Finance, Investment and Economic Development: Towards An Investment-Friendly Financial Environment

• Author: Courtney Blackman
• Pages: 226-247

THE PRACTICE OF ECONOMIC MANAGEMENT

226

This paper examines the inter-relationship between finance and

investment with the view to formulating an appropriate policy-

mix for the promotion of economic development in LDCs such

as those of CARICOM. The theoretical framework we employ is

in sharp disagreement with the McKinnon-Shaw thesis which

attributes the ills of LDCs to ‘financial repression’, and prescribes

the comprehensive deregulation of financial markets as a

precondition, indeed the requirement, of economic growth.

Since the McKinnon-Shaw thesis has underpinned the

structural adjustment programmes imposed by the IMF, World

Bank and IDB on several LDCs, including some CARICOM states,

it cannot be left unchallenged. We agree with the judgement of

Nobel Laureate J.E. Stiglitz that:

[M]uch of the rationale for liberalising financial markets is based

neither on a sound economic understanding of how these markets

work nor on the potential scope for government intervention. Often,

too, it lacks an understanding of the historical events and political

forces that have led governments to assume their present role.

Instead, it is based on an ideological commitment to an idealised

conception of markets that is grounded neither in fact nor in

economic theory.1

11

FINANCE, INVESTMENT AND

ECONOMIC DEVELOPMENT

TOWARDS AN INVESTMENT-FRIENDLY

FINANCIAL ENVIRONMENT

FINANCE, INVESTMENT AND ECONOMIC DEVELOPMENT

227

Our first task is to lay bare the dynamics of investment, savings

and finance in relation to economic growth. Secondly, we critique

the McKinnon-Shaw thesis. Thirdly, we develop a policy framework

based on the dynamics of investment, savings and finance in

developing countries. Finally, we identify ten minimal elements

of an investment-friendly financial environment.

Investment, Savings and Economic Growth

If there is one thing known about economic development it is

that investment must increase relative to consumption as a

proportion of the national income. Investment, in the words of

John Maynard Keynes, is the engine of growth. Investment is made

possible through savings. According to Sir Arthur Lewis, no

industrial revolution can be understood ‘until it can be explained

why savings increased relative to the national income.’2 Economic

development, then, is about accelerating the rate of savings and

investment, that is, of capital formation.

The equality of savings and investment is a fundamental

proposition of Keynes’s General Theory;3 indeed, he had great

difficulty explaining this equality. The Swedish School came to

his assistance with the ex ante and ex post analytical device: whereas

savings and investment may diverge ex ante (since savers were not

necessarily the same as investors), equality between the two

variables would be restored ex post. If part of ex ante savings

remained uninvested, there would be a corresponding decrease

in income, leading in turn to reduced savings and restoration of

equality between savings and investment ex post. Similarly, should

investment exceed savings ex ante, the resulting increase in income

would raise savings proportionately, thus restoring the equilibrium

between savings and investment ex post. Keynes is effectively saying

that not only are savings and investment equal, but they are really

two aspects of the same phenomenon. It is therefore as true to

say that investment is a function of savings as to say that savings is a