Financial Sector Development in Africa: Opportunities ... - World Bank

184 Dafe
In sum, high transaction costs reduce the profitability of dealing with
SMEs, especially in light of the small amounts of money involved in transactions
with these clients. More attractive alternatives—such as serving
large enterprises with tangible assets that can be used as collateral and
that fit with the existing business model—tend to lower the banks’ incentives
to reduce prices, compete for market shares in underserved segments,
or innovate and find more inexpensive ways of serving SMEs.
Moreover, the failures of the credit market in developing countries tend
to reduce not only the supply but also the demand for credit. If the unit
costs of provision are high, credit becomes less affordable for some
smaller firms, such as SMEs, and this, in turn, reduces the demand for
credit from the formal banking sector.
These examples demonstrate how market failures can impede the
development of inclusive financial systems. They provide an argument,
based on welfare economic theory and information economics, that some
form of government intervention going beyond financial regulation and
supervision to remove market failures might increase social welfare. 7
Thus, governments should choose their policy to mitigate a particular
market failure depending on the nature of this market failure, in order to
achieve the best possible economic outcome. 8 For instance, if the major
constraint on the operation of a payment system is a problem of scale and
small market size, policies that spur regional financial integration might
be appropriate. In cases where several ways of addressing a specific market
failure are possible, welfare economic theory suggests that governments
should seek to implement those policies that address the market
failure most directly and provide the highest benefits at the lowest costs.
Thus, normative economic theory does not only provide a basis for
considering activism as a way to enhance social welfare, but it also offers
some guiding principles for choosing and designing government interventions.
However, contrasting these theoretical insights with actual experiences
suggests that governments often lack the capacity or willingness to
design activist policies in a way that achieves the positive outcome predicted
by the theory.
The Experience with Activism
Assessing the actual experience with activist policies is not straightforward.
First, it is difficult to provide empirical evidence of whether economic
growth or productive investment would have been higher or lower
in the absence of interventions—the counterfactual. Second, convincing
evidence on whether the government-supported expansion of financial