Schmid , Reinha d H.
A icle
Finance a he F on ie
K edi und Kapi al
P o ided in Coope a ion wi h:
Duncke & Humblo , Be lin
Sugges ed Ci a ion: Schmid , Reinha d H. (1993) : Finance a he F on ie , K edi und Kapi al, ISSN
0023-4591, Duncke & Humblo , Be lin, Vol. 26, Iss. 2, pp. 313-327,
h ps://doi.o g/10.3790/ccm.26.2.313
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Be ich e
Finance a he F on ie
*
A Re iew A icle
By Reinha d H. Schmid , F ank u /M.
* *
I. The Backg ound
Only abou en yea s ago, a small g oup o specialis s a he Wo ld Bank
and a Ohio S a e Uni e si y u ned de elopmen inance om a dull
adminis a i e ou ine in o an exci ing ield o academic esea ch and p o-
essional excellence. The ailblazing insigh o J. D. on Pischke, Dale
Adams and hei associa es was ha de elopmen inance should be much
mo e conce ned wi h de eloping inancial ma ke s and ins i u ions han
wi h channelling subsidized unds om dono s in indus ial coun ies o
bene icia ies in de eloping coun ies. The people belonging o his g oup
we e able o pinpoin he "abuse o ... inancial ma ke s in de eloping coun-
ies" by he p e ailing app oach o dono s and LDC go e nmen s, and o
show how ex e nal inancing h ough con en ional de elopmen banks was
in ac "unde mining... de elopmen (in pa icula he de elopmen o local
inancial sys ems) wi h cheap c edi ".1
* J. D. on Pischke: Finance a he F on ie . Deb Capaci y and he Role o C edi
in he P i a e Economy. EDI De elopmen S udies, Economic De elopmen Ins i u e
o he Wo ld Bank, Washing on, D.C.: The Wo ld Bank 1991, XII + 427 pages, biblio-
g aphical e e ences and index, ISBN 8213-1818-7, US-$ 22.95 (DM 50,50).
* *
D . Reinha d H. Schmid , Wilhelm-Me on-P o esso o In e na ional Business,
Uni e si y o F ank u /Main, Ge many.
1 The quo a ions a e aken om he i les o he wo mos in luen ial books on he
new hinking abou inancial ma ke s in de eloping coun ies. These a e: J. D. on
Pischke; Dale W. Adams; Go don Donald (eds.): Ru al Financial Ma ke s in De elop-
ing Coun ies: Thei Use and Abuse, Bal imo e /London: The Johns Hopkins Uni e -
si y P ess 1983, and Dale W. Adams; Douglas H. G aham; J. D. on Pischke (eds.):
Unde mining Ru al De elopmen wi h Cheap C edi , Boulde , Col.: Wes iew P ess
1984.
21*
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314 Be ich e
The c i ique was o ce ul and in ellec ually con incing. I also had some
p ac ical impac , bu i did no succeed in causing a comple e e ision o
dono policies. This esilience can be explained in pa by he gene al slow-
ness o poli ical and adminis a i e p ocesses. Ano he pa o he explana-
ion is p obably ha , a a ime o p e ailing inancial ep ession, on
Pischke, Adams and hei iends could no be oo speci ic in desc ibing a
mo e sensible ma ke -o ien ed app oach o de elopmen inance. An impo -
an hi d eason was poin ed ou in one o he mos s imula ing ea ly pape s
by J. D. on Pischke and his associa es, in which hey iden i ied and desc ibed
he ole o he es ed in e es s o all pa ies in ol ed in a p ocess which is
igh ly cha ac e ized as dis ibu ing pa onage unde he guise o aid.2
II. The Basic Messages
J. D. on Pischke's new book "Finance a he F on ie " is he i s com-
p ehensi e ea ise on de elopmen inance o small a me s, small
businesses and o he o dina y people w i en by one o he au ho s who
ini ia ed he new hinking and who has since hen ied o pu his ideas in o
p ac ice. Qui e na u ally, his new book a ac s he g ea es in e es on he
pa o all hose p ac i ione s and academics who we e in luenced by his
ea lie wo k. Ha e his ideas e ol ed du ing a decade in which ideologies and
policies in he indus ialized coun ies o he Wes ha e changed as much as
he economic si ua ion o mos LDCs? This, o cou se, aises he wo ques-
ions whe he he old c i ique is s ill alid and con inues o o m he basis o
his analysis and whe he i has been possible o make he cons uc i e ele-
men s o his concep mo e ope a ional. The answe o bo h ques ions is
clea ly "yes".
