Download Notes on Development Banks and the Investment Decision: finance

Notes on Development Banks and the Investment Decision: finance and coordination1
Ana Rosa Ribeiro de Mendonca2
Abstract
The ongoing international financial crisis started in 2008 and the policies adopted by different countries
for coping with its consequences shed light to mechanisms and institutions utilized for this purpose and,
among them, development banks. These experiences turned out to stimulate some countries, even with no
tradition and historical presence of this kind of institution, such as US and UK, to discuss the creation of
development banks, motivated, it is important to note, by different concerns and goals.
The fact that the creation of development banks is marked by historical conditionalities and specific
institutionalities places boundaries for attempts of the conceptualization of such institutions.
Conscious of those limitations, this paper aims to present how the literature on the subject has been
addressing the role of development banks. And departing from the acceptance of: i. the historical role of
these institutions in facilitating investment decisions; and ii. the contributions of Keynes that highlight the
centrality of investment as well as the instability that permeates the investment decisions, the paper
considers the role that the development banks can take not only on financing, but also on organizing the
environment in which such decisions are taken. For this, the article is organized as follows. After the
introduction, section 2 discusses some peculiarities of the decisions of financing investment. Section 3
presents how the literature deals with development banks. In section 4, the discussion of investment in
Keynes, its centrality in the process of employment and income creation, the instability around the
investment decision and the proposal of the socialization of investment is presented. Finally, concluding
remarks are delineated.
Key words: Development banks, investment decision and socialisation of investment
JEL code: B25 e O11
1.
Introduction
The ongoing international financial crisis started in 2008 and the policies adopted by
different countries for coping with its consequences shed light to mechanisms and
institutions utilized for this purpose and, among them, development banks. These
experiences turned out to stimulate some countries, even with no tradition and historical
presence of this kind of institution, such as US and UK, to discuss the creation of
development banks, motivated, it is important to note, by different concerns and goals.
Development banks are present in a wide range of countries. In the vast majority of the
cases, these institutions were created in the 1950s and 1960s, as a part of
industrialization efforts, and starting from the diagnosis of the centrality of
industrialization for the economic development. This diagnosis was pointed by the then
dominant development theories, and the consequent need of mechanisms for financing
1
2
I thank Pedro Duarte Evangelista, assistant professor at Federal University of Goias, for all his help.
Assistant professor, Institute of Economics, Unicamp.
industrial development, especially for financing investment was highlighted. Therefore,
it seems possible to associate the creation of development banks to the perception of the
need to face situations of underdeveloped economies and/or underdeveloped financial
systems. According to Torres (2007), development banks mean forms of directing credit
to specific purposes and are the result of mechanisms created after the Second World
War to rebuild destroyed large economies, including European countries and Japan, as
well as to promote industrialization and development, especially in Latin America and
Asia.
Figure 1 elucidates some of the issues raised above, pointing out to the period and
motives with which different development banks were created.
Figure 1: Development banks: objectives, assets, origin of capital and funding
Institution
Korea
Development
Bank
(KDB)
Foundation
Founded in
1945. In
1950 was
established
as The
Korean
Reconstructi
on Bank.
Nowadays is
part of the
KDB
Financial
Group
Objectives
Supplying and managing major
industrial capital to help develop
Korean industries and the national
economy. Since 1950, the bank
aims to support the nation’s
economic rehabilitation, restoring
industrial facilities destroyed during
the Korean War and prior support
to the base industries.
Total Assets
US$ 116,500
million
(2011)
Capital Origin
Governmentowned bank.
Business
Development
Bank of
Canada
Founded in
1944 as The
Industrial
Developmen
t Bank.
Succeeded
by The
Federal
Business
Developmen
t Bank in
1975.
Founded in
1955 as The
Japan
Developmen
t Bank.
Succeeded
Financing and management
consulting for industrial small
business, as well as financing for
trade and commerce services.
US$ 17,180
million
Governmentowned bank.
Facilitate the development of power
supply and the rationalization,
modernization and cultivation of its
major industries. The bank also
focused on support for industrial
system improvements, independent
US$ 187
million.
Governmentowned bank until
2008, when it
was privatized.
Development
Bank of
Japan
Funding
 Domestic
funding: bonds
– industrial
finance bonds
exclusively
issued by KDB

borrowing
public funds
 deposits :
savings, time
deposits,
certificate of
deposits, money
market deposit
accounts and
repurchase
agreements
 overseas
funding (global
markets).
All the capital is
funded by the
government of
Japan.
KfW
Bankengrupp
e
African
Development
Bank Group
Brazilian
Development
Bank
(BNDES)
3
4
by
Developmen
t Bank of
Japan Inc. in
2008.
