there fore , not g rea t ly improve our under-standing of the i n t e r r e l a t i o n s h i p between f inance and growth. T h e i r r e -s u l t s confirm and extend the Goldsmith f i n d i n g s : nat ions with lowest per cap i t a incomes appear to have the l e a s t e f f i c i e n t and improving f i n a n c i a l s t r u c t u r e s . Whether t h i s impl ies a d i r e c t i o n of c a u s a l i t y as i n our f o r -mulation a ' , b 1 , and c 1 above, i . e . , from f i n a n c i a l growth to r e a l growth i s s t i l l unc lear . The Uni ted Nations report which a l so deals with the cause-effect 9 i s sue i s more suggestive although again not conc lu s ive . In a number of ECAFE count r i e s , savings rates were r e l a t e d to the composition i n which these savings were h e l d . Only two broad c lasses were examined: measur-able holdings i n r e a l versus f i n a n c i a l w e a l t h . ^ The chart on the fo l low-ing page shows the r e s u l t s fo r the years 1954-59. I t i n d i c a t e s a r e l a t i v e l y high degree of c o r r e l a t i o n between c a p i t a l formation and f i n a n c i a l growth. However, t h i s information alone cannot demonstrate r i g o r o u s l y that a greater spread o f f i n a n c i a l i n s t i t u -t ions w i l l lead to increases i n savings rates and through t h i s to r i s e s i n rates of output growth. I t i s qu i te p o s s i b l e , that the observed i n -crease i n the savings r a t i o s p a r t i a l l y r e f l e c t s a reduct ion of household 9 Uni ted Nat ions , op. ctt. 3 p . 9. The percentage of household savings i s r e l a t e d to personal dis-posable income and compared to the r a t i o of saving i n f i n a n c i a l assets to t ang ib le assets . CHART I - l RATE AMD FORM OF HOUSEHOLD SAVINGS IN FOUR ECAFE COUNTRIES (1954 - 1959) 8 o o c 01 o cu 0) rrj C O CO U CU 0* o •p tr a -iH > ro to TJ rH O CU (fl O X M-4 O CU 0> ret •P C cu o rt CU CU 0 1 2 3 Ratio o f Saving i n F i n a n c i a l Assets to Saving i n Tangible Assets Key: •Ceylon - X Federat ion o f Malaya Japan - A P h i l i p p i n e s - • Four Countr ies - O Source: Uni ted Nat ions , op. cit., p . 9. holdings of tang ib le assets . In other words, estimated savings rates i n the beginning of the per iod s tudied may understate the propens i ty to save because of s t a t i s t i c a l measurement d i f f i c u l t i e s of t ang ib le assets . With t h i s hypothesis the l i n e s of the diagram would have a l e s se r p o s i -t i v e slope than those shown. For constant savings r a t i o s they would, obvious ly , be p a r a l l e l to the h o r i z o n t a l a x i s . Since we are not i n a p o s i t i o n to reso lve t h i s problem e m p i r i c a l l y , we s h a l l d iscuss i t fur ther i n Chapter I I I , where the t h e o r e t i c a l e f fec t s of f inance on output and growth are analyzed. The explanatory value of the examined evidence was poor. We only obtained a conf irmat ion of the a pvioTi expectat ion that a p o s i t i v e r e l a t i o n s h i p between f i n a n c i a l and r e a l development appears to e x i s t . For the d i r e c t i o n of c a u s a l i t y , from finance to growth and the extent of the mutual i n t e r a c t i o n between a l l re levant f ac tor s , no s a t i s f a c t o r y answer could be found. What i s r equ i red , there fore , i s a theory l i n k i n g f i n a n c i a l markets to the r e a l v a r i a b l e s of the system. As already noted i n the i n t r o d u c t i o n , the best s t a r t i n g po in t for such a t h e o r e t i c a l ana lys i s i s a bar ter economy. In our context of developing countr ies t h i s choice i s p a r t i c u l a r l y re levant s ince elements of bar ter trade can s t i l l be observed i n vary ing degrees i n these na t ions . Indeed, one of the questions we hope to answer as a r e s u l t of the fo l low-ing ana lys i s i s that the e l i m i n a t i o n of bar ter enclaves i n otherwise monetized economies i s l i k e l y to be economical ly more e f f i c i e n t than the r e t e n t i o n of ba r te r . MONEY, FINANCE AND GROWTH * Preface The fo l lowing two chapters are concerned wi th the t h e o r e t i c a l irn-^ portance of money and an e f f i c i e n t system of f i n a n c i a l markets. Specifid-e a l l y , we attempt to show tha t : 1. The use of money increases e f f i c i e n c y i n the resource a l l o c a t i o n process . Income per cap i t a w i l l conse-r quently r i s e to a new e q u i l i b r i u m l e v e l . 2. The emergence o f f i n a n c i a l markets represents a t e c h n o l o g i c a l improvement over a simple state of monetiza--t i o n . I t a l so increases the l e v e l of income per c a p i t a . 3. The steady s tate growth rates w i l l not change due to e i t h e r money and f i n a n c i a l markets. The same holds for the savings rates a f ter both innovat ions . The ea s i e s t way to prove these propos i t ions i s by ana lyz ing them separate^-l y . We therefore deal at f i r s t i n Chapter II with the invent ion and im-. plementation of a commodity money standard. An extension to a paper money system could then be e a s i l y added. I t i s omitted because none o f the r e s u l t s from d i scus s ing a commodity money would change s u b s t a n t i a l l y . * This preface serves as an i n t r o d u c t i o n fo r t h i s chapter and a l so for Chapter I I I . In Chapter I I I , the e f fects of the i n t r o d u c t i o n of d i r e c t and i n d i r e c t f i n a n c i a l markets are analyzed. For exposi tory convenience i t w i l l be assumed that both t echno log i ca l invent ions occur separate ly at a s p e c i f i c po in t i n t ime. In Chapter II we are f i r s t concerned with the quest ion of how and when an e x i s t i n g c a p i t a l good w i l l be se lec ted to funct ion as commodity money. Therea f ter , the e q u i l i b r i u m condi t ions o f t h i s new money market are der ived . This leads i n t o a d i s cus s ion of the o p t i m a l i t y condi t ions for the money supply under a commodity money standard. The r e s u l t s of the money markets are then used and extended for ana lyz ing the g l o b a l e f fec t s of monetizat ion on product ion and trade i n a c losed economy. A f t e r having e s t ab l i shed the comparative s t a t i c e q u i l i b r i u m c o n d i t i o n s , the dynamic e f fec t s o f the change are considered. At l a s t a s ec t ion on the e f fec t s of monetizat ion i n an open economy i s added. The conclusions from the monetizat ion stage of the model form the assumptions fo r the ana lys i s of d i r e c t and i n d i r e c t f i n a n c i a l markets. Put d i f f e r e n t l y , i t w i l l be assumed that an e f f i c i e n t f i n a n c i a l system i s superimposed on the a lready monetized economy. Chapter I I I then deals with the r e s u l t i n g i n i t i a l d i s e q u i l i b r i u m and the convergence of the econ-omy to a new steady s ta te . I t w i l l be shown that f i n a n c i a l markets are of p a r t i c u l a r importance for the saving—investment sector of an economy and that other economic e f fec t s can be explained as o r i g i n a t i n g i n t h i s sec tor . I m p l i c i t , i n our way of analyz ing the impact o f money and finance i s the ob jec t ive to separate the two major functions o f these markets: the admini s t ra t ion of a means of payment and the p r o v i s i o n of c r e d i t func t ion . Before starting the investigation, our hypotheses are repeated in diagrammatic .form: The diagram with time units on the horizontal axis, and the logar-ithms of total output per capita on the vertical axis, relates output growth rates to the incidence of the two financial changes. As mentioned, they are assumed to occur at the a r b i t r a r i l y chosen point i n time t^ and t^. From the linear segment of the curve AB i t i s obvious that the econ-omy is assumed to grow at a constant equilibrium rate. At t^, when money is introduced, the old equilibrium i's disturbed. After the dynamic effects o f the change have worked themselves out, segment BC, the economy i s assumed to reach a new equilibrium growth path, CD. This assumption im-plies that the disequilibrium path is regarded as converging to a new steady state, or put differently, that money does not result in explosive or c y c l i c a l growth. We even go a step further by asserting that the value of the equilibrium output growth rate w i l l be i d e n t i c a l to the s i t u a t i o n p r i o r to monetization, or CD and AB are p a r a l l e l . The next disturbance occurs when i n d i r e c t financing i s superimposed on the money economy at t .' The system w i l l again go through a phase of dynamic adjustments, segment DE u n t i l a new equilibrium expansion rate i s attained. I t i s frequently asserted that t h i s l a t t e r steady state rate w i l l be higher than the pre-vious rates such as E F ' . However, our conclusions w i l l refute t h i s pro-p o s i t i o n . I t w i l l be shown below, that the lowest possible and most l i k e l y value f o r the new equilibrium rates i s the magnitude of the two previous steady state rates. Under c e r t a i n conditions which w i l l be s p e c i f i e d , higher rates are attainable. From the above f i g u r e , i t i s possible to measure the t o t a l i n -crease i n output for any period a f t e r the f i r s t and second f i n a n c i a l change."'" I t could then be compared to the t o t a l output that would have p r e v a i l e d i n the absence of these two innovations. While t h i s comparison can e a s i l y be made i n a hypothetical graph, i t would be extremely d i f f i -c u l t to compute i t for any r e a l economy. The t r a n s i t i o n from barter to a monetized state and p a r t i c u l a r l y the second move are accompanied by s u b s t a n t i a l changes i n the whole s t r u c t u r e of the economic system. To disentangle a l l the cause-effect r e l a t i o n s h i p s and a t t r i b u t e quantitative The output per c a p i t a gain due to monetization f o r the time when a new equilibrium i s attained i s shown as GC. The t o t a l increase i n aggre-gate income would then be GC times the population. The second gain due to i n d i r e c t finance i s shown at t ^ as EI compared to the barter state and as EK compared to the monetized state. For periods a f t e r t^ there may be a cumulative further gain, equal to the d i f f e r e n c e between the new steady state rate and the o l d one such as FF' f o r t q . measures to them exceeds by far the scope o f the present a n a l y s i s . Our e m p i r i c a l par t i n Chapter IV i s , there fore , r e s t r i c t e d to the d e r i v a t i o n of some p a r t i a l q u a n t i t a t i v e i n d i c a t o r s about the e f f i c i e n c y of f i n a n c i a l markets i n Tha i l and . Using ceteris paribus assumptions, we attempt to show how aggregate output could have increased i n one year i f f i n a n c i a l markets were operated with maximum e f f i c i e n c y . B. The Nature of the Barter Economy At f i r s t , a monetary theory o f our model country must be developed. To f a c i l i t a t e t h i s the m a i n . c h a r a c t e r i s t i c s of a ba r te r system are sum-marized. The product ive s t ructure of a bar te r economy i s , almost by d e f i -n i t i o n , very s imple. As w i l l be shown below, i t i s p r e c i s e l y the lack o f money that prevents more soph i s t i c a ted product ion and trade pa t te rns . As to the form of o r g a n i z a t i o n , bar ter need not be i d e n t i f i e d only with a hand ic ra f t system where resource owners produce and s e l l the complete products . This assumption i s of ten made or the even more r e s t r i c t e d one of a Hicks i an type of exchange economy. We s h a l l not confine ourselves to such a r t i f i c i a l s tates but work from the outset with a dynamic frame-work of an enterpr i se economy. In such an economy the serv ices of the product ive resources , c a p i t a l and l abor , are s o l d to entrepreneurs i n re turn for t h e i r products . The income of i n d i v i d u a l s thus cons i s t s of tha t quant i ty of goods which they rece ive for t h e i r s e r v i c e s . Exchange takes place -•-< domest ica l ly and i n t e r n a t i o n a l l y u n t i l a l l i n d i v i d u a l s have achieved maximum s a t i s f a c t i o n , i . e . , an optimum c o l l e c t i o n of goods g iven r e l a t i v e p r i c e s , i n i t i a l resource endowment, incomes, tastes and the i n s t i t u t i o n a l framework. In s table competit ive e q u i l i b r i u m p r i c e s can be measured e i t h e r i n terms of one of the commodities or as i n a W i c k s e l l i a n pure c r e d i t economy i n terms of an abstract u n i t of account. I t f o l l o w s , there fore , that only r e l a t i v e p r i c e s and accounting p r i c e s are de f ined ; not , how-ever , the absolute p r i c e l e v e l . I t i s a meaningless construct i n t h i s s t a te . Re l a t ive p r i c e s are determined by supply and demand i n the d i f -ferent markets. Accounting p r i c e s are f i x e d a r b i t r a r i l y . They are not observable market phenomena and t h e i r v a l u e , thus , independent of market fo rce s . P a t i n k i n appropr ia te ly re fe r s to the extraneous force which f i xe s the accounting p r i c e of one of the goods at the value of "one" as 2 "deus ex machina." The existence of a bar ter economy impl ies Say's i d e n t i t y , i . e . , that a l l excess demand funct ions w i l l always p r e c i s e l y add up to zero . This appl ies obvious ly to both domestic as w e l l as i n t e r n a t i o n a l t r ans -act ions . By neces s i ty goods are only sold to buy other commodities. The homogeneity postulate which i s the l o g i c a l equivalent to Say's i d e n -t i t y a l so ho lds . O v e r a l l economic p o l i c y as a regula tory device i s therefore non-ex i s t en t and unnecessary, provided the proper d i s t r i b u t i o n of income and wealth e x i s t s . Should i t not , a simple r e d i s t r i b u t i o n scheme of taxes and subs idies could be i n s t i t u t e d . We can thus p i c t u r e the barter s tate as fo l lowing a golden age path with, minimal government i n t e r v e n t i o n . Unem-ployment and c y c l i c a l business f luc tua t ions would also, .be a b s e n t , „ i n .such a s t a te . Don P a t i n k i n , Money3 Interest and Prices, Second Edition,CNew York: Harper and Row, 1965), p . 195. However, t h i s s u p e r f i c i a l p i c t u r e i s treacherous because ba r te r -ing i s c o s t l y . An economy r e l y i n g on i t suf fers from ser ious f r i c t i o n s i n i t s product ion and exchange, thus l i m i t i n g the extent of pos s ib le s p e c i a l i z a t i o n . The costs i n terms of l a b o r ' s time and s p e c i a l i z e d s k i l l s requ i red for bar te r t ransact ions w i l l l a r g e l y depend on the complexity of the product ion s t ruc ture . The smal ler and simpler the array of d i f f e r e n t goods produced and exchanged, the eas ier and less c o s t l y w i l l genera l ly be the t r a n s a c t i o n . As a t h e o r e t i c a l exerc i se , one could conceive a growth model for a bar ter economy i n which the growth rate of output dec l ines over time due to the existence of p o s i t i v e and i n c r e a s i n g l y large bar ter cos t s . The necessary assumptions would be: 1. Transact ions costs are considered a funct ion 3 of t o t a l output and i t s changes over t ime. This assumption impl ies that the a l l o c a t i o n of resources i s completely divorced from the incidence and l e v e l of b a r t e r i n g cos t s . 2. The rate o f increase of t r ansac t ion costs i s r e l a t e d to t o t a l output growth. 3. The standard assumptions about a n e o - c l a s s i c a l growth model with disembodied t e c h n o l o g i c a l progress . Define t h i s ra te of progress , or of increased s p e c i a l i z a t i o n , as s. Wealth and the l e v e l of t e c h n i c a l progress could a l so be i n -cluded as re levant f ac tor s . Three so lu t ions are conceptual ly p o s s i b l e : (a) i f the rate of progress s i s accompanied by a more than p r o p o r t i o n a l increase i n t r ansac t ion cos t s , t (t > s) pa r t of p o t e n t i a l output growth would be absorbed by t ransac t ion co s t s . Eventua l ly t h i s would r e s u l t i n a d e c l i n e i n t o t a l output . Thi s assumption could be j u s t i f i e d on the grounds that bar-ter costs are l i k e l y to grow more than propor t iona te ly a f t e r a c e r t a i n l e v e l of s p e c i a l i z a t i o n i n the product ion s t ructure and i n the volume of goods exchanged has been achieved; (b) i f t ransact ions costs grow s t e a d i l y but le s s than t e c h -n i c a l progress Ct < s ) , they w i l l merely reduce the rate of e q u i l i b r i u m growth by that f ac tor t . I f (c) both costs and progress grow at the same rate (t = s)^ the e q u i l i b r i u m growth rates would obvious ly be i d e n t i c a l to a s i t u a t i o n without any t e c h n i c a l progress . Per capi ta gains through increased s p e c i a l i z a t i o n would be p r e c i s e l y o f f s e t by growing t ransact ions cos t s . The d i s cus s ion i s not pursued fur ther here . In a modif ied form i t w i l l be taken up l a t e r when d i scus s ing the determination of the op-t ima l money supply. A dynamic model along the l i n e s sketched above suf fers from the serious shortcoming that i t assumes away a c r u c i a l aspect of development and growth: the h i s t o r i c a l l y observable chain r e a c t i o n of t e c h n i c a l im-provements i n one sector of the economy leading to innovat ions i n o ther s . The above ana lys i s i s b u i l t on the assumption that a payments arrangement which was presumably optimal at one po int i n time becomes subsequently i n e f f i c i e n t or suboptimal without generating i t s e l f s u f f i c i e n t c o n d i -t ions ' f o r improvement. I t could be asserted before bar ter becomes a s u b s t a n t i a l growth, re ta rd ing f ac tor i n any r e a l economy, human i n v e n t i v e -ness and entrepreneurship would most l i k e l y devise some•superior pay-ments arrangement which e l iminates the emerging i n e f f i c i e n c i e s . On r a t i o n a l i t y grounds, a means of payment — h i s t o r i c a l l y some "commodity money" — should come in to existence when the bar te r ing costs exceed the cost of us ing an e x i s t i n g c a p i t a l good as money. A second ser ious d e f i c i e n c y of the model i s the complete separat ion of the resource a l l o -c a t i o n process from the payment mechanism. This assumption cannot be j u s t i f i e d on t h e o r e t i c a l grounds because i t presupposes that changes i n an economy's payment system leave the resource a l l o c a t i o n process , 4 and thus r e l a t i v e p r i c e s , unaffected. These few remarks should be s u f f i c i e n t to show that a dynamic model i n which t ransac t ion costs are s ing led out does not provide a s a t i s f a c t o r y framework for a comparative ana lys i s of a bar ter and money economy. I t should a l so be c l e a r that any further ana lys i s w i l l have to consider the j o i n t determination of resources for product ion and J . Niehans, "Money i n A S t a t i c Theory of Optimal Payment Arrange-ments ," Journal of Money, Credit and Banking, V o l . I (November 1969), p . 709. As the t i t l e ind ica te s the author analyzes the problem of determin-ing an optimal payment arrangement i n a s t a t i c context . He assumes that u l t imate t ransact ions are not a f fected by t ransact ions cos t s . By doing so, he s idesteps the more fundamental problem of the a l l o c a t i o n of r e -sources between the product ion t r ansac t ions . The fac t that he recognizes the problem himsel f does not d imin i sh i t . t r ansac t ion purposes. Thi s w i l l be the s t a r t i n g po in t for the fo l low-i n g a n a l y s i s . The operations of a ba r te r s tate can best be descr ibed as f ac ing 5 two c o n s t r a i n t s : 1. Barter exchanges always require b i l a t e r a l balance (see Say's i d e n t i t y above); 2. Savings and investment dec i s ions are r e s t r i c t e d to a double coincidence of a v a i l a b i l i t y of funds and p r o f i t -able investment opportuni t ie s — a consequence which was im-p l i c i t i n the d i scus s ion thus f a r . Increas ing e f f i c i e n c y and s p e c i a l i z a t i o n over time i s genera l ly a s s o c i -ated with b i l a t e r a l imbalance subject to the e x i s t i n g budget c o n s t r a i n t s . I t i s to be shown i n the fo l lowing how the existence o f money contr ibutes to the achievement of these ends. B. The Introduct ion of Money Assume that our model country has reached a l e v e l of s p e c i a l i z a -t i o n and volume o f t ransact ions where the t o t a l t ransact ions cost i n terms o f scarce resources could be reduced i f bar te r was replaced by some form of money. For s i m p l i c i t y ' s sake add the assumption that the t r a n s i t i o n from bar te r to monetizat ion takes p lace w i t h i n a s ing le time p e r i o d . I t would be f a l l a c i o u s to i n f e r from the shortcomings o f a bar-t e r payment arrangement that i t cannot be Pareto opt ima l . This conclus ion would only be v a l i d from an ex post p e r s p e c t i v e , a f t e r the knowledge of a be t t e r payment mechanism has become genera l ly spread. As long as an economy s t i l l r e l i e s e x c l u s i v e l y on b a r t e r , the presumption should be In any r e a l economy t h i s process would, of course occur .on ly g radua l ly . The speed of monetizat ion w i l l depend upon a number of v a r i a b l e s ; of the greatest importance i s the rate of t e c h n i c a l progress when seen to imply increased l e v e l s of s p e c i a l i z a t i o n . In a d d i t i o n , the organiza-t i o n a l s t ructure of the economy, wealth and income, and the payment h a b i t s , to l i s t ju s t a few f a c t o r s , are instrumental i n t h i s process . Ubiqui ty of a s ing le commonly accepted money good or a very small number of s imultaneously used commodity monies marks the end of t h i s t r a n s i t i o n . Many underdeveloped countr ies today have not yet reached t h i s stage. This f a c t makes an ana lys i s of the economic consequences of monetizat ion p e r t i n e n t for development theory and p o l i c y . According to ac tua l h i s t o r i c a l development i t could be assumed that the commodity chosen as money i s go ld , or some other meta l . How-ever, we s h a l l not make t h i s assumption i n i t i a l l y , but ra ther we s h a l l t r y to exp la in why and how t h i s choice i s made. The very fac t that most countr ies se lec ted t h e i r moneis from a narrow range of l a r g e l y s i m i l a r goods should not be considered as mere coincidence of a r b i t r a r y dec i s ions but ra ther as the outcome of a r a t i o n a l process of cho ice . I t could be seen as the l o g i c a l extension of the conceptual b i r t h of money men-t ioned above. To make t h i s po in t c l e a r e r we s h a l l attempt to simulate that t h i s arrangement cons t i tu te s a r a t i o n a l cho ice . This impl ies that given the s tate of the ar t s t o t a l t r ansac t ion costs are minimized under bar ter c o n d i t i o n s . M i s a l l o c a t i o n of resources only a r i s e s once a bet-t e r , i . e . , l e s s c o s t l y , o r g a n i z a t i o n a l payment mechanism i s invented . This p o i n t seems to be o c c a s i o n a l l y confused i n the l i t e r a t u r e . the d e c i s i o n making process lead ing towards the s e l e c t i o n of the money good (or goods) from the t o t a l number of e x i s t i n g commodities i n the economy. I n i t i a l l y , there was the i n t e l l e c t u a l achievement o f conce iv ing the advantages of a genera l ly acceptable means of payment. This inven-t i o n , when r a t i o n a l l y a p p l i e d , should then lead to the choice of a spec-i f i c commodity or at best a smal l number of goods; the dec i s i on c r i t e r i o n being that the t o t a l benef i t s of us ing t h i s p a r t i c u l a r good. Under e q u i l i b r i u m condi t ions i n the bar te r s t a t e , the marginal benef i t s — i . e . , the marginal p r o d u c t i v i t y — of a l l c a p i t a l goods are equal . With the event of the invent ion o f the money n o t i o n , some goods w i l l have to be re-evaluated as to t h e i r expected benef i t s i n t h i s a l t e r n a t i v e use.