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Financial Liberalization, Financial Restraint and Entrepreneurial Development

  • M. Shahe Emran

    ()

    (Department of Economics/Institute for International Economic Policy, George Washington University)

  • Joseph E. Stiglitz

    ()

    (Department of Economics and IPD, Columbia University)

This paper argues that there is a fundamental conflict between financial liberalization and private sector led development strategy in developing countries. Using a simple model of occupational choice with moral hazard, it shows that under financial liberalization banks may (i) fail to finance new entrepreneurs because of poaching externality, and (ii) systematically favor pro jects with front-loaded returns at the expense of pro jects with strong learning effects. We identify two types of policies that are helpful in escaping from a ‘no entrepreneurial experimentation equilibrium’: intersectoral and intertemporal policies. Among intersectoral policies, a deposit rate ceiling, or a tax on the deposits coupled with a ‘contingent subsidy’ to the new industrial financing (but not interest rate subsidy) may be helpful for entrepreneurial discovery. The intersectoral policies are, however, not effective in weeding out short-termism in pro ject choice. Among intertemporal policies, a dual track policy where competition is preserved in the lending to competing activities (agriculture) but limited duration monopoly is awarded to industrial lending is shown to be effective for both the discovery of new industrial entrepreneurs and tackling shorttermism in project choices.

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File URL: http://www.gwu.edu/~iiep/assets/docs/papers/Emran_IIEPWP2009-2.pdf
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Paper provided by The George Washington University, Institute for International Economic Policy in its series Working Papers with number 2009-02.

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Length: 36 pages
Date of creation: Jan 2009
Date of revision:
Handle: RePEc:gwi:wpaper:2009-02
Contact details of provider: Web page: http://www.gwu.edu/~iiep/
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  1. Oriana Bandiera & Gerard Caprio & Patrick Honohan & Fabio Schiantarelli, 2000. "Does Financial Reform Raise or Reduce Saving?," The Review of Economics and Statistics, MIT Press, vol. 82(2), pages 239-263, May.
  2. Nicola Cetorelli & Michele Gambera, 1999. "Banking Market Structure, Financial Dependence and Growth: International Evidence from Industry Data," Center for Financial Institutions Working Papers 00-19, Wharton School Center for Financial Institutions, University of Pennsylvania.
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