Founded in
1948 as
Reconstructi
on Credit
Institute.
Succeeded
by KfW
Bankegrupp
e in 2002.
technological development, social
and regional development, and
logistic modernization.
Finance the reconstruction of the
economy and integration of
refugees after Second World War,
especially to the new federal states
in the eastern Germany. The bank
has three fronts – domestic
promotion, export finance and
development finance – focusing in
development cooperation and
commercial project financing, and a
domestic SME promotion.
US$ 623,400
million
(2011)
Governmentowned bank.
Founded in
1963. Adds
three banks:
African
Developmen
t Bank –
founded in
194, African
Developmen
t Fund –
founded in
1972, and
Nigeria
Trust Fund –
founded in
1976.
Spur sustainable economic
development and social progress in
its regional member countries,
contributing to poverty reduction by
mobilizing and allocating resources
for investments in regional member
countries and providing policy
advice and technical assistance to
support development efforts.
African
Development
Bank:
US$ 102,84
billion (2011)
Owned by
member
governments.
Founded in
1952, as
BNDE.
Stimulate the expansion of industry
and infrastructure in the country.
 Its operations have evolved in
accordance with the Brazilian
socio-economic challenges and
includes support for exports,
technological innovation,
sustainable socioenvironmental development
and the modernization of
public administration.

Marshall Plan
and the
European
Recovery
Programme
Special Funds,
which came
from the
counterpart
funds.
 Capital market
funds
 Money market
fund
 subordinated
liabilities
Capital markets.
African
Development
Group:
US$ 9.3
billion3
Nigeria Trust
Fund:
US$ 200
million4
Fund’s activities for 2011-2013.
In the end of 2010.
US$ 319,800
million
(2011)
Governmentowned bank.





FAT/PIS-PA
SEP
National
treasury and
other
governmental
sources
committed
operation
bond issuance
fundraising
abroad
China
Development
Bank (CDB)
Founded in
1994 as a
policy bank
named
China
Developmen
t Bank. In
2008,
transformed
in a
Developmen
t Bank
Corporation,
a joint stock
commercial
bank.
•
Mission: strengthening the
competitiveness of China and
improving the living standards of
its people
•
promote the development
of the market
support the State's policies of
development : infrastructure,
regional development, urbanisation,
SME, agriculture, rural
communities and farmers,
education, low-income housing,
medical and health care and
environmental protection.
US$ 990,700
million
(2011)
Established
jointly by the
Ministry of
Finance (the
"MOF") and
Central Huijin
Investment Ltd.
("Huijin").



Debt securities
Borrowings
from
government
Demand and
term deposits
Sources: KDB Annual Report 2011; KfW Annual Report 2011; CDB Annual Report 2012; BNDES Annual Report 2011;
Valor; Banks websites.
1.
Fund’s activities for 2011-2013.
2.
In the end of 2010
The creation of development banks, marked by historical conditionalities and specific
institutionalities places boundaries for attempts of conceptualization of such institutions.
Conscious of those limitations, this paper aims to present how the literature on the
subject has been addressing the role of development banks. And departing from the
acceptance of the: i. historical role of these institutions in facilitating investment
decisions; and ii. contributions of Keynes that highlight the centrality of investment as
well as the instability that permeates the investment decisions, this article considers the
role that the development banks can take not only on financing, but also on organizing
the
environment
in
which
such
decisions
are
taken.
In order to pursue that goal, the current article is presented as follows. After this
introduction, section 2 discusses some conceptual reasons and peculiarities of the
decisions of financing investment. Section 3 presents how the literature deals with
development banks, highlighting their historical phases, which are attached to the
understanding of their role, and the diversity of concepts of what should be and how
should act these institutions. Section 4, in its turn, set forth the discussion of investment
in Keynes, its centrality in the process of employment and income creation, the
instability around the investment decision and the proposal of the socialization of
investment, as a result of the perception of the environment in which the investment is
decided. It is important to highlight that is from the theoretical background that an
enlarged view of development banks is proposed. Finally, concluding remarks are
delineated.
2.
Financing Investment Decisions: conceptual reasons and peculiarities
Based on relations supported by different authors, such as the role played by industrial
development in economic development, and the centrality of investment for the former,
it is worth noting the importance of the presence of mechanisms for financing
investment. When developing the theory of the determination of investment in his
masterpiece, “The General Theory of Employment, Interest and Income (GT), Keynes
did not stand out, except for a few rare moments, the role assumed by the financing on
the investment decision.
According to Wray (2008, p.8),
“There seems to be an implicit assumption in the General Theory that the
investment project will get funded.”