^ More g e n e r a l l y , we can define every advancement i n knowledge to imply a change i n some or a l l of the marginal equivalences o f general e q u i l i b r i u m . Furthermore, by d e f i n i t i o n of the term "progress" the d i r e c t i o n of the change of the marginal condi t ions i s a l so predetermined. The product ion p o s s i b i l i t y f r o n t i e r must have moved outward for at l e a s t one good — i n most cases a number of goods. This impl ies that a given amount of out-put can be produced with le s s inputs of resources than before . We can assume that only demand condi t ions account fo r the r e -eva lua t ion o f the expected benef i t s for p o t e n t i a l money goods. The t e c h n i c a l product ion s ide i s considered unaffected fo r the subset K . While t h i s i s not s t r i c t l y accurate t h i s l a s t assumption w i l l prove useful for the d e r i v a t i o n of the e q u i l i b r i u m condi t ions i n the emerging money market. In the case of money, i t i s r e l a t i v e l y easy to narrow down the range of p o s s i b l e choices of goods a f t e r e s t a b l i s h i n g a d e f i n i t e set of a t t r i b u t e s the money commodity should have. We can def ine these charac-t e r i s t i c s as : p o r t a b i l i t y , i n d e s t r u c t a b i l i t y , homogeneity, d i v i s i b i l i t y , 7 and c o g n i z a b i l i t y . This s p e c i f i c a t i o n e l imina te s , obv ious ly , a l l con-sumption goods and leaves us wi th the bundle of N d i f f e r e n t c a p i t a l goods assumed to e x i s t i n the country. For one or more of these c a p i t a l goods, c a l l the subset K , the expected rates of re turn when used as money goods m are l i k e l y to be higher than the p r e v a i l i n g e q u i l i b r i u m r a t e . Therefore , the fo l lowing i n e q u a l i t y can be expected to e x i s t for the whole c a p i t a l goods s e c t o r : n n [ Z p . K . ] > [ E. pK. ] i = l 1 1 t+1 i = l 1 t where i = (1, . . . , n) . Since [K.] = [K.] for the per iod of the change, i t fo l lows 1 t+1 1 t tha t the new short-term e q u i l i b r i u m p r i c e of c a p i t a l goods w i l l tend to be higher than the o l d , i . e . , p_^  > p . To see the a d d i t i o n a l imp l i ca t ions for the i n d i v i d u a l rates of re turn for c a p i t a l goods we have, to disaggregate them f i r s t . The inven-t i o n of money i s comparable to a d i s e q u i l i b r i u m s i t u a t i o n i n which the r e l a t i v e p r i c e s of a l l those c a p i t a l goods which are su i t ab le to func-t i o n as money w i l l be changed. How other r e l a t i v e p r i c e s are a f fected J , Niehans, op. e%t.3 p . 706. as a secondary consequence of using a money commodity does not concern us yet. Since the c a p i t a l goods sector comprises a set of rather heter-ogeneous goods, i t i s easy to eliminate most of them as "non/suitable." Machines, f o r example, would f a l l i nto t h i s l a t t e r category. The p u r s u i t of t h i s process of gradual e l i m i n a t i o n w i l l lead to a small subset of b a s i c a l l y s u i t a b l e money goods, the above mentioned K (m = a, m). m I t can be expected that t h i s subset possesses a large degree of homogeneity, and a high e l a s t i c i t y of s u b s t i t u t i o n . For these goods the a n t i c i p a t e d marginal rates of return w i l l s h i f t upwards i n varying degrees or p o s s i b l y by the same proportion. I t can be asserted that the degree of s h i f t i s a p o s i t i v e function of the costs incurred i n ex-changing these goods under ba r t e r . To estimate the s h i f t the costs of using one or a number of c a p i t a l goods as money would have to be compared with the t r a n s a c t i o n cost savings. The f i g u r e below shows the pos s i b l e r e s u l t s . f o r the s h i f t s of c a p i t a l goods i n the subset. 4 I t i s obvious from the above that i f there i s one good which dominates the subset because i t s expected y i e l d increase exceeds a l l o thers , i t w i l l be chosen as the one and on ly money good. While i t i s easy to assert the existence of a s h i f t i n the a n t i c i p a t e d rates of r e -turn for the re levant number of c a p i t a l goods, the s i z e of the s h i f t cannot be e s tab l i shed wi th accuracy. Af te r the i n t r o d u c t i o n of money a higher rate of r e turn can be expected i n the e x i s t i n g c a p i t a l s tock. Standard supply and demand theory p r e d i c t s that resources w i l l , there fore , be d i r e c t e d in to the product ion of those goods wi th the highest a n t i c i p a t e d y i e l d s . This process continues u n t i l the expected rates of re turn from fur ther investments i n the produc-t i o n of money are reduced to some new e q u i l i b r i u m r a t e , which may or may not be the same as the rate p r i o r to the change. A necessary c o n d i t i o n for the new e q u i l i b r i u m i s that the marginal rates of re turn are again equal i n a l l a l t e r n a t i v e uses. Secondly, a l l excess demand funct ions for c a p i t a l goods must p r e c i s e l y equal zero . I t i s only then that the stock-f low con-d i t i o n for an o v e r a l l e q u i l i b r i u m are s a t i s f i e d . I t may be, as was s tated e a r l i e r , that severa l goods emerge as pos s ib le choices with equal a n t i c i p a t e d y i e l d s . The f i n a l d e c i s i o n fo r a s ing le money good would then be a r b i t r a r y . In fac t i t i s f e a s i b l e to Q choose a l l those goods wi th equal y i e l d s s imultaneously. The e q u i l i b r i u m condi t ions remain the same. For the fo l lowing par t s of the paper we s h a l l nevertheless use the There i s p lenty of h i s t o r i c a l evidence that t h i s a c t u a l l y p i c -tures past and to a c e r t a i n extent even present experience bes t . s i m p l i f y i n g assumption that there was a s ing le optimal cho ice . For con-venience sake we say that the choosen good i s g o l d . Up to now we have been concerned wi th the s e l e c t i o n of an appro-p r i a t e commodity to funct ion as money without exp la in ing the reasons and the extent of the asserted s h i f t i n the demand for gold f u n c t i o n . The d i s c u s s i o n a l l along was based on the t a c i t assumption that the knowledge about the advantages of using money were i n s t a n t l y known by a l l members of the community. Although information and'knowledge can u s u a l l y not be acquired c o s t l e s s l y and/or i n s t a n t l y , t h i s assumption s t i l l appears mod-e r a t e l y r e a l i s t i c . At l e a s t i t compares favorably wi th the a s se r t ion 9 " that money f a l l s l i k e manna from heaven." The above notes have attempted to descr ibe the s e l e c t i o n p r o -cess of a money goods as endogenous to the system and based on the p r i n c i p l e of r a t i o n a l c h o i c e . In t h i s sense, our approach appears p r e -ferab le to a l t e r n a t i v e analyses . C. Determination of the E q u i l i b r i u m i n the Gold-Money Market The e q u i l i b r i u m condi t ions for the gold market a f ter monetizat ion have to be developed i n greater d e t a i l . The ana lys i s i s r e s t r i c t e d to comparative s t a t i c s for the time be ing . We assume that the competit ive e q u i l i b r i u m condi t ions p r e v a i l e d i n a l l markets under bar ter and that the economy does not trade i n t e r n a t i o n a l l y . Below, the dynamic im-p l i c a t i o n s of monetizat ion are cons idered , and trade flows are allowed f o r . D. P a t i n k i n , op. oit.3 p. 4. To restate the problem: the invention of money implies that the e x i s t i n g gold market receives a new dimension. The p e c u l i a r i t y of the market f o r the commodity money i s i t s d i r e c t r e l a t i o n s h i p to a l l other markets i n the economy v i a the inverse dependence of the p r i c e of money on the general p r i c e l e v e l . ^ The determination of the gold market equilibrium thus e n t a i l s two main problems: the knowledge of the supply and demand conditions f o r gold as a non-money commodity, and the modi-f i c a t i o n of these conditions given the s p e c i a l c h a r a c t e r i s t i c s of a money good. In the following, i t w i l l be shown under what conditions the i n i t i a l equilibrium i n the money market simultaneously f u l f i l l s o p t i m a l i t y conditions. Take the barter supply conditions f o r gold as c o n s i s t i n g of an i n i t i a l stock and constant proportional additions to t h i s stock over time. A t t h e ^ p e r i o d of t r a n s i t i o n to money, assume that the e x i s t i n g quantity of gold can be expanded to the desired equilibrium l e v e l with-i n a s i n g l e time u n i t . I t i s furthermore asserted that the technical ^More accurately the dependence of the p r i c e of money on the p r i -ces of other goods can be expressed as: 1_ C (p.) - v 1 1  Pm " E l. f o r a l l i / m ( i = 1, ..., n) where p = average r e l a t i v e p r i c e of the money good; p. = the r e l a t i v e p r i c e o? a l l other goods; Cj, = the share of the ir-th good i n t o t a l wealth. The expression explains the average r e l a t i v e p r i c e of money as the sum of a l l r e l a t i v e p r i c e s weighted by t h e i r r e l a t i v e share i n t o t a l wealth. See B. P. Pesek and T. R. Saving, Money, Wealth and Economic Theory CNew York.: Macmillan, 1967] , p. 56. product ion or supply condi t ions remain unchanged due to monet izat ion. Why t h i s l a s t assumption appears reasonable w i l l become c l e a r a f t e r the demand condi t ions are d i scussed . To exp la in the p r e v i o u s l y a l l eged s h i f t i n the demand for go ld curve we could use the three standard Keynesian arguments about the reasons why money i s demanded: the t r a n s a c t i o n s , precaut ionary , and specula t ive motive. A d i s cus s ion about the probable magnitude of each component appears undes irable because i t would be l a r g e l y based on specu la t ion . A concise estimate o f the aggregate s h i f t i n the demand for gold a f ter monetizat ion curve thus seems unv iab le . Since the most important advan-tage of money i s the p o s s i b i l i t y of b i l a t e r a l imbalance i n exchanges and because t h i s c h a r a c t e r i s t i c of money d i r e c t l y benef i t s economic t r ans -act ions , i t seems pre ferab le to concentrate on the t ransact ions component i n the demand for money. Af ter the e q u i l i b r i u m condi t ions are e s tab l i shed for the t ransact ions demand of money, i t w i l l be easy to d i scuss the 12 other elements of the money demand. Assume that the i n i t i a l demand for gold depends on the l e v e l of income and thus under condi t ions of constant exchange v e l o c i t y on the l e v e l of t ransact ions under b a r t e r . Take t ransact ions costs as an i n -A change i n cost condi t ions because of economies or diseconomies of sca le r e s u l t i n g from the required expansion of gold product ion are , thus , considered non-exi s tant . 12 By d e f i n i t i o n of a c a p i t a l good, money always represents a s tore of va lue , even i f the asset demand for money i s assumed zero . creas ing funct ion of the t o t a l volume of goods exchanged. Assume f u r t h e r -more that these costs are t o t a l l y embodied i n f ac tor and product p r i c e s before monet izat ion. . A reduct ion i n these costs i s considered to accrue to both consumers as w e l l as producers through decreased p r i c e s for fac-tors and products . This conclus ion i s based on the p r o p o s i t i o n that factors of product ion are t i e d up i n the maintenance of an exchange system i n vary-ing degrees. While t h i s a s se r t ion appears obvious for the f ac tor l abor , i t can be e a s i l y extended for c a p i t a l . r e s o u r c e s . The exchange of c a p i t a l goods under bar ter condi t ions i s l i k e l y to be d i f f i c u l t and in f requent . This d i f f i c u l t y can be a t t r i b u t e d to the general c h a r a c t e r i s t i c s of c a p i t a l goods: they are r e l a t i v e l y c o s t l y compared to consumption goods and t y p i c a l l y e i ther immobile and/or bu lky . The infrequency of t rading would be the r e s u l t of the b i l a t e r a l balance requirement under b a r t e r . This r e l a t i v e disadvantage of c a p i t a l goods i n exchange i s l i k e l y to necess i ta te greater inventory holdings of c a p i t a l goods. I t c o u l d , there fore , be argued that market forces w i l l account f o r t h i s d i f f i c u l t y by incorpora t ing a t ransact ions cost element i n the f i n a l product p r i c e . The i n t r o d u c t i o n of a money good w i l l f a c i l -i t a t e exchange i n genera l . Re la t ive product p r i c e s can be expected to d e c l i n e i n accordance with the r e l a t i v e c a p i t a l i n t e n s i t y i n t h e i r produc-t i o n processes . Because there i s a l so a d i s t i n c t l abor saving e f f ec t due to monet izat ion, i t i s d i f f i c u l t to assert a Tpviovi which of the two e l e -ments i s r e l a t i v e l y s t ronger . For s i m p l i c i t y ' s sake we s h a l l assume that both fac tors of product ion are a f fected p r o p o r t i o n a t e l y . This impl ies that r e l a t i v e p r i c e s w i l l remain unchanged, or that the r e l a t i v e cos t sav-ings of both factors of product ion dec l ine by the same propor t ion a f ter the i n t r o d u c t i o n of money. The r e l a t i o n s h i p between t ransact ions cost and t o t a l output i s assumed to be most appropr ia te ly represented by the l i n e OA i n Figure 2-1. The inc rea s ing slope of OA impl ies that these costs are growing at a r i s -ing ra te i n r e l a t i o n to output. E v e n t u a l l y , the increase i n costs of ex-change may exceed the rate of output growth. At the product ion l e v e l Y(B) the economy would stop growing. Since we assumed that output of the eco-nomy was i n i t i a l l y s t i l l inc rea s ing at some p o s i t i v e constant e q u i l i b r i u m r a t e , the permissable values for t o t a l t ransact ions costs o f the bar ter economy must l i e between 0 and B. Assume t o t a l output had the aggregate value o f Y(O) before the i n t r o d u c t i o n o f money. T o t a l t ransact ions costs are thus TC(O). The problem i s to f i n d the quant i ty of monetary gold which minimizes t rans-act ions costs while f u l f i l l i n g e f f i c i e n c y condi t ions i n the gold market. The r e l a t i o n s h i p between the stock of gold and aggregate output i s p i c t u r e d i n the lower l e f t -hand par t of F igure 2-1. The l i n e OG i s nece s s a r i ly l i n e a r because of our assumption of steady state growth. I t represents e q u i l i b r i u m p o s i t i o n s i n the gold market for vary ing l e v e l s of t o t a l output. From the steady state condi t ions we know that gold produc-t i o n increases at the o v e r a l l rate of output growth i f the demand e la s -t i c i t y with respect to output equals one. I f i t s absolute value i s • • * • l e s s than one, G/G w i l l be smal ler than Y / Y ; i f i t exceeds one, G/G > Y / Y . Assume that the stock of gold i n existence p r i o r to monetizat ion and for an aggregate amount of output Y(0) equals G(0) . For the e l a s -t i c i t y c o e f f i c i e n t i t appears reasonable to assume a value of one under Figure 2-1 b a r t e r . F i n a l l y , we must define the dependence of t o t a l t ransact ions costs on the r e a l quant i ty of money demanded. I t seems obvious that the r e l a t i o n s h i p i s inver se , although the prec i s e slope of the curve cannot be predetermined with accuracy. Assume that the funct ion re levant f o r the given output can adequately be represented by our l i n e TC(O) - MP(0). This impl ies that for inc rea s ing quant i t i e s of money t o t a l t ransact ions costs w i l l f a l l u n t i l they are reduced to zero at a p o i n t such as M(0). The i n t e r s e c t i o n o f t h i s curve can be a t ta ined i f and only i f two cond i -t ions are s a t i s f i e d : (a) money can be produced c o s t l e s s l y ; and (b) the ho ld ing of money does not create any i m p l i c i t costs i n terms of y i e l d s foregone on other assets . With g o l d , cos t l e s s product ion i s c l e a r l y not p o s s i b l e . Our prob-lem i s , there fore , dual i n nature : the determination of the optimal quan-t i t y of money for a given output must r e c o n c i l e the minimizat ion of t ransac t ions costs with the minimizat ion of resources used for the p ro-v i s i o n o f the commodity money. Both minima cannot be a t ta ined s imul tan-eously . Therefore , the problem must be reformulated as a choice between Although t h i s i s an e m p i r i c a l ques t ion , there are no a Tpviovi arguments why the demand for gold should not have increased i n propor t ion with t o t a l income under b a r t e r . , One could not expect , however, that the e x i s t i n g stock of gold p r i o r to monetizat ion was comparatively small be-cause of the l i m i t e d product ive usefulness of g o l d . the v i a b l e t rade-of f po int s which e i t h e r (a) minimize t ransact ions costs given a c e r t a i n quant i ty of g o l d ; (b) minimize resources spent on the product ion of money such that the marginal reduct ion i n t ransact ions costs equals the marginal cost of us ing money. The l i t e r a t u r e f requent ly approaches the op t imiza t ion problem by assuming that the nominal quant i ty of money i s given and constant . This impl ies that the (a) approach-is used. The absolute s i ze of the money stock i s considered unimportant, because demand w i l l create i t s 14 own supply v i a p r i c e l e v e l changes. We s h a l l examine t h i s approach f i r s t and show why the p r o b a b i l i t y i s small that an optimum can be a t t a ined i n the money market wi th a given and constant stock of g o l d . Return to Figure 2-1. Given an income l e v e l Y (0) and a stock of gold G(O), the i n t r o d u c t i o n of money permits a reduct ion of t o t a l t r a n s -act ions costs from TC(O) to TC (M). P r i o r to monet izat ion , t h i s l e v e l of t ransac t ions costs would have corresponded to an aggregate volume of output Y ( C ) . T o t a l resource savings are thus represented by the d i f -ference between the o l d and new t o t a l t ransact ions costs or TC (0) - TC (M) These were considered as accruing to both labor and c a p i t a l i n the same r e l a t i v e p r o p o r t i o n . We can , there fore , w r i t e : TCC01 =wL-- + r K m rp I m p l i c i t i n t h i s type of reasoning i s the f a m i l i a r n e u t r a l i t y assumption. where equals the labor serv ices absorbed i n the bar ter exchange p r o -cess ; L T < L where L i s the t o t a l quant i ty of l abor . i s def ined as the c a p i t a l used for bar ter exchanges and < K, where K equals the t o t a l c a p i t a l s tock, w and r are the e q u i l i b r i u m p r i c e s of l abor and c a p i t a l r e s p e c t i v e l y . Due to the above assumption of p r o p o r t i o n a l f ac-tor savings , these remain unchanged a f te r the i n t r o d u c t i o n of money. With monetizat ion we have TC(M) < TC(0) or M M „ 0 0 wL + rK < wL + rK T T r r with the s igns M and 0 denoting the r e l a t i v e f ac tor share before and a f t e r monet izat ion. Whether t h i s s o l u t i o n i s optimal cannot be in fe red from the r e s u l t s thus f a r . We can only conclude that the i n t r o d u c t i o n of money w i l l not requi re a greater amount of resources for t ransact ions purposes. than under b a r t e r . I f i t d i d , money would not be used a t a l l , s ince i t would decrease s o c i e t y ' s wel fare . However, g iven our previous arguments about the nature and t iming of the invent ion of money, i t appears most l i k e l y that p o s i t i v e resource savings w i l l occur . In the extreme, the costs of us ing money would equal the t ransact ions costs savings with o v e r a l l welfare remaining unchanged. The inconclus iveness of the r e s u l t s for a f ixed quant i ty of go ld neces s i t a te s a d i s cus s ion of a l t e r n a t i v e (b) above, where the gold stock i s assumed to be v a r i a b l e . As mentioned e a r l i e r , we assume that any desired increase i n the gold supply i s t e c h n i c a l l y f e a s i b l e within a s i n g l e time period — i . e . , during the period of t r a n s i t i o n from bar-t e r to money, the a d d i t i o n a l gold f o r monetary purposes can be produced. Add the assumption that the cost curve for the expansion of gold produc-t i o n i s known and that a d d i t i o n a l gold production reduces investments i n other c a p i t a l goods. The estimated increase i n the demand for gold together with the barter equilibrium stock can be assumed to represent the desired quan-t i t y of "gold" for monetary and non-monetary purposes. Let t h i s desired quantity be G" i n Figure 2-1 for the given l e v e l of output Y (0) . The hypothetical expansion curve i n GY"space could then be p i c t u r e d such as OG'. R e c a l l i n g that t h i s curve represents d i f f e r e n t equilibrium points i n the gold market for varying l e v e l s of output, the steeper slope indicates a greater r e l a t i v e share of gold i n t o t a l output with monetization. Furthermore, we can i n f e r from the above assumption that the r e l a t i v e equilibrium p r i c e of gold would have r i s e n . The new o v e r a l l e quilibrium conditions are now apparent. The greater quantity of gold would reduce transactions costs below the l e v e l which could be attained with the i n i t i a l stock. [See point TC(M) i n F i g -ure 2-1]. However, the increase i n resource savings can only be ob-tained by decreasing the production of other c a p i t a l goods. The decision on the optimal possible s o l u t i o n must, thus, weigh the a d d i t i o n a l advan-tages of reduced transactions costs against the simultaneous decrease i n investments other than money. The optimal s o l u t i o n cannot be shown i n the f i g u r e . We s h a l l therefore der ive i t i n more formal terms. Let the e x i s t i n g stock of go ld represent a f r a c t i o n a of the t o t a l c a p i t a l s tock , and the p o r t i o n of c a p i t a l serv ices used i n t r ans -act ions a f r a c t i o n 3. We then have' aK = ;G ?K = ^ YK = ic with K represent ing the r e s i d u a l c a p i t a l s tock. We can wr i te a + g + y = 1 and ass igning a p o s i t i v e value to a l l c o e f f i c i e n t s a > 0; 3 > 0; Y >0. Furthermore, l e t Y > 3; y > a and assume a range of permissable values for a and 3 > Y > a < 3 < Y • Analogous to the above, we def ine the share of labor serv ices needed for t ransact ions as aL = L T bL = L where again a + b = 1 and a and b both have values greater than zero a > 0; b > 0; Given these assumptions, we can wr i te the optimum condi t ions that t ransact ions costs should exceed and/or equal the costs of us ing money as wL T + rK >_ rG which i s equiva lent to waL + rgK >_ raK. So lv ing the above we get w . a . > K r a-& L The e q u i l i b r i u m condi t ions for r e l a t i v e fac tor p r i c e s are w _ 6~K r " 61/ the optimum s o l u t i o n w i l l then be a-6 _ ± a or This impl ie s that the share of gold - the t o t a l c a p i t a l stock should equal the sum of the c a p i t a l and labor share used for t ransact ions under b a r t e r . I f t h i s c o n d i t i o n i s s a t i s f i e d we have both an e f f i c i e n t and optimal s o l u t i o n . The range of po s s ib l e values for a and 6 can now be redef ined as a > B s : I f the stock of gold at the time of the invent ion of money s a t i s f i e s the above o p t i m a l i t y c o n d i t i o n , there i s no immediate need for expansion of the gold stock for the attainment of an i n i t i a l money market e q u i l i -br ium. I t appears, however, h i g h l y u n l i k e l y that the ac tua l stock of gold co inc ides p r e c i s e l y wi th the most e f f i c i e n t quant i ty . We, there fo re , have to consider the two remaining a l t e r n a t i v e s for the s i ze of ac tua l and des i red stock of gold for t h e i r relevance and r e a l i s m . These a re : 1. a + 6 > a 2. a + B < a The f i r s t a l t e r n a t i v e impl ies that the ac tua l stock of gold i s smaller than the optimal s tock, because the share of t ransact ions costs exceeds the cost s of us ing g o l d . The second a l t e r n a t i v e obvious ly descr ibes the reverse s i t u a t i o n . A priovi, ne i ther p o s s i b i l i t y can be excluded. The p r o b a b i l i t y of the f i r s t a l t e r n a t i v e appears greater on the bas i s of our e a r l i e r inferences about the bar ter s t a te . The d i s c u s s i o n i s , there fore , r e s t r i c t e d to t h i s case . We know that the e q u i l i b r i u m condit ion.remains unchanged and thus — = -r— s t i l l h o l d s . T h i s deduction can be made s ince the t r ans -r SL i t i o n to money was considered to take place i n a s i n g l e time p e r i o d . The c a p i t a l stock and the t o t a l l abor force remain unchanged and con-sequently a l so the e q u i l i b r i u m wage r e n t a l r a t i o . An expansion of the gold stock i s necessary u n t i l the i n i t i a l i n e q u a l i t y of a + (3 > a has been e l iminated and the optimum cond i t ion a + 3 = ct ho ld s . Given our e a r l i e r assumption that the des i red gold expansion i s a t t a ined by channel l ing par t s of the constant share of investment i n t o t a l output to the product ion of g o l d , the i m p l i c a t i o n of t h i s expansion i s e a s i l y d e r i v e d . In the c losed economic system, without government a c t i v i t i e s , the fo l lowing i d e n t i t i e s h o l d : X = C + I I = G + K ± where K_^ ; i = (1, m) represents the m-capi ta l goods produced; X represents t o t a l output; I = aggregate investment; C = consumption; and dots i n d i c a t e add i t ions to the stock of gold and other c a p i t a l goods. With Q-.' increa s ing beyond i t s normal ra te to accommodate the monetary demand, and Y, C and I unchanged, we must have IG + + IK. + xK J = I wi th * This impl ies a change i n r e l a t i