The role of financial development in poverty alleviation

31-May-2010    This article by Beck, Kunt and Levine (2007) provides empirical evidence supporting the theory that financial development has a successful impact on poverty alleviation and income redistribution in developing countries.

There are huge differences in poverty levels and distribution of resources amongst populations across the globe. One of the many reasons lays in the structures of a country's financial market. The poorest usually find many problems in accessing the credit markets since they often cannot provide enough guarantees to the banking system. This paper, by Beck et al. (2007), provides empirical evidence supporting the theory that financial development has a successful impact on poverty alleviation and income redistribution in developing countries. Policy makers have to develop financial instruments in order to extend credit facilities to the low-income part of a country's population. Indeed, financial development may affect the poor in two ways: by boosting economic growth (and making people richer) and by changing the distribution of income.

The results of this article are striking and provide empirical evidence for the above theoretical conclusion. The authors find that:

 

 

  1. financial development reduces income inequality. Countries with higher levels of financial market development experienced faster reductions in the income inequality in the period 1960-2005. Furthermore, countries with more skewed distribution of income tend to experience faster reductions in income inequality than countries with lower levels of initial income inequality.

  2. Financial development has the most relevant impact on the poorest part of the population. As a matter of fact, the improved financial services increase the income of the poorest more than the average-income part of the population, thus making the income distribution fairer.

  3. Financial development reduces the growth rate in poverty, affecting the share of population living with less than $1 per day. For example, Chile's financial markets are more developed than Peru's one. This means that the Chile's population access to credit is easier than in any other Latin American country. As a result, the percentage of the population living on less than $1 per day decreased at an annual growth rate of 14% between 1987 and 2000. In the same period, Peru's share of population living with less than $1 per day increased at an annual growth rate of 14%.

 

Given this result, the importance of micro finance and micro pension services is pivotal in the contribution in poverty alleviation where financial markets are still developing. Micro organizations use to operate at a local level; this carries two main benefits. First, it allows potential clients to access to credit instruments designed ad-hoc by micro institutions. Second, the close and trustee relationship between micro banks and households helps in alleviating the impact of all the constraints that usually exclude from the formal financial sector poor people lacking guarantees. In the micro finance sector, the group-based lending programs, for example, do not require putting up collaterals for their loans. Collateral is optimally substituted by joint liability that disciplines the borrowers through “social” and indirect sanctions. Indeed, these sanctions are induced by peer pressure from fellow villagers jointly responsible for the micro loan. Concerning micro pensions, instead, the focus on small local communities helps in easily making aware the population of the importance of savings for their retirement and in spreading financial literacy.

 

Easier access to credit, more transparency in financial services provided and lower transaction costs help the poorest by enhancing economic growth and affecting the income distribution, making it fairer. In this context, the peculiar structure of microcredit and micropension programs may contribute in relaxing credit constraints, playing a central role in poverty alleviation and more efficient capital redistribution.

 

 
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