View Single Post
Old 12-28-2004, 05:15 AM
Institute Institute is offline
Join Date: Dec 2004
Posts: 52

I just want to add something about Keynes.

For example, In my opinion (of course I could be wrong) Keynesian system is inherently incapable of allocating available liquid funds among firms and activities in the society according to considerations of efficiency, productivity and growth.

Just consider this -as far as I know according to the Keynesian theory every businessman would estimate the marginal efficiency of investment MEI ( while the interest rate is determined by money demand and supply) and if
(MEI) is equal or greater than interest it will be rewarding to borrow and finance the investment project. Otherwise the project will not be undertaken.
Accordingly, available money for lending will be allocated efficiently among firms and activities.

In my opinion this Keynesian theory is wrong and we see it in practice.
Let’s say for sake of simplicity that interest measures accurately the opportunity cost of money available for lending in the credit market, and that a uniform interest rate is applied by banks (lenders) in all cases of borrowing. Hence investment projects for which (MEI) below interest will be excluded.

On the other hand all projects fulfilling the condition MEI greater then intererst will find excess to loanable funds without any preference given by banks (lenders) to projects with relatively higher (MEI).

Therefore in a Keynesian free market economy we can not claim that loanable funds would be optimally or best allocated in this way.
(theoretically speaking only interest-free financial institutions that would aim at maximizing their “interest free” revenues would give preference to projects with higher (MEI) over other projects with relatively lower MEI).

Investors with projects satisfying the (MEI) condition and seeking interest-based finance are not treated equally by banks (lenders),in a free market economy as we have simply assumed.
Large corporations are given priority and better borrowing terms, irrespective of how funds will be used by them. In fact banks (lenders) are concerned, above anything else, with borrowers solvency. Hence, preferential treatments and financing priorities are set by banks on credit-worthiness basis. Consequently small enterprises are either neglected or given least attention by bankers, even if their investment projects are expecting highest returns.
The problem of small enterprises is quite serious in the developing world..

"Surveys indicate that less than I% of small firms in developing countries obtain credit at controlled rates from financial institutions; the remainder rely on the informal sector. The combined net effect is to raise their capital costs and reduce their ability to compete against large firms", according to W.B (I987). In fact failure of small businesses to obtain finance from banks have forced them quite frequently, in the absence of equity finance, to borrow from money lenders in the informal market at very high rates of interest. So they have jumped from the frying pan to the fire.

A study concerning the informal credit market in Peru mentioned that interest rate in that market was as high as 800% - I000% per annum sometimes in the mid 1980s. Todaro, M., states that "commercial banking system of many LDCs restricts its activities almost exclusively to rationing scarce loan able funds to "credit-worthy" medium-and large-scale enterprises in the modern manufacturing sector. Small farmers and indigenous small scale entrepreneurs and traders in both the formal and informal manufacturing and service sectors must normally seek finance elsewhere sometimes from family members and relatives, but more typically from local moneylenders and loan sharks who charge exorbitant rates of interest.
And so on, and so on.
Reply With Quote