v e fac tor p r i c e s . + G = - XK. 1 and x denoting the c o e f f i c i e n t for the r e l a t i v e increase i n go ld produc-t i o n . gold stock to the optimal l e v e l can only be obtained by reducing i n v e s t -ments i n other c a p i t a l goods riby the same extent . As long as the decrease i n t ransac t ions cost s exceeds the costs of decreasing investments for non-monetary purposes, the money supply should be increased . On the mar-g i n , the a d d i t i o n a l bene f i t s of producing an a d d i t i o n a l u n i t of money should p r e c i s e l y equal the opportuni ty costs of an investment. Put d i f -f e r e n t l y , the f a m i l i a r p r o d u c t i v i t y c o n d i t i o n a l so holds for the g o l d -money market. In o v e r a l l e q u i l i b r i u m , the above e q u a l i t y must be s a t i s f i e d not only for addi t ions to the stock of go ld , but for the t o t a l quant i ty of gold i n existence or I t fo l lows from our simple formulat ion that the increase i n the S.Y 6Y 6Kt <SY = 6Y'' 6G <5K. 1 which can simply be r e w r i t t e n as r = r G K In order fo r the above to represent a t rue optimum s i t u a t i o n , we know that the fo l lowing marginal condi t ions w i l l a l so h o l d : g MU. K r K with MU = marginal u t i l i t y . The convenience y i e l d of money should equal i t s opportunity cost - terms of other p h y s i c a l c a p i t a l goods. the equilibrium conditions for the money market. S p e c i f i c a l l y , we s h a l l discuss the n e u t r a l i t y question, the asset demand f o r money and the f e a s i b i l i t y and d e s i r a b i l i t y of competition i n the gold-money market. sary, r e l a t i v e p r i c e s will'change; If they do there appears to be a case f o r the non-neutrality of money. However, t h i s conclusion does not • s t r i c t l y follow for two reasons. F i r s t l y , the required growth i n the gold stock which s a t i s f i e s o p timality conditions may be too small to change r e l a t i v e equilibrium p r i c e s . Secondly, the term n e u t r a l i t y usually r e f e r s to a d i f f e r e n t context and i s thus not d i r e c t l y a p p l i c a b l e here. The conventional d e f i n i t i o n of n e u t r a l i t y assumes a s i t u a t i o n where money i s already i n existence and a number of f i n a n c i a l assets as w e l l . The question then posed i s whether v a r i a t i o n s i n the equilibrium quantity of money a f f e c t the r e a l v a r i a b l e s i n the system. Thus f a r , we have merely analyzed the adjustments from a barter to a monetized state or to a s i t u a t i o n where an-absolute p r i c e l e v e l i s established. The r e a l neu-t r a l i t y issue a r i s e s only a f t e r the t r a n s i t i o n period i s completed. Next we s h a l l explain why a p o s i t i v e asset demand f o r money i s undesirable under any type of commodity money standard. We are now i n a p o s i t i o n to derive a number of implications of If an expansion of the gold stock to i t s optimal l e v e l i s neces-Assume that the demand fo r money i s composed of two elements: u = asset demand component -t = t ransact ions demand component where u + t = 1 Let the savings ra te be a constant p ropor t iona l ra te of the c a p i t a l stock K, or S = sK where S = aggregate savings , s = savings r a t e . Assume that the i n t r o d u c t i o n of money does not a f f ec t t h i s savings r a t e , and furthermore that a n i i n i t i a l money market equ i l ib r ium has been estab-l i s h e d with money simply serving as a means of exchange. L a s t l y , a s ser t that the current money t ransact ions costs are f inanced out of consumption expenditures . With the emergence of a p o s i t i v e asset demand for money the composition to aggregate savings changes to S = uM + vK where K stands for a l l p h y s i c a l c a p i t a l goods. The aggregate amount ;of .product ive investments i s thus reduced to S - uM s ince money only y i e l d s a convenience y i e l d i n terms of l i q u i d i t y and/or increased s e c u r i t y but does not obvious ly add to the product ive capac i ty of the economy. I f the o v e r a l l ob jec t ive of the economy i s the maximi-za t ion of the rate of per cap i t a output growth over t ime , "^ i t i s c l e a r that t h i s goal cannot be a t ta ined i f a p o s i t i v e asset demand for money e x i s t s . In each per iod i n which more than that quant i ty of money i s held which i s necessary for t ransact ions purposes, there i s an aggregate investment loss which equals to uM, where the dot denotes the change of asset money holdings over t ime. In a d d i t i o n , there ex i s t s the i n i t i a l investment loss of kM for the per iod i n which the asset demand f i r s t emerged. At the end of the n-th per iod the aggregate investment loss L amounts t o : L = uM ( l+r ) n + uM (1+r ) fco fci * n-1 + uM (1+r) n-2 + . . . uMt (1+r) n I f — = constant , M t h i s can be rewr i t t en as L = uM e 0 g+rt where Subject to some defined minimum for the average standard of l i v i n g . g = rate of growth, of money, r = rate of investment on p h y s i c a l c a p i t a l . Competition i n the gold market i s f e a s i b l e under monetization as long as the gold industry is- not operating under d e c l i n i n g cost con-ditions'. I t i s also d e s i r a b l e because i t leads to the attainment of a stable equilibrium, as long as marginal cost p r i c i n g i s observed. If and only i f a sizeable asset demand f o r gold e x i s t s , i t could be argued that p o l i c y makers should c o n t r o l the quantity of gold supplied to e l i -minate the divergence between p r i v a t e and s o c i a l valuations. D. The E f f e c t s of Monetization on Production The conclusions about the equilibrium conditions i n the money market imply already the d i r e c t i o n and the extent of the adjustments i n a l l the other markets. These are now discussed f o r the short run. Below they are extended to cover dynamic long-term equilibrium conditions. For the period of t r a n s i t i o n from barter to money, we defined above: X B = X M This expression i l l u s t r a t e s the economic loss which may a r i s e because of a divergence between p r i v a t e and s o c i a l valuations. I f i n d i -v i d u a l s ' preferences are such, that they value.the s e c u r i t y and l i q u i d i t y of money holdings h i g h l y enough., to forego the a l t e r n a t i v e y i e l d on p h y s i -c a l assets, a market f a i l u r e a r i s e s . The o v e r a l l economic objective of maximizing output growth, could then not be achieved. This argument w i l l reappear i n a modified version i n Chapter IV i n the context of the d i s -cussion about cash hoarding. where the subscr ipt s B and M stand f o r bar ter and monetizat ion respect ive-l y , and X represents t o t a l output . Furthermore, i t was assumed that the fo l lowing e q u a l i t y holds for addi t ions to the product ive c a p i t a l stock I „ = I., B M To be accurate , the r i g h t hand s ide of t h i s equa l i ty would have to be m u l t i p l i e d by the ba r te r e q u i l i b r i u m growth rate s ince dynamic steady s tate condi t ions were assumed for the b a r t e r . I f the t r a n s i t i o n occurs w i t h i n one time p e r i o d , then t = t + 1. This q u a l i f i c a t i o n i s only minor because i t would not change the substance of the r e s u l t s and i s thus d i s regarded . I t was a l so shown above that due to monetization the composition of investments changes. Under b a r t e r , investments were com-posed of I = (K. + G j B 1 B With money t h i s takes the new form where I = K - K + G + G M M B M M or the a d d i t i o n i n the gold stock equals the reduct ion i n other produc-t i v e investments. The above formulat ion i s incomplete because i t excludes the t ransact ions cost aspect . Define K = . tK r. i Transact ions costs i n terms of c a p i t a l resources used under bar ter equal led a constant por t ion g of the non-gold c a p i t a l goods produced. Since G = gK, i . e . , gold product ion was a l so assumed to increase at a constant ra te i n r e l a t i o n to the t o t a l c a p i t a l s tock, t r a n s a c t i o n s ' c o s t are thus proport ionate to t o t a l investment and i n steady s tate to the c a p i t a l s tock. The c a p i t a l share used for t ransact ions i s denoted = aK. The t o t a l e f f ec t of monetizat ion on the savings—investment market thus becomes: I- = K. + tK. + G + G - K M 1 i • • • • M M I- = (1+t) K. + G M i i - = i + t k . M B i The bar over the subscr ipt s ind ica te s the t o t a l e f f e c t . Since the p r o -p o r t i o n a l i t y f ac tor t and a was shown to have a value of 1 > t > 0; l > a > 0 ; and t > a i t can be concluded XM > X B The investment p o t e n t i a l given monetizat ion thus exceeds that under bar-ter c o n d i t i o n s . For the labor market the conclus ions are obvious ly analogous be-cause of the way the t r ansac t ions cost funct ion was s p e c i f i e d i n i t i a l l y . The number of workers i s again assumed unchanged during the t r a n s i t i o n p e r i o d , or L = L B M This holds under the assumption that the t o t a l number o f hours worked under bar te r remains unchanged i n the money economy. Should some economic u n i t s decide to use parts of t h e i r time savings from monetizat ion for increases i n l e i s u r e the above e q u a l i t y would not h o l d . An accurate p r e d i c t i o n presupposes the knowledge o f the shape of labor supply curve. I t appears reasonable to assume that to the extent that increases i n l e i s u r e are en-joyed by i n d i v i d u a l s , they do not decrease the aggregate working time. Consumers s t i l l bene f i t from the change by r e q u i r i n g l e s s time of t h e i r 17 l e i s u r e hours to make t h e i r given number of t r ansac t ions . Since changes i n the use of l e i s u r e time are not accounted i n economic c a l c u l a t i o n of pro-duct ion e f f e c t s , only that p o r t i o n of time savings w i l l be re levant that was p rev ious ly p roduc t ive ly employed, i . e . , T B The c o e f f i c i e n t 3 thus denotes the savings of labor which can be employed i n a l t e r n a t i v e uses with money. The conc lus ion fol lows d i r e c t l y : I t cou ld be argued that consumers may change t h e i r t r ad ing habi t s a f t e r monet izat ion; ins tead of p r e f e r r i n g more l e i s u r e they may be induced to trade even more because i t i s ea s i e r . A d e c i s i o n on t h i s quest ion cannot be made a Tpviovi. but needs to be based on compara-t i v e study of preferences . B or (1+6) L. B where again 1 > g > 0 > L B The aggregate production function X can now be written as: X = f [ (K + CtK) (L+r3L)] If a = g, t h i s equation can be reformulated as: X = fI(l+a)K; (l+a)L] Since K = + G, money i s considered as factor of production i n t h i s equation. Conventionally, t h i s function i s written as: where the r e a l quantity of money G/p (p = p r i c e l e v e l ) i s singled out as fact o r . This l a s t formulation shows more c l e a r l y the implication of our assumption of proportional f a c t o r savings. Our s p e c i f i c a t i o n of the func-t i o n asserts that the c a p i t a l resources saved by monetization also bene-f i t s gold by the same extent. This i s presumably not s t r i c t l y true be-cause of the reasons f o r the choice of gold as money was i t s r e l a t i v e l y low transactions cost under barter. However, i t s t i l l appears a reason-able working assumption since i t i s l i k e l y that gold aslo becomes r e l a -t i v e l y cheaper to use with monetization. There are, thus, two d i s t i n c t X = f(K, L, G/p) e f f e c t s . The f i r s t was the increase i n the demand for go ld which led to a higher share of gold i n t o t a l output and as a secondary e f f ec t a reverse movement reducing the required share For s i m p l i c i t y ' s sake we s h a l l therefore r e t a i n the assumption that a = g for both f ac tor s of product ion i n c l u d i n g g o l d . I f we now de-f i n e product ion cond i t ions as l i n e a r and homogeneous, the above equation can be s i m p l i f i e d t o : X / L = f l t l + a l k j wi th k = K/L or r ede f in ing Y 1 + a-~ e we get X = f [ e Y k] This l a s t formulat ion shows the o v e r a l l e f fec t s of monetizat ion are d i r e c t l y equivalent to a once and for a l l Hicks neu t ra l t echno log i ca l Y change. It should be noted that e does not have time i n the exponent because monetizat ion e f fec t s cannot be considered to grow independently and permanently over t ime. The i m p l i c a t i o n s of the above for the dynamic context are now ob-v i o u s . We s h a l l demonstrate them, ! f i r s t i n a f i g u r e i n comparative s t a t i c form. Thereafter they are t r a n s l a t e d i n formal terms. The assumption of equal r e l a t i v e fac tor augmentation impl ies an equiproport ionate outward s h i f t of the product ion p o s s i b i l i t y f r o n t i e r for both productions i n the economy: go ld and Y , a homogeneous c a p i t a l and consumption good. The new e q u i l i b r i u m wi th monetizat ion w i l l be charac ter ized by greater t o t a l output and changed r e l a t i v e p r i c e s as demonstrated i n the two f igures on the fo l lowing page which show the r e s u l t s i n f ac tor and product space. Because both f igures are l a r g e l y se l f -exp lanatory we s h a l l only b r i e f l y d i scuss the changes i n the p r o -duct markets. Let the bar ter e q u i l i b r i u m be represented by po in t A . Due to the increase i n the demand for g o l d ' d u r i n g monetizat ion the e q u i l i b r i u m share of gold i n t o t a l output w i l l r i s e . Re la t ive p r i c e s change as a consequence of t h i s expansion. In the accounting e q u i l i b r i u m p o s i t i o n B the r e l a t i v e p r i c e of gold w i l l thus exceed i t s barter l e v e l . Besides an expansion of the gold market monetizat ion simultaneously leads to the shown savings of resources as a r e s u l t of decreased t ransact ions cos t s . This i s represented by the c u r v i l i n e a r p a r a l l e l s h i f t of the product ion p o s s i b i l i t y f r o n t i e r . I f resource savings do not a f f e c t both fac tors p ropor t iona te ly as was assumed above (a = (3) the s h i f t would be biased toward e i t h e r of the axes. The o v e r a l l e q u i l i b r i u m i s reached at po in t C. There, the same r e l a t i v e p r i c e s p r e v a i l as i n po int B. The p r i c e l e v e l w i l l therefore remain constant provided absolute pr ices .were only set a f t e r the money market a t ta ined i t s e q u i l i b r i u m p o s i t i o n . I f we as ser t that s o c i a l preference functions are. homothetic we can unambig-uously conclude that the movement from A to C impl ies an increase i n welfare for s o c i e t y . E. Dynamic Aspects of Monet izat ion The preceeding comparative s t a t i c r e s u l t s can now be e a s i l y con-verted i n t o dynamic steady state c o n d i t i o n s . In t h i s s ec t ion we s h a l l prove (veri fy) the p r o p o s i t i o n made at the beginning o f t h i s chapter , tha t monetizat ion i s not l i k e l y to change the e q u i l i b r i u m growth ra te of the system. For the money market the steady state growth rate genera l ly de-pends on two f a c t o r s : f i r s t l y , the p o l i c y ob jec t ives i n regard to the 18 p r i c e l e v e l ; and secondly, the demand e l a s t i c i t y of money with respect to t o t a l output. I f the p o l i c y ob jec t ive i s the maintenance of a constant p r i c e l e v e l , and i f the income e l a s t i c i t y equals one, the money supply growth should be i d e n t i c a l to that of t o t a l output , or G = X G X For e l a s t i c i t i e s smaller or greater than one, t h i s obvious ly has to be reformulated as: G X • , G X • — > — for e > 1; — < — for e < 1. G X m G X m Which of the three a l t e r n a t i v e s i s most r e a l i s t i c i s an e m p i r i c a l ques-t i o n and need not concern us here . The quest ion now i s whether the e q u i l i b r i u m growth ra te of t o t a l output remains unchanged a f te r the i n t r o d u c t i o n of money. Put d i f f e r -e n t l y , i t has to be shown that the e q u i l i b r i u m condi t ions under bar te r With competit ive gold product ion t h i s f ac tor i s no separate p o l i c y v a r i a b l e — p r i c e s t a b i l i t y w i l l be ensured through market forces . s t i l l hold with money. Assuming a n e o - c l a s s i c a l world i n which only the two mentioned goods G and Y are produced, the barter by growth conditions were G = XX and Y = (l-X)X which implies constant shares i n t o t a l output over time or unitary elas-t i c i t y . Given t h i s , the growth rates of t o t a l output w i l l be — = — = — = — = "k + T p X G K Y L which has to equal the rate of growth of ph y s i c a l labor plus the labor augmenting progress f a c t o r , which was assumed to e x i s t . Thus, i f and only i f population growth and/or technological progress change w i l l the equilibrium values of the system be aff e c t e d . Population growth i s u n l i k e l y to change due to mo n e t i z a t i o n . 1 9 With constant p a r t i c i p a t i o n rates, t h i s also holds f o r labor force growth. As to the technical progress factor there do not appear to be any cogent arguments ei t h e r to prove that money w i l l induce an increase i n t h i s r a t e. An explanation to the contrary would have to be based on assump-tio n s along the following l i n e s : Ca) endogeneous rate of population growth, depending on per capita income? (b) constant population growth rate under barter due to un-changing standard of l i v i n g — presumably close to the subsistence l e v e l ; Reconsider the basic e f f e c t s of money as to t h e i r p r o b a b i l i t y of r a i s i n g the rate of t e c h n i c a l progress. Money f a c i l i t a t e s exchange by permitting b i l a t e r a l imbalances i n transactions. Furthermore, as was shown above, money saves scarce resources compared to a barter state. Both factors do not lead to the conclusion that the rate of progress i s , therefore, l i k e l y to increase. One could assert that the existence of money induces greater s p e c i a l i z a t i o n i n production and that t h i s process r e f l e c t s p e r s i s t i n g increases i n e f f i c i e n c y . However, a sequence of lab-or and/or c a p i t a l saving innovations does not appear to follow n e c e s s a r i l y 20 from monetization, a conclusion which seems supported by a s u p e r f i c i a l examination of economic h i s t o r y . On t h e o r e t i c a l grounds, the proposition can thus not be resolved and we are l e f t with the i n d e f i n i t e s o l u t i o n : TP„ > TP„ M — B where subsigns denote monetization and barter r e s p e c t i v e l y . For lack of proof, we s h a l l assume that to the extent that an improvement i n technol-ogy follows monetization i t i s i n s i g n i f i c a n t . We can then disregard the i n e q u a l i t y sign. (c) r i s i n g income per c a p i t a as a consequence of monetization which induces r i s i n g population growth rates. 20 There i s one sector of the economy i n which the invention of money has the r e l a t i v e l y highest p r o b a b i l i t y of leading to further inno-vations, namely i n the saving-investment markets. Organizational improve-ments i n the c a p i t a l markets leading to the development of i n d i r e c t f i n a n -c i a l markets are purposely disregarded f o r the time being since they are separately discussed i n Chapter I I I . There are a number of a l t e r n a t i v e ways i n which i t can be mathe-m a t i c a l l y shown that the steady state condi t ions remain i n v a r i a n t with respect to a s ing le t e c h n o l o g i c a l improvement. A glance through the per-21 t i n e n t l i t e r a t u r e i s s u f f i c i e n t to confirm t h i s . The l a s t two issues that need mentioning are : the i m p l i c a t i o n s for the new e q u i l i b r i u m values o f the c a p i t a l output and c a p i t a l labor r a t i o , and the time requi red for the attainment of the new steady s ta te . The b a r t e r e q u i l i b r i u m value o f the c a p i t a l output r a t i o depends on the type of savings funct ion i n ex i s tence . There are three f requent ly used 1 s p e c i f i c a t i o n s of t h i s funct ion w i t h i n n e o - c l a s s i c a l theory: a propor-t i o n a l savings funct ion depending on t o t a l output , a c l a s s i c a l savings funct ion which depends on the c a p i t a l stock and r e l a t e d to the second an optimal savings func t ion . s 1 = sX 5 2 = sK 5 3 = rK where r = rate o f i n t e r e s t . Regardless o f the s p e c i f i c savings cond i -t ions that p r e v a i l e d under ba r te r we know that i f savings behavior r e -mains unchanged with monetization the e q u i l i b r i u m c a p i t a l output r a t i o must a l so have remained constant. Furthermore, we have i m p l i c i t l y the Inter alia: P. A . Neher, Growth With Technological Change (un publ i shed manuscr ipt) , U n i v e r s i t y of B r i t i s h Columbia, 1969, Chapter VII R. G. D. A l l e n , Macroeconomic Theory (New York: Macmil lan, 1968), Chap-ters 13, 14. well-known s t a b i l i t y cond i t ion that even i f savings do change e q u i l i b r i u m growth, ra tes are not a f fec ted . Adjustments are assumed to occur i n the value of the c a p i t a l output r a t i o o n l y . As wi th t echno log ica l .p rogre s s i t i s po s s ib l e to argue i n d i f -ferent ways about the e f f e c t s of money on. savings behavior . On theore-t i c a l grounds, the i ssue can. again not be re so lved . The empi r i ca l e v i -dence presented i n the f i r s t chapter was not capable of answering t h i s quest ion e i t h e r . The te s t s d i d not s t r i c t l y r e l a t e to monetizat ion e f fec t s but to the impact of f i n a n c i a l markets, i n genera l . I f a p o s i -t i v e r e l a t i o n s h i p between f inance and savings ex i s t s at a l l , i t should have appeared there s ince one would expect that a d d i t i o n a l f i n a n c i a l instruments are l i k e l y to compound the e f fec t s of money. Consequently, i t seems reasonable to assume unchanged savings behavior and thus , by i m p l i c a t i o n , a constant e q u i l i b r i u m c a p i t a l output r a t i o . For the remaining ratiosochanges can unambiguously be i d e n t i f i e d . The e q u i l i b r i u m c a p i t a l l abor r a t i o r i s e s to (1+a) K/L and the same holds for income per cap i ta for steady s t a te . Thus ( Y / L ) B + a ( Y / L ) B = ( Y / L ) M The increase i n per cap i ta incomes impl ies an increase i n welfare i f the income d i s t r i b u t i o n remains unchanged and preferences are homothetic. The Pareto c o n d i t i o n for a. welfare improvement are f u l f i l l e d s ince "everybody i s be t te r o f f and no one worse o f f . " As to the required, time for. t h e . t r a n s i t i o n to the new dynamic e q u i l i b r i u m , we know from e x i s t i n g theory that the approach, to the new steady state w i l l only be gradual . For a Cobb-Douglas product ion func-a 1-a t i o n X = K L , the speed of adjustment i s g iven by the terms Cl-a) 22 (L/L + TP) . Depending, on the values for l a b o r ' s share " a " , i t s growth ra te and the labor augmenting progress f a c t o r , d i f f e r e n t values are ob-ta ined for "S" . Assume, fo r example, that L / L = 0 .03, TP = 0.02, and a = 0 .8 . The adjustment speed.then i s 0.025.or. 2.5 per cent per p e r i o d . This f i n d i n g . ind ica tes that the concern wi th steady states may be h igh ly u n r e a l i s t i c for. p r a c t i c a l purposes s ince i t i s u n l i k e l y that the conver-gence process to a new e q u i l i b r i u m can be completed without new d i s t u r b -ances i n any r e a l economy. What appears as the important conclus ion i n -stead i s the f ac t that during t h i s slow adjustment process and as a r e -s u l t of monet iza t ion , income per cap i t a r i s e s p e r i o d i c a l l y and s i m i l a r l y s o c i a l wel fare . F . Monet izat ion In Ah:Open Economy Before concluding t h i s chapter , a short sec t ion on the monetiza-t i o n e f fec t s fo r an open economy i s added. This w i l l increase the e m p i r i -c a l relevance of the f indings and simultaneously provide a bas i s for com-par i son of the e f fec t s for the two a l t e r n a t i v e assumptions. I n i t i a l l y , we intended to d i scuss i n d e t a i l the impl i ca t ions of monetizat ion for an economy with trade f lows. Some thoughts on the prob-lem ;made i t c l e a r , however, that the r e s u l t s do not change i n substance 'Neher, op. cit., p . 