Financial systems and development

3 V/ The evolution of financial systems
In preindustrial economies, finance was largely ting around the regulations. In recent years the
concerned with the development of a medium of focus has shifted back to deregulation, partly in
exchange. Barter was inefficient, transaction costs response to financial innovation and partly to prowere
high, and the lack of a medium of exchange mote competition and efficiency.
limited the extent of the market and the opportuni- The evolution of financial systems ought to cast
ties for specialization. With the growth of nonlocal light on two questions that are of interest to policytrade,
the development of payment media became makers in developing countries. What role should
linked to the financing of trade. Otherwise, apart financial systems play in promoting industrializafrom
the financing of governments and seaborne tion and development? And what role should govtrade,
borrowing and lending were mostly infor- ernments play in creating such systems?
mal and on a small scale.
The spread of urban society, and above all the Development of payment systems
advent of large-scale industrialization in the second
half of the nineteenth century, altered the role The search for an efficient medium of exchange
that finance had to play. Finance was now con- gradually led to the monetization of precious
cerned with mobilizing resources for large infra- metals. As a result the payment mechanism bestructure
projects and for investments with heavy came simpler and safer. The new monies facilitated
capital requirements that exceeded the capabilities trade and provided a store of value and a unit of
of small family firms.
account. Governments played an important part in
The systems that emerged often suffered from this change by owning and regulating mints and
fraud and mismanagement. They proved unstable thus ensuring the quality and acceptability of
and experienced frequent crises. Speculative ma- coins. But they were also frequently responsible
nias, fueled by financial institutions, caused for debasing coins by lowering their weight or
mounting concern, and after the Great Depression adulterating them with less precious metals, such
of the 1930s governments began to supervise their as copper.
financial systems more closely. But government in- Metallic payment was a big step forward. Gradutervention
was by no means entirely successful. It ally, however, paper-based instruments, which
made the financial system less flexible, and al- were cheaper and more convenient, came to rethough
it reduced fraud it did not eliminate it. place coins and bullion. Payment orders, letters of
Moreover, economic agents proved adept at get- credit, and negotiable bills of exchange evolved
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