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From the foregoing, the question of financial development leading to economic growth has long since been debated but perhaps not completely resolved (Spratt 2009). The intention of this literature review or the research in general is not to prove that financial development definitely leads to economic growth but to highlight pockets of evidence as a framework to examine how the character of a state could possibly alter the relationship to a minor or significant degree. To achieve this, attributes of financial development, economic growth and relevant institutional framework have been drawn from various schools of economic thought such as the Austrian school, the neoclassical school, the Chicago school, the Institutional school, the Orthodox Keynesian school and the Post-Keynesian school. A clear distinction has not been drawn between these schools while presenting the argument on the basis of the fact that most of their attributes are primarily viewed as complimentary rather than opposing (Mair and Miller 1991:18) and the core intention of this research is a focus on the character of an African state distinct from most Western states. Literature to highlight a few of these characters considered salient such as ethnicity, prebendalism and military governance has also been reviewed as a framework for a more detailed historical review.

2.1.2 What Constitutes Financial Development Before moving on to examine the literature on the relationship between financial development and economic growth, there is an implicit need to clearly define the limitations and boundaries of what is referred to as financial development. In very basic terms, this study seeks to define financial development as the development of the financial system in an economy. The financial system consists of financial Intermediaries (for bank loans and deposits) and financial markets (for corporate and government bonds as well as for equity). The development of this system therefore implies the putting in place of structures and mechanisms to enable this system run as efficiently as possible with a view to imbibe in savers the confidence to part with their life savings in trust to capital investors for a future anticipated return (King and Levine, 1993). Financial intermediaries are deemed to be efficient if they provide services to lower costs of managing the risk of investment such as cost of actual transaction, corporate control, investment research (to lower information asymmetry), and the cost of transferring exposures from one beneficiary to the other (Levine, Loayza, and Beck, 2000). Schumpeter (1911) defined financial development as the increase in capacity (by government agencies) of the financial system to enable the financing of innovative ideas leading to increased economic activity. This increase in financial capacity was required to be done by government agencies as the surplus of household income over expenditure held in the banking system was considered insufficient to fund major capital intensive innovative ideas.

Levine (2004) identifies five criteria that qualify as financial development viz:

ease of procurement of post-investment information, avenues for effective corporate governance and investment scrutiny, availability of skills and instruments for risk management, proper channels for savings mobilization and investment and organised markets for the trading of goods and services.

Before analysing Levine’s criteria for financial development it is crucial at this stage to point out that a grave omission has occurred in what we understand as financial development according to Levine’s criteria. The above criteria ordinarily assumes that society has been organised therefore there would be no further need to go back to the basics. In most African countries such as Nigeria the major focus of this research, there is no valid post code system or personal identification records (credit scoring) with the implication that Levine’s criteria’s one and two will be non existent in these societies. In addition to this, the credit rating system which is used to monitor individual as well as corporate use of credit in society is missing in the Nigerian context. It will therefore be impossible for financial intermediaries to effectively provide information about individual or corporate use of savers funds therefore causing savers to renege from parting with their savings for investment purposes. Nigeria has in recent times embarked on economic reforms which saw foreign debt drop from a staggering 60% of GDP to a meagre 3% of GDP; this ordinarily gives a clear macroeconomic indication of improved livelihood but it is amazing to note that more than 54.4% of the population still live in abject poverty (FT.Com, article by William Wallis, July 12 2007). In the same article (William Wallis), Bolaji Balogun, Managing Partner of Chapel Hill Advisors, a Lagos based Investment Bank is of the view that the Government must focus on improving three key areas of the system (Power, Transport and Education) in order to sustain the trend of investment that will lead to future economic growth. This study therefore identifies two new criteria as constituting financial development in a developing society viz: provision of reputable personal as well as corporate identification databases and provision of essential infrastructure (road networks, power supply systems, guarantied security of individuals and assets etc) giving a total of seven criteria for a developing society. Education will inadvertently fall under Levine’s skill criteria.

In Nigeria, in addition to ill-maintained road networks, police and customs road blocks constitute a plague to the free and easy movement of goods and services around the country and outside the country constituting a hindrance to economic exchange with neighbouring countries Collier (2007). This invariably mandates savers to curtail their activities to their immediate environments for fear of harassment by government agencies invariably restricting the free flow of capital across the nation.

In view of the fact that production of quality information relating to individuals and firms who seek credit for investment will no doubt be extremely expensive in developing economies of the sort described above if not impossible due to the absence of databases from which such information can be accessed, we consequently determine that a move towards financial development will involve the creation of intermediaries such as can provide these relevant information (Boyd and Prescott, 1986 cited in Levine 2004). Such intermediaries would include local government departments, state government departments, federal government departments as well as private organisations with the primary function of putting neighbourhoods, cities, states and regions on a national grid such that individuals and firms can be associated with particular locations on the grid leading to a tracking system of their activities and actions. The attainment of this goal will not only lower the cost of searching for information but will also account for technological advancement thereby empowering bond and equity holders to exercise due judgement in disbursing their funds. This view of financial development is closely linked to the views of Schumpeter (1911) which was further analysed in King and Levine (1993). Schumpeter’s relationship of finance and growth was directed towards the provision of basic services and infrastructure in the society as a bed rock for future economic growth.