40. when compared to those of a c losed system. I t appears, there fore , not necessary to develop the monetizat ion e f fec t s i n great l e n g t h . Instead, we chose the form of a table, to show a summary of our f i n d i n g s . The fo l lowing assumptions under l i e the a n a l y s i s . Trade flows are b i l a t e r a l between the domestic economy and a large wor ld . Thus, r e l a t i v e product f ac tor p r i c e s are g iven and constant . Furthermore, f ac tors of product ion are assumed i n t e r n a t i o n a l l y immobile. For a l l other economic va r i ab le s the ceteris part-bus assumption based on the model of the c losed economy i s used. The tab le i s shown on the fo l low-ing four pages; for completeness three f igures are added on page 69. Together, chart and f igures c l ea r ly , i n d i c a t e the d i f f e rences and s i m i -l a r i t i e s of the monetizat ion e f fec t s for both types of economic systems. Bes ides , they serve w e l l as a f i r s t conclus ion of the r e s u l t s of t h i s chapter . MONETIZATION EFFECTS FOR A CLOSED AND AN OPEN ECONOMY' CLOSED ECONOMY OPEN ECONOMY BARTER Domestic product ion p o s s i b i l i t y f r o n t i e r EQUILIBRIUM i d e n t i c a l ; d i s t r i b u t i o n of the t o t a l p r o -duct between the two goods a lso assumed equal . Per cap i ta income X / L Q < X^Lo Thus, welfare W„ < VJ C O INVENTION OF MONEY Increase i n demand for go ld . I m p l i c i t change i n the s o c i a l preference funct ion ind ica ted by a rightward s h i f t and increased slope of the s o c i a l welfare f u n c t i o n . (See Figure 2-2). This table i s constructed on the assumption that t e c h n i c a l progress a f fect s both i n d u s t r i e s i n equal proport ions . For the a l t e r n a t i v e assumption of an uneven impact of f ac tor savings on both product ion sec tors , see M. C. Kemp, The Pur>e Theory of International Trade (Englewood C l i f f s , N . J . : P r e n t i c e - H a l l , 1964), pp. 30-32. Kemp discusses the i m p l i -cat ions of t echn ica l change for output, factor proport ions and f ac tor rewards fo r the two i n d u s t r i e s separately . CLOSED ECONOMY OPEN ECONOMY TRANSITION IN GOLD MARKET AND IN COM-POSITION OP TOTAL OUTPUT Increase i n gold product ion at the cost of other product ive investments. Increase i n share of go ld . A n t i - t r a d e bias due to mone-t i z a t i o n : decrease i n ex-por t s or increase i n trade v i a greater imports . Un-changed composit ion. PRICE OF GOLD P r i c e of gold r i s e s thus r e l a t i v e P r i c e of go ld remains unchanged pr i ce s change. therefore r e l a t i v e p r i c e s are a l so unchanged. EQUILIBRIUM IN GOLD MARKET When excess demand for gold equals zero Base for establishment of s table P r i c e s equals bar te r e q u i l i b r i u m absolute p r i c e l e v e l ; i n i t i a l bar- p r i c e s , therefore p r i c e l e v e l ter,-price of gold as basis for could have been set i n s t a n t l y p r i c e l e v e l would not have repre- a f t e r i n v e n t i o n , sented s table e q u i l i b r i u m . <7i CLOSED ECONOMY OPEN ECONOMY PRICE LEVEL p r i c e of money p^ . p r i c e l e v e l = p p r i c e of money p 0 p r i c e l e v e l p 0 OVERALL EFFECTS Resource savings v i a reduct ion i n t ransact ions costs analogous to s ing le f ac tor saving t echno log i ca l progress implies equiproport ionate outward s h i f t of product ion p o s s i -b i l i t y f r o n t i e r . TRANSITION PERIOD GRADUAL Gradual approach of the new steady s ta te . Income per capi ta r i s e s . Factor i n t e n s i t i e s change, Factor reward w changes wt; r = r B M Income per cap i t a r i s e s . Factor i n t e n s i t i e s remain unchanged. ** Factor rewards remain unchanged i n both i n d u s t r i e s . Explanations for these footnotes are given on page 6 8 . cr. CLOSED ECONOMY OPEN ECONOMY „ „ . , „ Growth rates for both systems unchanged DYNAMIC . . . * u \ • -, i f populat ion and t echno log ica l progress CONDITION growth rates remain constant . (x/x) c = (X/X) Q E q u i l i b r i u m income per capi ta compared to bar ter X/L < X / L „ „ X / L ™ < X / L „ „ BC MC BO MO X/L X/L WELFARE Increase Increase W < W W < W BC MC BO MO Rela t ive Increase W > w „ , ( b ) i f an t i - t r ade condi t ions MC MO p r e v a i l W < W MC MO(c) i f imports b ias ex i s t s V D ^ < W M 0 ( C ) Explanation of the symbols: subscr ipts " C " and "0" denote closeness and openess of the economy; "B" and "M" stand f o r bar te r and monetizat ion r e s p e c t i v e l y ; "w" = wage ra te ; " r " = i n t e r e s t r a t e ; "W" = s o c i a l welfare . Other symbols'were explained e a r l i e r . * Proof for the constancy of factor i n t e n s i t i e s for l i n e a r homogeneous product ion f u n c t i o n . I f dY/dL can be expressed i n terms of k = K/L constancy i s proven. dY/dL = d l ^ / d L . k y " a where y = k y 1 ~ a ; ; Y = , Y / L y ; g = k ^ 1 ~ b ; G= G/LQ and K = k y . L Y + k Q . L G wi th d L y = dL Q dK = k y d L y - k y d L y ; or dK = d L y (k y - k Q ) ; d K / d L y = k y - k Q i n s e r t i n g i n f i r s t expression we get dY/dL = (k y - kQ) k y a and dY/dK = d k y (k y a)/k^ The p o i n t s A , A ' and A" show the i n i t i a l e q u i l i b r i u m s i t u a t i o n under b a r t e r . The p o i n t s C , C , and C" the f i n a l e q u i l i b r i u m points with, monet iza t ion . The arrows of the . lines'AC i n d i c a t e the d i r e c t i o n of the change which can be separated in to two d i s t i n c t movements analogous- to F igure 2^2. The table i s l a r g e l y self-explanatory. Two points, however, deserve separate mention. The f i r s t i s the establishment of the i n i t i a l absolute p r i c e l e v e l . For the closed economy i t was i l l u s t r a t e d above that i t i s d e s i r a b l e to assign nominal p r i c e s to a l l goods and f a c t o r s only a f t e r the money market has reached a new equilibrium with monetiza-t i o n . This does not apply f o r the case of an open economy as assumed here. If p r i c e s are determined outside the domestic economy the absolute p r i c e l e v e l can be established i n s t a n t l y a f t e r the invention of money. However, under such circumstances., money pr i c e s lose t h e i r s i g n i f i c a n c e because they merely function as parameters, not as p o l i c y v a r i a b l e s of the system. Secondly, the'.table shows that the welfare increases i n the two systems d i f f e r w i t h t h e precise extent depending on the i n i t i a l trade conditions under barter. For a country which exports gold under barter i t appears that the r e l a t i v e increases-in welfare i s l e s s than for a comparable closed economy. This conclusion i s based on the following thoughts. I f a closed economy's preference function changes due to mone-t i z a t i o n given a c e r t a i n l e v e l of t o t a l output, i t can be i n f e r r e d that a movement from A to B would leave the l e v e l of s o c i a l welfare unchanged. The second movement from B to C increases welfare by the proportion of 23 the s h i f t i n the production p o s s i b i l i t y f r o n t i e r . Therefore, the f i n a l p o s i t i o n i s "better" than the i n i t i a l point A. A necessary and s u f f i c i e n t condition for t h i s conclusion i s the assumption of homotheity of the s o c i a l preference functions. For the country which exported gold i n i t i a l l y the welfare improve-ment i s less because of the ant i - t rade b ias of the invent ion of money. This fo l lows , i f i t i s assumed that the welfare increase for a given product ion l e v e l depends p o s i t i v e l y on the d i f ference between the domestic t o t a l output of both goods and the f i n a l e q u i l i b r i u m l e v e l wi th t rade . Put d i f f e r e n t l y , the r e l a t i v e s i ze of trade flows i s assumed to be a p o s i t i v e funct ion of the improvements i n welfare that can be a t ta ined through trade. I t then c l e a r l y fol lows that the r e l a t i v e gain from mone-t i z a t i o n i s less for the gold export nat ion than for the c losed economy. I f r e l a t i v e product p r i c e s l e d to the import of gold under b a r t e r , then the import b ias from monetizat ion appears to increase welfare more than propor t iona te ly compared to both a l t e r n a t i v e s i t u a -t ions d i scussed . This holds i f the same arguments about r e l a t i v e wel -fare gains are again app l i ed . Since p r i c e s are determined outs ide the domestic economy for the two types of an open economy assumed here , the quest ion about maximizing the welfare increase i s not subject to the con-t r o l of the domestic p o l i c y maker. D i r e c t l y analogous to the conclusions about the absolute p r i c e l e v e l , the i n t e r n a t i o n a l market determines i n t h i s s i t u a t i o n how much the domestic economy w i l l b e n e f i t . G. Conclusions This l a s t chapter was concerned w i t h the development of a mone-tary theory for a barter, economy. The invent ion of money was t e n t a t i v e l y explained as the necessary and l o g i c a l outcome of increa s ing t ransact ions costs over t ime. S i m i l a r l y the d e c i s i o n on a s p e c i f i c money good was seen to be the r e s u l t . o f a process of r a t i o n a l c h o i c e . I m p l i c i t i n our d i s c u s s i o n was.the assumption that i n d i v i d u a l s c o r r e c t l y a n t i c i p a t e the benef i t s of. money as means of. payment. The aggregate demand for money then ; s a t i s f i e s the combined minimax c o n d i t i o n s : maximum s a t i s f a c t i o n r for consumers, wi th s imultaneously minimizat ion of t ransact ions cos t s . A t h i r d cond i t ion i s necessary to assure that the e q u i l i b r i u m i n the money market a l so . . sat is f ies o p t i m a l i t y c o n d i t i o n s : e f f i c i e n c y i n the a l l o c a t i o n of scarce resources i n the product ion of money and i n the use of the e x i s t i n g stock of money. Several impl i ca t ions emerged a f ter the o p t i m a l i t y condi t ions were e s t ab l i shed . 1. There ex i s t s one and only one quant i ty of money for a given l e v e l of output which f u l f i l l s a l l optimum con-d i t i o n s . 2. Therefore , there i s a l so only a unique absolute p r i c e l e v e l which i s both s table and op t ima l . 3. Competit ion i s capable of producing t h i s equ i -l i b r i u m i f t e c h n i c a l product ion condi t ions a l low for t h i s market s t ruc ture . 4. To the extent that the product ion and use of a money good requires p o s i t i v e amounts of scarce factors and products the demand for money as s tore of value for precaut ionary or specula t ive motives , i s s o c i a l l y un-de s i r ab le because i t t i e s up resources which could be used p r o d u c t i v e l y . Commodity money should thus only funct ion as a means of payment. This l a s t conc lus ion i m p l i c i t l y descr ibes the advantages of a non-commodity standard for money. I f product ion costs of money are zero or c lose to zero , no economization o f money balances i s necessary from a product ion po int of view; money then becomes a free good. From the po in t of view of money demand, a s a tura t ion of demand could only be a t ta ined i f the y i e l d of money equal led the r e turn on a l t e r n a t i v e 24 c a p i t a l goods: L a s t l y , i t i s obvious that competit ive product ion of such a zero-cost money i s not pos s ib le without government c o n t r o l . As to the e f fec t of monetizat ion on economic growth the f i n d i n g was not conc lu s ive . I t was shown that monetizat ion alone i s not l i k e l y to increase the e q u i l i b r i u m growth ra te of a competit ive economy. Never-theless , i t could be demonstrated that the i n t r o d u c t i o n of money i s im-portant and s o c i a l l y de s i r ab le on severa l accounts : I f the re turn on money equals the y i e l d s on p h y s i c a l , assets i t could be expected that t h i s leads to the undes irable s i t u a t i o n where con-sumers w i l l e x c l u s i v e l y save i n the form of money ho ld ings . Furthermore, increased money balances would decrease p h y s i c a l investment p o s s i b i l i t i e s g iven a constant, share of savings . In the absence of f i n a n c i a l intermedia-t i o n or a l t e r n a t i v e s as long as money i s he ld i n cash , t h i s inference i s j u s t i f i e d . This conc lus ion would be f a l l a c i o u s i n a system w i t h . i n d i r e c t f i n a n c i a l markets. A m u l t i p l e quant i ty o f investment loans can be provided by the f i n a n c i a l system for a g iven amount of money depos i ted . (a) i t increases per cap i t a income; (b) i t r a i s e s e f f i c i e n c y i n the organiza t ion of product ion and t rade ; Cc) i t increases l e i s u r e time for consumers; Cd) i t increases wel fare . The above f ind ings provide s u f f i c i e n t reasons to consider e f f i c i e n t monetizat ion as an important p recond i t ion fo r growth. In Chapter IV below we s h a l l address .ourselves to the quest ion whether Thai land uses money ef f i c i e n t l y . In the fo l lowing . chapter we must f i r s t d i scuss the r e l a t i o n s h i p between f i n a n c i a l intermediat ion and growth. FINANCIAL MARKETS AND GROWTH A. Int roduct ion The fo l lowing chapter examines the p r o p o s i t i o n that the develops ment of f i n a n c i a l markets and institutions"*" i s not only more e f f i c i e n t than a system r e l y i n g merely on money, but that i t i s furthermore neces-sary fo r exchange e f f i c i e n c y i n the c a p i t a l market. In the l a s t chapter i t was argued that the invent ion o f money was a l o g i c a l necess i ty i n the face o f r i s i n g t ransact ions cost . S i m i l a r reasoning could be used for an explanat ion of the emergence of f i n a n c i a l i n s t i t u t i o n s . New f i n a n c i a l instruments would be created and used when^-ever an economic need a r i s e s , i . e . , i f under e x i s t i n g circumstances cer-t a i n ob jec t ives cannot be a t ta ined with known technolog ies . Such a deter-m i n i s t i c approach could be termed bot t leneck-causa t ion or a compulsory sequence of i n v e n t i o n . This l i n e of arguments i s not pursued here . In-stead, we s h a l l assume that a set of e f f i c i e n t f i n a n c i a l markets i s in^-troduced at a c e r t a i n p o i n t i n t ime, thereby abs t rac t ing from the gradual development of these markets. The assumption i s made i n view of our s tated ob jec t ive to determine the cause-effect r e l a t i o n s h i p between f inance and growth. Evidence c i t e d i n the f i r s t chapter on t h i s i ssue only e s tab l i shed a one-way dependence between r e a l and f i n a n c i a l growth. I t was not capable The express ions : f i n a n c i a l markets, f i n a n c i a l i n s t i t u t i o n s , fin-^ a n c i a l systems, and d i r e c t and i n d i r e c t f inance are used coterminously . of e x p l a i n i n g the pos s ib le feedback e f fec t s from f i n a n c i a l systems to development,,which are most c r u c i a l for eva luat ing the importance of f i n a n c i a l markets. The.'linconclusiveness may have p a r t i a l l y a r i s en be-cause e x i s t i n g f i n a n c i a l markets i n developing nations are not operat ing e f f i c i e n t l y and/or because t h e i r s i z e i s too small given the extent and growth of the economy. I t appears d e s i r a b l e , there fore , to base the ana lys i s on the assumption of f u l l y developed, and e f f i c i e n t f i n a n c i a l markets. This impl ies that a l l those f i n a n c i a l instruments are a v a i l s able which warrant maximum e f f i c i e n c y i n the operat ion o f the c a p i t a l market, given t e c h n o l o g i c a l knowledge. This approach w i l l a id the under-standing explanat ion of the p o t e n t i a l e f f ec t these markets could have on the process of growth. B. E f f i c i e n c y of F i n a n c i a l Markets The ana lys i s of the monetizat ion e f fects i n the l a s t chapter ended with the establishment of the new steady state c o n d i t i o n s . I t was shown that the growth rates i n a monetized system are l i k e l y to remain un-changed when compared to a bar te r s t a te . We use these conclusions as frame of reference for the present chapter. We, furthermore, assume that the monetized economy had not developed any f i n a n c i a l markets. This al lows us to show the s i g n i f i c a n c e of f i n a n c i a l markets i n terms of an extension of the advantages of money. By the term " f i n a n c i a l markets" we inc lude both d i r e c t as w e l l as i n d i r e c t f i n a n c i a l r e l a t i o n s h i p s . H i s t o r i c a l l y , d i r e c t f inance pre-ceded the system of i n d i r e c t f inance ; s i m i l a r l y the invent ion o f a commo-d i t y money occured before that of a paper or bank money. In the l a s t chapter i t was pos s ib le to concentrate e n t i r e l y on the economic i m p l i c a -t i o n of in t roduc ing a commodity money s ince a l l major consequences would be shown by using t h i s assumption. A s i m i l a r procedure i s not de s i rab le for the present chapter because the most important advantages of f i n a n c i a l markets appear only a f ter the establishment o f f i n a n c i a l intermediar ies and, there fore , with i n d i r e c t f inance . We focus , there fore , immediately on the aggregate e f f ec t of a l l f i n a n c i a l markets. The i n t r o d u c t i o n of money allowed investment spending to be d i s -t r i b u t e d i n a d i f f e r e n t way from saving . Without opera t iona l f i n a n c i a l markets, the d i s t r i b u t i o n d i f ferences due to the existence of money are only o f inter tempora l nature; not however, i n t e r p e r s o n a l . In other words, money allows economic un i t s to inves t i n excess of current savings by drawing down prev ious ly accumulated money balances . The reverse , o b r -v i o u s l y , holds true as w e l l . Saving greater than current investment i s pos s ib le v i a increased money h o l d i n g s . Under b a r t e r , savings and i n v e s t -ments were always s imultaneously determined, equal not only ex post but 2 a l so ex ante because the person of saver and inves tor co inc ided . Money increases the scope for the i n d i v i d u a l by adding f l e x i b i l i t y i n the t iming o f investments. As Gurley c o r r e c t l y points out , t h i s f ac t i s conducive This i s an o v e r s i m p l i f i c a t i o n . I t i s more l i k e l y that some borrowing and lending already took place under bar ter c o n d i t i o n s . How-ever , the amount of r e a l goods loaned and borrowed i s assumed i n s i g n i f i -cant enough that i t can be neglected . to increased s p e c i a l i z a t i o n and opens up the p o s s i b i l i t y for a more 3 e f f i c i e n t order ing of investment throughout the economy. The drawback to monetizat ion without f i n a n c i a l markets i s that the l e v e l of investment i s constra ined by the e x i s t i n g income and wealth d i s t r i b u t i o n . The i n e f f i c i e n c y of such an arrangement can be c l e a r l y seen i f the fo l lowing assumptions are accepted. In accordance with h i s t o r i c a l and present evidence take the d i s t r i b u t i o n o f income and wealth as r e l a t i v e l y unequal. Add the assumption that i n t e l l i g e n c e and entre-p r e n e u r i a l a b i l i t i e s are normally d i s t r i b u t e d among the members of s o c i e t y . I t then fol lows that unless a r e d i s t r i b u t i o n o f resources i s f ea s ib le the economic system i s not e f f i c i e n t l y a l l o c a t i n g i t s t o t a l resources — human and non-human. This i s where f i n a n c i a l markets can improve the a l l o c a t i v e process . The most important feature o f f i n a n c i a l markets for debt i n s t r u -ments i s that they al low for the separat ion of the saving and investment dec i s ions among d i f f e r e n t i n d i v i d u a l s , subject to the cons t r a in t that a l l d e f i c i t s must be matched by surpluses i n other economic u n i t s . The con-sequences of t h i s i n i t i a l innovat ion are w e l l expressed by Gur ley : "The a b i l i t y of economic un i t s to borrow d i r e c t l y from one another affords those with h i g h l y product ive investment p ro jec t s more scope than before to b i d away resources from others withe less product ive p r o j e c t s . Primary s e c u r i t i e s s t imulate r e a l growth by increa s ing the p r o b a b i l i t y that a l t e r n a t i v e investments w i l l be exp lo i t ed i n order o f t h e i r p r o d u c t i v i t y . They a l so J . G. Gur ley , "The Saving-Investment Process and the Market for Loanable Funds , " i n Money and Economic Activity, T h i r d E d i t i o n / L . s. R i t t e r (ed . ) , (Boston: Houghton, M i f f l i n , 1967), p . 51. more f u l l y e x p l o i t f i n a n c i a l incent ives to saving and thereby make i t more l i k e l y that the l e v e l o f savings and investment w i l l be r a i s e d . " 4 Gurley i n t h i s quote addressed himsel f to a system of d i r e c t f inance . The i n t r o d u c t i o n of f i n a n c i a l intermediar ies adds s u b s t a n t i a l l y to the benef i t s o u t l i n e d above. F i n a n c i a l intermediar ies^ stand between ul t imate borrowers and lenders . By borrowing surpluses of household uni t s i n exchange for the i n d i r e c t s e c u r i t i e s that they i s sue , they p a r t l y r e -solve the c o n f l i c t between lenders and borrowers which s t i l l ex i s t s i n a system of d i r e c t f inance . The cause of th i s c o n f l i c t can be a t t r i b u t e d to the character of a primary s e c u r i t y , which impl ies a d i r e c t dependence between the borrowing of funds and the use o f the savings fo r s p e c i f i c investment p r o j e c t s . To the extent that savers and lenders des i re d i f f e r -ent a t t r i b u t e s i n a s e c u r i t y (for example greater or l e s se r l i q u i d i t y ) t h e i r wants are not l i k e l y to be s a t i s f i a b l e i n a system of d i r e c t f inance , but can only be achieved through f i n a n c i a l in te rmed ia r i e s . The funct ion of these i n s t i t u t i o n s can be def ined as the transformation o f long term, r e l a t i v e l y i l l i q u i d assets in to comparatively sa fer , l i q u i d , short term f i n a n c i a l assets . By o f f e r i n g a wide v a r i e t y of a l t e r n a t i v e choices they Gur ley , op. ait., p . 52. 5 By intermediar ies a l l those agents are inc luded which funct ion i n the borrowing and lending markets. H i s t o r i c a l l y , these were f i r s t and foremost commercial banks, supplanted l a t e r by a p le thora of other f i n -a n c i a l i n s t i t u t i o n s such as savings and loans a s soc i a t ions , insurance agencies , stock brokers , and the l i k e . thus reduce the above mentioned c o n f l i c t . In t h i s process of transmuta-t i o n of assets , f i n a n c i a l in te rmediar i e s , furthermore achieve economies of scale i n the costs of t r a n s f e r r i n g funds and of p o o l i n g r i s k . ^ The quest ion now i s to determine the impl i ca t ions of having a set of such agents i n an economy i n which they were p rev ious ly non-exis tant . The f i r s t l o g i c a l step towards t h i s ob jec t ive i s aga in , as i n the moneti-za t ion case, the establishment of the e q u i l i b r i u m condi t ions i n those newly created f i n a n c i a l markets. Thereaf ter , the o v e r a l l economic e f fec t s can be der ived . Analogous to the l a s t chapter , i t i s assumed that the attainment of the e q u i l i b r i u m i n the f i n a n c i a l markets can be achieved w i t h i n a s ing le time p e r i o d . We further add the assumption that the i n i t i a l establishment 7 of f i n a n c i a l i n s t i t u t i o n s i s c o s t l e s s . In t h i s re spec t , the s i t u a t i o n i s thus considered d i f f e r e n t from the gold monetizat ion case, where a scarce resource had to be a l l o c a t e d e f f i c i e n t l y i n i t s new funct ion as money. We asser t that the emergence of f i n a n c i a l markets does not nece s s a r i ly reduce product ion or consumption of any good i n the economy. To the ex-tent that resources are needed to set up f i n a n c i a l agencies , we thus im-The problem o f r i s k appears p a r t i c u l a r l y severe for underdeve-loped count r i e s . There the resource a l l o c a t i o n process may be improved s u b s t a n t i a l l y because of a reduct ion between the d i f ference i n p r i v a t e and s o c i a l r i s k s . I f p r i v a t e investment dec i s ions are dominated by con-s idera t ions of r i s k and the p r i v a t e r i s k fac tor exceeds the s o c i a l r i s k i n v o l v e d , resource m i s a l l o c a t i o n r e s u l t s . I f f i n a n c i a l intermediar ies spread r i s k s they can improve the e f f i c i e n c y i n the a l l o c a t i o n of resources . 