The Assessment: Financial Liberalization, Financial Systems and Economic Development

The World Bank Development Report (World Bank, 1989) provides an excellent synthesis of current wisdom about the relationship between financial systems and economic development. The purpose of this article is to evaluate the proposals presented in that Report. The Report addresses four sets of issues: macroeconomic policy to promote growth, the role of financial liberalization, government intervention in credit markets, and the design of financial systems. It puts forward the following blueprint for reform: Reform should start by getting the fiscal deficit under control and establishing macroeconomic stability. The government should then scale down its directed credit programs and adjust the level and pattern of interest rates to bring them into line with inflation and other market forces. In the initial stage of reform the government should also try to improve the foundations of finance - that is, the accounting and legal systems, procedures for the enforcement of contracts, disclosure requirements, and the structure of prudential regulation and supervision. It should encourage managerial autonomy in financial institutions. If institutional insolvency is widespread, the government may need to restructure some financial institutions in the early stages of reform.