Pressure group influence on policymaking: The case of the Costa Rican nationalized banking system

The new political economy paradigm is used to answer why financial repression is pervasive in developing countries. Assuming policymaking as endogenous to the political economy system, and that policies are partly a result of the interaction among interest groups in the political arena, the political economy of the Costa Rican nationalized banking system is studied. The creation and competition for rents in the banking system are analyzed in historical perspective, since the nationalization in 1948, until 1989. A model, based on Zusman (1976) and Rausser, Lichtenberg and Lattimore (1982), is built to estimate the weights, in the Central Bank's objective function, for the interest groups participating in the system.; After estimation of a six-equation model of the economic structure, these weights are computed from a solution to a non-linear minimax problem. The evolution of the weights reflects developments in the political and economic systems. In the political arena, increased public sector participation in the economy and loss of independence of the Central Bank from the Executive resulted in growing public sector weights.; Erosion of the monopoly of the state-owned banks in mobilizing deposits altered the system's power structure. Given regulatory avoidance, financial innovations, and the reduction of transaction costs in international financial markets, the ability of borrowers to tax depositors through financial repression diminished. Changes in the international economic environment, such as the debt crisis of the 1980s and liberalization efforts in other countries, increased the predisposition of policymakers towards financial reform. As a result, financial liberalization was attempted during the 1980s, to lure depositors back towards formal finance.; These trends have been overridden by the still large participation of the non-financial public sector in ways that jeopardize the success of the reform. It is important, for a financial reform to be successful, that it be accompanied by the proper institutional setting. The Central Bank must be allowed to be independent with respect to policy matters. This would make it possible to curb excessive public sector demands for credit. The intervention of interest groups in the policymaking process, specially that of the public sector, must be limited.