7 The serv ices of f i n a n c i a l i n s t i t u t i o n s a re , o f course, not assumed c o s t l e s s . p l i c i t l y assume that they have no p r i o r use and/or that they are s u b s t i -tuted for former l e i s u r e t ime. A second d i f ference from monetizat ion ana lys i s should a l so be noted a t t h i s p o i n t : because borrowing i s l a r g e l y done for investment^ p r o j e c t s , the main e f fec t s of f inance are l i k e l y to be found i n the cap-i t a l goods market. The impl i ca t ions for o v e r a l l product ion and growth i n the economy w i l l , consequently, o r i g i n a t e p r i m a r i l y i n t h i s market. To the extent that other d i r e c t s p i l l - o v e r e f fect s e x i s t to non-cap i t a l markets, they are assumed to be of secondary importance and thus not d i s -g cussed. By comparison, the important fac tor with monetizat ion was the g l o b a l impact o f the invent ion o f money on a l l economic t r ansac t ions . I t should, however, not be i n f e r r e d from t h i s statement that the aggre-gate e f f e c t of money on output i s , by d e f i n i t i o n , greater than that of f i n a n c i a l markets. How t h e i r respect ive impacts compare w i l l be d i s -cussed i n the conclus ions to t h i s chapter . C. E q u i l i b r i u m i n the F i n a n c i a l Markets and O v e r a l l E q u i l i b r i u m Condi t ion The stages of the process towards a new e q u i l i b r i u m '.are f i r s t shown i n diagrammative form. Thereaf ter , we s h a l l b r i e f l y summarize the e f fec t s on the new aggregate volume of loanable funds more formal ly . In the market for loanable funds, the emergence of f i n a n c i a l in termediar ie s i s l i k e l y to produce a reduct ion i n the e q u i l i b r i u m i n -Consumption of loans are r e l a t i v e l y important i n the context o f developing count r i e s . We s h a l l s t i l l d i s regard t h e i r existence and d i s -cuss the mod i f i ca t ion of the present arguments i n Chapter IV. t e re s t rate for a given quant i ty of funds provided to the borrowing sec t o r . Furthermore, there w i l l be an expansion i n the volume of loanable funds. The aggregate s h i f t i n the supply of funds curve i s composed of four elements: 1. The r e l a t i v e cost savings achieved by f i n a n c i a l in termediar ie s i n the p r o v i s i o n of f i n a n c i a l serv ices com-pared to those of households before the change. 2. The des i red c r e d i t m u l t i p l i e r by the f i n a n c i a l i n s t i t u t i o n . 3 . The reduct ion i n r i s k achieved wi th widely d i v e r -9 s i f i e d p o r t f o l i o s of in te rmed ia r i e s . 4. The quant i ty of money used for t r ansac t ion pur-poses p r i o r to the change. ' The sum o f these components when subtracted from the former supply p r i c e for vary ing q u a n t i t i e s of funds represents the new supply curve o f f i n a n c i a l in te rmed ia r i e s . The w i l l i n g n e s s of households to accept lower returns fo r vary ing q u a n t i t i e s of funds i s determined by the greater l i q u i d i t y , safety and v a r i e t y of asset a l t e r n a t i v e s house-holds can acquire with t h e i r savings . I f we r e t a i n the former assumption, made i n Chapter II about competit ive markets operat ing under condi t ions of c e r t a i n t y , the r i s k element obvious ly does not e x i s t . Thus only (1) and (3) account for the s h i f t . Figure 3-1 below is drawn on the assumption that the demand for funds remains unchanged with the emergence of financial markets. The demand for funds curve is thus seen as a reflection of technical productivity conditions in the capital goods market. ' Figure 3-1 Let point A reflect the equilibrium position before the change. Borrowers thus pay an average interest rate of r which money lenders and m private individuals receive for their savings. Point B and B' i s taken to represent the new equilibrium point for the period after the transition. ; 10 Private savers get the new and lower return of r , financial institutions P are assumed to change an average interest rate of r^ for the provision of funds. The difference BB' i s explained by the costs of providing financial services. would be an average rate for time and chequing deposits. Thus f a r , we focused on the i n t e r e s t rate e f f ec t of f i n a n c i a l markets. Looking now at the impact on the aggregate volume.of loanable funds the extent of the ga in through f inance can be more c l e a r l y demon-s t r a t e d : Assume a c e r t a i n amount of money M i s he ld cash fo r t r ansac t ion purposes p r i o r to the emergence of f i n a n c i a l i n s t i t u t i o n s . A s u b s t a n t i a l share of these balances w i l l be deposited with intermediar ies except for a minimum necessary for pet ty cash payments. C a l l t h i s f r a c t i o n v , with v c lose to zero . The volume of t ransac t ion balances deposited thus amounts to ( l -v )M. In a d d i t i o n , assume that the t o t a l volume of savings i s a l so p laced wi th f i n a n c i a l i n s t i t u t i o n s . Furthermore, take the des i red deposit m u l t i p l i e r as d , with 0 > d < 1. The p o t e n t i a l expansion of c r e d i t then amounts t o : i - ( l-v)M + |i'S= L^ d d F where S = aggregate savings , L = t o t a l loanable funds with f inance . F Specify M = tY S = sY C = 6l-s)Y with t = ra te of t ransac t ion balances demanded, s = savings r a t i o , C = aggregate consumption. We can then wri te — ( l - v ) t Y + — sY = L d a F j Y [ ( l -v ) t + S] = L p For subtrac t ing the quant i ty of loanable funds p r i o r to the change from t h i s l a s t express ion, we assert that t h i s amounted to we thus get i - Y ( l - v ) t + sY (i- - 1) = L - L d d F M This represents the aggregate e f f ec t of the i n t r o d u c t i o n of f i n a n c i a l markets on the volume of loanable funds which could be provided under ceteris paribus assumptions for the l e v e l of income, savings and the r t r ansac t ion balances . The formulat ion makes i t obvious that the poten-t i a l increase i n loanable funds i s subs t an t i a l and may amount to a mul-t i p l e of aggregate output at the time of the change. The above showed that borrowers are be t te r o f f under the new arrangement s ince they.pay the new lower i n t e r e s t r for t h e i r loans and F furthermore, that the a v a i l a b i l i t y of funds has g r e a t l y increased . Sav-e r s ' welfare d i d not d e c l i n e e i t h e r , because they now enjoy greater l i q u i d i t y and secur i ty for t h e i r savings . I t thus fol lows that aggregate welfare must have increased . The d i f f e rence between the o l d and the new This impl ies a m u l t i p l i e r of one p r i o r to the change. e q u i l i b r i u m goes, however, beyond a welfare ga in . The cause i s aggregate resource savings shown as the rectangle r B 'Ar i n F igure 3-1. The f a c t , that a given quant i ty of loans can be borrowed for fewer resources than before , without c rea t ing a corresponding decrease i n the supply of funds, impl ies that a c e r t a i n quant i ty of resources are now a v a i l a b l e fo r other uses. In essence, the i n t r o d u c t i o n of f i n a n c i a l markets i s thus comparable to t e c h n o l o g i c a l progress , s ince the precond i t ion for the occurrence o f ' , progress i s f u l f i l l e d : f ac tor savings are a t ta ined i n producing a given quant i ty of output. A l t e r n a t i v e l y we could descr ibe the consequence of the emergence of f i n a n c i a l markets i n terms of a s h i f t i n the product ion p o s s i b i l i t y f r o n t i e r . What has to be resolved next i s the quest ion how, and to what extent , factors of product ion are a f fec ted . D i f f e r e n t so lu t ions could be g iven , depending on the s p e c i f i c assumptions made about the borrowers' use of these resource savings . Given our assumption above that loans are only used to f inance investments, we can i n f e r that savings w i l l f i r s t d i r e c t l y b e n e f i t the investment sec tor . Thi s i s shown i n p o i n t C i n F igure 3-1, which represent the e q u i l i b r i u m p o i n t at the end of the t rans-i t i o n p e r i o d . We can der ive t h i s conc lus ion more c l e a r l y by t r a n s l a t i n g the e q u i l i b r i u m condi t ions of the f i n a n c i a l markets i n t o f ac tor space. F igure 3-2 i l l u s t r a t e s the e f f e c t . Let I represent the re levant isoquant under monetizat ion without f i n a n c i a l markets. The l i n e KL shows the p r e v a i l i n g r e l a t i v e f ac tor p r i c e s and p o i n t M denotes the e q u i l i b r i u m q u a n t i t i e s of c a p i t a l and labor used. The i n t r o d u c t i o n Figure 3-2 COMPARATIVE STATIC EFFECTS OF FINANCE IN FACTOR SPACE of f i n a n c i a l in termedia t ion decreases the p r i c e o f c a p i t a l as shown i n the diagram above for investment f lows. Thi s impl ies that r e l a t i v e f ac to r p r i c e s changed as i n d i c a t e d by the l i n e KL. For an unchanged l e v e l o f output , t h i s input p r i c e change induces a s u b s t i t u t i o n of c a p i t a l f o r l abor as shown by the dashed l i n e which has the same slope as the new p r i c e l i n e . In a d d i t i o n , there i s the output e f f ec t due to the decreased product ion cos t s . Both e f fec t s lead to a new e q u i l i b r i u m s i t u a t i o n i n which a greater quant i ty of output i s produced with r e l a -t i v e l y more c a p i t a l . For s i m p l i c i t y ' s sake, we assume that the quant i ty o f l abor used a f ter the change equals the p r e v i o u s l y p r e v a i l i n g f u l l em-ployment amount. This assumption i s i l l u s t r a t e d by the equa l i ty of and L i n the diagram. The increase i n aggregate output due to the i n -t r o d u c t i o n o f f i n a n c i a l markets can a l so c l e a r l y be seen i n the lower p o r t i o n of the f i r s t diagram, which re la te s ( the flow of c a p i t a l formation, e . g . , I , to t o t a l output. Drawn on the assumption o f constant r e l a t i v e shares of savings out o f t o t a l income X, the reduct ion i n costs for i n -vestment funds i s seen to r e s u l t i n an increase of aggregate output from X to X . M F In the new e q u i l i b r i u m we thus have an increased c a p i t a l i n t e n s i t y , increased investments, h igher income per c a p i t a and correspondingly higher consumption per c a p i t a l . Given the knowledge of the comparative s t a t i c e q u i l i b r i u m condi t ions the d e r i v a t i o n o f the steady state condi t ions fol lows automat ica l ly . I t was already e s tab l i shed above that the e f f ec t of the i n t r o d u c t i o n of f i n a n c i a l markets was e s s e n t i a l l y equal to a once and f o r a l l t e c h n o l o g i c a l improvement. The d i scus s ion of the r e s u l t i n g f ac tor market changes showed that the nature of t h i s change can be descr ibed as a c a p i t a l augmenting t e c h n i c a l change. We can, there fore , note a further d i f f e rence of the e f fects of f i n a n c i a l markets as compared to those o f mon-e t i z a t i o n : whi le money augmented both factors o f p roduc t ion , f i n a n c i a l markets appear to induce only c a p i t a l saving e f f e c t s . The- . s imi lar i ty of both innovations thus far seems to be that monetizat ion as w e l l as f i n a n -c i a l markets have only the character of a s ing le t e c h n i c a l improvement. Given t h i s , we know from the l a s t chapter that the steady state growth condi t ions remain unchanged. The e q u i l i b r i u m growth rate would only change i f e i t h e r the rate of labor force growth and/or the rate o f t ech-n o l o g i c a l progress would increase permanently as a r e s u l t of the emergence of f i n a n c i a l markets. R e c a l l furthermore that r i s i n g savings rates cannot a l t e r the e q u i l i b r i u m condi t ions but merely produce corresponding adjust-ments i n the c a p i t a l output r a t i o . Increased savings do, however, lead to greater r i s e s i n income per c a p i t a i n the t r a n s i t i o n p e r i o d to a new steady state than i f the savings r a t i o remains constant . This f a c t , t o -gether with the known length of the adjustment p e r i o d to a new steady s t a te , reaf f i rms a priori expectations about the importance o f the savings v a r i a b l e . From a p o l i c y p o i n t of view, i t appears most appropriate to d i s -cuss the p r o b a b i l i t y of increased savings rates induced by the existence of f i n a n c i a l markets. Pos s ib le l inkage between finance and popula t ion growth and/or t e c h n o l o g i c a l progress are not considered because no con-c l u s i v e arguments about the existence and magnitude of such e f fec t s cou ld be e s t ab l i shed . The general consensus of authors who have w r i t t e n about the r e -l a t i o n s h i p between f i n a n c i a l and r e a l development seems to be that f i n a n -c i a l markets induce r e a l growth v i a increased savings r a t e s . The argu-ments provided for t h i s conc lus ion d i f f e r s u p e r f i c i a l l y but not i n sub-13 stance. None of them appears convinc ing . For savings rates to r i s e permanently, i t has to be argued that des i red savings depend upon the e x i s t i n g i n s t i t u t i o n a l s t ructure and/or that an increase i n choice of assets r a i s e s the preference for savings . Both assumptions seem to be ra ther far reaching when compared to the conventional hypothesis about the determinants of savings: income, wealth and the i n t e r e s t r a t e . The i n t r o d u c t i o n of f i n a n c i a l markets was shown to decrease the l e v e l of i n t e r e s t rates and r a i s e the income l e v e l . In terms of conven-t i o n a l theory t h i s impl ies that as long as the r e l a t i v e increase i n out-put exceeds"the r e l a t i v e dec l ine i n the e q u i l i b r i u m i n t e r e s t rate savings could even be expected to d e c l i n e . A simple formulat ion of the permanent savings hypothesis would thus lead to the fo l lowing three pos s ib le r e s u l t s : I f Y / r = W 12 J . G. Gurley and E . S. Shaw, " F i n a n c i a l Aspects of Economic De-velopment," American Economic Review, V o l . X L V (September, 1955), pp. 515-39; H. T . P a t r i c k , " F i n a n c i a l Development and Economic Growth i n Underde-veloped C o u n t r i e s , " Economic Development and Cultural Change, V o l . x i v (January, 1966), pp. 174-89; D. S. Paauw, "F inanc ing Economic Development i n Indones ia , " Economic Development and Cultural Change, V o l . IV (January, 1956), pp. 171-85. 13 Gurley and Shaw use an extension of the d i v i s i o n of labour argu-ment; P a t r i c k emphasizes the a v a i l a b i l i t y of funds; others s t res s the i n -creased need for funds with increased s p e c i a l i z a t i o n . A l l conclude that for these d i f f e r e n t reasons f i n a n c i a l i n s t i t u t i o n s w i l l induce r a i s i n g savings r a te s . where Y represents annual income, r = e q u i l i b r i u m i n t e r e s t r a t e , W t o t a l weal th , and S = f(W) and dS = f ' (W) with " d " denoting the rate of change. (a) dY > r W increases dS decreases (b) dY = dr W constant dS zero (c) dY < dr W dec l ines dS increases Some type of permanent savings hypothesis appears to be the most reason-able assumption about savings behavior that can be made a pviovi and as long as one be l ieves i n an i n d i v i d u a l ' s as w e l l as s o c i e t y ' s a b i l i t y to p lan r a t i o n a l l y fo r the fu ture . If t h i s a s se r t ion i s accepted, i t f o l -lows that no simple inference can be made about the d i r e c t i o n of change i n the rates of savings . To do so would require the knowledge about the r e l a t i v e output and i n t e r e s t changes which fo l low the invent ion of f i n -a n c i a l markets. We s h a l l not t r y to estimatet.these ga ins , s ince we only want to emphasize how dubious as ser t ions about savings behavior can be. Another reason why some authors argue that savings w i l l increase wi th the development of f i n a n c i a l markets may be that they i d e n t i f y de- " s i r e d savings r a t ^ s - w i t h o b s e r v a b l e d i f fe rences between^national product and consumption. This r e s i d u a l approach i s c l e a r l y unsa t i s f ac to ry . With emerging a l t e r n a t i v e p o s s i b i l i t i e s f o r the forms i n which savings can be he ld one would expect that p r e v i o u s l y accumulated hoards of d i f f e r e n t types are subs t i tu ted for f i n a n c i a l a s set s . Such a replacement process does, however, not increase the ra te of savings but merely changes the compo-s i t i o n of assets h e l d . D. Necess i ty of F i n a n c i a l Markets In t h i s l a s t sec t ion we s h a l l look a t f i n a n c i a l markets from a d i f f e r e n t pe r spec t ive : thus f a r , t h e i r benef i t s over and above a money economy without d i r e c t and i n d i r e c t f i n a n c i a l were s t re s sed . We now argue that trade i n c a p i t a l goods i s a necessary cond i t ion for e f f i c i e n c y i n the resource a l l o c a t i o n process . Since f i n a n c i a l markets were shown to perform t h i s t r ad ing funct ion most e f f i c i e n t l y , the arguments w i l l , there fore , i n d i r e c t l y prove the importance (necessity) of these i n s t i -t u t i o n s . I f the fo l lowing few© -assumptions about the state of nature and technology are accepted together with the next two as ser t ions about the e x i s t i n g s tate of a f f a i r s i n s o c i e t y , the proof i s easy. 1. The d i s t r i b u t i o n of i n t e l l i g e n c e approximates a normal d i s t r i b u t i o n . 2. E f f i c i e n c y i n investments requires a c e r t a i n minimum quant i ty of both human and p h y s i c a l c a p i t a l . The ac tua l s i z e v a r i e s wi th t echno log ica l knowledge. 3. The i n i t i a l resource endowment with p h y s i c a l 14 c a p i t a l i s unevenly d i s t r i b u t e d . I f we furthermore assumed that the average i n i t i a l endowment of p h y s i c a l c a p i t a l per man i s smaller than the quant i ty required for e f f i c i e n t investments, the trade neces s i ty would be s e l f - e v i d e n t . This assumption i s , however, not necessary for the d e r i v a t i o n of the conc lus ions . 4. Human c a p i t a l or i t s observable proxy income per cap i t a i s a l so unevenly d i s t r i b u t e d . i From standard theory we know the fo l lowing e f f i c i e n c y condi t ions for a s tab le e q u i l i b r i u m : where Sx : 5 K H = K1 K = human c a p i t a l , H K = p h y s i c a l c a p i t a l , X = t o t a l output. SX _ X _ tSK ~ K P P Average and marginal returns on both physi-c a l as w e l l as human c a p i t a l must be equal . Without having to der ive the impl i ca t ions of the condi t ions f o r m a l l y , i t i s obvious from the four assumptions, that maximum e f f i c i e n c y cannot be a t ta ined without t rad ing i n c a p i t a l goods. Some resources w i l l have to be t rans ferred from those i n d i v i d u a l s with r e l a t i v e l y large endowments i n p h y s i c a l c a p i t a l and low entrepreneur ia l a b i l i t i e s to others with r e l a t i v e l y greater a b i l i t i e s but l e s s command over resources . In f i n a l e q u i l i b r i u m welfare would be maximized i f incomes per c a p i t a , thus human c a p i t a l would a l so approach normal d i s t r i b u t i o n . The optimal s i ze of investments would be determined by t e c h n i c a l product ion and cost c o n d i -t i o n s . I t i s a t ta ined i f product ion costs are minimized and a l l c a p i -t a l earns the average market ra te of r e t u r n . This approach could lead to a d i s cus s ion of d i f f e r e n t normative i s sues , which we s h a l l d i s regard . Two po int s are worth mentioning, how-ever : an i n i t i a l i n e q u a l i t y i n the d i s t r i b u t i o n of t o t a l wealth does not impede e f f i c i e n c y i n the a l l o c a t i o n of resources , provided c a p i t a l t r ad ing e x i s t s . An optimal arrangement of c a p i t a l market services would al low for the p r o v i s i o n of loans depending on a b i l i t i e s and/or t e c h n i c a l product ion requirements but independent of e x i s t i n g endowment of c a p i t a l resources . Thi s i s Utopia. In r e a l i t y , the a b i l i t y to borrow depends h e a v i l y on the amount and type of c o l l a t e r a l an i n d i v i d u a l can o f f e r , not on expected returns on p h y s i c a l and human investments. F i n a n c i a l i n s t i t u t i o n s , such as competit ive banks, are not i n a p o s i t i o n to imple-ment Utopia for the obvious reason of the r i s k element involved' , due to the low p r o b a b i l i t y of c o r r e c t l y assess ing i n d i v i d u a l a b i l i t i e s . The above re-a f f i rms our previous f i n d i n g s : f i n a n c i a l i n s t i t u t i o n s are necessary to guarantee maximum e f f i c i e n c y i n the resource a l l o c a t i o n process . However, even i f an optimal arrangement of f i n a n c i a l s e rv ice was p r a c t i c a l l y f e a s i b l e , i t i s doubtful whether i t would induce r i s e s i n the economic growth rate of an economy. E . Conclusions We have shown i n Chapters II and III that the only d e f i n i t e causal e f f ec t of the i n t r o d u c t i o n of money and f i n a n c i a l markets on the growth process takes the form of two separate s ing le t e c h n o l o g i c a l improve-ments. In the case o f monetizat ion the t echno log i ca l progress fac tor appeared to augment both factors of p roduc t ion , while i t only increased the input f ac tor c a p i t a l a f t e r the .es tabl i shment of f i n a n c i a l markets. Induced increases i n the savings rate through each f i n a n c i a l change seemed a pvCovi u n l i k e l y for monetizat ion and for f i n a n c i a l mar-ke t s . S i m i l a r l y , inconc lus ive r e s u l t s were found for the l inkage e f fec t s between a permanent r i s e i n the ra te of t e c h n o l o g i c a l progress and the two f i n a n c i a l improvements. For an economy which was growing i n steady state under bar ter these r e s u l t s impl ied that the new e q u i l i b r i u m growth rates a f t e r monetizat ion and f inance are l i k e l y to remain unchanged. These f ind ings suggest the i n t e r p r e t a t i o n that ;money and f inance appear to be important precondi t ions for e f f i c i e n t e q u i l i b r i u m growth. Taken by themselves, t h e i r existence provides only a necessary but not s u f f i -c i e n t cond i t ion -for induced increases i n the growth p o t e n t i a l of an eco-nomy . The d e s i r a b i l i t y of both types of f i n a n c i a l improvement could c l e a r l y be e s t ab l i shed . Each innovat ion was shown to increase income per cap i t a and thus t o t a l wel fare , as a d i r e c t consequence of t h e i r appearance. The s i m p l i f i e d set of assumptions used i n the model proved h e l p -f u l i n the d e r i v a t i o n of these r e s u l t s . I t prec luded , however, the i n -corporat ion of c e r t a i n f a c t o r s , which may more r e a l i s t i c a l l y r e f l e c t the s i t u a t i o n i n the developing count r i e s . One of these model assumptions was the sudden "overnight" appearance of both money as w e l l as f i n a n c i a l markets, which were asserted to operate e f f i c i e n t l y and under e q u i l i b r i u m condi t ions w i t h i n a s i n g l e time per iod a f t e r t h e i r emergence. The r a t i o n -a le for t h i s p a r t i c u l a r assumption was twofold : f i r s t l y , we found incon-c l u s i v e empi r i ca l evidence about the e x i s t i n g r e l a t i o n s h i p between finance and growth. Secondly, there was a strong presumption that t h i s lack of s i g n i f i c a n c e i n the explanatory value of the data was at l e a s t p a r t i a l l y due to the i n e f f i c i e n c y with which these markets a c t u a l l y operate . With our model assumptions and the r e s u l t i n g conclusions we are now i n a p o s i -t i o n to examine the e m p i r i c a l evidence once again with two r e l a t e d objec-t i v e s : 1. I d e n t i f i c a t i o n of e x i s t i n g sources of i n e f f i c i e n c i e s . 2. Es t imat ion of the increases i n income per c a p i t a which could be a t ta ined i f these i n e f f i c i e n c i e s were e l imina ted . I t i s obvious from the l i m i t e d scope of t h i s paper that the second ques-t i o n cannot be answered r i g o r o u s l y . We therefore only attempt to provide some i n d i c a t i o n about the r e l a t i v e s i ze of some of the observable i n e f f i -c i e n c i e s . The ana lys i s w i l l only consider p a r t i a l improvements which could be obtained by a bet ter organiza t ion of f i n a n c i a l markets. Before turn ing to these e m p i r i c a l questions i n the fo l lowing chapter , we f i r s t develop some further eva luat ion c r i t e r i a for judging the performance of a developing n a t i o n : . To t h i s end, we s h a l l b r i e f l y d i scuss the condi t ions for optimal economic growth. SOME EMPIRICAL NOTES ON OPTIMALITY AND EFFICIENCY IN THAILAND A. Introduct ion The l a s t two chapters analyzed the r e l a t i o n s h i p between money, fin--?-a n c i a l markets, and growth. On a priori grounds, no d i r e c t feedback e f f ec t between an e f f i c i e n t f i n a n c i a l system and r i s e s i n the savings rate could be proven to e x i s t . Our hypothesis about the growth inducing e f fec t s of money and f inance , formulated as a 1 , b ' and c' i n Chapter I , was thus r e -futed . Since savings are a c r u c i a l determinant for the rate o f g rowth , 1 i t fo l lows that p o l i c i e s aimed at opt imiz ing growth rates should f i r s t consider the l e v e l and rate's of e x i s t i n g savings and compare them wi th des i red r a t e s . I f ac tua l rates f a l l short of the optimal e f f i c i e n c y con-s idera t ions o f the e x i s t i n g saving-investment sec tor i n genera l , and o f f i n a n c i a l i n s t i t u t i o n s i n p a r t i c u l a r , become of r e l a t i v e l y l e s se r p o l i c y importance. Put d i f f e r e n t l y , the expected rates of r e turn from expanding and/or improving the e f f i c i e n c y of the e x i s t i n g f i n a n c i a l sector may then be le s s than for investments i n a l t e r n a t i v e product ion p o s s i b i l i t i e s which induce r i s e s i n the savings r a t i o . Thi s concluding chapter w i l l , there fore , e s t a b l i s h a working d e f i n i t i o n of o p t i m a l i t y and of i t s imp l i ca t ions for the des i red short-and long-term savings rate-.