After savers have parted with their savings either in the form of bank deposits, corporate bonds or equity investments, their ability to follow the progress of their investment even in an industrialized society with availability of investment information may not be so simply put. The reporting format of financial information is often so complex and complicated for non-finance professionals (Brigham and Houston, 2003) that savers may have to employ finance professionals to follow the complicated trends and networks in their investment portfolios. This invariably restricts savers desire to invest their funds in corporate bonds and equity due to their inability to directly exert corporate governance (Levine 2004) leaving them with a preference for traditional savings deposits where the banking system has a history of stability (the failed bank crisis of 1994 in Nigeria is still fresh in the minds of most Nigerians and West Africans). This decision has huge implications on economic growth given that deposit banks are restricted from making long term investments in the bond and equity market (where they can access information at a cheaper rate than individual savers) due to the short term nature of their funds in order not to distort their asset to liability balance (Koch and Macdonald 2000).

Another aspect of financial development which is paramount in the prediction of the behaviour of savers is the availability of risk management practices, professionals and instruments to diversify their investment portfolios (Levine 2004:16). With the advent of these services, investors can confidently decide to go for high risk projects for higher returns or low risk projects for lower returns according to their aversion towards risk (Merton 1974, Arnold 2008).

Risk however in this regard looks at financial risk in a stable society; in most African societies such as Nigeria, political risk is a significant influence on investor’s behaviour. Political Issues like the Niger Delta crisis, the legal tussle over the validity of the April 2007 Presidential elections and the continuous insistence by the Movement for The Actualization of the Sovereign State of Biafra ( a pocket of political activists) for the creation of an Independent Republic of Biafra (against the will of the predominantly Igbo speaking east) widely publicised in the Nigerian news media all constitute key draw backs not only for foreign investors but also for domestic savers to invest their funds in more economically viable longer term ventures. This type of risk will see savers reluctant to invest their savings in long term investments due to an unstable political arena thereby creating uncertainty in liquidity planning.

Levine (2004:17) looks at the case of 18th century England as a case of an investment boom ignited by liquidity in the capital markets. This could only have occurred because savers felt they faced minimal risk in letting go of their savings which they exchanged for highly liquid investment certificates enabling them access to these funds whenever they required use of them. In the article by William Wallis (Ft.com July 12 2007), Bolaji Balogun boldly asserts that investment will boom in Nigeria and there is nothing the government can do to stop this from happening, in complete defiance to political risk. A tradition I observed during my seven year career in the Nigerian banking industry is that investors are not keen to invest in the shares or bonds of manufacturing companies rather preferring to invest in certificates of deposits, treasury bills and other short term low income assets in order to reduce their time horizon risk. This behaviour is consistent with the two tier savers model in Diamond and Dybvig (1983). Even though the Diamond and Dybvig model succinctly describes the Nigerian investment climate, there is need to add that the model was oversimplified in its assumption of a one bank economy representative of the financial intermediary industry.

One of the criteria cited in Levine (2004) as financial development is the ability of society to reach out to savers to invest in viable projects. Avenues such as the market for equity and bonds provide liquid piecemeal securities which are easily transferable from one party to the other. In less developed societies, the issue of trust is a crucial concept in mobilization of savings. Today, Nigerians are increasingly confident in their investment drive in the equity market but are also very selective in the choice of investments, the banking and oil industry shares being the most heavily traded as evidenced from the All Share Index, the Nigerian Stock Market index found on the website of the Nigerian Stock Exchange. The reason for this is the lack of trust in the performance of the nearly non-existent manufacturing industry against a track record of high growth rates in the banking and oil industries. In spite of the recent growth of the Nigerian All Share Index, the complete absence of a market for corporate bonds is largely evident. Could this be due to a lack of knowledge of how the bond market functions or are there regulatory, political or social issues that deter investors from exploring these markets? Do corporations simply prefer to collect equity and hold on to it in a liquid market where they believe transferability is possible? The answers to these questions could well be hinged on poor corporate governance practices by private sector businesses preventing them from being willing to be subject to the scrutiny and discipline of the corporate bond market. Another possible reason could also be the fact that investment opportunities and hence the prospect of stable periodic returns required to finance corporate bond usage by businesses may not always exist so businesses may deliberately seek shelter using the traditional pillow softness of equity holdings (Brigham and Houston 2003).

Trans-border trade is an organised form of the informal economy in West Africa in particular and Africa as a whole. Meagher (2003) has identified this as a means of employment and livelihood for the downtrodden and poor in West Africa whereby they illegally transport both legal and illegal merchandise across national borders avoiding taxes and tariffs in the process. While these structures sustain a vast majority of people on a daily basis, they will continue to undermine the role of financial intermediaries in the movement of capital as these traders carry large sums of cash across national borders to pay for their transactions (Flynn 1997). Concerted effort (as evidenced by the heavy police and military presence at Nigerian borders particularly the Nigerian-Benin Republic border) has been made by the Nigerian government to curb these trades but without providing an alternative source of livelihood for those affected inadvertently raising unemployment levels and by default crime and other social disturbances in the absence of a social security system.

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