Finance – The magic app Africa needs to develop

09 Dec 2014
by Blog

In his book, Civilisation: The West and the Rest, economic historian Niall Ferguson contended that Western Europe was able to out-develop other regions of the world because it developed what he described as six killer applications that others lacked. These were competition, consumerism, democracy, medicine, science and work ethic.

There is no doubt that in the period leading to the industrial revolution European countries exceeded in these areas, at least five of them. It is debatable whether Europeans were harder workers or believed in the goodness of labour more than peoples elsewhere in the world did. Nonetheless, Ferguson’s thesis has merit over the works of many other analysts who have explained Europe’s material advancement in terms of geography, climate, culture or politics, though it is unlikely to be the last prognosis on the fundamental drivers of Europe’s economic advance. It is debateable whether the six apps identified by Ferguson were root causes or the consequences of Europe’s wealth creation. It may be that European countries had more competition and consumerism and better education and medicine because they were wealthier than other nations.

People in other regions knew science and medicine in the pre-industrial age, but Europe was able to push ahead in these fields because it had the material resources to invest in their development. Competition, consumerism and the work ethic are also the consequences of increased economic activity and wealth. As for democracy, it is debatable how much of it existed in mid-eighteenth century Britain. In any case modern day China and some other non-democratic Asian countries have achieved rapid economic growth without this app.

There is one crucial element missing in Ferguson’s growth enhancing apps list. It is financial innovation. This is the creative use of money/capital to enable production and trade and thereby create wealth. Although all regions of the world used money in one form or the other in pre-industrialisation eras, it was in Europe that financial innovation developed and became integral to economic development.

We cannot comprehend the occurrence of the industrial revolution without understanding the role of financial institutions in its emergence and evolution. The rise of manufacturing could not have happened without the operation of financial institutions such as banking, insurance, joint stock and debt. It was the fuller understanding that money and capital can be used to create wealth that gave Europeans a considerable advantage over others. Financial innovation enabled people and companies to share risks, share ownership, mobilise resources for production, generate future wealth, and dare I say, spend beyond their immediate earnings.

In a modern economy, virtually every aspect of production, distribution and consumption is underpinned by finance. A subsistence farmer may, without need for money, use his hands to plough his land and gather his crops. But if he is to increase output, he is likely to require money to obtain inputs such as fertilizer, seeds, ploughs etc. Beyond a certain level of pure labour productivity it is capital and the knowledge of how to use it that creates additional wealth. A commercial farm owner uses money to buy labour, equipment and services needed to produce at a profitable level. Of course, he could exchange some produce for the work of labourers, but it is not feasible to use barter to acquire a tractor or the fuel to run it. Financial debt allows the farm to pay labourers for work and to pay suppliers for other inputs needed to create wealth. Financial instruments allow individuals and companies to pay for the production of goods and services before the items reach the market and generate revenue.

This is not to say that all economic production issues can be simply solved with money. A subsistence farmer cultivating a tiny plot of land with potential to generate a maximum of $1,000 in annual revenue is unlikely to be given a commercial bank loan of $10,000 at 10% interest rate to buy a tractor or other input. This is not because bankers do not appreciate the importance of food, but the fact that the farmer is unlikely to be unable to service the loan. Even here, money used as a measure of value helps us to assess the present and future commercial viability of any given business endeavour.

Finance is one of the most vital elements in the allocation of scarce resources in a market economy where decisions on production and consumption are based on assessments of value. We should be careful in the current social climate of distrust of bankers and other financial services practitioners that we in Africa do not undervalue the importance of finance in economic growth and development. African countries need to develop systems for financial risk sharing, savings and debt management to enable economic collaboration between individuals across ethnic, national and regional boundaries. A modern financial system enables people with excess funds in one part of the world to invest and share risks with strangers in another of the planet. This could involve all sorts of activities – the building of factories, construction of railways, planting of new species of crops or setting up of novel services.