- Should the data suggest, then a s i g n i f i c a n t This obvious ly does not hold for e q u i l i b r i u m growth rates i n a n e o - c l a s s i c a l system. discrepancy ex i s t s between observable and optimal savings r a t e , we would know that expansionary p o l i c i e s i n the f i n a n c i a l markets would not have the highest p r i o r i t y r a t i n g for development p lanners . If e m p i r i c a l mater i a l on past economic•performance can.be in terpre ted as approximating des i red growth and.savings r a t e s , the e f f i c i e n c y quest ion would, however, ra te h igh i n terms of planning p r i o r i t i e s . . From the t o t a l of four tes tab le cases on o p t i m a l i t y and e f f i c i e n c y : 1. O p t i m a l i t y - e f f i c i e n c y 2. Opt imal i ty—inef f ic iency .-3. Subopt ima l i ty -e f f i c i ency . 4. S u b o p t i m a l i t y - i n e f f i c i e n c y : we thus want to determine the a l t e r n a t i v e which character izes the e x i s t i n g s i t u a t i o n i n Thai land bes t . In accordance wi th p o l i c y p r i o r i t i e s , we f i r s t t e s t for o p t i m a l i t y , .assuming e f f i c i e n c y p r e v a i l s i n a l l markets. The r e s u l t serves as a bas i s for the subsequent e f f i c i e n c y a n a l y s i s , which i s r e s t r i c t e d to the f i n a n c i a l s ec tor . S u r p r i s i n g l y , we found a r e l a t i v e l y c lose correspondence between the savings rate i n Thai land and that which we def ined opt imal . This r e s u l t , together with the knowledge that b l i s s , i . e . , a l t e r n a t i v e (1) does not e x i s t , allowed us to i d e n t i f y the Thai s i t u a t i o n with the second hypothes i s . E s t i -mating the e x i s t i n g i n e f f i c i e n c i e s fo r the f i n a n c i a l s ec tor , ind ica ted that subs t an t i a l gains i n terms of aggregate output could be achieved, i f money and f i n a n c i a l markets were operated e f f i c i e n t l y . With respect to p o l i c y , the e l i m i n a t i o n of i n e f f i c i e n c i e s fu r ther -more acquires great p r a c t i c a l s i g n i f i c a n c e . B. Object ives The ob jec t ives of development planners regarding the saving i n -vestment process i s assumed to be the maximization of the stream of r e a l consumption over t ime. Two major i ssues need to be reso lved before the c r i t e r i o n or ob jec t ive funct ion can be s p e c i f i e d —,assuming that t ech-n o l o g i c a l o r supply condi t ions are known with c e r t a i n t y over t ime: 1. The re levant time hor i zon for the p lanning p e r i o d ; 2. The value judgments concerning the e x p l i c i t or i m p l i c i t u t i l i t y ( s o c i a l welfare) func t ion . 2 The l i t e r a t u r e presents a number of a l t e r n a t i v e types o f optimal growth models. These d i f f e r e n t approaches can best be shown i n a simple char t : TIME HORIZON No e x p l i c i t use UTILITY FUNCTION E x p l i c i t use Turnpike I n J^yj^ Golden Rule Pontryagin Path Modi f ied Golden Rule The op t imiza t ion problem genera l ly cons i s t s of maximizing consumption over time given the product ion cond i t ions . The instrument or p o l i c y For fur ther extensive b i b l i o g r a p h y , see E . Burmeister , A . R. D o b e l l , Mathematical Theories of Economic Growth (London: Macmil lan , 1970) , pp. 325-420. v a r i a b l e i s u s u a l l y the savings r a t i o s and the s tate var i ab le ( s ) are the c a p i t a l i n t e n s i t y C i e s ) " k " . The value o f a l l other v a r i a b l e s can be deter-mined once the optimal values of s and ksare found. The now well-known r e s u l t s fo r the Golden Rule s tate that c a p i t a l accumulation should proceed at a . ra te such that the marginal p r o d u c t i v i t y of c a p i t a l ' f ' (k) equals the ra te of i n t e r e s t , or f ' Ck) = r = A where A = na tura l rate of populat ion growth. This r u l e i s optimal on ly as long as future u t i l i t i e s are not d i scounted. If they a re , we obta in the genera l ized or modif ied Golden Rule r e s u l t s : * _ r = p + g = A with p = i n d i v i d u a l rate of time preference . The optimal ra te of i n t e r -est thus needs to be higher than the growth rate g whenever future con-sumption i s valued le s s than present consumption. Hence, savings are a l so le s s under the modif ied Rule. If labor augmenting t echno log ica l progress i s present , two a d d i t i o n a l f ac tors have to be taken in to account: the rate of t e c h n i c a l progress i t s e l f and the degree of homogeneity of 3 the u t i l i t y f u n c t i o n . It has been proven by Phelps and M i r l e e s that an E . S. Phelps , Golden Rules^of Economic Growth (New York: W. W. Norton, 1966), pp. 69 f f ; J . A . M i r l e e s , "Optimum Growth. When Technology i s Changing," Review of Economic Studies, V o l . XXXIV C 1 9 6 7 ) , pp. 93 f f . optimum path ex i s t s on ly i f a + p >_ b where a = e l a s t i c i t y of u t i l i t y , b = labor augmenting progress f a c t o r . This c o n d i t i o n must be s a t i s f i e d for the convergence of the u t i l i t y i n -t e g r a l . I f u t i l i t y i s not discounted s u f f i c i e n t l y , no optimal p o l i c y can be d e r i v e d . Combining these r e s u l t s , i t can thus be seen that a necessary c o n d i t i o n for the exis tence of. an optimal t r a j e c t o r y i s that the i n t e r e s t ra te cannot be lower and thereby saving and c a p i t a l i n t e n s i t y not higher than i n the o r i g i n a l Golden Rule . In t h i s sense, i t can be 4 considered as a separa t r ix or d i v i d i n g l i n e between dynamically e f f i -c i e n t and i n e f f i c i e n t growth paths . I f the time hor izon i s f i n i t e , the r e s u l t s are le s s c l e a r - c u t : they depend on the planning p e r i o d , the i n i t i a l c a p i t a l endowment, and the des i red c a p i t a l i n t e n s i t y at the end of the time h o r i z o n . G e n e r a l l y , i t can be s a i d , that the longer the planning p e r i o d , the more c l o s e l y the system w i l l arch toward the Golden Rule and the longer i t w i l l stay i n i t s neighborhood.^ However, i f the time hor izon i s r e l a t i v e l y short p . A . Neher, An Introduction to the Theory of Optimal Economic Growth (Unpublished manuscr ipt ) , U n i v e r s i t y of B r i t i s h Columbia, 1969. Burmeister and D o b e l l , op. cit., p. 318. and the target c a p i t a l i n t e n s i t y smaller than the e q u i l i b r i u m optimal v a l u e , a movement towards the optimal path may not be d e s i r a b l e . With the knowledge of the above the answer to our i n i t i a l two ques t ions , i . e . , f i n d i n g . t h e re levant time hor izon a n d . u t i l i t y f u n c t i o n , becomes a l i t t l e e a s i e r . R e c a l l that our framework i s that of a develop-ing country , which, i s assumed to have a number of s t y l i z e d f a c t s : a low c a p i t a l i n t e n s i t y , a low savings ra te and thus a h igh l e v e l of i n t e r e s t r a t e s , a h igh ra te of populat ion growth, low per cap i ta incomes and con-sumption l e v e l s . For s i m p l i c i t y ' s sake'and to r e t a i n comparabi l i ty with the o u t l i n e d model, the rather u n r e a l i s t i c assumptions must be added that f u l l employment and competit ive e q u i l i b r i u m condi t ions p r e v a i l i n a l l mar-kets and that populat ion growth i s exogenously determined. Some of these assumptions w i l l be relaxed below. For now we s h a l l take them as g iven . The quest ion i s thus : what dec i s ions can we expect and/or should we recommend to the planning a u t h o r i t i e s concerning the time hor izon of t h e i r p lanning periods and.the shape of the s o c i a l welfare f u n c t i o n . I f the i n t e n t i o n i s to formulate a long-term reference framework, the Golden Rule (or i t s modif ied version) with i n f i n i t e time hor izon i s probably the best cho ice . Furthermore, zero time d i scount ing seems pre ferab le to any p o s i t i v e ra te of time preference s ince the l a t t e r would not only r e t a rd the accumulation process but a l so imply a lower boundary to the optimal c a p i t a l i n t e n s i t y . Furthermore; an i n f i n i t e time hor izon without d i s -counting appears more reasonable.on equi ty grounds than any a r b i t r a r i l y se lec ted time per iod and ra te of time preference . I f the future i s dis-r counted at a s i n g l e p o s i t i v e r a t e , r e t a i n i n g the assumption of an i n f i n i t e h o r i z o n , i t must be assumed that future generations would have i d e n t i c a l preferences with, respect to present and future consumption.. Put d i f f -e r e n t l y , the degree of myopia r e f l e c t e d i n the p o s i t i v e ra te of d i s -counting must remain unchanged at a l l t imes. With zero d i scount ing we s t i l l have the i m p l i c i t assumption of constant preference functions but the s o l u t i o n seems somewhat.less r e s t r i c t i v e and a r b i t r a r y : the problem of choosing an optimal saving p o l i c y i n which many of those a f fected are not able to vote because they are not born yet i s solved by g i v i n g future generations the same weight as the present . As to the formulat ion of the u t i l i t y funct ion there are two main a l t e r n a t i v e s : aggregate or per cap i t a u t i l i t y func t ions . The f o r -mer seems more adequate for o v e r a l l p o l i c y and s o c i a l welfare ;>planning. Both concepts can be r e c o n c i l e d i f they are formulated i n the fo l lowing way: t= ° ? U = / e P L(t ) u[c(t)3 dt t=0 t=p? U = / e P u[c (t) ] dt t=0 These two formulations can be used interchangeably bearing i n mind that the va lue of the d i scount rates d i f f e r s by the ra te of populat ion growth. p = p - g If p o s i t i v e weighting by popula t ion o f f se t s the negative weight of time pre ference , the e f f e c t i v e s o c i a l d i scount r a te could be negat ive . I t w i l l d e f i n i t e l y assume a negat ive absolute va lue i f p = 0 and g > 0. The problem then i s to f i n d an appropriate converging c r i t e r i o n f u n c t i o n a l We know^ f o r p = 0 that i f the absolute value of the marginal u t i l i t y . f unction i s equal to or exceeds one, convergence i s warranted. We s h a l l assume an e l a s t i c i t y value of E > 1 f o r two reasons. F i r s t , i t appears 7 i n l i n e with e m p i r i c al research on the subject, and secondly, i t provides us with the d e s i r e d r e s u l t that the optimal savings rate i s not lower than the one prescribed by the Golden Rule. We are now able to summarize the above by sp e c i f y i n g the c r i -t e r i o n f u n c t i o n a l as: t=°° U = / L(t) u[ Sit] ] dt t=0 1 ' where U(c) = l o g c and L(t) = L(0) e^*"; g = A + b, b = labor augmenting progress, or more simply t=<*> O = / e log c dt. t=0 B. S- Frey, "Eine einfache Eipfuehrung zu Pontryagins Maximum-P r i n z i p im Wirtschaftswachstum," Sonderdruck, Weltwirtschaftliches Archiv3 (Band 103, 1969), p. 227. 7 Empirical r e s u l t s on the issue are rather sharply diverging. Mera found an e l a s t i c i t y value of -0.05-0.25 while F e l l n e r computed the marginal u t i l i t y e l a s t i c i t y as -1.5. The value of -1.00 appears as reas-onably midpoint between the two estimates. K. Mera, "An Empirical Deter-mination of A Dynamic U t i l i t y Function," Review of Economies and Statis-tics, V o l . L (1968), p. 117; W. F e l l n e r , "Operational U t i l i t y : The Theo-r e t i c a l Background and Measurement," i n Ten Economic Essays in the Trad-ition of Irving Fisher (New York.: 19671, quoted i n Frey, Idid.3 p. 226. This formulat ion impl ies fo r the optimal pa th : * -s = s p = 0 f ' (k) = r r = g where * s = the optimal Golden Rule savings r a t e ; s = the e f f i c i e n t a t t a inab le savings rate given the target and the c o n s t r a i n t s . I f planners are instead concerned with s p e c i f i c short-term plans the i n -f i n i t y assumption would c l e a r l y be i r r e l e v a n t . However, t h i s should not imply that short-term optimal pathmoves away from the Golden Rule path . It i s more p l a u s i b l e that they w i l l approach i t i n stepwise fa sh-ion through a number of appropriate short-term p lans . For underdeveloped countr ies t h i s presumption may not hold t r u e . They may require a per iod of "overshoot ing" of the Golden Rule e q u i l i -brium values at the present stage, i f they have a strong preference for increa s ing the aggregate c a p i t a l stock and eventual ly catching up with the i n d u s t r i a l i z e d na t ions . The choice of the Golden Rule impl ies that accumulation beyond the e q u i l i b r i u m values for c a p i t a l i n t e n s i t y and sav-ings r a t i o i s dynamical ly i n e f f i c i e n t . When the planning per iod i s f i n -i t e and thus a terminal data of decumulation allowed f o r , savings i n exr--cess o f the Golden Rule r a te can be e f f i c i e n t ; They w i l l be i f the bene-f i t s of the f ina l .decumula t ion outweighs the s a c r i f i c e s of i n i t i a l l y fo re-gone consumption. With, r a p i d l y growing populat ions t h i s cond i t ion i s l i k e l y to be f u l f i l l e d . We could thus conceive of movements such as and n n+m where n + m <_ 0 0 as i l l u s t r a t e d i n F i g u r e 4-1 below. F i g u r e 4-1 We can t h e r e f o r e r e d e f i n e the range of p e r m i s s i b l e and d e s i r a b l e va lues f o r the opt imal savings r a t e as s > s where _ * _ * s = s holds for an i n f i n i t e time hor izon and s > s f o r op-t imal f i n i t e p l ans . This information can now be used to examine e x i s t i n g e m p i r i c a l evidence on savings ra tes i n Tha i l and . . Although a fur ther narrowing of the range of values for the savings ra tes would have been pre ferab le and necessary for a r igorous t e s t , the above provides a s u f f i c i e n t con-d i t i o n for i l l u s t r a t i n g Thai economic performance. C. E m p i r i c a l Evidence About Opt imal i ty and E f f i c i e n c y i n Thai land The problem i s to determine whether or not e x i s t i n g savings could a l so be in terpre ted as op t ima l , g iven the previous assumption••• about modi-f i e d Golden Rule o p t i m a l i t y ( inc luding a labor augmenting progress f ac -tor) . The a l l o c a t i o n of ac tua l savings and investment i s assumed e f f i -c i e n t for the time be ing . The same cond i t ion i s imposed on the perfor--mance of a l l other markets. Restat ing the e q u i l i b r i u m condi t ions from above, we have: g = f ' (k) = A + b + ap where a = -~1 and p = 0 are assumed va lues . The optimal condi t ions for the savings and investment markets a re : The Thai data can now be compared wi th the above e q u i l i b r i u m c o n d i t i o n s ; the data are averages from a per iod of 10 years from 1959 to 1969. The fo l lowing s t a t i s t i c a l information i s r e a d i l y a v a i l a b l e : g = 0.08 A = 0.0025 No compiled data e x i s t for the rate of r e turn on c a p i t a l or the savings 9 r a t i o . T h e i r value i s approximated as s = 0.20 r = 0.08 What values can be reasonably imputed to the rate of t e c h n i c a l progress and the c a p i t a l output r a t i o ? For the e q u i l i b r i u m condi t ions to be sat-i s f i e d they would have to assume va lue s .o f b = 0.055 and for the imputed c a p i t a l output r a t i o of 2 .5 . An exogenous progress fac tor of 5.5 per cent annual ly seems rather h igh at f i r s t s i g h t . However, i t appears to be w i t h i n to lerance i n t e r -v a l for a developing nat ion where the rate of t e c h n i c a l progress can be 8 A l l data are obtained from Bank of Thailand, Monthly Report , V o l . X (January 1970). 9 The data on populat ion growth and the r e a l growth of n a t i o n a l output can be assumed as r e l a t i v e l y accurate 1 es t imates . The savings r a te could only be approximated from.the share of gross, c a p i t a l forma-t i o n i n GNP over the s tated periods As c l o s e s t proxy fo r the y i e l d on p h y s i c a l c a p i t a l the c e n t r a l bank loan ra te was s e l ec ted . expected to exceed those of i n d u s t r i a l i z e d nat ions . The same can be sa id about the c a p i t a l output r a t i o : i f the r a t i o of f i n a n c i a l wealth 10 11 to r e a l p h y s i c a l wealth hovers around 15 per cent and f i n a n c i a l wealth ranges from 30 to 35 per cent of n a t i o n a l product (the r a t i o i s increa s ing over t ime) , we can der ive a ser ie s of estimates for the aggregate c a p i t a l stock and thus the c a p i t a l output r a t i o v o f roughly 2 to 2 .5 . The estimates suf fer from too many ser ious shortcomings to be discussed i n great length.. The noteworthy po in t i s , however, that a f i r s t cursory examination of the data suggests that present savings rates may w e l l be c lose to a long-term optimal l e v e l . In accordance with our previous conclus ions , we cou ld , then t e n t a t i v e l y say that a target rate of savings which exceeds the present l e v e l may be des i rab le presumably for shorter term p l a n s . A l t e r n a t i v e l y , i f present rates f a l l short of the optimal target (case of 5-2) a r a i s i n g of the ra te i s c a l l e d for u n t i l the optimal l e v e l i s reached. For shorter term p lanning ac tua l rates may even exceed t h i s optimum as was shown above. To sum up: under assumed e f f i c i e n c y condi t ions for the opera-* t ions of the savings-investment markets we f i n d s T <_ s opt imal . The above evidence ind ica te s that T h a i l a n d ' s savings rates may be c lose to the long-run optimal l e v e l . I t appears, there fore , more Assuming that only banks hold f i n a n c i a l assets . 11 R. W. Goldsmith, "The Determinants of F i n a n c i a l S t r u c t u r e , " Organization for Economic Co-operation and Development, Study No. 2, 1965, p . 2. important to focus on those observable economic factors which could account for i n e f f i c i e n c i e s i n the operations of the f i n a n c i a l sav ing-investment sec tor . An examination of a l l pos s ib le sources of i n e f f i c i e n -c ie s i n t h i s s ing le sector c l e a r l y exceeds the scope of t h i s paper. We s h a l l thus discuss only a few se lec ted i n d i c a t o r s to determine the oper-a t i o n a l e f f i c i e n c y of the money market and f i n a n c i a l i n s t i t u t i o n s . E f f i c i e n c y i n the f i n a n c i a l sector i s def ined as : 1. E f f i c i e n t admini s t ra t ion of the means of payment 12 by the c e n t r a l bank and commercial banks; 2. E f f i c i e n t p r o v i s i o n o f c r e d i t for c a p i t a l forma'-t i o n . As p r e - r e q u i s i t e for studying the second ques t ion , we have to determine the r e l a t i v e s i ze of the organized f i n a n c i a l s ec to r , i . e . , commercial banks, versus the s i ze of the unorganized sec tor , i . e . , p r i v a t e money lenders , pawnbrokers, e tc . I f a v a i l a b l e evidence suggests that the un^ organized f i n a n c i a l markets are r e l a t i v e l y l a r g e , t h e i r operat ions must be examined together with those of commercial banks. As major t h e o r e t i c a l sources of i n e f f i c i e n c i e s we have: (a) non-competit ive market s t ruc ture s ; (b) e x t e r n a l i t i e s i n the form o f product ion or consumption economies or diseconomies. Genera l ly , cases of market f a i l u r e are due to the divergence between p r i v a t e and s o c i a l va lua t ions ; Commercial banks are the only i n s t i t u t i o n s operat ing i n the organ-i z e d par t of f i n a n c i a l markets i n Tha i l and . (c) i n e f f i c i e n t , although, competit ive organ iza t ion of product ion i n terms of known technolog ica l a l t e r n a t i v e s , i . e . , f o r given quant i t i e s of outputs a reduct ion in^produc-t i o n c o s t s . i s pos s ib le i f e f f i c i e n t techniques are imple-mented; Cd) i n s t i t u t i o n a l i n e f f i c i e n c i e s . The observable i n e f f i c i e n c i e s i n the f i n a n c i a l sector w i l l be compared and c l a s s i f i e d i n the above three ca tegor ie s . For s i m p l i c i t y ' s sake, the ceteris paribus assumption for e f f i c i e n c y i n a l l other markets i s maintained throughout the d i s c u s s i o n . I t al lows us to add up i n d i v i -dual estimates of i n e f f i c i e n c i e s and to compare t h e i r t o t a l to na t iona l otuput and investment data . In t h i s way, we hope to obta in an i n d i c a -t i o n of the p o t e n t i a l aggregate output increase that could be achieved i f the f i n a n c i a l markets operated more e f f i c i e n t l y . D. E f f i c i e n c y i n the Money Market The money supply i s provided by two types of f i n a n c i a l i n s t i t u -t i o n s : c e n t r a l and commercial banks. We f i r s t examine the operat ions of the c e n t r a l bank, d e f i n i n g e f f i c i e n c y as the minimizat ion of costs of supplying the means of payment. We assume that the domestic cur ren-cy could.be produced at t o t a l costs which are s u f f i c i e n t l y smal l to be approximated by zero . For i n t e r n a t i o n a l payments, we add the assumption that the amount of required reserves should not. f a l l below the d e f i c i t 1 3 i n the balance of payment i n one year . Excess reserves are thus def ined as the d i f f e rence between the minimum amount of required reserves and the quant i t i e s of reserves a c t u a l l y he ld per p e r i o d . In Chapter II the condi t ions for an optimal p r o v i s i o n of money under a commodity standard were d e r i v e d . We know from there that as long as product ion costs of money are p o s i t i v e , the s i z e of the money supply i s not immater ia l . The quant i ty of money not only a f fect s the p r i c e l e v e l and thereby other r e a l va r i ab le s i n the economy, but a l so the l e v e l of t o t a l product ion . In the f o l l o w i n g , we s h a l l t r y to deter-mine whether the Bank of Thai land suppl ie s given quant i t i e s of money at minimum cos t s . I f a v a i l a b l e evidence ind ica te s that observed costs ex-ceed the necessary minimum we s h a l l t r y to estimate the increments i n t o t a l product ion which could be a t ta ined i f the same quant i t i e s of money were provided at minimum cos t s . Furthermore, the quest ion should be ex-amined whether the ac tua l q u a n t i t i e s of money suppl ied exceed the q u a n t i -ty necessary for an e f f i c i e n t operat ion of the money market. Put d i f f e r -e n t l y , the i d e n t i f i c a t i o n of large cash hoards together wi th greater than minimum money costs would suggest that the ac tua l money suppl ied was too large and thus i n e f f i c i e n t . Data on the monetary reserve holdings of the Bank of Thai land i n r e l a t i o n to trade f lows, Gross Nat iona l Product , and aggregate i n v e s t -ment for the per iod from 1957 to 1963 are i l l u s t r a t e d i n Tables IV-1 and IV-2 on the fo l lowing pages. The f i r s t t ab le c l e a r l y shows that excess q u a n t i t i e s of monetary reserves i n the form of gold and i n t e r n a t i o n a l reserve .reserve currenc ies are he ld by the Bank of Thai land f o r a l l years examined. RESERVE HOLDINGS OF THE BANK OF THAILAND IN RELATION TO TRADE FLOWS AND GROSS NATIONAL PRODUCT FOR THE PERIOD 1957 to 1967 IN MILLIONS OF BAHT C U C21 (3) £41 (51 (6) (71 YEAR EXPORTS IMPORTS GNP GOLD INTERN. RES. : TOTAL TRADE DEF. C 4 1 + (5) 1957 7.54 8.53 2.24 3.15 5.40 .99 1958 6.44 8.23 2.26 3,05 5.30 1.79 1959 7.56 8.98 2.08 3.11 5.20 1.42 1960 8.61 9.62 2.08 3.71 5.80 1.00 1961 9.99 10.28 2.08 5.40 7.48 .29 1962 9.52 11.50 68.92 2.08 6.79 8.87 1.97 1963 9.67 12.80 68.92 2.16 8.29 10.46 3.12 1964 12.33 14.25 73.73 2.16 9.58 11.74 1.94 1965 12.91 15.43 81.27 2.00 11.14 13.15 2.49 1966 14.09 18.50 96.80 1.90 14.89 16.80 4.40 1967 14.16 22.18 105.63 1.90 16.76 18.67 8.02 SOURCE: Bank of Thailand , Monthly -Bulletin, Vol. X (January 1970), p. 6, p. 34, p. 90. The t o t a l i n column (6) and the b a l -ance of trade i n (7) are rounded fi g u r e s as given by the Bank of Thailand. RELATIONSHIP BETWEEN TOTAL MONETARY RESERVES, THE BALANCE OF PAYMENTS FOR 1957-1967, AND INVESTMENT FOR 1963-1967 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 (6)/(7) 5.4 2199 2.99 5.8 25.9 4.50 3.35 6.14 5.28 3.81 2.32 (6)-(7) MB 4.41 3.51 3.78 5.80 7.19 6.90 7.34 9.83 10.66 12.40 10.65 Total Investment (8) MB 14.96 16.94 19.15 23.13 26.74 [(6)-(7)]/(8) 49% 58% 56% 53% 40% SOURCE: Bank'of.Thailand, op. ait., and p. 91. Data on Investment not ava i l a b l e p r i o r to 1963. MB = M i l l i o n s of Baht Now assume that the t o t a l surplus of monetary reserve balances , as def ined above, could be