However, in writings published after the GT, the author highlighted the importance of
finance, which allows the investment decision as well as the importance of the funding,
created in the process of growth of income derived from investment decisions. Minsky,
in another way, added and advanced on Keynes’ discussion, as he placed, in the center
of the discussion, the importance assumed by the liability positions, including and
especially, the importance assumed by the financing conditions of investment decisions.
Still in Wray’s words (2008, p.8),
“Minsky believed that Keynes’s investment theory of the cycle is incomplete
because it does not really analyze how investment is financed when the marginal
efficiency of some capital asset exceeds the marginal efficiency of money .“
And, according to the model developed by Minsky, considering the relevance of the use
of external funds for the feasibility of investment and, thus, the incorporation of
borrower’s and lender’s risk when assessing the investment decision, such decisions are
affected, one can even say conditioned, by the environment in which funding is
established.
“Investment can proceed only if the demand price (adjusted for borrower’s risk)
exceeds the supply price (adjusted for lender’s risk) of capital assets. Because
these prices include margins of safety, they are affected by expectations
concerning unknowable outcomes.” (Wray, 2008, p. 11)
Therefore, based on the contributions of Keynes and Minsky, it is possible to point out
the significance of the conditions whereby investment is financed.
The financing of the investment requests not only adequate volumes of resources but
also, and above all, resources in appropriate format. Concerning the volumes,
investments in long term projects require large amounts of resources and, in general,
cannot be divided into smaller projects. As regards the format, emphasis should be
provided to the risks and especially to the time limits, since investment projects
generally have long-term maturity, which raises limits on financing through short-term
funds, such as the usually negotiated by commercial banks. According to Mantega
(2005, p. 4),
“Ideally, the terms and conditions of the funding should be consistent with the
cash flow of the project in question, which presupposes the existence of
institutions capable of providing an adequate funding, that is, institutions that
absorb long-term bonds at an interest rate that does not hinder the project to be
funded. "
So, what one can gather from this discussion is: the presence of appropriate mechanisms
of financing is a critical issue for both, investors, i.e. borrowers of funds, and lenders, in
general, financial institutions.
3. Development Banks: Historical phases and a diversity of concepts
As already stated, the large institutional diversity and broad historical background
branded different experiences of DBs. It is possible to highlight some ways to
differentiate development banks, according to different aspects such as their structure,
ownership and mandate. Regard the structure, they can be organized as first tier or
second tier banks; as local, regional or multilateral banks; as depositary or non
depositary institutions; as linked to specific economic sectors or country regions, global
or import-export banks. Related to their ownership, they can be public, private or even
combination of both. Concerning to their strategies or mission, these institutions can be
branded by the presence of developing or social mandates. Among all these large range
of possibilities, the reviewed literature points out as the mostly observed development
banks the ones with the following characteristics:
local and public banks and, in
general, non depository with social and/or development mandates. 5 And this typology
will be followed in this paper.
In this regard, the different definitions of development banks found in the literature are
grounded primarily on what are or should be its functions and objectives, but also on its
structure. In a broad way, which is coherent with the observation of different
experiences of development banks, observed in different countries, the United Nations
5
Important part of the articles and discussion papers produced by the Intermerican Development Bank
(IDB), institution widely embedded in the discussion of development banks, focuses on non-depositary
public financial institutions, marked by social and development mandates, with public funding, access to
capital markets or through loans from multilateral or regional institutions.
compendium defines development banks, essentially domestic development banks, as
a:
“Financial institution primarily concerned with offering long- term capital
finance projects generating positive externalities and hence underfinanced by
private creditors.” (UN, 2005, p.iii).
According to Amyx and Toyoda (2006), development banks are among the possible
types of government financial institutions, in their great majority laid down in early
stages of industrial development to ensure long-term funding for industries
perceived as relevant for development. Besides the public funding, they can also rely
on private funding and among the projects supported by them may be those related to
government policies. Amyx and Toyoda (2006) pointed out that as economic
development took place in many countries, liberalization and deregulation of the
financial markets and the emergence of long term securities markets happed, these
institutions became less important, and some of them were dismantled or privatized.
Two definitions of DB are presented by Pena (2001), one related to their goals and other
to their function, but both founded on the purpose of ensuring a higher level of
development. The first one is, "Development banking is a form of financial
intermediation designed to help the country reach the higher level of sustainable
development and (...) includes development of the whole spectrum of socio-economic
progress." (P. 9). And the second one, DB can be understood: "... as a form of
intermediary providing financing to high priority projects Investment in Developing
Economy." (P.10).