"Finance a he F on ie " is a g ea book: i is hough ul and hough -
p o oking, c i ical and cons uc i e, lucid in con en and b illian in s yle.
And i will ce ainly ha e a s ong and las ing in luence on concep ual
hinking and p o essional p ac ice. I is exac ly he kind o book which his
many admi e s ha e expec ed om J. D. on Pischke!
Wha is " he on ie "? Von Pischke de ines i "as he limi o he ac i i ies
o o mal inancial ins i u ions" (p. 317). "Finance a he F on ie " is abou
he p oblems and p ospec s o pushing he on ie ou wa d. The main mes-
sage o he book is ha his should be a emp ed, and can be achie ed. I is
2 J. D. on Pischke; Pe e He e man; Dale W. Adams: The Poli ical Economy o
Specialized Fa m C edi Ins i u ions, S a Wo king Pape No. 446, Washing on,
D.C.: The Wo ld Bank.
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Be ich e 315
possible " o make good loans o indi iduals and i ms a he on ie "
(p. VII). Financial ins i u ions can lend o people who a e no con en ionally
ega ded as c edi wo hy - people, in o he wo ds, who do no seem o ha e
deb capaci y. I is " he unc ion o inancial ma ke s o de elop and exploi
deb capaci y, (and) deb capaci y c ea ed is a p oxy o de elopmen "
(p. 316).
Von Pischke builds his book on he p emise ha " inancial ma ke s c ea e
alue" (p. 5). Bu a he same ime hey c ea e isk. The coun e weigh o
isk, and hus an indispensable p e equisi e o he c ea ion o alue, is con-
idence. Con idence is mo e han "emo ion and pe cep ion" (p. 42); i is a
s a e o expec a ions which is well g ounded in ac s and expe ience. The
abili y o manage and assume isk c ea es con idence. A decline in con i-
dence des oys alue.
In o de o c ea e alue, inancial ins i u ions mus lend wi h an ex eme
awa eness o he isks which c edi en ails o bo owe s and lende s. As he
au ho emphasizes and elabo a es in he book, cu en lending policies a e
no isk-conscious enough and hus ail o achie e hei objec i e. And isk-
awa e lending a he on ie can only be expec ed om inancial ins i u-
ions which a e s able and iable. This equi emen is also no sa is ied by
mos lending ins i u ions cu en ly ope a ing a he on ie in de eloping
coun ies.
Wi h he all-impo an p o iso ha isk be aken in o accoun p ope ly
and ha lending ins i u ions be sus ainable, on Pischke's second main
message o he communi y o de elopmen aid p o essionals is ha "lending
a he on ie can be emune a i e o comme cial banks, de elopmen
banks and o he de elopmen inance agencies who e ail c edi and assume
c edi isk". This message is encou aging and simple. Bu , o cou se, i does
no imply ha lending a he on ie is simple. I is in ac qui e di icul .
Von Pischke is an ad oca e o simplici y, bu in a e y speci ic con ex and
wi h espec o e y speci ic aspec s o his app oach. As he a gues con inc-
ingly, success ul c edi p og ams mus ha e a simple design and pu sue
simple lending s a egies. One o he easons o he ailu e o many pas and
p esen p ojec s is ha hey we e no simple enough; hey ied o accom-
plish oo many di e en hings simul aneously.
