Unemployment and the Independent European System of Central Banks: prospects and some alternative arrangements

American Journal of Economics and Sociology, The,  July, 1997  by Philip Arestis,  Malcolm Sawyer

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Sixth, the promotion of industrialization of the E.U. periphery is an important ingredient of this proposal. In addition to establishing the EIA, it would require the creation of more localized institutions charged with the objective of producing an economic order to help finance economic growth and development.

Regional banking (and regions would in some cases encompass countries) is most relevant. The argument for regional banking is based on the premise that financial institutions, banking in particular, play a vital role in regional growth and development. Banking sectors in these countries, rather than the stock market or other financial institutions, are the main source of finance for investment. The supply and the average maturity of loans made available for investment are determined by banks' liquidity preference, in addition to demand. Since the countries' financial markets are underdeveloped, banks' liquidity preference is high and thus lending activity is relatively low. In any case, the banking sectors in the E.U. periphery are within the remit of the state, and as such they are used to finance government deficits. Much of any lending to the private sector that may take place is in the form of short-term loans to finance consumption and speculation. The relatively slow pace of banking developments along with slow income growth mean that these monetary sectors do not have a strong base for their operations. As a result they are not in a position to innovate to the same extent as corresponding sectors in the core countries and are thus less equipped to contribute to development. In turn, development is not robust enough to enhance the position of the banking sector. More concretely, peripheral countries in the E.U. are characterized by volatile credit creation, which is absorbed by the center especially in periods of high liquidity preference, since this is satisfied by holding assets issued in the core (Arestis and Paliginis 1993). The financial center acts as a magnet especially for large corporate investors who possess market power and thus better access to credit. As credit creation is increasingly centralized, concentration of production becomes concomitant with financial concentration. This remoteness of financial markets from the business of the periphery discriminates against firms and projects there, with the added implication that the periphery experiences tight financial constraints. An asymmetry in regional credit creation and thus in regional development ensues. Regional banking should be expected to alleviate this problem and also enhance regional growth and development. One envisages, for example, a network of regional public investment banks with close ties with local industry and the EIA. Since they would have knowledge of the credit, collateral, and character of all major borrowers in the regions, they would be in a better position than European-wide institutions to boost the capacity for local industrial initiative.(9)