The concepts of DB highlighted above indicate the needs for financing mechanisms that
ensure economic and social development, particularly by means of financing
investment. As underlying elements, made explicit or not, show up the State as an
important agent in confronting the fragilities of the economic and social development,
and the lack or inoperativeness of private financing arrangements. Both of these
elements, the State intervention and the level of development of private financial
markets, have labeled the discussion not only of the role, but further, the needs for such
institutions. Such a discussion, which started in the 1950s and 1960s, can be organized
in three phases, and can be associated with changes in prevailing economic
development theory for each time: development or interventionist view, laissez-faire
view and pro-market activism view (Smallridge & Olloqui, 2011).6
The development or interventionist view took place in the 1950s and 1960s, period in
which a large part of the DB were created, as already presented. At that time, the theory
of economic development considered the capital investment as catalyst for economic
growth. And the public development banks were understood as State instruments to face
the deficiencies of private financing – as markets mismatches were perceived, especially
in developing countries - and, in a more specific way, of the financing of investment.
Thus, DB should mitigate the lack of long-term funding in fundamental areas, such as
infrastructure and industrial projects. And besides, also supply rural and housing credit,
and loans to small and medium enterprises.
Starting in late 1980’s, as a part of a broader liberalization process, the state's
participation in the credit allocation was questioned, especially when credit was
conceived by public banks. World Bank (WB) and Interamerican Development Bank
(IDB) views of on public banks, presented in a sort of documents in early 2000s, put
into question the functionality of these institutions. According to the WB, the
government property of a bank tends to restrict financial development, which can even
affect the economy’s growth. The IDB, despite criticizing the role of such institutions,
found no solid evidence that these financial institutions limit development and growth
(Torres Filho, 2007). This environment branded the laissez-faire view. In accordance
with Smallridge & Olloqui (2011), this environment rested on the broad perception that
public banks were not complying with their mandates and were presenting inadequate
financial performances. This phase was marked by privatization, restructuring and even
closure of public financial institutions. It is worth noting that the critical arguments
were much more on the government ownership of banks than on the concept or
functions of development banks.
Besides, Amyx and Toyoda (2006) pointed out that as economic development took
place in many countries, liberalization and deregulation of the financial markets and the
emergence of long term securities markets happed, these institutions became less
important, and some of them were dismantled or privatized.
6
It is important to highlight that laissez-faire and the pro-activism views are more closely, but nor
uniquely, related to the evolution of public banks and among them development banks in Latin America.
In the 2000s, a new vision of public banks was launched, which might be defined as
intermediate, when one has in mind the earlier discussed views, development and
laissez-faire views. The intervention was once again understood as constructive, based
on the analysis of market failure and its major causes. In this regard, government
intervention could be used to complement private sector activities and to ease the
development of the markets. However, it should be short in time and include an exit
strategy. Such ideas were behind to what Smallridge & Olloqui (2011) come to name
the pro-market activism view.
In this context, it was observed, in Latin America, a renewed interest in public
development banks as tools to address the private market failures and to promote the
financial deepening.7 The following quotations clearly states these observations,
“ […] the objectives of PDBs are increasingly not just access to finance, but
promotion of public policy objectives. Thus, in recent years they have expanded
their role and been used for designing, financing and implementing climate
change related infrastructure projects, and for delivering non financial services
such as business development.” (BID, 2011, p.10.) ” (Smallridge & Olloqui,
2011 p.10)
“As such, the fundamental role of the PDB is to contribute to economic and/or
social development by supporting economic agents and segments that are
underserved by the private sector, but are nevertheless deemed to be of critical
importance to the government’s economic policy. In other words, PDBs should
address market failures and play a complementary role to commercial banks
and other sources of finance and risk capital, instead of crowding them out.”
(Smallridge & Olloqui, 2011, p. 21)
"The most relevant and up to date rationale for Intervention by PDBs is to
address the existence of market gaps “ . (Smallridge & Olloqui, 2011, p. 21)
These so highlighted market gaps could be understood as difficulties that emerge from
the fears of private sector to accept risks or even transaction costs perceived as too high.
As a result, strategically important companies or sectors, such as small and medium
enterprises (SME) or rural activities, would not be well served by private credit.
Anyway, the mere presence of these gaps would not justify the intervention, as actions
based on incorrect or incomplete diagnosis could be ineffective or even harmful. So,
interventions could take place based in solid analysis of costs and benefits.
7
There was a diagnosis that credit to socially important sectors had become elusive.
This "new view" redeems the defense of more active public institutions, even when one
considers the expected restrictions on this “activeness”, as proposes actions to promote
public policy objectives and to address the market failures. As a matter of fact, this
“new view” does not establish a new, but reinforces the already established central
function or role to these institutions: to fill the private role market gaps. (Smallridge &
Olloqui, 2011, p. 11)
"The most relevant and up to date rationale for Intervention by PDBs is to
address the Existence of market gaps “ .