III. Finance: Value, Risk, and Con idence
"Finance a he F on ie " con ains 14 chap e s and is di ided in o ou
pa s. Pa I de ines he basic concep s o alue, isk and con idence, shows
how hey a e in e ela ed, and de elops he book's main p oposi ions. I is
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316 Be ich e
e y help ul o he eade ha he au ho explains and illus a es his con-
cep s so ca e ully, as hey a e indeed no always used in acco dance wi h
s anda d economic heo y. Bu his is all he be e in iew o he se ious
p oblems which economic heo y has wi h he win concep s o inance and
de elopmen . Howe e , on Pischke's concep o alue is less uno hodox
han he seems o hink (p. 4) as i is in ac qui e close o he concep used in
he Aus ian adi ion o alue heo y. The concep o con idence emains
unde ined, bu i is so well illus a ed ha he lack o a p ope de ini ion
does no cause any p oblems.
The bes chap e in pa I, and pe haps e en in he en i e book, is chap e 3,
which deals wi h " he cha ac e is ics o inance". I con ains he essence o
he book. I is e y easy o ead and p esen s an abundance o insigh s. The
chap e begins wi h an impo an s a emen : "The ma ke o inance is
basically di e en om he ma ke o soap o cemen " (p. 67) and a e e -
ence o he amous S igli z and Weiss pape on c edi a ioning.3 To a much
g ea e deg ee han in he ma ke s o con en ional goods and se ices, he
pe o mance o inancial ma ke s depends on he dis ibu ion o in o ma-
ion and he accu acy and s abili y o expec a ions. Incen i e p oblems a e
endemic o inancial ma ke s. Tha is he " heo e ical" eason why con i-
dence and long- e m ela ionships be ween bo owe s and lende s a e so
impo an : hey help o o e come he in o ma ion and incen i e p oblems
which would keep inancial ma ke s om unc ioning p ope ly i all ans-
ac ions we e conduc ed by aceless agen s. In poin ing ou he necessi y o
con idence and endu ing inancial ela ionships - and, indeed, by building
his en i e app oach on hese ideas - on Pischke has, mo e o less in passing,
made a g ea con ibu ion o b idging he gap be ween he mode n heo y o
inancial ma ke s unde impe ec in o ma ion (S igli z) and de elopmen
inance.4 We shall e u n o his poin below.
3 Joseph E. S igli z; And ew Weiss: C edi Ra ioning in Ma ke s wi h Impe ec
In o ma ion, in: Ame ican Economic Re iew, Vol. 71 (1981), pp. 393 - 410. Ano he
and mo e ex ensi e e e ence o S igli z and Weiss is on page 215 o he book.
4 S igli z himsel and o he s who wo k in close collabo a ion wi h him ha e w i en
ex ensi ely on in o ma ion economics and de elopmen inance, see e.g. Joseph E.
S igli z: The New De elopmen Economics, in: Wo ld De elopmen , Vol. 14 (1986),
pp. 257 - 265; Joseph E. S igli z: Ma ke s, Ma ke Failu es, and De elopmen , in:
Ame ican Economic Re iew, Pape s and P oceedings, Vol. 79 (1989), pp. 197 - 203;
A ishay B a e man; Luis
Guasch:
Ru al C edi Ma ke s and Ins i u ions in De elop-
ing Coun ies: Lessons o Policy Analysis om P ac ice and Mode n Theo y, in:
Wo ld De elopmen , Vol. 14 (1986), pp. 1253 - 1267, and A ishay B a e man; Luis
Guasch: Ru al C edi Re o ms in LDCs: Issues and E idence, in: Jou nal o Economic
De elopmen , Vol. 14 (1989), pp. 7 - 33.
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Be ich e 317
IV. An Upda e o he Old C i ique
Pa II is a summa y and upda e o he de as a ing c i ique om he ea ly
80s. The au ho does no ake back wha he and his iends ha e w i en. The
e dic in chap e 4 on "c edi needs" and o he "bank up app oaches"
which s ill domina e de elopmen aid p ac ice is as ou spoken and uncom-
p omising as e e . "Common s a egic laws in e o s o channel c edi o
he on ie " (chap e 5), "policy and p ac ice ha educe alue a he on-
ie " (chap e 6) and "signs o poo i a he on ie " (chap e 7) a e
analyzed and c i icized wi h admi able cla i y. They a e iden i ied as one
impo an eason why he billions o dolla s which ha e, o e he yea s,
lowed in o a ge -g oup-o ien ed lending in he de eloping coun ies
(p. 65) ha e ailed o mo e he on ie ou wa d.
