Informal Finance, Institutional Change And Economic Growth

The coexistence of formal and informal finance markets is a widespread phenomenon in developing country. In the financial system of our country, there is typically a dual credit market. The traditional theory on financial development neglects the study about informal finance. Moreover, they affirm that informal finance is only an unefficient financing mechanism. But the advancement of modern economic analysis urges us to reinterpret the phenomenon of informal finance. We argue that the informal finance is a rational response of bargainers facing the constraints of information, institutions and technology etc. To a certain extent, it can be regarded as a remedy for the formal financial market failure. The persistent existence of this classical, spontaneous informal finance in social economic system, performing an important economic role such as providing loan and insurance, dispersing risk, constitutes a significant sector of the whole financial system. The data of finance and economic growth in china reveal that there is an economic growth puzzle, which is the coexistence phenomenon of low efficient financial sector and fast economic growth in the process of economic development. In particular, non-state owned economic sector is very difficult to obtain the loan from the formal financial sector when they achieve a great performance and make an important contribution to the economic growth, which is a paradox according to the theoretical expectation of the research on the relationship between the financial development and economic growth. The paper holds that the informal finance can provide a partial interpretation for the economic growth puzzle. More importantly, the informal finance as an institutional arrangement is induced and spontaneous in the structure of financial institutions, and it has oriented significance in the process of financial institutional transition. The purpose of the paper is to probe into the importance of informal finance to the long-run economic growth, and the relating mechanism between the informal finance and financial institutional change, based on the inquiry into the system root and endogenous causes of the formation of informal finance, the transaction features and the mechanism of the contractual governance of informal finance. According to the theoretical and empirical study of the relationship between the finance and economic growth, We try to construct a general analytical framework of trinity by integrating the microeconomic analysis, macroeconomic analysis and institutional analysis, adopting the modern analytic approach of information economics, contract economics and neoinstitutional economics. It is argued that the policy of financial repression including government interest rate ceiling and other regulations is responsible for why formal and informal credit markets coexist. This is the cause from the traditional economic system. From the point of view of equilibrium credit rationing in market with imperfect information, the creation of informal finance is endogenous. In essence, the financial transaction can be viewed as a kind of arrangement of contracts. Thus the dual credit market is an equilibrium outcome that the rational investors and bargainers freely choose the financial transaction contracts. Combining the above two aspects, the conclusion we obtained is informal finance is endogenous in the economic system. On the analytic level of microeconomics, the paper demonstrates that informal finance arrangements can improve the well-being of the people by modeling the random Roscas and the bidding Roscas. The study open out why the interest rate is higher than that of formal finance, which can be mainly attributed to the opportunity cost, risk premium and transaction cost. There exists a general equilibrium between the formal and informal credit markets if reckoning the implicit income from the rent-seeking. The lower rates of default have an important economic implication that the lenders manage to devise contracts and create incentives to circumvent the problem of involuntary or strategic default. The contractual governance of informal financial transaction mainly relying on the local social connectedness of the participants and private mechanism of governance, such as substitution of "social capital"in character for physical collateral, sequences of repeated transactions and reputation mechanism, group lending and joint liability etc, which ensure the enforcement of contracts together. The paper studies the relationship between the informal finance and economic growth by using a macroeconomic level data of china during the period of 1981-2002. Our empirical results show that the existence of informal credit markets brings the two economic effects, i.e, the effect of resource allocation and the effect of output. The economic implication of the former is that informal finance has enhanced the productivity of the capital and investment efficiency. The latter means that informal finance has a positive impact on economic growth. We make an inquiry into the interaction between the informal finance arrangement and the financial system change. It is argued that the financial institutional structure is trappedby disequilibrium, which creates an opportunity for profiting and provides an incentive to the financial system transition. The institutional evolution often begins on the "margin"of formal norm, namely informal rule. Our main finding is that the informal finance as "margin"of formal finance is characterized by its inducibility. That is to say, the innovations in the field of informal finance possess an oriented significance for the formal financial system. The paper strengthens the role of entrepreneur in the process of financial institutional transition. From the perspective of the interaction between the government and the market, some policy suggestions are provided finally. The study implies that we should bring into play the advantages and positive effects of informal finance to the design of formal finance schemes, improving the financing and the reform of financial system. This dissertation makes a contribution to the literature about the relationship between finance and economic growth. The innovations of the dissertation are as follows:(1) we attempt to construct an analytical framework of trinity including the microeconomic analysis, macroeconomic analysis and institutional analysis; (2) the paper anatomizes the endogenous character of informal finance; (3) a general analytic model of the random Roscas and the bidding Roscas is constructed; (4) we probe into the economic implication of informal finance to the institutional change; (5) the effect of resource allocation and the effect of output of informal finance are tested.