Are my bananas green because of market distortions or wrong policies?

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Green bananas. Saturday morning I head to the market to buy bananas, but I find only green ones at the stand. There is no large banana importer to complain to, no government bureaucrat to sympathize with my need for ripe bananas, and certainly no banana grower to chat with. I have to make an economically rational decision (buy them green, buy them later, or don’t buy at all) and move on to the apples, where the cycle repeats. This is a market imperfection that I understand and have to live with (although it drives me bananas).

But what about when we wear another hat, that of the Bank financial sector project designer? We are used to generating investment projects that fit different market situations, regulatory systems, and political realities. Under tight time constraints, we do what an economist might do – assume there is a market imperfection and brainstorm on the most appropriate effective solution. But a true economist would want evidence of the market imperfection from statistics, recent assessments, etc.
So what is a financial sector specialist to do?  The first step is to understand which of the many imperfections represents the binding constraint – the one that blocks government and private sector counterparts from taking the first steps to correct a problem. This is where the economists come in.  

Economists would ask, 'When is the distortion due to market structure and dynamics and when is it caused by policies?' 

Political economy realities drive more imperfections than you might think. It is hard to think of a country where small-and-medium enterprises (SMEs) receive a significant chunk of the overall credit pie. But is it due to valid market concerns, such as that SMEs fail more than large firms, so it is more dangerous to lend to them?  Or is the gap in lending caused by policies and regulations such as interest rate subsidies and caps, which might lead to poor investment decisions or credit diversion? The root cause of the gap matters, since the range of effective solutions might be very different.

If the issue is the lack of market information…

If the root cause is that bankers don’t know whether a certain small business is a good credit risk, there are tools for that, such as credit guarantees to cover that “getting to know you” time between a bank and a new small business client.
If the business can’t produce a credible investment plan and financial records, a matching grant mechanism might play an important role.

If the business can’t demonstrate a record of timely repayment, a credit information system with the business owner’s payment history (with, say, records of mobile bills and electricity bills) offers a solution. In some cases, we can combine these tools to have an even greater impact.

But what about policy-made imperfections?

These artificial creations always exist for a reason, many times with good intentions. To control abusively high interest rates, a government may set interest rate caps.

To benefit certain groups that are traditionally excluded, a state bank may set up priority lending (for instance agricultural credit to very small landowners with valid land titles in India). But remember – unlike market imperfections, these aren’t based on underdeveloped markets alone – these are value judgments from policy makers, who are also politicians. We have all seen cases where policy-based imperfections stubbornly resist logical interventions.

How to tackle these imperfections?

First, we need to recognize which imperfections are market-based and which come from policy-decisions. 

Then, we can use the World Bank Group’s finance and markets toolkit – from financial infrastructure to build market information, to good practices for commercially oriented lines of credit design, South-South knowledge exchanges and examples from recent bank projects. We can also work with our partners - other donors, and local and international think tanks. Somewhere in this array is the perfect combination for ripe bananas.


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