What makes firms decide whether to buy their inputs from another firm or to vertically integrate and become their own supplier? Contracting problems between buyers and suppliers motivate a vast literature on the boundaries of the firm (e.g., Coase 1937, Williamson 1975, Grossman and Hart 1986). In particular, firms may choose to enter into procurement contracts with suppliers or source goods internally depending on the degree to which future contingencies can be specified between the two parties (i.e., what economists refer to as “contract incompleteness”). For example, if there is no contractual way to mitigate the uncertainty about the value of an intermediate good, a buyer firm may prefer to vertically integrate and avoid having to renegotiate with the good’s supplier in the future. In this context, trade credit, or delayed payment, may play a key role in allowing suppliers to guarantee the quality of their goods, enabling market-based procurement relationships. In a new paper, Emily Breza (Columbia) and I test this claim empirically.
Bitcoin is indeed a rather surprising mix of frightfully clever ideas and frightfully simplistic mechanisms, as I argue in a recent paper. You can dismiss bitcoin as a doomed monetary experiment, but you must not pass over the opportunity to let your imagination run with it as it can shake some basic assumptions you have on how financial systems must work. Might there be some lessons in there for how to 'fix' what's broken in our financial system? Take it as an invitation to dream about the following three questions, which are based around the three basic design premises of bitcoin.
First: What if digital money was something that I could hold for myself and pass onto others, without necessarily having to go through a licensed financial institution? You can't do that now: you cannot hold digital money without becoming a customer of Citibank, PayPal or M-PESA. We've been delivered into their hands, and yet they do not necessarily see it their business to serve everyone. It didn't use to be that way: you can hold coins and bank notes by yourself, there is decentralized management of that. What if we held the option to serve ourselves financially with electronic payments, on a peer-to-peer basis, even if only as a countervailing power or last resort?
Back in 2005, the International Year of Microcredit, it had already become clear that microfinance is much more than microcredit and that other financial services are as, if not even more, important for the poor. There has been an increasing focus on microsaving products, with several recent studies gauging the effect of providing the poor with access to formal savings accounts. Looking across the developing world, however, the large majority of the low- and even middle-income households continue to use different forms of informal saving channels. In a recent paper, we explore how these different savings practices are associated with the likelihood that a microentrepreneur reinvests her earnings into her enterprise.
We make use of a novel enterprise survey conducted at the MSE-level in Tanzania. The survey data was collected by the Financial Sector Deepening Trust Tanzania in 2010 from a nationwide representative cross-section of 6,083 micro- and small enterprises. The respondents of the questionnaire are entrepreneurs with an active business as of September 2010. The median initial capital is about 35 USD and average monthly sales are 149 USD. 50 percent of the entrepreneurs are female. More than three quarters of the entrepreneurs in the sample save for business purposes. However there is considerable heterogeneity among saving practices of Tanzanian entrepreneurs. Informal individual saving is the most popular practice among Tanzanian entrepreneurs. 75% of the savers save informal-individually (i.e. under the mattress), whereas around 13% of them save formally. The remainder save their funds via people outside the household such as members of ROSCAs and moneylenders or give them to household members for save-keeping.
Why would savings practices matter for reinvestment decisions? In the absence of easy access to informal or formal credit, entrepreneurial savings might become important if liquidity needs arise. However, the extent to which savings are channelled into the company might depend on the ease of access to these savings, where some informal practices (such as ROSCAS or saving with household members) might not offer as easy access as formal savings accounts or saving below the mattress.
Access to formal financial services has been expanding in recent years. But as people start to use these services for the first time, it has become clear that the challenge is not only providing access to financial services, but also ensuring that people have the behaviors and attitudes to use financial products responsibly and to their advantage. If not, increased access to finance could potentially lead to over-indebtedness and even financial crises.
Two recent nationwide surveys of 1,526 adults in Colombia and of 2,022 adults in Mexico measure financial capability to provide insights on how people manage their finances. The term “financial capability” refers to a broader concept than financial literacy or knowledge alone. It covers a number of different behaviors and attitudes related to participation in financial decisions, planning and monitoring the use of money, and balancing income and expenses to make ends meet.
The financial capability surveys find for example that, in Mexico, many make financial plans, but far fewer adhere to them. Seventy percent of those surveyed say they budget, but just one-third reported consistently adhering to a budget. Similarly, just 18 percent knew how much they spent last week. In Colombia, while 94 percent of adults reported budgeting how income would be spent, less than a quarter of those surveyed actively monitored spending or had precise knowledge of how much is available for daily expenses.
Mobile banking (m-banking) — the use of mobile phones to conduct financial and banking transactions — represents a key area of financial innovation in recent times. Mobile banking allows banks’ customers convenient access to a variety of banking functions, and increases efficiency. Customers can access funds in their bank accounts at all times through mobile phones, and transaction costs are driven down. Even when individuals have access to bank accounts with low fees, m-banking can reduce the opportunity cost of financial transactions.