This more proactive view was enlarged by the role assumed by public banks in some
countries, among which development banks, in facing the international financial crisis
generated by the spillover of the U.S. subprime market. Their behavior and performance
ended in a extension of their functions and, thereby, their concept, as can be inferred
from the ALIDE’s position,
“In this context, the action of development banking takes on a greater relevance in
fulfilling its counter cyclical role, without losing sight of the long term and a permanent
income distribution policy. In this sense, financial institutions have provided new credit
facilities with their own resources or funds provided by the State for the industrial,
agricultural and housing sectors, SMEs, international trade, infrastructure, etc.”
(ALIDE, 2009, p.5).
And, according to Statement of Curaçao, it was established by the development banks
associated to ALIDE the necessity of:
“[…] intervention of the government on situations of crisis, like the current one,
to stabilize the markets; […] the quick action of development banking and the
renewed importance they have attained in the current situation.”(p.10)
In the same sense, Smallridge & Olloqui (2011) highlights the importance of
development public banks as anti-cyclical actors in crises, situations in which private
banks in general get more conservative and paralyze or at least decrease the transactions
with financial and especially non financial institutions. In this sense, public
development banks could act in order to catalyze the supply of funding of others
financial institutions and investors.8 And PDB could also stimulate the demand for
financing in order to promote economic development.
8
The PDB goal could be to mobilize other agents through the use its financial resources, setting
standards the knowledge of market conditions.
These authors also propose a broader role the PDB: to be part of the financial regulation
framework, in order to ensure "the safety and soundness of the banking system", and to
counter “the substantial economic and political power of large private banks" (p.8). In
this sense, the PDB should act not only as back up and counter cyclical sources of
liquidity, but also as instruments through which monetary policy is transmitted. And
also act in order to regulate the market interest rates, preventing oligopolistic behavior,
i.e., keeping interest rates within appropriate boundaries.
According to Torres Filho (2007), development banks can be understood as part of the
instrumental tools through which governments can act in credit markets, beside
financial regulation and monetary policy. It is worth to note that, unlike the other
instruments, development banks behavior do not the focus the market as a whole, but
may lead to a directing of financial resources for what is understood as priority, which
can be especial sectors, regions, type of borrower and / or terms of the loans.
What can be gathered from the discussion above is that, in the last decades other
functions and roles have come to be proposed for and implemented by development
banks, beyond their original functions and roles as fundamental agents for the feasibility
of investment decisions, which were perceived as crucial to economic development.
This could be understood based on two major vectors: the consolidation of the
industrialization in some countries, including Germany, Japan and Korea, and the
liberalization movement of the 1980s and 1990's, which has put into question the very
existence of public financial institutions, including development banks, especially
affecting BD Latin America. Regarding their role on the allocation of credit, no longer
restricted to the financing of investment, emphasis continued to be given to the role of
BDs in filling the gaps of private markets, now guided by the perception of market
failures.
A broader course of development banks actions can certainly be relevant, especially
considering they can be genuine arms of economic policy, not only through its role in
the credit allocation, i.e., credit policy, but also implementing financial policies in a
broader sense such as regulating the interest rates and, in that sense, regulating the
banking competition environment, stimulating the democratization of the access to the
financial system, implementing sectorial policy and regional policy, among others. It
should be noted, however, that such functions might be carried out not only by
development banks, but also by other public financial institutions, when it is feasible.
This paper aims to aggregate and advance in the discussion of the role originally
associated with those institutions: the course of acting to ensure investments as
understood their centrality to the economic development and, related to that, to the
determination of employment and income. In this sense, it aims to reflect on the role to
be played by development banks in enabling investment, in addition to the fundamental
function of finance them. And for this we will resume the discussion of the centrality of
Investment and the specifics surrounding investment decisions present in the conceptual
model presented by Keynes in the 1930s.
4. Keynes: Investimento and Investimento decisions
In the conceptual framework developed by Keynes in his General Theory, investment is
crucial for the employment and income determination in capitalist economies. While
building his model, concerned about the understanding of how the levels of employment
and income are determined and float, Keynes emphasizes the central role played by
private and domestic spending decisions, consumption and investment. In this regard,
the author explains the centrality of investment and highlights the complexity of the
environment in which the investment decisions are taken, marked by uncertainty
regarding the expected returns and the interest rates.
The author explicits in different moments of the GT that investment decisions are based
on the confrontation of marginal efficiency of capital and the interest rate, and will be
taken whenever the first is greater than the second.
