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Does Financing Benefit Only the Rich?
A.K. Mishra | MHPA, January 29, 2014
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 Woodrow Wilson during presidential campaign in the United States during the year 1912 stated the following;

"The great monopoly in this country is the money monopoly. So long as it exists, our old variety and freedom and individual energy of development are out of question. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of few men, who, even if their actions be honest and intended for the public interest, are necessarily concentrated upon the great undertakings in which their own money is involved and who, necessarily, be every reason of their own limitations, chill and check and destroy genuine economic freedom."

Wilson recognized the importance of finance ("A great industrial nation is controlled by ...... credit") but lamented that its power was used to "chill and check and destroy genuine economic freedom." Are these two seemingly opposite perceptions-financers' being useless while at the same time being too powerful-compatible?

Why is finance so limited in an economy without financial infrastructure? Financing is the exchange of sum of money today for promise to return more money in the future. Not surprisingly, such an exchange can be problematic. First, even the most honest borrower may be unable to live up to his/her promise, due to the uncertainty intrinsic in any investment. Thus, financiers have to bear some risk. When the risk involved is substantial and concentrated, it becomes difficult to find people willing to bear it. Second, promises are hard to value. People who do not intend to keep them are more willing to promise a lot. Hence, the very nature of the exchange tends to favor the dishonest. Finally, even individuals with the best intentions may be tempted to behave in an opportunistic way when they owe money. In an economy without the infrastructure to mitigate these problems, financing becomes restricted to the few who have the necessary connections or wealth to reassure the financers. The financer can prosper simply by acting as a gatekeeper. The limited access to finance severely reduces the choices citizens have in determining the way they work and live.

It is appropriate to know that the economic revolution which took place in US in the financial markets in last twenty (20) years, has already enhanced economic freedom greatly, placing the human being rather than capital at the centre of economic activity.

To attract funds to risky ventures, individuals or firms undertaking them have to promise their investors a risk premium over what they would earn safe investments. In a developed financial system, financers reduce the premium required of a borrower by spreading the risk widely over a variety of investors or allocating it to those investors who can best bear it. Because financers in an underdeveloped financial system do not have the ability to distribute the risk appropriately, the risk premium their investors demand is high and finance becomes extremely costly.

The problems caused by uncertainty are exacerbated because not all people are intrinsically honest. Without extensive information on a borrower's past credit history, it is hard for a financier to tell the honest from the dishonest. Even if there is a default, it is not easy to separate the bad luck from crookery. Since the dishonest are hard to identify and punish, financiers with limited information again have to resort to charging high rates.

In developing nations, where the financial infrastructure is still in developmental stage, the benefits which could have benefited an ordinary citizen through borrowing credit facilities are lost as the prevailing system doesn't trust the ordinary borrower. In turn, the lender/financiers are also looking for creditable borrowers which are usually falling in the high income group brackets get the advantage of financing. In the same context, it is to be mentioned here that US took reasonable time to establish the dependable financial infrastructure which is providing the back-up to an ordinary citizen.

In continuation to above, it is not out of place to mention here that the Obama Health Care in US, which is proposed to be available to an ordinary citizen at an affordable premium through health insurance is becoming possible due to the availability of the robust financial infrastructure driven by the market forces. Although, the political consensus on Obama Health Care is still in debate, but an alternative is being searched through innovation which may be useful for the developing nations in future time to come.


(A.K. Mishra)

Managing Director

Mangdechhu HE Project Authority

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