Financial systems and development

j
Box 2.1 Life without money
"Some years since, Mademoiselle Zelie, a singer . . . In some countries neighbors help one another to build
gave a concert in the Society Islands . . . in exchange their houses without payment (gotooig royong in Java,
for a third part of the receipts. When counted, her barn raising in the United States).
K share was found to consist of three pigs, twenty-three The economy of ancient Egypt operated for 2,000
turkeys, forty-four chickens, five thousand cocoa nuts, years before the invention of money (although prebesides
considerable quantities of bananas, lemons and cious metals served as a medium of exchange for some
oranges . . . as Mademoiselle could not consume any transactions). Even after several surrounding states
1 considerable portion of the receipts herself, it became adopted coinage, the government of Egypt opposed
necessary in the meantime to feed the pigs and poultry the use of money. The Inca Empire of Peru may not
with the fruit."
have used money as a medium of exchange, despite
W. S. Jevons being exceptionally rich in gold and silver. Some reli-
Money and the Mechanism of Exchange gious societies (including the almost self-sufficient Je- K
(Jevons 1898, p. 1) suit Republic of Paraguay in the sixteenth and seven-
I:l teenth centuries) and authoritarian or paternalistic
Even in modern economies many transactions do not communities (such as the large haciendas of Latin Amerinvolve
money. For example, barter is used to escape ica) make little or no use of money, at least for internal
taxation and regulation. In developing countries most transactions.
exchanges within extended families are handled with- Nonmonetary transactions tend to be aspects of a
out cash. The multiple incomes of an extended family longstanding social compact, whose individual parts
offer a substitute for insurance, pension plans, and so- cannot be valuecd separately. But in advanced econocial
security. In many areas of the world, share- mies most exchanges are impersonal. As Mademoiselle
cropping involves a series of nonmonetary transactions Zelie discovered, trade can be quite costly without a
J concerning inputs, land tenure, crop sales, and so on. widely accepted medium of exchange.
institutions can mediate between the many small past three decades Hong Kong, Japan, the Repubdepositors
who prefer liquid assets and the few lic of Korea, and Singapore have had among the
large borrowers who need long-term loans to fi- world's highest per capita income growth rates denance
investment. They can provide other useful spite their relatively poor resource endowments.
services too: insurance, hedging (using options Resource-rich Argentina has hardly grown at all.
and futures contracts), and so on. In a diversified The biggest difference between rich and poor is
market-based system, governments retain a key the efficiency with which they have used their rerole
as prudential regulators, because experience sources. The financial system's contribution to
has shown that financial markets-essential growth lies precisely in its ability to increase
though they are-can be prone to instability and efficiency.
vulnerable to fraud.
Finance and trade
Finance and growth
The financial system makes its biggest contribution
Malthus predicted that growing populations and to growth by providing a medium of exchange. In
fixed amounts of land and other natural resources a barter econorny, trade requires a "mutual coinciwould
ultimately stifle economic growth. But natu- dence of wants." It is therefore limited by the
ral resource endowments have declined in impor- costly search fcr trading partners. Specialization is
tance in most high-income countries. In Great Brit- discouraged in economies with no medium of exain,
for example., the value of land and minerals change, so their productivity is low. Money faciliwas
60 percent of the value of all tangible assets in tates specialization by reducing trading costs and
1688 but only 15 percent in 1977. In fact, natural linking different markets. The adoption of a stanresources
have not determined wealth. In 1870, dard unit of account serves the same goal (see Box
Australia, a country rich in natural resources, had 2.1).
twice the per capita income of Switzerland, which Historically, economies moved first from basic
has few; today Switzerland's per capita income ex- self-sufficiency to barter trade and then to trade
ceeds Australia's by more than half. During the against commonly accepted commodities such as
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