“[…] the inducement to invest depends partly on the investment demandschedule and partly on the rate of interest. […] neither the knowledge of an
asset’s prospective yield nor the knowledge of the marginal efficiency of the
asset enables us to deduce either the rate of interest or the present value of the
asset. (p. 137)”
“[…] the scale of investment depends on the relation between the rate of interest
and the schedule of the marginal efficiency of capital corresponding to different
scales of current investment, […] .(p. 147)”
The marginal efficiency of capital is the discount rate that brings to the present the
values of the proceeds expected from the sale of production to be carried out by the
capital goods, which purchase are to be decided. It is important to note that the expected
flow of proceeds to be considered regards the whole lifetime of such capital goods. That
being said, the major issue which arises is how to estimate the prospective yields,
especially for being the results of the investment decisions only stated in the long term.
The state of long-term expectation are based on the most probable forecast the agents
can make, and also in the confidence on the this forecast, once the future is marked by
uncertainty and “Our knowledge of the factors which will govern the yield of an
investment some years hence is usually very slight and often negligible.” (p.149)
The interest rate, for its turn, is a monetary phenomenon, a result from the confrontation
of the liquidity preference and its availability. The money, understood by economic
actor as such, is the asset that carries the liquidity, a key attribute in a world marked by
the presence of uncertainty. Liquidity signifies a safe refuge to the unknown future.
Therefore, the interest rate is defined as the premium for giving up liquidity, i.e., the
reward that agents charge for giving up the control over their resources, “[...]the rate of
interest at any time, being the reward for parting with liquidity, is a measure of the
unwillingness of those who possess money to part with their liquid control over it.”
(p.167)
While discussing the determination of the interest rate, Keynes attempts to establish a
causal relation between the availability of liquidity, expressed in money supply, given
the liquidity preference, and interest rate. And so to understand the role, in fact, the
ability of the monetary authority to determine the interest rate by implementing the
monetary policy. The author stands out that it is not the level of interest rate that
matters, but to what extent this level differs from the rate understood as safe by the
economic agents. What leads to the conclusion that an expansionary monetary policy
should induce a fall in the interest rate, depending on how the agents understand this
movement and to what extent this movement does not imply a higher remoteness of the
potentially resulting interest rate from the considered as the “normal one”. What leads to
the conclusion that the interest rate is a psychological or even a conventional
phenomenon.
“ It follows that a given M2 will not have a definite quantitative relation to a
given rate of interest of r; — what matters is not the absolute level of r but the
degree of its divergence from what is considered a fairly safe level of r, […]. It
is evident, then, that the rate of interest is a highly psychological phenomenon.”
(p. 202)
And go further and as states that more than psychological, the interest rate is a
conventional phenomenon, since
“the long-term market-rate of interest will depend, not only on the current policy
of the monetary authority, but also on market expectations concerning its future
policy, [… ] . The long-term rate may be more recalcitrant when once it has
fallen to a level which, on the basis of past experience and present expectations
of future monetary policy, is considered “unsafe” by representative opinion” (p.
202/203).
That makes investment decisions complex and problematic since deriving from the
contrast between largely stable, conventional and highly resistant to decreases interest
rates - given the peculiarities of money9 - and the marginal efficiency of capital, fickle
and highly unstable. These findings have important implications to the author's model,
once investment plays a fundamental role, being central to the determination of
employment and income. And, from the nature of the determination of the interest rate,
the author points out limitations to the role the to be played by monetary policy as a tool
for enabling, through the interest rate, the determination of appropriate levels of
investment, which could guarantee full employment, central concern of the GT model.
Actually, in a world in which crucial decisions are taken by wealth owners in their
lasting pursuit of enhancement of wealth, being the investment one among different
possibilities of wealth application, the author presents the idea that interest rates low
enough to ensure full employment may not prove proper to those agents, the wealth
owners.
Given the perception of constraints to ensure, through the management of interest rate,
adequate levels of investment, the author argues that the State could act on the marginal
efficiency of capital-goods, moving towards the organization of investment decisions.
This proposal can be deduced from the following quotation,
“For my own part I am now somewhat skeptical of the success of a merely monetary
policy directed towards influencing the rate of interest. I expect to see the State,
which is in a position to calculate the marginal efficiency of capital-goods on long
views and on the basis of the general social advantage, taking an ever greater
responsibility for directly organising investment; since it seems likely that the
fluctuations in the market estimation of the marginal efficiency of different types of
capital, calculated on the principles I have described above, will be too great to be
offset by any practicable changes in the rate of interest.” (p.165)
9
These specificities would be lower elasticities of production and substitution. Since money is not subject
to private production from market conditions, conditions which are revealed by pricing mechanisms, the
monetary interest rate would be more resistant to decreases and, as such, would be reference to the
decisions of capital application, including investment. It is important to note that, given the role of money
as an asset, as liquidity per se, and in that sense part of the wealth owners’ asset portfolio, attached to the
fact that Money is not produced by hiring workers, explains the presence of involuntary unemployment as
a result natural of normal running of capitalist economies.