used to increase 'aggregate domestic i n v e s t -ment output . Table IV-2 then shows.by how much the l e v e l of t o t a l i n -vestments could have been r a i s ed for each year i n d i v i d u a l l y . While these percentage :figures i n d i c a t e the r e l a t i v e magnitude of excess reserves i n terms of an annual investment l o s s , they do not show the aggregate e f f ec t for the whole p e r i o d . A crude estimate of the t o t a l opportuni ty costs of these excess reserves can be obtained by summing up a l l past excess balances and com-par ing them wi th ; the requi red reserves fo r the same p e r i o d . For 1957 to 1967 the costs of these reserves are then found to amount to 81.44 m i l l i o n Baht. Thi s equals roughly three times the aggregate amount of investments for 1967 or 80 per cent of GNP for the same year . For the s ing le year 1967 the r e l a t i v e share of excess reserves amounts to 10 per cent of the current GNP. For a more accurate computation of the aggregate increase i n product ion that could have been a t ta ined i f the l e v e l of reserves were always kept at the minimum l e v e l , i t i s important to know how these reserve savings would have been used. I f they were e n t i r e l y channelled in to investment or for the import of c a p i t a l goods the t o t a l e f f ec t would be greater than i f these funds were used to f inance increases i n consump-14 t i o n . We s h a l l leave out a l l these cons iderat ions and thus compound i n t e r e s t y i e l d s on investments foregone, and rather thereby understate the value of the p o t e n t i a l g a i n . A simple m u l t i p l i e r c a l c u l a t i o n of the t o t a l increase of GNP ( c a l -culated fo r each year separate ly and the r e s u l t s for the 11 years added t o -gether) would, however, be i d e n t i c a l f o r consumption or investment. This can be done because the f ind ings unquestionably demonstrate that the T h a i a u t h o r i t i e s a re 'no t prov id ing money w i t h maximum e f f i c i e n -cy . Since we were looking f o r . a n i n d i c a t o r fo r the r e l a t i v e s i z e of the opportuni ty costs and not a p rec i s e est imate, the above approximation p r o -cedure i s s u f f i c i e n t . I t would not have been had the data not so c l e a r l y pointed to the existence of i n e f f i c i e n c y i n the p r o v i s i o n of money. Thi s observed i n e f f i c i e n c y would not disappear even i f one allowed for somewhat increased reserve h o l d i n g s . Since i t i s p r a c t i c a l l y imposs-i b l e to match reserve holdings p r e c i s e l y , wi th balance of payments d e f i -c i t s for every year , p o l i c y makers may not want to decrease reserve h o l d -ings to the minimum l e v e l we assumed f e a s i b l e . However i t i s an open quest ion whether the costs for hold ing negative excess re serves , i . e . , for not being able to meet a l l trade payments as they become due, i s not less than the marginal gain v i a increases i n domestic p roduct ion . I t appears qui te l i k e l y that a thorough study of the costs and benef i t s i n -volved would show that a c e r t a i n average of negative excess reserves are l e s s c o s t l y and thus more e f f i c i e n t than an average of p o s i t i v e reserves . I m p l i c i t i n our r e s u l t s i s the assumption of zero gold and i n t e r n a t i o n a l reserve currency backing of the domestic money supply . This po in t was purposely l e f t unmentioned thus f a r . We want to emphasize that there i s abso lu te ly no economic reason why an economy should hold reserves on t h i s account other than to meet trade o b l i g a t i o n s . Beyond those , nothing can be sa id i n favor of the long cherished t r a d i t i o n to hoard gold and. i n t e r -n a t i o n a l reserve c u r r e n c i e s . Any government's a b i l i t y to tax p l u s the aggregate wealth and output of a country provides s u f f i c i e n t s e c u r i t y for the value of i t s currency, provided the money supply i s e f f i c i e n t l y ad-ministered. I t should, therefore, be impressed upon a u t h o r i t i e s i n a l l coun-t r i e s , p a r t i c u l a r l y i n developing nations which complain about t h e i r lack of funds, that the hoarding of reserves i s a non-sensical convention. Every u n i t of excess reserves beyond the required minimum has a p o s i t i v e cost i n terms of l o s t output. We s h a l l now b r i e f l y discuss the implications of our findings f o r cash hoards. With the knowledge of large p o s i t i v e excess reserves, i t i s obvious that cash, hoards are c o s t l y and thus i n e f f i c i e n t . As long as an economy l i k e Thailand adheres to a p o l i c y of p a r t i a l l y backing i t s domestic currency by gold and i n t e r n a t i o n a l reserve cash hoards are undesirable. By hoarding we mean the holding of money for other than transactions purposes, i . e . , f o r precautionary or speculative mo-t i v e s . Hoards may be p r i v a t e l y e f f i c i e n t i f the marginal benefits derived from them equals t h e i r costs i n terms of i n t e r e s t foregone. S o c i a l l y , they are c l e a r l y undesirable, since they imply the loss of produc t i v e inve s tments. To i l l u s t r a t e : assume a country's trade flows are always balanced and that i t s prescribed reserves against the money supply are 20 per cent, which could be used to increase investments. Furthermore, take the produc-t i o n costs of money supply as zero. I t then follows that every u n i t of money held i n excess of current transaction needs has an imputed s o c i a l cost of .2 of the nominal p r i c e of money, i f held f o r a single time per-iod. The s o c i a l costs increase with, the length of time, f o r which, hoards are h e l d . Genera l ly , the fo l lowing chain e f f ec t w i l l thus h o l d : the l a rger the s i ze of cash hoards, the greater the e q u i l i b r i u m money supply, the l a r g e r the absolute l e v e l of required reserves and thus the r e l a t i v e m i s a l l o c a t i o n of reserves . An estimate of past cash hoards i n Tha i l and i s not necessary s ince our i n d i c a t o r about the p o t e n t i a l output increase from the e l i m i n a t i o n o f excess reserves i m p l i c i t l y takes account of the output loss due to past hoards. A determination of t h e i r r e l a t i v e s i ze would only be important i f i t i s u n l i k e l y that present currency reserve requirements w i l l be changed for the c e n t r a l bank. Should t h i s i n s t i t u t i o n a l cons t r a in t remain, i t would be the r e s p o n s i b i l i t y of the p o l i c y maker to estimate the magni-tude o f hoarding for determining the s o c i a l l y e f f i c i e n t money supply. The evidence thus far i n d i c a t e d that the source of the observed i n e f f i c i e n c y appears to be i n s t i t u t i o n a l . I t could be e l iminated i f appro-p r i a t e p r o v i s i o n s i n the e x i s t i n g l e g a l s t ructure were made. Next, we s h a l l examine the commercial banks' e f f i c i e n c y i n t h e i r p r o v i s i o n o f the means of payment func t ion . Some authors ass ign r e l a t i v e l y l i t t l e importance to the phenomenon of hoarding. H i g g i n s , for example, claims that there i s a s i g n i f i c a n t d i f -ference between the economic e f fec t s of cash hoards over other forms of hoards such as jewelry , l i v e s t o c k , e t c . He asserts that monetary a u t h o r i -t i e s could increase the money supply by the estimated amount of these hoards to f inance investment pro jec t s without c rea t ing i n f l a t i o n a r y pressures . The macroeconomic r e s u l t s would be the same as i f the money had been deposited i n the banking sector i n the f i r s t p l a c e . Higg ins , op. oit. 3 p . 279. This conc lus ion obvious ly does not h o l d . Although increases i n the money supply may not create i n f l a t i o n a r y pres sures , they are c o s t l y i n terms o f reserves . The requi red reserve r a t i o could be seen as an add i t ion to the investment costs or a lowering of i t s expected r e t u r n . As a c r i t e r i o n f o r evaluation.we assume that the spread of bank-ing o f f i c e s i n a country should correspond to the population d i s t r i b u t i o n . This assertion appears reasonable because the number of economic tr a n s -actions, productive investment opportunities, and thus c r e d i t demand seems p o s i t i v e l y r e l a t e d to the density of population. Should the evidence point to a s i g n i f i c a n t l y uneven d i s t r i b u t i o n of bank branches throughout the country, the banks performance could not be considered to be s o c i a l l y e f f i c i e n t . Inspection of the data on the d i s t r i b u t i o n of branch banks and population f o r 1965 (this information i s reproduced i n the Appendix as Appendix 1) showed a s t r i k i n g l y low c o r r e l a t i o n between the two varir-ables. As to be expected, the greatest density i n bank o f f i c e s was found f o r the Bangkok area where the average number of people per bank o f f i c e amounted to 11,000. For r u r a l highly populated areas t h i s f i g u r e varied roughly between 50,000 and 250,000 per branch. The l e a s t populated areas were found to have as l i t t l e as one o f f i c e per 600,000 people. I t i s clear from these data that banks are not only highly unevenly d i s -t r i b u t e d but also f a r from ubiquitous a v a i l a b l e . Since t h i s l a t t e r f a c -tor represents a precondition f or e f f i c i e n c y i n exchange we can therefore conclude that commercial banks performance appears s o c i a l l y i n e f f i c i e n t . A d d i t i o n a l . s t a t i s t i c a l material together with Rozenthal's an a l y s i s on branch banking i n Thailand suggest that commercial banks A. A. Rozenthal, "Branch Banking i n Thailand," Journal of Deve-loping Areas, V o l . III. (October 1 9 6 8 1 , pp. 3 7 - 5 1 . view t h e i r branches p r i m a r i l y as means of c o l l e c t i n g resources from the countryside and t r a n s f e r r i n g them to the c a p i t a l . From the po int of view of the i n d i v i d u a l bank, such, a d e c i s i o n presumably r e f l e c t s p r o f i t maxi-miz ing behavior . I t i s , however, s o c i a l l y undes i rab le . The source of the i n e f f i c i e n c y could p a r t i a l l y be seen i n a market f a i l u r e , because p r i v a t e and s o c i a l va lua t ions d i f f e r although the commercial banking sec-tor seems compet i t ive ly organized. I n s t i t u t i o n a l f ac tors provide a second pos s ib le explanat ion for the i n e f f i c i e n c y i n so far as e x i s t i n g laws do not give s u f f i c i e n t i n c e n t i v e s to banks to open more branches i n the country. An estimate of the aggregate benef i t s a t t a inab le from a more even and dense spread of banking o f f i c e s could not be made d i r e c t l y . An i n d i r e c t answer i s attempted i n the next s ec t ion on the unorganized money market. Costs for f i n a n c i a l serv ices i n the unorganized market above those charged by commercial banks are considered as the benef i t s foregone from the e x i s t i n g lack of banks. Before we can discuss t h i s ques t ion , we need an estimate on the r e l a t i v e s i ze of the unorganized f i n a n c i a l s ec tor . This estimate serves furthermore'as necessary i n t r o -duct ion for the d i s c u s s i o n of the second po int a b o v e , . i . e . , the commer-c i a l banks e f f i c i e n c y i n the p r o v i s i o n of c r e d i t for c a p i t a l format ion. For est imating the r e l a t i v e s i z e of the unorganized f i n a n c i a l sector i t i s assumed that the f low of currency t ransact ions i s conduc-ted p r i m a r i l y i n t h i s market whi le t ransact ions s e t t l e d by cheques are done i n the organized f i n a n c i a l , s ec tor . The s i z e of the unorganized market, and thus by i m p l i c a t i o n , . t h a t of the organized f i n a n c i a l i n s t i t u -t ions i s measured by c a l c u l a t i n g the r a t i o of currency he ld by the p u b l i c to t o t a l money supply over time and the r a t i o of domestic bank c r e d i t to n a t i o n a l income. While t h i s assumption lacks accuracy, i t should be 17 useful , as a f i r s t i n d i c a t o r , e s p e c i a l l y when compared with the data from other c o u n t r i e s . I t i s furthermore the p r e - r e q u i s i t e for the c a l -c u l a t i o n of the aggregate output loss due to the excessive t ransact ions cost s incurred i n the unorganized f i n a n c i a l market (compared to those i n the o r g a n i z e d . s e c t o r ! . The two char t s on the fo l lowing page show these r a t i o s for?': Thai land and for the years 1954 to 1967. They i l l u s t r a t e that the per*-centage of currency he ld by the p u b l i c amounted to approximately 70 per cent i n 1954 and d e c l i n e d s t e a d i l y thereaf ter to about 55 per cent i n 18 1967. This impl ies that the r e l a t i v e s i ze of the unorganized sector remains ra ther large although of somewhat d e c l i n i n g importance. The i n -ference was confirmed by comparing the Thai data with those of the United States for some years of the same p e r i o d . The U . S . r a t i o of currency to money supply remained almost constant at about 20 per cent of the t o t a l Both markets are i n par t competit ive and complementary. Money lenders as w e l l as borrowers i n the unorganized money market may use chequing accounts, thus i n f l a t i n g the r a t i o a t t r i b u t e d to the organized sec tor . On the other hand ind ice s r e l a t e d only to commercial banks per -formance somewhat understate the c o n t r i b u t i o n made by the t o t a l organized sec tor . 18 Our estimate presumably understates the s i z e of the unorganized f i n a n c i a l market cons iderab ly . Rozenthal ' s work report on the "Sources of Urban C r e d i t for Ongoing Purposes" shows that the r e l a t i o n s h i p between funds from commercial banks compared to those of other sources amounted to only 40 per cent for 1965. The r a t i o for sources of i n i t i a l c a p i t a l p ro-vided by the banking sector compared to other sources i s cons iderably smal ler y e t ; i t was f i v e per cent only i n 1965. A . A . Rozenthal , " F i n a n -c ing Thai Business E n t e r p r i s e , " op. ovt., p . 45 and p . 54. CHART IV-1 PERCENTAGE OF CURRENCY HELD BY PUBLIC TO MONEY'SUPPLY — . l a 1 t 1 i i 1 ! i 1 1 : ! ! W5H 55 St S7 56 31 to fcl (>Z *3 6*+ b$ &7 SOURCE: Bank of Thailand, Monthly Report (December 1967), p. 4, CHART IV-2 PERCENTAGE OF DOMESTIC CREDIT TO NATIONAL INCOME 19,54- 55 5fc, ST 58> S3 (dO &i fa*. fa3 fa5 4t 6.7 SOURCE: Bank of Thailand, Ibid., pp. 8-9, 72,- International ' Financial Statistics, V o l . XXI (October 1968), pp. 298-301. money supply. The same r e s u l t s was found fo r the United Kingdom. On the other hand, developing nations broadly comparable to T h a i l a n d , showed s i m i l a r l y high, r a t i o s for. the i r , currency h o l d i n g s , which sug-gests that the s i t u a t i o n i n Thai land seems a t l ea s t somewhat r epre -senta t ive ; As to the percentage of domestic c r e d i t to n a t i o n a l income the chart demonstrates a steady increase of t h i s r a t i o . I t thus supports the above f i n d i n g of a r e l a t i v e extension o f . t h e scope of organized f i n a n c i a l i n s t i t u t i o n s . From about 13 per cent i n 1957 (the f i r s t year for which s t a t i s t i c a l informat ion was ava i l ab le ) the c r e d i t r a t i o rose to s l i g h t l y over 20 per cent i n 1967. On a comparative b a s i s , these data do, however, i n d i c a t e that Tha i l and ' s supply of bank c r e d i t i s p re -sumably le s s than for s i m i l a r developing count r i e s . For the l a t t e r , the c r e d i t r a t i o was genera l ly found to vary between 20 to 40 per cent , while i t amounted to a constant average value of 60 per cent for both the U . S . as w e l l as the U . K . Both r a t i o s i n d i c a t e that the unorganized f i n a n c i a l sector i s s t i l l r e l a t i v e l y l a r g e , even i f the extension of the c o n t r i b u -t i o n of organized f i n a n c i a l i n s t i t u t i o n s i s taken in to account. Next, we need an estimate about the absolute s i ze of the unorgan-ized money market. I t could be obtained i f one subtracted the United States ' r a t i o of currency hold ings from the Thai percentage f i g u r e . This procedure appears j u s t i f i a b l e on the assumption that unorganized f i n a n -c i a l markets appear non-existant i n the United States . The percentage D e t a i l s on comparable data for currency and c r e d i t r a t i o s are shown i n Appendix 2 of the Appendix. The f igures were compiled from International Financial Statistics. of currency held i n the United States should, therefore, r e f l e c t the minimum currency holding necessary a f t e r the monetization process i s com-pleted, i . e . , a widespread.network of commercial bank established. Using t h i s assumption.we .find that the r e l a t i v e s i z e of the unorganized f i n a n -c i a l sector amounted to about 50 per cent i n 1954 and declined to 35 per cent u n t i l 1967. In absolute terms t h i s implies that 2,466 m i l l i o n Baht were held i n the unorganized sector at the beginning of the period com-pared to 3,907 m i l l i o n Baht at the end.of the period. Now.assume that the transactions v e l o c i t y i s i d e n t i c a l for' both sectors. It.would then f o l l o w that 50 to 35 per cent of the aggregate volume of transaction were made in.the unorganized money market. This l a s t assumption.only serves as a f i r s t approximation, since i t i s cer-t a i n l y not r e a l i s t i c to assume that both v e l o c i t y figures are the same. One would expect that the v e l o c i t y of funds deposited with commercial 20 banks exceeds that of cash holdings by a s i g n i f i c a n t margin. Data on t o t a l transactions for each sector or f o r the whole economy, and thus information about the transactions v e l o c i t y was not a v a i l a b l e . As proxy for o v e r a l l v e l o c i t y , we therefore used national product data. For the estimate about i t s r e l a t i v e magnitude i n both f i n a n c i a l sectors we could only make an i n t u i t i v e l y p l a u s i b l e assumption. On t h i s basis we c a l c u -l a t e d the modified estimate of t o t a l transactions i n the unorganized For that part of cash, holdings which, is hoarded, the trans-actions velocity would be zero or close to i t . money market, tak ing the value of v e l o c i t y i n t h i s market as h a l f that of the o v e r a l l average. I t was found that 10,000 to approximately 16,000 m i l l i o n Baht' i n 1967 were used p r i m a r i l y for f inanc ing t ransact ions i n the unorganized sec tor . . T h i s estimate appears r e l a t i v e l y conservat ive because the t o t a l volume of t ransact ions c l e a r l y exceeds the value of n a t i o n a l product 'on which the estimate was based. This, l a s t i n d i c a t o r can now be used to estimate the benef i t s l o s t i n terms of foregone product ion . Take the t ransac t ions cos t s for those exchanges performed i n the organized f i n a n c i a l markets as representat ive of the costs incurred by using cash. The benef i t s of chequing accounts can be seen as the serv ice of the bank rendered i n r e turn f o r obta in ing deposi t funds. This y i e l d on a demand deposi t or a l t e r n a t i v e l y the costs of us ing cash could be approximated by taking the re turn on h i g h l y l i q u i d , short-term time de-p o s i t s r which amounts to s ix per cent per annum i n T h a i l a n d . A rough i n d i c a t o r for the s o c i a l costs of us ing cash can thus be der ived by m u l t i p l y i n g the t o t a l quant i ty of cash holdings by the y i e l d 21 foregone. For the year 1967 for which we estimated the r e l a t i v e s i ze of cash balances i n the unorganized f i n a n c i a l market the i n e f f i c i e n c y c o e f f i c i e n t then amounts to 600 to 960 m i l l i o n Baht. This represents An a d d i t i o n a l argument could be made which would increase the value of the i n e f f i c i e n c y i n d i c a t o r fu r ther . Depos i t ing cash wi th the f i n a n c i a l i n s t i t u t i o n s leads to a p o t e n t i a l , expansion of c r e d i t of the amount of cash deposi ted times the. des i red depos i t m u l t i p l i e r . This fo l lows only i f the a u t h o r i t i e s d i d not a l low for an expansion of c r e d i t s by the estimated quant i ty of hoards. approximately f i v e to e ight per cent o f GNP fo r t h i s year . Together, the observed i n e f f i c i e n c i e s i n the i n t e r n a t i o n a l reserve holdings and the s i ze of cash h e l d i n the unorganized market add up to about 15 to 18 per cent of GNP for 1967. With due allowance for e r r o r s , t h i s magnitude i s s i g n i f i c a n t l y large to permit the conc lus ion that s i zeab le i n e f f i c i e n c i e s e x i s t i n the p r o v i s i o n of money i n T h a i l a n d . E . E f f i c i e n c y i n the P r o v i s i o n of C r e d i t In the fo l lowing sec t ion we want to examine the quest ion whether the e x i s t i n g f i n a n c i a l system i s e f f i c i e n t l y p rov id ing c r e d i t s for c a p i -22 t a l formation. Analogous to the previous sec t ion we t r y to estimate the r e l a t i v e s i z e of observable i n e f f i c i e n c i e s i n terms o f output l o s t for both the organized and unorganized f i n a n c i a l sec tor . The e f f i c i e n c y i n the p r o v i s i o n of c r e d i t s i s c l e a r l y r e l a t e d to the e f f i c i e n c y of ad-^ m i n i s t e r i n g the means of payment, s ince both are merely two s ides of the aggregate balance sheet for the f i n a n c i a l sec tor . Given the widespread lack of banking f a c i l i t i e s and thus a r e l a t i v e l y large unorganized f i n a n -c i a l s ec tor , i t can already be i n f e r r e d that o v e r a l l maximum e f f i c i e n c y does not e x i s t . The magnitude of the i n e f f i c i e n c i e s w i l l now be e s t i -mated for the unorganized f i n a n c i a l market. I t should again be empha-s i zed that the estimate has only t en ta t ive character . An estimate about the r e l a t i v e s i z e of i n e f f i c i e n c i e s i n the p r o v i s i o n o f the e x i s t i n g volume of c r e d i t s by commercial banks i s not der ived s ince these markets appear to operate under competit ive condi^ t i o n s , For d e r i v i n g an approximate measure of e x i s t i n g i n e f f i c i e n c i e s i n the p r o v i s i o n of c r e d i t s we need s t a t i s t i c a l information about the i n -t e r e s t rate structure and the aggregate volume of c r e d i t s and t h e i r uses. Our measure f o r the unorganized f i n a n c i a l market i s based on the assumption that the e x i s t i n g t o t a l volume oS c r e d i t for productive pur-poses could be provided by commercial banks. We want to determine f o r a s i n g l e year what the competitive loan charges f o r a given aggregate amount of loans.would have been and compare t h i s figure with the i n t e r -est payments.actually incurred i n the unorganized market. The d i f f e r -ence then represents a measure of the resources which could have been saved by a more e f f i c i e n t organization of the f i n a n c i a l sector. A pre-r e q u i s i t e for our estimate i s an explanation of the observable i n t e r e s t rate d i f f e r e n t i a l between the two f i n a n c i a l markets. I t has to be shown what proportion of t h i s d i f f e r e n t i a l i s a t t r i b u t a b l e to r i s k , and/ or monopoly rents, and t e c h n i c a l production cost d i f f e r e n c e s . For t h i s purpose, the following assumptions are made: 1. Economies of scale e x i s t i n the p r o v i s i o n of f i n a n c i a l s e r v i c e s , which are not used i n the e x i s t i n g un-organized f i n a n c i a l market because of the smallness of i n -d i v i d u a l money lenders' operations. 2. The organized and unorganized f i n a n c i a l sector 23 are e n t i r e l y separated. Although not s t r i c t l y true, the The a g r i c u l t u r a l sector nesses are assumed to be serviced A. A. Rozenthal, op. ovt., p. 20. and small scale service and trade'busi-by the unorganized f i n a n c i a l market. the above evidence on branch bank operations j u s t i f i e s this., approximation. By d e f i n i t i o n , borrowers i n the unorganized f i n a n c i a l market do, therefore, not have access to commercial banks. The non-existence of choice suggests a r e l a t i v e l y large degree of i n e l a s t i c i t y of the demand curve i n t h i s sector. 