In one and subs ance he c i ique is clea ly in he adi ion o he ea lie
wo k o on Pischke, Adams and hei associa es.5 I is impo an and,
indeed, g a i ying o see ha he c i ique has no been aken back o
wa e ed down because he e is no hing o ake back! Wi h one excep ion
which will be discussed below, concep s, policies and p ac ices o de elop-
men aid bu eauc a s ha e no changed e y much du ing he las decade.
To mos "expe s" in he bu eauc acies, i is s ill a mys e y why he no ion
o "c edi need" is disc edi ed, as hey keep sending ou o he expe s as
consul an s who oam he de eloping coun ies in sea ch o "c edi needs".
And almos in a iably hese consul an s come back wi h es ima es o
"c edi needs" which a e much la ge han he olume o c edi which indi-
iduals and i ms would demand i c edi we e p iced in acco dance wi h
cos and isk, and g ea ly in excess o wha isk-awa e lende s could eason-
ably lend ou a he on ie . As hey we e a decade ago, c edi p og ams a e
bu dened wi h i ele an equi emen s pe aining o he ques ions o who
bo ows and o wha pu poses. And he p oblems o in e media ies a e
ea ed as negligen ly as e e .
The old gospel has no been hea d o unde s ood well enough! The e o e,
i is good ha i is epea ed - in a language which does no in imida e p ac-
i ione s, and in a book which is easily accessible.
In spi e o all he appa en con inui y in his pa o he book, he e a e
some in e es ing elemen s o change. Some a e jus changes o emphasis,
some a e changes in subs ance, and some a e bo h.
5 See also he syn hesis in Dale W. Adams; Douglas H. G aham: A C i ique o T a-
di ional Ag icul u al C edi P ojec s and Policies, in: Jou nal o De elopmen
Economics, Vol. 8 (1984), pp. 347 - 366.
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318 Be ich e
One example o an old opic wi h a new emphasis is he lack o ha d
empi ical da a ela ing o he pe o mance o ins i u ions which e ail c edi
a he on ie (pp. 128 and 164). This lack is indeed e iden and annoying. I
only shows ha ins i u ional de elopmen is no a genuine conce n o mos
dono agencies. Ano he example is on Pischke's skep icism is-à- is
c edi as a ool o de elopmen policy: "Howe e help ul i may be, c edi is
no an essen ial componen o de elopmen " (p. 70), and i is o en no help-
ul a all. And in many cases, o he ins umen s a e mo e app op ia e han
c edi o add ess speci ic de elopmen p oblems (e.g. p. 282).
Mo e change han con inui y is e lec ed in a s a emen on p. 110: "Ex-
pe ience wi h c edi and de elopmen inance p ojec s sugges s ha ins i u-
ional de elopmen is s ubbo nly di icul , especially when incen i es a e
no ca e ully analyzed". This is clea ly a lesson o he las decade. Ten yea s
ago i seemed ha libe alizing in e es a es and gi ing some limi ed s a -
up suppo o ins i u ions would su ice o make hem ope a e success ully
a he on ie . The new skep icism is jus i ied. I does no in alida e he
undamen al c i ique, no does i imply ha ins i u ional de elopmen
should no be a emp ed. I only makes he c i ique appea mo e ai and
hus also ha de o e u e. And i is, o cou se, he main mo i e unde lying
he new and cons uc i e pa s o he ea ise.
