Financial sector development - Sida

markets. Of course, financial market development projects could in principle be used to
obtain similar results, for example through the earmarking of credit funds for environmentally
sustainable technologies. However, from an efficiency point of view, it is
generally more efficient to give direct subsidies to the preferred products/production
methods and to avoid direct subsidy interventions in the financial markets.
Environmental concerns are particularly low when working with institutional development
of the financial sector per se. However, when the financial sector is used as a means to
channel financial support to projects, the case is somewhat different. Sida is subject to farreaching
scrutiny by the public on the use of Swedish aid funds. Thus, in the case of
on-lending of aid funds, the environmental effects of the projects for which the funds are
ultimately used need to be assessed.
Finally, it is interesting to note that in all Sida Action Programmes as well as in this report
on financial sector development, good governance and an appropriate institutional
framework are emphasised as essential preconditions.
3. SAVINGS, INVESTMENT AND GROWTH
To save is to sacrifice current consumption for the future. In the national accounting
system, savings are defined as the residual when the value of the total production is
reduced by the value of total consumption. The savings rate, i.e. gross national savings as
a share of GDP, has fallen world-wide since the 1970s, although there is considerable
variation between countries. When analysing the economic performance of developing
countries in recent decades, an apparent empirical relationship emerges: economies
showing high real growth rates usually also have high rates of savings and investment.
Nevertheless, it is not necessarily the case that high savings is a prerequisite for
investment, in turn causing high growth. It may be that there are other features of an
economy that promote growth, which in turn encourage further savings and investment. It
may be that other features drive savings, investment and growth.
3.1 Growth and investment
A cherished view among development economists ever since the 1940s has been that
growth is best promoted by increasing investment, i.e. physical capital accumulation (the
Harrod-Domar model). The approach may be labeled capital fundamentalism, and has
been a guiding principle for a substantial share of development policies. In contrast,
traditional neoclassical theory assigns a very limited role to capital accumulation, and thus
the savings rate (the Solow-Swan model). A more recent theoretical development is the so
called endogenous growth school which assumes, briefly, that technological change is
determined by research and development activities. An implication of these newer theories
is that investments in physical or human capital indeed may raise the rate of growth. In
certain respects this is the return of capital fundamentalism.
Nevertheless, the causality between investment and growth remains unsettled. Recent
empirical findings suggest a reverse causality: economic growth starts accelerating before
investment ratios start to increase. Other studies examine the relationship between growth
and investment in more detail, investigating the kind of investments which seems to go
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