As concerned about the understanding of how the levels of employment and income are
determined and float, Keynes emphasizes the central role of private and domestic
spending decisions, especially investment decisions, taken, as already discussed, in an
environment marked by uncertainty regarding the expected returns and the interest rates.
And, as investment and production decisions are among several possibilities of wealth
application faced by the wealth owners, in their relentless pursuit of the wealth
valuation. The normal functioning of economies of that nature leads to the constant
presence of involuntary unemployment and to an unequal income distribution. In the
author's words,
The outstanding faults of the economic society in which we live are its failure to
provide for full employment and its arbitrary and inequitable distribution of
wealth and incomes. (p. 372).
The observation of these flaws, inherent to the normal functioning of capitalist
economies - understood as monetary economies – led the author to provide proposals
for State action: tax policy in order to promote income distribution, euthanasia of the
rentier and the socialization of the investment. In a certain sense, these proposals can be
understood as the author's view on the promotion of economic development.
The last proposal can be understood as a recovery of the proposal of investment
organization. To explain what would be “a somewhat comprehensive socialisation of
the investment”, Keynes defends the State can act in order to ensure the necessary
resources to raise the instruments of production and to guarantee a minimum
profitability for the instrument of production’s owners. Concerning to the first, the
amount of resources, the author does not seem to be restricted to the concept of
resources to finance the instruments of production. And regarding to the second, the
idea seems to be, in some sense, the increase of the Marginal efficiency of capital. And
it appears that the author refers to, primarily, but not exclusively, to private owners, as
defends initiatives of public-private partnerships.
The author stands out the concept of socialisation of investment very shortly following,
once again, the emphasis on the boundaries of the State action in the levels of
investment by means of the interest rate, as can be seen in the following quotation,
which is all the author presents on the concept under discussion,
“Furthermore, it seems unlikely that the influence of banking policy on the rate
of interest will be sufficient by itself to determine an optimum rate of investment.
I conceive, therefore, that a somewhat comprehensive socialisation of investment
will prove the only means of securing an approximation to full employment;
though this need not exclude all manner of compromises and of devices by which
public authority will co-operate with private initiative. But beyond this no
obvious case is made out for a system of State Socialism which would embrace
most of the economic life of the community. It is not the ownership of the
instruments of production which it is important for the State to assume. If the
State is able to determine the aggregate amount of resources devoted to
augmenting the instruments and the basic rate of reward to those who own
them, it will have accomplished all that is necessary. Moreover, the necessary
measures of socialisation can be introduced gradually and without a break in
the general traditions of society.”(p.378)
Both of these proposals, organizing and socialising the investments - which we defend
as presenting the same meaning - are quite large and provide more a sense than an
explicit format of action. This amplitude can be observed by how different authors take
up this issue.
Pollin (1996) argues that, having in mind the institutional framework of the U.S.
financial system, “important steps can be taken toward the Keynesian goals of a
‘somewhat comprehensive socialization of investment’ and ‘the euthanasia of the
rentier’”(p.61). The combination of using the institutional framework to direct resources
and thus stimulate investments - especially those with high social returns -, public
investments and expansionary monetary and fiscal policies could be successful in
addressing unemployment.
The proposal of socialization of investment presented by this author is closed linked to a
design of credit allocation policies, considering the financial system institucionalities,
in order to stimulate productive investments and to prevent speculative assets
transactions. In fact, it means the proposal for directing credit, mainly attached to three
different instruments. First, the enforcement of application of the Community
Reinvestment Act, which “obligates banks to lend for projects among unserved areas of
the communities in which they are located. […] it would have significant impact on the
composition of both lending and investment […]” (p. 60). Second, the pension funds,
which are “heavily subsidized by government policies” should be required to take into
account the social rate of return of their investments. And third, the Fed could use the
discount window and capital requirements on financial institutions to stimulate lending
to high social rates of return and to discourage speculative ones. So, as already said, the
idea of socialization of investment is closely attached to the directing of funds to
socially relevant investments, given the institutionality. One could say that, if the
institutional environment allows, this type of role to be played by development banks.
The proposal of socialization of investment shows up in Dostaler (2007) in a discussion
of what would be possible interpretations for Keynes’s contribution concerning policies
to fight unemployment, actually “instruments of economic ‘fine tuning’” (p.201).
