Domestic Resource Mobilization and Financial Development

Looking at the MDGs from a Different Angle?

George Mavrotas

While recent years have witnessed new interest in the finance–growth nexus, the relationship between domestic resource mobilization and financial development remains relatively unexplored. However, issues related to domestic resource mobilization and financial development are central to the overall development process. Recently they have been raised in connection with the attainment of the Millennium Development Goals (MDGs). Financial development, broadly defined to include not just financial sector deepening but also improvements in the efficiency of the financial sector, can enhance domestic resource mobilization – which is vital for pro-poor growth.

The policy agenda has recently moved in new interesting directions partly because of the relevance as well as the importance of domestic resource mobilization for accelerating progress in achieving the MDGs, and partly through the emergence of new initiatives. These include the United Nations International Year of Microcredit (in 2005) and the 'blue book for policy-makers’, Building Inclusive Financial Sectors for Development, published in 2006 by the United Nations Capital Development Fund (UNCDF) and the UN Department of Economic and Social Affairs (UN-DESA), which emphasized in particular the issue of ‘financial access’ and the centrality of ‘inclusive financial sectors’.

It is broadly recognized that developing economies often lack an appropriate financial sector that provides incentives for individuals to save and acts as an efficient intermediary to convert these savings into credit for borrowers. The financial liberalization experience of many low-income countries in recent years, although in the right direction in certain cases, seems to suggest that transforming the financial structure of an economy is a complex process that assumes a deep understanding of the entire set of interactions between financial sector reforms and the economy. At the same time, the experience of the Asian financial crisis clearly suggests that, while financial liberalization may be desirable, the process must be regulated correctly, and this requires the building of institutional capacity – a costly, though important, process.

It is equally fair to argue that, until very recently, orientating the domestic financial system towards domestic resource mobilization has been neglected as a potential source of development financing for the MDGs. However, there is substantial potential here, which, if realized, can help to accelerate progress significantly towards the MDGs. It also needs to be stressed that the above important route has the additional advantage of engaging local communities directly in the overall development financing process. Further to building the financial system as whole, it is also vital to provide microcredit and to create insurance mechanisms for the poor.

The above discussion suggests that, while substantial progress has been made in recent years on the research and policy front in this important area, a number of issues remain unresolved and require further attention. In this regard, a recently published UNU-WIDER volume entitled Domestic Resource Mobilization and Financial Sector Development, brings together a collection of essays by leading experts in the field who discuss various aspects of the financial development–domestic resource mobilization nexus in an effort to delve more deeply into the above important relationship. The volume provides also a good balance of recent theoretical developments in this area; the application of recent innovations in econometric methodology; important case studies that discuss country experiences with financial sectors reforms – in both Africa and Asia (including China); and useful policy lessons. The study was prepared as part of UNU-WIDER’s research on Globalization, Finance and Growth, linked to the project on Financial Sector Development for Growth and Poverty Reduction.

A central message that emanates clearly from the study is that policies enhancing domestic resource mobilization – for example, by mobilizing domestic savings, expanding the tax base in developing countries (particularly in Sub-Saharan Africa), increasing access to financial services and deepening financial sector development) – have a prominent role to play in the challenging effort to use all available sources, both domestic and external, so as to accelerate progress with the MDGs. In particular:

  • Deepening financial sector development is becoming a key priority in low income countries along with the challenge to move beyond financial deepening towards improving substantially the efficiency of the financial sector.

  • Policies that attempt to build better financial institutions (thereby increasing the confidence of savers), encourage competition and provide a broader variety of instruments for saving. They can further strengthen the overall saving mobilization process in low-income countries with substantial gains in the area of poverty–reducing growth and MDG achievement.

  • Most individuals, as well as small and medium enterprises, continue to depend on informal and non-financial assets for their savings facilities and arrangements. Policy-makers need to encourage microfinance institutions, which, with a relatively small cost base, are a more viable way of delivering savings facilities to low income individuals and small enterprises, especially in rural areas.

  • On the other hand, the challenge for microfinance institutionsis to create structures that facilitate the clients of successful microfinance-institutions to access larger, more diverse and longer-term sources of finance.

  • Last but certainly not least, improving access to saving institutions is of crucial importance for domestic resource mobilization. Rural savings mobilization, in particular, requires an institutional network providing easy access to potential savers. The absence of saving institutions collecting deposits from the rural sector, especially in remote areas, may simply discourage savings or encourage consumption, and perhaps wasteful expenditure, or it may lead to saving in a non-monetized form.

It is hoped that the volume will contribute in a fruitful and forward looking way to the ongoing debate amongst the international development community regarding the mobilization of domestic resources in developing countries, and the crucial role that financial development can and should play in this regard.

WIDER Angle newsletter, January 2009

ISSN 1238-9544