The e is one sec ion o chap e 6 which exhibi s oo much con inui y and
e lec s oo li le change. On pages 118-126, on Pischke ei e a es he
c i ique o "a i icially low in e es a es" as a cha ac e is ic o ill-designed
c edi schemes. This issue is no as s aigh o wa d oday as i was a decade
ago. A ound 1980, " inancial ep ession" was s ill p e ailing in mos coun-
ies o he wo ld. This ga e a simple and clea meaning o he e m "a i i-
cially low in e es a es": "A i icially low" mean "nega i e in eal e ms".
Only by way o implica ion did i also mean "below economic cos ". The
meaning and he objec o he old c i ique we e easy o iden i y. The in el-
lec ual unde pinning o he c i ique appea ed o be equally beyond doub . In
ac , he e we e wo s ands o easoning behind he a ack on excessi ely
low in e es a es. One was a poli ical-economy a gumen spelled ou mos
o ce ully by Edwa d Kane.6 The o he a gumen was aken om s anda d
wel a e heo y applied o inancial ma ke s. The classical sou ce is Claudio
Gonzalez-Vega's a icle on " he i on law o in e es a e es ic ions".7
6 Edwa d J. Kane: Poli ical Economy o Subsidizing Ag icul u al C edi in
De eloping Coun ies, in: Dale W. Adams, Douglas H. G aham and J. D. on Pischke
(eds.): Unde mining Ru al De elopmen wi h Cheap C edi , Boulde , Col.: Wes iew
P ess 1984, pp. 166 - 182.
7 Claudio Gonzalez-Vega: C edi -Ra ioning Beha io o Ag icul u al Lende s: The
I on Law o In e es Ra e Res ic ions, in: Dale W. Adams, Douglas H. G aham and J.
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Be ich e 319
Bu eali y and heo y ha e changed. The las decade b ough a wa e o
libe aliza ion and s abiliza ion o many pa s o he wo ld and as a conse-
quence eal in e es a es ha e soa ed in se e al coun ies. The e a e now
legi ima e conce ns ha in e es a es may be oo high ins ead o oo low.
This change in eali y is no e lec ed adequa ely in on Pischke's ea men
o he issue. The same applies o changes in economic heo y which a e ele-
an he e. Gonzalez-Vega's analysis ea s inancial ma ke s as i hey we e
jus like he ma ke s o "soap and cemen " (p. 67). I implies ha inancial
ma ke s wi hou in e es a e es ic ions would lead o equilib ium in e es
a es wi h he desi able s anda d wel a e p ope ies. Bu due o he wo k o
S igli z and his collabo a o s on in o ma ion, incen i es and c edi a ion-
ing, which is igh ly acknowledged by on Pischke and in ac undamen al
o he main h us o his book, i has now become he accep ed iew ha he
equilib ium in " ee" inancial ma ke s may simply no exis , o may no be
unique and is mos likely o ha e undesi able wel a e p ope ies. The no ion
o "a i icially low in e es a es" has become obscu e, and he wel a e-
analysis o he Gonzalez-Vega a icle is simply no alid any mo e. E en
among he in ellec uals a he Wo ld Bank, in e es a e es ic ions and
in e es subsidies a e now no longe ega ded as un hinkable.
Von Pischke a oids his con o e sy. Bu he seems o be awa e o i
because in his exposi ion he only elies on he poli ical-economy a gumen s
and does no e en quo e Gonzalez-Vega in his pa o he book. I appea s
ha he c i ique which is p esen ed is s ill alid a e inancial ep ession
ended in a la ge pa o he de eloping wo ld and a e in o ma ion
economics s a ed o become a pe asi e o ce in hinking on inance and
de elopmen . Bu how w ong a e hose who li wi h he idea o es ic ing
he in e es a es which inancial in e media ies a e pe mi ed o cha ge
"poo bo owe s"? And con e sely, how high mus in e es a es be o a oid
he cha ge o being "a i icially low"? Wha is he s anda d o de e mining
app op ia e in e es a es? Should hey be se acco ding o p e ailing ma -
ke a es o based on o al cos s, and wha should be done i cos - and ma -
ke -based a es di e conside ably? And a e some e aile s o c edi who
eally ope a e "a he on ie " jus i ied in cha ging e ec i e eal in e es
a es o close o 100 pe cen (on an annualized basis) in o de o co e hei
cos s? In iew o he ac ha such policies a e being pu sued, i seems di i-
cul o discuss in e es a e es ic ions sepa a ely om he issue o he e i-
ciency o c edi e aile s.