Therefore,
according to the author, it is understood from Keynes that capitalists
economies, although not highly unstable” (p. 201), are normally marked by the absence
of full or even almost full employment. These economic instruments of ‘fine tuning’
could emerge from different perspectives: a moderate and a more radical
Keynesianism.10 The later was presented by Keynes in his discussion of the euthanasia
of the rentier and the socialization of investment. Dostaler highlights that the idea of the
socialization of investment aims to face the capital development problems that emerge
from casino, very speculative, highly attached to short term results, economic activities.
“The socialization of investment aims to solve the problem raised by the
societies in which ‘the capital development of a country becomes a by-product of
the activities of a casino’ (ibid., p. 159) […] led by the lure of short-term
financial gain. The struggle against the instability of the marginal efficiency of
capital and thus the investment, must involve the structural intervention of
the State […].” (p. 202)
It is important to note, from this discussion presented by Dostaler around the
socialization of investment, emerges the proposal that the action of the State to face the
instability of the investment should be structural, one could say even permanent.
By revisiting the discussion of Keynes on conventions and the role of these in the
determination of investment, Davis (1997) relates the proposal of socialisation of
investment to the establishment of an institutional framework that contributes to the
creation of more conducive and appropriate environment for making such decisions.
And this shape of the socialization of investment proposal, strongly associated with the
institutionality, is closed related to the proposal defended in this article, since
development banks are or may be an important part of the institutional framework in
different economies.
The author understands that, on Keynes’ view, conventions depend on the economic
agent’s perception that individual judgments are interdependent, and that confidence is a
central element in the establishment of those judgments. The state of confidence derives
from the success or the non-success with which the agents access each other's opinions
about the market. And, given the complexity involved in the formation of the individual
10
Dostaler highlighs that the moderate Keynesianism, largely associated to instruments such as the ISLM model, has marked the economic policy in different countries.
judgments, the explanation of different states of confidence is quite difficult. Thus, it
would be incorrect to infer that Keynes believed or hoped that a convergence of
individual judgments in any markets would take place, even considering that he would
defend that a less unstable environment would be more conducive to investment. It is in
this sense that the author translates or understands Keynes's proposal of socialisation of
investment, i.e., in the sphere of long-term policies that would mainly contribute to
raising the level of confidence and thereby to the establishment of more stable rates of
investment.
‘A somewhat comprehensive socialisation of investment’ could be generated by public
or semi-public institutions that would be in charge of an important part of the
investment. And that institutionality could guarantee a better communication and a
higher comprehension among the involved agents, as also an increased state of
confidence and, therefore, would allow more stable investment rates. In the author’s
own words,
“Thus, as long-term policy proposal, Keynes recommended ‘a somewhat
comprehensive socialisation of investment’ (CW VII: 378); whereby public and
semi-public boards and agencies such as universities, port authorities,
redevelopment corporations, and son on, would direct a larger share of total
investment expenditure. This institutionalizations of investment would un his
view create conditions for better communication and understanding among
individuals within organizations having shared purposes, and, on the grounds
that like minds would conceivably exhibit higher states of confidence, lead to
more stable investment rates in part of the economy. The investment community
at large, Keynes believed, was simply too atomistic to avoid the regular swings
in confidence that lend the convention surrounding investment in periodic
instability, and accordingly a long-term policy sensitive to the conditions of
confidence was in order.” (Davis, p.217)
4. Concluding Remarks
As already said, both of these proposals, organizing or socializing investments, are quite
large, guiding more a sense of acting than explicit formats of actions. This amplitude
can be observed by how different authors take up this issue and also allows the
consideration of different forms of implementation, conditioned by specific
characteristics such as institutional environment and historicity. Thus, it is possible to
reflect on expanding the role to be played by development banks, in addition to those
observed in the literature, especially the filling the gap left by the private sector, the
proposal of the present article. Without ignoring or not giving the necessary attention to
the fundamental role to be played by the financing of investment, especially when its
peculiarities are conceived, such as long-term horizon towards outcomes and/or the
higher risks involved, from relations one can stand out from Keynes’ conceptual
framework, one could say that it would not be enough to guarantee the adequate
investment rate. And we mean by adequate investment rate the one which could imply
low or even no unemployment rate.
The proposal of socialization of investment, somehow, embodies the role of
development banks in the financing of the investment decision, in what we could
understand as their “classic function”.
What we propose here is that development
banks could be instruments under the State’s umbrella, as we are referring specially to
public development banks, for the action of organizing investments, which could have
reflects, for instance, in the marginal efficiency of investment.
Development banks could go beyond the financing of investment, assuming a role in the
organization of individual investment decisions, guiding the individual action of
investors in the pursuit of individual results for wealth11, making the environment in
which those decisions are taken more prone to them, and creating a better
communication among the agents, increasing, in that sense, the state of confidence.
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