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Research Highlights 2007: Finance and Private Sector Development

Themes
Highlights
Across the developing world, less than half of the population has an account with a financial institution; in Sub-Saharan Africa it is less than 20 percent
Small informal firms, which are major employers in developing countries, hold the potential for income growth for their owners 
Making finance work for Africa is an important development goal for the continent
Team 
Notes

The Finance and Private Sector Development group focuses on understanding the role of the financial and private sectors in promoting economic development, and reducing poverty and identifying policies to improve their effectiveness. Research on finance is organized around two dimensions—access to financial services and risk management. Research on private sector development focuses on determinants of firm entry and performance to better understand the microeconomics of the growth process.

Themes

The research on access to finance—which is important in promoting growth and alleviating poverty—includes documenting and benchmarking access to financial services by small firms and poor households, and identifying underserved groups and analyzing barriers to building more inclusive financial systems.

Evaluative research is studying the channels through which access to finance can contribute to growth through promoting entrepreneurship, innovation, and the process of technology adoption. The goal is to evaluate the impact of firms’ financing constraints and households’ inability to access financial services on economic growth and poverty alleviation, and to identify different ways of improving this access, ranging from microfinance innovations to improving how mainstream financial institutions and systems function.

The research on risk management—which is important for ensuring the sustained effectiveness of financial systems and financial stability over the long run—investigates the impact of supervision strategies, as well as the impact of compliance with Basel Core Principles on bank stability, the interaction of bank insolvency resolution and deposit insurance policies, and the impact of financial globalization on bank efficiency and access to financial services. New work includes the area of capital market development and insurance.

Research on the private sector focuses on firm dynamics—changes in the composition of the private sector and entry and exit over time—and performance, and how this affects firm productivity and growth. Special areas of focus include research on the determinants and consequences of informality, innovation, and governance and their impact on firm performance. Research also includes a study of the impact of the business environment and its reforms on firm performance.



Highlights

Across the developing world, less than half of the population has an account with a financial institution; in Sub-Saharan Africa it is less than 20 percent

Lack of access to finance is often the critical driver of persistent income inequality, as well as slower growth. A recent Policy Research Report, Finance for All? Policies and Pitfalls in Expanding Access, documents the extent of financial exclusion around the world; addresses the importance of access to financial services for growth, equity and poverty reduction; and discusses policy interventions and institutional reforms that can improve access for underserved groups.

The report notes that expanding access to financial services will benefit from government initiatives aimed at reforming institutions, developing infrastructure to take advantage of technological advances, encouraging competition, and providing the right incentives through prudential regulations, and relying less on direct government interventions—such as through credit subsidies or government-owned financial institutions.

The policy messages of the report are being disseminated widely; and the report has already received significant press coverage including an article in The Economist and attracted the attention of the development community.[6]



Small informal firms, which are major employers in developing countries, hold the potential for income growth for their owners

The rapid increase in development funding for microfinance organizations is based on the belief that small informal firms can earn high returns to capital if given the opportunity. Critics of this view argue that creating wage jobs is a more effective way of pulling people out of subsistence self-employment.
Two recent randomized experiments in Sri Lanka and Mexico credibly identify the return to capital of such small enterprises. This has been historically difficult to measure, given that firms with less capital stock also differ in many other ways from firms with more capital stock.

The results show that the average microenterprise is able to meet the high interest rates of a microfinance organization like Compartamos, the largest pure microlender in Mexico. High returns suggest that the constraint is not the cost of capital but rather limited access to capital.

It appears that credit constraints lead to an inefficient allocation of capital but they do not cause poverty traps. Overall, the research suggests that microenterprise owners do have viable investment projects and are not just making subsistence returns. Hence, the best policy strategy is to reduce barriers to growth in this sector rather than solely focus on creation of wage jobs.[7]



Making finance work for Africa is an important development goal for the continent

The recent report, Making Finance Work for Africa, takes a critical look at Africa’s financial systems, both at the large and small scales. It synthesizes and applies our research findings in finance to Africa, and underlines the importance of a coherent financial sector policy to support development goals for the continent that include encouraging modern technology and making sure benefits of organizational innovation and internationalization are exploited to the maximum. It identifies promising trends and pinpoints shortcomings.

The report is a good example of how research can be influential in the World Bank’s work. This high-impact publication, which played an instrumental role in the 2007 G-8 summit’s decision to create the “Partnership for Making Finance Work for Africa,” which has been disseminated widely and also won a Chief Economist Best Practice Award from the Africa region.[8]

Team

Notes

 6. Demirgüç-Kunt, Asli, Thorsten Beck, and Patrick Honohan. 2007. Finance for All? Policies and Pitfalls in Expanding Access. Policy Research Report. Washington, DC: World Bank.

7. De Mel, Suresh, David McKenzie, and Christopher Woodruff. 2007. "Returns to Capital in Microenterprises: Evidence from a Field Experiment." Policy Research Working Paper 4230, World Bank, Washington, DC.

De Mel, Suresh, David McKenzie, and Christopher Woodruff. 2007. "Measuring Microenterprise Profits: Don’t Ask How the Sausage is Made." Policy Research Working Paper 4229, World Bank, Washington, DC.

McKenzie, David. 2007. "Review of ‘Poverty Traps’ by Samuel Bowles, Steven Durlauf, and Karla Hoff, eds." Economic Development and Cultural Change 55(4): 845–48.

8. Honohan, Patrick, and Thorsten Beck. 2007. Making Finance Work for Africa. Policy Research Report. Washington, DC: World Bank. Download | Order the book




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