D. on Pischke (eds.): Unde mining Ru al De elopmen wi h Cheap C edi , Boulde ,
Col.: Wes iew P ess 1984, pp. 78 - 95.
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320 Be ich e
V. F on ie De elopmen
Pa III on "s uc u al conside a ions in on ie de elopmen " discusses
in o mal inance (chap e 8) and inno a ion (chap e 9). Chap e 10 com-
bines he wo concep s and d aws s a egic implica ions.
I would be w ong o belie e ha he e is no hing beyond he on ie
which o ms he ou e edge o he a ea in which o mal inancial ins i u ions
cu en ly ope a e. Indeed, beyond he on ie lies he domain o in o mal
inance, a sub le and ex emely complex web o inancial ela ionships and
a mul i ude o inancial a angemen s and inancial ins i u ions. O en
in o mal inance is simply igno ed o disc edi ed by de elopmen planne s.
The common and e oneous no ion ha he main ope a o s in in o mal
inancial ma ke s a e "malicious moneylende s" (p. 174) is an indica ion o
bo h igno ance and hos ili y. I is impo an , acco ding o on Pischke, ha
hose who wan o shi he on ie ou wa d unde s and he exis ence as
well as he speci ic s eng hs o in o mal inance. Such speci ic s eng hs
mus in ac exis , since, a e all, in o mal inancial ma ke s c ea e " alue
o he people" (p. 173) unde condi ions whe e o mal inancial ins i u ions
ei he ail o do no e en y o ope a e. And hese speci ic s eng hs a e
essen ial a and beyond he on ie , "because ( o mal) in e media ies'
a ionale o passi i y, ha con en ional se ices a e unlikely o be p o i a-
ble when o e ed o on ie clien s, is a co ec comme cial assessmen "
(p. 199).
I he e we e a acuum beyond he on ie i would make sense o o de
o mal inancial ins i u ions o b oaden he ange o people and i ms which
hey y o se e, o o alk hem in o simply pushing ahead. Tha is exac ly
wha has adi ionally been done by de elopmen planne s and poli icians.
The esul s o his s a egy ha e been disappoin ing because i was based on
an inco ec diagnosis o he p oblem. Von PischJce's diagnosis is ha con-
en ional o mal inance is no compe i i e a he on ie . This insigh leads
o d as ic consequences. Simply expanding con en ional inancial se ices
canno succeed. I hey a e o ope a e success ully, i.e. wi hou cons an
losses, a he on ie , i would seem ha o mal inancial ins i u ions ha e
only wo op ions. One would be o adop as much as possible o he ech-
niques and ins umen s o in o mal inance. Howe e , i is ha d o imagine
how his could be done success ully "in he comme cial bank o de elop-
men bank o ma wi h mode n o ices, na ional wage scales, and unionized
s a " (p. 220) and unde he obliga ion o comply wi h mode n comme cial
and banking laws. The o he op ion - and in ac he only ealis ic op ion -
is inno a ion: "S uc u al inno a ion" is an absolu e necessi y o any
OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/
DOI h ps://doi.o g/10.3790/ccm.26.2.313 | Gene a ed on 2023-01-16 13:03:38
Be ich e 327
pemen de econnaî e e de comp end e les impulsions e la na u e des p oblèmes de
communica ion qui dé e minen les ela ions inanciè es, no ammen dans le sec eu
épu é in o mel. C'es à pa i de ce cons a ondamen al que l'au eu dé eloppe des
concep ions ès p ome euses quand aux moyens à me e en œu e pou ai e ecule
la « on iè e».
2 2 K edi
und Kapi al
2/1993
OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/
DOI h ps://doi.o g/10.3790/ccm.26.2.313 | Gene a ed on 2023-01-16 13:03:38