Mobile banking has also been identified as a potentially significant contributor to financial inclusion by the G-20. While half the adults worldwide do not have access to formal bank accounts, it is estimated that more than 2 billion of those unbanked already own a mobile phone. Unbanked individuals cite difficulties in obtaining a bank account such as living too far away from branches, not possessing necessary documents, or high banking costs. All such barriers to finance can in theory be overcome through a pivot in business model that is supportive of m-banking.
M-banking has flourished both in developed and developing countries in various forms in response to structural characteristics. The model of providing financial services through a mobile phone linked to a bank account is referred to in the literature as the additive model. The use of m-banking in developed economies often follows the additive model. This contrasts with the practice of using m-banking to target the unbanked - the transformative model. Under this model, non-banks issue electronic currency to offer costumers payment services and value storage services.
The answer is yes, but not as fast. In the U.S. for example, we know that new businesses start small, and if they survive, grow fast as they age. An average 40 year old US plant employs over seven times as many workers as the typical plant five years or younger. In a new paper, my co-authors Meghana Ayyagari, Vojislav Maksimovic and I focus on developing countries and look at what happens to firms in the formal sector as they age. We focus on formal firms because informal firms look very different from formal firms in terms of size, productivity and education level of managers and there is little evidence that growth occurs by informal firms eventually becoming large formal establishments. We see that there the average 40 year old plant employs almost five times as many workers as the average plant that is five years or younger.
Informal economies are a significant part of developing countries across the world and according to some estimates can represent around 60 percent of countries’ official GDP (Schneider, et al. 2010). IFC estimates suggest that some 80 percent of micro, small, and medium enterprises in emerging markets and developing countries are informal today. Access to finance is by far the biggest obstacle these firms face (Figure 1). This obstacle is more acute for firms that would like to register, and it becomes critical as firms grow in size (Figure 2). Considering that about two-thirds of full-time jobs in developing economies are provided by such firms, it is essential to better understand issues around access to finance for informal firms. A paper that I recently wrote on the subject (Farazi 2014) as part of the work on the 2014 Global Financial Development Report is an attempt in this direction.
Credit is actively used by only about 8 percent of people in developing countries and about 14 percent in developed countries (World Bank Findex). The observed gaps in financial inclusion thus suggest that greater access to credit is warranted.
However, finance can be a double-edged sword. Rapid financial development and deepening can cause accumulation of systemic risk and lead to costly financial crises (Reinhart and Rogoff 2009). Banking crises in Thailand (1997), Colombia (1982), and Ukraine (2008), for example, were preceded by excessive credit growth of 25 percent, 40 percent, and 70 percent per year, respectively. Providing the right amount of credit—not too much and not too little—is thus a major concern for countries and their policy makers.
When credit provision becomes excessive or insufficient is judged against an unobserved benchmark known as equilibrium credit. Estimating equilibrium credit is one of the most challenging tasks of determining excessive or insufficient credit provision.
- WDR 2014
Attend a seminar or read a report on Islamic finance and chances are you will come across a figure between $1 trillion and $1.6 trillion, referring to the estimated size of the global Islamic assets. While these aggregate global figures are frequently mentioned, publically available bank-level data have been much harder to come by.
Considering the rapid growth of Islamic finance, its growing popularity in both Muslim and non-Muslim countries, and its emerging role in global financial industry, especially after the recent global financial crisis, it is imperative to have up-to-date and reliable bank-level data on Islamic financial institutions from around the globe.
To date, there is a surprising lack of publically available, consistent and up-to-date data on the size of Islamic assets on a bank-by-bank basis. In fairness, some subscription-based datasets, such Bureau Van Dijk’s Bankscope, do include annual financial data on some of the world’s leading Islamic financial institutions. Bank-level data are also compiled by The Banker’s Top Islamic Financial Institutions Report and Ernst & Young’s World Islamic Banking Competitiveness Report, but these are not publically available and require subscription premiums, making it difficult for many researchers and experts to access. As a result, data on Islamic financial institutions are associated with some level of opaqueness, creating obstacles and challenges for empirical research on Islamic finance.
- Financial Sector
(Non-)rationality in economic decisions
As last year’s choice of the Nobel award for economic sciences well reflects, economists are deeply divided as to whether, and how, rationality should be modified as a basic assumption for modeling asset allocation and pricing decisions.
The three Nobel laureates for 2013 — Eugene Fama, Lars Peter Hansen, and Robert Shiller — epitomize the economics profession’s broad spectrum of positions currently existing on the subject: from Fama’s unflinching faith in the full rationality of economic action to Shiller’s recognition of the influence of non-rational and irrational factors upon human economic determinations, passing through Hansen’s acceptance of “distorted beliefs” as explanations of some otherwise inconsistent economic behaviors empirically observed.
The unresolved differences bear on the scientific status of contemporary macroeconomic analysis, especially since the crisis of 2007-09 has demonstrated the inadequacy of its underlying microfoundations. Particular attention has since been placed by economists on what they really know about asset bubbles, as these cannot be endogenized within purely rational choice models, and policymakers have re-considered whether bubbles can (or should) be managed in the public interest.