3. Private money lenders enjoy p e r s i s t i n g mono-poly p o s i t i o n s . While freedom of entry t h e o r e t i c a l l y e x i s t s , the non-competitive structure can presumably be maintained because.of the high costs or low p r o f i t expectations f o r p o t e n t i a l entrants. The e f f e c t i v e b a r r i e r to entry for commercial banks appears to be the l e g a l c e i l i n g on loan i n t e r e s t rates, imposed by the Bank of Thailand. For poten-t i a l non-bank competitors, the deterrent f o r entry may be, among other reasons, the r e l a t i v e l y large p r o f i t a b i l i t y of a l t e r n a t i v e investments, geographical b a r r i e r s , etc. 4. The average r i s k factor f or providing c r e d i t s i n the unorganized f i n a n c i a l market does not d i f f e r sub-s t a n t i a l l y from the r i s k faced by commercial banks. A l -though i t i s conventionally asserted that most, i f not a l l , o f the i n t e r e s t rate d i f f e r e n t i a l can be explained by d i f f e r e n c e s i n r i s k , t h i s argument does not appear con-24 v i n c i n g . Risk, premiums charged on a loan depend i n v e r s e l y Inter alia: A. Bottomley, "The Premium f o r Risk as a Deter-minant of Interest Rates i n Underdeveloped Rural Areas," Quarterly Jour-nal of Economics, V o l . LXXVIT CNovember 1963), pp. 637-47. on the p r o b a b i l i t y of d e f a u l t . The f a i l u r e to repay a c r e d i t d e c l i n e s with increasing coverage of the loan by c o l l a t e r a l . A v a i l a b l e evidence on Thailand suggests that the r e l a t i o n s h i p between loan demand and c o l l a t e r a l i s broadly s i m i l a r ' f o r the a g r i c u l t u r a l and i n d u s t r i a l sector. According to our s p e c i -f i c a t i o n above, the former i s serviced by the unorganized 25 f i n a n c i a l market and the l a t t e r by commercial banks. Given these assumptions, the s i t u a t i o n f o r a representative money lender can now e a s i l y be shown as i l l u s t r a t e d i n Figure 4-2. + L Figure 4-2 Sithi-Amnuai, Finance and Banking in Thailand (Bangkok: 1964), pp.- 175 f f ; A. A. Rozenthal, op. cit. 3 pp. 45-54. The l i q u i d i t y of the types of c o l l a t e r a l offered by a g r i c u l t u r e and industry may d i f f e r . Land, which is. r e l a t i v e l y i l l i q u i d represents the primary source of c o l l a t e r a l holdings i n the commercial banking sector ..amounted to 60 per cent i n 1965. (continued) The loan rate charged on the given quant i ty of c r e d i t s i s represented as r . The money lenders ' cost curve , + R i n c o r -M M porates a p r o p o r t i o n a l r i s k fac tor of R . The hypothe t i ca l cost curve B for a commercial bank i s shown as B + R^ where the element R^ r e f l e c t s the r i s k element which cannot be e l iminated through p o o l i n g . Competitive banks could supply the same aggregate volume of c r e d i t s , L^, f o r the i n -t e re s t ra te r . The d i f f e rence between r and r shows the t o t a l i n t e r -B M B est cost savings due to the reduct ion i n product ion cos t , r i s k , and the e l i m i n a t i o n of monopoly r e n t . M u l t i p l y i n g t h i s d i f f e rence by the t o t a l value of loans then measures the s i z e o f the e x i s t i n g i n e f f i c i e n c y i n 26 the a l l o c a t i o n of resources for one time p e r i o d . For est imating the m i s a l l o c a t i o n of resources take the average commercial bank loan rate as 15 per cent per annum from the prescr ibed range of 12 to 18 per cent . Assume, i n a d d i t i o n , that t h i s ra te r e -f l e c t s competit ive product ion costs for the given volume of c r e d i t s . The i n t e r e s t charges i n the unorganized f i n a n c i a l sector vary broadly 27 between 40 and 60 per cent for product ive loans . As approximation, Thi s f igure ind ica te s that even i f money lenders charge negative l i q u i -d i t y premiums for a g r i c u l t u r a l loans i t i s u n l i k e l y that these are the so le cause for the observable i n t e r e s t rate spread. 2 ^ I f i n t e r e s t rates would i n fact be reduced to . the l e v e l of com-p e t i t i v e cos t i t i s obvious that t o t a l loan demand would a l so increa se . T h i s secondary e f f ec t w i l l enhance the primary bene f i t of resource savings . 27 Our data are based on Rozenthal ' s f indings.who conducted exten-s ive f i e l d research i n Tha i l and , For the unorganized f i n a n c i a l s ec to r , he found i n t e r e s t r a te s ranging from two per cent per month, to more than 10 per cent per month.. The l a r g e s t percentage r a te s appeared to per-t a i n only to consumption loans . Manufacturers , small and medium bus iness-es. ..have to pay an average of 40 to 60 per cent i n t e r e s t per annum. See we s h a l l assume a value of 50 per cent as the representat ive average. In accordance w i t h previous arguments we s h a l l a t t r i b u t e the re la t ive ly-l a r g e s t par t of the i n t e r e s t r a te d i f f e r e n t i a l between the two f i n a n c i a l markets to monopoly r e n t s . The rent element i s thus taken to be an aver-age of 30 per cent and the r i s k premium i n the unorganized market as 10 per cent of which h a l f can be e l iminated by the poo l ing of r i s k . The r e -mainder, or f i v e per cent , i s therefore assumed as the approximate per-centage f i gure for the increase i n r i s k i n e s s for loans i n the unorganized f i n a n c i a l s ec tor . I t fo l lows from these .a s ser t ions that the same q u a n t i -ty of loans now suppl ied by money lenders could be provided by commer-c i a l banks for approximately 20 per cent i n t e r e s t per annum. For an aggregate a g r i c u l t u r a l loan volume of 5.201 m i l l i o n Baht for 1967, the resource savings i n the same year would have amounted to 28 approximately 156 m i l l i o n Baht, or about one per cent of GNP f o r 1967. Although t h i s percentage f igure appears ra ther s m a l l , i t should be r e -c a l l e d that no account was taken of the compounded e f f ec t of the i n e f f i -c i e n c i e s over t ime. Furthermore, our data on the loan volume of the a g r i c u l t u r a l sector understates the true value of product ive c r e d i t s and exclude consumption loans . However, even as l i t t l e as one per cent i s hot i n s i g n i f i c a n t i n the context of a developing country l i k e Thai land A . A . Rozenthal , Financing Thai Business Enterprise,; F i e l d Report No. 21, .(Washington, D . C . : Nat iona l Planning A s s o c i a t i o n , 1968). 28 * J' Si th i -Amnuai , op. cit., p . 179. Our estimate i s an ex t rapo la-t i o n of the increased value of a g r i c u l t u r a l indebtedness from 1955 to 1963. because of the great s c a r c i t y of funds for product ive purposes. Th i s concludes our observations on the e f f i c i e n c y wi th which the e x i s t i n g Tha i f i n a n c i a l system provides for the means of payment and for product ive c r e d i t s . We found c l e a r i n d i c a t i o n s that i n e f f i -c i e n c i e s do e x i s t and that s i g n i f i c a n t gains would be obtained by e l i -minating them. I t appears from the f i n d i n g s , that p o l i c y makers should concern themselves p r i m a r i l y w i t h i n s t i t u t i o n a l changes', s ince the ob-served market f a i l u r e s seem condit ioned by the e x i s t i n g set of l e g a l c o n s t r a i n t s . I t would be de s i r ab le to d i scont inue the p r a c t i c e of h o l d -ing f r a c t i o n a l reserves against .^the money supply i n the form of go ld or i n t e r n a t i o n a l re serves . Instead, only an e f f i c i e n t minimum amount of reserves should be kept for trade o b l i g a t i o n s . In a d d i t i o n , i t was found advisable to reduce the s i ze of the unorganized f i n a n c i a l markets and thus by i m p l i c a t i o n of cash t r ansac t ions . Organized f i n a n c i a l i n s t i t u t i o n s should be given increased incent ives to open o f f i c e s i n areas which are at present undersupplied with banking s e r v i c e s . This would presumably imply a r i s e i n the l e g a l c e i l i n g of i n t e r e s t rates on bank loans , to account f o r increased costs and r i s k s of small r u r a l branches. I f e x i s t i n g laws cannot e a s i l y be changed, p o l i c y makers should consider the p o s s i b i l i t y of operat ing and/or f inanc ing bank o f f i c e s wherever i t appears s o c i a l l y d e s i r a b l e . B I B L I O G R A P H Y A. Books Adelman, I. , and C. Taf ^ M o r r i s . . Society, Politics and Economic Develop-ment: A Quantitative Approach. Ba l t imore : The Johns Hopkins Press , 1967. A l l e n , R. G. D. Macroeconomic Theory. New York: S t . M a r t i n ' s Press , 1968. B e l l , F reder ick W. , and N e i l B. Murphy. Costs in Commercial Banking: A Quantitative Analysis of Bank Behaviour and its Relations to Bank Regulation. Research report of the Federa l Reserve Bank of Boston, No. 41 ( A p r i l 1968). Burmeister , E . , and A. R. D o b e l l . Mathematical Theories of Economic Growth. London: C o l l i e r - M a c m i l l a n , 1970. Capital Formation and Economic Growth: A Conference of the Universities •National Bureau Committee for Economic Research. A Report of the Nat iona l Bureau of Economic Research. Pr ince ton , ; . N . J . : Pr inceton U n i v e r s i t y Press , 1955. Commission on Money and C r e d i t . Money and Credit. Englewood C l i f f s , N . J . : P r e n t i c e - H a l l , 1961. . Private Financial Institutions. Engle^-wood C l i f f s , N . J . : P r e n t i c e - H a l l , 1963. Comptrol ler of the Currency. Studies in Banking Competition and the Bank-ing Structure. Washington, D . C . : Government P r i n t i n g O f f i c e , 1966. Cookson, Forest E . The Dynamics of the Thai Economy: An Application of The Open, Dualistic National Income Accounting Framework. F i e l d Report No. 7. Washington, D . C : The Nat iona l Planning A s s o c i a t i o n , 1966. Gramley, L y l e E . A Study of Scale Economies in Banking. Research Depart-ment o f the Federa l Reserve Bank of Kansas C i t y , 1962. Greenbaum, Stuart I . Banking Structure and Costs. A Statistical Study of The Cost^-Output Relationship In Commercial Banking. Unpublished d o c t o r a l d i s s e r t a t i o n , Johns Hopkins U n i v e r s i t y , 1964. Gur ley , John G . , and E . C. Shaw. Money In A Theory of Finance. Washing-ton , D . C : The Brookings I n s t i t u t i o n , , 1960. Higg ins , Benjamin H. Economic Development: Principles, Problems and Policies. (Revised E d i t i o n ) . New York: W. W. Norton, 1968. Hirschman, A. O. Strategy of Economic Development. New Haven, Conn . : Yale U n i v e r s i t y Press , 1959. Janlekha, Kamol O. A Study of the Economic of A Rice Growing yillage Central Thailand. Bangkok: M i n i s t r y of A g r i c u l t u r e , 1957. Johnson, Harry G. Essays in Monetary Economics. London: A l l e n and Unwin, 1967. Kemp, M. C International Trade. Englewood C l i f f s , N . J . : P r e n t i c e -H a l l , 1964. Khazzoom, Dan ie l J . The Currency Ratio in Developing Countries. New' York: Praeger, 1966. L e i b e n s t e i n , Harvey. Theory of Economic Development. P r i n c e t o n , N . J . : Pr ince ton U n i v e r s i t y Press , 1954. Meigs, James A. Free Reserves and. the Money Supply. Chicago: Univer -s i t y of Chicago Press , 1962. Mousny, Andre. The Economy of Thailand. An Appraisal of the Liberal Exchange Policy. Bangkok: S o c i a l Science A s s o c i a t i o n Press of Tha i l and , 1964. Muscat, R. J . Development Strategy in Thailand. A Study of Economic Growth. New York: Praeger, 1966. Neher, P. A. A Neoclassical Theory of Economic Growth. Unpublished manuscript . U n i v e r s i t y of B r i t i s h Columbia: Department of Economics, 1969. Nevin , E . Capital Funds in Underdeveloped Countries. New York: Mac-m i l l a n , 1961. Nurske, Ragnov. Problems of Capital Formation in Underdeveloped Countries. Oxford, E n g . : B a s i l B l a c k w e l l , 1953. Paauw, D. s . Financing Economic Development. Glencoe, 111. : The Free Press , 1960. Patinkin' , . Don. Money, Interest and Prices. (Second e d i t i o n ) . New York: Harper and Row, 1965. Pesek, B. P . , and T. R. Saving. Money, Wealth and Economic Theory. New York: 1967. Rozenthal , Alek A . Financing Thai Business Enterprise. F i e l d Work Report No. 21. Washington, D . C : The Nat iona l Planning A s s o c i a t i o n , 1967. S a l t e r , w. E . G. Productivity and Technical Change. Cambridge: Cambridge U n i v e r s i t y Press , 1966. S i th i -Amnuai , P a u l . Finance and Banking in Thailand. A Study of the Com-mercial System, 188 - 196S. Bangkok, T h a i l a n d , 1964. Thorn , -Richard S. (Ed . ) . Monetary Theory and Policy. New York: Random House, 1966. B. A r t i c l e s and P e r i o d i c a l s Adelman>. I . , and C. Taft-^Morris. "Performance C r i t e r i a for Eva lua t ing Economic Development P o t e n t i a l : An Operat ional Approach, " Quarterly Journal of Economics, V o l . LXXXl l (May 1968), pp. 260-81. Amatayakul, Ravi and A . Pandit S h r i k r i s h n a . " F i n a n c i a l I n s t i t u t i o n s i n T h a i l a n d , " International Monetary Fund Staff Tapers, V o l . VII I (1960-61), pp. 464-89. Aubrey, Henry G. "Investment Decis ions i n Underdeveloped C o u n t r i e s , " Capital Formation and Economic Growth, Report of the Nat iona l Bureau of Economic Research. P r i n c e t o n , N . J . : Pr inceton U n i v e r s i t y Press , 1955, pp. 397-440. A y a l , E l i e z e r B. "Some C r u c i a l Issues i n T h a i l a n d ' s Economic Develop-ment," Pacific Affairs,- V o l . XXXIV (Summer 1961), pp. 157-64. Bator , F ranc i s M. "The Anatomy of Market F a i l u r e , " Quarterly Journal of Economics, V o l . LXXII (August 1958), pp. 351-79. . "The Simple A n a l y t i c s of Welfare Max imiza t ion , " Ameri^-can Economic Review, V o l . XLVII (March 1957), pp. 22-59. Reprinted i n Readings in Microeconomics, W. B r e i t and H. M. Hodiman (.eds.). New York: H o l t , Reinhart and Winston, 1968, pp. 385-414. Benston, George J . "Branch Banking and Economies of S c a l e , " Journal of Finance, V o l . XX (May 1965), pp. 312-21. . . "Economies of Scale and Marginal Costs i n Banking Opera t ions , " National Banking Review (June 1965). ' Reprinted i n Comptroller of the Currency, 1966, pp. 355^97. Berns te in , E . M . . "F inanc ing Economic Growth i n Underdeveloped C o u n t r i e s , " Savings in the Modern Economy, w. w. He l le s et al. (Eds . ) . Minnea-p o l i s , M i n n . : U n i v e r s i t y of Minnesota Press , 1953, Chapter XVI . Birnbaum, Eugene A. "The Growth o f . F i n a n c i a l Intermediaries as a Factor i n the Ef fec t iveness of Monetary P o l i c y , " International Monetary Fund Staff Papers, V o l . VI (1957*58), p p . 384-427. B loomf ie ld , Arthur T . "Monetary P o l i c y i n Underdeveloped C o u n t r i e s , " i n Readings in Foonomio Development. Morgan, Betz and Chondhry (Eds . ) , Belmont, Wadsworth, 1966, pp. 365-75. 'Bottomley, Anthoney. "The Premium for Risk as a Determinant of Interes t Rates i n Underdeveloped Rural A r e a s , " Quarterly Journal of Economics, V o l . LXXVII (November 1963), pp. 637-47. Chandavarkar, A. G. "The Premium for Risks as- a Determinant of Interes t Rates i n Underdeveloped Rural A r e a s , " Quarterly Journal of Economics, V o l . LXXIX ( A p r i l 1965), pp. 322-37. Crosse , Howard D. "Banking Structure and Compet i t ion , " Journal of Finance, V o l . XX (May 1965), pp. 349-57. E n t h o v e n , ' A l a i n C. "A N e o - C l a s s i c a l Model of Money, Debt and Economic Growth," Appendix to Money in a Theory of Finance. J . G. Gurley and E . S. Shaw (Eds . ) , Washington: The Brookings I n s t i t u t i o n , 1960. Friedman, M i l t o n . "A T h e o r e t i c a l Framework of;Monetary A n a l y s i s , " Journal of Political Economy, V o l . LXXVIII (March/Apri l 1970), pp. 193-238. Goldsmith, R. W. "The Determinants of F i n a n c i a l S t r u c t u r e , " Organization of Economic Co-operation and Development, study No. 2, 1965. Greenbaum, Stuart T . "Competit ion and E f f i c i e n c y i n the Banking System," Journal of Political Economy, V o l . LXXV (Supplement)(August 1967),• pp. 461-79. Gur ley , John G. and E . S. Shaw. " F i n a n c i a l Aspects of Economic Develop-ment," American Economic Review, V o l . XLV (September 1955), pp. 515--39. Gurley , John G . , and E . S. Shaw. " F i n a n c i a l Structures and Economic Development," Economic Development and Cultural Change, V o l . xy , ( A p r i l 1967), pp. 257-68. . "The Saving-Investment Process and the Market for Loan-able Funds , " i n Money and Economic Activity. L . s. R i t t e r (Ed.) (Third e d i t i o n ) . Boston: Houghton M i f f l i n , 1967. Hahn, F . "On Money and Growth," Journal of Money, Credit and Banking, V o l . I (May 1969), pp. 172-87. Hooley, R. W. " Impl ica t ions of the Saving Structure for Economic Develop-ment," The Philippine Economic Journal (Second Semester 1962), pp. 110-30. Horootz , P. "Economies of Scale i n Banking . " Reprinted i n Private Fin-ancial Institutions. Englewood C l i f f s , N . J . : P r e n t i c e - H a l l , 1963, pp. 1-54. Johnson, Harry G. "Monetary Theory and P o l i c y , " i n American Economic Association Surveys of Economic Theory, V o l . I . New York: Mac-m i l l a n , 1966, pp. 1-46. . "The N e o - C l a s s i c a l One-Sector Growth Model : A Geometri-c a l Expos i t i on and Extension to a Monetary Economy," Economica, V o l . XXXIII (August 1966) , pp. 265-87. . "The N e u t r a l i t y o f Money i n Growth Models: A R e p l y , " Economica, V o l . XLIV (February 1967), pp. 73-74. Koopmans, T . C. " E f f i c i e n t A l l o c a t i o n o f Resources ." Econometrica, V o l . XIX (October 1951), pp. 455-65. Kurosak i , Hideo. " C h a r a c t e r i s t i c s of Finance i n Underdeveloped C o u n t r i e s , " Developing Economies, V o l . I ( F a l l 1963), pp. 35-49. L e v h a r i , David and Don P a t i n k i n . "The Role of Money i n a Simple Growth M o d e l , " American Economic Review, V o l . LVIII (September 1968), pp. 713-54. Marty, A l v i n L . "The Optimal Rate of Growth of Money," Journal of Poli-tical Economy 3 V o l . LXXVI (July/August 1968), pp. 860-74. M e t z l e r , L loyd A. "Wealth, Saving, and the Rate of I n t e r e s t , " Journal of Political Economy, V o l . Lix ( A p r i l 1951), pp. 93-116. Mishan, E . J . "A Survey of Welfare Economics, 1939 - 59 , " Economic Jour-nal, V o l . LXIX (March 1959), Reprinted i n American Economic Associr--ation Surveys of Economic Theory, V o l . I , New York: Macmil lan, 1965, pp. 154-222. Narayan, G. "The M o b i l i z a t i o n of Pr iva te Gold Holdings . : A Comment," Indian Economic Journal, V o l . XI (January-March 1964), pp. 381-82. Niehans, J . "Money i n a Theory of Optimal Payment Arrangements," Journal of Money, Credit and Banking, V o l . I (November 1969), pp. 708-20. Paauw, Douglas S. "F inanc ing Economic Development i n Indones ia , " Economic Development and Cultural Change, V o l . XIV (January 1966) , pp. 174-89. P a t r i c k , Hugh T . " F i n a n c i a l Development and Economic Growth i n Under-developed C o u n t r i e s , " Economic Development and. Cultural Change, V o l . XIV (January 1966), pp. 174-89. Rozenthal , Alek A. "Unorganized F i n a n c i a l Markets and Developmental S t ra tegy , " Journal of Developing Areas,-Vol. I (July 1967), pp. 453-60. - . "Branch Banking i n T h a i l a n d . " Journal of Developing Areas, V o l . I l l (October 1968), pp. 37-51. Saving, T . R. "Es t imat ion of Optimum Size of P l an t by the Survivor Tech-r-n i q u e , " Quarterly Journal of Economics, V o l . LXXV (November 1961), pp. 569-97. Sen, Amortya K. "On Opt imizing the Rate of Sav ing , " Economic Journal, V o l . (September 1961}, pp. 479-96. S h u l l , B . , and P. H o r v i t z . "Branch Banking and the Structure of Competi-t i o n , " National Banking Review (March 1964). Reprinted i n Comptrol-ler of the Currency (1966), pp. 99-139. S t e i n , Jerome. "Money and Capacity Growth," Journal of Political Economy, V o l . LXXIV (October 1966), pp. 451-65. Thorn, Richard . "Nonbank F i n a n c i a l Intermediar ies , C r e d i t Expansions and Monetary P o l i c y , " International Monetary Fund Staff Papers, V o l . V I , (1957-58), pp. 369-84. T o b i n , James. "A Dynamic Aggregative M o d e l , " Journal of Political Economy, V o l . LXII ( A p r i l 1955), pp. 103-115. . " L i q u i d i t y Preference as Behaviour Towards R i s k , " Review of Economic Studies, V o l . xxv (February 1958), pp. 65-86. . "Money and Economic Growth," Journal of Political Economy, V o l . LXXVI (July/August 1968), pp. 833-60. Turvey, Ralph. "On Divergences Between S o c i a l Costs and P r i v a t e C o s t s , " Economica, V o l . XXX (August 1963), pp. 309-13. Usher, Dan. "Tha i Interes t Rates , " Journal of Development Studies, V o l . I l l ( A p r i l 1967), pp. 267-80. U Tun Wai. " In te re s t Rates Outside the Organized Money Markets fo r Under-developed C o u n t r i e s , " International Monetary Fund Staff Papers, V o l . VI (November 1957) , pp. 80-142. . "Role of the Money Market i n Supplementing Monetary P o l i c y , " Fiscal and Monetary Problems of Developing States. Proceedings of the T h i r d Rehavoth Conference 1965. David K r i v i n e (Ed . ) . New York: Praeger, 1967, pp. 161-79. Zuntz , Michae l . "Some Observations on Monetary P o l i c y i n Underdeveloped C o u n t r i e s , " Economic Development and Cultural Change, V o l . "I ( A p r i l 1952), pp. 273-87. THE RATIO OF CURRENCY TO MONEY SUPPLY (A), AND THE RATIO OF COMMERCIAL BANK CREDIT TO DOMESTIC NATIONAL INCOME (B) FOR SELECTED COUNTRIES A B In Per Cent i n Per Cent 1965 1966 1967 1964 1965 1966 Argent ina 50 50 49 30 28 29 B o l i v i a * 79 76 ' 75 16 17 18 B r a z i l * * * 19 22 19 49 45 43 Ceylon 53 53 54 38 40 41 C h i l e 38 39 40 27 28 26 Columbia 40 39 37 25 26 29 Cameroon*** * 50 55 54 8 10 11 E t h i o p i a (x) 72 73 70 6 6 7 Ghana (x) 48 46 46 19 20 24 Greece 71 70 75 45 48 51 India 65 65 70 29 31 30 I r a q * * 79 78. 78 16 18 • 21 I s r a e l 34 37 37 25 25 30 Jordan (x) 54 52 67 20 20 23 Kenya* — 20 30 — 12 14 Korea 54 60 63 14 17 17 L i b y a * (x) 50 50 49 8 9 8 Malays ia 56 54 51 16 16 19 Mexico 41 41 — 14 15 16 Morocco** 36 37 38 30 31 30 N i g e r i a * * * (x) 63 61 64 6 9 12 Pakistan*: 60 59 57 30 32 30 Paraguay* 60 58 57 18 21 25 P ^ ^  ^ ^  58 57 — 20 20 24 P h i l i p p i n e s * 57 55 53 36 37 43 Sudan 55 58 56 1 5 10 S y r i a * * 87 83 85 50 47 50 Tanzania — 39 47 15 20 . 16 Thai land 57 57 55 20 21 21 T u n i s i a 34 . 36 35 57 58 70 Turkey* 69 69 70 41 43 44 A B In Per Cent In Per Cent 1965 1966 1967 1964 1965 1966 U . A . R . * * * (x) Uruguay** * Venezuela* Vietnam (South)** West A f r i c a * * * Zambia 70 65 64 60 71 66 32 33 32 70 70 73 55 54 52 22 25 30 49 52 53 47 45 45 20 20 20 28 34 40 11 11 12 11 15 SOURCE: Compiled from International Financial Statistics 3 V o l . XXI (October 1968). For Index B: *1965-67; **1963-65; * * *1962-64; (x) GNP f igure subs t i tu ted for NI. THAI COMMERCIAL BANKS — THE DISTRIBUTION OF BANK BRANCHES AT THE END OF DECEMBER, 1965 CHANGWAD POPULATION NO. OF BANK OFFICE (PROVINCE) (CENSUS 1960) BANK OFFICES PER 1000 POPULATION (1) (2) (3) (2) : (3) Bangkok 1,577 142 11 Songkla (Haadyai Included) 500 20 25 Dhonburi 559 19 29 Trang 240 13 18 Chiengmai 798 13 61 Ra jbur i 411 12 34 Cholbur i 392 12 33 Nakorn Sawan 648 11 58 Khon Kaen 844 10 84 Ya la 149 10 15 Nakorn Srithamaraj 730 10 73 Lampang 472 9 52 Nakorn Rajasima 1,095 . 9 121 Naradhiwat 266 9 29 Surajdhani 325 S8 41 Chiengra i 812 7 116 Chumporn 175 7 25 Chanaburi 158 6 26 Ubol Rajadhani 1,131 6 188 Udorndhani 744 6 124 Kanchaaburi 233 6 39 Puket 76 6 13 P i c h i t 389 5 78 Sukothai 316 5 63 Pa t t an i 282 5 56 Ayudhaya 479 4 120 Lopburi 335 4 84 Saraburi 304 4 76 Samud Prakarn 235 4 59 Prae 299 4 75 Pi t sanulok 352 4 88 Nakorn Pathom 370 4 92 Petchaburi 238 •?4 59 CHANGWAD POPULATION NO. OF BANK OFFICE (PROVINCE) (CENSUS 1960) BANK OFFICES PER 1000 POPULATION PER 1000 (1) (2) (3) (2) : (3) Samud Songkram 162 4 41 Supanburi 491 4 123 Nondaburi 196 3 65 Chazerngsao 323 3 108 Rayong 148 3 49 Chayapoom 486 3 162 Nongkai 257 3 86 Lampoon 250 3 83 U t t a r a d i t 260 3 87 Tak 168 3 56 Petchaboon 320 3 107 Prajuab Kirikhan 152 3 51 Pang-Nga 93 3 31 Ranong 38 3 13 Buriram 584 2 292 Surin 582 2 291 Nakorn Panom 436 2 218 Roi-et 668 2 .334 Skol Nakorn 427 2 213 Nan 240 2 120 Uthaidhani 146 2 73 Samud Sakorn 166 2 83 Patalung 234 2 117 Chainat 245 1 245 Patoomthani 190 1 190 Singburi 154 1 154 Angtong 198 1 198 Tra t 66 1 66 Nakorn Nayok 154 1 154 Prachinburi 335 1 335 S r i Saket 601 1 601 Kai a s i n 427 1 427 Mahasarakam 499 1 499 Loey 211 1 211 Kampaeng Petch 173 1 173 Krabee 94 1 94 S t u l 70 1 70 Sub T o t a l 26,178 474 Mae Hong Sorn 81 -T o t a l 26,259 474 SOURCE: Based on information provided by the Bank of Thailand, c i t e d i n Rozenthal, op. cit.3 p. 39. 

Cite

Citation Scheme:

        

Citations by CSL (citeproc-js)

Usage Statistics

Share

Embed

Customize your widget with the following options, then copy and paste the code below into the HTML of your page to embed this item in your website.
                        
                            <div id="ubcOpenCollectionsWidgetDisplay">
                            <script id="ubcOpenCollectionsWidget"
                            src="{[{embed.src}]}"
                            data-item="{[{embed.item}]}"
                            data-collection="{[{embed.collection}]}"
                            data-metadata="{[{embed.showMetadata}]}"
                            data-width="{[{embed.width}]}"
                            async >
                            </script>
                            </div>
                        
                    
IIIF logo Our image viewer uses the IIIF 2.0 standard. To load this item in other compatible viewers, use this url:
http://iiif.library.ubc.ca/presentation/dsp.831.1-0093317/manifest

Comment

Related Items